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LESSON 1

(a) Tax planning, tax management, tax evasion and tax avoidance

(b) Types of companies, residential status of companies and tax incidence

(A) TAX PLANNING, TAX MANAGEMENT, TAX EVASION

AND TAX AVOIDANCE

1. STRUCTURE

1.1 Concept of Planning

1.2 Tax Management

1.3 Objectives of Tax Planning

1.4 Importance of Tax Planning

1.5 Essential of Tax Planning

1.6 Tax Evasion and Tax Avoidance

1.7 Difference Between Tax Planning and Tax Management

1.8 Difference Between Tax Planning and ‘Tax Evasion’

1.9 Difference Between Tax Avoidance and Tax Evasion

1.10 Definition of Company (Section 2(17)

1.11 Types of Companies

1.12 Residence of a Company (Section 6(3)

1.13 Incidence of Tax

1.14 Incomes Received or Deemed to be Received in India (Section 7)

1.15 Income Accruing or Arising in India or Deemed to be Accrued

Tax payment has never been a pleasure for any tax payer. Though tax is defined as a

contribution by the people to the government but it is a levy and an unpleasant burden on

every assessee. Tax is defined as something which taxes your strength, your patience or your

resources it uses nearly all of them so that you have great difficulty in carrying out what you

are trying to do. It is a task which requires lot of mental and physical efforts. One tries to

reduce tax burden by many means because tax is reduction in his disposable income which he

earned from his physical and mental efforts. Therefore every tax payer tries to minimise the

burden of tax by his own means.

1.1 CONCEPT OF TAX PLANNING

Tax Planning is an exercise undertaken to minimise tax liability through the best use

of all available allowances, deductions, exclusions, exemptions, etc., to reduce income.

Tax planning can be defined as an arrangement of one's financial and business affairs

by taking legitimately in full benefit of all deductions, exemptions, allowances and rebates so

that tax liability reduces to minimum. In other words, all arrangements by which the tax is

saved by ways and means which comply with the legal obligations and requirements and are

not colourable devices or tactics to meet the letters of law but the spirit behind these, would

constitute tax planning.

The Hon'ble Supreme Court in McDowell & Co. v. CIT (1985) 154 ITR 148 has

observed that "tax planning may be legitimate provided it is within the framework of the law.

Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain

the belief that it is honourable to avoid payment of tax by resorting to dubious methods." Tax

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planning should not be done with intent to defraud the revenue; though all transactions

entered into by an assessee could be legally correct, yet on the whole these transactions may

be devised to defraud the revenue. All such devices where statute is followed in strict words

but actually spirit behind the statute is marred would be termed as colourable devices and

they do not form part of tax planning. All transactions in respect of tax planning must to be in

accordance with the true spirit of statute and should be correct in form and substance.

Various judicial pronouncements have laid down that substance and form of the

transactions shall be seen in totality to determine the net effect of a particular transaction. The

Hon'ble Supreme Court in the case of CIT v. B M Kharwar (1969) 72 ITR 603 has held that,

"The taxing authority is entitled and is indeed bound to determine the true legal relation

resulting from a transaction. If the parties have chosen to conceal by a device the legal

relation, it is open to the taxing authorities to unravel the device and to determine the true

character of relationship. But the legal effect of a transaction cannot be displaced by a

probing into substance of the transaction."

In brief tax planning may be defined as an arrangement of one's financial affairs in

such a way that without violating in any way the legal provisions of an Act, full advantages

are taken of all exemptions, deductions, rebates and reliefs permitted under the Income Tax-

act, so that the burden of the taxation on an assessee, as far as possible be the least.

Actually the exemptions, deductions, rebates and reliefs have been provided by the

legislature to achieve certain social and economic goals. For example section 80IB of the

Income Tax Act, 1961 provides deduction from gross total income in respect of profits from

newly established industrial undertakings in industrially backward State or industrially

backward district as may be notified in this behalf. The object of the tax concession is clear,

i.e., economic development of industrially backward district or State. Section 80C provides

deduction from gross total income, if an individual or H.U.F. saves the amount and invests or

deposits it in the prescribed schemes. The deduction has been provided to encourage savings

and investments for economic development of the country. Thus, if a person takes .the

advantages of the aforesaid deductions, he not only reduces his tax liability but also helps in

achieving the objective of the legislature, which is lawful, social and ethical. Thus, tax

planning is an act within the four corners of the Act and it is not a colourable device to avoid

the tax liability.

1.2 TAX MANAGEMENT

Tax planning is a broader term which requires management of affairs in such a way

that results in the reduction in minimisation of tax liability. Tax planning is not possible

without tax management. It refers to the compliance of statutory provisions of law. Some

important areas of tax management are as stated below.

(i) Deduction of tax at source u/s 194 to 196

(ii) Payment of tax and self assessment u/s 140A

(iii) Payment of tax an demand u/s 220

(iv) Maintenance of accounts u/s 44AA

(v) Audit of accounts u/s 44AB

(vi) Payment of cess, duty or fees, bonus and commission to employees etc v/s 43B

(vii) Furnishing return of income u/s 139

(viii) Documentation and maintenance of tax files etc.

(ix) Review of order received from tax Authorities.

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1.3 OBJECTIVES OF TAX PLANNING

The objective of tax planning is to minimise tax liability and to avail maximum

benefits of the taxation laws within their framework. The objectives of tax planning cannot be

regarded as offending any concept of the taxation laws and subjected to reprehension of

reducing the inflow of revenue to the Government coffers, so long as the tax planning

measures are in conformity with the statute laws and the judicial expositions thereof. The

Basic objectives of tax planning are:

(a) Reduction of tax liability

(b) Minimisation of litigation

(c) Productive investment

(d) Reduction in cost

(e) Healthy growth of economy

(f) Employment generation

(a) Reduction in tax liability: The basic objective of tax planning is to reduce the tax

liability so that enough surplus out of profits remains with the earner of it for his personal and

social needs and also for future investments in his business. This is only possible by planning

his tax affairs properly and availing the deductions, exemptions and reliefs, etc. which are

admissible under the Acts. He can succeed in doing so by updating his knowledge about the

various concessions available in the taxation laws and the conditions to be fulfilled to avail

them.

(b) Minimisation of litigation: There is always a tug-of-war between the tax payers

and the tax administrators. The tax payers try their best to pay the least tax and the tax

administrators attempt to extract the maximum. This sometimes results in prolonged

litigation. Actually the main reason of litigation lies in tax avoidance and not in tax planning.

Whenever a tax payer wants to reduce his tax liability by finding a loophole in the Act and

title tax administrator does not agree with the interpretation of the assessee under which he is

demanding exemption, deduction or relief, it results in litigation. A good tax planning is

always based on clear words of the statute or in conformity with the provisions of the taxation

laws. In such a case the chances of litigation are minimised.

(c) Productive investment: A proper tax planning brings fiscal discipline in the

functioning of a tax payer and reduces the transfer of money, from the person who has earned

it by hard labour, to the Government for waste and misuse. The amount so saved enhances

the capacity of the tax payer for expansion and growth, which in turn increases the tax

revenue of the Government.

(d) Reduction in cost: Incidence of tax (direct and indirect) forms a part of cost of

production. The reduction of tax by tax planning reduces the overall cost. It results in more

sale, more profit and more tax revenue and more investment.

(e) Healthy growth of economy: The growth of a nation's economy depends upon

the growth of its peoples. Savings through tax planning devices foster the growth of economy

while savings through tax evasion lead to generation of black money, the evils of which are

obvious. The tax planning plays an important role in the development of backward districts

and backward states and development of infrastructure facilities or in other words it takes the

economy in the intended direction.

(f) Employment generation: The amount saved by tax planning is generally invested

in commencement of new undertakings or expansion of the business. This creates new

employment opportunities in the society. Further, taxation laws are so complicated that by

and large tax payers cannot plan their affairs efficiently. Hence, such persons need services of

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chartered accountants, financial advisers and lawyers. Such persons join the business

concerns either as employees or provide their services as tax experts.

1.4 IMPORTANCE OF TAX PLANNING

Though the basic objective of the planning is to minimise the tax liability of tax payer

yet following are the some considerations which are important for tax planning-

(i) When an assessee has not claimed all the deductions and relief, before the

assessment is completed, he is not allowed to claim them at the time of appeal. It

was held in CIT u/s Gurjargravures Ltd. (1972) 84 ITR 723 that if there is no tax

planning and there are lapses on the part of the assessee, the benefit would be the

least.

(ii) Tax planning exercise is more reliable since the Companies Act, and other allied

laws narrow down the scope for tax evasion and tax avoidance techniques, driving

a taxpayer to a situation where he will be subjected to severe penal consequences.

(iii) Presently, companies are supposed to promote those activities and programmes,

which are of public interest and good for a civilised society. In order to encourage

these, the Government has provided them with incentives in the tax laws. Hence a

planner has to be well versed with the laws concerning incentives.

(iv) With increase in profits, the amount of corporate tax also increases and it

necessitates the devotion of adequate time on tax planning to minimise' tax

burden.

(v) Tax planning enables a company to bear the burden of both direct and indirect

taxation during inflation. It enables companies to make proper expense planning,

capital budgeting, sales promotion planning etc.

(vi) Repairs, renewals, modernisation and replacement of plant and machinery are

indispensable for an industry for its continuous growth. The need for capital

formation in the corporate sector cannot be ignored and heavy taxation reduces the

inflow of corporate funds. Capital formation helps in replacing the technologically

obsolete and outdated plant and machinery and enables carrying on of

manufacturing operation with a new and more sophisticated system. Any decision

of this kind would involve huge capital expenditure which is financed generally

by ploughing back the profits, utilisation of reserves and surplus along with the

availing of deductions. Availability of accumulated profits, reserves and surpluses

and claiming such expenses as revenue expenditure are possible through proper

implementation of tax planning techniques.

(vii) In current days of credit squeeze and dear money conditions, even a rupee of tax

decently saved may be taken as an interest-free loan from the Government, which

perhaps, an assessee need not repay. It is rightly said that money saved is money

earned.

Thus, any legitimate step taken by an assessee directed towards maximising tax benefits,

keeping in view the intention of law, will not only help it but also the society since it

promotes the spirit behind the legal provisions. All those assessees which practice tax

planning may have the satisfaction that they are contributing their best to the nation's broad

objectives and goals in a welfare State like ours. At the same time, the law makes the

fulfillment of certain conditions obligatory before allowing the benefits to be claimed by the

assessees. In this way, the assessees, besides helping themselves, also help in securing the

objectives, tasks and goals set before them by the country.

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1.5 ESSENTIALS OF TAX PLANNING

Successful tax planning techniques should have following attributes:

(a) It should be based on uptodate knowledge of tax laws. Not only is an uptodate

knowledge of the statute law necessary, assessee must also be aware of judgments

made various by the courts. In addition, one must keep track of the circulars,

notifications, clarifications and Administrative instructions issued by the CBDT from

time to time.

(b) The disclosure of all material information and furnishing the same to the income-tax

department is an absolute pre-requisite of tax planning as concealment in any form

would attract the penalty clauses - the penalty often ranging from 100 to 300% of the

amount of tax sought to be evaded.

(c) Whatever is planned should not simply satisfy the requirements of law by complying

with legal provisions as stated and meeting the tax obligations but also should be

within the framework of law. It means that sham transactions or make-believe

transactions or colourable devices, which are entered into just with a view to misuse

the legal provisions, must be avoided.

Every citizen is obliged to honestly pay the taxes. Therefore, only colourable devices

resorted to by the tax payers for evading a tax liability will have to be ignored by the

court. Accordingly, a tax planning within the four corners of the taxation laws is not

to be turned down only because it legitimately reduces the tax inflow to the

Government. A genuine tax-planning device, aimed at carrying out the rules of law

and courts' decisions and to overcome heavy burden of taxation, if fully valid and

ethical.

(d) A planning model must be capable of attainment of the desired objectives of a

business and be suitable to its possible future changes. Therefore, all the important

areas of corporate planning, whether related to strategic planning, project planning or

operational planning involving tax considerations for long-term or short-term

management objectives and policies should be strictly scrutinised in relative

situations. Foresight is the essence of a business. Tax planning is one of its important

attributes.

1.6 TAX EVASION AND TAX AVOIDANCE

In the context of not paying tax, there are generally two methods which are used by

the assesses. They are (1) Tax Evasion (2) Tax Avoidance.

(1) Tax Evasion: It refers to a situation where a person tries to reduce his tax liability by

deliberately suppressing the income or by inflating the expenditure showing the

income lower than the actual income and resorting to various types of deliberate

manipulations. An assessee guilty of tax evasion is punishable under the relevant

laws. Tax evasion may involve stating an untrue statement knowingly, submitting

misleading documents, suppression of facts, not maintaining proper books of accounts

of income earned (if required under the law) omission of material facts in assessments

etc. An assessee who dishonestly claims the benefit under the statute by making false

statements, would be guilty of tax evasion.

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Thus when a person reduces his total income by making false claims or by withholding the

information regarding his real income, so that his tax liability is reduced, is known as tax

evasion. Tax evasion is not only illegal but it is also immoral, anti-social and anti-national

practice. Therefore, under the direct tax laws, provisions have been made for imposition of

heavy penalty and procedure of prosecution proceedings against tax evaders.

A tax evader reduces his taxable income by one or more of the following steps :

(a) Unrecorded sales.

(b) Claiming bogus expenses, bad debts and losses etc.

(c) Charging personal expenses as business expenses, e.g., car expenses, telephone

expenses, travelling expenses, medical expenses incurred for self or family may be

shown in the account books as business expenses.

(d) Submission of bogus receipts for charitable donations for claiming deduction u/s 80G.

(e) Non-disclosure of capital gains on sale of asset.

(f) Non-disclosure of income from 'Benami transactions'.

(2) Tax Avoidance: The line of demarcation between tax planning and tax avoidance is

very thin and blurred. There could be elements of malafide motive involved in tax

avoidance also. Any planning which, though done strictly according to legal

requirements defeats the basic intention of the Legislature behind the statute could be

termed as instance of tax avoidance. It is usually done by adjusting the affairs in such

a manner that there is no infringement of taxation laws and by taking full advantage

of the loopholes therein so as to attract the least incidence of tax. Earlier tax

avoidance was considered completely legitimate, but at present it may be illegitimate

in certain situations only. In the latest judgement of the Supreme Court in McDowell's

case 1985 (154 ITR 148) SC, tax avoidance has been considered as heinous as tax

evasion and a crime against society. Most of the amendments are now aimed at

plugging loopholes and curbing practice of tax avoidance.

Per Jagadisan J. [in Aruna Group of Estates vs. State of Madras (1965) 55 ITR 642

(Mad.)], observed "Avoidance of tax is not tax evasion and it carries no ignominy

with it, for it is a sound law and; certainly, not bad morality, for anybody to so arrange

his affairs as to reduce the burnt of taxation to a minimum."

However, now the Supreme Court is of the view that the colourable devices to avoid

tax should not be encouraged and this is the duty of the court to expose the persons

who avoid tax and refuse to approve such practice because the social evils of tax

avoidance are manifold, which may be summarised as below:

(a) substantial loss of much needed public revenue, particularly in a welfare state like

India;

(b) serious disturbance caused to the economy of the country by piling up of mountains of

black money directly causing inflation;

(c) large hidden loss to the community by some of the best brains in the country being

involved in the perpetual war waged between tax avoider and his expert team of

advisers, lawyers and accountants on one side, and Tax Officer and perhaps hot so

skilful advisers on the other side;

(d) sense of injustice and inequality of those who are unwilling or unable to profit by it;

(e) Tactics of transferring the burden of tax liability to the shoulders of the guideless,

good citizens from those of artful dodgers.

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One may not agree with the issue of generating black money by avoidance of tax. In

legal tax avoidance the money neither goes out of books nor it is spent unnecessarily but it is

used for further expansion of business.

In CWT vs. Arvind Norottam [(1988) 173 ITR 479] the Supreme Court has observed,

"It is true that tax avoidance in an undeveloped country should not be encouraged on practical

as well as ideological grounds.

Recently the legislature has inserted the provisions in direct and indirect tax laws for

checking tax avoidance. But so long there are loopholes in the laws, tax avoidance cannot be

checked by the courts. The function of judiciary in India is clearly not legislative, its role lies

in interpreting the law made by the legislature.

1.7 DIFFERENCE BETWEEN TAX PLANNING' AND TAX MANAGEMENT'

Tax planning primarily aims at adopting an arrangement so as to bring about the least

incidence of tax under the four corners of law. On the other hand, tax management comprises

a wider field like compliance with the statutory provisions of law, prospective planning so as

to ease the financial constraints if any, that would arise when discharging the commitments

through payment of tax, keeping close watch and monitoring the statutory requirements of

other laws, claiming the due reliefs arising on account of double taxation avoidance

agreements or claiming unilateral relief, etc. Thus, while tax planning is the pivot which

enables the drawing up of the different incentives and keep the incidence of tax law, the tax

management is the revolving wheel, which translates the policy in terms of results. The

difference between tax planning and tax management are stated as under:

1. Tax planning is a wider-term. It includes tax management. Tax management is the

first step towards tax planning.

2. The primary aim of tax planning is minimising incidence of tax, whereas main aim of

tax management is compliance with legal formalities.

3. Tax planning is not essential for every assessee, while tax management is essential for

every person, otherwise he may be liable for penal interest, penalty and prosecution.

For example, a person may not be reducing his tax liability by claiming any

exemption, deduction, relief, etc. in computing his total income but if he is liable to

pay advance tax or responsible for deduction of tax at source, etc. he has to comply

with all legal formalities.

4. Tax planning is a guide in decision making while tax management -is a regular feature

of an undertaking.

5. In tax planning exemptions, deductions and reliefs are claimed while in tax

management the conditions are complied with to claim the exemptions, deductions

and reliefs.

6. In tax planning alternative economic activities are studied and an activity with least

incidence of tax is selected whereas tax management includes maintenance of

accounts in prescribed form, getting books audited, filing the required forms and

returns, payment of taxes, etc.

7. Tax planning essentially looks at future benefits arising out of present actions. Tax

management relates to past, present and future. In respect of appeals, revision,

rectification of mistakes, etc. it deals with the past. Maintenance of records, self-

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assessment, filing the return and other _ documents, keeping pace with the changes,

etc. are present activities. Follow-up plans, etc. are in future.

1.8 DIFFERENCE BETWEEN TAX PLANNING AND 'TAX EVASION'

1. Tax planning is an act within the four corners of the Act to achieve certain social

and economic objectives and it is not a colourable device to avoid the tax. Tax evasion is a

deliberate attempt on the part of tax-payer by misrepresentation of facts, falsification of

accounts including downright fraud.

2. Tax planning is a legal right and a social responsibility. By tax planning certain

social and economic objectives are achieved. Tax evasion is a legal offence coupled with

penalty and prosecution.

3. Tax planning requires thorough knowledge of the relevant Acts, social, economic

and political situation of the country while tax evasion requires misadventure to infringe the

law.

4. Tax planning helps in economic development of the country by providing

additional funds for investment in desired channels while tax evasion generates black money

which is generally utilised for smuggling, bribery, extravagant expenses on luxury and

unlawful activities.

5. A tax planner enjoys its fruits freely and he does not suffer from high blood

pressure, whereas a tax evader remains always in anxiety of search and seizure and suffers

from many abnormalities.

As our society has become 'money society', whatever the evils of black money may

be, it has become a part of the life of most of the people and in near future there is no hope of

Putting a check on it. There is depth of honest tax payers.

1.9 DIFFERENCE BETWEEN 'TAX AVOIDANCE' AND 'TAX EVASION'

1. Tax avoidance is legal but tax" evasion is illegal.

2. In case of tax avoidance the objects and spirit of the law are not followed while in

the case of tax evasion the provisions of the law are flouted.

3. In case of tax avoidance no penalty can be imposed while in case of tax evasion the

person is liable to penalty and prosecution.

4. In case of tax avoidance, black money is not generated, hence, it is not very

harmful to the society. In case of tax evasion, black money is generated which is mostly used

for unproductive illegal and immoral purposes.

(B) TYPES OF COMPANIES, RESIDENTIAL STATUS OF COMPANIES

AND TAX INCIDENCE

1.10 DEFINITION OF COMPANY (SEC. 2(17)

A company means:

(i) any Indian company, or

(ii) any body corporate incorporated by or under the law of a country outside India, or

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(iii) any institution, association or body which is or was assessable or was assessed as

a company for any assessment year under the Income Tax Act, 1922, or which is or was

assessable or was assessed under the Income Tax Act, 1961 as a company for any assessment

year upto 1970-71, or

(iv) any institution, association or body, whether incorporated or not and whether

Indian or non-Indian, which is declared by general or special order of the Board to be a

company provided that it will be deemed to be a. company only for the assessment years

specified in the order.

The definition of company under the Income Tax Act is much wider than the Indian

Companies Act. The Income Tax Act has empowered the Central Board of Direct Taxes to

declare any association, institution, or body to be a company for income tax purposes.

Accordingly, on a few occasions Chamber of Commerce, Club, etc., have been declared by

the Board to be a company even though these bodies do not possess the ordinary

characteristics a company.

1.11 TYPES OF COMPANIES

Under the Income Tax Act companies are classified as under:

(1) Indian Company [Sec. 2(26)]

It means a company formed and registered under the Indian Companies Act, and

includes :

(i) a company formed and registered under any law relating to companies formerly in

force in any part of India other than the State of Jammu and Kashmir and the places specified

in (v);

(ii) a corporation established by or under a Central, State or Provincial Act;

(iii) any institution, association or body which is declared by the Board to be a

company;

(iv) in the case of the State of Jammu and Kashmir, a company formed and registered

under any law for the time being in force in that state;

(v) in the case of Dadra and Nagar Haveli, Goa, Daman and Diu and Pondicherry, a

company formed and registered under any law for the time being in force in these place

places.

(2) Domestic Company

It means an Indian company, or any other company which in respect of its income

liable to tax under the Income Tax Act, has made the prescribed arrangements for the

declaration and payment within India, of the dividends (including dividends on preference

shares) payable out of such income.

In other words:

(i) All Indian companies are domestic companies. or

(ii) A foreign company which has made the prescribed arrangements for the

declaration and payment of dividends (out of taxable income in India) within India is also a

domestic company.

(3) A company in which the public are substantially interested: (section 2(18) :

As per section 2(18) such companies include:

(i) A company owned by Government or Reserve Bank of India. or

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(ii) A company having Govt. participation i.e. A company in which not less than 40%

of its shares are held by Government or the RBI or a corporation owned by the RBI. Or

(iii) Companies registered under section 25 of the Indian Companies Act, 1956:

Companies registered under section 25 of the Companies Act, 1956 are companies which are

promoted with special object such as to promote commerce, art, science, charity or religion or

any other useful object and these companies do not have profit motive. However, if at any

time these companies declare dividend they would loose the status of a company in which the

public are substantially interested. Or

(iv) A company declared by the CBDT i.e. a company without share capital and

which having regard to its object, nature and composition of its membership or other relevant

consideration is declared by the Board to be a company in which public are substantially

interested. Or

(v) A Mutual benefit finance company, where principal business of the company is

acceptance of deposits from its members and which has been declared by the Central

Government to be a Nidhi or a Mutual Benefit Society. Or

(vi) A company having co-operative society participation i.e. a company in which at

least 50% or more equity shares have been held by one or more co-operative societies.

(vii) A public limited company i.e. company is deemed to be a public limited

company if it is not a private company as defined by the Companies Act,1956 and is fulfilling

either of the following two conditions:

(a) Its equity shares were listed on a recognised stock exchange, as on the last day of

the relevant previous year; or

(b) Its equity shares carrying at least 50% of the voting power (in the case of an

industrial company the limit is 40%) were beneficially held throughout the relevant previous

year by Government, a Statutory Corporation, a Company in which the public is substantially

interested or a wholly owned subsidiary of such a company.

(4) Widely held company

It is a company in which the public are substantially interested.

(5) Closely held company

It is a company in which the public are not substantially interested.

Burden of proof: The onus is on the department to establish that the public are not

substantially interested in a company. [Jayantilal Amritlal Ltd. v CIT (1965) 55 ITR (SC)] In

other words, the onus is on the department to establish that the company was a closely-held

company. On the other hand, the Bombay High Court had earlier held that the burden of

proving that a company is one in which the public are substantially interested is on the

company. [P.M. Hutheesingh & Sons Ltd. v CIT (1946) 14 ITR 653 (Bom)].

(6) Foreign Company [Section 2(23A)]

Foreign company means a company which is not a domestic company.

(7) Investment Company

Investment company means a company whose gross total income consists mainly of

income which is chargeable under the heads Income from house property, Capital gains and

Income from other sources.

1.12 RESIDENCE OF A COMPANY [SECTION 6(3)]

A company is said to be a resident in India during the relevant previous year if: (a) it

is an Indian Company, or (b) if it is not an Indian company then, the control and the

management of its affairs is situated wholly in India on the other hand.

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A company is said to be non-resident in India if it is not an Indian company and the

control and management of its affain; is situated outside India fully or partially

Note :

As a rule, the direction, management and control, the head, seat and directing power

of a company's affairs is situated at the place where the directors meetings are held.

Consequently a company would be resident in the country if the meetings of directors

who manage and control the business are held there. It is not what the directors have

power to do, but what they actually do, that is important in determining the question

of the place where the control is exercised. (Egyptian Hotels Ltd. v. Mitchell 6 T.C.

542). In this case Lord Sumner observed.

Where the directors forbore to exercise their powers, the bare possession of those powers was

not equivalent to taking part in or controlling the trading. Control means de facto control and

not merely de jure control. The control and management of a company's affairs is not situated

at the place where the shareholders meetings are held, even if one shareholder, by reason of

his holding an absolute majority of shares, has a decisive voice in matters relating to the

company's affairs.

1.13 INCIDENCE OF TAX

The residence of a company is important to determine total income and tax liability.

As per section 5 of the Income Tax Act 1961, following are the scope of total income of a

company on the basis of residence.

I. Resident. The total income of any previous year of a person who is a "Resident'

includes all income from whatever source derived which :

(a) is received or is deemed to be received in India in such year by or on behalf of

such person; or

(b) accrues or arises or is deemed to accrue or arise to him in India during such year;

or

(c) accrues or arises to him outside India during such year.

It is important to note that under clause (c) only income accruing or arising outside

India, is included. Income deemed to accrue or arise outside India is not includible. Hence,

net dividends received from foreign companies is includible in income and not the gross

dividends. [CIT v Shaw Wallace & Co. Ltd, (1981) 132 ITR 466 (Cal.)]

II. Non-Resident. The total income of any previous year of a person who is a *Non-

Resident' includes all income from whatever source derived which:

(a) is received or deemed to be received in India in such year by or

(b) accrues or arises or is deemed to accrue or arise to him in India during such year.

Note: (i) Income accruing or arising outside India shall not be deemed to be received

in India within the meaning of section 5 by reason only of the fact that it is taken into account

in a balance sheet prepared in India.

(ii) Income which has been included in the total income of a person on basis that if

has accrued or arisen or deemed to have accrued or arisen to him shall not again be so

included on the basis that it is received or deemed to be received by him in India.

12

1.14 INCOMES RECEIVED OR DEEMED TO BE RECEIVED IN INDIA

[SECTION 7]

(1) Received in India: Any income which is received in India, during the previous

year by any assessee, is liable to tax in India, irrespective of-the residential status of the

assessee and the place of accrual of such income. Receipts means the first receipt i.e. the

receipt of income refers to the first occasion when the recipient gets the money under his own

control. Once an amount is received as income, any remittance or transmission of the amount

to another place does not result in receipt within the meaning of this clause at the other place.

This principle is of importance because firstly, in determining the year of receipt, and

secondly, for ascertaining the incidence of taxation where it depends purely upon receipt of

income. For example, in the case of non-residents, their foreign income is not assessable,

unless it is actually received in India. In their case, unless, at the time the money is received

in India, it is received as income from an outside source, such receipt will not be an income

receipt. If a non-resident had already received amount outside India (in an earlier year or

during the previous year) as income or exempt income and he was transferring the funds into

India in the previous year, such amount will not count as income in the eyes of law.

(2) Income deemed to be received in India [Section 7]: The following incomes

shall be deemed to be received in India in the previous year even in the absence of actual

receipt:-

(i) Contribution made by the employer to the recognized provident fund in excess of

12% of the salary of an employee;

(ii) Interest credited to the Recognised Provident fund of an employee which is in

excess of 9.5% p.a.

(iii) Transferred balance from the unrecognized fund to a Recognised Provident Fund.

(iv) The contribution made, by the Central Government or any other employer in the

previous year, to the account of an employee under a notified contributory pension scheme as

referred to in section 80CCD.

1.15 INCOME ACCRUING OR ARISING IN INDIA OR DEEMEND TO BE

ACCRUED

(i) Income Accruing or Arising in India (Sec. 9) Income-tax is attracted not only or

receipt but also on accrual basis. Accrual of income means a stage where the assessee has

acquired a right to receive the income. If a person has not received an income but acquired a

right to receive such income, the income is said to have accrued to him:

The words 'accrue' and 'arise' may seem to carry the same meaning but this is not so.

Income accrues when the right to receive it comes into existence whereas it is said to arise

when it is actually treated as such in the accounts. For example, when the accounts are kept

on cash basis, some incomes may accrue in one previous year but arise in the next previous

year when they " are actually shown as such in the book of accounts.

(ii) Income Deemed to be accrued or Arisen in India [Sec. 9]: Some incomes shall

be deemed to accrue or arise in India even if such incomes, in reality, have not accrued or

arisen in India. They are as follows as per section 9:

1. All incomes accruing or arising, whether directly or indirectly, through or from:

(i) any business connection in India,

(ii) any property in India,

(iii) any asset or source of income in India, and

(iv) any transfer of a capital asset situated in India.

13

Explanation:

(i) In the case of a business of which all the operations are not carried out in India,

the income of the business deemed to accrue or arise in India shall be only such

part of the income as is reasonably attributable to the operations carried out in

India.

(ii) In the case of non-resident, no income shall be deemed to accrue or arise in

India to him through or from operations which are confined to the purchase of

goods in India for the purposes of export,

(iii) No income will be deemed to accrue or arise in India to a non-resident engaged

in the business of running a news agency or of publishing newspapers,

magazines or journals from activities confined to collection of news or views in

India for transmission outside India.

(iv) No income will be deemed to accrue or arise in India to a non-resident through

or from operations which are confined to the shooting of any cinematograph

film in India, if such non-resident is either an individual, who is not a citizen of

India, or a firm which does not have any partner who is a citizen of India or who

is resident in India, or a Company which does not have any shareholder who is a

citizen of India or is a resident in India.

2 Any salary payable for services rendered in India and the salary for the rest period

or leave period which is preceded and succeeded by services rendered in India will be

regarded as income earned in India.

3. Salary payable by the Government to a citizen of India for the service rendered

outside India.

4. Dividend paid by an Indian company outside India.

5. Income from interest, royalty or technical fee is deemed to accrue or arise in India

if:

(a) it is received by a non-resident;

(b) it is payable by:

(i) the government,

(ii) resident in India who utilises it in India for business or profession,

(iii) non-resident in India who utilises it for business or profession carried on by

him in India.

However, so much of the income by way of royalty as consists of lump-sum

consideration for the transfer outside India of, or the imparting of information outside India in

respect of any data, documentation, drawing or specification relating to any patent, invention,

model, design, secret formula or process or trademark or similar property shall not be deemed

to accrue or arise in India if such income is payable in pursuance of an agreement made

before 1.4.76 and the agreement is approved by the Central Government.

Further, so much of the income by way of royalty as consists of lump-sum payment

made by a resident for the transfer of all or any rights (including granting of a licence) in

respect of Computer software supplied by a nonresident manufacturer along with computer or

computer based equipment under any scheme approved under the Policy on Computer

Software Export, Software Development and Training, 1986 of the Government of India,

shall not be deemed to accrue or arise in India.

Meaning of Business Connection in India

Business connections may be in several forms e.g. a branch office in India or an agent

or an organization of a nonresident in India. Formation of a subsidiary company in India to

14

carry on the business of the non-resident parent company would also be a business

connection in India. Any profit of the non-resident which can be reasonably attributable to

such part of operations carried out in India through business connections in India are deemed

to be earned in India.

In the case of a Non-Resident the following shall not, however, be treated as business

connection in India:

(i) Operations confined to purchase of goods in India for purpose of exports;

(ii) Operations confined to collection of news and views for transmission outside

India by or on behalf of Non-Resident who is engaged in the business of running news

agency or of publishing newspapers, magazines or journals;

(iii) Operations confined to shooting of cinematograph films in India if such Non-

Resident is:

(a) In the case of an individual, he should not be a citizen of India; or

(b) In the case of a firm, the firm should not have any partner who is a citizen of India

or who is resident in India; or

(c) In the case of company, the company does not have any shareholder who is a

citizen of India or who is resident in India.

Example : Samsung, a South Korean Company, a non-resident under the Income-tax

Act, 1961, had the following receipts of royalty in 2015-16. Indicate whether they will be

taxable in India. Give reasons for your answer.

a. Rs. 50,000 from the Government of India under an agreement approved by the

Governments of South Korea and India;

b. Rs. 1,00,000 from Calcutta Co. Ltd., a resident Indian Company, for import of

technical know-how for use in a business in India;

c. Rs. 75,000 from Bombay Co., a resident Indian organisation, for import of

drawings for use in its business in Singapore and Malaysia;

d. Rs. 50,000 from Keshava, a non-resident under Indian tax law for use of a

formula for a business in India; and

e. Rs. 40,000 from Rajesh, an. Indian non-resident, for use of drawings and

technical know-howfor a business in the U.K.

Solution: Under Section 5, a non-resident is taxable in India on (a) income received

or deemed to be received in India. (b) Income accruing orarising or deemed to accrueorarise

in India and in this background, the assessability of the receipts by the South Korean

Company is as under

a. Any payment of royalty to a non-resident by the Government is deemed to accrue

in India. Hence Rs. 50,000 is taxable in India.

b. Payment of royalty to a non-resident by a resident for use of technical know-how

in India is taxable in India on an accrual basis. Hence Rs. 1,00,000 is taxable in

India.

c. Rs. 75,000 is not taxable in India since the payment was for the user of asset

outside India exempt.

d. Rs. 50,000 is taxable in India since the formula is used in India to earn an

income.

e. The payment of Rs. 40,000 made by Rajesh, an Indian non-resident to the non-

resident company is not taxable in India since the user of asset was for a business

outside India.

15

Questions

1. "Tax planning is a legal and moral way of tax saving" Discuss the statement and

describe it importance.

2. Explain with example tax evasion and tax avoidance.

3. Distinguish between tax planning and tax management. What are objectives of tax

planning.

4. A foreign company has on Indian subsidiary company. Indian company exports its

production to its associated company at a price of Rs. 100 per unit while the same

product is sold to another foreign custome at Rs. 150 per unit Discuss the purpose of

differential pricing by Indian company.

5. State with reason whether following transaction are an act of (i) Tax evasion (ii) Tax

avoidence (iii) Tax management.

(a) A ltd. maintains a regester for tax deducted at source for timely compliance

(b) Rakesh deposite Rs. 7000/- in P.P.F. account to avail deduction v/s 80C

(c) R. Ltd. purchases an expensive car for the use of the son of a director which is shown

as business assets.

(d) A transfer some debenture to his friend without any consideration to save tax on

interest an debentures.

(e) X Ltd. deducts at source tax from the payments but does not deposit the same in the

government treasury.

6. Ritu Ltd., a German company, which is non-resident in India-earned the following

incomes by way of fee for technical services. Advise about the taxability of such

income in the hands of Ritu Ltd. in India:

(a) Government of India paid Rs. 20,00,000 under an agreement, to be used for a

project in India.

(b) S Ltd., an Indian company, paid Rs. 30,00,000 for the know-how to be used in

India.

(c) Y Ltd. an Indian company, paid Rs. 40,00,000 for know-how acquired in

Germany to be used in China.

(d) Z Ltd. a non-resident company paid Rs. 24,00,000 for acquiring a know-how to

be used in India for carrying on certain manufacturing business.

Ans.: (a) Taxable, (b) Taxable, (c) Not taxable (d) Taxable.

7. State with reason south what will be residential status of following company for the

assessment year 2016-17.

Dalmia Company is an Indian company carrying on business in India as well as in South

Africa. The control and management of its affairs was wholly situated in India during the

year ended 31st March, 2015. Its income accruing or arising in South Africa in that year far

exceeded its incomes accruing or arising in India.

Ans. Dalmia Company is an Indian Company therefore it is a resident company. It is

immaterial whether its foreign income exceeded the Indian income or otherwise.

16

8. Define the following keeping in view the points involved while planning tax:

(a) Indian Company

(b) Domestic Company

(c) Foreign Company

(d) Company in which public is substantially interested.

(e) Closely-held Company.

9. Discuss the concept of income deemed to accrue or arise in India as per section 9 of

the Income Tax Act.

10. 25% of Shares capital of a public company are held by the life insurance Corporation

of India and remain 75% by the public. Its share are not listed in any recognised stock

exchange. State whether the company is one in which public are substantially

interested. Give you answer with reasons.

11. When a company in said to be non-resident company. Discuss the tax liability of a non

resident company.

12. Distinguish between income received and income deemed to receive in India. Give

suitable examples of income deemed to be received in India.

17

LESSON 2

Corporate Tax In India

2. STRUCTURE

2.1 Computation of Gross Total Income of a Company

2.2 Deductions Available to Corporate Assessees

2.1 COMPUTATION OF GROSS TOTAL INCOME OF A COMPANY

Following steps should be followed to compute the gross total income of a company:

(a) A certain net income of the company under different heads i.e. income from

House property, profit and gains of business or profession, capital gains and

income from other sources

(b) Add income of other persons includible under section 60

(c) Adjust current and brought forward losses as for section 70 to 80

The total income so computed is known as gross total income of the company.

2.2 DEDUCTIONS AVAILABLE TO CORPORATE ASSESSEES:

Before discussing deductions available under section 80 to corporate assessees, let us

understand see about the general rules for deductions.

General Principles For Deductions From Incomes Under Section 80a

1. From gross total income deductions shall be allowed under sections 80C to 80U.

2. The aggregate amount of deductions under sections 80C to 80U shall not exceed the

gross total income.

Note:- Deductions are not allowed against short-term capital gains specified in Sec.

111A and long-term capital gains.

3. If an association of persons or a body of individuals is entitled to any of the

deductions referred to in sections 80G, 80GGA, 80GGC, 80IA, 80IB, 80IC, 80ID and

80IE a member of the association is not again entitled to claim the same deduction in

his own assessment in respect of his share in the income of the association. This is to

prevent duplication of deductions.

4. Where deductions under sections 10AA or 80IA to 80RRB have been claimed and

allowed against the income specified in these sections for any assessment 'year, the

deduction in .respect of such profits and gains shall not be allowed under any other

provisions of the Act.

5. Where the assessee fails to make a claim in his return of income for any deduction in

sections mentioned above, no deduction shall be allowed to him thereafter.

Deductions under section 80: Following are the important deductions available to corporate

assessees under section 80

1. 80G Donations to certain funds / charitable institution, etc.

2. 80GGA Certain donations for scientific research or rural development.

3. 80GGB Contributions given by companies to political parties.

4. 80-IA Profits and gains of new industrial undertakings or enterprises

engaged in infrastructural development, etc.

5. 80-IAB Deductions in respects of profits and gains by an undertaking or

enterprises engaged in development of Special Economic Zone.

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6. 80-IB Profits gains from certain industrial undertakings other than

infrastructure development undertakings.

7. 80-IC Deduction in respect of certain undertakings or enterprises in certain

special category States.

8. 80-ID Deduction in respect of profits and gains from business of hotels and

convention centres in specified area

9. 80-IE Special provision in respect of certain undertakings in North-Eastern

States

10. 80JJA Deduction in respect of profits and gains from business of collecting

and processing of bio-degradable waste

11. 80JJAA Deduction in respect of employment of new work men

12. 80-LA Deductions in respect of certain incomes of Offshore Banking Units

and International Financial Services Centre

1. Deduction in respect of donations to certain Funds, Charitable Institution, etc. (Sec.

80G): This section allows deduction in respect of amounts given as charitable donations and

it is allowed to all types of assessees. Where amount of donation exceeds Rs. 10,000, it

should be paid by any mode other than cash.

The donations can be classified as under:

(A) No limit donations, i.e., the whole amount qualify for deduction.

Such donations can further be classified as :

(i) deduction allowed @ 100% of qualifying amount; and

(ii) deduction allowed® 50% of qualifying amount.

(B) With limit of donations, i.e., the qualifying amount for deduction under this section

shall not exceed 10% of gross total income after deducting the following :

(a) Exempted income included in gross total income;

(b) Short-term capital gains specified in section 111A;

(c) Long-term capital gains;

(d) Incomes assessable under sections 115A, 115AB, 115AC and 115AD;

(e) Deductions under sections 80C to 80U except u/s 80G.

Such donations are also further be classified as :

(i) deduction allowed @ 100% of qualifying amount;

(ii) deduction allowed @ 50% of qualifying amount.

[A(i)] No limit donations where deduction is allowed @ 100% are as under :

(1) the National Defence Fund set-up by the Central Government; or

(2) the Prime Minister's National Relief Fund; or

(3) the Prime Minister's Armenia Earthquake Relief Fund; or

(4) the Africa (Public Contributions—India) Fund; or

(5) the National Foundation for Communal Harmony; or

(6) a University or Educational Institution of national eminence as may be approved by

the prescribed authority in this behalf; or

(7) the Maharashtra Chief Minister's Relief Fund or Chief Minister's Earthquake Relief

Fund, Maharashtra; or

(8) Zila Saksharta Samitis constituted under the Chairmanship of District Collector for

the purpose of improvement of primary education and for literary and post-literary

19

efforts in villages and towns with population not exceeding one lakh according to the

latest census; or

(9) the National Blood Transfusion Council or any State Blood Transfusion Council; or

(10) any Fund set-up by State Govt. to provide medical relief to the poor; or

(11) the Central Welfare Fund of the Army and Air Force and the Indian Naval Benevolent

Fund established for the welfare of the past and present members of such forces or

their dependents; or

(12) the Andhra Pradesh Chief Minister's Cyclone Relief Fund; or

(13) the National Illness Assistance Fund; or

(14) the Chief Minister's Relief Fund or the Lt. Governor's Relief Fund; or

(15) National Sports Fund to be set-up by the Central Govt.; or

(16) National Cultural Fund set-up by the Central Govt.; or

(17) the Fund for Technology Development and Application set-up by the Central Govern-

ment; or

(18) any fund set-up by the State Government of Gujarat exclusively for providing relief to

the victims of earthquake in Gujarat; or

(19) the National Trust for welfare of persons with Autism, Cerebral Palsy, Mental Retar-

dation and Multiple Disabilities.

(20) National Children's Fund.

[A(ii)] No limit donations but deduction is allowed @ 50% of qualifying amount of are

as under :

(1) Jawahar Lal Nehru Memorial Fund;

(2) Prime Minister's Drought Relief Fund;

(3) Indira Gandhi Memorial Trust;

(4) Rajiv Gandhi Foundation.

[B(i)] With limit donations where deduction is allowed @ 100% of qualifying amount:

(1) the Government or to any such local authority, institution or association as may be

approved in this behalf by the Central Government to be utilized for the purpose of

promoting family planning;

(2) sums paid by a company to the Indian Olympic Association or any other Association

or Institution established in India and as notified by the Central Government for

development of infrastructure for sports and games in India or for sponsorship of

sports and games in India.

B(ii) With limit donations where deduction is allowed @ 50% of qualifying amount:

(1) the Government or any local authority to be utilized for any charitable purpose other

than the purpose of promoting family planning; or

(2) any other fund or any institution which is established in India for a charitable purpose,

if it fulfils the following conditions:

(a) its income is not included in total income under sections 11 and 12 of the

Income Tax Act, or it is Regimental Fund established by Armed Forces of the

Union for the welfare of the past and present members of the force or their

dependents;

(b) under the rules governing the institution or fund no part of the income or

assets of the institution or fund can be used for non-charitable purposes;

(c) the institution or fund is not expressed to be for the benefit of any particular

religious community or caste;

20

(d) the institution or fund maintains regular books of accounts of its receipt and

expenditure;

(e) the institution or fund is a public charitable trust or is registered under the

Societies Registration Act, 1860 or under section 25 of the Companies Act,

1956, or is a University established by law, or is any other educational

institution recognized by the Government or by a University established by

law, or it is an institution established in India for the control and supervision

of the games of cricket, hockey, football, tennis or any other game approved

by the Central Government, or is an institution financed wholly or in part by

the Government or a local authority; and the fund or institution is approved by

the Commissioner.

(3) any authority constituted in India by or under any law enacted either for the purpose

of the dealing with and satisfying the need for housing accommodation or for the

purpose of planning development or improvement of cities, towns and villages or for

both; or

(4) any corporation established by the Central Govt. or any State Govt. for promoting the

interests of the members of a minority community; or

(5) the sums paid by the assessee in the previous year as donations for the renovation or

repair of any temple, mosque, gurudwara, church or any other place which is notified

by the Central Government in the Official Gazette to be of historic, archaeological or

artistic importance or to be a place of public worship renowned throughout any State

or States.

Conditions for allowing deduction under this section :

(i) Not in Kind: No deduction will be allowed under section 80G unless the donation is

of a sum of money. It should not be given in kind.

(ii) Donation should not be given for the benefit of any particular religion, class, creed,

community, etc. Donation given for the benefit of scheduled castes, scheduled tribes,

backward class or women or children are not for any particular religion or caste.

Example 1:

Mr. Vivek's G.T.I. for the P.Y. 2015-16 was Rs. 5,00,000. He made the following

donations by cheques:

(a) Maharashtra Chief Minister's Earthquake Relief Fund-Rs. 10,000.

(b) National Foundations for Communal Harmony-Rs. 15,000.

(c) Rs. 10,000 to an Educational Institution of National Eminence.

(d) Rs. 5,000 to National Children's Fund.

(e) To Municipal Corporation for promotion of family planning-Rs. 40,000.

(f) To Minority Community Corporation (Notified) - Rs. 25,000.

Compute his taxable income for the Assessment Year 2016-17

Solution:

Computation of Total Income

for the Assessment Year 2016-17

Rs. Rs.

Gross Total Income

5,00,000

Less: Deduction u/s 80G:

(1) No limit donation, deduction allowed 100%:

(a) MCMERF 10,000

(b) NF for CH 15,000

21

(c) EI of NE 10,000

(d) NCF - Rs. 5,000 5,000

(2) With limit donation Rs. 40,000 + 25,000

Qualifying amount 10% of GTI Rs. 50,000

(a) Deduction @ 100% for

family planning Rs. 40,000 40,000

(b) Deduction @ 50% for

Minority Community Rs. 10,000 5,000 85,000

Total Income 4,15,000

Deduction in respect of certain donations for scientific research or rural development

[Section 80GGA]

Deduction is permissible to an assessee whose "Gross Total Income" does not

include income chargeable under the head "profits and gains of business or profession".

The deduction is available in respect of the payments made during the previous year

to the following institutions:

(i) to an approved research association, university, college or other institution to be used

for scientific research (Business assessees are allowed this deduction u/s 35);

(ii) to an approved research association which has as its objects the undertaking of

research in social sciences or statistical research or to university, college or other

institution for research in social science or statistical research (Business assessees are

allowed this deduction u/s 35);

(iii) to an association or institution engaged in any approved programme for rural

development, or which is engaged in training of persons for implementation of rural

development programmes, or to a notified rural development fund or to the notified

National Urban Poverty Eradication Fund (Business assessees are allowed this

deduction u/s 35CCA). In this case the assessee should furnish a certificate as is

required under section 35CCA;

(iv) to a public sector company or a local authority, or to an association or institution

approved by the National Committee, for carrying out any eligible project or scheme

(Business assessees are allowed this deduction u/s 35AC). In this case also the

assessee should furnish a certificate as a required under section 35AC.

Quantum of deduction: 100% of the sum paid to the above institutions.

Note : (A) Where a deduction under this section is claimed and allowed for any assessment

year then no deduction shall be allowed in respect of such payments under any other

provision of the Act for the same or any other assessment year.

(B) Deduction allowed to the assessee shall not be denied if subsequent to the

payment of the sum by the assessee, the approval granted to any of the above institution is

withdrawn.

3. Deductions in respect of contribution given by companies to Political Parties (Section

80GGB):

A sum donated by an Indian company to any political party or an electoral trust shall be allow

however no deduction is allowed for donation in cash.

22

4. Deduction in respect of profits and gains from new industrial undertakings or

enterprises engaged in infrastructural development etc. [Section 80-IA]

The deduction under this section is available to an assessee whose Gross Total Income

includes any profits and gains derived by:

(a) any enterprise carrying on the business of (i) developing, (ii) operating and

maintaining, or (iii) developing, operating, maintaining of any infrastructure facility;

(b) an undertaking which is engaged in the business of providing telecommunication

service, etc.;

(c) an undertaking which develops, maintains, etc. an industrial park or special economic

zone;

(d) an undertaking which is engaged in generation, transmission, distribution of power,

etc.

(a) Essential conditions for enterprises carrying on the business of infrastructure

facility [Section 80-IA(4)(i)]

(i) The enterprise should carry on the business of—

(a) developing,

(b) operating and maintaining, or

(c) developing, operating and maintaining,

any infrastructure facility.

(ii) the enterprise is owned by an Indian company or a consortium of such companies or

by an authority or a Board or a Corporation or any other body established or

constituted under any Central or State Act.

(iii) the enterprise has entered into an agreement with Central/State Government or a local

authority or any other statutory body for (i) developing, (it) operating and maintaining

or (iii) developing, operating and maintaining, a new infrastructural facility.

(iv) the enterprise has started or starts operating and maintaining the infrastructural

facilities on or after 1.4.1995. Meaning of infrastructural facility

For the purposes of this clause, "infrastructure facility" means:

(a) a road including toll road, a bridge or a rail system;

(b) a highway project including housing or other activities being an integral part of the

highway project;

(c) a water supply project, water treatment system, irrigation project, sanitation and

sewerage system or solid waste management system;

(d) a port, airport, inland waterway or inland port or navigational channel in the sea.

(b) Essential conditions for any undertaking which is engaged in providing

telecommunication services etc. [Section 80-IA(4)(ii)]

(i) The undertaking should have started or starts providing telecommunication service

whether basic or cellular, including radio paging, domestic satellite services or

network of trunking, broadband network and internet services.

(ii) Deduction is allowed to all assessees;

(iii) It should start providing telecommunication services at any time on or after 1.4.1995

but on or before 31.3.2005.

(i) Such undertaking should not be formed by splitting up, or the reconstruction, of a

business already in existence. However, this condition shall not apply to an

23

undertaking which is formed as a result of the re-establishment or revival of an

undertaking, in circumstances specified u/s 33B. i.e. discontinued business in the

circumstances specified in section 33B.

(ii) It should not be formed by the transfer to a new business of machinery or plant

previously used for any purpose. However, plant and machinery, already used for any

purpose, can be transferred to the new undertaking, provided value of such plant and

machinery does not exceed 20% of the total value of plant and machinery of the new

undertaking. It may be noted that it is not essential that the building in which the

undertaking carries on the business should also be new. Deduction under section 80-

IA will be available even if the undertaking is set up in an old building.

(c) Essential conditions for undertaking which develops, maintains etc., any

industrial park [Section 80-IA(4)(iii)]

(i) The under-taking should develop, develop and operate or maintain and operate an

industrial park notified by the Central Government in accordance with a scheme

framed for such purpose.

(ii) The industrial park should begin to operate, develop, etc., at any time on or after

1.4.1997 but before 1.4.2011.

(d) Essential conditions of undertaking engaged in generation transmission,

distribution of power, etc. [Section 80-IA(4)(iv)] It is an undertaking which:—

(i) is set up in any part of India for the generation or generation and distribution of power

if it begins to generate power at any time during the period beginning on 1.4.1993 and

ending on 31.3.2013;

(ii) starts transmission or distribution by laying a network of new transmission or

distribution lines at any time during the period beginning on 1.4.1,999 and ending on

31.3.2013. However, the deduction in this case shall be allowed only in relation to the

profits derived from laying of such network of new lines for transmission or

distribution;

(iii) undertakes substantial renovation and modernisation of the existing transmission or

distribution lines at any time during the period 1.4.2004 to 31.3.2013'. "Substantial

renovation and modernisation" shall mean an increase of plant and machinery by

atleast 50% of the book value of such plant and machinery as on 1.4.2004.

Other conditions

(i) Such undertaking should not be formed by splitting up, or the reconstruction, of a

business already in existence. However, this condition shall not apply to an

undertaking which is formed as a result of the re-establishment or revival of an

undertaking, in circumstances specified u/s 33B.

(ii) It should not be formed by the transfer to a new business of machinery or plant

previously used for any purpose. However, plant and machinery, already used for any

purpose, can be transferred to the new industrial undertaking, provided value of such

plant and machinery does not exceed 20% of the total value of plant and machinery of

the new industrial undertaking. It may be noted that it is not essential that the building

in which the undertaking carries on the business should also be new. Deduction u/s

80-IA will be available even if the industrial undertaking is set up in an old building.

Exceptions:

1. In view of the ongoing reforms of the State Electricity Boards, in case of

substantial renovation and modernisation, the restrictions imposed on the transfer of old plant

24

and machinery and splitting up of an old business shall not apply in the case of splitting up

or, reconstruction, or re-organisation of State Electricity Boards.

2. Any machinery or plant, which was used outside India by any person other than the

assessee shall not be regarded as machinery or plant previously used for any purpose, if the

following conditions are fulfilled, namely.

(a) such machinery or plant was not at any time previous to the date of the installation

by the assessee, used in India.

(b) such machinery or plant is imported into India from any country outside India; and

(c) no deduction, on account of depreciation in respect of such machinery or plant, has

been allowed or is allowable under the provisions of this Act in computing the total income

of any person for any period prior to the date of the installation of the machinery or plant by

the assessee.

Conditions applicable to all undertakings/enterprises eligible under section 80IA:-

(1) Audit of accounts [Section 80-IA(7)]: The deduction under section 80-IA from

profits and gains derived from an undertaking shall not be admissible unless the

accounts of the undertaking for the previous year relevant to the assessment year for

which the deduction is claimed have been audited by a chartered accountant and the

assessee furnishes, alongwith his return of income, the report of such audit in Form

No. 10CCB duly signed and verified by chartered accountant.

(2) Inter-unit transfer of goods or services [Section 80-IA(8)]: Where any goods or

services held for the purposes of the eligible business are transferred to any other

business carried on by the assessee, or where any goods or services held for the

purposes of any other business carried on by the assessee are transferred to the

eligible business and, in either case, the consideration, if any, for such transfer as

recorded in the accounts of the eligible business does not correspond to the market

value of such goods or services as on the date of the transfer, then, for the purposes of

the deduction under this section, the profits and gains of such eligible business shall

be computed as if the transfer, in either case, had been made at the market value of

such goods or services as on that date:

However, where in the opinion of the Assessing Officer, the computation of the

profits and gains of the eligible business presents exceptional difficulties, the

Assessing Officer may compute such profits and gains on such reasonable basis as he

may deem fit.

(3) Double deduction not allowed [Section 80-IA(9)]: Where any amount of profits and

gains of an undertaking or of an enterprise in the case of an assessee is claimed and

allowed under this section for any assessment year, deduction to the extent of such

profits and gains shall not be allowed under the heading "deductions in respect of

certain incomes", and shall in no case exceed the profits and gains of such eligible

business of undertaking or enterprise, as the case may be.

(4) Restriction of excessive profits [Section 80-IA(10)]: Where it appears to the

Assessing Officer that, owing to the (i) close connection between the assessee

carrying on the eligible business to which this section applies and any other person, or

(ii) for any other reason, the course of business between them is so arranged that the

business transacted between them produces to the assessee more than the ordinary

profits which might be expected to arise in 'such eligible business, the Assessing

Officer shall, in computing the profits and gains of such eligible business for the

purposes of the deduction under this section, take the amount of profits as maybe

reasonably deemed to have been derived therefrom.

25

(5) Power of Central Government to declare that the section shall not apply [Section

80-IA(11)]: The Central Govt. may, after making such inquiry as it may think fit,

direct, by notification in the Official Gazette, that the exemption conferred by this

section not apply to any class of industrial undertaking or enterprise with effect from

such date as it may specify in the notification.

(6) Deduction not to be allowed in cases where return is not filed within the specified

time limit [Section 80AC]: No deduction shall be allowed to the assessee under this

section unless he furnishes a return of his income of the relevant assessment year on

or before the due date specified u/s 139(1).

Quantum and period of deduction in case of all above undertakings/enterprises [Section

80-IA]

Undertaking/enterprises Period and quantum of deduction

(1) For all the above

undertaking/ enterprises other

than the enterprise engaged in

the business of providing

telecommunication, etc.

100% of profits and gains derived from such

business for 10 consecutive assessment years out of

15 years beginning with the year in which

undertaking or the enterprise develops and begins to

operate any infrastructure facility or develops an

industrial park or special economic zone or

generates power or commences transmission or

distribution of power or undertakes substantial

renovation or modernisation.

(2) For enterprise engaged in the

business of providing

telecommunication services, etc.

For the first 5 consecutive assessment years @

100%,

Subsequent 5 consecutive assessment years @ 30%

out of 15 years beginning with the year in which

enterprise starts providing telecommunication

services.

5. Deduction in respect of profits and gains by an undertaking or an enterprise engaged

in development of Special Economic Zone [Section 80-IAB]

The deduction under this new section is available where the gross total income of an

assessee, being a Developer, includes any profits and gains derived by an undertaking or an

enterprise from any business of developing a Special Economic Zone, notified on or after

1.4.2005 under the Special Economic Zones Act, 2005.

Quantum of deduction: The deduction shall be allowed of an amount equal to 100%

of the profits and gains derived from such business for 10 consecutive assessment years.

The deduction may, at the option of the assessee, be claimed by him for any 10

consecutive assessment years, out of 15 years beginning from the year in which a Special

Economic Zone has been notified by the Central Government

26

Conditions prescribed under section 80-IA(7) to (11) to be applicable to

undertaking for claiming deduction under section 80-IAB [Section 80-IAB(3)]: The

provision contained in section 80-IA(7) to (11) shall so far as may be, apply to the eligible

business under this section. These provisions relate to following:

1. Audit of accounts [Section 80-IA(7)];

2. Inter unit transfer of goods or services [Section 80-IA(8)

3. Restriction of double deduction [Section 80-IA(9)

4. Restriction of excessive profits [Section 80-IA(10)];

5. Power of Central Government to notify undertakings to which section 80-IAB shall

not apply [Section 80-IA(11)];

6. Deduction not to be allowed where return is not filed within the time limit specified

under section 139(1) [Section 80-ACJ.

6. Deduction in respect of profits and gains from certain industrial undertakings other

than infrastructure development undertakings [Section 80-IB]

The deduction under this section is available to an assessee whose Gross Total

Income includes any profits and gains derived from the business of:

(1) commercial production and refining of mineral oil;

(2) processing, preservation and packaging of fruits or vegetables, meat and meat products or

poultry or marine or dairy products;

(3) integrated business of handling, storage and transportation of food grains;

(4) operating and maintaining a hospital located anywhere in India other than the excluded

area.

7. Deduction in respect of profits and gains from undertaking or enterprise in special

category States - (Sec- 80IC)

A deduction will be allowed from gross total income to an assessee in respect of

profits and gains derived from business specified below:

The undertaking or enterprise :

(a) has begun or begins to manufacture or produce any article or thing (not being any

article or thing specified in the Thirteenth Schedule), or which manufactures or

produces any article 'or thing (not being any article or thing specified in the Thirteenth

Schedule) and undertakes substantial expansion in any Export Processing Zone or

Integrated Infrastructure Development Centre or Industrial Growth Centre or In-

dustrial Estate or Industrial Park or Software Technology Park or Industrial Area or

Theme Park, as notified by the Board, during following period:

(i) in the State of Sikkim—after 22.12.2002 but before 1.4.2007;

(ii) in North-Eastern States—after 23.12.1997 but before 1.4.2007;

(iii) in the State of Himachal Pradesh or the State of Uttaranchal— after 6.1.2003 but

I before 1.4.2012.

(b) has begun or begins to manufacture or produce any article or thing or commences any

operation specified in the Fourteenth Schedule, or which manufactures or produces

any article or thing or commences any operation specified in the Fourteenth Schedule

and undertakes substantial expansion during the period :

(i) in the State of Sikkim—after 22.12.2002 but before 1.4.2007;

(ii) in North-Eastern States—after 23,12.1997 but before 1.4.2007;

(iii) in the State of Himachal Pradesh or the State of Uttaranchal—after 6.1.2003 but

before 1.4.2012.

27

Quantum of deduction : (1) In case of (a) (i) and (ii) and (b) (i) and (ii)—100% of

such profits for initial ten assessment years.

(2) In case of (a) (iii) and (b) (iii):

(i) Five initial assessment years—100% of such profits;

(ii) Next five assessment years : .

(a) In case of Companies—30% of such profits

(b) In case of other assessees—25% of such profits.

No deduction shall be allowed under sections 80C to 80U in relation to the profits and

gains of the undertaking or enterprise specified above.

Where the assessee has claimed exemption u/s 10C or deduction regarding industrial

undertaking located in North-Eastern Region the undertaking shall be entitled to deduction

only for the unexpired period of ten consecutive assessment years.

Conditions for deduction: The deduction shall be allowed if the following

conditions are satisfied:

(i) It is not formed by the splitting up, or the reconstruction, 'of a business .already in

existence.

Exception. Where the business of an industrial undertaking carried on in India is

discontinued in any previous year by reason of extensive damage to, or destruction of, any

buikling, plant, machinery or furniture owned by the assessee and used for such business, as a

direct result of:

(a) flood, typhoon, hurricane, cyclone, earthquake or other natural calominities or

(b) riot or civil disturbance; or

(c) accidental fire or explosion; or

(d) action by an enemy or action taken in combating an enemy (whether with or without

declaration of war) .

and thereafter at any time before the expiry of three years from the end of previous year, the

business is re-established or revived, by the assessee, it will not be deemed to be

reconstruction of a business already in existence.

(ii) It is not formed by the transfer to a new business of machinery or plant (exceeding

20%) previously used for any purpose.

Exception. Any machinery or plant which was used outside India by any person other

than the assessee shall not be regarded as machinery or plant previously used for any purpose,

if the following conditions are fulfilled :

(a) such machinery or plant was not used in India before installation by the assessee;

(b) it is imported into India from outside India; and

(c) no depreciation has been allowed or allowable under this Act for any period prior to

the installation of the Plant and machinery by the assessee.

Amalgamation/Demerger: Where any undertaking of an Indian company is

transferred, before the expiry of the period specified in this section, to another Indian

company in a scheme of amalgamation or demerger, then

(a) no deduction shall be allowed to amalgemating company in the your in which

amalgamation or demerger take place and

28

(b) the deduction for the remaining period shall be allowed to the amalgamated or

resulting company as it would have been allowed if the amalgamation or demerger

had not taken place.

Other provisions. The provisions relating to the following aspects are the same as

discussed u/s80-IA:

Note: (1) "North-Eastern Region" mean State of Arunachal Pradesh, Assam, Manipur,

Meghalaya, Mizoram, Nagaland and Tripura.

(2) "Substantial expansion" means increase in the investment in the plant and

machinery by "at least 50% of the book value of plant and machinery (before taking

depreciation in any year), as on the first day of previous year in which the substantial

expansion is undertaken.

8. Deduction in respect of profits and gains from business of hotels and convention

centres in specified area (Sec. 80-ID)

Eligibility: (i) An undertaking engaged in the business of hotel (two-star, three-star or

four-star category), located in the specified area, if such hotel is constructed and has started

or starts functioning between 1.4.2007 and 31.7.2010.

(ii) An undertaking engaged in the business of building, owning and operating a

convention centre, located in the specified area, if it is constructed between 1.4.2007 and

31.7.2010.

Specified area mean: The National Capital Territory of Delhi and the districts of

Faridabad, Gurgaon, Gautam Budh Nagar and Ghaziabad.

(iii) An undertaking engaged in the business of hotel (two-star, three-star or four-star

category) located in the specified district having a World Heritage Site, if such hotel is

constructed and has started or starts functioning between 1.4.2009 and 31.3.2013.

Quantum of deduction and period for deduction:100% of the profits and gains

derived from such business for five consecutive assessment years.

Conditions for deduction: The deduction u/s 80ID will be allowed if the following

conditions are satisfied:

(i) It is not formed by the splitting up or the reconstruction of a business already in

existence,

(ii) It is not formed by the transfer of a building previously used as a hotel or a

convention centre, as the case may be.

(iii) It is not formed by the transfer of machinery or plant (exceeding 20%) previously

used for any purpose.

Exception: Any machinery or plant which was used outside India by any person other

than the assessee shall not be regarded as machinery or plant previously used for any purpose,

if the following conditions are fulfilled :

(a) such machinery or plant was not used in India before installation by the

assessee;

(b) it is imported into India from outside India; and

(c) no depreciation has been allowed or allowable under this Act for any period

prior to the installation of the Plant and machinery by the assessee.

29

(iv) The assessee furnishes along with the return of income, the audit report in the

prescribed form certifying that the deduction has been correctly claimed.

Other provisions: The provisions relating to the following aspects are the same as

discussed U/S 80IA:

1. Computation of income for deduction.

2. Withdrawal of deduction.

Note : Benefit under this section shall not be available to amalgamated company in

case of amalgamation.

Explanation: 'Convention centre a building of a prescribed area comprising of

convention halls to be used for the purposes of holding conferences and seminars, being of

such size and number and having such other faculties and amenities as may be prescribed.

9. Deduction in respect of profits and gains in respect of certain undertakings in

North-Eastern States (Sec. 80IE)

The deduction shall be allowed to an undertaking which has, during the period beginning on

the 1-4-2007 and ending before the 1-4-2017, begun or begins, in any of the North-Eastern

States :

(i) to manufacture or produce any eligible article or thing;

(ii) to undertake substantial expansion to manufacture or produce any eligible article

or thing;

(iii) to carry on any eligible business.

Quantum and period for deduction: 100% of the profits derived from such business

for ten consecutive assessment years commencing with the initial assessment years.

Conditions for deduction: The deduction shall be allowed if the following

conditions are satisfied:

(i) It is not formed by the splitting up, or the reconstruction, of a business already in

existence.

Exception: Where the business of an industrial undertaking carried on in India is

discontinued in any previous year by reason of extensive damage to, or destruction of, any

building, plant, machinery or furniture owned by the assessee and used for such business, as a

direct result of:

(a) flood, typhoon, hurricane, cyclone, earthquake or other natural calaminities or

(b) riot or civil disturbance; or

(c) accidental fire or explosion; or

(d) action by an enemy or action taken in combating an enemy

and thereafter at any time before the expiry of three years from the end of previous year, the

business is re-established or revived, by the assessee, it will not be deemed to be

reconstruction of a business already in existence.

(ii) It is not formed by the transfer to a new business of machinery or plant (exceeding

20%) previously used for any purpose.

30

Exception: Any machinery or plant which was used outside India by any person other

than the assessee shall not be regarded as machinery or plant previously used for any purpose,

if the following conditions are fulfilled :

(a) such machinery or plant was not used in India before installation by the assessee;

(b) it is imported into India from outside India; and

(c) no depreciation has been allowed or allowable under this Act for any period prior

to the installation of the Plant and machinery by the assessee.

Amalgamation or Demerger: Where any undertaking of an Indian company is

transferred, before the expiry of the period specified in this section, to another Indian

company in a scheme of amalgamation or demerger, then :

(a) no deduction shall be allowed to amalgamating or demerged company in the year

in which amalgamation or demerger takes place; and

(b) the deduction for the remaining period shall be allowed to the amalgamated or

resulting company as it would have been allowed if the amalgamation-or demerger had not

taken place.

Other provisions. The provisions relating to the following aspects are the same as

discussed U/S 80IA: regarding

(i) Computation of profits for deduction.

(ii) Audit of accounts.

(iii) Withdrawal of deduction.

10. Deduction in respect of profits from Business of Collecting and Processing of

Biodegradable Waste (Sec. 80JJA)

Where the gross total income of an assessee includes any profits derived from the

business of collecting and processing or treating of bio-degradable waste for generating

power or producing bio-fertilizers, bio-pesticides or other biological agents or producing bio-

gas or making pellets or briquettes for fuel or organic manure, he is entitled to a deduction in

computing total income.

Quantum of deduction. 100% of such income for a period of five assessment years

beginning with the assessment year relevant to the previous year in which the business

commences.

11. Deduction in respect of Employment of New Workmen (Sec. 80JJAA)

Eligibility: An Indian Company engaged in the manufacture of goods in a factory.

Quantum of deduction. 30% of additional wages paid to the new regular workmen

employed by the assessee in such factory in the previous year such deduction is available for

three assessment year including the Assessment Year relevant to the previous year in which

such employment is provided. Conditions for deduction :

(1) The factory should not be formed by spilling up or reconstruction or transfer from

another existing entity or acquired by the assessee company as a result of amalgamation with

another company.

(2) The assessee furnishes along with the return of income the audit report giving the

prescribed particulars.

31

Meaning of Additional Wages

(1) In the case of new factory. 'Additional wages' means the wages paid to the new

regular workmen in excess of 100 workmen employed during the previous year.

(2) In the case of existing factory. The additional wages shall be nil if the increase in

number of regular workmen employed during the year is less than 10% of existing number of

workmen employed in the factory as on the last day of preceding year and the total number of

employees is less than 100.

Meaning of Regular Workman': Regular Workmen

(a) a casual workman; or

(b) a workman employed through contract labour; or

(c) any other workman employed for a period of less than 300 days during the previous

year.

12. Deduction in respect of certain incomes of Offshore Banking Units or

International Financial Services Centre. (Sec. 80LA)

This deduction is allowed to where (i) a scheduled bank or any bank incorporated by

or under the laws of a country outside India having an offshore banking unit in a special

economic zone; or Unit of an International Financial Services Centre, derives income from an

offshore banking unit in a special economic zone; or from the business referred to in Sec.

6(1) of the Banking Regulation Act, 1949, with an undertaking located in a special economic

zone or any other undertaking which develops, develops and operates or develops, operates

and maintains a special economic zone; or from any unit of the International Financial

Services Centre from its business for which it has been approved for setting up such a centre

in a Special Economic zone.

Quantum of deduction : 100% of such income for first five consecutive assessment

years beginning with the assessment year relevant to previous year in which permission u/s

23(lXa) of the Banking Regulation Act, 1949, or permission or registration under the

Securities and Exchange Board of India Act, 1992 or any other relevant law was obtained and

Thereafter, 50% of such income for five consecutive assessment years.

Conditions for deduction. The assessee must furnish alongwith the return of income:

(1) A report of the Chartered Accountant in the prescribed form certifying that the

deduction has been correctly claimed in accordance with the provisions of this section.

(2) A copy of the permission obtained u/s 23(1)(a) of the Banking Regulation Act,

1949.

Carry forward and set off of losses in case of certain companies [Section 79]

In the case of a company, not being a company in which public are substantially interested,

where a change shareholding has taken place in a previous year, then no loss incurred in any

year prior to the previous year shall be carried forward and set off against the income of the

previous year unless on the last day of that previous year and on the last day the previous year

in which the loss was incurred, the shares of the company carrying not less than 51% of the

voting right were beneficially held by the same person.

However this provision shall not apply to a change in the voting right consequent

upon:

32

(a) the death of a shareholder, or

(b) on account of transfer of shares by way of gifts to any relative of such shareholder, or

(c) any change in the shareholding of an Indian company which is subsidiary of a foreign

company arising as a result of amalgamation or demerger of a foreign company

subject to the condition that 51% of the shareholders of the amalgamating or

demerged foreign company continue to remain the shareholders of the amalgamated

or the resulting foreign company.

Note:

(i) Section 79 would not apply if shares carrying 51% of the voting powers continue to

be held by the same group which held shares carrying 51% of the voting power in the

year in which the loss was incurred, although within the group itself there may be any

amount of change of shareholding.

(ii) Section 79 applies to all losses, including losses under the head Capital gains.

However, overriding provisions of section 79 do not effect the set off of unabsorbed

depreciation which is governed by section 32(2).

Example: Jet Pvt. Ltd. has three shareholders i.e. A, B and C. All the three

shareholders have equal shareholding of the company. During the previous year 2015-16 the

company incurred a loss of Rs. 1,20,000. On 25.3.2017 A and B transferred their

shareholding to D. On 31.3.2013 the shareholders are.

C. 1/3rd shareholding

D. 2/3rd shareholding.

Will the company be able to carry forward and set off the loss of Rs. 1,20,000 to the

subsequent year?

Solution: As there has been a change in the shareholding to the extent of more than

49%, the company cannot any forward and set off the loss to the subsequent year.

Questions

1. Discuss the condition to be satisfied for deductions under section 80G

2. Explain the new provisions of section 80JJAA in respect of employment of new

workers by an Indian company.

3. Discuss the provisions under section 80IAB regarding deduction of profits and gains.

4. Discuss the provisions of section 80A regarding general rules for deductions from

G.T.I.

33

5. X Pvt. Ltd. submits the following information:

Previous Year

2013-14

Previous Year

2014-15

Previous Year

2015-16

Business income/loss (-) 1,50,000

40,000

F 35%

A 20%

B 15%

C 30%

(-) 2,50,000

80,000

F 35%

A 20%

D 15%

E 30%

(+) 5,00,000

-----

F 35%

G 20%

D 15%

E 30%

Unabsorbed

depreciation

Shareholding as on

last day of previous

Can the losses of previous year 2013-14 and 2014-15 be set off against the income of

previous year 2015-16

Answer:

Losses of previous year 2013-14 could be carried forward to previous year 2014-15 as the

change in shareholding is only to the extent of 45% (in order to attract section 79, the change

in the shareholding should be more than 49%). However, these cannot be carried forward to

previous year 2015-16 because change in 65%. However losses of 2014-15 can be carried

forward in the P.Y. 2015-16.

34

LESSON 3

Tax Liability and Minimum Alternate Tax, Tax on Distributed Profits

3. STRUCTURE

3.1 Constitutional Provisions

3.2 Incidence of Tax

3.3 Rates of income Tax For the Assessment Year 2015-16

3.4 Rates of Income-Tax for A.Y. 2016-17

3.5 Special Provision for Payment of Tax by Certain Companies or Minimum Alternative

Tax (MAT) (Section 115JB)

3.6 Tax Credit Respect of Tax Paid on Deemed Income Under Mat Provisions Against Tax

Liability in Subsequent Year [Section 115JAA]

3.7 Dividend Distribution Tax (DDT) (Section 115-0)

3.8 Tax on Income Distributed to Unitholders [Section 115R, 115S and 115T]

3.9 Tax on Distributed Income of Domestic Company on Buy-Back of Shares [Sections,

115QA, 115QB and 115QC]

3.1 CONSTITUTIONAL PROVISIONS

Under the Constitution, Entry 85 of the Union List in the Seventh Schedule specifies

Corporation tax as a tax on companies.

Article 366(6) defines corporate tax as follows:

Corporate tax means any tax on income, so far as that tax is payable by companies and is a

tax in case the following conditions are fulfilled:

(i) It is not chargeable in respect of agricultural income;

(ii) No deduction in respect of tax paid by companies is by any enactments which may

apply to the tax authorised to be made from dividends payable by the companies to

individuals;

(iii) No provision exists for taking the tax so paid into account in computation for the

purposes of Indian income tax, the total income of individuals receiving such

dividends, or in computing the Indian income tax payable by, or refundable to, such

individuals.

3.2 INCIDENCE OF TAX

Incidence of tax depends upon the residential status of a company. A company may be

resident or nonresident in India.

As per Section 6(3), a company is resident in India in any previous year, if

(i) It is an Indian company; or

(ii) Its place of effective management, in that year, is fully situated in India;

Therefore, if any of the above two tests is not satisfied, the company would be a non-resident

in India during that previous year.

According to Section 5(1) of the Income Tax Act, the total income of a resident company

would consist of:

35

(i) Income received or deemed to be received in India during the previous year by or on

behalf of such company; or

(ii) Income which accrues or arises or is deemed to accrue or arises to it in India during

the previous year; or

(iii) Income which accrues or arises to it outside India during the previous year;

Under Section 5(2) of the Act, the total income of a non-resident company would consist of:

(i) Income received or deemed to be received in India during the previous year by or on

behalf of such company; or

(ii) Income which accrues or arises or is deemed to accrue or arise to it in India during the

previous year;

3.3 RATES OF INCOME TAX FOR THE ASSESSMENT YEAR 2015-16

Domestic company:

(i) For income other than capital gain 30%

(ii) on long term capital gain 20%

(iii) On short term capital gain emanating from transfer of short term capital

being equity shares or units of an equity oriented fund 15%

Surcharge of Income Tax

(i) No surcharge if total income doesn't exceed Rs.1 crore. But if more than 1

crore and upto Rs. 10 crore 5%

(ii) and if more than 10 crore 10%

Cess:

Education cess 2% plus 1% secondary and Higher Education is levied on tax

including surcharge 3%

In the. case of a company other than a domestic company :

(i) on income from royalty received from Government or an Indian concern„ j hi

pursuance of agreement made after 31st March, 1961, but before 1st April, 1976

50%

(ii) on income from fees for rendering technical services received from Government or an

Indian concern in pursuance of an agreement made after 29th February, 1964 but

before 1st April, 1976 50%

In respect of income under (i) and (ii) there should be an agreement with the

Government or Indian concern for the purpose, which should be approved by the

Central Government.

(iii) Winnings u/s 115BB 30%

(iv) Short-term capital gains specified in Sec. 111A 15%

(v) Long-term capital gains u/s 112 10% / 20%

(vi) Other income 40%

Surcharge, (i) @ 2% on the amount of income-tax, if total income exceeds one crore rupees

but does not exceed ten crore rupees;

36

(ii) @ 5% if total income exceeds ten crore rupees. Marginal relief. As discussed under

domestic company. Education cess. On the amount of income-tax and surcharge @ 3%.

Tax on certain dividends received from foreign companies

1. Where the total income of an Indian company includes any income byway of

dividends declared, distributed or paid by a specified foreign company, the Indian company

shall be liable to tax as under

(i) On such dividend, income :

(a) Income-tax @ 15%.

(b) Surcharge: (i) 5% if total income exceeds one crore rupees but does not exceed ten

crore rupees.

(ii) @ 10% if total income exceeds ten crore rupees.

(c) Education cess : @ 3%

(ii) On other income, as per other provisions of the' Income Tax Act.

2. In computing the income no deduction in respect of any expenditure or allowance

shall be allowed from aforesaid dividends income.

3. "Dividends" shall have the same meaning as given in Sees. 2(22) (a), (b), (c) and

(d).

4. "Specified foreign company" means a foreign company in which the Indian

company holds 26% or more in nominal value of the equity share capital of the company.

3.4 RATES OF INCOME-TAX FOR A.Y. 2016-17

(I) Domestic Companies

(i) For income other than long term capital gains : 30% of total income

(ii) On short term capital gains emanating from transfer of a short term capital asset being

an equity share or unit of an equity oriented fund : 15% of such short term capital

gains

(iii) On long term capital gains emanating from transfer of a long term capital asset: 20%

Surcharge @ 7% is applicable if total income of the domestic company exceeds Rs. one crore

but does not exceed Rs. ten crores. Surcharge @ 12% shall be levied if total income of

domestic company exceeds Rs. ten crores.

1. Education cess @ 2% and Secondary & Higher education cess (SHEC) @ 1% is levied

on tax including surcharge.

(II) Foreign Companies

In the case of a company other than a domestic company (i) On so much of the total income as consists of royalties received from Government or

an Indian concern in pursuance of an agreement made by it with the Government or

the Indian concern after the 31st March 1961 but before 1st April; 1976; or fees for

technical services received from Government or an Indian concern in pursuance of an

agreement made by it with the Government or the Indian concern after 29th February,

1964 but before 1st April, 1976, and such agreement has, in either case, been

37

approved by the Central Government: 50% of such royalty or fees for technical

services, as the case may be; (ii) On other incomes: 40% of such income

Surcharge @ 2% is applicable if total income of the domestic company exceeds Rs. one crore

but does not exceed ten crores. Surcharge @ 5% shall be levied if total income of domestic

company exceeds Rs. ten crores.

2. Education cess @ 2% and Secondary & Higher education cess (SHEC) @ 1% is levied

on tax including surcharge. ,

Marginal Relief: However, in case of domestic as well as other companies, the total amount

payable as income-tax and surcharge on total income exceeding one crore rupees but not

exceeding ten crore rupees shall not exceed the total a mount payable as income tax on the

total income of one crore rupees by more than the amount that exceeds Rs. 1 crore similarly

the total amount payable an income tax and surcharge on total income exceeding Rs. 10

crores shall not exceed the total amount payable an income tax and surcharge on the total

income of Rs. 10 crore by more than the amount of income that exceeds Rs. 10 crore No

marginal relief is available for education cess and secondary & Higher Education cess.

Example :

Compute the taxable income of P.Ltd. for the previous year 2015-16 from the

following Profit & Loss Account and additional informations:

Rs. Rs.

To Salaries & Bonus 1,00,000 By Gross Profit 5,00,000

To Office Rent 10,000 By Interest 10,000

To Risk Insurance 10,000 By Short-term capital

gains

10,000

To Postage & Stationery 10,000

To General Charges 20,000

To Reserve for dep. 25,000

To Income tax 2014-16 50,000

To Provision for Income tax

2015-16

2,00,000

To Net Profit 1,00,000

Total 5,25,000 Total 5,25,000

Additional Information:

(a) The general charges include Rs. 5,000 for advertising; Rs. 1,000 for charitable

donation; Rs. 3,000 paid to a Motor-car Company for exchanging the old car for new

one; Rs. 1,000 for charity and Rs. 5,000 for miscellaneous repairs.

(b) The amount of depreciation admissible under the Income Tax Act is Rs. 15,000 only.

(c) The amount of interest is from Govt. securities.

Solution:

Computation of Income from Business

For A.Y. 2016-17

Rs. Rs.

Net Profit as per P. & L. A/c 1,00,000

Add: Items not allowed:

38

(i) Reserve for Depreciation 25,000

(ii) Income tax 2014-15 50,000

(iii) Provision for Income tax 2015-16 2,00,000

(iv) Donation 1,000

(v) Payment for Car being Capital Expenditure 3,000

(vi) Charity 1,000 2,80,000

3,80,000

Less (i) Short term capital gain 15,000

(ii) Interest on securities 10,000

(iii) Depreciation Allowed 15,000 40000

Profit from Business 3,40,000

Statement of Total Income

Rs.

1. Income from Business 3,40,000

2. Capital Gains - Short-term 15,000

3. Income from other Sources : Interest on Securities 10,000

Gross Total Income 3,65,000

Less: 50% of Donations u/s 80G, i.e., 50% of Rs. 1,000 500

Total Income Rs. 3,64,500

3.5 SPECIAL PROVISION FOR PAYMENT OF TAX BY CERTAIN

COMPANIES OR MINIMUM ALTERNATIVE TAX (MAT) (SEC. 115JB)

Where in the case of a company the normal income-tax payable on its total income is

less than 18.5% + surcharge, if any + Education cess of its book-profit, such book-profit shall

be deemed to be the total income and the tax payable on such total income shall be the

amount of income-tax @ 18.5%+ Surcharge + Education cess of such book-profit.

Note: Surcharge: For A.Y. 2016-17

(a) In case of domestic company, (i) If total income or book-profit (deemed total income)

exceeds Rs. one crore but does not exceed ten crore rupees Rs. 7%; (ii) if total income

or book-profit exceeds ten crore rupees @ 12%.

(b) In case of company other than domestic company, (i) if total income or book-profit

(deemed total income) exceeds Rs. one crore but does not exceed ten crore rupees @

2%. (ii) If total income or book-profit exceeds ten crore rupees @ 5%

Education cess : On the amount of income tax and surcharge 3%

While computing the normal profit the following points shall be kept in mind in case of

companies.

(i) Any insurance or banking company or any company engaged in generation or supply

of electricity shall prepare its P & L A/c in accordance with provisions of the Act

governing such class of company. Any other company shall prepare its profit & loss

account in accordance with the provisions of Parts II of Schedule VI to the Companies

Act.

(ii) While preparing the annual accounts including profit & loss account: the accounting

policies; the accounting standards followed for preparing accounts; the method and

39

rates adopted for calculating depreciation, shall be the same as have been adopted for

preparing such accounts laid before the company at its annual general meeting.

Meaning of Book Profit

As per explanation given below Section 115JB(2), Book Profit means the net profit as shown

in the profit and loss account for the relevant previous year prepared under Section 115JB(2)

increased by the following amounts:

(a) The amount of income tax paid or payable and the provision thereof; or

(b) The amounts carried to any reserve other than shipping reserve u/s 33AC of the Act;

or

(c) The amount or amounts set aside to provisions made for meeting unascertained

liabilities; or

(d) The amount by way of provision for losses of subsidiary companies; or

(e) The amount or amounts of dividends paid or proposed; or

(f) The amount or amounts of expenditure relatable to any income to which section 10

[other than section 10(23G) or 10(38)] or section 11 or section 12 apply;

(g) The amount of depreciation; or

(h) The amount of deferred tax and provisions thereof; or

(i) The amount or amounts set aside as provision for diminution in the value of any asset.

(j) The amount standing in revaluation reserve relating to revalued asset on the

retirement or disposal of such asset.

The net profit as increased by the amounts referred to in Clauses (a) to (j) shall be reduced by

the following amounts:

(i) The amount withdrawn from any reserves or provisions if any such amount is credited

to the profit and loss account; Provided that the amount withdrawn from reserves

created or provisions made in a previous year shall not be reduced from the book

profit unless the book profit of such year or any earlier year has been increased by

those reserves or provisions.

(ii) The amount of income to which any of the provisions of Section 10 or Section 11 or

Section 12 apply, if any such amount is credited to the profit and loss account; or

(iii) The amount of depreciation debited to the profit and loss account (excluding the

depreciation on account of revaluation of assets); or the amount withdrawn from

revaluation reserve and credited to the profit and loss account, to the extent it does not

exceed the amount of depreciation on account of revaluation of assets.

(iii) The amount of loss brought forward or unabsorbed depreciation, whichever is less, as

per books of account. For-the purpbses of this clause, the loss shall not include

depreciation. Therefore, in a case where an assessee has shown profit in a year, but

after adjustment of depreciation it results in a loss, no adjustment in book profit is

allowed;

(iv) The amount of profits of sick industrial company for the assessment year commencing

on and from the assessment year relevant to the previous year in which the said

company has become a sick industrial company under Section 17(1) of the Sick

Industrial Companies (Special Provisions) Act, 1985 ('SICA') and ending with the

Assessment year during which the net worth (as per section 3 of the SICA) of such

company becomes equal to or exceeds the accumulated losses.

(v) The amount of deferred Tax, if any such amount is credited to the profit and loss

account.

40

Notes:

(1) Nothing contained in Section 115JB shall affect the determination of the amounts of

unabsorbed depreciation under Section 32(2), business loss under Section 72(1),

speculation loss u/s 73, Capital loss u/s 74 and loss u/s 74A in relation to the relevant

previous year to be carried forward to the subsequent year or years.

(2) Every company to which this section applies, shall furnish a report in the prescribed

form from a chartered accountant as defined in Section 288(2) certifying that the book

profit has been computed in accordance with the provisions of Section 115JB,

alongwith the return of income.

(3) Save as otherwise provided in Section 115JB, all other provisions of the Act shall

apply to every assessee, being a company, mentioned in this section.

(4) The provisions of Section 115JB shall apply to the income accrued or arising on or

after 1st April, 2005 from any business carried on, or services rendered, by an

entrepreneur or a Developer, in a Unit or SEZ (Special Economic Zone), as the case

may be (amendments made by Finance Act, 2011 and shall be effective from AY

2012-13, earlier the MAT provisions did not apply to SEZ enterprises and SEZ

developers).

(5) Provisions of MAT on the book profits of a Company would not apply to a Foreign

Company not having any physical presence in India Timken India Ltd. (2003) 273

ITR.67]'. In order to comply with the requirement of MAT provisions regarding Profit

and Loss Account in accordance with the provisions of the Indian Companies Act, it

is essential that the foreign company should have a place of business in India.

3.6 TAX CREDIT IN RESPECT OF TAX PAID ON DEEMED INCOME UNDER

MAT PROVISIONS AGAINST TAX LIABILITY IN SUBSEQUENT YEAR

[SECTION 115JAA]

Section 115JAA provides that where any amount of tax is paid under section 115JB(1) by a

company for any assessment year beginning on or after 1.4.2006, credit in respect of the taxes

so paid for such assessment year shall be allowed on the difference of the tax paid under

section 115JB and the araount.of tax payable by the company on its total income computed in

accordance with the other provisions of the Act. In other words, MAT credit shall be

computed as under:

MAT credit available = Tax paid u/s 115JB - Tax payable on the total income under

normal provisions of the Income Tax Act.

The amount of tax credit so determined shall be allowed to be carried forward and set

off in a year when the tax becomes payable on the total income computed under the normal

provisions. However, no carry forward shall be allowed beyond the tenth assessment year

immediately succeeding the assessment year in which the tax credit becomes allowable. The

set off in respect of the brought forward tax credit shall be allowed for any assessment year to

the extent of the difference between the tax on the total income and the tax which would have

been payable under section 115JB for that assessment year. No credit will be allowed in

respect of MAT paid in any assessment year prior to 2006-07.

41

In other words, MAT credit will be allowed only in that previous year in which tax

payable on the total income as per normal provisions of the income tax Act is more than tax

payable under section 115JB and it shall be allowed to the extent of the following:

Tax payable on total income under the normal provisions of the Act - tax payable

under section 115JB = MAT credit to be allowed.

Note:- No interest shall be allowed on the amount of tax credit available under section

115JAA

Where as a result of an order under sub-section (1) or sub-section (3) of section 143, section

144, section 147, section 154, section 155, sub-section (4) of section 245D, section 250,

section 254, section 260, section 262, section 263 or section 264, the amount of tax payable

under this Act is reduced or increased, as the case may be, the amount of tax credit allowed,

under this section shall also be increased or reduced accordingly.

For the purpose of computing interest chargeable under section 234A, 234B and

234C, credit of MAT under section 115JAA would have to be reduced from the amount of

tax payable. [CIT v Tulsian NEC Ltd. (2011) 330ITR 224 (SC) and also CIT v Deccan

Creations Pvt. Ltd. (2011) 55 DTK 206 (Kar).

Where a private company or unlisted public company is converted into limited liability

partnership in any previous year, MAT credit which was available to the company shall lapse.

In other words, the tax credit under section 115JAA shall not be allowed to the successor

LLP.

Example 2:

From the following information compute tax payable by X Ltd. for A.Y. 2016-17

Rs.

1. Total Income of the company for P.Y. 2016-17 6,00,000

2. Book profit u/s 115 JB of the company for P.Y. 2016-17 8,00,000

3. Carried forward credit U/S 115 JAA from A.Y. 2016-17 1,50,000

Solution:

Computation of Tax Payable by X Ltd. for the Assessment Year 2016-17

Tax on total income of Rs. 6,00,000 @ 30.9% (a) 1,85,400

Tax on book profit of Rs. 8,00,000 @ 19.055% (b) 1,52,440

MAT credit set-off (a-b) (c) 32,960

Tax payable (a-c) 1,52,440

Example 3:

The net profit of Pinki Ltd., an Indian company, as per its profit and loss account prepared as

per the Income-tax Act, 1961 is Rs. 90,00,000 after debiting and crediting following items:

Rs.

Provision for income-tax 5,00,000

Provisions for deferred tax 3,00,000

Proposed dividend 7,50,000

Depreciation including depreciation on revaluation of Rs. 20,00,000 debited to profit and loss

account 60,00,000

42

Profit from industrial unit in SEZ are 80,000

Provision for permanent diminution in the value of

investments 70,000

Compute tax liability under section 115JB for the assessment year 2016-17.

Solution: Computation of book profits of Pinki Ltd. under section 115JB

Rs.

Net profit as per profit and loss account 90,00,000

Add: Net profit to be increased by following amounts as per Explanation 1 to Section 115JB

- Provision for income tax 5,00,000

- Provision for deferred tax 3,00,000

- Proposed dividend 7,50,000

- Depreciation 60,00,000

- Provision for diminution in value of investment 70,000

1,66,20,000

Less: Net profit to be reduced by following amounts as per Explanation 1 to Section 115JB -

- Depreciation (excluding depreciation on revaluation of assets)

[Rs. 60 lakhs - Rs. 20 lakhs = Rs. 40 lakhs] 40,00,000

Book profits 1,26,20,000

Computation of tax liability of Pinki Ltd.

Mat @ 18.5% of the book profits

(i.e. 18.5% of Rs. 1,26,20,000) 23,34,700

Add: Surcharge @ 7% 1,63,429

Tax including surcharge 24,98,129

Add: Education Cess @ 3% 74,944

Total tax payable by the company

(rounded of to nearest Rs. 25,73,070

3.7 DIVIDEND DISTRIBUTION TAX (DDT) SECTION 115-0)

A domestic company is liable to pay tax on the amounts distributed, declared or paid as

dividend (whether interim or otherwise) and it shall be payable @ 15% plus surcharge @

10% and education cess and SHEC @ 3% in addition to the income tax payable.

Exclusions from DDT:

The amount distributed, declared or paid as dividend may be out of accumulated or current

year profits but same shall exclude:

(i) The amount of dividend if any received by the domestic company during the

financial year, if such dividend is received from its subsidiary and;

(a) Where such subsidiary is a domestic company, the subsidiary has paid tax

which is payable under this section on such dividend; or.

(b) Where such subsidiary is a foreign company, the tax is payable by the

domestic company under Section 115BBD on such dividend.

43

However, the same amount of dividend shall not be taken into account more than once.

Note: A company shall be a subsidiary of another company, if such other company holds

more than half in nominal value of the equity share capital of the company.

(ii) Dividend shall not include deemed dividend u/s 2(22)(e) i.e. loan or advance given by a

closely held company to a shareholder holding beneficial interest of 10% or more in the

company or loan or advance given by a closely held company to a concern in which the

aforesaid shareholder has substantial interest, but include dividend u/s 2(22)(a), (b), (c) or (d).

Example 4:

From the following information compute the tax liability of Z Ltd. (a closely-held company)

for A.Y. 2016-17

Rs.

(i) Accumulated profits of the company on 31.3.2015 30,00,000

(ii) On 28.8.2015 the company redeemed bonus

Preference shares issued to equity shareholders

8,00,000

(iii) On 9.9.2015 the company declared dividend in its

annual general body meeting

10,00,000

(iv) A shareholder holding 15% equity shares in the

Company borrowed on 30.1.2015 @ 12% p.a. interest

60,00,000

Solution:

Computation of Tax Liability of Z Ltd.

for the assessment year 2016-17 Rs.

1. Redemption of bonus shares [Treated as dividend distribution

u/s 2/22 (a)]

8,00,000

2. Dividend declared 10,00,000

Dividend liable to tax u/s 115-0 18,00,000

Tax on dividend distribution:

Income Tax @ 15% 2,70,000

Add: Surcharge @ 10% 27,000

2,97,000

Add : Education cess @ 3% 8,910

3,05,910

Applicability of DDT on SEZ

Finance Act, 2011 inserted a proviso to sub-section 6 of Section 115O by which the

provisions of Section 115O shall also be applicable on an enterprise or undertaking engaged

in developing, operating and maintaining a SEZ.

Time limit for payment

(a) Declaration of dividend; or

(b) Distribution of dividend; or

(c) Payment of dividend

Any amount paid as DOT shall not be allowed as deduction under the provisions of the Act.

44

Amendment by Finance Act, 2014

The Finance Act 2014 has inserted sub-section (1B) in section 115-0 to ensure that tax is

levied on a proper base. In order to ensure that tax is levied on a proper base, the dividend

actually received need to be grossed up for the purpose of computing the dividend

distribution tax.

For the purpose of determining the tax on distributed profits payable in accordance with this

section, any amount by way of dividend referred to in sub-section (1) as reduced by the

amount referred to in subsection (1A) shall be called net distributed profits. This net

distributed profit shall be increased to such amounts as would, after reduction of the tax on

such increased amount at the rate of 15% plus surcharge @ 10% and education cess & SHEC

@ 3%, be equal to the, net distributed profits. [Surcharge has been increased vide Finance

Act, 2015]

As per the decision of Calcutta High Qourt in case of Jayshree Tea and Industries Ltd- v. UOI

[2006] 285 ITR 506, the tax on distributed profits is a tax on the company and not on

shareholders. Therefore, the distributed profits retain the same character as that of the income

being distributed. Therefore, in case of a company engaged in agricultural activities in India,

tax on distributed profits shall be levied only on the amount of non-agricultural income i.e.

40% of the amount declared as dividend.

Example 5:

A foreign company which has made prescribed arrangements for declaration and payment of

dividends within India, pays preference share dividend of Rs. 100 lakh for financial year

2015-16. It company liable to pay DDT.

Solution:

A foreign company, which has made prescribed arrangements for declaration and payment of

dividends within India, will be a domestic company [Section 2(22AJ] Therefore, in the above

case, the foreign company is a domestic company and it would be liable to pay a dividend

distribution tax just like a domestic company.

Dividend received from subsidiary company sec. 1150(11A) For the purpose of computation

of tax on distributed profits, the amount of dividend distributed by the domestic company

during the financial year shall be reduced by the following:

(1) the amount of dividend, if any , received by the-domestic company (holding company)

during the financial year, if—

(a) such dividend is received from its subsidiary;

(b) the subsidiary company has paid the tax which is payable under this section of

such dividend.

(2) the amount of dividend, if any, paid to any person for or behalf of the New Pension

Scheme trust referred to in section 10(44).

W.e.f. A.Y. 2013-14 any dividend received by a holding company (whether such holding

company itself is a subsidiary of another company or not) from any subsidiary company shall

be reduced from the dividend distributed by such holding company. In other words, dividend

distributed by the holding company in the same year, to the extent, shall not be subject to

dividend distribution tax under section 115-O of the Act.

45

Note: A. The expression 'dividend as used above, shall have the same meaning as is given in

section 2(22) which shall Include section 2(22)(a), (b), (c) and (d) but shall not Include

deemed dividends under section 2(22)(e), i.e. a loan or an advance given by a closely held

company to a substantial shareholder.

B. The above additional tax shall be payable even if no income-tax Is payable by such

company on its total income. [Section 115O(2)]

C. For the purposes of section 115-O(1A), a company shall be a subsidiary of another

company, If such other Company holds more than half in nominal value of the equity share

capital of the company.

Example 6:

R Ltd. holds 60% shares in S Ltd. & 20% shares in T Ltd. S Ltd. holds 55% shares in T Ltd.

T Ltd. paid Rs. 2,00,000 as dividend to R Ltd. and Rs. 5,50,000 as dividend to S Ltd.

S Ltd. declares a dividend of Rs. 10,00,000 to its shareholders, and R Ltd. received Rs.

6,00,000 as its share of dividend. R Ltd. declares a dividend of Rs. 20,00,000. Discuss the tax

liability of companies.

Solution:

(1) In this case T Ltd. will pay DDT @ 16.2225% on Rs. 10,00,000 (Rs. 5,50,000 paid to S

Ltd. holder of 55% shares, Rs. 2,00,000 paid to R Ltd. holder of 20% shares and Rs. 2,50,000

distributed to the balance 25% shareholders.

(2) S Ltd. will not get the benefit under section 115-O(1A) in respect of dividend of Rs.

5,50,000 received from T Ltd., while paying its dividend of Rs. 10,00,000 as it is a subsidiary

of R Ltd. Hence, it will pay dividend distributed tax of Rs. 1,62,223.

However, w,e.f. A.Y. 2013-14 S Ltd will get the benefit under section 115-O(1A) in respect

of dividend received from T Ltd. Hence, it will have to pay dividend distribution tax @

16.2225% on Rs. 4,50,000 (Rs.10,00,000-5,50,000) instead on f 10,00,000.

(3) R Ltd. will get the benefit under section 115-O(1A). In respect of Rs. 6,00,000 dividend

from its subsidiary. S Ltd. and shall pay dividend distribution @ 16.2225% on Rs. 14,00,000

(Rs. 20,00,000-6,00,000) = Rs. 2,27,115 R Ltd. will not get benefit of dividend of Rs.

2,00,000 form U Ltd., as U Ltd. will not be treated as subsidiary of R Ltd. as R Ltd. holds

only 20% shares in U Ltd.

3.8 TAX ON INCOME DISTRIBUTED TO UNITHOLDERS [SECTIONS 115R,

115S AND 115T]

1. The income distributed to a unit holder of the Unit Trust of India or a Mutual Fund

shall be charged to tax under section 115R.

2. The tax under section 115R shall not be chargeable in respect of any income

distributed to the unit holders of the Unit Scheme, 1964 of the Unit Trust of India or

any other open-ended (and from June 1, 2006, even close ended) equity oriented fund

in respect of income distributed under such schemes. For this purpose, "equity

oriented fund" is such fund where the investible funds are invested by way of equity

shares in domestic companies to the extent of more than 65 per cent (up to May 31,

2006, 50 per cent) of the total proceeds of such fund. The percentage of equity

shareholding of the fund shall be computed with reference to the annual average of

the monthly averages of the opening and closing figures.

46

3. The recipient of income will not be chargeable to tax whether the income comes

under (1) or (2) above.

4. The person responsible for making the payment of income distributed by the UTT or a

Mutual fund and the UTI or the Mutual Fund itself , as the case may be, shall be liable

to pay the tax to the credit of the Central Government within 14 days from the date of

distribution or payment of such income, whichever is earlier.

5. No deduction under any other provision of the Act shall be allowed to the Unit Trust

of India or to a Mutual Fund in respect of the income which has been charged to the

aforesaid tax.

6. If the person or UTI or Mutual Fund liable to make the payment fails to so pay the tax

to the credit of the Central Government, he or it shall be liable to pay simple interest

at the rate of 1 per cent every month or part thereof on such amount of tax which has

not been paid or was not paid in time.

7. If the person or UTI or Mutual Fund liable to make the payment fails to so pay the tax

to the credit of the Central Government, he or it shall be deemed to be an assessee in

default in respect of the amount of tax payable and all the provisions of the Act for the

collection and recovery of income-tax shall apply.

8. The person responsible for making payment of the income distributed by the Unit

Trust of India or the Mutual Fund and the Unit Trust of India or the Mutual Fund, as

the case may be, shall be liable to file a statement of distributed income in Form No.

63 (for UTI) or Form No. 63 A (for mutual fund), giving details of income distributed

to unit holders, tax paid thereon and other relevant details. The statement should be

submitted on or before September 15 giving details of amount distributed during the

immediately preceding previous year.

3.9 TAX ON DISTRIBUTED INCOME OF DOMESTIC COMPANY ON BUY-

BACK OF SHARES (SECTIONS. 115QA, 115QB AND 115QC)

A. Rate of Tax: If a domestic company buy-back of its own shares (not being shares

listed on a recognised stock exchange) from a shareholder, it shall be liable to pay

additional income-tax on the distributed income as under :

Income-tax @ 20%, Surcharge @ 10% and Education cess @ 3%.

Note: "Distributed income" means the consideration paid by the company on buy-back of

shares as reduced by the amount which was received by the company for issue of such shares.

B. Payment of Tax: Tax shall be paid to the credit of the Central Government within

fourteen days from the date of payment of consideration to the shareholder.

C. Payment of Interest: If the principal officer of the company or the company fails to

pay the whole or part of the tax within the period mentioned (B), he or it shall be

liable to pay simple interest @ 1% for every month or part thereof for the delayed

period.

If the principal officer or the company does not pay tax on distributed income within

prescribed time, then, he or it shall be deemed" be an assessee in default and all the

provisions of this Act for collection and recovery of income tax shall apply.

47

D. Tax Liability of Shareholders: The income arising to the shareholders in respect of

such buy-back by the company, shall be exempt provided company has paid tax u/s

115QA.

Example 7:

Following are the partition of a domestic company for the year ending 31.3.2016

Rs.

(i) Business profit 4,20,000

(ii) Dividend from an Indian public sector company (gross) 10,000

(iii) Dividend from an Indian company whose 80% income is

agricultural income (gross)

9,000

(iv) Income from Mutual Fund (gross) 5,000

(v) Royalty received from a foreign concern for providing

technical service

16,000

(vi) Fee from an Indian company for technical advise 12,000

(vii) Dividend from a foreign company 8,000

(viii) Company has donated to National Rural Development

Fund during the previous year

8,800

Compute the total income of company for the Assessment Year 2016-17. Find out tax

liability if the book profit of the company is Rs. 7,00,000 u/s 115JB.

Solution:

Computation of Total Income

for the Assessment Year 2016-17

Rs.

Business Profit 4,20,000

Less : Donation to N.R.D.F. (u/s 35CCA) 8,800 4,11,200

Income from other Sources:

Dividend under (ii) & (iii) above Exempt

Income from M.F. Exempt

Royalty from foreign concern 16,000

Fees from Indian company 12,000

Dividend from foreign company 8,000 36,000

Gross Total Income 4,47,200

Less : Deduction Nil

Total Income

Computation of Tax Liability

Tax on Rs. 4,47,200 @ 30% 1,34,160

Add : Surcharge Nil

1,34,160

48

Add : Education cess @ 3% 4,025

1,38,185

Tax on Book-profit Rs. 7,00,000 @ 18.5% 1,29,500

Add : Surcharge Nil

1,29,500

Add : Education cess @ 3% 3,885

Tax Liability 1,33,385

Tax Liability: Tax on total income Rs. 1,38,185 or tax on book-profit Rs. 1,33,385,

whichever is more. Hence, tax payable Rs. 1,38,185.

Questions / Problems

1. Form the following information compute the total income of Z Ltd. and the tax

liability for A.Y. 2016-17

Profit & Loss Account

for the year ended 31.3.2016

Rs. Rs.

To Expenses relating to textile

business

24,00,000 By Interest on Bank

Deposit

30,000

To General Reserve 6,00,000 By Sale of textile

business

38,40,000

To Income tax paid 1,50,000

To Provision for contingent

liability

1,50,000

To Proposed Dividend 3,00,000

To Balance c/d 2,70,000

38,70,000 38,70,000

Additional information:

(i) Brought forward loss as per books of account Rs. 3,00,000

(ii) Brought forward unabsorbed depreciation as per income tax Act Rs. 16,00,000

(iii) Brought forward unabsorbed depreciation as per books of account Rs. 2,40,000

Ans. Book profit B. 1230000 Tax payable Rs. 234380

2. Daver Cement Ltd. is an Indian company. The company earned income from following

sources for the year ended 31st March, 2016.

Cement production profit 7,50,000

Dividend from an Indian Company 'A' Ltd. 80,000

Dividend from 'B' Ltd. a Foreign Company 20,000

Interest on Central Govt. Securities 10,000

Short-term capital gain 50,000

Long-term capital gain (computed) 97,000

The company donated by cheque Rs. 1,75,000 on 28th February, 2016 to P.M. Drought Relief

Fund. This amount was not deducted from cement production profit Rs. 7,50,000.

Company's capital is Rs. 20 lakh and dividend distributed 10% on 30th Sept., 2015

49

Compute total income for the assessment year 2016-17 and calculate tax liability. The

company has paid Rs. 1,50,000 as advance tax.

Ans. Total Income Rs. 8,39,500; Tax Liability Rs. 99,410. Tax on dividend distributed Rs.

33,990.

3. The book profits of a company in the previous year 2015-16 computed in accordance

with section 115JB is Rs. 15 lakh. If the total income computed for the same period as

per the provisions of the Income-tax Act, 1961 is Rs. 3 lakh, calculate the tax payable

by the company in the assessment year 2016-17 and also indicate whether the

company is eligible for any tax credit. Tax payable Rs. 2,85,825 Mat Credit Rs.

1,93,125

4. Discuss the provision of Income Tax Act under Section 115JB. What is the time limit

for carry forward of tax credit.

5. Is domestic company liable to pay income tax on buy back of its own shares? What is

the rate of tax and rate of interest payable an delayed payment of tax.

6. The business income of the assessee before claiming depreciation, for the financial

year 2016-17 Rs. 15,00,000. The book profit of the company as per provisions of

section 115JB is Rs. 8,00,000. The other details are as under.

Rs.

(i) Current year depreciation 2,80,000

(ii) Brought forward business loss 8,00,000

(iii) Brought forward unabsorbed depreciation 5,20,000

Compute the tax payable by the company for the assessment year 2016-17

7. The profit as per P & L A/c of M/s ABC Ltd. is Rs. lakhs. for P.Y. 2015-16 You are

required to compute tax liability of the company under section 115JB after taking into

account the following considerations-

(i) Provision for Income-tax Rs. 20 details as follows : Current tax : Rs. 15 lakhs;

Dividend distribution tax : Rs. 3 lakhs; Deferred tax : Rs. 2 lakhs

(ii) Provision for doubtful debts : Rs. 10 lakhs

(iii) Profit on sale on land credited to P & L A/c : Rs. 18 lakhs

(iv) Amount withdrawn from statutory reserve account Rs. 12 lakhs credited to P

& L A/c.

Ans : Book Profit - 76,00,000

X Company Limited, an Indian company, furnished the following particulars of its

income for the previous year ended 31st March, 2016. Compute its total income for the

assessment year 2016-17

Rs.

1. Business income 4,20,000

2. Dividends from : Domestic Company (Gross) 20,000

A foreign company 15,000

3. Capital Gains : short-term 25,000

Long-term 70,000

50

Additional Information:

(a) General expenses charged include Rs. 5,000 revenue expenditure and Rs. 20,000

capital expenditure for family planning progrramme amongst employees.

(b) Donation to Delhi University, Rs. 30,000 by cheque; Ved Mata Gayatri Trust, Shanti

Kunj, Haridwar (an approved trust u/s 80G) Rs. 70,000 by cheque and Rajiv Gandhi

Foundation Rs. 5,000 in cash were debited to P. & L. A/c.

Ans - Rs. 6,19,450

51

LESSON 4

Tax Planning With Reference to Setting up of A New Business:

Locational Aspect, Nature of Business, Form of Organisation

4. STRUCTURE

4.1 Location fo Business

4.2 Nature of Business

4.3 Special Provisions in Respect of Newly Established Undertakings in Free Trade

Zone etc. [Section 10A]

4.4 Special Provisionsin Respect of Newly Established Units in Special Economic

Zone [Section 10 AA]

4.5 Agricultural Income [Section 2(1a)]

4.6 Tea Development Account, Coffee Development Account and Rubber

Development Account [Section 33ab]

4.7 Deduction in Respect of Prospecting for, or extraction or production of

Petroleum or Natural gas or Both in India – [Section 33ABA]

4.8 Expenditure for Obtaining Licence to operate Telecommunication Services

[Section 35ABB]

4.9 Expenditure or Eligible Projects or Schemes [Section 35AC]

4.10 Deduction in Respect of Expenditure on Specified business [Section 35AD]

4.11 Weighted Deduction of 150% for Expenditure Incurred on Agricultural

Extension Project [Section 35CCC] W.w.f. A.Y. 2013-14

4.12 Weighted Deduction of 150% for Expenditure Incurred by a Company on Skill

Development Project [Section 35CCD]

4.13 Expenditure on Prospecting, etc. for Development of Certain Minerals ([Section

35E]

4.14 Special Provisions for Computing Profits and Gains of any Business [Section

44AD]

4.15 Special Provisions for Computing Profits and Gains of Business of Plying,

Hiring or Leasing Goods Carriages [Section 44AE]

When an entrepreneur or a management plan to set up a new business from the tax point of

view, two consideration are very important namely location of the business and the nature of

business besides form of business. There are many tax concessions and deduction which

depend upon the location and the nature of the business. Following are the main provisions of

income Tax Act regarding tax exemption and other concession on the basis of location of

business and the nature of business.

4.1 LOCATION OF BUSINESS

Following tax incentives are available on the ground of location of business.

1. Newly established industrial under-taking in free trade zone-section 10A

2. Newly established units in special economic zone section10AA

3. Undertaking or enterprise engaged in development of special economic zone-section

80-IAB

4. Newly setup industrial undertaking or substantial expansion of existing undertaking

in certain special Calgary states-section 80 IC

5. New established hotel and convention centre in the specified area-section ID

6. Certain undertaking established in north eastern states-(section 80 IE)

52

4.2 NATURE OF BUSINESS

Tax exemption and tax incenting depend upon the nature of business also. Following are the

provision of income tax where a business in given tax incentive on the basis of its

nature.

1. Agriculture income-section 10(1)

2. Tea development account coffee development account and Rubber development

account section (33AB)

3. Deduction in respect of prospecting for or extracting or production of petroleum or

natural gas or both in India (section 33ABA)

4. Expenditure for obtaining licence to operate telecommunication Services (Sec.

33ABA).

5. Expenditure on eligible projects or schemes (Sec. 35AC)

6. Deduction in respect of expenditure on specified business (Sec. 35AD).

7. Weighted deduction of 150% for expenditure incurred on agricultural extension

projects (Sec. 35CCC)

8. Weighted diction 150% for expenditure incurred by a company on skill development

– (Sec. 35CCD)

9. Expenditure on prospecting etc of certain minerals – (Sec. 35E)

10. Special provisions for computing profit and gains of any business (except covered u/s

44AD (Sec. 44AD)

11. Special provisions for computing profit and gains of business plying, hiring or leasing

goods carriage - (Sec. 44AE)

12. Special provision for computing profit and gains of shipping business of a non –

resident – (Sec. 44B)

13. Special provisions for computing profit and gain in connecter with the business of

exploring etc. of mineral oils (Sec. 44BB)

14. Deduction of Head office expenditure in the case of non-residnt (Sec. 44C)

15. Computation of income by way of royalty etc. in the case of foreign companies (Sec.

44DA)

16. Deduction in respect of profit and gains from business collecting and processing of

bio-degradable waste (Sec. 80JJA)

17. Deduction in respect of employment of new workers (Sec. 80JJAA)

18. Deduction in respect of certain incomes of off-shore Banking units and International

financial services centre (Sec. 80LA)

4.3 SPECIAL PROVISIONS IN RESPECT OF NEWLY ESTABLISHED

UNDERTAKINGS IN FREE TRADE ZONE, ETC. [SEC. 10A]

The provisions of section 10A are given below—

Conditions to be satisfied - In order to get deduction, an undertaking must satisfy the

following conditions:

(A) MUST BEGIN MANUFACTURE OR PRODUCTION IN FREE TRADE ZONE

- It has begun or begins to manufacture/ produce articles or things or computer

software during the following years—

53

Free Trade Zone: During the previous year relevant to the assessment year 1981-82 or any

subsequent year.

Electronic hardware technology park or software technology park: During the previous

year relevant to the assessment year 1994-95 or any subsequent year.

Special economic zone: During the previous year relevant to the assessment year 2001-02 or

any subsequent year but before April 1, 2005.

Note: In the case of unit which begins to manufacture or produce an article or thing or

computer software on or after April 1,2005 in a special economic zone, deduction will not be

available under section 10A. Such unit can claim deduction under section 10AA.

Free trade zones - Free Trade Zones are : Kandla Free Trade Zone, Santacruz Electronics

Export Processing Zone, Falta Export Processing Zone, Madras Export Processing Zone,

Cochin Export Processing Zone and Noida Export Processing Zone.

Electronic/software /hardware technology park- "Electronic hardware technology park"

means any park set up in accordance with the Electronic Hardware Technology Park (EHTP)

Scheme notified by the Government of India in the Ministry of Commerce and Industry.

Software technology park- "Software technology park" means any park set up in

accordance with the Software Technology Park (STP) Scheme notified by the Government of

India in the Ministry of Commerce and Industry.

Computer software- It means

a. any computer programme recorded on any disc, tape, perforated media or other

information storage device; or

b. any customized electronic data or any product or service of similar nature, as may be

notified by the Board, which is transmitted or exported from India to any place

outside India by any means.

For the purpose of section 10A as long as a unit in the EPZ/EOU itself produces computer

programmes and exports them, it should not matter whether the programme is actually

written within the premises of the unit. Where a unit in the EPZ/EOU develops software at

the client's site abroad, such unit should not be denied the tax holiday under section 10A on

the ground that it was prepared on-site, as long as the software is a product of the unit, ie., it

is produced by the unit.

The Central Board of Direct Taxes has specified the following Information Technology

enabled products or services, as the case may be, for this purpose namely: (i) Back-office

Operations; (ii) Call Centres; (iii) Content Development or Animation; (iv) Data Processing;

(v) Engineering and Design; (vi) Geographic Information System Services; (vii) Human

Resource Services; (viii) Insurance Claim Processing; (ix) Legal Databases; (x) Medical

Transcription; (xi) Payroll; (xii) Remote Maintenance; (xiii) Revenue Accounting; (xiv)

Support Centres; and (xv) Web-site Services.

Maintenance of software is an inherent part of software development and, hence, an assessee

engaged in such maintenance is entitled to exemption under section 10A.

54

(B) Should Not Be Formed By Splitting Reconstruction Of Business - The industrial

undertaking should not have been formed by the splitting up or reconstruction of a business

already in existence. However, where an industrial undertaking is formed as a result of re-

establishment, reconstruction or revival by the assessee of the business of any such industrial

undertaking as is referred to in section 33B, in the circumstances and within the period

specified in that section the same will qualify for the tax concession.

(C) Should Not Be Formed By Transfer Of Old Machinery- The industrial undertaking

should not have been formed by the transfer of a new business of machinery or plant

previously used for any purpose.

Exception-For this purpose, any machinery or plant which was used outside India by any

person other than the assessee is not regarded as machinery or plant previously used for any

purpose if such machinery or plant was not previously used in India; and such machinery or

plant is imported into India from a foreign country; and no deduction on account of

depreciation in respect of such machinery or plant has been allowed or is allowable in

computing the total income of any person for any period prior to the installation of the

machinery or plant by the assessee.

Note: This tax 'concession is not denied in a case where the total value of used machinery or

plant transferred to the new business does not exceed 20 per cent of the total value of the

machinery or plant used in that business.

(D) There Must Be Repatriation Of Sale Proceeds Into India - Sale proceeds of

articles or things or computer software exported out of India must be received in India by the

assessee in convertible foreign exchange during the previous year or within a period of six

months from the end of the relevant previous year. For instance, for the assessment year

2015-16, the repatriation of the sale proceeds into India must be completed on or before

September 30, 2015. The sale proceeds shall be deemed to have been received in India where

such sale proceeds are credited to a separate account maintained for the purpose by the

assessee with any bank outside India with the approval of the Reserve Bank of India.

Note:- 1. The aforesaid time limit of six months can be extended by the Reserve Bank of

India or such other competent authority as is authorised under any law for the time being in

force for regulating payments and dealings in foreign exchange. Extension of time for

realization of export proceeds by competent authority under FEMA can be said to be

approval granted by competent authority under section 10A(3) and assessee would be entitled

to benefits under section 10A in respect of such export proceeds.

2. If foreign exchange is not remitted within six months from the end of the previous

year (or within the extended time-limit as approved by RBI), then deduction under sections

10A, 10B and 10BA is not available. If the foreign currency is remitted after the expiry of

time-limit of 6 months (or after the expiry of extended time-limit); the Assessing Officer shall

amend the order of assessment so as to allow deduction under sections 10A, 10B and 10BA;

The order shall be amended within a period of 4 years from the end of the previous year in

which the foreign currency is remitted.

(E) Audit - The assessee should furnish audit report in Form No. 56F along with the

return of income.!

55

(F) Deduction Should Be Claimed In The Return Of Income And Return Should Be

Submitted Within Time Period

Deduction under section 10A is not available unless it is claimed in the return of income.

Moreover, return of income should be submitted on or before the due date of submission of

return of income given by section 139(1). Deduction under section 10A is not available if

return of income is not submitted, or return of income is submitted late, or in the return of

income deduction under section 10A is not claimed.

(G) Deduction - If the aforesaid conditions are satisfied, the deduction under section 10A

may be computed as under:

(1) Period Of Deduction –

(i) If the aforesaid conditions are satisfied, the assessee can claim deduction under

section 10A from his total income, for a period of 10 consecutive assessment years

beginning with the assessment year relevant to the previous year in which the

undertaking begins to manufacture or produce such articles or things or computer

software.

(ii) For the undertakings which have claimed exemption up to the assessment year 2000-

01 under the old section 10A, the deduction shall be available for the unexpired

period of 10 consecutive assessment years' under the new. section 10A.

(iii) For an undertaking which was initially located in free trade zone or export processing

zone and is subsequently located in a special economic zone by reason of conversion

of such zones into a special economic zone, the deduction shall be available for 10

years from the previous year in which the undertaking begins to manufacture or

produce such articles or things or computer software in such free trade zone or export

processing zone.

(iv) The aforesaid deduction is not available to any undertaking from the assessment year

2012-13.

(2) Computation of Deduction: The deduction under Sec. 10A is computed by fallowing

formula: Profit of the business × Exporturnover / Total Turnover

(3) Amount of deduction - The deduction under section 10A in the case of an

undertaking which begins to manufacture or produce articles or things or computer software

during April 1,2002 and March 31,2005 in any special economic zone, shall be as follows—

It is available for first 10 assessment years.

(i) First 5 years -100 per cent of profits and gains derived from the export of such articles

or things or computer software is deductible for a period of 5 consecutive assessment

years (beginning with the assessment year relevant to the previous year in which'the

undertaking begins to manufacture or produce such articles or things or computer

software, as the case may be).

(ii) Sixth and seventh year - 50 per cent of such profits and gains is deductible for further

2 assessment years.

(iii) Eighth, ninth and tenth year - For the next 3 years, a further deduction would be

available to the extent of 50 per cent of the profit provided an equivalent amount is

debited to the profit and loss account of the previous year and credited to Special

Economic Zone Re-investment Allowance Reserve Account. The following

conditions should be satisfied—

56

(A) The Special Reserve Account should be utilised for the purpose of acquiring new

plant and machinery.

(B) The new plant and machinery should be first put to use before the expiry of 3 years

from the end of the year in which the Special Reserve Account was created.

(C) Until the acquisition of new plant and machinery the Special Reserve Account can

be utilised for the business purposes of the undertaking but it cannot be utilised for

distribution of dividends/ profits or for remittance outside India as profits or for

creating an asset outside India.

(D) Prescribed particulars should be submitted in respect of new plant and machinery

along with the return of income for the previous year in which such plant and

machinery was first put to use in Form 56FF.

(E) If the Special Reserve Account is misutilised then the deduction would be taken

back in the year in which the Special Reserve Account is misutilised. If the Special

Reserve Account is not utilised for acquiring new plant and machinery within three

years as stated above then the deduction would be taken back in the year

immediately following the period of three years.

Consequences of amalgamation/demerger - If a company which is entitled for deduction

under section 10A is amalgamated/demerged with another company (before claiming tax

holiday for 10 years), the amalgamated company/resulting company can avail the benefit

under section 1OA for the unexpired period of tax holiday (including the previous year in

which amalgamation/ demerger takes place). However, this facility is available only when

transferor-company and transferee-company are Indian' companies. In order to get the benefit

for the unexpired period, the assessee company must prove that it is a successor to the

predecessor who was enjoying the benefit of section 10A/10B.

4.4 SPECIAL PROVISIONS IN RESPECT OF NEWLY ESTABLISHED UNITS IN

SPECIAL ECONOMIC ' ZONE [SECTION 10AA]

Section 10AA has been inserted to give income-tax concession to newly established units fa

Special Economic Zone.

(A) Conditions - The following conditions should be satisfied to claim deduction under

10AA

1. The assessee is an entrepreneur as defined in section 2(j) of SEZ Act, 2005.

Entrepreneur is a person who has been granted a letter of approval by the

Development Commissioner to set up a unit in a Special Economic Zone.

2. The unit in Special Economic Zone begins to manufacture or produce articles or

things or provide services during the financial year 2005-06 or any subsequent year.

Manufacture for this purpose means to make, produce, fabricate, assemble, process or

bring into existence, by hand or by machine, a new product having a distinctive name,

character or use and shall include processes such as refrigeration, cutting, polishing,

blending, repair, remaking, re-engineering and includes agriculture, aquaculture,

animal husbandry, floriculture, horticulture, poultry, sericulture and mining.

3. It is not formed by the splitting up, or reconstruction, of a business already in

existence [for a few exceptions, see para 254.1-la].

4. It is not formed by the transfer to a new business, of old plant or machinery. However,

it can be formed by transfer of old plant or machinery to the extent of 20 per cent.

57

5. The assessee has income from export of articles or thing or from services from such

unit. In other words, the assessee has exported goods or provided services out of India

from the Special Economic Zone by land, sea, air or by any other mode.

6. Books of account of the taxpayer should be audited. The taxpayer should submit audit

report in Form No. 56F along with the return of income.

7. Deduction under section 10AA is not available unless it is claimed in the return of

income. In other words, if the assessee fails to make a claim in his return of income of

this deduction, the same will not be allowed.

(B) Amount of deduction - If the above conditions are satisfied, one can claim deduction

under section 10AA. Deduction depends upon quantum of profit derived from export of

articles or things or services (including computer software). It is calculated as:

Profit of Undertaking X Export turnover / Total Turnover

(C) Consequences for merger and demerger - Where an undertaking is transferred to

another company under a scheme of amalgamation or demerger, the deduction under section

10 AA shall be allowable in the hands of the amalgamated or the resulting company for the

unexpired period. However, no deduction shall be admissible under this section to the

amalgamating company or the demerged company for the previous year in which

amalgamation or demerger takes place*.

(D) Consequences of claiming deduction under section 10AA

1. Unabsorbed depreciation allowances or unabsorbed capital expenditure on scientific

research or family planning (pertaining to the assessment year 2005-06 or earlier years) are

not allowed to be carried forward and set off against the income of assessment years

following the period of deduction. However, this restriction is not applicable to losses in

respect of other businesses.

2. The losses under section 72(1) or 74(1) or 74(3) (pertaining to the assessment year 2005-06

or earlier years) are not allowed to be carried forward in assessment years succeeding the

period of deduction. The deductions under section 80-IA or 80-IB shall also not be available

to such undertakings after the expiry of tax holiday period. However, there is no bar to adjust

losses under sections 70 and 71. In other words, if loss is incurred by an undertaking which is

otherwise eligible for deduction under section 10AA, it can be set off under the provisions of

sections 70 and 71 against other incomes of the taxpayer.

3. In the assessment year following period of deduction, the depreciation will be computed on

the written down value of the asset as if the depreciation has actually been allowed in respect

of each assessment year falling in the period of exemption.

(E) Deduction

(a) Deduction for first five assessment years - 100 per cent of the profit and gains

derived from export of articles or things or from services is deductible for a period of 5

consecutive assessment years. Deduction for the first year is available in the assessment year

relevant to the previous year in which the unit begins to manufacture or produce articles or

things or provide services.

(b) Deduction for sixth assessment year to tenth assessment year - 50 per cent of the

profit and gains derived from export of articles or things or from services is deductible for the

next 5 years.

58

(c) Deduction for eleventh assessment year to fifteenth assessment year - For the next

5 years, a further deduction would be available to the extent of 50 per cent of the profit

provided ah equivalent amount is debited to the profit and loss account of the previous year

and credited to Special Economic Zone Re-investment Allowance Reserve Account.

4.5 AGRICULTURAL INCOME [SEC. 2(1A)]

Under Section 10(1) of the Act, agricultural income is exempt from tax. A detailed study of

this income is, therefore, quite necessary to make a clear interpretation of its definition.

According to Section 2(1A) of the Act, agricultural income means the following:

1. Any rent or revenue derived from land which is situated in India and is used for

agricultural purposes.

2. Any income derived from such land by: (i) agriculture, or

(ii) the performance by a cultivator or receiver of rent in kind of any process ordinarily

employed to render the produce fit to be taken to market, or

(iii) the sale by a cultivator or.receiver of rent in kind of the produce raised or received by

him in respect of which only the process mentioned in (ii) has been performed.

3. Income derived from. The income from a farm house is treated as agricultural income if

the following conditions are satisfied:

(i) the building is owned and occupied by the cultivator or receiver of the rent or revenue of

any such land; and

(ii) it is situated on or in the immediate vicinity of the agricultural land; and

(iii) the building is, by reason of his connection with the land, used as dwelling house or a

store-house or an out-house by the cultivator or receiver of rent-in-kind;

(iv) the land is either assessed to land revenue in India or is subject to a local tax; or

(v) the land (though not assessed to land revenue or local tax) is situated in non-urban' area,

i.e., an area which, though, is within municipality or cantonment board jurisdiction, has a

population of less than 10,000; or where the land is not assessed to land revenue or subject to

local rate, and if the farm building is situated within the area specified below, the income

derived from such building shall not be agricultural income. The land is situated in any area

within.

(1) not being more than two kilometres from the local limits and which has population more

than ten thousand but not exceed ing one lakh, or

(2) not being more than six kilometres from the local limits and which has a population of

more than one lakh but not exceeding ten lakh; or

(3) not being more than eight kilometres from the local limits and which has a population

more than ten lakh.

Notes:

(i) The income derived from any arising from the use of such building or land for any

purpose other than agricultural (mentioned in 1 and 2) shall not be exempt.

(ii) Any surplus arising on sale or transfer of agricultural land is not treated as rent or revenue

derived from land.

(iii) Following important points emerge out of the definition of agricultural income:

(a) Land must be situated in India.

(b) Land must be used for agricultural purposes.

(c) Income must be derived from agricultural land directly and not indirectly.

59

Explanation

(a) Land must be used for agricultural purposes in the relevant previous year. But all

incomes from land may not be treated as agricultural income. The Act is silent on the point as

to which incomes can strictly be considered as agricultural or as derived from land actually

used for agricultural purposes. We can, therefore, depend upon an important decision of the

Supreme Court in order to understand this term clearly. As pointed out in the judgment of the

Supreme Court in C.I.T. v. Raja Benoy Kumar Sahas Roy (1957) 32 ITR 466, 'agriculture in

its primary sense denotes the cultivation of land in the strict sense of the term, i.e., tilling of

the land, sowing seeds, planting and similar operation on the Land'. On this broad principle,

income from the sale of wild grass, bamboos, trees and fruits of spontaneous growth cannot

be treated as agricultural income because these items grow on the land spontaneously and

without any intervention of human skill and labour or agricultural operations.

(b) Income should be received either by the tenant or the owner or a mortgagee in

possession of the land who is directly responsible for carrying out the agricultural operations

on the land. Income earned by a merchant, who purchases a standing crop from the cultivator

and after carrying out the harvesting process sells the produce at a profit, is not agricultural

income because the land in this case is not the direct or immediate source of income for the

merchant. Similarly interest on arrears of rent or revenue is not treated as agricultural income

because the source of interest is not the land but it is the rent or revenue.

(c) Where the crop as harvested does not find a market and it requires some operations to

make it a marketable commodity, such operations enhances the value of the produce.

Whenever, such operations are carried out by the cultivator or receiver of rent-in-kind, the

additional income to him is also agricultural income.

(d) Where the cultivator or receiver of rent-in-kind sells the produce direct to the

consumers instead of Mandi, he earns some additional income. This additional income is also

treated as agricultural income.

(e) For exemption of farm house it should be occupied and owned by:

(a) if the owner of the land, or

If the building is occupied by the cultivator—whether owned by him or not.

Kinds of Agricultural Income: Various kinds of agricultural income, as explained in

Section 2(1 A) of the Act, are given below:

(i) Any rent or revenue derived from land used for agricultural purposes.

(ii) Income derived from cultivation of such land,

(iii) Income derived from such land by the performance of any process which is,

ordinarily, employed by the cultivator or receiver of rent in kind to render the produce

fit for marketability, e.g., ginning of cotton, curing of coffee, rice from paddy etc.

(iv) Income derived from such land by the sale of the produce raised on it.

(v) Income derived from building situated on or in immediate vicinity of the agricultural

land which is used for agricultural purposes.

Non-agricultural Incomes: The following incomes, being related to land, appear to be

agricultural incomes but they are not so because either the land in these cases is not used for

agricultural purposes or income is not derived directly from land:

(i) Income from markets and fisheries,

(ii) Income from mining royalties.

(iii) Income from the supply of water for irrigation purposes,

60

(iv) Income from stone quarries,

(v) Income from land used for bricks.

(vi) Income from land used for storing agricultural produce,

(vii) Remuneration received by the manager of an agricultural farm,

(viii) Income from forest trees of spontaneous growth,

(ix) Income from dairy farm.

(x) Interest on arrears of rent in respect of agricultural land,

(xi) Income from poultry farming, butter and cheese-making,

(xii) Income from the sale of silk cocoons produced by silk worms is not treated as

agricultural income [K. Lakshmansa & Co. v. C.I.T. (1981).

(xiii) Income from supply of water from a tank situated in the agricultural land [Sri Ranga

Vilas Ginning and Oil Mills v. CIT (1982).

Partly Agricultural Income: In some cases, there is composite income which is partly

agricultural and partly non-agricultural. For example, an assessee manufactures finished tea

or tobacco or sugar from the raw material grown by him or received as rent-in-kind on the

land used for agricultural purposes. In such cases, the profits relating to manufacturing

process is treated as business income and that relating to the agricultural process as

agricultural income.

[1] Profits of Sugar Factory [Rule 7]: While determining the taxable income in such cases,

the market value of the agricultural produce, i.e., sugarcane, which has been utilized as a raw

material, shall be deducted from the income of the factory. No further deduction is

permissible in respect of any expenditure incurred by the assessee as cultivator or receiver of

rent-in-kind. Where the agricultural produce is not ordinarily, sold in the market, all the

expenses of its cultivation and land revenue or rent paid for the land plus a reasonable rate of

profit will be deducted from the income. The balance will be taxable as business income.

[2] Income from Manufacture of Tea [Rule 8]: Income derived from the sale of tea grown

and manufactured by the seller in India shall be computed as if it were income derived from

business. After that, 40% of such income shall be treated as business profit liable to tax and

the remaining 60% shall be treated as agricultural income. Salary and profit received by a

partner from a firm engaged in growing tea leaves and manufacturing tea is taxable in his

hands to the extent of 40 per cent of such receipt as business income, the remaining 60 per

cent is exempt from tax being agricultural income [C.I.T. v. R. Chidambaram Pillai (1977)

106 ITR 292 (SC)].

[3] Income from the manufacture of centrifuged latex or cenex (Rule 7A). Sixty-five per

cent of the income derived from the sale of centrifuged latex or cenex or latex based crepes or

brown crepes or technically specified block rubbers manufactured or processed from rubber

grown in India is deemed to be agricultural income and the remaining thirty-five per cent is

taken as Business income.

[4] Income from the manufacture of Coffee (Rule 7B) Seventy five percent of the income

derived from the sale of coffee grown and cured by the seller in India is deemed to be

agricultural income and twenty five percent is taken as business income, Sixty per cent of the

income derived from the sale of coffee grown, cured, roasted and grounded by the seller in

India is deemed ; to be agricultural income and the remaining forty per cent is taken as

business income.

61

Notes:

1. Amount received from insurance company on account of damage caused! by hail-storm to

growing tea, the entire amount is agricultural income [Camellia Tea Croup Pvt. Ltd. v. C.I.T.

(1993) 203 ITR 80].

2. Interest on capital and salary received by a partner from a firm which is engaged in

agricultural operations is agricultural income.

Illustration State whether the following are Agricultural Income or not:

Example 1:

1. An assessee earns Rs. 20,0000 as commission for selling the agricultural produce of his

tenants.

2. A partner received Rs. 10,000 as interest on his capital from the firm engaged in

agricultural operations.

3. Compensation received from insurance company.

Solution:

1. Commission for selling the agricultural produce of tenants is not agricultural income. Such

income has no direct connection with the agricultural land. But any profit on the sale of

agricultural produce will be agricultural income in the hands of the tenant since he earns it

direct from land used for agricultural purposes by carrying out agricultural operations on it.

2. In the case of C.I. T. v. R. Chidambaram Pillai, it was held that any payment received by a

partner from the firm in the form of salary, interest etc. is only a mode of adjustment of the

firm's income. In view of this, interest on capital received by a partner from the firm will be

treated as agricultural income.

3. Compensation received from an insurance company for damage of crop is agricultural

income because it is received on account of loss of agricultural income.

(E) Tax on non-agricultural income if the assessee earns agricultural income also or

integration of Agricultural income:

As already discussed, there is no tax on agricultural income but if an assessee has

non-agricultural income as well as agricultural income, such agricultural income is included

hi his total income for the purpose of computation of Income-tax on non-agricultural income.

This is also known as partial integration of agricultural income with non-agricultural income

or indirect way of taxing agricultural income. Such partial integration is done only in the case

of: (i) individual; (ii) HUF; (iii) AOP/BOI; (iv) Artificial juridical person. It is not done in the

case of: (i) firm; (ii) company; (iii) co-operative society; (iv) local authority.

The partial integration is done to compute the tax on non-agricultural income only when the

following two conditions are satisfied:

(i) non-agricultural income of the assessee exceeds the maximum exemption limit which for

assessment year 2016-17 is Rs. 250,000 in the case of an individual (other than individual of

the age of 60 years or above) and HUF, etc.; and

(ii) the Net Agricultural Income exceeds Rs. 5,000.

Notes:

In the case of individual (where male of female) who is resident in India and who is of the

age of 60 years or more but less than 80 years at any time during the previous year, the

maximum exemption limit shall be Rs. 3,00,000 instead of Rs. 2,50,000 and in case of an

62

individual who is resident in India who is of the age of 80 years or more at any time during

the previous year, the maximum exemption limit shall be Rs. 5,00,000 instead of Rs.

2,50,000.

Computation of tax where there is agricultural income also: The following steps should

be followed to calculate the tax:

Step 1: Add agricultural income and non-agricultural income together and calculate tax on

the aggregate as if such aggregate income is the Total Income.

Step 2: Add agricultural income to the maximum exemption limit available in the case of the

assessee and compute-tax on such amount as if it is the Total Income.

Step 3: Deduct the amount of income-tax as computed under Step 2 from the tax computed

under Step 1.

The net amount so arrived at shall be total Income-tax payable by the assessee.

Step 4: Add education cess and SHEC @3%

Example 2: Gross Total Income of aged 50 years as computed under Income tax Act, for the

assessment year 2016-17 is Rs. 3,00,000. He deposits Rs. 20,000 in a PPF account. Compute

the tax payable by him assuming that he has agricultural income of (a) Nil; (b) Rs. 5,000; and

(c) Rs. 3,50,000.

Solution: (a) and (b) Since the agricultural income is either Nil or does not exceed Rs. 5,000,

there will be no partial integration arid the Income-tax will be calculated on Rs. 2,80,000 as

usual. Tax on Rs. 2,80,000 will be Rs. 3,090 (Rs. 3,000 + 60+30).

(c) Step 1 Rs.

Aggregate of agricultural and non-agricultural income (Rs.

3,50,000+2,80,000

630000

Tax on Rs. 630000 51000

Step 2

Add Rs. 250000 (Maximum exemption limit) to agricultural

income of Rs. 3,50,000

6,00,000

Tax on Rs. 6,00,000 45,000

Step 3

Deduct Tax under Step 2 from Tax under Step 1 (Rs. 51000 -

45000)

6,000

Therefore, tax on non-agricultural income 6,000

Step 4

Add : Education cess & SHEC - @ 3% 180

Therefore, total tax payable 6180

Example 3: A, a resident in India, aged 60 years earned agricultural income of Rs. 5,00,000

during the previous year 2015-16. Compute his tax liability assuming that he has non-

agricultural income of:

(a) Rs. 2,20,000 (b) Rs. 2,50,000; (c) Rs. 3,30,000.

Solution: (a) and (b) Since the non-agricultural income does not exceed the maximum

exemption limit of 300000 (being individual of the age of 60 years of more) there will be no

partial integration and tax payable on non-agricultural income will be Nil. Further,

63

agricultural income itself is exempt. Therefore, the total tax payable is nil. However in case

of (c) the total tax payable will be Rs. 6180.

4.6 TEA DEVELOPMENT ACCOUNT, COFFEE DEVELOPMENT ACCOUNT

AND RUBBER DEVELOPMENT ACCOUNT (SECTION 33AB)

Where an assessee is carrying on the business of growing and manufacturing tea or Coffee or

Rubber in India and has, before the expiry of six months from the end of previous year or

before furnishing the return of income, whichever is earlier, deposited with the National Bank

of Agriculture and Rural Development (NABARD) any amount in a Special Account

maintained by him in the bank in accordance with the scheme approved in this behalf by the

Tea Board or the Coffee Board or the Rubber Board then the assessee will be entitled to a

deduction.

(A) Quantum of Deduction:

A. a sum equal to the amount or the aggregate of the amounts so deposited; or B. a sum

equal to forty per cent of the profits of such business computed under the head 'profits

and gains of business or profession' before making any deduction under this section

and Section 72, i.e., before set off any loss brought forward from earlier years);

whichever is less.

Where the assessee is a firm or an association of persons or body of individuals, the

deduction under this section shall not be allowed again in the computation of the income of

any partner or member as the case may be. Further where any deduction, in respect of any

amount deposited in the Special Account, has been allowed in any previous year, no

deduction shall be allowed in respect of such amount in any other previous year.

(B) Audit of accounts: The deduction under this section will not be allowed unless the

accounts of the business of the assessee are audited and the audit report is furnished along

with the return of income.

(C) Prohibition of utilisation of the deposit: Amount withdrawn from deposit can

not be utilised for:

(i) any machinery or plant to be installed in office premises or residential

accommodation including a guest house;

(ii) any office appliances (not being computers);

(iii) any machinery or plant, the whole of the actual cost of which is allowed as a

deduction in any one previous year in computing the income chargeable under the

head 'Profits and gains of business or profession';

(iv) any new machinery or plant installed in an industrial undertaking for the purposes of

business of construction, manufacture or production of any article or thing specified

in the Eleventh Schedule; the amount so utilised shall be deemed to be the profits of

that previous year and chargeable to tax.

(D) Withdrawal from the Deposit: Any amount standing to the credit of the assessee in

the Special Account shall not be allowed to be withdrawn except for the specified purposes in

the scheme or in the following circumstances:

(i) Closure of business.

64

(ii) Death of an assessee.

(iii) Partition of a H.U.F.

(iv) Dissolution of a firm.

(v) Liquidation of a company.

Where the amount from the Special Account is withdrawn in any previous year at the closure

of business or dissolution of firm, the whole amount so withdrawn shall be deemed to be the

income of that previous year and chargeable to income-tax.

(E) Disallowance of expenditure: Where any amount out of the Special Account is

utilised by the assessee for the purpose of any expenditure in connection with the business in

accordance with the scheme, such expenditure shall not be allowed in computing the income.

(F) Withdrawal chargeable to tax in certain cases: Where any amount is released out

of the Special Account for being utilised by the assessee for purposes specified in the scheme

or at the time of closure of the account is not utilised in accordance with the scheme and

within that previous year either wholly or in part, the amount not so utilised shall be deemed

to be the profits of the business or profession and accordingly charged to tax.

(G) Restriction on sale or transfer of assets: The assets in respect of which deduction

has been allowed must not be sold or otherwise transferred by the assessee to any other

person for a period of 8 years immediately following the previous year in which the asset was

acquired. However, this restriction of 8 years will not apply in the following cases:

(i) Where the assets has been sold or transferred to the Government, a local authority, a

statutory corporation or a Government company.

(ii) Where the sale or transfer of an asset is made in a scheme of succession of a firm by a

company provided the following conditions are satisfied: a. all the assets and

liabilities of the firm relating to the business immediately before succession become

the assets and liabilities of the company. b. all the shareholders of the company were

the partners of the firm immediately before the succession.

If the asset is sold or transferred otherwise than mentioned above, such part of the cost of

such asset as it is relatable to the deduction allowed under this section shall be deemed to be

the profits of the business of the previous year in which the asset is sold.

Note: The deduction under Section 33AB will also be available, if the assessee deposits in an

account (known as Tea Deposit Account) Coffee Deposit Account/Rubber Deposit Account

in accordance with a scheme framed by the Tea Board/Coffee Board/Rubber Board with the

previous approval of the Central Government.

4.7. DEDUCTION IN RESPECT OF PROSPECTING FOR, OR EXTRACTION OR

PRODUCTION OF PETROLEUM OR NATURAL GAS OR BOTH IN INDIA —

(SECTION 33ABA)

(A) The main provisions of this section are as under:

(i) Deduction will be allowed if the Central Government has entered into an agreement

with the assessee.

(ii) The assessee before the end of the previous year has deposited the amount:

(a) in a special account with the State Bank of India, for the specified purposes in

a scheme approved in this behalf by the Government of India.

65

(b) in an account—Site Restoration Account (S.R.A.) for the purposes specified in

a scheme framed by the Government.

(B) Quantum of deduction:

(a) a sum equal to the amount or the aggregate of the amounts so deposited; or

(b) 20% of the profits of such business (computed under the head 'Profits and

gains of business or profession' before making any deduction under the section

33ABA whichever is less.

Notes:

(i) The profits shall be computed before deducting the brought forward losses from

earlier years,

(ii) Where assessee is a firm, A.O.P., or B.O.I, the deduction shall not be allowed to

partners or members, as the case may be.

(iii) Where any deduction is respect of deposits has been allowed in any previous year, no

deduction shall be allowed in respect of such amount in any other previous year. For

example, an assessee deposits 25% of the profits of such business in S.R.A. in

previous year 2014-15. He wi 11 get the deduction of only 20% of such profits. In the

following year he cannot claim the deduction in respect of additional 5% amount

deposited.

(C) Condition for deduction. The accounts of the assessee must be audited for the

previous year in which the deduction is claimed and the audit report must be furnished

along with the return of income.

(D) Withdrawal from the deposit. The amount deposited in special account or S.R.A.

shall not be allowed to be withdrawn except for the purposes specified in the scheme or in the

circumstances specified below:

(i) closure of business

(ii) death of an assessee

(iii) partition of a H.U.F.

(iv) dissolution of a firm

(v) liquidation of a company.

(E) No deduction will be allowed in respect of any amount utilised for the purchase

of:

(a) any machinery or plant to be installed in any office premises or residential

accommodation or guest house;

(b) any office appliances (not being computers);

(c) any machinery or plant, the whole of the actual cost of which is allowed as a

deduction in computing business income of any one previous year;

(d) any new machinery or plant to be installed in an industrial undertaking for the

purposes of business of construction, manufacture or production of any article

or thing specified in the Eleventh Schedule.

(F) Chargeability on withdrawl

(a) Where the amount is withdrawn from S.R.A. on closure of business or

dissolution of a firm it will be deemed to be the income of that previous year

and chargeable to tax accordingly.

66

(b) Where the amount is withdrawn for being utilised for the purposes of such

business in accordance with the scheme, is not so utilised, wholly or partly,

within that previous year, the unutilised amount shall be deemed to be the

profits and gains of business and accordingly chargeable to tax for that

previous year.

(c) Where any asset acquired in accordance with the scheme is sold or otherwise

transferred in any previous year by the assessee to any person at any time

before the expiry of eight years from the end of previous year in which it was

acquired, such part of cost of such asset as it relatable to the deduction shall be

deemed to be the profits and gains of business of the previous year in which

the asset is sold or otherwise transferred. However, this provision shall not

apply in the following cases:

(i) where the asset is sold or transferred to Government, a local authority, a corporation

established by or under a Central, State or Provincial Act or a Government Company.

(ii) where the sale or transfer of the asset is made in connection with the succession of a

firm by a company and the Scheme continues to apply to the company inthe same

manner applicableto the firm.

(G) No deduction for expenses out of special account or S.R.A.: Where the amount is

withdrawn and utilised for such business in accordance with the scheme, such expenditure

shall not be allowed as a deduction in computing the income under the head 'Profits and gains

of business or profession.

(H) Withdrawal of deduction. The Central Government may, by notification, withdraw

the deduction after such date as may be specified in the notification.

4.8 EXPENDITURE FOR OBTAINING LICENCE TO OPERATE

TELECOMMUNICATION SERVICES [SECTION 35ABB]

Where any capital expenditure is incurred by the assessee for acquiring any right to

operate telecommunication services either before the commencement of the business to

operate telecommunication service or thereafter any time during any previous year and for

which payment has actually been made a deduction will be allowed in equal instalments over

the period for which the license remains in force, subject to the following conditions:

(a) If the fee is paid for acquiring any right to operate telecommunication services before

the commencement of such business, the deduction shall be allowed for the previous

years beginning with the previous year in which such business commenced.

(b) If the fee is paid for acquiring such rights after the commencement of such business

the deduction shall be allowed for the previous years beginning with the previous year

in which the license fee is actually paid.

Notes:

(i) Where a deduction for any previous year has been claimed and allowed under this

section, no depreciation shall be allowed under section 32(1) for the same or any

subsequent year.

(ii) Payment has actually been made" means the actual payment of expenditure

irrespective of the previous year in which the liability for the expenditure was

incurred according to the method of accounting regularly employed by the assessee.

67

Example 4: Z. Ltd. obtained a licence to operate telecommunication services from

Department of Telecommunication on 1.7.2012 for a period of 11 years i.e. till 30.6.2023 for

a sum of Rs. 13,20,000. Calculate the amount of deduction available to the company under

section 35ABB for the various previous years assuming:—

(a) The payment of the entire licence fee was made on the date of acquisition of the

licence;

(b) Rs. 4,00,000 was paid on the date of acquisition, Rs. 2,60,000 was paid on 15.10.2012

and balance Rs. 6,60,000 will be paid in two equal instalments of Rs. 3,30,000 each

during previous year 2013-14 and 2014-15.

Solution: (a) Since the entire licence fee has been paid during the previous year 2012-13, the

deduction under section 35ABB shall be allowed for 12 relevant previous year in

equal amount of Rs. 1,10,000 each year starting from previous year 2012-13.

(b) Amount to be allowed as deduction

in previous year 2012-13 Rs.660000

12= 55,000

Amount to be allowed as deduction

in previous year 2013-14

55,000 (1/12th the amount paid in 2012-13

30,000 (3,30,000/11 i.e. amount paid in 2013-14

unexpired period of licence i.e. Rs. 85,000

Amount to be allowed as deduction in previous year 2014-15

Rs. 85,000 + 33,000 (3,30,000/10)

i.e. Rs. 118000

Previous years 2015-16 to 2013-24 Rs. 1,18,000

(A) Sale of licence

(a) Where the entire licence is transferred: (i) If the sale proceeds is less than the written down value of the licence, such deficiency shall

be allowed as deduction in the year in which the licence is transferred.

(ii) If the sale proceeds exceeds the written down value of the licence then such excess shall

be taxable as under:

(a) Where the sale proceeds does not exceed the original cost of the licence Sale

proceeds — Written down value of the licence shall be business income

taxable under this section.

(b) Where sale proceeds exceeds the original cost of licences

Original cost — WDV of the licence shall be business income taxable under this section and

Sale proceeds — Original cost (indexed cost in case the assets are held for more than 36

months) shall be short-term or long-term capital gain of the previous year in which such

assets are sold.

(b) Where only a part of the licence is transferred: (i) Where a part of the licence is transferred for a sum less than the written down

value of the total licence, the balance amount not yet written off shall be allowed as

deduction in the balance number of years in equal instalments.

(ii) If part of the licence is transferred for a sum exceeding the written down value of

the licence, then such excess shall be taxable as under:

68

Where the sale proceeds does not exceed the original cost of the licence Sale proceeds —

WDV of the entire licence shall be business income taxable under this section.

Where sale proceeds exceeds the original cost of licences

(i) Original cost — WDV of the entire licence shall be business income taxable

under this section.

(ii) Sale proceeds — Original cost of entire licence (indexed cost in case the assets

held for more than 36 months) shall be short-term or long-term capital gain of

the previous year in which such asset is sold.

Notes:

(a) Amalgamation demerger the; amalgamated! company or the resulting company, as the

case may be, shall be allowed to write off the balance amount of licence which was

not written off by the amalgamating company or demerged company in the same

manner as was allowed to the amalgamating company or demerged company as the

case may be.

(b) Where a deduction for any previous year u/s 35ABB(1) is claimed and allowed in

respect of any expenditure referred to in that sub-section, no deduction shall be

allowed on account of depreciation u/s 32(1) in the same previous year or any

subsequent previous year.

4.9 EXPENDITURE ON ELIGIBLE PROJECTS OR SCHEMES [SECTION

35AC]

Where an assessee incurs any expenditure by way of payment of any sum to a public

sector company or a local authority or to an association or institution approved by the

National Committee for carrying out any eligible project or scheme for promoting the social

and economic welfare of or the uplift of the public as the Central Government may specify,

the amount so paid, shall be allowed as deduction provided a certificate in Form No. 58A is

obtained from the said institution and furnished alongwith the return of income.

However, in the case of a company assessee, the deduction of such expenditure can be

allowed as under:

(a) Expenditure by way of payment to aforesaid institutions for specified purpose: The expenditure incurred by the company by way of payment of any sum to a public

sector company or to a local authority, or to an approved institution/association as

specified above. The deduction shall not be allowed unless the assessee furnishes,

alongwith a return of income, a certificate from such public sector company or local

authority or association in Form No. 58A.

(b) Direct expenditure: The expenditure incurred directly by the company on the

eligible project or scheme undertaken by it. The deduction shall not be allowed to the

assessee unless it furnishes, alongwith the return of income, a certificate from a

Chartered Accountant in Form No. 58B.

Notes:

(i) All assessees other than companies are allowed deduction only for payments made to

outside agencies whereas the companies may either make the payment to outside

agencies or incur the expenditure themselves.

69

(ii) If deduction is claimed under this provision, it shall not be allowed under any other

provision of the Act for the same or any other assessment year.

4.10 DEDUCTION IN RESPECT OF EXPENDITURE ON SPECIFIED BUSINESS

[SECTION 35AD]

(A) Eligibility: Deduction under section 35AD shall be allowed to the assessee who is

carrying on any of the following specified business:

(i) Setting up and operating a cold chain facility;

(ii) Setting up and operating a warehousing facility for storage of agricultural produce

(iii) laying and operating a cross-country natural gas or crude or petroleum oil pipeline

network for distribution, including storage facilities being an integral part of such

network

(iv) The business of building and operating anywhere in India, a hotel of two-star or above

category, as classified by the Central Government;

(v) Building and operating, anywhere in India, a hospital with at least 100 beds for

patients;

(vi) Developing and building a housing project under a scheme for slum redevelopment or

rehabilitation framed by the Central Government or a State Government, as the case

may be, and notified by the Board in this behalf in accordance with the guidelines as

may be prescribed;

(vii) Developing and building a housing project under a scheme for affordable housing

framed by the Central Government or a State Government, as the case may be, and

notified by the Board in this behalf in accordance with the guidelines as may be

prescribed;

(viii) Production of fertiliser in India;

(ix) Setting up and operating an Inland Container Depot or Container Freight Station

notified and approved under the Customs Act, 1962;

(x) Bee-keeping and production of honey and beeswax; and

(xi) Setting up and operating a warehousing facility for storage of sugar.

(B) Nature and amount of deduction: 100% deduction shall be allowed on account of

any expenditure of capital nature incurred wholly and exclusively for the purpose of the

above specified business carried on by such assessee during the previous year in which such

expenditure in incurred by him. However, in case any of the following business has

commenced its operation on or after 1-4-2012, the deduction allowed shall be 150% of such

capital expenditure incurred instead of 100%. The deduction is allowed for:

(a) Setting up and operating a cold chain facility.

(b) Setting up and operating a warehouse for storage of agricultural produce.

(c) Building and operating, anywhere in India, a hospital with atleast one hundred beds

for patients.

(d) Developing and building a housing project under a scheme for affordeable housing

framed by the Central Government or State Government and notified by the Board in

accordance with guidelines as prescribed.

(e) Production of fertilizer in India.

(C) Expenditure incurred prior to commencement of operation to be allowed in the

year of commencement of operation: The expenditure incurred, wholly and exclusively, for

the purposes of any specified business, shall be allowed as deduction during the previous year

in which he commences operations of his specified business, if—

70

(a) the expenditure is incurred prior to the commencement of its operations; and

(b) the amount is capitalized in the books of account of the assessee on the date of

commencement of its operations.

(D) Conditions: This section is applicable to the specified business which fulfils all the

following conditions:

(i) it is not set up by splitting up, or the reconstruction, of a business already in existence;

(ii) it is not set up by the transfer to the specified business of machinery or plant

previously used for any purpose;

(iii) where the business is of laying and operating a cross country natural gas or crude or

petroleum oil pipelines network it should satisfy the following conditions also:

(a) it is owned by an Indian or by a consortium of such companies or by an

authority or a board or a corporation established or constituted under any

Central or State Act;

(b) it has been approved by the Notified Petroleum and Natural Gas Regulatory

Board;

(c) it has made such proportion of its total pipeline capacity available; for use on

common carrier basis by any person other than the assessee or an associated

person as prescribed' by the Petroleum and Natural Gas Regulatory Board;

(d) any other condition as may be prescribed.

Notes:

(A) "Cold chain facility" means a chain of facilities for storage or transportation of

agricultural and forest produce, meat and meat products, poultry, marine and dairy

products, products of horticulture and apiculture and processed food items under

scientifically controlled conditions including refrigeration and other facilities

necessary for the preservation of such produce.

(B) Any expenditure of capital nature shall not include any expenditure incurred on the

acquisition of any land or goodwill or financial instrument.

(C) Where a deduction under section 35AD is claimed and allowed for any assessment

year, no deduction shall be allowed section 80-IA to 80RRB for the same.

Example 5: P.Ltd. constructed a building and started operating a hotel of 3 star category

w.e.f. 1.4.2015. The assessee incurred following expenditure in this connection.

1. Capital expenditure (including cost of land Rs. 50 lakhs)

incurred during December, 2014 to March 2015 which

were capitalized in the books of account 31.3.2015 Rs. 1,10,00,000

2. Capital expenditure incurred during previous year 2015-16

(it includes Rs. 20 lakhs paid for Goodwill) Rs. 1,40,00,000

(a) Compute the deduction available under section 35AD in the

assessment year

2016-17

(b) What will be your answer if such building was constructed

for operating a hospital of 100 beds.

Solution: Rs.

(a)

Capital expenditure incurred before commencement but capitalized

in books of account 1,10,00,000

Less: Cost of land not eligible for deduction under section 35AD 50,00,000

71

60,00,000

Capital expenditure incurred during previous year 2015-16

exclusive of value of goodwill 1,20,00,000

Deduction allowable under section 35AD 1,80,00,000

(b) Deduction shall be 150% of Rs. 1,80,00,000.

4.11 WEIGHTED DEDUCTION OF 150% FOR EXPENDITURE INCURRED ON

AGRICULTURAL EXTENSION PROJECT [SECTION 35CCC] [W.E.F. A.Y.

2013-14]

In order to incourage the business entities to provide better and effective agriculture extensive

services, new section 35CCC has been inserted in the Income-tax Act to allow weighted

deduction of 150% of the expenditure incurred on agricultural extension project. The

agricultural extension project eligible for this weighted deduction shall be notified by the

Board in accordance with the prescribed guidelines.

Where a deduction claimed and allowed for any assessment year in respect of any

expenditure referred to in section 35CCC(1), deduction shall not be allowed in respect of

such expenditure under any other provisions of the Income-tax Act for the same or any other

assessment year.

4.12 WEIGHTED DEDUCTION OF 150% FOR EXPENDITURE INCURRED

BY A COMPANY ON SKILL DEVELOPMENT PROJECT [SECTION

35CCD]

In order to in courage companies to invest on skill development projects in the manufacturing

sector, new section 35CCD has been inserted in the Income-tax Act to provide weighted

deduction of 150% of expenses (not being expenditure in the nature of cost of any land or

building) incurred on skill development project from [A.Y. 2013-14] The skill development

project eligible for this weighted deduction shall be notified by the Board in accordance with

the prescribed guidelines.

Where a deduction claimed and allowed for any assessment year in respect of any

expenditure referred to in section 35CCD(1), deduction shall not be allowed in respect of

such expenditure under any other provisions of the Income-tax Act for the same or any other

assessment year.

4.13 EXPENDITURE ON PROSPECTING, ETC. FOR DEVELOPMENT OF

CERTAIN MINERALS (SECTION 35E)

Where an Indian Company or any other non-corporate person resident in India incurs, any

expenditure wholly and exclusively on the prospecting of any mineral (specified in Schedule

VII of the Income tax or on the development of mines or other natural -deposit of any such

mineral, the assessee shall be allowed a deduction of an amount equal to l/10th of such

expenditure for each of the ten successive previous years beginning with the year of

commercial production. The expenditure should have been incurred during the five-year

period ending with the year of commercial production under specified heads only.

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(A) Deduction: The deduction to be allowed for any previous year shall be the lesser of

the following two alternative amounts :

(a) An amount equal to l/10th of the total expenditure eligible for deduction under this

section; or

(b) The income of the previous year arising from the commercial exploitation of any mine or

other natural deposit in respect of which the expenditure was incurred.

(B) Carry-forward of Unabsorbed Amount. If, in any year, the profits are insufficient

to absorb the whole amount of instalment relating to that previous year, the unabsorbed part

of the instalment shall be carried forward and added to the instalment of the following year

and so on, for succeeding previous years upto the tenth previous year commencing from the

year of commercial production.

(C) Audit of Accounts. Where the assessee is a person other than a company, or a co-

operative society deduction u/s 35D and 35E will be allowed only if the accounts of the

concern are duly audited by a Chartered Accountant and the assessee furnishes along with the

Return of Income for the first year in which the deduction is claimed; the report of such audit

in the prescribed form duly signed and certified by such chartered accountant.

4.14 SPECIAL PROVISIONS FOR COMPUTING PROFITS AND GAINS OF ANY

BUSINESS [SECTION 44AD]

Notwithstanding anything to the contrary contained in sections 28 to 43C, there is a special

scheme for estimating the profits and gains of assessees engaged in any business excluding

the business of transport covered under section 44AE. The broad features of the scheme are

as under:

(a) The scheme shall be applicable to an individual, a HUF or partnership firm who is a

resident but not to a Limited liability partnership firm. Thus, the scheme is not

applicable to LLP, a company assessee or AOP/BOI, etc.

(b) The provision of section 44AD shall not apply to—

(i) a person carrying on specified profession as referred to in section 44AA(1),

(ii) a person earning income from commission or brokerage, or

(iii) a person carrying on any agency business.

(c) It shall also not be applicable to an assessee who is availing deduction under section

10AA or deduction under any provisions of Chapter VIA under the heading "C.—

deductions in respect of certain incomes" in the relevant assessment year.

(d) The scheme is applicable for any other business (excluding a business of plying,

hiring or leasing goods carriages referred to under section. 44AE) whose total

turnover gross receipts in the previous year does not exceed an amount of Rs. 1 crore.

(e) a sum equal to 8% of the total turnover or gross receipts of the assessee in the

previous year on account of such business or as the case may be, a sum higher than

the aforesaid sum claimed to have been earned by the eligible assessee shall be

deemed to be the profits and gains of such business.

(f) Any deduction allowable under the provisions of section 30 to 38 shall be deemed to

have been already given effect to and no further deduction under these sections shall

be allowed. However, where the eligible assessee is a firm, the salary and interest

payable to its partners shall be deducted from the income specified in section 40(b).

(g) The written down value of any asset of an eligible business shall be deemed to have

been calculated as if the eligible assessee had claimed and had been actually allowed

the deduction in respect of the depreciation for each of the relevant assessment years.

73

(h) An assessee opting for the above scheme shall be exempted from payment of advance

tax related to such business under provisions of the Income-tax Act.

(i) An assessee opting for the above scheme shall be exempted from maintenance of

books of accounts related to such business as required under section 44AA of the

Income-tax Act.

(j) An assesses with turnover not exceeding Rs. 1 crore, who shows an income below the

presumptive rate prescribed under these provisions, will, in case his total income

exceeds the maximum amount which is not chargeable to income tax, be required to

maintain books of accounts as per section 44AA and also get them audited and furnish

a report of each such audit as required u/s 44AB.

Note:

Profession referred to in section 44AA(1): Legal, medical, engineering or architectural

profession, or profession of accountancy or interior decoration or any other profession as is:

notified by the Board in the Official Gazette,

4.15 SPECIAL PROVISIONS FOR COMPUTING PROFITS AND GAINS OF

BUSINESS OF PLYING, HIRING OR LEASING GOODS CARRIAGES

[SECTION 44AE]

Notwithstanding anything to the contrary contained in sections 28 to 43C, the scheme u/s

44AE provides for a system for estimating the income of an assessee engaged in the business

of plying, hiring or leasing of goods carriages. The broad features of the scheme are as under:

(a) the scheme is applicable to an assessee who owns not more than 10 goods carriages at

any time during the previous year and who is engaged in the business of plying, hiring

or leasing of such goods carriages;

(b) the profits and gains of each goods carriage owned by the above assessee in the

previous year shall be estimated as under:

(i) For heavy goods vehicle — Rs. 5,000 for every month or part of a month during

which the heavy vehicle is owned by the assessee in the previous year;

(ii) For goods carriage other than heavy goods vehicle — Rs. 4,500 for every month

or part of a month during which the goods carriage is owned by the assessee in

the previous year.

Note: The assessee may declare a higher income than that specified above.

(1) Consequence if presumptive income scheme is opted: following will be the result of

opting section 44AE:

(a) Expenses deemed to have been allowed: Any deduction allowable under the

provisions of sections 30 to 38 shall, for the purposes of the above income, be deemed to

have been already given full effect to and no further deduction under those Sections shall be

allowed. Remuneration and interest payable to partners, shall be allowed as deduction from

the income. Such deduction shall, however, be subject to the conditions and limits specified

u/s 40(b).

(2) Depreciation deemed to have been allowed: The written down value of any asset used

for the purpose of the business shall be deemed to have been calculated as if the assessee had

claimed and had been actually allowed the deduction in respect of the depreciation for each

of the relevant assessment years.

74

(3) Turnover of this business not to be included for computing limit of section 44AA and

44AB: The provisions of sections 44AA and 44AB shall not apply in so far as they relate to

this business and in computing the monetary limits under sections 44AA and 44AB for other

business, the gross receipts or, as the case may be, the income from the said business shall be

excluded.

Consequences if presumption income scheme is not opted: The assessee may choose not

to opt for the scheme and may declare an income lower than the specified amount. In this

case, the assessee shall have to maintain books of account and get his accounts audited by a

Chartered Accountant.

Notes:

1. An assessee, who is in possession of a goods carriage, whether taken on hire purchase

or on instalments and for which the whole or part of the amount payable is still due,

shall be deemed to be the owner of such goods carriage.

2. The income estimated as per section 44AE, shall be his income from the business of

plying, hiring or leasing goods carriages. This income will be aggregated with other

income of the assessee and deductions u/s 80C to 80U will be available to the

assessee, subject to fulfilment of conditions.

3. Income from vehicles is to be computed for every month or part of the month during

which these were owned by the assessee even though these are not actually used for

business.

4. Provision of section 44AE are not applicable in case the assessee owns more than 10

goods carriage or where he declares lower profits and gains than the profits and gains

specified in section 44AE.

Example 6: A transporter owns the following commercial vehicles:

(i) 2 light commercial vehicles — One for 9 months and two days and the other for 2

months.

(ii) 2 heavy goods vehicle — one for 6 months and 25 days and the other for 11 months

and 12 days

(iii) 2 medium goods vehicles — One for 6 months and the other for 8 months and 15

days.

(a) Compute the income from business if transporter opts for the scheme u/s

44AE.

(b) What will be the income if the trucks were not used for business for two

months during the year due to strike?

Solution

(a) The income u/s 44AE shall be computed as under: Rs.

(i) 10 x 4500 + 12 x 4500 99,000

(ii) 7 x 5000 + 12 x 5000 95,000

(iii) 6 x 4500 + 9 x 4500 67,500

Total 2,61,500

(b) Income from vehicles is to be computed for every month or part of the month during

which these were owned by the assessee even though these are not actually used for business.

Therefore there will be no change in the income of the assessee.

75

LESSON 5

Tax Planning With Reference to Financial Management Decision –

Capital Structure, Dividend Including Deemed Dividend and Bonus Shares

5. STRUCTURE

5.1 Capital Structure

5.2 Meaning of Dividend [Section 2(22)]

5.3 Accumulated Profits

5.4 Tax Treatment of Dividend

5.5 Bonus Share

5.6 Tax Planning in Relation to Dividend Income

5.1 CAPITAL STRUCTURE

Management decision regarding capital structure is very important because it effects

the dividend payable to the shareholder as well as profit alter tax of a company. A company

may face problem of raising find for expansion of its exiting activity or a new company may

decide about it capital structure before raising funds.

Capital structure refers to the mix of sources from which funds required for the

business are raised. The choice relating to raising of funds and planning the capital structure

of an undertaking would be between capital and borrowings and the planning of the optimum

debt-equity ratio.

From tax point of view expenses incurred on raising loans/debentures and interest

payable on loans is deductible in computing taxable income of the assessee. Any amount of

interest paid, in respect of loan for acquisition of an asset for extension of existing business

capitalised in the books of account or not for any period beginning from the date on which

loan was taken for acquisition of such asset till the date on which such asset was first put to

use, shall not be allowed as a deduction. However, it will be added to the cost of the asset. On

the other hand, the expenses incurred on raising capital/share capital and interest on

capital/dividend on share capital is not deductible in computing the taxable income of the

assessee. However, the following expenses in relation to capital are deductible :

1. If the assessee is a firm, the interest payable to partners on their capital and loan

capital, subject to a maximum of 12% p.a. (u/s 40(b)

2. If the assessee is an Indian company and in connection with the issue, of shares and

debentures incurs expenses (being underwriting commission, brokerage and charges

for drafting, typing, printing and advertisement of the prospectus) twenty percent of

such expenses are allowed for each of the five successive previous years beginning

with the previous year in which the business commences.

From this it may be concluded that the borrowings contribute to tax saving resulting a higher

rate of return on owner's equity. But this does not hold good in every case. If the rate of

return on total capital is more than the rate of interest, definitely the borrowing would

increase the rate of return on owner's equity. Otherwise it would reduce his rate of return. It is

clear from the following illustration:

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Example 1: Y Ltd. wants to raise Rs. 2,00,000 which is required to meet the expansion of the

business. It has three options I-issue of share capital only II-Rs. 1,60,000 though issue of

share capital on Rs. 40,000 loan from bank at 10% interest III-Rs. 40,000 by issue of share

capital and Rs. 160000 through loan from bank 10% interest. You are required to advise the

management regarding the best option in following cases. Case I-Rate of Returns 25% Case

II. Rate of Return - 10%, Case III - Rate of return-8% and Rate of tax 30%.

Solution:

Case I (Return 25%)

Options

I.

Rs.

II.

Rs.

III.

Rs.

Return 50,000 50,000 50,000

Less: Interest on

loans @ 10%

--- 4,000 16,000

Profits before Tax 50,000 46,000 34,000

Less: Tax @ 30% 15,000 13,800 10,200

Profits after Tax 35,000 32,200 23,800

Rate of Return on

capital

17.5% 20.125% 59.5%

Case II - (Return 10%)

Situations

I II III

Rs. Rs. Rs.

Return 20,000 20,000 20,000

Less: Interest on

loans @ 10%

--- 4,000 16,000

Profits before Tax 20,000 16,000 4,000

Less: Tax @ 30% 6,000 4,800 1,200

Profits after Tax 14,000 11,200 2,800

Rate of Return on

capital

7% 7% 7%

Case III (Return 8%)

Situations

I II III

Rs. Rs. Rs.

Return 16,000 12,000 16,000

Less: Interest on

loans @ 10%

--- 4,000 16,000

Profits before Tax 16,000 12,000 Nil

Less: Tax @ 30% 4,800 3,600 Nil

Profits after Tax 11,200 8,400 Nil

Rate of Return on

capital

5.6% 5.25% Nil

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Conclusion. (1) When rate of return on capital is 25% (which is more than rate of

interest 10%) the capital structure of company III is the best. The company can declare

dividend at a higher rate.

(2) When rate of return on capital is equal to rate of interest, the rate of return on

capital is same, whether the company takes the loan or issues share capital.

(3) When the rate of return in less than rate of interest it is better to raise more capital

to maintain a minimum divided rate.

Management Planning regarding capital structure:

1. Where rate of return on investment is more than the rate of interest, it will increase the

rate of return of equity capital. However, the legal requirements for raising capital

through any means of finance cannot be ignored.

2. The capital may be utilised for acquisition of non-depreciable assets like land,

goodwill, etc. and borrowed funds may be utilised to acquire depreciable assets. The

interest on loans for the .period 'after setting up of business' but before the asset was

put to use will be capitalised and a higher amount of depreciation will be allowed.

3. If the gestation period in an industry is more it is better to use capital rather than

loans. On the loan interest will be paid out of capital. This interest payment will be

carried forward as business loss which the assessee may not be able to set-off within

the prescribed period of eight years. On the other hand, the money-lenders have to pay

tax on their interest income.

4. If interest is payable outside India tax must be deducted at source. If tax has not been

deducted at source, the amount paid as interest will not be allowed as a deduction in

computing business income.

5. The term 'interest' has been defined in section 2(28A) of the Income Tax Act, 'Interest'

means interest payable in any manner in respect of any amount borrowed or debt

incurred and includes any service fee or other charge in respect of the moneys

borrowed or debt incurred or in respect of any credit facility which has not been

utilised. Hence, not only interest but also service fee or other charge on loans, whether

utilised or not, should be claimed as revenue expenses in computing the business

income.

Example 2:

X Ltd. is a widely-held Indian company. It is currently considering a major expansion of its

business and the following alternatives are available for funds:

I

Alternative

Rs.

II

Alternative

Rs.

III

Alternative

Rs.

Share capital 5,00,00,000 2,00,00,000 1,00,00,000

Debentures (14%) --- 2,00,00,000 1,50,00,000

Loan from financial institution @ 18

per cent)

-- 1,00,00,000 2,50,00,000

Expected rate of return (before tax) is 25 per cent. The rate of dividend of the company since

2005 is not less than 20 per cent.

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Capital structure decision

I

Alternative

Rs.

II

Alternative

Rs.

III

Alternative

Rs.

Return on Rs. 5 crore 1,25,00,000 1,25,00,000 1,25,00,000

Less:

Interest on debenture -- 28,00,000 21,00,000

Interest on loan -- 18,00,000 45,00,000

profit before tax 1,25,00,000 79,00,000 59,00,000

Tax @ 30% (plus 5% of tax as

surcharge plus 3% of tax and

surcharge as education cess and

secondary and higher education

cess)

40,55,625 24,41,100 18,23,100

Return on equity share capital before

dividend tax

84,44,375 54,58,900 40,76,900

Rate of return on equity share capital 16.89% 27.29% 40.77%

The company should, therefore, opt for the third alternative.

5.2 MEANING OF DIVIDEND [SEC. 2(22)] –

Section 2 (22) gives the definition of "deemed dividend". However, the definition

laid down by section 2(22) is inclusive and not exhaustive. If, therefore, a

particular distribution is not regarded as dividend within the extended meaning of

the expression in section 2(22), it may still be dividend for the purpose of the

Income-tax Act.

Under section 2(22), the following payments or distributions by a company to its

shareholders are deemed as dividends to the extent of accumulated profits of the company:

A. any distribution entailing the release of company's assets

B. any distribution of debenture, debenture-stock, deposit certificates and bonus to

preference shareholders

C. distribution on liquidation of company

D. distribution on reduction of capital

E. any payment by way of loan or advance by a closely-held company to a shareholder

holding substantial interest provided the loan should not have been made in the

ordinary course of business and money-lending should not be a substantial part of the

company's business.

If dividend comes under (A) to (D), then the payer-company will pay dividend tax under

section 115-O and in the hands of recipient shareholders, it is not chargeable to tax.

Conversely, if dividend comes under (E), then it is taxable in teh hands of shareholder. In

such case, the payer-company will not pay dividend tax.

The following shall not be treated as "dividend"—

a. any payment made by a company on purchase of its own shares in accordance with

the provisions contained in section 77A of the Companies Act; or

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b. any distribution of shares made in accordance with the scheme of demerger by the

resulting company to the shareholders of the demerged company whether or not there

is a reduction of capital in the demerged company.

5.3 ACCUMULATED PROFITS

Any payment or distribution under the aforesaid clauses is treated as dividend. However, the

payment or distribution under the aforesaid clauses can be treated as dividend only to the

extent of accumulated profits of the company. Therefore, it is essential to discuss the meaning

and scope of the expression "accumulated profits" It includes:

1. It is expressly provided that it does not include capital gains arising after March 31,1948

but before April 1, 1956.

2. In the case of a company, which is not in liquidation, it includes all profits of a company

up to the date of distribution or payment.

3. In the case of a company which is in liquidation, it includes all profits of the company up

to the date of liquidation. But Where, the liquidation is consequent on the compulsory

acquisition of a company's undertaking by the Government or a Government company,

accumulated profits do not include any profits of the company prior to the three successive

years immediately preceding the previous year in which such acquisition took place. For

instance, if compulsory acquisition takes place on March 31, 2016, its accumulated profits

will exclude profits accumulated up to March 31.

Notes:

1. Accumulated profits include all profits (accumulated or current) up to the date of

distribution or payment (or up to the date of liquidation in the case of liquidation). In

a number of cases it has been held that accumulated profits are computed on the basis

of commercial profits.

2. Under sub-clause (a) of section 2(22), any distribution by a company of its

accumulated profits (whether capitalised or not) is dividend if it entails the release of

company's assets. In other words, there are two conditions prescribed by this clause—

first, distribution should be from accumulated profits (not from capital) and secondly,

such distribution must result in the release of the assets by the company. As no

specific mode of distribution is prescribed by the clause, distribution may be in the

form of payment in cash or kind.

3. Under this clause the following two distributions are treated as dividend to the extent

of accumulated profits (whether capitalised or not) of the company :

(a) distribution by a company to its shareholders (whether equity shareholders or

preference shareholders) of debentures, debenture-stock or deposit certificates in any

form, whether with or without interest; and

(b) distribution by a company to its preference shareholders of bonus shares. _

4. Under sub-clause (c), any distribution made by a company to its shareholders on its

liquidation is treated as dividend to the extent to which such distribution is

attributable to the accumulated profits (whether capitalised or not) of the company

immediately before its liquidation.

80

However are following are not treated as dividend :

(a) any distribution in respect of preference shares issued for full cash consideration; and

(b) any distribution to the extent such distribution is attributable to the capitalised profits

of the company representing bonus shares allotted to its equity shareholders after

March 31,1964, but before April 1,1965.

Reduction of share capital:

Any distribution by a company to its shareholders on the reduction of capital is treated as

dividend to the extent the company possesses accumulated profits (whether capitalised or

not). However, the following are not treated as dividend under this clause :

(i) any distribution in respect of preference shares issued for full cash consideration; and

(ii) any distribution to the extent such distribution is attributable to the capitalised profits

of the company representing bonus shares allotted to its equity shareholders after

March 31, 1964, but before April 1,1965.

Loan or advance:

Under sub-clause (e), any loan or advance to a shareholder or concern is treated as dividend

in certain cases.

(a) Loan or advance is given by a closely-held company.

(b) Such loan is given to a registered shareholder.

(c) The shareholder (getting the loan) beneficially holds 10 per cent or more of equity

shares in the company.

(d) Such loan or advance is treated as dividend in the hands of shareholder.

Important points:

1. Such loan or advance is treated as dividend to the extent of accumulated profits

(excluding capitalized profit).

2. Loan or advance for the above purpose may be given to a shareholder directly or it

may be given for the benefit of shareholder or on behalf of shareholder.

3. "Concern" for this purpose may be a HUF, sole proprietor, firm, AOP, BOI or a

company.

4. A person shall be deemed to have a substantial interest in a concern, if he is (at any

time during the previous year), beneficially entitled to at least 20 per cent of income

of such concern (if such concern is a company, then he should beneficially hold at

least 20 per cent equity share capital of the company). Shares held by a person in two

different capacities, ie., as individual and as HUF, cannot be clubbed for purpose of

deciding whether a person has substantial interest in a concern.

5. Where money-lending is a substantial part of the business of the company, the above

provisions are not applicable. For this purpose, the factual position as it stands during

relevant previous year alone is supposed to be taken into consideration to decide

whether lending of money is substantial part of business of concerned company.

6. If after giving loan or advance to a shareholder, the company declares normal

dividend and such dividend is set off against outstanding loan/advance, the amount so

set off will not be treated as "dividend".

81

5.4 TAX TREATMENT OF DIVIDEND

1. If dividend is covered by section 2(22) [not by clause (e) of section 2(22)] and

declared, distributed or paid during April 1,1997 and March 31,2002 or after March

31,2003, then it is not taxable in the hands of shareholders by virtue of section 10(34).

On such dividend the company declaring dividend will be liable to pay dividend tax

under section 115-O.

2. If a loan or advance is given after May 31,1997 which is deemed as dividend under

section 2(22)(e), then such loan or advance is taxable under section 56 as "dividend"

in the hands of recipient.

3. If the divided in received from a company other than a domestic company it is

chargeable to tax.

5.5 BONUS SHARES

When a company issues shares to the existing shareholders in lieu of dividends such

shares are termed as 'bonus shares'. By issue of bonus shares a company capitalises its profits

and widens the capital base. Expenditure incurred on issue of bonus shares is capital

expenditure hence, not deducted in computing the income of the company.

Where bonus shares are issued to the equity shareholders, the value of the shares is

not taxed as dividend distributed. However, when redeemable preference shares are issued as

bonus shares, on their redemption, the amount shall be taxed as dividend distributed.

When an equity shareholder sells the bonus shares the cost of bonus shares is taken as

zero. Hence, the whole net consideration (consideration less selling expenses if any) is treated

as long-term or capital gains, as the case may be.

5.6 TAX PLANNING IN RELATION TO DIVIDEND INCOME :

1. A domestic company may issue bonus shares to its equity shareholders in lieu of

dividend in cash. By this method it can avoid the tax u/s 115-O on dividend

distributed. However, it will increase tax liability of its shareholders on transfer.

2. Payment made by a closely-held company to a shareholder who is the beneficial

owner of not less than 10% of the equity shares of the company or on his behalf or for

his benefit, is deemed to be dividends to the extent of accumulated profits. [This

deemed dividend is not exempt u/s 10(34).] Such a shareholder should not take loan

from the company or ask the company to make payment on his behalf or for his

benefit. However, if it is not possible, he should reduce his shareholding to less than

10% of equity share capital.

3. Similarly, a concern, in which the aforesaid shareholder has substantial interest

(entitled to not less than 20% of the income of the concern or 20% voting right in the

company), should not borrow from the closely-held company. Otherwise, it will be

taxed as deemed dividend in the hands of the concern,

4. Where a loan in the hands of a shareholder or concern, has been taxed as deemed

dividend, such loan should not be repaid to- the closely-held company. It should be

adjusted against the dividends declared by the company in future. The dividend

declared in future and adjusted against the loan is not treated as dividend declared.

Thus, the double taxation liability can be avoided.

82

5. The tax liability of the company can he reduced by purchase of own shares by the

company instead of distribution of dividend. Where a domestic company distributes

dividends to its shareholders, the company is liable to tax on dividend distributed u/s

115-O. However, purchase of own shares by a company from shareholders is not

deemed to be dividend distribution. Where a company purchases its own shares from

a shareholder, then the capital gains shall be chargeable to tax in the hands of

transferor. The capital gains shall be computed as provided in sec. 48 in the year in

which such shares are purchased by the company.

Example 3:

A domestic company possesses huge accumulated reserves. It wants do distribute dividends

of Rs. 100 crore to its equity. For this purpose it may issue 3 year 10% redeemable preference

shares or 3 year 10% redeemable debentures. Keeping in view the following information

suggest to the company whether it should issue bonus shares or bonus debentures so that the

tax liability of the company and its shareholders is reduced:

Assume Rate of tax on income of company and shareholder is 30% and Dividend

Distribution Tax is 15%.

Solution:

Option I

(1) Tax Liability When Company Issues Bonus Shares

(a) Tax liability of Company : Rs.

(i) On issue of bonus shares Nil

(ii) On dividend distribution on Rs. 30 crore for 3 year @ 15%

- DDT

4,50,00,000

(iii) On redemption of bonus shares at Rs. 100 crore @ 15% -

DDT

15,00,00,000

Total Tax Liability 19,50,00,000

(b) Tax liability of Shareholders:

(i) At the time of receiving bonus shares Nil

(ii) On dividend for 3 years Nil

(iii) On redemption of bonus shares Nil

Total Tax Liability Nil

Therefore Total Tax liability of company and shareholders

under option-I (a+b) Rs. 19,50,00,000

Option-II

2. Tax Liability when Company Issues debentures:

(a) Tax liability of company: Rs.

(i) On issue of debentures on Rs. 100 crore @ 15% - DDT 15,00,00,000

(ii) On payment of interest on debentures Nil

(iii) On redemption of debentures Nil

(iv) Tax saved by company on interest payment on debentures

Rs. 100 crore @ 10%, i.e., on Rs. 10 crore @ 30% = Rs. 3

crore

83

Tax saved for 3 years (Rs. 3×3) 9,00,00,000

Tax Liability 6,00,00,000

(b) Tax liability of Shareholders:

(i) At the time of receiving bonus debentures Nil

(ii) On interest Rs. 10 crore @ 30% = Rs. 3 crore

On interest for 3 years (Rs. 3 crore × 3) 9 crore

(iii) On redemption of bonus debentures Nil

Tax Liability 9 crore

Total tax liability of company and shareholders Rs. 15

crore

Therefore it may be suggested to the company that it should issue bonus debentures to its

equity shareholders instead of bonus shares to reduce tax liability.

Questions:

1. What are the factors which must be considered by a company to decide whether to

issue share or debenture to raise funds?

2. Discuss deemed dividend as per the provisions of section 2(22).

3. From tax point of view which of the following would you prefer:

(a) Issue of shares or issue of debentures

(b) Payment of dividend or issue of bonus hares

4. P. Ltd., a domestic company, furnishes the following particulars of its income and

payments for the previous year 2015-16

Rs.

Profits of business (computed) 5,00,000

Dividend from B. Ltd., a domestic company 2,00,000

Dividend from C Ltd., a foreign company 5,00,000

Dividend paid to shareholders of P Ltd.

on 1.10-2014 4,00,000

Compute the total income and tax payable

for A.Y. 2016-17

Ans. Total Income Rs. 10,00,000, Income Tax = Rs. 3,09,000

Note: Company is also liable to pay Dividend Distribution tax @ 16.995% on the amount of

dividend distributed to its shareholders.

5. P holds 12.5% shares carrying voting power in a domestic company in which public

are not substantially interested. On 1st Jan., 2015, he obtained a loan of Rs. 5 lakh at

10% interest per annum from the company. As on that date, the company had

accumulated profits of Rs. 4 lakh. Explain the tax implications of the transaction for P

and also for the company.

Ans. Shareholder : Deemed dividend Rs. 4,00,000; Taxable in hands of P.

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6. A company has share capital of Rs. one crore and is planning to invest an additional

fund of Rs. 80 lacks towards its expansion programme. Suggest the best option from

the following from tax planning point of view:

(i) To issue share capital of Rs. 80 lacs.

(ii) To borrow Rs. 20 lacs @ 18% p.a. and to issue debentures of Rs. 20 lacs @ 11%

p.a. and the balance amount be collected by issuing shares in the public.

(iii) To issue debentures for Rs. 50 lacs @ 11% p.a. and the balance be collected by

issuing shares in the public.

(iv) Rate of return is 30% before paying any interest and tax.

(v) Rate of tax is 30%.

Ans. Company will opt for (iii) alternative

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LESSON 6

Tax Planning With Reference to Specific Management Decisions –

Make or Buy; Own or Lease; Repair or Replace

6 STRCUTURE

6.1 Tax Related Considerations

6.2 Tax Planning in Respect of Owing or Leasing as Asset

6.3 Repair or Replace

6.4 Tax Planning in Relation to Repair and Replacement of an Asset

6.5 Shut Down or Continue

6.6 Tax Planning

Make or Buy

When business concern requires a product or any part or component of the product for its

existing unit, it has to decide whether it should make the product, part or component or buy it

from the other manufactures. There are many costing and non-costing considerations guiding

the decision towards make or buy it. Some to the important factors affecting such decisions

are :

1. Whether for manufacture infra-structural facilities are available.

2. Whether the present capacity of the undertaking is fully utilised. If not, it can be

utilised in making the required product.

3. If an additional unit is required for manufacture the required product, whether the

concern possesses adequate funds for establishing the unit and whether the whole

production of the unit will be consumed by the concern or there is market for the sale

extra production.

4. Whether the product is available in the market easily and at reasonable terms.

5. If the cost of manufacture of a component is lower than the cost of purchase, it should

be manufactured.

6. If the product is not manufactured in the country it has to be imported and then import

trade control relations and foreign exchange control regulations have also a role.

7. If there is change in the technology in production of that product, the concern should

be in a position to acquire the new technology without much difficulty. If the product

has to be imported, if not manufactured, and there is risk of the security of the

country, it must be manufactured in the country, whatever the cost of manufacture

may be.

6.1 TAX RELATED CONSIDERATIONS

1. If a concern has surplus capacity and even decide to buy a product it may require to

sell a part of its plant and machinery. In such a case it may be liable to capital gains

tax.

2. If a new industrial undertaking (unit) is established to make the product, which fulfils

the conditions laid down in section 80IA, 80-IB80-IC etc of the Act, a deduction will

be allowed in computing the income and tax liability of the undertaking.

3. If the product, which is manufactured or purchased, is a capital asset, its cost will not

be allowed as a deduction in computing the income. However, if the asset is such on

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which depreciation is allowed, it will be allowed in both the cases i.e., manufactured

or purchased.

4. If the product is a consumable one, raw material is required to replace a worn out part

at the time of repair, its cost will be treated as revenue expense and deductible in

computing the income from the business.

Example 1:

Z R Ltd. produces of its own parts and components. The standard wage rate in the

parts department is Rs. 12 per hour. Variable manufacturing overhead is applied at a standard

rate of Rs. 9 per labour-hour.

For its current years output, the company will require a new part. This can be made in

the parts department without any expansion of existing facilities. Nevertheless, it would be

necessary to increase the cost of product testing and inspection by Rs. 1,500 per month.

Estimated labour time for the new part is half an hour per unit. Raw materials cost has been

estimated at Rs. 24 per unit.

The other alternative before the company is to purchase part from an outside supplier

at Rs. 36 per unit. The company has estimated that it will need 20,000 new parts during the

current year.

Advise the company whether it would be more economical to buy or make the new

parts.

Solution:

Cost of Manufacturing

Per unit (Rs.) Total (Rs.)

Raw material 24.00 4,80,000

Direct wages 6.00 1,20,000

Variable overheads 4.50 90,000

Product testing and inspection

(Rs. 1,500 × 12)

0.90 18,000

Total cost 35.40 7,08,000

Total cost if the parts are bought Rs. 20,000 × 36 = Rs. 7,20,000.

Hence, it is advisable to make the parts as there is saving of Rs. 12,000.

The above illustration does not attract any special tax consideration as whether we

manufacture or buy the goods, the expenses relating to both are allowed as deduction.

Example 1:

A company requires a component. From the following information suggest to the company

wether it should make the component or buy it from the market:

A. For Making the component: A new machine will be purchased for Rs. 10,00,000. After

five years it will be sold for Rs. 2,00,000. Rate of depreciation 15%. Manufacturing cost of

component:

I. year Rs. 14,00,000; II. year Rs. 16,00,000;

III. year Rs. 18,00,000; IV. year Rs. 20,00,000;

V. year Rs. 24,00,000;

Rate of tax 30%

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B. Buying the component:

Cost: I. year Rs. 20,00,000; II. year Rs. 22,00,000;

III. year Rs. 24,00,000; IV. year Rs. 26,00,000;

V. year Rs. 26,00,000;

Solution:

(A) Making the Component

(Computation of Depreciation)

Year Depreciation WDV

I 1,50,000 8,50,000

II 1,27,500 7,22,500

III 1,08,375 6,14,125

IV 92,119 5,22,006

V 78,301 4,43,705

Short-term capital loss:

WDV Rs. 4,43,705 – Selling Price Rs. 2,00,000 – Rs. 2,43,705

Computation of Cost of Component

Year Manufacturing

Cost

Depreciation Total cost Tax Saving Net Cost

I 14,00,000 1,50,000 15,50,000 4,65,000 10,85,000

II 16,00,000 1,27,500 17,27,500 5,18,250 12,09,250

III 18,00,000 1,08,375 19,08,375 5,72,513 13,35,862

IV 20,00,000 92,119 20,92,119 6,27,636 14,64,483

V 24,00,000 78,301 24,78,301 7,43,490 17,34,811

STCL... 2,43,705 73,112 1,70,593

69,99,999

(B) Buying the Component

Year Total Cost Tax Saving Net Cost

I 20,00,000 6,00,000 14,00,000

II 22,00,000 6,60,000 15,40,000

III 24,00,000 7,20,000 16,80,000

IV 26,00,000 7,80,000 18,20,000

V 30,00,000 9,00,000 21,00,000

Total Net Cost -- -- 85,40,000

Conclusion- In case of making the component the cost is Rs. 69,999,999 and in case of

buying the component the cost is Rs. 85,40,000. Hence, the component should be

manufactured.

6.2 TAX PLANNING IN RESPECT OF OWNING OR LEASING AN ASSET:

A lease of property is a transfer of right to enjoy such property, made for certain time,

in consideration of a price payable periodically to the transferor by the transferee.

In other words, leasing is an arrangement that provides a person with the use and

control over an asset, for a price payable periodically, without having a title of ownership. In

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case of lease agreement the owner of the asset is called the lessor and the user is called the

lessee.

When a person needs an asset for his business purposes, he has to decide whether the

asset should be purchased or taken on lease. While taking this decision he should keep in

mind the following factors :

1. Cash position. When a person has sufficient cash or he can borrow funds at a

reasonable rate of interest to purchase an asset or can acquire the asset under hire purchase

system, he may decide to buy it. The cost of asset is not deductible in computing the income

but the interest on borrowed amount or instalment system is deductible in computing the

income. If he neither has sufficient cash nor he can borrow due to stringent credit control, he

has to take the asset on lease. The lease rent is deductible in computing the income.

2. Depreciation. When the asset is purchased or acquired under hire

purchase/instalment system, the depreciation is allowed in computing income. When the asset

is taken on lease the depreciation is not allowed to the lessee, because user is not the owner of

the asset, but it is allowed to the lessor. Non availability of depreciation to the lessee will

increase his tax liability. If the asset is such on which depreciation is not allowed, e.g., land,

the increase or decrease in the value of the asset in future must be considered. If the asset is

such where increase in the value is expected, it may be purchased otherwise it may be taken

on lease.

3. Obsolescence risk. When a plant or machinery is purchased and it becomes

obsolete earlier than its expected working life, it has to be replaced. The replacement cost can

be met partly out of depreciation fund and partly by arranging further funds. In case of lease

the asset will be replaced by the lessor. However, the lessor will also keep in mind the risk of

obsolescence and increase the lease rent to offset such a loss.

4. Residual Value. When a person owns an asset, he has full rights to the value of the

asset at the end of given period. In the case of asset with large residual value it is better to

purchase it rather than taken on lease.

5. Profit margin. Where profit margin is low, it is better to purchase the asset. If the

asset has been purchased by borrowed funds the cash outflow would be equal to loan

instalment, interest payment. On the other hand, in case of lease the lease rent would be equal

to part of the cost of asset to lessor, interest on investment: and profit to the lessor. The cash

outflow will be equal to lease rent less nominal tax saving.

6. Profit after tax. It is an important consideration in tax planning. The assessee

should follow such a method for obtaining an asset which reduces his tax liability and the

profits after tax are greater. For this purpose it is suggested that own funds should not be used

in purchase of an asset because interest on own funds is not deductible in computing the

income, whereas interest on borrowed funds is deductible. But one should keep in mind that

if own funds are invested outside the business, the interest earned will offset the interest

payment. Further, one must consider the difficulty involved in raising loans and the other cost

factors incidental thereto.

Conclusion. As far as possible the asset should be purchased and not taken on lease

because the cost of use of the asset purchased is less than the cost of lease asset. However,

where the assessee is suffering from scarcity of funds and and cannot invest in an asset nor

can he avail substantial credit from the suppliers or money-lenders, he should take an asset on

lease.

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Example 3:- From the following information advise whether the asset should be owned or

taken on lease.

1. Cost of Asset - Rs. 1,00,000

2. Rate of Depreciation - 15%

3. Rate of interest 10%

4. Repayment of loan by the assessee Rs. 20,000 p.a.

5. Rate of tax 30.9%

6. Residual value - Rs. 20,000 after five years.

7. Profit of the assessee Rs. 1,00,000 before depreciation, interest and tax.

8. Lease rent Rs. 30,000 p.a.

Solution I

When Asset is purchased

Year

I II III IV V Total

Rs. Rs. Rs. Rs. Rs. Rs.

A Depreciation 15,000 12,750 10,838 9,212 7,830 55,630

B Interest 10,000 8,000 6,000 4,000 2,000 30,000

C Tax 23,175 24,488 25,697 26,817 27,863 1,28,040

D Profit after

tax

51,825 54,762 57,465 59,971 62,307 2,86,330

E Total 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000

Loss on sale of asset = Rs. 1,00,000 – (55,630 + 20,000) = Rs. 24,370

II . Asset on lease

Rs. Rs. Rs. Rs. Rs. Rs.

1. Lease

rent

30,000 30,000 30,000 30,000 30,000 1,50,000

2. Tax 21,630 21,630 21,630 21,630 21,630 1,08,150

3. Profit

after

tax

48,370 48,370 48,370 48,370 48,370 2,41,850

5. Total 10,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000

When asset is purchased profit is (Rs. 2,86,330 – 24,370=) Rs. 2,61,960

When asset is taken on lease profit is Rs. 2,41,850. Hence, asset may be purchased.

Example 4:- (when P.V. Factor is considered)

A Ltd. wants to acquire an asset costing Rs. 1,00,000. It has two alternatives. The first

one is buying the asset by taking a loan of Rs. 1,00,000 repayable in 5 equal instalments of

Rs. 20,000 each with interest @ 14% p.a. The second one is leasing the asset for which

annual lease rent is Rs. 30,000 upto 5 years. The lessor charges 1% as processing fees in the

first year. Assume the interenal rate return to be 10%. The present value factors are as under.

Years: 1 2 30 4 5

PV Factor: 0.909 0.826 0.751 0.683 0.621

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Assume lease rentals, processing fees, loan as well as interest amount are payable at

year end. Suggest which alternative is better for the company. Assume rate of depreciation @

15% and tax rate at 33.99%.

Solution:

Asset Taken on Lease

Particulars: Year

1 2 3 4 5

Rs. Rs. Rs. Rs. Rs.

1. Lease rent 30,000 30,000 30,000 30,000 30,000

2. Processing fee 1,000 -- -- -- --

3. Gross cashflow

(1+2)

31,000 30,000 30,000 30,000 30,000

4. Tax saved @

33.99%

10,537 10,197 10,197 10,197 10,197

5. Net cash outflow

(3-4)

20,463 19,803 19,803 19,803 19,803

6. P.V. factor @ 10% 0.909 0.826 0.751 0.683 0.621

7. P.V. of net cash

outflow

18,601 16,357 14,872 13,525 12,298

Total Net present value of cash out flow = Rs. 75,653

Asset purchased by borrowed funds

Particulars: Year

1 2 3 4 5

Rs. Rs. Rs. Rs. Rs.

1. Loan repayment 20,000 20,000 20,000 20,000 20,000

2. Interest paid 14,000 11,200 8,400 5,600 2,800

3. Cash outflow

(1+2)

34,000 31,200 28,400 25,600 22,800

4. Depreciation @

15%

15,000 12,750 10,838 9,212 7,830

5. Total 2 and 4 29,000 23,950 19,238 14,812 10,630

6. Tax saved @

33.99% on 5

9,857 8,141 6,539 5,035 3,613

7. Net cash outflow

(3-6)

24,143 23,059 21,861 20,565 19,187

8. P.V. factor @ 10% 0.909 0.826 0.751 0.683 0.621

9. P.V. of net cash

outflow

21,946 19,047 16,418 14,046 11,915

Total P.V. of net cash outflow = Rs. 83,372

Conclusion. Asset should be taken on lease because P.V. of cash outflow is lesser.

Example:

From the following information determine whether the assessee should purchase the

machine by instalment or hire it.

1. Cost five annual instalments of Rs. 2,00,000 each payable in the beginning of each

year.

2. Hire charges Rs. 1,50,000 p.a. for eight years payable in the beginning of each year.

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3. Residual value Rs. 50,000 after eighth year.

4. Rate of depreciation 15%

5. Cost of Capital 10%

6. Rate of tax 30%

7. Present value @ 10%

1 2 3 4 5 6 7 8

.909 .826 .751 .683 .621 .564 .513 .467

Solution:

(A) Asset purchased by instalments

Date of payment Instalment (Amount) Present Value

Rs. Rs.

Down payment 2,00,000 2,00,000

instalment - I 2,00,000 1,81,800

instalment - II 2,00,000 1,65,200

instalment - III 2,00,000 1,50,200

instalment - IV 2,00,000 1,36,600

Cash Outflow 8,33,800

Cash inflow at the end of 8th year Rs. 50,000 on account of residual value of machine. Present

value Rs. 23,350.

Savings on account of depreciation:

Year Amount of

Depreciation

Tax savings on

depreciation

Present value of tax

savings

Rs. Rs. Rs.

I year 1,50,000 45,000 40,905

II year 1,27,500 38,250 31,595

III year 1,08,380 32,514 24,418

IV year 92,120 27,636 18,875

V year 78,300 23,490 14,587

VI year 66,555 19,967 11,261

VII year 56,572 16,972 8,707

VIII year 48,086 14,426 6,737

7,27,513 1,57,085

Short-term capital loss on sale of machine

= Rs. 10,00,000 – (7,27,513 + 50,000) = Rs. 2,22,487 may be set off

Tax saved on Rs. 2,22,487@30% = Rs. 66,746

Present value of tax savings = Rs. 31,170

Cash Outflow Rs. Rs.

8,33,800

Less: (i) Cash inflow on sale of machine 23,350

(ii) Tax savings on account of

depreciation

1,57,085

(iii) Tax savings on account of STCL 31,170 2,11,605

Net Cash Outflow 6,22,195

(B) Asset taken on Hire

Date of Payment Hire Discounted Value Present Value of

Tax savings

Rs. Rs. Rs.

I year 1,50,000 1,50,000 45,000

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II year 1,50,000 1,36,350 40,905

III year 1,50,000 1,23,900 37,170

IV year 1,50,000 1,12,650 33,795

V year 1,50,000 1,02,450 30,735

VI year 1,50,000 93,150 27,945

VII year 1,50,000 84,600 25,380

VIII year 1,50,000 76,950 23,085

12,00,000 8,80,050 2,64,015

Present value of Cash outflow on account of Hire

8,80,050

Less : Present value of tax savings 2,64,015

Net Cash Outflow 6,16,035

Conclusion - Asset should be taken on lease.

6.3 REPAIR OR REPLACE

From the accounting point of view a person can debit, the expenses incurred on repair

or replacement of an asset, in profit and loss account. But to show a better profitability or to

increase the groas block of assets so that higher amount of loans could be taken from banks

or financial institutions, the expenses on replacement of an asset are capitalised. When

expenses incurred on replacement of an asset are capitalised, this increases the tax liability.

From tax point of view the person is not at liberty to capitalise or not to capitalise the

expenses incurred on replacement of a part of asset or the asset itself. Let us consider the

provisions of the Income Tax Act regarding deduction of expenses incurred on repairs and

renewal/replacement of an asset.

Deduction of Expenses Incurred on Repairs

Where an assessee uses a building for the purpose of business or profession, he is

entitled to a deduction of the amount paid on account of 'current repairs' of the premises. If he

has taken the building on rent and has undertaken to bear the cost of repairs to the premises,

he is entitled to a deduction u/s 30 of the amount paid on account of such repairs Similarly if

the assessee uses any machinery, plant or furniture for the purposes of his business or

profession he is entitled to a deduction, in computing his income, the amount paid on account

of current repairs u/s 31.

Now the question is that what is the meaning of the expressions repairs' and 'current

repairs.

In New Shorrock Spinning & Manufacturing Ltd. vs. CIT [(1956) 30 ITR 338] the

Bombay High Court has observed that the expression 'repairs' means any expenditure

incurred to preserve and maintain an existing asset. The object of the expenditure is neither to

bring a new asset into existence nor to obtain any fresh advantage from such machine.

As regards the expression 'current repairs' High Courts are not unanimous. The Delhi High

Court in Modi Spinning and weaving Co. Ltd. [(1993) 200 ITR 544] has observed that

current repairs means repairs which are required to be carried out from time to time as and

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when a defect arises. If there has been wear and tear on an item, like the floors of a building,

over a number of years and ultimately they are replaced, then such replacement cannot be

regarded as current repairs from such machine.

The Allahabad High Court in Ramkrishan Sunder Lal vs. CIT [(1951) 19 ITR 324]

has held that current repairs means petty repairs usually carried out periodically and does not

include repairs or renewals costing large sums of money which has to be spent after a

machine has been used for a number of years.

The Supreme Court in Mahalaxmi Textile Mills Ltd. vg, CIT [(1967 ) 66 ITR 710]

has held that where only a replaceable part of a composite piece of machineiy is renewed,

such part having a comparatively lesser life than the machinery itself, it will be reasonable to

regard the cost of such renewal as revenue expenditure.

In summary the expression 'current repairs neither refers to petty repairs nor the

repairs carried out year to year but it refers to the repair carried out presently, whatever its

cost may be-

Replacement or Renewal where an expenditure is incurred to bring new asset into

existence or to obtain a new or fresh advantage it is considered as a replacement or renewal.

The replacement may be of a defective part or replacement of the entire machinery of a

substantial part of the entire machinery. If the replacement is of parts only, the expenditure

for such replacement is deductible in computing the income. On the other hand if the

replacement is the whole machinery with a view to bring a new asset into existence, the

expenditure will not be deductible being capital in nature. However, on such asset the

depreciation may be allowed u/s 32.

6.4 TAX PLANNING IN RELATION TO REPAIR AND REPLACEMENT OF AN

ASSET

The following points should be kept in mind to reduce the tax liability while taking a

decision to repair or replace an asset :

(i) There are stringent conditions to carry-forward and set-off of business losses. Hence,

if in the relevant year less income is expected, it will be better to slow down the pace

of repair and renewal of a part of asset in such a manner that it is spread over a

number of years.

(ii) As far as possible a part of the asset should be replaced and not the in entire asset. In

case of replacement of a part of asset, the cost of replacement is allowed as a

deduction in computing the income for tax purposes. On the other hand the cost of

replacement of the asset itself is treated as a capital expense.

6.5 SHUT DOWN OR CONTINUE

Losses co-exist with profits in a business. A business may suffer losses due to one or

more of the following reasons:

(a) Fall in demand. The demand of the product may fall due to availability of new

products in the market, change in fashion increase in number of

producers/competitors etc.

94

(b) Financial problems. A firm may not have sufficient finance of its own nor further

credit available from banks or financial institutions due to government restrictions.

(c) Change in technology. Where the growth of technology is rapid and if is not possible

to keep pace with it the net result may be a loss.

(d) High rates of taxes. High rate of taxes import- duty, excise, duty sales tax, control,

etc., increase the price of the product. Due to this demand of the product may fall and

the business may suffer losses.

(e) Mismanagement. Efficient management is an important factor for success of

business. If it is inefficient, the result may be huge loss.

When a business suffers loss continuously, whatever the reason of loss may be, the

.management has to decide whether the business should be shut-down or continue. While

taking this decision, the impact of Income Tax provisions cannot be overlooked. Following

factors are considered.

(1) Treatment of losses and unabsorbed depreciation. When a business as a whole is

discontinued or closed down, the brought forward business losses and unabsorbed

depreciation shall be dealt with as under :

(a) Business Loss. If the business or profession has been discontinued loss can be carried

forward and set-off against profits and gains of business or profession.

(b) Unabsorbed Depreciation. If the business or profession has been discontinued,

unabsorbed depreciation is dealt as fallows:

(i) It can be set-off against income from business or profession or income under any

other head;

(ii) It can be carried forward and set-off for indefinite period, whether business is carried

on or discontinued.

(2) Discontinuance of Business

Where a part of a business (unit, department or activity) is discontinued or a business is

continued with reduced level of activity it is not a discontinuation of business.

The Supreme Court has held that whether the business carried on is the same business

or not is to be decided by seeing whether the several businesses carried on by the assessee are

inter-connected, inter-linked, inter-dependent and have a unity. Such inter-connection, inter-

dependence and unity are evidenced by the existence of common management, common

business organisation, common administration, common fund and common place of business.

[CIT vs. Prithvi Insurance Co. Ltd. (1967) 63ITR 632 (SC)]. Hence, if there was business of

import and sale of cotton fabrics in year I and export and sale of textiles in year II with every

thing common, this would be the same business. Similarly, the same assessee carried on

business at-two places A and B in Beedi leaves. Business at place A was discontinued and at

place B continued, he would be entitled to set-off loss brought forward from place A against

profit at another place B because the assessee carried on business in beedi leaves. [CIT vs.

Dharma Reddy (1969) 73 ITR 751 (SC)]. Thus in short the following cases cannot be said

discontinuance:

1. Where the business of the assessee has been shifted from one premises to another or

from one market to another or from one city to another city.

2. Where one or the other department of the business had been closed down.

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For example assessee carrying on business of running tea plantations and manufacturing of

tea and selling tea. Manufacture of tea discontinued for three years, machinery used in

manufacture leased out but employees retained. Assessee continued running of tea plantations

and selling green tea. Business had not been discontinued. Losses incurred in manufacturing

activity can be carried. Where the business of an industrial undertaking carried on in India is

discontinued in any previous year by reason of extensive damage to, or destruction of any

building, plant, machinery or furniture owned by the assessee and used for the purpose of

such business and such business is re-established, reconstructed or revived by the assessee

within three years from the end of previous year in which the business was discontinued, the

losses of such a business shall be carried forward and set-off against the profits and gains of

the business or any other business carried on by him. The loss can be set-off by the same

person who has suffered the loss. But in this connection the following points are to be

considered:

(a) Where succession takes place by inheritance, the loss incurred by the father in the

course of carrying on his business can be carried forward and set-off by his son, if he

succeeds to the business of his father.

(b) Where an assessee transfers his business to his spouse or minor child and the income

from such business is to be included in his total mcome u/s 64(1), the assessee is

entitled to the set-off of his loss carried forward from the previous year against the

income of wife or minor child included in his income.

(c) Where two or more companies amalgamate and form a new company, the assessee

(amalgamating companies and amalgamated company) and the business are not :the

same the losses sustained by amalgamating companies cannot be carried forward and

set-off by the amalgamated company. However, section 72A provides exceptions to

this general rule.

(d) Where there has been a demerger of an undertaking, the accumulated loss and the

unabsorbed depreciation directly relatable to the undertaking transferred by the

demerged company to the resulting company shall be allowed to be carried forward

and set-off in the hands of the resulting company.

If the accumulated loss or unabsorbed depreciation is not directly relatable to the undertaking,

the same will be apportioned between the demerged company and the resulting company in

the same proportion in which the value of the assets have been transferred.

The Central Government may notify such conditions as it consider necessary to ensure that

demerger or amalgamation is for genuine business purpose.

(e) Where a firm is succeeded by a company/a proprietary concern which fulfils the

conditions laid down in Sec. 47 (xiii)/47 (xiv) or the accumulated loss and unabsorbed

depreciation of predecessor firm shall be deemed to be the loss and unabsorbed

depreciation of the successor company for the previous year in which business

reorganisation was effected. The provisions of the Act relating to set-off and carry-

forward loss and unabsorbed depreciation shall apply accordingly.

If any of the conditions laid down in Sec. 47 (xiii) or 47 (xiv) are not complied

with, the set-off of loss or depreciation made in any previous year in the hands of the

successor company, shall be deemed to be the income of the company chargeable to

tax in the year in which such coiiditions are not complied with.

(f) Where the business carried on by a H.U.F. is transferred to the members of the family

on partition there is a change in persons carrying on the business. Hence, the losses

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suffered by the family in its business cannot be set-off by the members after partition

of the family.

(g) Where a partner leaves a firm (on retirement or death) his share of less con not be

carried forward and set-off by the reconstituted firm.

(h) A closely-held company shall not be allowed to carry-forward and set-off its losses

against the income of the previous year unless on the last day of the previous year the

shares of the company carrying not less than 51% of the voting power were

beneficially held by persons who beneficially held shares of the company carrying not

less than 51% of the voting power on the last day of the year in which the loss was

incurred.

Exceptions :

(i) Where a change in the said voting power takes place in the previous year due to the

death of a shareholder or on account of transfer of shares by way of gift to any

relative of the shareholder making such gift.

(ii) Any change in the shareholding of an Indian company which is subsidiary of a foreign

company, arising as a result of amalgamation or demerger of a foreign company

subject to the condition that 51% of the shareholders of the amalgamating or

demerged foreign company continue to remain the shareholders of the amalgamated

or resulting foreign company. (Sec. 79)

Speculation loss can be set-off against speculation income either in the same year or in

subsequent four years.

In case of such loss even, if the particular speculation business in which there is loss is

discontinued, it can be carried forward to be set-off in the succeeding year against the profits

of any other speculation business.

However, the loss from an illegal speculation business (loss incurred in speculation business

in banned items) neither can be set-off against income from any lawful speculation business

nor it can be carried forward for being set-off in the subsequent year against income even

from an illegal speculation business because the law assumes that any illegal business dies

with all its losses in the same year. [CITvs. Kurji JinabhaiKotecha (1977) 107 ITR 101

(SC)]

Important Notes :

(1) From tax point of view it is suggested that the assessee should avoid indulgence in illegal

speculation business; if the old speculation business is not profitable the assessee should start

a new profitable speculative business so that he can set-off the brought forward losses against

such income within specified time.

(2) Withdrawal of certain deductions. The benefit of deductions under section 33AB (Tea

Development Account/Coffee Development Account/Rubber Development Account) and

115VT (Reserve for Shipping Business) may be withdrawn and liable to tax for the year in

which business is discontinued.

(3) Deemed Income. If the business is discontinued and the assets used for scientific research

and family planning are sold, the selling price to the extent of deduction claimed shall be

deemed as profits of the previous year in which such assets are sold.

(4) Sale of depreciable assets. The assets on which the assessee has claimed depreciation,

are sold in the event of discontinuance of business, the difference between the net

97

consideration and W.D.V. shall be treated as short-term capital gain/loss. If there is a gain it

will be liable to tax. In case of loss it can be set-off only against the capital gains, if any.

(5) Sale of other assets: When other assets are sold, there may be long-term or short-term

capital gain/loss, as the case may be. Such gain is liable to tax.

6.6 TAX PLANNING

If a person is running more than one business the loss making business should not be

discontinued but operated at a low key for some time to claim the certain losses and expenses

against the income of profit making business. Provisions are as below:

(i) Retrenchment compensation to staff: If the business is closed and retrenchment

compensation paid, the expenditure would be disallowed as not incurred for 'carrying

on business'. [CIT vs. Gemini Cashew Sales Corporation (1967) 65 ITR 643 (SC)]

(ii) In case of closely-held company: It may be taken care that there may not be a change

in the shareholding exceeding 49% of the shareholding. If there is a change in

shareholding exceeding 49%, and the transferor/s and transferee/s are relatives, they

may transfer some percentage of shares as gift rather than sale so that the conditions

for set-off of losses are complied with.

(iii) If the assessee is a company: it may amalgamate/demerge with other company after

satisfying the conditions laid down in Sec. 72A.

Example 6:

X Ltd. a domestic company, has two businesses A and B. For the last two years business A

has been running into a loss wiping out the entire, profits of business 'B. At the end of

financial year 2014-15 there are brought forward losses of Rs. 8,00,000 and unabsorbed

depreciation Rs. 5,00,000.

In the financial year 2016-17 onwards it is expected that business B will earn a profit of Rs.

5,00,000 annually and if business A is continued at a minimum level there will be an annual

loss of Rs. 1,00,000.

Please suggest to the management of the company regarding:

(i) Whether business A should be continued or shut-down.

(ii) If continued for how many years.

Solution

If business A is continued in P. Y. 2016-17 the company will not loose the right to carry-

forward and set-off the past losses and unabsorbed depreciation. Let us calculate profit after

tax in both the situations: (i) business A continued; (ii) business A discontinued, and then

arrive at any conclusion

Business A Continued

Future Years

I II III IV

Rs. Rs. Rs. Rs.

Profit of business B 5,00,000 5,00,000 5,00,000 5,00,000

Less: Current Loss of

business A

1,00,000 1,00,000 1,00,000 1,00,000

4,00,000 4,00,000 4,00,000 4,00,000

Less: B/f Previous loss of

business A

4,00,000 4,00,000 -- --

Less: Unabsorbed Nil Nil 4,00,000 1,00,000

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depreciation

Profit of Business B Nil Nil Nil 3,00,000

Tax @ 30.9% Nil Nil Nil 92,700

Business A Discontined

Future Years

I II III IV

Rs. Rs. Rs. Rs.

Profit of business B 5,00,000 5,00,000 5,00,000 5,00,000

Less: B/f Previous Loss of

Business A

5,00,000 3,00,000 Nil Nil

Less : Unabsorbed

depreciation

Nil 2,00,000 3,00,000 Nil

Profit of Business B Nil Nil 2,00,000 5,00,000

Tax @ 30.9% Nil Nil 61,800 1,54,500

Conclusion: Business A should be continued for at least four years.

Questions:

1. Discuss the points which are taken into consideration while deciding to buy or lease

on asset for expansion of production facilities.

2. An asset costing Rs. 1,00,000 is to be acquired. There are two alternative available to

the taxpayer. First one is buying the asset out of own funds. The second one is taken

on lease for which annual lease rent is Rs. 40000 upto 5 years. Lease management fee

: Rs. 1,000.

Suppose:

(i) International rate of return to be 10% and present value at 10% is: .909; .826; .751;

683; .621 for 5 years.

(ii) Rate of Income Tax - 30%

(iii) Rate of Depreciation - 30%

Ans. : The asset should be bought

3. What are the considerations which are kept in mind while making manufacture or buy

decision from tax point of view.

4. When a loss making business should be shut down to minimise tax liability?

5. Problem Bright Ltd. Manufacture electric pumping sets. The company has the option

to either make or buy from the market component Y used in manufacture of the sets.

The following details are available:

The component will be manufactured on new machine costing Rs. 1 lakh with a life of 10

years. Material costs Rs. 2 per kg. and wages re. 0.30 per hour. The salary of the foreman

employed is Rs. 1,500 per month and other variable overheads included Rs. 20,000 for

manufacturing 25,000 components per year. Material requirement is 25,000 kgs. and 50,00

labour hours required.

The component is available in the market at Rs. 4.30 per piece.

Will it be profitable to make or to buy component? Does it make any difference if the

component can manufactured on an existing machine?

Ans. Case-I - Better to buy

Case-II - Better to manufacture

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LESSON -7

Tax Planning with Reference to Employee Remuneration

After studying this chapter, students will be able to compute the taxable amount of salary

received by an employee from the employer. Since the chapter is about tax planning,

assessment year 2017-18 is applicable.

Following provision are explained in this lesson –

1. Tax rates for assessment year 2016-17 and 2017-18

2. Brief explanation of concepts of ‘salary’.

Computation of Net Taxable Income of an assessee:

Computation of net taxable income of an assessee for the assessment year 2016-17 (or

assessment year 2017-18):

Particulars Amount (Rs.)

Income under the head “Salaries” XX

Income under the head “House Property” XX

Income under the head “Profits and gains of business or profession” XX

Income under the head “Capital Gains” XX

Income under the head “Income from other sources” XX

Gross total income XX

Less: Deductions under chapter VIA XX

Net taxable income or Total income XXX

Computation of Net Tax Liability of an assessee:

Computation of tax liability of an assessee for the assessment year 2016-17 (or assessment

year 2017-18):

Particulars Amount (Rs.)

Income-tax on net taxable income XX

Less: Rebate under section 87A XX

Tax (a) XX

Add: Surcharge [% of tax (a)] XX

Total (b) XX

Add: Education Cess (EC) @ 2% on (b) XX

Add: Secondary and Higher Education Cess (SHEC) @ 1% on (b) XX

Total XX

Less: Relief under section 86, 89, 90, 90A or 91 XX

Tax liability XX

Add: Interest/ Penalty etc. XX

Less: Pre-paid taxes

[i.e., advance tax, self-assessment tax, TDS, TCS, MAT credit]

XX

Tax Payable XXX

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Tax rates for Assessment Year 2016-17 [Individual, HUF, AOP, BOI and Artificial

juridical person]:

Situation 1: For a resident senior citizen (who is 60 years or more at any time during the

relevant previous year 2015-16 but less than 80 years on the last day of the relevant previous

year 2015-16 i.e., born during April 1, 1936 and March 31, 1956):

Annual net taxable income Tax

Up to Rs. 3,00,000 Nil

Rs. 3,00,001 – Rs. 5,00,000 10% of income exceeding Rs. 3,00,000

Rs.5,00,001 – Rs. 10,00,000 Rs. 20,000 + 20% of income exceeding Rs. 5,00,000

Above Rs. 10,00,000 Rs.1,20,000 + 30% of income exceeding Rs. 10,00,000

Situation 2: For a resident super senior citizen (who is 80 years or more at any time during

the relevant previous year 2015-16 i.e., born before April 1, 1936):

Annual net taxable income Tax

Up to Rs. 5,00,000 Nil

Rs. 5,00,001 – Rs. 10,00,000 20% of income exceeding Rs. 5,00,000

Above Rs. 10,00,000 Rs. 1,00,000 + 30% of income exceeding Rs. 10,00,000

Situation 3: For any other resident individual (who is born on or after April 1, 1956), any

non-resident individual, every HUF/ AOP/ BOI/ artificial juridical person:

Annual net taxable income Tax

Up to Rs. 2,50,000 Nil

Rs. 2,50,001 – Rs. 5,00,000 10% of income exceeding Rs. 2,50,000

Rs. 5,00,001 – Rs. 10,00,000 Rs. 25,000 + 20% of income exceeding Rs. 5,00,000

Above Rs. 10,00,000 Rs. 1,25,000 + 30% of income exceeding Rs. 10,00,000

Tax rates for Assessment Year 2017-18 [Individual, HUF, AOP, BOI and Artificial

juridical person]:

Situation 1: For a resident senior citizen (who is 60 years or more at any time during the

relevant previous year 2016-17 but less than 80 years on the last day of the relevant previous

year 2016-17 i.e., born during April 1, 1937 and March 31, 1957):

Annual net taxable income Tax

Up to Rs. 3,00,000 Nil

Rs. 3,00,001 – Rs. 5,00,000 10% of income exceeding Rs. 3,00,000

Rs. 5,00,001 – Rs. 10,00,000 Rs. 20,000 + 20% of income exceeding Rs. 5,00,000

Above Rs. 10,00,000 Rs. 1,20,000 + 30% of income exceeding Rs. 10,00,000

Situation 2: For a resident super senior citizen (who is 80 years or more at any time during

the relevant previous year 2016-17 i.e., born before April 1, 1937):

Annual net taxable income Tax

Up to Rs. 5,00,000 Nil

Rs. 5,00,001 – Rs. 10,00,000 20% of income exceeding Rs. 5,00,000

Above Rs. 10,00,000 Rs. 1,00,000 + 30% of income exceeding Rs. 10,00,000

Situation 3: For any other resident individual (who is born on or after April 1, 1957), any

non-resident individual, every HUF/ AOP/ BOI/ artificial juridical person:

101

Annual net taxable income Tax

Up to Rs. 2,50,000 Nil

Rs. 2,50,001 – Rs. 5,00,000 10% of income exceeding Rs. 2,50,000

Rs. 5,00,001 – Rs. 10,00,000 Rs. 25,000 + 20% of income exceeding Rs. 5,00,000

Above Rs. 10,00,000 Rs. 1,25,000 + 30% of income exceeding Rs. 10,00,000

Common provisions for assessment year 2016-17 and 2017-18:

1. Tax rates for Individual, HUF, AOP, BOI and Artificial juridical person:

For individual, HUF, AOP, BOI and artificial juridical person, tax rates are same in

assessment year 2016-17 and 2017-18. The only difference is in checking date of birth of

assessees to compute the age of assessees.

2. Rebate under section 87A:

This rebate is given to provide tax relief to individual taxpayers who are in lower income

bracket. Any resident individual whose net taxable income (i.e., GTI minus deductions under

section 80C to 80U) is Rs. 5 lakhs or less is entitled to claim rebate under section 87A. This

rebate is available from income tax (before adding surcharge and cess).

Rebate Assessment year 2016-17 Assessment year 2017-18

Amount

of Rebate

100% of income tax payable on total

income or Rs. 2,000, whichever is less

100% of income tax payable on total

income or Rs. 5,000, whichever is less

3. Firms:

A firm is taxable at the rate of 30% for assessment year 2016-17 as well as 2017-18.

4. Companies:

The following rates of income-tax are applicable:

Company Assessment

year 2016-17

Assessment

year 2017-18

In the case of a domestic company:

- where its total turnover (or gross receipts) during the

previous year 2014-15 does not exceed Rs. 5 crore

- any other domestic company

30%

30%

29%

30%

In the case of a foreign company:

- Royalty received from Government or an Indian concern in

pursuance of an agreement made by it with the Indian

concern after March 31, 1961, but before April 1, 1976, or

fees for rendering technical services in pursuance of an

agreement made by it after February 29, 1964 but before

April 1, 1976 and where such agreement has, in either case,

been approved by the Central Government

- Other income

50%

40%

50%

40%

5. Surcharge:

Surcharge is applicable as a percentage of income-tax.

Assessee Assessment

year 2016-17

Assessment

year 2017-18

Any assessee:

- If net taxable income does not exceed Rs. 1 crore

Nil

Nil

102

Individual, HUF, AOP, BOI and Artificial juridical person:

- If net taxable income exceeds Rs. 1 crore

12%

15%

Firm:

- If net taxable income exceeds Rs. 1 crore

12%

12%

Domestic company:

- If net taxable income exceeds Rs. 1 crore but does not

exceed Rs. 10 crore

- If net taxable income exceeds Rs. 10 crore

7%

12%

7%

12%

Foreign company:

- If net taxable income exceeds Rs. 1 crore but does not

exceed Rs. 10 crore

- If net taxable income exceeds Rs. 10 crore

2%

5%

2%

5%

Surcharge is subject to marginal relief. In the case of an assessee having a net income

exceeding Rs. 1 crore, the amount payable as income tax and surcharge shall not exceed the

total amount payable as income-tax on total income of Rs. 1 crore by more than the amount

of income that exceeds Rs. 1 crore. Similarly, in the case of a company having a net income

exceeding Rs. 10 crore, the amount payable as income tax and surcharge shall not exceed the

total amount payable as income-tax on total income of Rs. 10 crore by more than the amount

of income that exceeds Rs. 10 crore.

6. Education cess [EC]:

Education cess is 2% [of income-tax calculated after adding surcharge (if any)] irrespective

of any income.

7. Secondary and Higher Education cess [SHEC]:

Secondary and higher education cess is 1% [of income-tax calculated after adding surcharge

(if any)] irrespective of any income.

Computation of salary income –

Income under the head “Salaries” is computed in the following manner:

Particulars Amount (Rs.)

Income from salary XX

Income by way of allowances XX

Taxable value of perquisites XX

Gross salary XX

Less: Deductions under section 16:

Entertainment allowance XX

Professional tax XX

Income from salaries XXX

RETIREMENT BENEFITS

Leave Salary –

Tax treatment – The tax treatment is given below:

Nature of leave encashment Status of employee Taxability

Leave encashment during

continuity of employment

Government/

non-Government employee

It is fully chargeable to tax.

However, relief can be taken

under section 89.

103

Nature of leave encashment Status of employee Taxability

Leave encashment at the time

of retirement/ leaving job

Government employee It is fully exempt from tax

(see the provisions given

below).

Non-Government employee It is fully or partially exempt

from tax. Here, exemption

depends upon the provisions

given below (see the

provisions given below).

Non-Government employees getting leave encashment at the time of retirement – In case of

non-Government employees (including an employee of a local authority or public sector

undertaking), leave salary is exempt from tax to the extent of least of the following four

amounts:

a. Period of earned leave (in number of months) standing to the credit of employee at the

time of retirement/ leaving the job (earned leave entitlements cannot exceed 30 days

for every year of actual service)*Average monthly salary

b. 10*Average monthly salary

c. Amount specified by the government (i.e., Rs. 3,00,000 minus amount exempted

earlier)

d. Leave encashment actually received at the time of retirement

Notes:

1. How to find out the leave standing to the credit of employee at the time of retirement or

leaving the job -

Step 1: Find out duration of service in years (ignore any fraction of the year)

Step 2: Find out the rate of earned leave entitlement from the service book of the employees –

such entitlement cannot exceed 30 days in a year. For example, if leave entitlement allowed

is 20 days per year, then 20 days per year will be taken (because it is less than 30 days in a

year). However, if leave entitlement allowed is 40 days per year, then for the purpose of

computing leave entitlement, 30 days would be taken and not 40.

Step 3: Find out the leaves actually availed or encashed while in service (in number of days)

Step 4: Multiply step 1 with step 2 and then divide the resulting figure by step 3 and result

would be in number of days. For example, if duration of service is 24 years 9 months, step 1

becomes 24. If leave entitlement as per service rules is 35 days per year, step 2 becomes 30.

If leaves actually availed while in service is 90 days, then step 3 becomes 90. Thus, step 4

becomes 24*30–90 = 630 days which is to be further divided by 30 to get the result in

number of months and the final leaves standing to one’s credit in numbers of months comes

out to be 21 (630/30).

2. Meaning of salary – Salary for this purpose means basic salary (+) dearness allowance (if

terms of employment so provide) (+) commission based upon fixed percentage of turnover

achieved by an employee. It is to be noted that dearness allowance/ pay shall be considered

only when it is part of salary for computing all retirement benefits (like provident fund,

pension, leave encashment, gratuity, etc.). If dearness allowance/ pay is part of salary for

computing only some (not all) of the retirement benefits, then it is not taken into

consideration for this purpose.

104

3. Average salary – Average salary for this purpose is to be calculated on the basis of average

salary drawn during the period of 10 months immediately preceding the retirement. For

example, if a person retires on 30 Nov. 2016, average salary will be taken from Feb. 1, 2016

to 30 Nov. 2016.

4. Actual years of service – While computing completed/ actual years of service, any fraction

of the year shall be ignored.

5. When earned leave encashment is received from two or more employers – Where leave

salary or leave encashment is received by a non-Government employee from two or more

employers (may be in the same year or different years), the maximum amount of exemption

cannot exceed Rs. 3,00,000 during the lifetime of the concerned employee.

6. Other relevant points –

Relief under section 89 would be admissible in respect of encashment of leave salary

by an employee while in service.

Salary paid to the legal heirs of the deceased employee in respect of privilege leave

standing to the credit of such employee at the time of his/ her death is not taxable as

salary.

Gratuity –

Tax treatment – The tax treatment is given below:

Status of employee Taxability

Government employee It is fully exempt from tax

Non-Government

employee

Covered by the Payment of

Gratuity Act, 1972

See the provisions given below

Not covered by the Payment

of Gratuity Act, 1972

see the provisions given below

Non-Government employees covered by the Payment of Gratuity Act, 1972 – In such cases,

least of the following amount is exempt from tax:

a. 15 days salary (7 days salary in the case of employees of a seasonal establishment)

based on salary last drawn for every completed year of service or part thereof in

excess of 6 months.

For example, if service is rendered for 20 years and 6 months, then we have to take 20

years.

b. Rs. 10,00,000 being the amount specified by the Government

c. Gratuity actually received

Notes:

1. Relief under section 89 – Gratuity in excess of the aforesaid limits is taxable in the hands

of the assessee. However, the assessee can claim relief under section 89.

2. Salary for this purpose means – Salary last drawn by an employee and dearness allowance

(whether forming part or not) but does not include any bonus, commission, etc.

3. Calculation of 15 days’ salary – Salary of 15 days is calculated by dividing salary last

drawn by 26 i.e., the maximum number of working days in a month.

For example, if monthly salary at the time of retirement is Rs. 3,000, 15 days salary would

come to Rs. 1,730.77 (Rs. 3,000/26*15).

Non-Government employees not covered by the Payment of Gratuity Act, 1972 – In such

cases, least of the following amount is exempt from tax:

105

a. Half months average salary for each completed year of service

b. Rs. 10,00,000 minus amount exempted earlier

c. Gratuity actually received

Notes:

1. Relief under section 89 – Gratuity in excess of the aforesaid limits is taxable in the hands

of the assessee. However, the assessee can claim relief under section 89.

2. Salary for this purpose means – Basic salary (+) dearness allowance (if terms of

employment so provide) (+) commission based on fixed percentage on turnover achieved by

an employee. It is to be noted that dearness allowance/ pay shall be considered only when it is

part of salary for computing all retirement benefits (like provident fund, pension, leave

encashment, gratuity, etc.). If dearness allowance/ pay is part of salary for computing only

some (not all) of the retirement benefits, then it is not taken into consideration for this

purpose.

3. Average monthly salary – is calculated on the basis of average salary for 10 months

immediately preceding the month in which the employee has retired. For example, if a person

retires on February 19, 2017, average salary will be considered on the basis of salary drawn

from April 1, 2016 to January 31, 2017.

4. Completed/ actual years of service – While computing completed/ actual years of service,

any fraction of the year shall be ignored. The words “each year of completed service” used

for the purpose of ‘gratuity’ in are not confined to completed years of service under one

employer and have to be interpreted to mean an employee’s total service under two different

employers including employer other than one from whose service he has retired, for purposes

of calculation of period of years of his completed service, provided he was not paid gratuity

by former employer.

5. Employee – Covered under Gratuity Act 1972 or not – If nothing is mentioned whether the

employee is covered under the Payment of Gratuity Act, 1972 or not, it would be assumed

that the employee is not covered under the Payment of Gratuity Act, 1972.

Gratuity paid while in service is taxable – Any gratuity paid to an employee while he

continues to remain in service (whether or not after he has put in a minimum specified period

of service) is not exempt from tax. However, here also, assessee can claim relief under

section 89.

Gratuity received by family members after the death of the employee – If gratuity is paid after

the death of an employee, then following situations may arise:

a. When gratuity becomes due before the death of the assessee but paid after the death of

the assessee, it will be taxable (as per the provisions) in the hands of the assessee even

if it is received by his legal heirs after his death.

b. When gratuity becomes due and paid after the death of a person, then the gratuity

amount will neither be taxable in the hands of that person nor in the hands of legal

heirs of that person.

Pension –

Pension is always given to the employee after retirement. The tax treatment of pension

received by the employee from the employer is given below –

Pension Status of employee Is it chargeable to tax

Uncommuted pension

(Periodical payment)

Government/

Non-Government employee

It is fully chargeable to tax

106

Commuted Pension

(Lump sum payment

in lieu of periodical

payment)

Government employee (including

the employees of local authority

and statutory corporation)

It is fully exempt from tax

Non-Government employee See the provisions given below

Exemption of commuted pension for non-government employees depends upon the receipt of

gratuity (i.e., whether employee has received gratuity also or not):

a. In case where a non-government employee receives Gratuity –

the commuted value of one-third of the pension which he is normally entitled to

receive is exempt from tax.

b. In case where a non-government employee does not receive Gratuity –

the commuted value of one-half of such pension which he is normally entitled to

receive is exempt from tax.

Notes:

1. Assessee can claim relief under section 89 in respect of taxable pension.

2. Pension received from UNO by the employees or his family members is not chargeable to

tax.

3. Family pension received by the family members of armed forces is exempt from tax under

section 10(19) in some cases.

4. Family Pension received by family members (not being the family members of armed

forces) after the death of an employee is taxable in the hands of recipients under section 56

under the head “Income from other sources”. Standard deduction is available under section

57 which is one-third of such pension or Rs. 15,000, whichever is lower.

5. Judges of the Supreme Court and High Courts are also entitled to the exemption of the

commuted pension under section 10(10A)(i) of the Act.

Pension scheme in case of an employee joining Central Government or any other

employer on or after January 1, 2004:

National Pension Scheme (NPS) is applicable to new entrants to Government service or any

other employer. Even a self-employed person can join NPS. As per the scheme, it is

mandatory for persons entering the service on or after January 1, 2004, to contribute 10% of

salary every month towards NPS. A matching contribution is required to be made by the

employer to the said account. The tax treatment under the new scheme is as follows –

a. Contribution by the employer to NPS is first included under the head “Salaries” in

hands of the employee and then deduction is also available under section 80CCD(2)

for such contribution (shown in the table given below).

b. When pension is received out of the aforesaid amount, it will be chargeable to tax in

the hands of the recipient. However, from the assessment year 2017-18, the whole

amount received by the nominee from NPS on death of the assessee shall be

exempt from tax.

c. No deduction will be allowed under section 80C in respect of amounts on which

deduction has been claimed under section 80CCD.

d. “Salary” for the above purpose of NPS means basic salary + dearness allowance

(forming part) + commission based on fixed percentage of turnover achieved by the

employee.

e. Deduction for contribution towards NPS is available under section 80CCD which is

explained below in detail:

107

Provisions Maximum deduction Cumulative maximum

deduction

Section 80C (Investments) Rs. 1,50,000

Rs. 1,50,000

[Section 80CCE]

Section 80CCC (Pension Fund) Rs. 1,50,000

Section 80CCD(1)

[i.e., employee’s contribution or

assessee’s contribution towards NPS]

10% of salary (if a salaried

individual)/ 10% of GTI

(if a non-salaried

individual)

Section 80CCD(1B)

[i.e., employees contribution or

assessee’s contribution towards NPS]

Rs. 50,000 Not Applicable

Section 80CCD(2)

[i.e., employer’s contribution towards

NPS]

10% of salary Not Applicable

Compensation received at the time of voluntary retirement [Sec. 10(10C)] –

Compensation received/ receivable at the time of voluntary retirement is exempt from tax

upto Rs. 5,00,000 if few conditions are satisfied. One of the conditions is the amount payable

on account of voluntary retirement or voluntary separation of the employees should not

exceed:

a. the amount equivalent to 3 months’ salary for each completed year of service; or

b. salary at the time of retirement multiplied by the balance months of service left before

the date of his retirement on superannuation,

whichever is more.

In this case, relief under section 89 is not available.

Retrenchment Compensation [Sec. 10(10B)] –

Compensation received by a workman at the time of his retrenchment is exempt from tax to

the least of the following amounts –

a. Rs. 5,00,000 (amount specified by the Government);

b. 15 days average pay for every completed year of service or part thereof in excess of 6

months;

c. Amount actually received.

In this case, relief under section 89 is available.

Provident Funds –

Tax treatment of different types of provident funds –

Situations Statutory

Provident

Fund (SPF)

Recognized

Provident Fund

(RPF)

Unrecognized

Provident Fund

(UPF)

Public

Provident

Fund

(PPF)

Employer’s

contribution

Exempt from

tax

Exempt up to 12% of

salary.

Exempt from tax Employer

does not

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Situations Statutory

Provident

Fund (SPF)

Recognized

Provident Fund

(RPF)

Unrecognized

Provident Fund

(UPF)

Public

Provident

Fund

(PPF)

to provident

fund

Excess of employer’s

contribution over

12% of salary is

taxable.

contribute

Interest

credited to

provident

fund

Exempt from

tax

Exempt from tax if

rate of interest does

not exceed 9.5%;

excess of interest

over this rate is

taxable.

Exempt from tax Exempt

from tax

Lump sum

payment at

the time of

retirement or

termination of

service

Exempt from

tax

Exempt from taxes in

some cases given

below§. When not

exempt, provident

fund will be treated

as an unrecognized

fund from the

beginning.

Employer’s

contribution and

interest thereon is

taxable under the

head “Salary”.

However, payment

received in respect of

employee’s own

contribution is

exempt from tax.

Interest on

employee’s

contribution is

taxable under the

head “Income from

other sources”.

Exempt

from tax

Salary for this purpose means – Basic salary (+) dearness allowance/ dearness pay (if terms

of employment so provide) (+) commission based on fixed percentage of turnover achieved

by an employee.

It is to be noted that dearness allowance/ pay shall be considered only when it is part of salary

for computing all retirement benefits (like provident fund, pension, leave encashment,

gratuity, etc.). If dearness allowance/ pay is part of salary for computing only some (not all)

of the retirement benefits, then it is not taken into consideration for this purpose.

§ Cases in which lump sum payment (RPF) is exempt –

1. If the employee has rendered continuous service with his employer for a period of 5 years

or more. If accumulated balance includes any amount transferred from his individual account

in any other recognized provident fund(s) maintained by his former employer(s), then, in

computing the period of 5 years, the period(s) for which the employee rendered continuous

service to his former employer(s) is also to be included; or

2. If the employee is not able to fulfill the conditions of such continuous service due to his

service having being terminated by reason of his ill-health or by reason of the contraction or

discontinuance of the employer’s business or due to some other reason beyond the control of

the employee; or

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3. If the employee has resigned before completion of 5 years but he joins another employer

(who maintains recognized provident fund and provident fund money with the current

employer is transferred to the new employer).

4. If the entire balance standing to the credit of the employee is transferred to his account

under a pension scheme referred to in section 80CCD and notified by the Central

Government (i.e., NPS) [Amended for Assessment year 2017-18]

Approved Superannuation Fund –

Tax treatment –

1. Employer’s contribution towards an approved superannuation fund will be chargeable to

tax to the extent it exceeds Rs. 1,50,000 per annum [In Assessment year 2016-17, this limit

was Rs. 1,00,000 per annum].

2. Employee’s contribution towards such fund is exempt from tax under section 80C.

3. Interest on accumulated balance is exempt from tax.

4. Payment from the fund is not chargeable to tax in the following cases:

a. refund of contribution or any payment from fund on the death of employee (i.e.,

payment to widow); and

b. lump sum payment by way of commutation of annuity to the employee on his

retirement.

ALLOWANCES

Allowances are divided under three categories for the purpose of taxability:

1. Fully taxable allowances;

2. Fully exempt allowances; or

3. Partially exempt allowances:

a. Exemption depending upon actual expenditure; or

b. Fixed exemption depending upon the provisions of the Act.

Fully taxable allowances –

There can be hundreds of fully taxable allowances. Some of the common fully taxable

allowances are –

1. City compensatory allowance (CCA)

2. Tiffin allowance

3. Fixed medical allowance

4. Servant allowance

5. Dearness allowance

6. Deputation allowance

7. Lunch/ meal/ dinner/ refreshment allowance

8. Overtime allowance

9. Family allowance

10. Non practicing allowance

11. Warden allowance

12. Planning allowance

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Special allowances prescribed as exempt under section 10(14) –

When exemption depends upon actual expenditure by the employee –

In the case of given below six allowances, lower of the following is allowed as deduction:

the amount of the allowance; or

the amount utilized for the specific purpose for which allowance is given.

These allowances are as follows –

1. Travelling allowance/ Transfer allowance

2. Conveyance allowance

3. Daily allowance

4. Helper allowance

5. Research/ Academic allowance

6. Uniform allowance –

When exemption does not depend upon the actual expenditure –

In case of given below allowances, the amount of exemption does not depend upon the

expenditure actually incurred by the employee. Amount of exemption is –

the amount of allowance; or

the amount specified in rule 2BB,

whichever is lower.

1. House rent allowance [Section 10(13A) and rule 2A] –

In case of house rent allowance, least of the following amount is exempt from tax –

1. An amount equal to 50% of salary, where residential house is situated at Bombay,

Calcutta, Delhi or Madras and an amount equal to 40% of salary where residential

house is situated at any other place.

2. House rent allowance received by the employee in respect of the period during which

rental accommodation is occupied by the employee during the previous year.

3. The excess of rent paid over 10% of salary.

Notes:

1. Salary for this purpose means – Basic salary (+) dearness allowance (if terms of

employment so provide) (+) commission based on fixed percentage of turnover achieved by

an employee.

It is to be noted that dearness allowance/ pay shall be considered only when it is part of salary

for computing all retirement benefits (like provident fund, pension, leave encashment,

gratuity, etc.). If dearness allowance/ pay is part of salary for computing only some (not all)

of the retirement benefits, then it is not to be taken into consideration for this purpose.

2. Due basis – Salary for this purpose is determined on “due” basis in respect of the period

during which rental accommodation is occupied by the employee in the previous year. It,

therefore, follows that salary of a period, other than the previous year, is not considered even

though such amount is received during the previous year and is taxable on “receipt” basis.

Likewise, salary of the period during which rental accommodation is not occupied in the

previous year, is left out of the aforesaid computations.

3. Exemption is denied where an employee lives in his own house, or in a house for which he

does not pay any rent or pays rent which does not exceed 10% of salary.

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2. Entertainment allowance [Sec. 16(ii)] –

It is first included in salary income under the head “allowances” and thereafter a deduction is

given on the following basis:

a. In case of a Government employee, the least of the following is deductible:

- Rs. 5,000;

- 20% of basic salary; or

- Amount of entertainment allowance granted during the previous year.

Basic salary for this purpose excludes any allowance, benefit or other perquisites. Further,

amount actually expended towards entertainment (out of entertainment allowance received) is

not taken in to consideration.

b. In the case of a non-government employee (including employees of local authority

and statutory corporation), entertainment allowance is not deductible. It if fully

taxable.

3. Allowance for transport employees working in any transport system –

Amount of exemption is 70% of such allowance or Rs. 10,000 per month whichever is lower.

4. Transport allowance –

Amount of exemption is limited to Rs. 1,600 per month (Rs. 3,200 per month in case of an

employee who is blind or orthopaedically handicapped).

It is to be noted that expenditure for covering the journey between office and residence is not

treated as expenditure in performance of duties of the office.

5. Children education allowance –

Amount exempt from tax is limited to Rs. 100 per month per child up to a maximum of two

children.

6. Hostel expenditure allowance –

Amount exempt from tax is limited to Rs. 300 per month per child up to maximum of two

children.

7. Tribal/ scheduled areas allowance –

Rs. 200 per month if an employee is posted in U.P., M.P., Tamil Nadu, Karnataka, West

Bengal, Bihar, Orissa, Assam or Tripura.

8. Underground allowance –

Underground allowance is granted to an employee who is working in uncongenial, unnatural

climate in underground mines. Exemption is limited to Rs. 800/ month.

9. Highly active field area allowance –

It is exempt from tax up to Rs. 4,200 per month.

10. Island duty allowance –

It is exempt from tax up to Rs. 3,250 per month.

11. Allowance to Government employees outside India –

Any allowance paid or allowed outside India by the Government to an Indian citizen for

rendering service outside India is wholly exempt from tax.

12. Allowance received from a UNO –

Not chargeable to tax

13. Allowance to High Court and Supreme Court Judges –

Not chargeable to tax

14. Allowances to Chairman/ members of UPSC –

In the case of serving Chairman and members of UPSC, transport allowance and sumptuary

allowance are not chargeable to tax.

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PERQUISITES

Perquisites are divided under five categories for the purpose of taxability:

1. Perquisites which are taxable for specified as well as non-specified employees;

2. Perquisites which are exempt for specified as well as non-specified employees;

3. Perquisites which are taxable only for specified employees and exempt for non-

specified employees;

4. Contribution by the employer to the approved superannuation fund in respect of the

assessee to the extent it exceeds Rs. 1,50,000;

5. Specified equity or sweat equity shares allotted or transferred by the employer to the

assessee.

Perquisites taxable only in the hands of a specified employee –

The following perquisites are taxable only in the hands of specified employees:

Service of a sweeper, gardener, watchman or personal attendant

Supply of gas, electricity or water for household purposes

Education facility to employee’s family members

Leave travel concession (LTC)

Medical facility

Car or any other automotive conveyance

Transport facility by a transport undertaking

VALUATION OF DIFFERENT PERQUISITES

Accommodation –

1. Rent-free unfurnished accommodation [Rule 3(1)] –

For Central and State Government employees – The value of perquisite in respect of

accommodation provided to such employees is equal to the licence fee which would have

been determined by the Central or State Government in accordance with the rules framed by

the Government for allotment of houses to its officers.

However, rent-free official residence provided to a Judge of a High Court or to a judge of the

Supreme Court is exempt from tax. A similar exemption is extended to an official of

Parliament, a Union Minister, a Leader of Opposition in Parliament and serving Chairman/

members of UPSC.

For private sector or other employees (including the employees of a local authority or a

foreign Government):

Population of city as per

2001 census where

accommodation is provided

Where the accommodation is

owned by the employer

Where the accommodation is

taken on lease or on rent by

the employer

Exceeding 25 lakh 15% of salary in respect of

the period during which the

accommodation is occupied

by the employee Amount of lease rent paid or

payable by the employer or

15% of salary, whichever is

lower Exceeding 10 lakh but not

exceeding 25 lakh

10% of salary in respect of

the period during which the

accommodation is occupied

by the employee

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Any other 7.5% of salary in respect of

the period during which the

accommodation is occupied

by the employee

Notes:

1. Salary for this purpose includes – Basic salary, dearness allowance/ pay (if terms of

employment so provide), bonus, commission, fees, all other taxable allowances (excluding

amount not taxable) and any monetary payment which is chargeable to tax (by whatever

name called).

It is to be noted that dearness allowance/ pay shall be considered only when it is part

of salary for computing all retirement benefits (like provident fund, pension, leave

encashment, gratuity, etc.). If dearness allowance/ pay is part of salary for computing only

some (not all) of the retirement benefits, then it is not taken into consideration for this

purpose.

2. Salary does not include –

employer’s contribution to provident fund account of an employee;

all allowances which are exempt from tax;

value of perquisites [under section 17(2)]; and

lump-sum payment received at the time of termination of service or superannuation or

voluntary retirement, like gratuity, severance pay leave encashment, voluntary

retrenchment benefits, commutation of pension and similar payments.

3. Salary shall be determined on “accrual” basis – For example, advance salary of a period

other than the previous year is not included even if the same is received in the previous year.

Similarly, salary due in the previous year is included, even if it is received after the end of the

previous year. In other words, we can say that salary accrued for the period during which

rent-free accommodation is occupied by the employee will be considered whether it is

received during the previous year or not.

In all we can say that advance salary/ bonus for a period other than the previous year will not

to be included in salary for the above purpose.

4. Monetary payments which are in the nature of perquisites under section 17(2) shall not be

included. Conversely, monetary payments which are not in the nature of perquisites under

section 17(2) shall be included. For example, bonus (not being a perquisite, but being a

monetary payment) is taken into consideration. However, income tax payment of an

employee by the employer, being a monetary payment but also a perquisite is not included for

the purpose of computing salary.

5. Salary from two or more employers – Salary from all employers in respect of the period

during which an accommodation is provided will be taken into consideration.

6. Accommodation provided on transfer – Where on account of the transfer of an employee

from one place to another, he is provided with accommodation at the new place of posting

while retaining the accommodation at the other place, the value of perquisite shall be

determined with reference to only one such accommodation which has the lower value for a

period not exceeding 90 days and thereafter the value of perquisite shall be charged for both

such accommodations.

7. Exemption – The above perquisite is not chargeable to tax in respect of any

accommodation located in a ‘remote area’ [i.e., an area located at least 40 kilometres away

from a town having a population not exceeding 20,000] provided to an employee working at

a mining site or an onshore oil exploration site, or a project execution site or a dam site or

power generation site or an offshore site.

114

2. Rent-free furnished accommodation (not being a hotel) –

First, find out the value of the perquisite assuming that the accommodation is unfurnished

and to the figures so arrived, add the value of furniture on the following basis –

a. 10% (p.a.) of the original cost of furniture, if furniture is owned by the employer;

b. actual hire charges (whether paid or payable) if furniture is hired by the employer.

Furniture, here, includes radio sets, televisions sets, refrigerators, air–conditioners and other

household appliances.

3. Rent-free furnished accommodation provided in a hotel –

Besides, accommodation in a hotel, it includes licensed accommodation in the nature of

motel, service apartment or guest house.

The value of perquisite shall be taken as 24% of salary paid or payable for the period during

which such accommodation is provided in the previous year or actual charges paid/ payable

by the employer to such hotel, whichever is lower.

However, in case of an accommodation provided in a hotel, nothing is chargeable to tax

(subject to the fulfilment of given below two conditions) –

1. The hotel accommodation is provided for a period not exceeding in aggregate 15 days

in a previous year and

2. Such accommodation is provided on an employee’s transfer from one place to another

place.

It is to be noted that if in the aforesaid case, the hotel accommodation is provided for more

than 15 days, then the perquisite is not taxable for the first 15 days. After that it is chargeable

to tax.

4. Accommodation provided at concessional rent –

Accommodation may be furnished or unfurnished or it is provided in a hotel. However, if it is

provided at a concessional rent, the valuation should be made as follows –

Step 1: Find out the value of the perquisite on the assumption that no rent is charged by the

employer (as per the above stated rules).

Step 2: From the value so arrived at, deduct the rent charged by the employer from the

employee.

Employee’s obligation met by the employer –

Amount paid by the employer in respect of any obligation which otherwise would have been

payable by the employee is taxable in all cases whether the employee is specified or non-

specified.

Amount payable by the employer to effect an assurance on the life of the employee –

Amount payable by an employer, directly or indirectly, to effect an assurance on the life of

the assessee or to effect a contract for an annuity is taxable in the hands of all employees.

This rule is, however, not applicable if the employer makes contribution/ payment towards

the following:

a. RPF (up to 12% of salary of the employee);

b. Approved superannuation fund (up to Rs. 1,50,000 per annum) [In Assessment year,

this limit was Rs. 1,00,000 per annum];

115

c. Group insurance schemes;

d. Employee’s state insurance schemes; and

e. Fidelity guarantee schemes.

Interest-free loan or loan at concessional rate of interest –

If a loan is given by an employer to the employee (or any member of his household), it is a

perquisite chargeable to tax. Value of perquisite is computed at the rate of interest charged by

SBI as on the first day of the relevant previous year in respect of loan for the same purpose

advanced by it.

Interest is calculated on the maximum outstanding monthly balance for each loan as on the

last day of each month.

Given below are the rates of State Bank of India:

Type of loan Different limit As on April 1, 2016 (applicable for the

assessment year 2017-18)

Housing loan 9.45% (9.40% for women)

Car loan 9.80% (9.75% for women)

Education loan Up to Rs. 7.5 lakh 11.20%

Above Rs. 7.5 lakh 10.90%

Personal loan 15.95%

In the following cases, however, the above perquisite is not chargeable to tax:

1. If a loan is made available for medical treatment in respect of diseases specified in rule 3A

(the exemption is, however, not applicable to so much of the loan as has been reimbursed to

the employee under any medical insurance scheme; in such a case, perquisite will be

chargeable to tax from the date of receipt of insurance compensation).

2. Where the amount of original loan (or loans) does not exceed Rs. 20,000 in aggregate.

Where, however, the amount exceeds Rs. 20,000, entire amount is chargeable to tax.

Use of movable assets –

The value of this perquisite is determined @ 10% p.a. of the actual cost of such asset (if the

asset is owned by the employer) or the amount of rent paid or payable (if the asset is taken on

hire by the employer).

From the value so arrived, deduct the amount received from the employee.

However, no perquisite is chargeable to tax in respect of use of computer/ laptops.

Movable assets sold by employer to its employees (or any member of his household) at a

nominal price –

The value of this perquisite is calculated as an actual cost of such asset to the employer minus

normal wear and tear at the rate given below for each completed year during which such asset

was put to use by the employer for his business purposes minus amount received from the

employee.

Following are the rates for normal wear and tear:

Electronic items/ computers : 50% by reducing balance method (WDV)

Motor Car : 20% by reducing balance method (WDV)

Any other asset : 10% of the actual cost

116

[Electronic item means data storage and handling devices like computer, digital diaries and

printers but does not include household appliances like mixers, washing machines, ovens,

etc.]

Lunch/ Refreshment, etc. –

The value of free food, tea and snacks etc. shall be as under:

Circumstances Value of perquisite

Tea or similar non-alcoholic beverages and

snacks (in the form of light refreshments)

provided during working hours

NIL

Food and non-alcoholic beverages is

provided in working hours in remote area or

in an offshore installation

NIL

Food and non-alcoholic beverages is

provided in working hours at any other place

(other than remote area or in an offshore

installation) i.e., either in office or business

premises or through non-transferable paid

vouchers usable only at eating joints

provided by an employer

NIL, if the value thereof in either case is up

to Rs. 50 per meal. However, expenditure in

excess of Rs. 50 per meal should be treated

as perquisite.

Amount received from the employee is

deducted to compute the taxable value of the

perquisite.

In any other case Actual amount of expenditure incurred by the

employer minus amount paid or recovered

from the employee

Travelling, Touring and Accommodation –

Following is the treatment in respect of travelling, touring, accommodation and any other

expenses paid by employer for any holiday availed by employee (or any member of

household) other than leave travel concession (LTC):

Where such facility is available uniformly to all employees:

Expenditure incurred by the employer minus amount recovered from the employee is the

taxable value of the perquisite.

Where such facility is not available uniformly to all employees:

Value at which such facilities are offered by other agencies to the public minus amount

recovered from the employee is the taxable value of the perquisite.

Gift, Voucher or taken –

The value of any gift, voucher or token in lieu of which gift may be received by the employee

(or by the member of his household) on ceremonial occasions or otherwise shall be

determined as the sum equal to the amount of such gift. Such gift is exempt from tax where,

the value of such gift, voucher or token, as the case may be, is below Rs. 5,000 in aggregate

during the previous year. Beyond Rs. 5,000, gift-in-kind is taxable.

However, gifts made in cash or convertible into money (gift cheques) are not exempt from

tax even if there value is less than Rs. 5,000.

Credit card –

Any expenditure incurred by the employer in respect of credit card used by the employee or

any member of his household after deducting the expenditure on use of this credit card for

official purposes is the taxable value of the perquisite. The expenditure incurred by the

117

employer includes the membership fees and annual fees incurred by the employee or any

member of his household, which is charged to a credit card (including any add-on-card),

provided by the employer (or otherwise paid or reimbursed by the employer).

Club expenditure –

This perquisite includes any expenditure on club facility used by the employee or any

member of his household which is paid or reimbursed by the employer. It also includes

amount of annual or periodical fees paid or payable to a club.

The amount of expenditure incurred by the employer in respect of club facility used by the

employee or any member of his household after deducting the expenditure on use of this club

facility for official purposes is the taxable value of the perquisite.

Expenditure for official use:

The amount of expenditure incurred on use of club facility for official purposes is deductible,

provided following conditions are satisfied:

1. Complete detail in respect of such expenditure is maintained by the employer which may,

inter alia, include the date of expenditure, the nature of expenditure and its business

feasibility.

2. The employer gives a certificate for such expenditure to the effect that the same was

incurred wholly and exclusively for the performance of official duties.

The following expenditure is exempt from tax:

1. Health club, sports facilities etc. provided uniformly to all classes of employees by the

employer at employer’s premises.

2. The initial one time deposit or fees for corporate or institutional membership, where

benefit does not remain with a particular employee after cessation of employment.

Sweat equity shares or Employees stock option plan (ESOP) –

Perquisite in respect of “sweat equity shares” or “ESOP” is chargeable to tax in the hands of

employees, provided such shares are allotted or transferred to the concerned employee after

March 31, 2009.

For the purpose of valuation of this perquisite, fair market value (FMV) of shares or

securities has to be calculated on the date on which the employee exercises the option.

Amount actually paid or recovered from the employee in respect of such shares or securities

shall be deducted.

This perquisite will be taxable in the hands of employee in the previous year in which shares

or securities are allotted or transferred to him. However, fair market value shall be calculated

on the date on which the employee exercises the option.

“Sweat equity shares” means shares issued by a company to its employees or directors at a

discount or for consideration other than cash for providing know-how or making available

rights in the nature of intellectual property rights or value additions, by whatever name called.

Such shares may be equity shares, any other shares, scrips, debentures, derivatives or units.

These may be transferred/ allotted (directly or indirectly) to the employee.

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Domestic servants –

The value of perquisite shall be the actual cost to the employer minus amount paid by the

employee for such services.

If an employer provides a rent-free house (owned by the employer) to his employee, expenses

(inclusive of salary of a gardener) incurred by the employer on maintenance of garden and

ground attached to the house, are not taxable separately.

Gas, Electricity or Water supply –

The value of perquisite shall be the cost to the employer as reduced by the amount recovered

from the employee.

Education –

1. Any amount spent for providing free education facilities to, and training of, the

employees is not taxable.

2. Any payment of school fees of the family members of the employee directly to the

school or any reimbursement of expenditure incurred for education of the family

members of the employee is taxable as a perquisite in all cases.

3. Education facility in employer’s institute:

It means:

a. an educational institute which is owned and maintained by the employer and

educational facility is provided; or

b. an educational facility is provided in any institute by reason of employee’s

employment with the employer.

Different situations Amount chargeable to tax

Where educational facility is provided to

employee’s children:

a. If cost of education or value of such

benefit does not exceed Rs. 1,000 per

month per child (no restriction on

number of children)

b. Where such amount exceed Rs. 1000

per month per child §1

Nil

Cost of such education in a similar institution

in or near the locality minus amount paid or

recovered from the employee

Where education facility is provided to

member of his household (other than

children)

Cost of such education in a similar institution

in or near the locality minus amount paid or

recovered from the employee

§1 A literal meaning of the line indicates that if the cost of education per child exceeds Rs.

1,000 per month, the entire cost will be the value of the perquisite. Also, the Punjab and

Haryana High Court in the case of CIT v. Director, Delhi Public School [2011] 202 Taxmann

318 ruled that nothing is taxable if cost of education in a similar institute is equal to or less

than Rs. 1,000 per month. In case, it exceeds Rs. 1,000 per month, the entire amount is

chargeable to tax.

119

Leave Travel Concession in India [Section 10(5)] –

Leave travel assistance extended by an employer to an employee for going anywhere in India

along with his family is exempt according to the provisions mentioned in the table given

below:

Different situations Amount of exemption (exemption is available

only in respect of fare for going anywhere in

India along with the family twice in a block of

four years)

Where journey is performed by air Amount of economy class fare of the national

carrier by the shortest route or the amount

spent, whichever is less

Where journey is performed by rail Amount of air-conditioned first class rail fare

by the shortest route or the amount spent,

whichever is less

Where the places of origin of journey and

destination are connected by rail and journey

is performed by any other mode of transport

Same as (2)

Where the places of origin of journey and

destination (or part thereof) are not

connected by rail:

a. Where a recognized public transport

exists

b. Where no recognized public transport

exists

First class or deluxe class fare by the shortest

route or the amount spent whichever is less

Air-conditioned first class rail fare by the

shortest route (as if the journey had been

performed by rail) or the amount actually

spent, whichever is less.

Notes:

1. Family for this purpose includes:

a. spouse and children of the employee; and

b. parents, brothers and sisters of the employee, who are wholly or mainly dependent

upon the employee.

2. Only two journeys performed in a block of four years is exempt:

Exemption of this perquisite is exempt from tax in respect of two journeys performed in a

block of four calendar years. The different blocks are:

a. 2010-2013 (i.e., January 1, 2010 to December 31, 2013);

b. 2014- 2017 (i.e., January 1, 2014 to December 31, 2017)

3. “Carry-over” concession:

If an assessee has not availed travel concession or assistance during any of the specified four-

year block periods on one of the two permitted occasions (or on both occasions), exemption

can be claimed in the first calendar year of the next block (but in respect of only one

journey). This is known as “carry-over” concession. In such case, exemption so availed will

not be counted for the purposes of claiming the future exemptions allowable in respect of two

journeys in the subsequent block.

4. Exemption is based on actual expenditure:

5. Exemption is available in respect of fare:

120

Exemption is strictly restricted to expenses on air fare, rail fare, bus fare etc. No other

expenditure, like scooter charges, lodging and boarding expenses etc. are qualified for

exemption.

6. Exemption is available in respect of shortest route.

Medical Facility –

The following expenses whether incurred or reimbursed by the employer are exempt from

tax:

Medical facilities in India:

1. Medical facility in employer’s hospital (including clinic, dispensary or nursing home).

2. Medical facility in a hospital maintained by Central/ State Government or by a local

authority or by any other person approved by the Government for the treatment of its

employees.

3. Treatment of prescribed disease given in rule 3A(2) in a hospital approved by the Chief

Commissioner.

4. Medical insurance premium for employees on any health insurance policy.

5. Medical facility in a private clinic not exceeding, Rs. 15,000 in aggregate in a year.

Medical facility outside India:

The amount is exempt from tax subject to the conditions given below in the table:

Perquisite not chargeable to tax Conditions to be satisfied

Medical treatment of employee or any

member of family of such employee outside

India

Expenditure shall be excluded from

perquisite only to the extent permitted by

RBI

Cost on travel of the employee/ any member

of his family and one attendant who

accompanies the patient in connection with

treatment outside India

Expenditure shall be excluded from

perquisite only in the case of an employee

whose gross total income, as computed

before included therein the said expenditure

(i.e., travelling) does not exceed Rs.

2,00,000

Cost of stay abroad of the employee or any

member of the family for medical treatment

and cost of stay of one attendant who

accompanies the patient in connection with

such treatment

Expenditure shall be excluded from the

perquisite only to the extent permitted by

RBI

Family for this perquisite means:

1. the spouse and children of the individual; and

2. the parents, brothers and sisters of the individual or any one of them wholly or mainly

dependent on the individual.

Motor Car –

Taxable value of perquisite in respect of car is computed in three steps:

Step 1: Check the ownership of car

Step 2: Check who incurs the running and maintenance expenditure of car

Step 3: Check the use of car

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Chart for computing the value of motor car

Ownership EmployEE EmployER

Expenses Employee EmployER EmployER Employee

Official use

Not a

perquisite

No value provided a few conditions are satisfied§

Private use Actual expenditure of the employer XX

Less: Amount recovered from the employee XX

XXX

Official

as well as

personal

use

Actual expenditure

of the employer

Less: Official expense

1,800/ m [≤ 1.6 ltr.]

or 2,400/ m [> 1.6 ltr.]

plus 900/ m [if driver is

provided]

OR

Higher amount (if

log book is

maintained)

Less: Amount recovered

from the employee

1,800/ m

[≤ 1.6 ltr.]

or 2,400/ m

[> 1.6 ltr.]

plus 900/ m

[if driver is

provided]

Note: Amount

recovered is not

deductible

600/ m

[≤ 1.6 ltr.]

or 900/ m

[> 1.6 ltr.]

plus 900/ m

[if driver is

provided]

Note: Amount

recovered is not

deductible

Note:

1. If car is owned by the employer which is used for official as well as personal use and

expenses for personal purpose are incurred by the employee, perquisite value will be

done according to the provision given in this column.

2. Amount recovered from the employee is never deducted in case of car owned by the

employer and the car is used for official as well as personal purpose.

§ Conditions to be satisfied if car is used for official purposes:

Where the employer or the employee claim that the motor-car is used wholly and exclusively

in the performance of official duty, the following two conditions should be satisfied –

1. The employer has maintained complete details of journey undertaken for official

purpose which may include date of journey, destination, mileage, and the amount of

expenditure incurred thereon.

2. The employer gives a certificate to the effect that the expenditure was incurred wholly

and exclusively for the performance of official duties.

It is to be noted that the above two conditions should also be satisfied if a car is owned by the

employee, expenses are incurred or reimbursed by the employer and the employee claims that

the expenses for official purposes is more than Rs. 1,800 per month (or Rs. 2,400 per month

if cc rating of car exceeds 1,600 cc).

Notes –

1. Month: ‘Month’ means complete month and a part of the month is left out of consideration.

2. The use of motor car by an employee for the purpose of going from his residence to the

place where the duties of employment are to be performed or from such place back to his

residence, is not chargeable to tax.

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3. Where two or more cars are owned or hired by the employer and maintenance and running

expenses are also met or reimbursed by the employer, and the employee (or any member of

his household) are allowed the use of such motor-cars (or all or any of such motor-cars)

(otherwise than wholly and exclusively in the performance of his duties), in such a situation

any one car (as selected by the employee) will be treated as used partly for official and

private purposes and others would be assumed as used wholly for private purposes for the

purpose of valuation of perquisite of car.

Free transport provided by a transport undertaking to its employees –

The value of this perquisite is equal to the value at which such benefit is offered by the

employer to the public minus amount recovered from the employee.

However, nothing is chargeable to tax in the hands of employees of railways/ airlines.

Any other benefit or amenity –

It covers any other benefit or amenity, service, right or privilege provided by the employer

and it is applicable to all employees. However, it does not cover the following –

1. Perquisites already discussed above

2. Telephone/ mobile phones

Value of such perquisites shall be determined on the basis of cost to the employer under an

arm’s length transaction as reduced by the employee’s contribution, if any.

DEDUCTIONS FROM SALARY

Deductions from salary are given in section 16. There are two deductions available from

gross salary –

1. Entertainment Allowance [Sec. 16(ii)]

2. Professional tax [Sec. 16(iii)]: Professional tax or tax on employment, levied by a State

under article 276 of the Constitution, is allowed as deduction. Deduction is available only in

the year in which professional tax is paid. If the professional tax is paid by the employer on

behalf of an employee, it is first included in the salary of the employee as a “perquisite” and

then the same is allowed as deduction on account of “professional tax” from gross salary.

It is to be noted that there is no monetary ceiling under the Income-tax Act. Under article 276

of the Constitution, a State Government cannot impose more than Rs. 2,500 per annum as

professional tax. However, under the Income-tax Act, whatever professional tax is paid

during the previous year is deductible.

Example:

Mr. X has received offers from companies of Delhi for service as under:

Offer A (Rs.) Offer B (Rs.)

Basic Salary 5,00,000 2,50,000

House Rent Allowance ---- 48,000

Travelling allowance

(for coming to office from residence and back) ---- 19,200

Contribution to approved superannuation fund by

the employer ---- 1,70,000

Mobile phone ---- 12,800

Total 5,00,000 5,00,000

Additional information:

a. His qualifying savings under section 80C will be Rs. 50,000.

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b. He will pay house rent Rs. 6,500 p.m.

c. He needs a mobile phone for private purposes.

Which offer should he accept and why? Further, is there any gain to the employer in case of

offer ‘B’? The rate of tax for the employer is 30% + surcharge @ 7% + Education cess @ 3%

= 33.063%.

Solution:

Since the topic is concerned with planning, assessment year 2017-18 has been applied.

Computation of taxable income and tax liability of Mr. X for the assessment year 2017-18:

Particulars Offer A (Rs.) Offer B (Rs.)

Salary 5,00,000 2,50,000

HRA received 48,000

Less: Exempt 48,000

Least of the following is exempt:

a. HRA received is Rs. 48,000

b. Rent paid – 10% of salary (78,000 – 10% of

2,50,000) i.e., 53,000

c. 50% of Rs. 2,50,000 i.e., 1,25,000

NIL

Travelling allowance (exempt up to 1,600 per

month)

NIL

Contribution to approved superannuation fund

(1,70,000 – 1,50,000)

20,000

Mobile phones Exempt

Gross total income 5,00,000 2,70,000

Less: Deduction under section 80C 50,000 50,000

Less: Deduction under section 80GG

Least of the following is exempt:

a. 60,000

b. Rent paid – 10% of total income (78,000 – 10%

of 4,50,000) i.e., 33,000

c. 25% of 4,50,000 i.e., 1,12,500

33,000

Net taxable income 4,17,000 2,20,000

Tax on NTI 16,700 Nil

Less: Rebate under section 87A 5,000 Nil

11,700 Nil

Add: Cess @ 3% 351 Nil

Net tax payable (Rounded off) 12,050 Nil

Conclusion: It is better to accept offer B since tax liability is less.

Computation of gain/ loss to employer:

Offer A (Rs.) Offer B (Rs.)

Total remuneration 5,00,000 5,00,000

Less: Tax saved @ 33.063% 1,65,315 1,65,315

Net burden 3,34,685 3,34,685

There is a neither any gain nor any loss to the employer in any case.

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Example:

Mrs. Z is employed in Indian Airlines on a monthly salary of Rs. 25,000 p.m. and is in receipt

of the following allowances:

a. Split duty allowance Rs. 500 p.m.

b. Lunch allowance Rs. 500 p.m.

c. Regularity allowance Rs. 600 p.m.

d. Transport allowance Rs. 1,600 p.m.

e. Outstation allowance Rs. 4,000 p.m.

f. Overtime allowance Rs. 1,000 p.m.

g. Servant allowance Rs. 500 p.m.

h. Deputation allowance Rs. 400 p.m.

i. Special compensatory (Tribal Areas) allowance Rs. 250 p.m.

Compute the gross salary of Mrs. Z for the assessment year 2017-18.

Solution:

Computation of gross salary of Mrs. Z for the assessment year 2017-18:

Particulars Amount (Rs.)

Basic salary 3,00,000

Split duty allowance 6,000

Lunch allowance 6,000

Regularity allowance 7,200

Transport allowance (Exempt up to Rs. 1,600 per month) NIL

Outstation allowance 48,000

Less: Exempt 70% of 48,000 or 10,000 p.m. whichever is less 33,600

14,400

Overtime allowance 12,000

Servant allowance 6,000

Deputation allowance 4,800

Tribal area allowance (Exempt upto Rs. 200 per month) 600

Gross salary 3,57,000

Example:

A Ltd. has offered you a job in Delhi at a basic salary of Rs. 15,000 per month and an option

to choose any one of the following two packages:

Package I Package II

1. HRA Rs. 4,500 per month

(Rent to be paid Rs. 4,500 per month)

Company owned unfurnished

accommodation

(F.R.V. Rs. 54,000 per annum)

2. Education allowance Rs. 400 per month

(for one child)

Education facility for one child in an

institution owned by employer valued at Rs.

300 per month

3. Telephone allowance Rs. 1,500 per

month

Free telephone facility at residence upto

Rs.1,000 per month

4. Medical allowance Rs. 2,000 per month Medical reimbursement upto Rs. 24,000 per

annum

5. Conveyance allowance Rs. 1,500 per

month (for private use)

Motor car facility for private use with

expenditure valued at Rs. 18,000

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The company also offers the services of watchman, sweeper and gardener in both the above

packages. The salary of each is Rs. 500 per month. Which package will you choose so that

your tax liability is minimized?

Solution:

Calculation of salary in case Package I is chosen:

Amount (Rs.)

Basic salary 1,80,000

HRA (4,500 – 3,000)*12 18,000

Education allowance (400 - 100)*12 3,600

Telephone allowance 18,000

Medical allowance 24,000

Conveyance allowance 18,000

Sweeper etc. [500*3*12] 18,000

Taxable salary 2,79,600

Calculation of salary in case Package II is chosen:

Amount (Rs.)

Basic salary 1,80,000

RFA (15% of 1,80,000) 27,000

Education facility (exempt as less than 1,000) ----

Telephone facility exempt

Medical facility (24,000 – 15,000) 9,000

Motor car 18,000

Sweeper etc. [500*3*12] 18,000

Taxable salary 2,52,000

Conclusion: Here, package II is better.

It is assumed that gardener is not provided along with the rent free unfurnished

accommodation.

Example:

Mrs. ‘X’ is offered an employment by ABC Ltd. at a basic salary of Rs. 24,000 p.m. Other

allowances according to rules of the company are:

Dearness allowance: 18% of basic pay (not forming part of the salary), bonus one month’s

basic pay, project allowance: 6% of basic pay.

The company gives Mrs. X an option either to take a rent-free unfurnished accommodation at

Bhopal for which the company would directly bear the rent of Rs. 15,000 p.m. or to accept a

house rent allowance of Rs. 15,000 p.m. and to find out own accommodation. If Mrs. X opts

for H.R.A., she will have to pay Rs. 15,000 p.m. as rent. Which one of the two options should

be opted by Mrs. X in order to minimize her tax bill?

Will it make any difference to her choice if Dearness Allowance forms part of salary for

long-term benefits?

Solution:

Computation of salary income for both the offers for the assessment year 2017-18:

Particulars Offer A

(RFA) [Rs.]

Offer B

(HRA) [Rs.]

Basic salary (24,000*12) 2,88,000 2,88,000

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DA (18% of 2,88,000) 51,840 51,840

Bonus 24,000 24,000

Project Allowance (6% of 2,88,000) 17,280 17,280

RFA [15% of (2,88,000 + 24,000 + 17,280) or

lease rent of Rs. 1,80,000 whichever is lower]

49,392 ----

HRA Received 1,80,000

Less: Exempt 1,15,200

Least of the following is exempt:

a. 40% of 2,88,000 i.e., 1,15,200

b. HRA received i.e., 1,80,000

c. Rent paid – 10% of salary i.e., 1,80,000 – 10% of

2,88,000 = 1,51,200

---- 64,800

Gross salary 4,30,512 4,45,920

Less: Deduction under section 16 NIL NIL

Net taxable salary 4,30,512 4,45,920

Conclusion: Mrs. X should, therefore, opt for rent free house.

If dearness allowance forms part of salary for long-term benefits;

Particulars Offer A

(RFA) [Rs.]

Offer B

(HRA) [Rs.]

Basic salary (24,000*12) 2,88,000 2,88,000

DA (18% of 2,88,000) 51,840 51,840

Bonus 24,000 24,000

Project Allowance (6% of 2,88,000) 17,280 17,280

RFA [15% of (2,88,000 + 51,840 + 24,000 +

17,280) or lease rent of Rs. 1,80,000, whichever is

lower]

57,168 ----

HRA Received 1,80,000

Less: Exempt 1,35,936

Least of the following is exempt:

a. 40% of 3,39,840 i.e., 1,35,936

b. HRA received i.e., 1,80,000

c. Rent paid – 10% of salary i.e., 1,80,000 – 10% of

3,39,840 = 1,44,016

44,064

Gross salary 4,38,288 4,25,184

Less: Deduction under section 16 NIL NIL

Net taxable salary 4,38,288 4,25,184

Conclusion: In this situation, Mrs. X should opt for house rent allowance.

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LESSON -8

(a) Tax Planning with Reference to Sale of Scientific Research Assets

(b) Tax Planning with Reference to Receipt of Insurance Compensation

(c) Tax Planning with Reference to Distribution of Assets at the

Time of Liquidation

(a)Tax Planning with reference to Sale of Assets used for Scientific Research

8 STRCUTURE

8.1 Sale of Assets Used for Scientific Research

8.1 SALE OF ASSETS USED FOR SCIENTIFIC RESEARCH

If an assessee purchases an asset for scientific research related to its business, the

expenditure incurred is deductible during the previous year in which it is incurred. If such

asset ceases to be of any use for scientific research purposes, the assessee can sell it or use it

in the business for some other purposes.

From tax planning point of view, we should consider whether it is beneficial to sell such asset

immediately or it should be sold after using it for some time in the business for some other

purposes. Following are the tax implications:

1. Sold the asset without having been used for other purposes:

Where the scientific research asset is sold off without having been used for other

purposes, then the net sale price or the cost of the asset, which was earlier allowed as

deduction under section 35, whichever is less, shall be treated as business income of

the previous year in which such asset is sold. Any excess1 of the sale price over cost

shall be subject to the provisions of the capital gains. This shall apply even if the

business is not in existence in that previous year.

2. Sold the asset after having been used for business:

Where the scientific research asset is used in the business after it ceases to be used for

scientific research, the actual cost of such asset to be included in the relevant block of

asset shall be taken as nil as the full amount has been allowed as deduction under

section 35. If this asset is later on sold, the money payable shall be deductible from

the block in which such asset was earlier included.

Example:

R purchased an asset for scientific research for Rs. 15,00,000 in the previous year 2008-09.

During the previous year 2015-16, the said asset ceased to be used for scientific research.

The following information is also submitted to you:

Amount (Rs.)

Profit from business before depreciation 5,00,000

WDV of BOA as on 01-04-2015 (15%) 10,00,000

The scientific research asset if used for business shall be eligible for depreciation @ 15%.

Compute the total income for the assessment year 2016-17, if the scientific research asset is

sold for Rs. 28,00,000 assuming:

a. It is sold without using for business; and

b. It is sold after using for business.

1 In case sale price does not exceed the cost of asset, provisions of capital gains does not apply.

128

Assume CII for 2008-09 is 582 and for 2015-16 is 1081.

Solution:

a. It is sold without using for business:

Amount (Rs.)

Business income 5,00,000

Less: Depreciation @ 15% on Rs. 10,00,000 1,50,000

3,50,000

Add: Profit on sale of scientific research asset

(to the extent of cost of asset) [U/S 41(3)] 15,00,000

Business income 18,50,000

Sale consideration 28,00,000

Less: Indexed cost of acquisition

(15,00,000/582*1081) 27,86,082

LTCG 13,918

GTI (PGBP + LTCG) 18,63,918

b. It is sold after using for business:

Business income 5,00,000

Less: Depreciation Nil

PGBP 5,00,000

Sale consideration 28,00,000

Less: WDV of the block on 01-04-2015 10,00,000

STCG [Sec. 50(1)] 18,00,000

GTI (PGBP + STCG) 23,00,000

Working note:

WDV on 01-04-2015 10,00,000

Add: Scientific research asset put to business use

[15,00,000 – 15,00,000 as deduction] Nil

10,00,000

Less: Sale price 10,00,000*

WDV on 31-03-2016 Nil

Therefore, depreciation is Nil

Example:

XYZ Ltd., a paper manufacturing concern, purchases a machine on March 1, 2006 for Rs.

6,10,000 for its laboratory with a view to improving the quality of art paper manufactured by

the company.

a. What will be the amount of deduction under section 35 on account of capital

expenditure of Rs. 6,10,000 for the assessment year 2006-07.

b. If the research activity for which the aforesaid machine is purchased ceases in 2014

and the machinery is brought into business proper on November 1, 2014 (market

129

value of the machine: Rs. 2,30,000); depreciation is admissible at the rate of 15 per

cent; depreciated value of the relevant block of assets on April 1, 2014 is Rs.

14,07,860, the scientific research machine is sold for Rs. 1,90,000 on April 4, 2015,

compute the following:

- what is the amount of chargeable profit under section 41(3) in assessment year

assessment year 2016-17.

- what will be the amount of depreciation for the assessment years 2014-15, 2015-

16, 2016-17 and 2017-18;

- what is the amount of capital gain in assessment year assessment year 2016-17.

c. If the research activity for which the machine was purchased ceases on November 1,

2014 (market value of the machine: Rs. 2,30,000) and the machine is sold on April 4,

2015 without using it for another purpose, sale price being Rs. 1,90,000, or Rs.

5,40,000, or Rs. 8,10,000 or Rs. 15,00,000. What will be the tax treatment for

different sale values?

The CII for 2005-06 is 497, 2014-15 is 1024 and for 2015-16 is 1081.

Solution:

a. As the scientific research is related to the business of the assessee, the whole of

capital expenditure of Rs. 6,10,000 is allowable as deduction under section 35(2)(ia)

for the assessment year 2006-07.

b. The machine is brought into business proper on November 1, 2014. In this case, profit

arising on sale of machinery is not chargeable under sub-section (3) of section 41.

Provision of sub-section (3) of section 41 would not apply as the section covers only

such assets which are represented by expenditure of capital nature on scientific

research that is sold without having being used for any other purpose.

Tax treatment of depreciation is given below:

(Rs.)

WDV on March 31, 2014 [14,07,860/85*100] 16,56,306

Less: Depreciation for the previous year 2013-14 (15%) 2,48,446

WDV on 01-04-2014 14,07,860

Add: Cost of machine transferred from laboratory on Nov. 1, 2014

[i.e., 6,10,000 – deduction of 6,10,000 claimed under section 35] Nil

WDV on 31-03-2015 14,07,860

Less: Depreciation for the previous year 2014-15 (15%) 2,11,179

WDV on April 1, 2015 11,96,681

Less: Sale proceeds of machine sold on April 4, 2015 1,90,000

WDV on 31-03-2016 10,06,681

Less: Depreciation for the previous year 2015-16 (15%) 1,51,002

WDV on 01-04-2016 8,55,679

Less: Depreciation for the previous year 2016-17 (15%) 1,28,352

WDV on 31-03-2017 7,27,327

There will be no capital gain or loss in the previous year 2015-16 in this case because

neither the block ceases to exist on March 31, 2016 nor WDV of the block on March

31, 2016 is Zero.

130

c. Tax treatment should be as under:

Particulars Sale price (Rs.)

1,90,000 5,40,000 8,10,000 15,00,000

Amount chargeable under section 41(3)

[i.e., sale proceeds but subject to

maximum of deduction claimed under

section 35 for the assessment year

2006-07] as PGBP

1,90,000 5,40,000 6,10,000 6,10,000

Capital gain under section 45:

Sale proceeds 1,90,000 5,40,000 8,10,000 15,00,000

Less: Indexed cost of acquisition

(6,10,000/497*1081)

13,26,781 13,26,781 13,26,781 13,26,781

LTCG (11,36,781) (7,86,781) (5,16,781) 1,73,219

Question:

1. Explain the consequences, where the scientific research assets are sold without having

been used for other purposes.

(b)Tax Planning with Reference to Receipt of Insurance Compensation

RECEIPT of insurance compensation [Sec. 45(1A)]

Where any person receives at any time during the previous year any money or other asset

under any insurance from an insurer on account of damage to or destruction of, any capital

asset, as a result of:

a. flood, typhoon, hurricane, cyclone, earthquake, or other convulsion of nature; or

b. riot or civil disturbance; or

c. accidental fire or explosion; or

d. action by an enemy or action taken in combating an enemy (whether with or without a

declaration of war),

then, any profits or gains arising from receipt of such money or other asset shall be

chargeable to tax under the head “capital gains” in the year in which such money or other

asset is received.

For computing capital gains, the value of any money or the fair market value of asset

received on the date of receipt shall be deemed to be the full value of consideration received

or accruing as a result of the transfer of damaged asset.

Notes –

1. The capital asset should be insured.

2. The asset should be damaged or destroyed due to any reason mentioned in (a) to (d)

above.

3. Capital gain shall be deemed to be income/ loss of the previous year in which

compensation (money or other asset) is received. It means if the asset was destroyed

in 2010-11 but the compensation is received in 2015-16, the capital gain shall be

computed in previous year 2015-16. However, indexation of cost of acquisition will

be based on the index of the year in which the asset was damaged or destroyed.

131

4. Full value of consideration shall be the money received or the fair market value of

asset received from the insurer.

5. If an asset is not a capital asset under section 2(14), the compensation for loss of it,

shall not be liable to tax under section 45(1A). It will be treated as normal trading

receipt.

6. If an insured capital asset is destroyed and compensation is received from the insurer,

there will be capital gain even if no capital asset has been transferred.

7. If an uninsured capital asset is destroyed, the loss cannot be deducted under the head

“capital gains” since is no transfer of an asset.

Illustration:

From the following information, compute the capital gain chargeable to tax for the

assessment year 2016-17:

Amount (Rs.)

a. Residential house constructed on 10.06.2009,

the cost of construction excluding cost of land 3,60,000

b. House destroyed by fire on 15.04.2014

c. Compensation received on 20.12.2015 from the insurance company 8,00,000

d. CII for 2009-10: 632, for 2014-15: 1024 and for 2015-16: 1081.

Solution:

Computation of capital gains for the assessment year 2016-17:

Amount (Rs.)

Compensation received 8,00,000

Less: Indexed cost of acquisition

(3,60,000/632*1024) 5,83,291

LTCG 2,16,709

Illustration:

a. The written down value of the block of assets as on 01-04-2015 was Rs. 5,00,000. An

asset of the same block was acquired on 11-05-2015 for Rs. 3,00,000. There was a

fire on 18-09-2015 because of which assets were destroyed and the assessee received

a sum of Rs. 11,00,000 from the insurance company. Compute the capital gain

assuming:

i. All the assets were destroyed by fire.

ii. Part of the block was destroyed by fire.

b. What will be the answer if assessee received Rs. 6,00,000 from insurance company

and assume that:

i. All the assets were destroyed by fire.

ii. Part of the block was destroyed by fire.

Solution:

(a) (i) All the assets were destroyed by fire;

Sale consideration 11,00,000

Less: WDV on 01-04-2015 5,00,000

Asset acquired 3,00,000

STCG [50(2)] 3,00,000

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(ii) Part of the block was destroyed by fire:

Sale consideration 11,00,000

Less: WDV on 01-04-2015 5,00,000

Asset acquired 3,00,000

STCG [50(1)] 3,00,000

Here, the block will continue next year at nil value.

Calculation of WDV at the year-end:

WDV on 01-04-2015 5,00,000

Asset acquired 3,00,000

8,00,000

Sale consideration 8,00,000*

WDV on 31-03-2016 Nil

(b) (i) All the assets were destroyed by fire;

Sale consideration 6,00,000

Less: WDV on 01-04-2015 5,00,000

Asset acquired 3,00,000

STCG [50(2)] (2,00,000)

(ii) Here, neither section 50(2) is applicable nor section 50(1) is applicable.

Here, depreciation can be calculated as follows:

WDV on 01-04-2015 5,00,000

Add: Cost of asset acquired 3,00,000

8,00,000

Less: Sale consideration 6,00,000

WDV on 31-03-2016 2,00,000

Suppose rate of depreciation is 15%, then depreciation for the previous year

2015-16 will be 15% on Rs. 2,00,000 i.e., Rs. 30,000.

Question

1. Write a short note on receipt of insurance compensation in case of damage or

destruction of capital asset under section 45(1A).

(c)Tax Planning with Reference to Distribution of Assets

at the Time of Liquidation

DISTRIBUTION of assets at the time of liquidation of company [Sec. 46]

Where the assets of a company are distributed to its shareholders on its liquidation, such a

distribution is not regarded as a transfer of a capital asset by the company for purposes of

taxation.

Notes –

1. Whatever is distributed by the company at the time of its liquidation out of

accumulated profits, it is treated as deemed dividend under section 2(22)(c) and the

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company is liable to pay tax on it @ 20.358% as CDT under section 115-O for the

assessment year 2016-17 and thus, the amount received by a shareholder is exempt

from tax under section 10(34).

2. Taxation of capital gains in the hands of the shareholders in case of liquidation of

company [Sec. 46(2)]:

A shareholder is liable to tax on capital gains if he receives any money or other assets

from the company on its liquidation. The income chargeable in the hands of the

shareholders under the head “capital gains” would be in respect of the money so

received or the market value of the assets on the date of distribution as reduced by the

amount of notional dividends under section 2(22)(c) (the proportion of distribution

attributable to the accumulated profit) and the amount so arrived at would be further

reduced by the cost of acquisition of the share. The amount, thus, ascertained would

be chargeable to tax as capital gains.

Where the payment is made by the liquidator in installments to registered

shareholders, the entire cost of the shares is deductible from the first installment of the

amount received.

3. The value of asset [even not an asset under section 2(14)] received on liquidation of a

company by a shareholder is assessable under section 46(2).

4. Extinguishment of the right of a shareholder amounts to transfer for the purposes of

section 48. Hence, where the receipt is ‘nil’ on the date of distribution on the

liquidation of the company, the case of such shareholder would fall under section

46(2). The deemed full value of consideration for the purpose of section 48 would be

regarded as ‘nil’ and on that basis the income chargeable to tax (in this case loss)

under the head ‘capital gains’ would have to be computed under section 48.

5. The capital gains on transfer of shares in case of liquidation of company shall not be

exempt under section 10(38), as shareholders are not supposed to pay STT in case of

liquidation of the company.

6. Cost of acquisition of an asset acquired on distribution of capital assets of a company

on its liquidation:

Where the capital asset became the property of the assessee on the distribution of the

capital asset of a company on its liquidation and the assessee has been assessed to

income tax under the head “capital gains” in respect of that asset under section 46(2),

the cost of acquisition to him shall be the fair market value of the asset on the date of

distribution.

Where the assessee was not charged to tax under section 46(2) on the basis of market

value of the asset received at the time of liquidation of the company, the cost of

acquisition to the assessee will be the cost to the previous owner for computation of

capital gains at the time of transfer of such asset.

7. In determining whether the capital gain is short term or long term, the period

subsequent to the date on which the company goes into liquidation shall not be

considered.

Example:

From the following information, compute the amount of capital gains under section 46(2) for

the assessment year 2016-17:

a. The shareholder holds 20% of the total shares in the company under liquidation.

b. Indexed cost of acquisition of shares Rs. 1,75,000.

c. Received assets worth Rs. 4,00,000 on its liquidation.

d. Accumulated profits of the company before distribution Rs. 6,01,790.

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Solution:

Assessment year 2016-17

Amount received 4,00,000

Less: Deemed dividend [2(22)(c)]

20% of (6,01,790 – Tax of 1,01,790) 1,00,000

3,00,000

Less: Indexed cost of acquisition 1,75,000

Long term capital gain 1,25,000

Corporate dividend tax = 1,01,790 [601,790/120.358* 20.358]

Question

1. When can a company claim exemption regarding capital gains on distribution of assets

at the time of its liquidation?

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LESSON 9

Double Taxation Relief, Provisions Regulating Transfer Pricing

9. STRUCTURE

9.1 Introduction of International Taxation

9.2 Double Tax Avoidance

9.3 Double Taxation Relief

9.4 Bilateral Relief

9.5 Bilateral Relief may be Granted by one of the following two Methods

9.6 Unilateral Relief u/s 91

9.7 Transfer Pricing

9.8 Transfer Pricing Provisions in India

9.9 Arm’s Length Price (ALP)

9.10 Associated Enterprises (Section 92 A)

9.11 Deemed Associated Enterprises

9.12 Conditions for Applicability of Arm’s Length Price in the International Transaction

9.13 Specified Domestic Transactions

9.14 Methods of Determination of ALP

9.15 Reference to Transfer Pricing Offer

9.16 Determination of Arm’s Length Price by Transfer Pricing Officer

9.17 Procedure of Computation of Arm’s Length Price by Transfer Pricing Officer (TPO)

9.18 Rectification of Arm’s Length Price Order by Transfer Pricing Officer

9.19 Maintenance, Keeping of Informations and Documents by Persons Entering into

International Transatcions

9.20 Advance Pricing Agreement (APA) [Section 92CC and 92 CCD]

9.21 Calculation of Arm’s Length Price Under Advance Pricing Agreement

9.22 Validity of Advance Pricing Agreement

9.23 Parties Bound by Advance Pricing Agreement

9.24 Void Advance Pricing Agreement

9.25 Effect of Void Agreement

9.26 Procedure of APA

9.27 Modified Return

9.28 Asessment under APA

Double Taxation Relief

9.1 INTRODUCTION OF INTERNATIONAL TAXATION.

After the liberalization of Indian economy and easing of restrictions on the entry of foreign

entities, cross border business transactions have increased. With the ratification of WTO by

the Government of India, our economy has become robust and an atmosphere has sprang up

where FII investments in India have increased tremendously. All these economic activities

has ramifications for tax laws of the country. Issues like tax havens, transfer pricing, double

taxation, WTO, F, etc. are required to be taken care of and have become part and parcel of

international taxation regime.

With the acceptance of the WTO regime India has embarked on the policy of market reforms

and merging with the international business community by providing market access to the

overseas investor with zero or qualitatively lesser restrictions.

136

In the context of international taxations, including cross border-investments, eliminated

double taxation become an important consideration in doing business in India and abroad

specially with the double taxation aspect became omnipresent in relations to transitions

involving cross border investments with those foreign entities belonging to those countries

with which India doesn't have double taxation avoidance agreements.

To overcome difficulties faced by investors from countries, India in recent years entered into

Double Taxation Avoidance Agreement (DTAA) with many countries. Section 91 of the

Income Tax Act deals with unilateral relief given to the concerned persons of the foreign

countries with whom India does not have DTAA under section 90 of the Act deals with

general aspect concerning bilateral relief,

Another way of resolving dispute relating to taxes involving international transaction is

through Mutual Agreement Procedure (MAP) in regard to those categories of disputes where

there are no DTAA. In order to reduce the misuse of tax havens, some countries have started

the concept of CFC (controlled foreign corporations) to deal with the problems of tax

evasion. There are nil tax haven destinations as well as low tax haven destinations.

In cases of double taxation the parties can get relief either through unilateral measures or

bilateral measures or under adjudication by judiciary or through commercial arbitration.

Section 90 of the Income Tax Act, 1961 deals with agreements entered by Government of

India with Government of other countries. Section 91 deals with provisions relating to those

issues for which India does not have any formal agreements with Government of other

countries, regarding avoidance of double taxation. Section 90A relates to granting to

permissions to 'specified association'-through official Gazette notification to enter into

agreement with foreign Government in regard to giving of relief for double taxation.

9.2 DOUBLE TAX AVOIDANCE

The situation of double taxation will arise where the income gets taxed in two or more than

two countries whether due to residence or source principle as the case may be. The problem

of double taxation arises if the income of a person is taxed in one country on the basis of

residence and on the basis of source in another country or on the basis of both. To mitigate

the double taxation of income the provisions of double taxation relief were made. The double

taxation relief is available in two ways one in unilateral relief and other is bilateral relief.

Government of India can enter into agreement with a foreign government vide Entry 14 of

the Union List regarding any matter provided Parliament verifies it. Double Tax Avoidance

Agreement is a kind of bilateral treaty or agreement, between Government of India and any

other foreign country or specified territory outside India. Such treaty or agreement or

agreement is permissible in terms of Article 253 of the Constitution of India.

In pursuance of Section 90, agreements for grant of relief on double taxation and agreement

for avoidance of double taxation are executed by the Government of India from time to time

Some of the countries with which such agreements are in force are: Canada, Korea, New

Zealand, Hungary, Czechoslovakia, Belgium, Sri Lanka, Swiss Federal Council, Sweden,

Denmark, Finland, Great Britain, Norway, Japan, The Federal Republic of Germany,

Republic of Austria, Greece, Romania, Republic of Lebanon, United Arab Republic, French

Republic, Iran, Libya, Malaysia, Singapore, Tanzania, Zambia, Australia, Bulgaria, Ethiopia,

Italy, Kuwait, USA, USSR etc.

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9.3 Double Taxation Relief

Double taxation means taxation of same income of a person in more than one country. This

results due to countries following different rules for income taxation. There are two main

rules of income taxation i.e. (a) Source of income rule and (b) residence rule.

As per source of income rule, the income may be subject to tax in the country where the

source of such income exists (i.e. where the business establishment is situated or where the

asset/property is located) whether the income earner is a resident in that country or not. On

the other hand, residence rule stipulates that power to tax should rest with that country in

which tax payer resides. In other words, the income earner may be taxed on the basis of his

residential status in that country. For example if a person is resident of a country, he may

have to pay tax on any income earned outside that country as well.

Thus problem of double taxation arises if a person is taxed in respect of any income on the

basis of source of income rule in one country and on the basis of residence in another country

or on the basis of mixture of above two rules.

In India, the liability under the Income-tax Act arises on the basis of the residential status of

the assessee during the previous year. In case the assessee is resident in India, he also has to

pay tax on the income which accrues or arises outside India, and also received outside India.

The position in many other countries may be broadly similar, it frequently happens that a

person may be found to be a resident in more than one country or that the same item of his

income may be treated as accruing, arising or received in more than one country with the

result that the same item becomes liable to tax in more than one country.

Relief against such happening can be provided mainly by two methods (a) Bilateral relief, (b)

Unilateral relief.

9.4 Bilateral relief

The Government of two countries can enter into Double Taxation Avoidance Agreement

(DTAA's) so that the same income may not be taxed twice. DTAA's lay down the rule of

taxation of the income by the source country and the residence country. Such rules are laid

for various categories of income, for example interest, dividend, royalties, capital gains,

business income, salary income etc. Each such category is dealt with by separate article in

DTAA.

Thus DTAA's are entered into to provide relief against such Double Taxation, worked out on

the basis of mutual agreement between the two concerned sovereign countries. This may be

called a scheme of 'bilateral relief' as both concerned countries agree as to the basis of the

relief to be granted by either of them.

9.5 BILATERAL RELIEF MAY BE GRANTED BY ONE OF THE FOLLOWING

TWO METHODS-

(a) Exemption method: Where two countries agree that income from various specified

sources which are likely to be taxed in both the countries should either be taxed only

in one of them or that each of the two countries should tax only a particular specified

portion of the income so that there is no overlapping. Such an agreement will result in

a complete avoidance of double taxation of the same income in the two countries.

This is known as exemption method of relief.

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(b) Tax credit method: This method does not evolve any such scheme of single

taxability but merely provides that, if any item of income is taxed in both the

countries, the assessee should get relief in a particular manner. Under this method, the

assessee is liable to have his income taxed in both countries but is given a deduction,

from the tax payable by him in the country of residence, of a part of the taxes paid

by him thereon, in the source country usually the lower of the two taxes paid. This is

known as tax credit method of relief.

9.6 UNILATERAL RELIEF U/S 91:

Section 91 provides for the grant of unilateral relief in the case of resident taxpayers on

income which has suffered tax in India as well as in the country with which there is no

DTAA agreement.

The following requirement have to be satisfied order that an assessee is entitled to claim

deduction on the doubly taxed income:

(a) The assessee must have been resident in India in the relevant previous year ;

(b) Income must have accrued or arisen to him during that previous year outside India ;

(c) In respect of that income which accrued or arose outside India, he must have paid by

deduction or otherwise tax under the law in force in the foreign country.

The relief will be worked out as under:

1. First, ascertain the amount of doubly taxed income. It consists such income which has

accrued or arisen to the taxpayer in a foreign country and has been subjected to

income-tax in that country as well as in India. It however, does not include income

which is deemed to have accrued or arisen to the taxpayer in India, even though it has

been charged to income-tax in a foreign country.

2. On the amount of that doubly taxed income so ascertained, income-tax calculated at

the Indian rate of tax and the rate of tax of the foreign country. The foreign tax rate

has to be calculate separately for each county.

3. Relief is granted by allowing to the taxpayer a deduction from the tax liability of an

amount equal to the tax calculated at the average Indian rate of tax or the amount of

tax calculated at the rate of tax of the foreign country on the doubly taxed income,

whichever is lower. For example, if out of income of Rs. 4,80,000 deduction of Rs.

40,000 is allowed under section 80 in computing the total income, the assessee will be

entitled to the double taxation relief under section 91 only in respect of Rs. 440000

which has been subject to income-tax India.

Therefore we can say that double taxable relief in the case of no agreement with the foreign

country is allowed unilaterally u/s 91. If a person has earned income outs India in a country

haring no agreement under Section 90 for the relief or avoidance of double taxation and he

proves that he has paid income tax by way of deduction or otherwise under the law in force in

that country in respect of the income so included he shall be entitled to a deduction from the

India income tax payable by him of a sum calculate on such taxed income so included at the

average Indian income tax rate or the average foreign tax rate whichever is lower or at the

Indian rate of tax it both the rates are equal.

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Example:

Mr. Rajeev an individual, resident of India in the previous year receive professional fees of

Rs. 1,70,000 on 7th August 2015 and Rs. 2,55,000 on 15th March 2016 for rendering services

in Pakistan on Which TDS of Rs. 30,000 and Rs. 45,000 had been deducted respectively. He

incurred Rs. 2,60,000 as expenditure for earning this fees. He paid Rs. 90,000 towards PPF.

His Income from other sources in India is Rs. 2,60,000. Compute Tax liability & relief under

section 91.

Solution:

Computation of Relief section 91 of Mr. Rajeev

For the Assessment Year 2016-17

1. Computation of tax liability of Mr. Rajeev as per the Income Tax Act, 1961

Rs. Rs.

Income under the head business & profession: 5,00,000

Less: Expenditure incurred 2,60,000 2,40,000

Income from other sources 2,60,000

Gross Total income 5,00,000

Less: Deduction u/s 80C: PPF 90,000,

Total Income 4,10,000

Tax on Rs. 4,10,000 16,000

Less: Rebate under section 87A1 (2,000)

Net Tax 14,000

Net Tax including cess 14,420

Less: Relief u/s 91 (8,441)

Tax Payable (rounded off) 5980

Computation of relief u/s 91

Double Taxed Income = Rs. 2,40,000

Total Income in India = Rs. 4,10,000

Tax on total income in India = Rs. 14,420

Tax paid in foreign country = Rs. 75,000

Total income assessed in foreign country = Rs. 5,00,000

(a) Tax in India on such doubly taxed income in foreign country: 14,420×2,40,000

4,10,000 × = Rs. 8,441

(b) Tax on such doubly taxed income in foreign country: Rs. 75000

Relief u/s 91 will be lower of (a) or (b) above i.e. Rs. 8,441

Example:

Mr. Ram, a resident of India, provides you the following particulars of his income for the

assessment year 2016-17

Rs.

(1) Interest on Government Securities 25,000

(2) Income form House Property (Computed) 45,000

(3) Business Income 4,40,000

(4) Income from a foreign country with which no agreement

for relief or avoidance of double taxation exists

1,00,000

(5) Income tax paid on foreign income Compute the amount

of income tax payable in India.

20,000

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Solution:

Computation of Total Income

for the Assessment Year 2016-17

Rs.

Interest on securities 25,000

Income from House Property 45,000

Business income 4,40,000

Foreign income 1,00,000

Gross Total Income 6,10,000

Deduction Nil

Total Income 610000

Computation of Tax Payable

for the assessment year 2016-17

Rs.

Income tax on Rs. 6,10,000 47,000

Add : Surcharge Nil

47,000

Add : Education cess @ 3% 1,410

Total

Less Relief on foreign income at Indian rate of tax or

foreign rate of tax, whichever is lower 48,410×1,00,000

6,10,000i.e., Rs. 7,936 or Rs. 20,000, whichever is less

Tax Payable

48410

7,936

40,747

9.7 TRANSFER PRICING

In the present age of globalization, diversification and expansion, most of the companies are

working under the umbrella of group in diversified fields/sectors leading to large number of

transactions between related parties. Related party transaction means the transaction between/

among the parties which are associated by reason of common control, common ownership or

other common interest.

The mechanism for accounting, the pricing for these related transactions is called Transfer

pricing.

Transfer Price refers to the price of goods/service which is used in accounting for transfer of

goods or services from one responsibility centre to another or from one company to another

associated company. Transfer price affects the revenue of transferring division and cost of

receiving division. As a result, the profitability, return on investment and managerial

performance evaluation of both divisions are also affected.

Example

Hero & Companies is a group Companies engaged in diversified business. One of its

units i.e. Unit X is engaged in manufacturing of automotive batteries. Another Unit Y is

engaged in manufacturing of Trucks. Unit X is supplying automotive batteries to Unit Y.

In such cases transfer price mechanism can be used to account for the transfer of

automotive batteries.

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9.8 TRANSFER PRICING PROVISIONS IN INDIA

Increasing participation of multi-national groups in economic activities in India has given rise

to new and complex issues emerging from transactions entered into between two or more

enterprises belonging to the same group. Hence, there was a need to introduce a uniform and

internationally accepted mechanism of determining reasonable, fair and equitable profits and

taxes in India. Accordingly, the Finance Ac, 2001 introduced law of transfer pricing in India

through Sections 92 to 92F of the Income Tax Act, 1961 which guides computation of the

transfer price and suggests detailed documentation procedures. Year 2012 brought a big

change in transfer pricing regulations in India whereby government extended the applicability

of transfer pricing regulations to specified domestic transactions which are enumerated in

Section 92BA. This would help in curbing the practice of transferring profit from a taxable

domestic zone to tax free domestic zone. The fundamental of transfer pricing provision is that

transfer price should represent the arm's length price of goods transferred and services

rendered from one unit to another unit.

9.9 ARM'S LENGTH PRICE (ALP)

In general arm's length price means fair price of goods transferred or services rendered. In

other words, the Arm's Lenth price should represent the price which could be charged from

an independent party in uncontrolled conditions. Arm's length price calculation is very

important for a company. In case the transfer price is not at arm's length, it may have

following consequences.

(a) Wrong performance evaluation

(b) Wrong pricing of final product (In case where the goods/services are used in the

manufacturing of final product)

(c) Non compliances of applicable laws and thus attraction of penalty provisions.

The same may be explained with the following three examples.

Company A and Company B is working under the common umbrella of AB & Company.

Company A manufactures a product which is raw material for Company B.

Case Criteria Effect on Company A Effect on Company B

1. Company A

charges price

more than the

Arm's length

price from

Company B

The revenue of

company A will

increase.

The total cost of company B will

increase. The will result into

wrong pricing of its product

which may further lead to non-

competitiveness of its product

2. Company A

charges price

less than the

Arm's from

company B

The revenue of

company parent

company A will

decrease and may

close the company A

treating it as loss

making entity.

The total cost of company B will

decrease. Therefore, the company

B may charge lower price which

may lead to loss.

3. Company A

charges Arm's

Length price

from Company

The revenue of

company A will be

representing true and

fair view of its

Company B will be paying the

price as equivalent to market

price of Company A product and

its cost will be correct. On the

142

B operation basis of the cost arrived after

considering the arm's length price

of company A product, company

B will be able to take correct

price decision.

9.10 ASSOCIATED ENTERPRISES (SECTION 92 A)

"The concept of associated enterprises and international transaction are very important

"Associated enterprise", (AE) in relation to another enterprise, means an enterprise-

(a) Which participates, directly or indirectly, in the management or control or capital of

the other enterprise; or

(b) In respect of which one or more person who participate, directly or indirectly, in the

management or control or capital of the other enterprise. Thus, from above definition

we may understand that the basic criterion to determine an Associated enterprise is

the participation in management, control or capital (ownership) of one enterprise by

another enterprise whereby the participation may be direct or indirect or through one

or more intermediaries.

9.11 DEEMED ASSOCIATED ENTERPRISES

As per Section 92A(2), two enterprises shall be deemed to be associated enterprises if, at any

time during the previous year-

(a) One enterprise holds, directly or indirectly, shares carrying not less than twenty-six

per cent of the voting powers in the enterprise; or

(b) Any person or enterprise holds, directly or indirectly, shares carrying not less than

twenty-six per cent of the of the voting power in each of such enterprise; or

(c) A loan advanced by one enterprise to the other enterprise constitutes not less than

fifty-one per cent of the book value of the total assets of the other enterprise; or

(d) One enterprise guarantees not less than ten per cent of the total borrowings of the

other enterprise; or

(e) More than half of the board directors or executive members of the governing board, or

one or more executive directors or executive member of the governing board of one

enterprise, are appointed by the other enterprise; or

(f) More than half of the directors or members of the governing board, or one or more

executive directors or members of the governing board, of each of the two enterprises

are appointed by the same person or persons; or

(g) The manufacture or processing of goods or articles or business carried out by one

enterprise is wholly dependent on the use of know-how, patents, copyrights, trade-

marks, licences, franchises or any other business or commercial rights of similar

nature, or any data, documentation, drawing or specification relating to any patent,

invention, model, design, secret formula or process, of which the other enterprise is

the owner or in respect or which the other enterprise has exclusive rights; or

(h) Ninety per cent or more of the raw materials and consumables required for the

manufacture or processing of goods or articles carried out by one enterprise, are

supplied by the other enterprise, or by persons specified by the other enterprise, and

the prices and other conditions relating to the supply are influenced by such other

enterprise: or

(i) The goods or articles manufactured or processed by one enterprise, are sold to the

other enterprise or to persons specified by the other enterprise, and the price and other

conditions relating thereto are influenced by such other enterprise; or

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(j) Where one enterprise is controlled by an individual, the enterprise is also controlled

by such individual or jointly by such individual and relative of such individual; or

(k) Where one enterprise is controlled by a Hindu undivided family, the other enterprise

is controlled by a member of such Hindu undivided family or by a relative of a

member of such Hindu undivided family or jointly by such member and relative of

such individual; or

(l) Where one enterprise is a firm, association of persons or body of individual, the other

enterprise holds not less than ten per cent interest in such firm, association of persons

or body of individuals; or

(m) There exists between the two enterprises, any relationship of mutual interest, as may

be prescribed.

In Brief, two enterprises will be deemed as Associated Enterprises as per fallowing criteria:

Quantum of Interest Criteria applied for Associated Enterprises

26% or more Shareholding with voting power either direct

or indirect

51% or more Advancement of loan by one entity to other

constituting percentage of the book value of

the total assets of the other entity.

51% or more The board of directors appointed in the

governing board of the entity in the other

90% or more The quantum of supply of raw materials and

consumables by one entity to the other.

10% or more Total borrowing guarantee by one enterprises

for other

10% or more Interest by a firm or Association of Person

(AOP) or by a Body of individuals (BOI) in

other firm AOP or BOI

9.12 CONDITIONS FOR APPLICABILITY OF ARM'S LENGTH PRICE IN THE

INTERNATIONAL TRANSACTION

The provisions under sections 92 to 92F have been enacted with an intention to provide

statutory framework which can lead to computation of reasonable, fair and equitable profit

and tax in India so that the profits chargeable to tax in India do not get diverted elsewhere by

altering the prices charged and paid in intra-group transactions leading to erosion of Indian

tax revenue. Any income arising from an international transactions shall be computed with

regard to arm's length price.

With effect from the assessment year 2013-14, section 92BA has been inserted to extend

transfer pricing provisions to a domestic transactions also.

The following conditions need to be satisfied for the applicability of the arm's length price in

the international transaction-

1. International transaction is subject to the arm's length price only in case of transaction

between two entities called associated enterprise. An enterprise would be regarded as

an associated enterprise of another enterprise, if-it participates, directly or indirectly,

or through one or more intermediaries, in the management or control or capital of the

other enterprise; or in respect of it one or more persons who participate, directly or

indirectly, or through one or more intermediaries, in its management or control or

144

capital, are the same persons who participate, directly or indirectly, or through one or

more intermediaries, in the management or control or capital of the other enterprise.

2. Two enterprises shall be deemed to be associated enterprises if the two enterprises

fall, at any time during the previous year, in any of the prescribed conditions stated

above. In addition, these provisions are applicable if there is complete dependency of

one enterprise on the other enterprise.

3. An international transaction should be carried out by the associated enterprise.

4. The transactions between an enterprise and another person is deemed as transactions

entered into between two associated enterprises if either there is a prior agreement in

relation to the relevant transaction between such other person and the associated

enterprise or the terms of the relevant transaction are determined in substance between

such other person and the associated enterprise.

9.13 SPECIFIED DOMESTIC TRANSACTIONS

Section 92BA has been inserted by finance act 2012 with effect from the assessment year

2013-14. It provides meaning of "specified domestic transaction" with reference to which the

income is computed under section 92 having regard to arm's length price. The following

transactions are covered within the meaning of "specified domestic transactions" if the

aggregate of these transactions entered into by the assessee in a previous year exceeds Rs. 20

crore.

(a) any expenditure in respect of which payment has been made or is to be made to be

made to a person referred to in section 40A(2)(b);

(b) any transaction referred to in section 80A;

(c) any transfer of goods or services referred to in section 80-IA(8);

(d) any business transacted between the assessee and other person as referred to in section

80-IA(10);

(e) any transaction referred to in any other section under Chapter VI-A or section 10AA,

to which provisions of section 80-IA(8)/(10) are applicable; or

(f) any other transaction as may be prescribed.

Any allowance for an expenditure or interest or allocation of any cost or expense or any

income in relation to the above domestic transactions shall be computed having regard to the

arm's length price. For this purpose, arm's length price shall be determined within the

parameters of sections 92 to 92F

9.14 METHODS OF DETERMINATION OF ALP.

Arm's length price can be computed by any the following methods:

(a) comparable uncontrolled price method; (CUPM)

(b) resale price method; (RPM)

(c) cost plus method; (CPM)

(d) profit split method; (PSM)

(e) Transactional and Net margin Method; (TNMM)

(f) such other method as may be prescribed by the (CBDT)

A. Comparable uncontrolled price method (CUP) – Under this method following

Procedure is adopted:

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(a) The price charged or paid for property transferred or services provided in a

comparable uncontrolled transaction, (i,e., a transaction between enterprises other

than associated enterprises whether resident or non-resident) or a number of such

transactions, is identified;

(b) Such price is adjusted to account for differences, if any, between the international

transaction and the comparable uncontrolled transactions or between the enterprises

entering entering into such transactions, which could materially affect the price in the

open market;

(c) The adjusted price arrived at under (b) is taken to be an arm's length price in respect

or the property transferred or services provided in the international transaction.

CUPM is applied when a price is charged for a product or service. This is essentially

comparison of prices charged for the property or services transferred in a controlled

transaction to a price charged for property or services transferred in a comparable

uncontrolled transaction. The essence of this method is the identification of an identical

transaction, in a situation where a price is charged for product or services between unrelated

parties.

B- Resale price method (RPM) is: The essence of this method.

(a) The price at which property purchased or services obtained by the enterprise from an

associated enterprise is resold or are provided to an unrelated enterprise, is identified;

(b) Such resale price is reduced by the amount of a normal gross profit margin accruing

to the enterprise or to an unrelated enterprise from the purchase and resale of the same

or similar property or from obtaining and providing the same or similar services, in a

comparable uncontrolled transaction, or a number of such transactions;

(c) The price so arrived at is further reduced by the expenses incurred by the enterprise in

connection with the purchase of property or obtaining of services;

(d) The price so arrive at is adjusted to take into account the functional and other

differences, including differences in accounting practices, if any, between the

international transaction and the comparable uncontrolled transactions, or between the

enterprises entering into such transaction which could materially affect the amount of

gross profit margin in the open market;

(e) The adjusted price arrived at under (d) above is taken to be an arm's length price in

respect of the purchase of the property or obtaining of the services by the enterprise

from the associated enterprise.

Example: A sold a machine to B (Associated enterprise) and in turn B sold the same machinery

to C (an independent party) at sale margin of 30% for Rs. 2,10,000 but without

making any additional expenses and change. Here arm's length price would be

calculated as

Sales price to C = Rs. 2,10,000

Gross Margin = 2,10,000 × 30% = Rs. 63,000

Arm's Lenth Prce = Rs. 1,47,000

Example:

A sold a machine to B (Associate enterprise) and in turn B sold the same machinery to

C (an independent party) at sale margin of 30% for Rs. 4,00,000 but B has incurred

Rs. 4000 in sending the machine to C. Here Arm's length price would be calculated as

Sales price to C = Rs. 4.00.000

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Gross Margin = Rs. 4,00,000 × 30% Rs. 1, 20,000

Balance = Rs. 2,80,000

Less : Expenses incurred by B : = Rs. 4,000

Arm's length price = Rs. 2,76,000

C- Cost Plus Method (CPM) – The essence of this method is:

(a) The direct and indirect costs of production incurred by the enterprise in respect of

property transferred or services provided to an associated enterprise, are determined;

(b) The amount of a normal gross profit mark-up to such costs (computed according to

the same accounting norms) arising from the transfer or provision of the same or

similar property of services by the enterprise, or by an unrelated enterprise, in a

comparable uncontrolled transaction, or a number of such transaction, or between, is

determined;

(c) The normal gross profit mark-up referred to in clause (b) is adjusted to take into

account the functional and other differences, if any, between the international

transaction and the comparable uncontrolled transactions, or between the enterprises

entering into such transaction, which could materially affect such profit mark-up in

the open market;

(d) The costs referred to in clause (a) increased by the adjusted profit mark-up arrived at

under clause (c)

(e) The sum so arrived at is taken to be an arm's length price in relation to the supply of

the property or provision of services by the enterprise.

This method is ordinarily used where some semi-finished goods are sold between related

parties or similar situations or in respect of joint facility agreements long-term buy and

supply arrangements of provisions of services, etc.

D- Profit Split Method (PSM) – This method is applicable mainly in international

transactions involving transfer of unique intangible or in multiple international transactions

which are so interrelated that they cannot be evaluated separately for the purpose of

determining the arm's length price of any one transaction. As per profit split method

following step are taken :

(a) The combined net profit of the associated enterprises from the international

transaction in which they are engaged, is determined;

(b) The relative contribution made by each of the associated enterprises to the earning of

such combined net profit, is then evaluated on the basis of the functions performed,

assets employed or to be employed and risks assumed by each enterprise and on the

basis of reliable external market data which indicates how such contribution would

be evaluated by unrelated enterprises performing comparable functions in similar

circumstances;

(c) The combined net profit is then split amongst the enterprises in proportion to their

relative contributions, as evaluated under clause (b)

(d) Profit thus apportioned to the assessee is taken into account to arrive at an arm's

length price in relation to the international transition.

E- Transactional Net Margin Method (TNMM)- According to transactional net margin

method following steps are taken to calculate ALP :

(a) The net profit margin realised by the enterprise from an international transaction

entered into with an associated enterprise is computed in relation to costs incurred or

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sales effected or assets employed or to be employed by the enterprise or having regard

to any other relevant base;

(b) The net profit margin realised by the enterprise or by an unrelated enterprise from a

comparable uncontrolled transaction or a number of such transactions is computer

having regard to the same base;

(c) The net profit margin referred to in (b) above arising in comparable uncontrolled

transactions is adjusted to take into account the differences, if any, between the

international transaction and the comparable uncontrolled transactions, or between the

enterprises entering into such transitions, which could materially affect the amount to

net profit margin in the open market;

(d) the net profit margin realised by the enterprise and referred to in clause (a) is

established to be the same as the net profit margin referred to in (c) above;

(e) The net profit margin thus established is then taken into account to arrive at an arm's

length price in relation to the international transaction.

Selection of Appropriate Method :

In selecting a most appropriate method, the following factors shall be taken into account as

per Rule 10C of Indian Income Tax Rules 1962;

(a) The nature and class of the international transaction.

(b) The class or classes of Associated Enterprises entering into the transaction and the

functions performed by them taking into account assets employed or to be employed

and risks assumed by such enterprises.

(c) The availability, coverage and reliability of data necessary for application of the

method.

(d) The degree of comparability existing between the international transaction and the

uncontrolled transaction and between the enterprises entering into such transaction.

(e) The extent to which to which reliable and accurate adjustments can be made to

account for differences, if any, between the international transaction and the

comparable uncontrolled transactions or between the enterprises entering into such

transactions.

(f) The nature, extent and reliability of assumptions required to be made in the

application of a method.

The starting point to select the most appropriate method is the functional analysis which is

necessary regardless of what transfer pricing method is selected. Each method may require a

deeper analysis focusing on aspects relating to various methods. The functions analysis helps

in the following.

I. To identify and understand the intra-group transactions;

II. To have a basis for comparability

III. To determine any necessary adjustments to the comparables;

IV. To check the accuracy of the method selected; and

V. To consider adaptation of the policy it the functions, risks or assets have been

modified.

There is no universally accepted method or model which describes the technique for choosing

a transfer pricing method. Traditionally comparable Uncontrolled Pricing Method, Profit

Split Method, Resale Price Methods are being used in transfer pricing. Other method as

TNMM may also be used after the functional analysis and global practices analysis.

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9.15 REFERENCE TO TRANSFER PRICING OFFICER

Section 92CA of Income Tax Act Deals Reference to the Transfer Pricing Officer by the

Assessing Officer. It provides that Assessing Officer with prior approval of the Principal

Commissioner or Commissioner may refer the computation of Arm's Length Price in an

International Transaction to transfer Pricing Officer if he considers it necessary or expedient

to do so. On reference by Assessing officer, Transfer Pricing officer (TPO) shall serve a

notice to the Assessee requiring him to produce the evidence in support of computation made

by him of Arm's Length Price in relation to an international transaction.

9.16 DETERMINATION OF ARM'S LENGTH PRICE BY TRANSFER PRICING

OFFICER

Transfer Pricing officer after hearing the evidences, information or documents as produced

by assessee and after considering such evidence as he may require on any specified points

and after taking into account all relevant materials which he has gathered, shall, by order in

writing, determine the arm's length price in relation to the international transaction/specified

transaction and send a copy of his order to the Assessing Officer and to the assessee.

On receipt of the order from Transfer Pricing officer, the Assessing officer shall proceed to

compute the total income of the assessee in conformity with the arm's length price as

determined by the Transfer Pricing Officer.

9.17 PROCEDURE OF COMPUTATION OF ARM'S LENGTH PRICE BY

TRANSFER PRICING OFFICER (TPO)

As per selection 92 (CA) the A.O. may refer the computation of arm's length price, with the

previous approval of the Commissioner, to the TPO. TPO means a Joint Commissioner or

Deputy Commissioner or Assistant Commissioner, authorised by the Board to perform all or

any of the functions of an A.O. specified in Secs. 92C and 92D in respect of any person or

class of persons.

Where a reference is made, the TPO shall serve a notice on the assessee to produce on a date

specified therein, any evidence on which the assessee may rely in support of the computation

made by him of the arm's Length price in relation to the international transaction. Keep the

TPO shall following in mind:

i. the evidence as the assessee may produce;

ii. any information or documents referred to in Sec. 92D()3;

iii. all relevant materials which he has gathered.

He will send a copy of the order to the A.O. and the assessee.

The TPO shall pass an order at least 60 days before the period of limitation referred to in Sec.

153/153B, for making the order of assessment or reassessment or recompilation or fresh

assessment, expires. The TPO shall determine the arm's length price keeping in view the

following:

On receipt of the order the A.O. will proceed to compute the total income of the assessee (u/s

92C(4)) in conformity with the arm's length price determined by the TPO. The TPO may

amend an order passed by him with a view to rectifying any apparent mistake keeping in

view the provisions of Sec. 154. Where an amendment is made by the TPO in his order, he

will send a copy of it to the A.O. who will thereafter proceed to amend the order of

assessment accordingly.

Penalty. Where an assessee enters into an international transaction (defined in Sec. 92B), any

amount is added or disallowed in computing the total income, then, the amount so added or

disallowed shall be deemed to represent the income in respect of which particulars have been

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concealed or inaccurate particulars have been furnished. A minimum 100% as maximum

300% penalty may be imposed of the amount of tax evaded.

9.18 RECTIFICATION OF ARM'S LENGTH PRICE ORDER BY TRANSFER

PRICING OFFICER

If any mistake is observed which is apparent from record, the Transfer Pricing Officer may

amend any order passed by him and the provisions of Section 154 for rectification of mistake

shall apply accordingly. Where any amendment is made by the Transfer Pricing Officer, he

shall send a copy of his order to the Assessing Officer who shall thereafter proceed to amend

the order of assessment in conformity with such order of the Transfer Pricing Officer.

9.19 MAINTENANCE, KEEPING OF INFORMATIONS AND DOCUMENTS BY

PERSONS ENTERING INTO INTERNATIONAL TRANSACTIONS

(1) Every person who has entered into an international transactions shall keep and

maintain such informations and documents in respect thereof, as may be prescribed.

(2) The informations and documents shall be kept and maintained for a period of eight

years from the end of the relevant assessment year.

Penalty. If a person fails to keep and maintain any such information and document as

required (u/s 92D (1) or (2) the Assessing Officer or Commissioner (Appeals) may impose a

penalty, a sum equal to two percent of the value to each international transaction entered into

by him.

(3) The Assessing Officer or the Commissioner (Appeals) may, in the course of any

proceeding under this Act, require any person who has entered into an international

transaction to furnish any information or document in respect thereof, as may be

prescribed, within a period of thirty days from the date of receipt of a notice issued in

this regard:

However, the Assessing Officer or the Commissioner (Appeals) may, on an application made

by such person, extend the period of thirty days by a further period not exceeding thirty days.

Penalty. If a person, who has entered into an international transaction, fails to furnish any

such information or document as required (u/s 92D(3) the Assessing Officer or the

Commissioner (Appeals) may impose a penalty on him, a sum equal to two per cent of the

value of the international transaction for each such failure.

Report form an accountant to be furnished by persons entering into international

transaction. Every person who has entered into an international transaction during a previous

year shall obtain a report from an accountant and furnish such report on or before the due

date of furnishing the return in the prescribed form (Form No. 3CEB) duly signed and

verified in the prescribed manner by such accountant and setting forth such particulars as may

be prescribed.

Penalty. If a person fails to furnish a report from an accountant relating to his international

transactions, the Assessing Officer may impose a penalty on him of Rs. 1,00,000

Note: No penalty shall be levied under aforesaid sections if the assessee proves that there was

reasonable cause for the said failure.

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Example 1:

A Ltd., an Indian company, sells computer monitor to its 100 per cent subsidiary X Ltd. in

United States @ $ 50 per piece. A Ltd. also sells its computer monitor to another company Y

Ltd. in United States @ $ 80 per piece. Total income of A Ltd. for the assessment year 2015-

16 is Rs. 12,00,000 which includes sales made for 100 computer monitors @ $ 50 to X Ltd.

Compute the arm's length price and taxable income of A Ltd. The rate of one dollar may be

assumed to the equivalent to Rs. 60

Solution

Computation of Arm's Length Price and

Taxable Income of A Ltd.

Arm's length price : 100×80×60 = Rs. 4,80,000

Rs.

Total Income 12,00,000

Add: Arm's length price 4,80,000

Less : Price charged 100×50×60 3,00,000

Taxable Income 13,80,000

9.20 ADVANCE PRICING AGREEMENT (APA) SEC. 92CC AND 92CCD

Advance Pricing Agreement is an agreement between taxpayer and a taxing authority on an

appropriate transfer pricing methodology for a set of transactions over a fixed period of time

in future. The APA offers better assurance on transfer pricing methods and are conducive in

providing certainty and unanimity of approach. Section 92CC and 92CD have been inserted

by the Finance Act, 2012 with effect from July 1,2012 to provide a framework for advance

pricing agreement under the Act. Section 92CC empowers the Board (with the approval of

the central Government) to enter into an advance pricing agreement, in relation to an

international transaction to be entered into by that person.

9.21 CALCULATION OF ARMS'S LENGTH PRICE UNDER ADVANCE PRICING

AGREEMENT

Arm's Length Price under Advance Pricing Agreement shall be calculated as per method

enumerated in section 92C (1) or any other method with such adjustment and variation as

may be necessary and expedient so to do.

Section 92 C (1) of Income Tax Act prescribes that the arm's length price in relation to an

international transaction shall by determined by any of the following methods, being the most

appropriate method, having regard to the nature of transaction or class of transaction or class

of associated persons or functions performed by such persons or such other relevant factors as

the Board may prescribe (see rule 10B) namely:-

(a) Comparable uncontrolled price method;

(b) Resale price method;

(c) Cost plus method;

(d) Profit split method;

(e) Transactional net margin method;

(f) Such other method as may be prescribed by the Board.

Notwithstanding anything contained in Section 92C or Section 92CA, if the Advance Pricing

Agreement has been entered between an assessee and Board in respect of one international

transaction, the arm's length price will be calculated as per the provisions of Advance Pricing

Agreement.

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9.22 VALIDITY OF ADVANCE PRICING AGREEMENT

The Advance Pricing Agreement shall be valid for a period as specified in the Advance

Pricing Agreement. However, this period will not be more than 5 consecutive years.

9.23 PARTIES BOUND BY ADVANCE PRICING AGREEMENT

Advance Pricing Agreement shall be binding on:

(a) the person in whose case, and in respect of the transaction in relation to which, the

agreement has been entered into; and

(b) on the Principal Commissioner or Commissioner, and the income-tax authorities

subordinate to him, in respect of the said person and the said transaction.

However the advance pricing agreement shall not be binding if there is a change in law or

facts having bearing on the agreement so entered.

9.24 VOID ADVANCE PRICING AGREEMENT

If an agreement has been obtained by fraud or misrepresentation or false documents it may be

declared void ab initio:

9.25 EFFECT OF VOID AGREEMENTS:

If an agreement in declared void;

(a) All the provisions of the Act shall apply of the person as if such agreement had never

been entered into; and

(b) Notwithstanding anything contained in the Act, for the purpose of computing any

period of limitation under this Act, the period beginning with the date of such

agreement and ending on the date of order for declaring an Advance Pricing

Agreement void ab initio shall be excluded. Provided that where immediately after the

exclusion of the aforesaid period, the period of limitation, referred to in any provision

of this Act, is less than sixty days, such period shall be extended to sixty days and the

aforesaid period limitation shall be deemed to be extended accordingly.

9.26 PROCEDURE OF APA

The Board is empowered to prescribe a scheme providing for the manner, form, procedure

and any other matter generally in respect of the advance pricing agreement.

9.27 MODIFIED RETURN

The person entering into such APA shall necessarily have to furnish a modified return within

a period of 3 months from the end of the month in which the said APA was entered into

respect of the return of income already filed for a previous year to which the APA applies.

The modified return has to reflect modification to the income only in respect of the issues

arising from the APA and in accordance with it.

9.28 ASSESSMENT UNDER APA

Where the assessment or reassessment proceeding for an assessment year relevant to the

previous year to which the agreement applies are pending on the date of filing of a modified

return, the Assessing Officer shall proceed to complete the assessment or reassessment

proceedings in accordance with the agreement, taking into consideration the modified return

so filed and normal period of limitation of completion of proceeding shall be extended by one

year.

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If the assessment or reassessment proceedings for an assessment year relevant to a previous

year to which the agreement applies has been completed before the expiry of period allowed

for furnishing of modified return, the Assessing Officer shall, in a case where modified return

is filed, proceed to assess or reassess or recomputed the total income of the relevant

assessment year having regard to and in accordance with the APA. To such assessment, all

the provisions relating to assessment shall apply as if the modified return is a return furnished

under section 139. The period of limitation for completion of such assessment or

reassessment is one year from the end of the financial year in which the modified return is

furnished.

Questions:

1. What is double taxation avoidance agreement? Discuss in the context of India.

2. Disuses the steps for calculating unilateral tax relief.

3. What are the condition for claiming double taxation relief?

4. Rakesh is a magician deriving income from shows performed outside India amounting

Rs. 2,50,000. Tax of Rs. 37,500 was deducted at source in the country where the

concerts were given. India does not have any agreement with that country for

avoidance of double taxation. Assuming that the Indian income of Rakesh is Rs.

5,00,000, what is the relief due to him under Section 91 for assessment year 2016-17.

Ans. Rs. 25750

5. An individual, resident of India has the following incomes during P.Y. 2015-16

Rs.

1. Business income in India 7,20,000

2. Business income in a foreign country with

which India does not have Double

Taxation avoidance agreement

3. Tax an income mentioned in 2 by foreign

country deposited in Public Provident Fund

Compute his tax liability

2,40,000

48,000

40,000

Ans. Rs. 83087

6. Discuss method under. Which arm's length price relating to an international

transaction determined.

7. When an enterprise is treated an associated enterprise under income tax act? Discuss

deemed associated enterprises.

8. Write notes on advance pricing agreement.

9. Distinguish between resale price method and cost plus method.

10. From the following information determined the 'Arm's' length price' and taxable

income of S. Ltd. a 100% Indian subsidiary company of a foreign Company F Ltd. :

a. F Ltd. sold 1,000 mobile phones to S. Ltd. @ $ 40 per unit.

b. F Ltd. sold 2,000 mobile phones to other Indian companies @ $ 50 per unit.

c. Total income of S Ltd. for the year Rs. 15,00,000

d. Assume the rate of a dollar = Rs. 65

Ans. ALP Rs. 3250000 income – Rs. 2150000

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LESSON 10

(a) Special Provisions Relating to Non-Residents

(b) Advance Ruling

(a) NON-RESIDENTS

According to section 2(30), “Non-resident” means a person who is not a resident in India.

However in the following cases, it also includes a person who is not ordinarily resident in

India:

1. Section 92 : relating to computation of income from international transactions

having regard to arm’s length price;

2. Section 93 : avoidance of income tax by transactions resulting in transfer of

income to non-residents;

3. Section 168 : executors.

TYPES OF NON-RESIDENTS IN INDIA

Under Income-tax Act, non-resident in India can be of two types:

1. Non-resident Indian:

“Non-resident Indian” means an individual, being a citizen of India or a person of Indian

origin who is not a resident.

2. Any other non-resident person:

Foreign nationals (other than individuals of Indian origin) or foreign companies or Overseas

financial organizations (Offshore funds) or foreign institutional investors, etc.

EXEMPTED INCOMES

1. Any income by way of interest on notified securities or bonds (including income by

way of premium on the redemption of such bonds) or any income by way of interest

on moneys standing to a non-resident individual’s credit in a Non-Resident (External)

Account in any bank in India in accordance with the relevant rules [Sec. 10(4)].

2. A foreign company deriving income by way of royalty or fees for technical services

received from Government or an Indian concern in pursuance of an agreement made

by the foreign company with Government or the Indian concern after the 31st day of

March, 1976 but before the 1st day of June, 2002 [Sec. 10(6A)].

3. A non-resident (not being a company) or a foreign company deriving income (not

being salary, royalty or fees for technical services) from Government or an Indian

concern in pursuance of an agreement entered into before the 1st day of June, 2002 by

the Central Government with the Government of a foreign State or an international

organisation, the tax on such income is payable by Government or the Indian concern

to the Central Government under the terms of that agreement or any other related

agreement approved before that date by the Central Government [Sec. 10(6B)].

4. Any income arising to notified foreign companies by way of royalty or fees for

technical services received in pursuance of an agreement entered into with that

Government for providing services in or outside India in projects connected with

security of India [Sec. 10(6C)].

5. Any payment made, by an Indian company engaged in the business of operation of

aircraft, to acquire an aircraft or an aircraft engine (other than a payment for providing

spares, facilities or services in connection with the operation of leased aircraft) on

lease from the Government of a foreign State or a foreign enterprise under an

agreement, not being an agreement entered into between the 1st day of April, 1997

and the 31st day of March, 1999,] and approved by the Central Government [Sec.

10(15A)].

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COMPUTATION OF CERTAIN INCOME OF NON-RESIDENTS

1. Profits and gains of shipping business [Sec. 44B]:

This section is applicable if the assessee is a non-resident in India and engaged in the

business of operation of ships.

Income shall be calculated @ 7.5% of the aggregate of the following:

a. the amount paid or payable (whether in or out of India) to the assessee on account of

carriage of passengers, livestock, mail or goods shipped at any Indian port; and

b. the amount received or deemed to be received in India by the assessee on account of

the carriage of passengers, livestock, mail or goods shipped at any port outside India.

The amount paid or payable or received or deemed to be received also include the amount

received by way of demurrage charges or handling charges or any other amount of similar

nature.

The provisions of section 44B are applicable to a ship which is engaged in regular business in

India and provisions of section 172 are applicable to a ship which occasionally visits the

Indian ports. However, assessees applying section 172 can opt for being governed by the

provisions of section 44B, and accordingly, in such cases taxes paid under section 172 shall

be adjusted in light of the tax liability computed under section 44B.

Section 172 Section 44B

Tax liability 7.5% of amount received on account

of carriage of goods, passengers, etc.,

is taxable at the rate applicable to a

foreign company [if not opted for

regular assessment]

7.5% of such collection is taken as

business income; other provisions

will be applicable to find out taxable

income which will be taxable at the

rate applicable to a non-resident.

Overriding

effect

It overrides all other provisions of the

Act subject to availing the facility of

regular assessment

It overrides sections 28 to 43A

2. Profits and gains of business of exploration etc. of mineral oils [Sec. 44BB]:

This section is applicable if the assessee is non-resident and engaged in the business of

providing services and facilities in connection with, or supplying plant and machinery on

hire, used or to be used in the exploration for, and exploitation of, minerals oils.

Income is calculated @ 10% of the amounts given below:

a. amount paid or payable to the assessee (whether in or out of India) for the aforesaid

services or facilities or supplying plant and machinery for the aforesaid purposes; and

b. amount received or deemed to be received in India for the aforesaid services or

facilities or supply of plant and machinery.

For this purpose, "plant" includes ships, aircraft, vehicles, drilling units, scientific apparatus

and equipment, used for the purposes of the said business.

The provisions of sections 28 to 41, 43 and 43A are not applicable.

3. Profits and gains of the business of operation of aircraft [Sec. 44BBA]:

This section is applicable in the case of a non-resident engaged in the operation of aircraft.

Income from such business is calculated @ 5% of the following:

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a. the amount received (whether in or out of India) by the assessee on account of

carriage of passenger, livestock, mail or goods from any place in India; and

b. the amount received or deemed to be received in India by the assessee on account of

carriage of passenger, livestock, mail or goods from any place outside India.

4. Profits and gains of business of civil construction etc. in certain turnkey power

projects [Sec. 44BBB]:

This section is applicable in the case of a foreign company engaged in the business of civil

construction or the business of erection of plant or machinery or testing or commissioning

thereof, in connection with a turnkey power project approved by the Central Government.

Income @ 10% of the amount paid or payable (whether in India or out of India) to the said

assessee (or to any person on his behalf) on account of such civil construction, erection,

testing or commissioning, shall be deemed to be the profits and gains of such business

chargeable to tax under the head “Profits and gains of business or profession”.

In such a case, provisions of sections 28 to 44AA are not applicable.

5. Head office expenditure in the case of non-resident [Sec. 44C]: Deduction in respect of head office expenditure is restricted to the least of the following:

a. an amount equal to 5% of the “adjusted total income”, or in the case of loss, 5% of

“average adjusted total income”; or

b. the actual amount of head office expenditure attributable to the business or profession

in India;

The term “adjusted total income” means the total income without giving effect to unabsorbed

depreciation, allowance under section 44C, capital expenditure in respect of promoting

family planning amongst its employees, business loss brought forward, speculation loss

brought forward, loss under the head “capital gains” or any deduction under sections 80C to

80U.

The term “average adjusted total income” means one-third of the aggregated amount of

adjusted total income in respect of three previous years preceding the relevant assessment

year. If the assessee has assessable income for less than three years out of the preceding three

years, the average will be based upon those lesser number of years only, i.e., in case of two

years, the aggregate of two years will be divided by two and in case of one year only the

actual amount of adjusted total income will be the average also.

The term “Head office expenditure” means executive and general administration expenditure

incurred by the assessee outside India, including expenditure incurred in respect of:

a. rent, rates, taxes, repairs or insurance of any premises outside India used for the

purposes of the business or profession;

b. salary, wages, annuity, pension, fees, bonus, commission, gratuity, perquisites or

profits in lieu of or in addition to salary, whether paid or allowed to any employee or

other person employed in, or managing the affairs of any office outside India;

c. travelling by any employee or other person employed in, or managing the affairs of

any office outside India; and

d. such other matters connected with executive and general administration as may be

prescribed.

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6. Royalties and fees for technical services [Sec. 44D]: Provisions of section 44D are divided into two categories:

a. In case of a foreign company, the deduction that would be admissible in computing its

income by way of royalty or fees for technical services received from Government or

an Indian concern in pursuance of an agreement made by it with them before April 01,

1976 will be limited to 20 percent of the gross amount of such income, as reduced by

the amount, if any, of so much of the royalty income as consists of lump sum

consideration for the transfer outside India of, or the imparting of information outside

India in respect of, any data, documentation, drawing or specification relating to a

patent, invention, model, design, secret formula or process or trademark or similar

property.

The aforesaid ceiling is applicable in relation to all royalties and fees for technical services

received by foreign companies from Indian concerns, irrespective of whether such royalties

or fees for technical services are received under agreements which have been approved by the

Central Government or not.

b. In case, the agreement is made after March 31, 1976 but before April 01, 2003, no

deductions under sections 28 to 44C shall be allowed to foreign companies having

income by way of royalty or fees for technical services received from Government or

an Indian concern (applicable whether the agreement is approved by the Central

Government or not).

7. Royalties and fees for technical services in case the agreement is made after

March 31, 2003 [Sec. 44DA]:

The income by way of royalty or fees for technical services received from Government or an

Indian concern in pursuance of an agreement made after March 31, 2003 by a non-resident

non-corporate assessee or a foreign company with the aforesaid person shall be computed

under the head “Profit and gains of business or profession” if the following conditions are

satisfied:

1. The assessee carries on business in India through a permanent establishment (PE)

situated in India, or performs professional services from a fixed place of profession

situated in India.

2. The right, property or contract in respect of which the royalties or fees for technical

services are paid to the taxpayer is effectively connected with such permanent

establishment or fixed place of profession.

In computing the income for this purpose, the following expenses shall not be allowed:

a. Any expenditure or allowance which is not wholly and exclusively incurred for the

business of such permanent establishment or fixed place of profession in India.

b. Any amount paid (otherwise than towards reimbursement of actual expenses) by the

permanent establishment to its head office or to any of its other offices.

Deductions under sections 28 to 44D and 57 are allowed from such incomes.

DETERMINATION OF TAX IN CERTAIN SPECIAL CASES (CHAPTER XII):

Section 110 to 115BBE relates to computation of tax as special cases. For example, section

111A tax income from STCG @ 15%, section 112 tax income from LTCG @ 20%, section

115BB tax lottery income @ 30%, etc. But we will discuss only those special tax rates which

are applicable to non-residents.

157

Tax on dividends, royalty and fees for technical services [Sec. 115A]: This section is applicable for non-resident non-corporate assessee or a foreign company.

Incomes covered under section 115A are divided into two categories:

1. Following incomes are covered:

a. Dividend (not being dividend covered under section 115-O); and

b. Interest received from Government or an Indian concern on moneys borrowed or

debt incurred by Government or Indian concern in foreign currency; and

c. Income received in respect of units, purchased in foreign currency, of a Mutual

Fund specified under section 10(23D) or of UTI

2. Four different cases of royalties and fees for technical services received under an

agreement made on or after April 01, 1976 (not being covered by section 44DA):

a. Where such agreement is with the Government of India; or

b. Where such agreement is with an Indian concern, the agreement is approved by

the Central Government; or

c. Where such agreement relates to a matter included in the industrial policy, for the

time being in force, of the Government of India, the agreement is in accordance

with that policy; or

d. Where such royalty is in consideration for the transfer of all or any rights

(including the granting of a licence) in respect of copyright in any book to an

Indian concern or in respect of any computer software to a person resident in

India.

No deduction under sections 28 to 44C and section 57 is allowed from such incomes.

Tax rates on incomes covered under section 115A are given in table 2.

Table 1: Collective impact of sections 44D, 44DA and 115A:

Royalty or fees for technical services received by a

foreign company or a non-resident non-corporate

assessee from Government or an Indian concern

Deductions

under

sections 28 to

44C and 572

Deductions

under

sections 80C

to 80U

Tax rate

(%)3

Such royalty or technical fee is received under an

agreement made after March 31, 1976 but before

April 01, 2003:

a. Where such agreement is with Government

b. Where such agreement is with an Indian

company, the agreement is approved by the

Central Government

c. Where such agreement relates to a matter

included in the industrial policy, for the time

being in force, of the Government of India, the

agreement is in accordance with that policy

d. Where such royalty is in consideration for the

transfer of all or any rights (including the

granting of a licence) in respect of copyright in

any book to an Indian concern or in respect of

No deduction

No deduction

No deduction

No deduction

Deduction

available

Deduction

available

Deduction

available

Deduction

available

10

10

10

10

2 Section 57 relates to deductions under the head “Income from other sources”. 3 Plus surcharge (if applicable) plus education cess plus secondary and higher education cess.

158

computer software to a person resident in India

e. In any other case

Foreign

company

cannot claim

any deduction,

non-resident

non-corporate

assessee can

claim

deduction

Deduction

available

Applicable

rate

Such royalty or technical fee is received under an

agreement made after March 31, 2003:

a. Where royalty or technical fee is effectively

connected to Permanent Establishment (PE) in

India

b. Where PE is absent but the case is covered by

section 115A(1) [i.e., a to d (supra)]

c. In any other case (means except a and b)

Deduction

available

No deduction

Deduction

available

Deduction

available

Deduction

available

Deduction

available

Applicable

rate

10

Applicable

rate

Table 2: Summary of provisions of sections having special rates of tax:

Sections Nature of income Deductions

under

sections 28

to 44C and

574

Deductions

under

sections 80C

to 80U

Tax rate

(%)5

115A

Following incomes in the case of a non-

resident non-corporate assessee or a foreign

company:

1. Dividend (not being dividend

covered under section 115-O)

2. Interest received from Government

or an Indian concern on moneys

borrowed or debt incurred by

Government or Indian concern in

foreign currency

3. Income received in respect of units,

purchased in foreign currency, of a

Mutual Fund specified under section

10(23D) or of UTI

Not available

Not available

Not available

Not available

Not available

Not available

20

20

20

Royalty or technical fees of a non-resident

non-corporate assessee or a foreign company

See the provisions given in table 1

115AC

Following incomes of a non-resident:

a. Income by way of interest or

dividends (not being covered by

section 115O), on notified bonds/

Global Depository Receipts (GDRs)

of an Indian Company or public

sector company, sold by the

Government and purchased by him

Not available

Not available

10

4 Section 57 relates to deductions under the head “Income from other sources”. 5 Plus surcharge (if applicable) plus education cess plus secondary and higher education cess.

159

Sections Nature of income Deductions

under

sections 28

to 44C and

574

Deductions

under

sections 80C

to 80U

Tax rate

(%)5

in foreign currency; or

b. Income by way of LTCG arising

from the transfer of aforesaid bonds

or GDRs

[in this case (b), first and second proviso to

section 486 are not applicable]

----

Not available

10

115BBA

Following income of a non-resident

sportsman (including an athlete) who is a

foreign citizen:

1. Participation in India in any game

(other than the game of winnings

wherefrom the income is taxable

under section 115BB) or sport; or

2. Advertisement; or

3. Contribution of articles relating to

any game or sport in India in

newspapers, magazines or journals

Not available

Not available

Not available

Not available

Not available

Not available

20

20

20

Any amount guaranteed to be paid or

payable to a non-resident sports association

or institution in relation to any game (not

being a game referred to in section 115BB)

or sports played in India

Not available Not available 20

Income of a non-resident foreign citizen

entertainer

Not available Not available 20

115D7

Following incomes of a non-resident Indian:

1. Investment income from foreign

exchange assets

2. LTCG on transfer of foreign

exchange assets

[in this point (2), first proviso to section 48 is

applicable but second proviso is not

applicable]

No deduction

under any

provision

----

Not available

Not available

20

10

SPECIAL PROVISIONS [Sec. 115C to 115I] [Chapter XIIA] The provisions under section 115C to 115I are applicable only in respect of the following

incomes derived by a non-resident Indian:

a. Investment income derived from “foreign exchange assets”; and

b. Long-term capital gains on sale or transfer of “foreign exchange assets”.

Foreign exchange assets:

6 First proviso to section 48 relates to computing capital gains by converting selling price (in Indian currency)

into foreign currency which the assessee had brought to invest in bonds etc. Second proviso to section 48 states

that benefit of indexation is not available.

7 Covered under chapter XIIA in detail.

160

It means any “specified asset” acquired, purchased or subscribed to, by the non-resident

Indian in foreign currency in accordance with the Foreign Exchange Regulation Act, 1973/

Foreign Exchange Management Act, 1999.

Specified assets:

Following are the “specified assets” for this purpose:

a. Shares in an Indian company;

b. Debentures of an Indian public limited company;

c. Deposits with an Indian public limited company;

d. Securities of the Central Government; and

e. Any other asset which the Central Government may by notification in the Official

Gazette specify in this behalf.

Computation of investment income:

In computing the investment income for the above purpose, no deduction shall be allowed in

respect of any expenditure or allowance under any provision of the Act. Further, no deduction

under sections 80C to 80U shall be allowed in respect of investment income for the above

purpose.

Computation of long-term capital gain:

Long-term capital gain on sale or transfer of foreign exchange assets shall be calculated

subject to the following points:

1. The benefit of indexation is not available in respect of sale or transfer of foreign

exchange assets.

2. No deduction is permissible in respect of long-term capital gain under sections 80C to

80U.

3. By investing sale consideration in another asset, the non-resident Indian can claim

exemption under section 115F.

Computation of tax:

Investment income is taxable @ 20% and LTCG is taxable @ 10%.

Section 115F:

If the following conditions are satisfied, one can take the benefit of section 115F:

1. The taxpayer is a non-resident Indian at the time of sale of capital asset.

2. He has transferred a capital asset [i.e., shares in an Indian company, debentures of an

Indian public limited company, deposits with an Indian public limited company, or

securities of the Central Government (hereinafter referred to as “original asset”)]

which has been acquired or purchased with, or subscribed to in, convertible foreign

exchange.

3. Such asset is a long-term capital asset.

4. Within 6 months of the transfer of original asset, the taxpayer has invested the whole

or any part of net sale consideration (i.e. sale minus expenses on sale) in any of the

following assets (hereinafter referred to as “new asset”):

a. Shares in an Indian company;

b. Debentures of an Indian public limited company;

c. Deposits with an Indian public limited company; or

d. Securities of the Central Government;

161

5. If the above given conditions are satisfied, exemption under section 115F is equal to 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑔𝑎𝑖𝑛𝑠

𝑁𝑒𝑡 𝑠𝑎𝑙𝑒 𝑐𝑜𝑛𝑠𝑖𝑑𝑒𝑟𝑎𝑡𝑖𝑜𝑛* Amount invested in new asset

In case the new asset, is transferred or converted (otherwise than by transfer) into money

within 3 years from the date of its acquisition, the capital gains arising from the transfer of

original asset exempted from tax on the basis of acquisition of new asset will be deemed to be

income by way of long-term capital gains of the previous year in which such new asset is so

transferred or converted into money.

Return of income not to be filed in certain cases [Sec. 115G]:

In cases where a non-resident Indian has income only from a foreign exchange asset or

income by way of long-term capital gains arising on transfer of a foreign exchange asset, or

both, and tax deductible at source from such income has been deducted, he is not required to

file the return of income under section 139(1).

The income from foreign exchange assets and long-term capital gains arising on transfer of

such assets would be treated as a separate block and charged to tax at a flat rate as explained

above. If the non-resident Indian has other income in India, such other income is treated as an

altogether separate block and charged to tax in accordance with other provisions of the Act.

Applicability of this benefit in certain cases even after assessee becomes resident [Sec.

115H]:

Where a person, who is a non-resident Indian in any previous year, becomes assessable as

resident in India in any subsequent year, he may furnish to the Assessing Officer a

declaration in writing (along with his return of income under section 139 for the assessment

year for which he is so assessable) to the effect that the special provisions shall continue to

apply to him in relation to the investment income derived from any foreign exchange asset

being debentures and deposit with an Indian public limited company and Central Government

securities. If he does so, the special provisions shall continue to apply to him in relation to

such income for that assessment year until the transfer or conversion (otherwise than by

transfer) into money of such assets.

Non-applicability of this special provision [Sec. 115I]:

A non-resident Indian may opt that the special provisions relating to taxation of the

investment income and long term capital gains at flat rate should not apply to him. This

option will be exercisable by the assessee making a declaration to that effect in his return of

income for the relevant assessment year. In cases where such an option is exercised by a non-

resident Indian, the whole of his total income (including income from foreign exchange assets

and long-term capital gains arising on transfer of a foreign exchange asset) is charged to tax

under the general provisions of the Act.

FIRST PROVISION TO SECTION 48

To avail the benefit of this provision, the following conditions should be satisfied:

1. The taxpayer is a non-resident (may be an Indian or foreign citizen, or a corporate-

assessee or a non-corporate assessee but not being an assessee covered by sections

115AC and 115AD) at the time of sale of capital asset.

162

2. He acquires shares8 in (or debentures of) an Indian company (may be public limited or

private limited) by utilizing foreign currency.

3. The asset may be short-term or long-term.

Rule of computation under this section:

If the aforesaid conditions are satisfied, then the following procedure shall be adopted to

determine capital gain (it may be noted that the procedure given below is applicable without

any exception whenever the above conditions are satisfied):

1. Capital gain shall be computed in the same foreign currency which was initially

utilized in acquiring shares or debentures.

2. Capital gain so calculated in the foreign currency shall be reconverted into Indian

currency.

3. The benefit of indexation shall not be available but the option of taking fair market

value on April 01, 1981 is available.

4. The aforesaid manner of computation of capital gain shall be applicable in respect of

capital gain accruing or arising from every re-investment thereafter in (and sale of)

shares in (or debentures of) an Indian company.

5. Average exchange rate:

It is the average of the telegraphic transfer buying rate and telegraphic transfer selling

rate of the foreign currency initially utilized in the purchase of the said asset.For this

purpose, telegraphic transfer buying/ selling rate in relation to a foreign currency is

rate of exchange adopted by the SBI for purchasing or selling such currency where

such currency is made available by that bank through telegraphic transfer.

6. Buying rate:

It is the telegraphic transfer buying rate of such currency.

7. The aforesaid provision is applicable even in the case of short-term capital gain.

Steps to be followed to compute capital gain under this section:

Following steps are to be applied whether the gain is short-term or long-term:

Step 1: Find out sale consideration in Indian currency and convert it into foreign currency at

“average exchange rate” on the date of transfer.

Step 2: Find out the expenditure on transfer in Indian currency and convert it into foreign

currency at “average exchange rate” on the date of transfer (and not on the date on

which expenditure is incurred).

Step 3: Find out the cost of acquisition in Indian currency and convert it into foreign currency

at “average exchange rate” on the date of acquisition.

Step 4: Capital gain (1 – 2 – 3) will be reconverted in to Indian currency at “buying rate” on

the date of transfer.

8 In some cases, capital gain on transfer of equity shares is not chargeable to tax under section 10(38).

163

TRANSACTIONS NOT TREATED AS TRANSFER [Sec. 47] The following transfers by a foreign company/ non-resident are not regarded as transfer,

hence, the capital gains arising out of the transaction is not liable to tax:

1. Any transfer of shares held in an Indian company, by the amalgamating foreign

company to amalgamated foreign company, in a scheme of amalgamation, if:

a. At least 25% of the shareholders of the amalgamating foreign company continue

to remain shareholders of the amalgamated foreign company; and

b. Such transfer does not attract tax on capital gains in the country in which the

amalgamating company is incorporated.

2. Any transfer of shares held in an Indian company by the demerged foreign company

to resulting foreign company, in a scheme of demerger, if:

a. Shareholders holding not less than 75% in value of shares of the demerged foreign

company continue to remain shareholders of the resulting foreign company; and

b. Such transfer does not attract tax on capital gains in the country in which the

demerged foreign company is incorporated.

3. Any transfer of bonds or Global Depository Receipts purchased in foreign currency

held by a non-resident to another non-resident, where the transfer is made outside

India.

TRANSFER OF SHARES OR UNITS IN A RECOGNIZED STOCK EXCHANGE IN

INDIA [Sec. 111A or 10(38)]

Whenever, equity shares or units of equity oriented mutual fund are transferred in a

recognized stock exchange in India on or after October 1, 2004, the transaction is chargeable

to securities transaction tax*.

In such cases, long-term capital gain is exempt from tax under section 10(38). However, if

the capital asset is short-term capital asset, then short-term capital gain is taxable under

section 111A @ 15%9. Such short-term capital gain is calculated without considering

securities transaction tax paid by the assessee.

Deductions under sections 80C to 80U is not allowed from LTCG or STCG (covered under

section 111A).

Normal LTCG is taxable at a flat rate of 20% + Surcharge (if any) + EC and SHEC @ 3%.

TAX INCIDENCE ON TRANSFER OF LISTED SECURITIES (and units of mutual

fund whether listed or not):

Listed securities include shares, bonds, debentures and Government Securities.

In this case, tax on LTCG can be computed under two options and the taxpayer has an option

to pay tax under option I or option II, whichever is lower.

Option I:

Compute LTCG after applying indexation and compute tax @ 20% + surcharge (if any) + EC

and SHEC (3%)

Option II:

9 Plus surcharge (if applicable) plus education cess plus secondary and higher education cess.

164

Compute LTCG without applying indexation and compute tax @ 10% + surcharge (if any) +

EC and SHEC (3%)

Example 1:

Mr. X, a non-resident Indian, furnishes the following information to you for the previous year

2015-16: Rs.

a. Income from property (Net) 1,12,000

b. Income from consultancy derived during his visits to India 80,000

c. Income from other sources 1,10,000

d. Capital gains on sale of shares in an Indian Company:

Cost in 1989-90 Rs. 1,90,000

Sale price in 2015-16 Rs. 4,80,000 2,90,000

CII for 1989-90 is 172 and 2015-16 is 1081.

Your advice is sought on his tax liability in India for the assessment year 2016-17 assuming

that the shares of the Indian Company were purchased in convertible foreign exchange. Can

the tax on capital gains be saved?

Solution:

Tax payable under sections 115C to 115I:

Amount (Rs.)

Income from property 1,12,000

Income from consultancy 80,000

Income from other sources 1,10,000

3,02,000

Long term capital gains on sale of shares 2,90,000

Net Taxable Income 5,92,000

Tax on Rs. 2,90,000 @ 10% 29,000

Tax on remaining income of Rs. 3,02,000

[10% of (3,02,000 – 2,50,000)] 5,200

34,200

Add: Surcharge Nil

34,200

Add: Cess @3% 1,026

Tax payable (Rounded off) 35,230

Tax payable under other provisions of the Act:

Amount (Rs.)

Income excluding LTCG 3,02,000

Long term capital gains:

Sale consideration 4,80,000

Less: Indexed cost of acquisition

(1,90,000/172*1081) 11,94,128 (7,14,128)*

Tax on Rs. 3,02,000 (i.e., income excluding LTCG) 5,200

Add: Surcharge Nil

5,200

Add: Cess @ 3% 156

Tax payable (Rounded off) 5,360

165

Conclusion: Mr. X should pay tax under other provisions of the Act.

The capital gains arising on the sale of foreign exchange asset can be saved by investment in

specified assets. If the cost of asset is not less than the net consideration in respect of the

original asset, the whole of the capital gains will not be charged to tax. Otherwise, the capital

gains will be exempt proportionately as given below:

Capital gain/ Net sale consideration* Cost of investment

Example 2:

The total income of a non-resident Indian includes: Rs.

a. Investment income (net after TDS) 40,000

b. Long-term capital gains 25,000

c. Other income 2,85,000

Total income 3,50,000

What will be the tax payable by him in respect of assessment year 2016-17 on the above

income under Chapter XIIA (Sections 115C to 115I) of the Income-tax Act? In what manner

can the tax liability be reduced in this case?

Solution:

It has been assumed that the investment income and long-term capital gains are from foreign

exchange assets.

The tax liability of a non-resident Indian shall be computed under chapter XIIA:

Amount (Rs.)

Investment income (40,000/80*100) = 50,000*20% 10,000

LTCG (25,000*10%) 2,500

Remaining Other income (2,85,000 – 2,50,000)*10% 3,500

16,000

Add: Surcharge Nil

16,000

Add: Cess @ 3% 480

16,480

Less: TDS 10,000

Net tax payable by the assessee 6,480

As far as reduction of tax liability is concerned, the tax liability on LTCG can be saved if the

assessee invests the net consideration on sale of original specified assets in specified assets

within 6 months from the date of transfer of original asset.

Example 3:

Mahesh, a non-resident Indian, has the following income from investments in foreign

exchange assets and other income: Rs.

a. Interest on Central Government Securities 50,000

b. Interest on debentures of public limited company 1,00,000

He spent on collection of above incomes 3,000

c. Long-term capital gains on transfer of debentures mentioned

in point (b) above [computed under section 48 (proviso)] 2,00,000

d. Other income 2,90,000

Determine his tax liability for the assessment year 2016-17 under sections 115C to 115H of

the Income-tax Act. How can ‘X’ reduce his tax liability?

166

Solution:

Tax payable under sections 115C to 115H:

Income from foreign exchange assets:

Amount (Rs.)

Interest on Central Government Securities 50,000

Interest on debentures of public limited companies 1,00,000

LTCG on transfer of debentures mentioned above 2,00,000

3,50,000

Add: Income from other sources 2,90,000

6,40,000

Tax on interest income (1,50,000*20%) [115D] 30,000

Tax on LTCG (2,00,000*10%) [115D] 20,000

Tax on Rs. 2,90,000 [10% of (2,90,000 – 2,50,000)] 4,000

54,000

Add: Surcharge Nil

54,000

Add: Cess @ 3% 1,620

Tax payable 55,620

Tax payable under other provisions of the Act:

Amount (Rs.)

Interest on debt in foreign currency:

a. Interest on Central Government Securities 50,000

b. Interest on debentures 1,00,000

LTCG 2,00,000

Income from other sources 2,90,000

6,40,000

Tax on debt in foreign currency (1,50,000*20%) [Sec. 115A] 30,000

Tax on LTCG (2,00,000*20%) [Sec. 112] 40,000

Tax on Rs. 2,90,000 (2,90,000 – 2,50,000)*10% 4,000

74,000

Add: Surcharge Nil

74,000

Add: Cess @ 3% 2,220

Tax payable 76,220

Conclusion: Mahesh should pay tax under the provisions of section 115C to 115H.

Example 4:

‘X’, a member of the New Zealand Cricket team, received a sum of Rs. 5 lakh for

participation in matches in India. He also received a sum of Rs. 1 lakh in India for endorsing

a product on T.V. He contributed articles in an Indian newspaper for which he received Rs.

10,000. During the tour of India, he won a prize of Rs. 10,000 in horse race. What will be his

tax liability for the assessment year 2016-17?

167

Solution:

Under section 115BBA, ‘X’ has to pay tax @20% on the following incomes:

Amount (Rs.)

Income from participation in matches 5,00,000

Articles in newspapers 10,000

Advertisement on TV 1,00,000

6,10,000

Tax on Rs. 6,10,000 @ 20% 1,22,000

Tax on Rs. 10,000 @ 30%

(Income from horse races is Rs. 10,000) 3,000

Total tax (1,22,000 + 3,000) 1,25,000

Add: Surcharge Nil

1,25,000

Add: Cess @ 3% 3,750

1,28,750

Example 5:

A non-resident company is engaged in the business of operation of ships. From the following

information compute its business income assessable in India under section 44B and tax

liability for the assessment year 2016-17:

Amount (Rs.)

1. Goods shipped in Bangladesh:

a. Freight paid in Bangladesh 1,00,000

b. Freight paid in India by the consignees 40,000

2. Goods shipped in India:

a. Freight paid in India 70,000

b. Freight paid in Pakistan by the consignees 40,000

c. One party delayed the goods, hence, the company

charged demurrage 20,000

Solution:

Computation of business income in India of non-resident shipping company for the

assessment year 2016-17:

Particulars Amount (Rs.)

Income received in India:

Freight paid in India by consignees of goods shipped in Bangladesh 40,000

Freight paid in India regarding goods shipped in India 70,000

Demurrage charges 20,000

Income accrues in India:

Freight paid in Pakistan by the consignees of goods shipped in India 40,000

Total receipts 1,70,000

Therefore, assessable income under section 44B = 7.5% of Rs. 1,70,000 = Rs. 12,750

Tax liability is Rs. 5,250 after rounding off [Rs. 12,750*41.20%]

168

(b) Advance Rulings

In order to avoid needless litigation and promote better relations with a non-resident, a

system of ‘advance rulings’ [Chapter XIX-B] has been incorporated under the Income Tax

Law by the Finance Act, 1993.

Meaning of advance ruling [Sec. 245N(a)] Advance ruling means:

1. A determination, by the Authority in relation to a transaction which has been

undertaken or proposed to be undertaken by a non-resident applicant and such

determination shall include the determination of any question of law or of fact

specified in the application; or

2. A determination by the Authority in relation to the tax liability of a non- resident

arising out of a transaction which has been undertaken or is proposed to be undertaken

by a resident applicant with such non-resident and such determination shall include

the determination of any question of law or of fact specified in the application; or

3. A determination by the Authority in relation to the tax liability of a resident applicant,

arising out of a transaction which has been undertaken or is proposed to be undertaken

by such applicant and such determination shall include the determination of any

question of law or of fact specified in the application; or

4. A determination or decision by the Authority in respect of an issue relating to

computation of total income which is pending before I.T. Authority or the Tribunal

and such determination or decision shall include the determination or decision of any

question of law or of fact relating to such computation of total income specified in the

application; or

5. A determination or decision by the Authority whether an arrangement, which is

proposed to be undertaken by any person being a resident or a non-resident, is an

impermissible avoidance arrangement as referred to in Chapter X-A or not.

Meaning of applicant [Sec. 245N(b)] Applicant means any person, who:

1. is a non-resident mentioned in point (1); or

2. a resident mentioned in point (2); or

3. is a resident mentioned in point (3) falling within any such class or category of

persons as the Central Government may, by notification, specify;

For this purpose, a resident, in relation to his tax liability arising out of one or more

transactions valuing Rs. 100 crore or more in total which has been undertaken or

proposed to be undertaken, has been notified by the Central Government.

4. is a resident falling within any such class or category of persons as the Central

Government may, by notification, specify in this behalf;

For this purpose, a public sector company has been notified by the Central

Government.

5. is referred in point (5) above; or

6. in makes an application under section 245Q(1).

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Authority for Advance Rulings [Sec. 245-O]

1. The Authority shall consist of a Chairman and such number of Vice-chairmen,

revenue Members and law Members as the Central Government may, by notification,

appoint.

2. A person shall be qualified for appointment as—

a. Chairman, who has been a Judge of the Supreme Court;

b. Vice-chairman, who has been Judge of a High Court;

c. a revenue Member from the Indian Revenue Service, who is a Principal Chief

Commissioner or Principal Director General or Chief Commissioner or

Director General;

d. a law Member from the Indian Legal Service, who is, or is qualified to be, an

Additional Secretary to the Government of India.

3. The Central Government shall provide to the Authority with such officers and

employees, as may be necessary, for the efficient discharge of the functions of the

Authority under this Act.

4. The powers and functions of the Authority may be discharged by its Benches as may

be constituted by the Chairman from amongst the Members thereof.

5. A Bench shall consist of the Chairman or the Vice-chairman and one revenue

Member and one law Member.

6. The Authority shall be located in the National Capital Territory of Delhi and its

Benches shall be located at such places as the Central Government may, by

notification specify.

Vacancies, etc., not to invalidate proceedings [Sec. 245P]

No proceeding before, or pronouncement of advance ruling by, the Authority shall be

questioned or shall be invalid on the ground merely of the existence of any vacancy or defect

in the constitution of the Authority.

Application for advance ruling [Sec. 245Q]

1. An applicant desirous of obtaining an advance ruling may make an application in

prescribed forms and in prescribed manner, stating the question on which the advance

ruling is sought.

2. The application shall be made in quadruplicate (four copies) and be accompanied by a

fee of Rs. 10,000 or prescribed fee in this behalf, whichever is higher.

3. An applicant may withdraw an application within 30 days from the date of the

application.

The prescribed forms are:

a. Form 34C in respect of a non-resident applicant referred in point (1) section 245N(a);

b. Form 34D in respect of a resident applicant referred in point (2) of section 245N(a);

c. Form 34DA in respect of a resident applicant referred in point (3) of section 245N(a);

d. Form 34E in respect of a resident referred in point (4) of section 245N(a); and

e. Form 34EA, in respect of an applicant referred in point (5) of section 245N of the Act.

Procedure on receipt of application [Sec. 245R]

1. On receipt of an application, the Authority shall cause a copy thereof to be forwarded

to the Principal Commissioner (or Commissioner) and, if necessary, call upon him to

furnish the relevant records.

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2. The Authority may, after examining the application and the records called for, by

order, either allow or reject the application. However, no application shall be rejected

unless an opportunity has been given to the applicant of being heard. Further, where

the application is rejected, reasons for such rejection shall be given in the order.

3. However, the Authority shall not allow the application where the question raised in

the application –

a. is already pending before any income-tax authority or Appellate Tribunal [except

in the case of a resident applicant mentioned in point (4) of section 245N(b)] or

any court;

b. involves determination of fair market value of any property;

4. relates to a transaction or issue which is designed prima facie for the avoidance of

income-tax [except in the case of a resident applicant mentioned in point (4) of

section 245N(b) or in the case of an applicant mentioned in point (5) of section

245N(b)].

Where an application is allowed, the Authority shall, after examining such further

material as may be placed before it by the applicant or obtained by the Authority,

pronounce its advance ruling on the question specified in the application.

5. On a request received from the applicant, the Authority shall, before pronouncing its

advance ruling, provide an opportunity to the applicant of being heard, either in

person or through a duly authorised representative.

6. A copy of every order shall be sent to the applicant and to the Principal Commissioner

(or Commissioner).

7. The Authority shall pronounce its advance ruling in writing within six months of the

receipt of application.

8. A copy of the advance ruling pronounced by the Authority, duly signed by the

Members and certified in the prescribed manner shall be sent to the applicant and to

the Principal Commissioner (or Commissioner), as soon as may be, after such

pronouncement.

9. No income-tax authority or the Appellate Tribunal shall proceed to decide any issue

in respect to which an application has been made by a resident applicant.

Applicability of advance ruling [Sec. 245S]

The advance ruling pronounced by the Authority under section 245R shall be binding only on

the applicant who had sought it and that too, in respect of the transaction in relation to which

the ruling had been sought. It is also binding on the Principal Commissioner (or

Commissioner), and the income-tax authorities subordinate to him, in respect of the applicant

and the said transaction.

The advance ruling shall be binding as aforesaid unless there is a change in law or facts on

the basis of which the advance ruling has been pronounced.

Advance Ruling to be void in certain circumstances [Sec. 245T]:

Where an authority finds (on a representation made to it by the Commissioner or otherwise)

that an advance ruling pronounced by it has been obtained by the applicant by fraud or

misrepresentation of facts, it may (by order) declare such ruling to be void ab-initio and

thereupon all the provisions of the Act shall apply (after excluding the period beginning with

the date of such advance ruling and ending with the date of order declaring such ruling as

void), to the applicant as if such advance ruling had never been made. However, on receipt of

such representation, a notice shall be issued to the applicant along with a copy of the

representation for rebuttal and reasonable opportunity shall be allowed to the applicant and

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the Commissioner for being heard before passing order declaring the advance ruling to be

void.

Powers of Authority [Sec. 245U]:

The Authority will have all the powers of a Civil Court in respect of discovery and

inspection, enforcing the attendance of any person including any officer of a banking

company and examining him on oath, issuing commissions and compelling the production of

books of account and other records. It will also have the power to regulate its own procedure

in all matters arising out of the exercise of its powers under the Act. The Authority would be

deemed to be a Civil Court for the purposes of section 195 of the Code of Criminal

Procedure, 1973, and every proceeding before the Authority shall be deemed to be a judicial

proceeding under certain provisions of the Indian Penal Code.

Questions

1. Explain briefly the amount of deduction allowed on account of head office

expenditure in the case of non-residents.

2. How the following incomes of a non-resident are determined:

a. profits of shipping business;

b. business of operation of aircraft;

c. business of civil construction in certain turnkey power project.

3. Mr. X is an individual of Indian origin through his residential status is non-resident.

During the previous year 2015-16, his income from investments in Foreign Exchange

Assets in India is as follows:

Amount (Rs.)

Interest on deposits with Public Limited Company 40,000

Interest on Central Government Securities 50,000

Dividend from an Indian Company 30,000

Determine the tax liability for the assessment year 2016-17 under sections 115C to

115H. [Ans. Rs. 18,540]

4. ‘A’, a member of the West Indian Cricket team, received a sum of Rs. 10 lakh for

participation in matches in India. He also received a sum of Rs. 2 lakh in India for

endorsing a product on T.V. He contributed articles in an Indian newspaper for which

he received Rs. 20,000. During the tour of India, he won a prize of Rs. 10,000 in

horse race. What will be his tax liability for the assessment year 2016-17?

[Ans. Rs. 2,54,410]

Questions:

1. Discuss the scheme of advance ruling briefly.

2. What is ‘Advance Ruling’? When does a ruling become void?

3. State the circumstances under which application for advance ruling shall not be

allowed by the Authority for Advance Ruling.

4. Mr. ‘A’ is a non-resident. The appeal pertaining to the assessment year 2015-16 is

pending before the Appellate Tribunal, the issue involved being computation of

income from house property. The same issue persists for the assessment year 2016-17

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also. A’s friend has obtained an advance ruling under chapter XIX B from the

Authority for Advance Ruling on an identical point. Mr. ‘A’ proposes to use the said

ruling for his assessment pertaining to the assessment year 2016-17. Advise ‘A’

suitably.

[Ans. Keeping in view the provisions of section 245S, A cannot use the ruling

obtained by his friend for his assessment.]

5. What is advance ruling as per section 245N(a). Who can be the applicant for advance

ruling under section 245N(b). Under what circumstances the authority shall reject the

application for advance ruling.

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LESSON -11

Tax Planning with Reference to Business Restructuring

11. STRUCTURE

11.1 Meaning of Amalgamation

11.2 Exceptions

11.3 Tax Incentives for Amalgamation

11.4 Accumulated Non-Speculative Business Losses and Unabsorbed Depreciation

11.5 Tax Liability of Amalgamated Company

11.6 Amalgamation of Banking Company

11.7 Tax Planning

11.8 Meaning of Demerger [Section 2(19AA)]

11.9 Important Points for Consideration for Demerger

11.10 Meaning of demerged Company [Section 2(19AAA)]

11.11 Meaning of Resulting Company [Section 2(41A)]

11.12 Tax Concession/Incentives in Case of Demerger

11.13 Tax Concession to the Resulting Company

11.14 Other Important Points

11.15 Distinction Between Amalgamation and Demerger

11.16 Slump Sale

11.17 Coversion of Sole Proprietary Concern/Partnership Firm into Company

11.18 Coversion of a Private Company or an Unlisted Public Company into a Limited

Liability Parternship (LLP)

11.19 Transfer of Assets between Holding and Subsidiary Companies

11.1 MEANING OF AMALGAMATION

Amalgamation is a merger of two or more existing undertakings into one undertaking. The

shareholders of each company become substantially the shareholders in the company which is

to carry on the business of merged undertakings. There may be amalgamation either by the

transfer of two or more undertakings to a new company, or by the transfer of one or more

undertakings to an existing company.

For the purpose of the Income-tax Act, amalgamation of companies means either merger of

one or more companies with another company or the merger of two or more companies to

form one new company. The definition of amalgamation under section 2(1B) covers the

following cases.

Merger of A Ltd. with B Ltd. A Ltd. goes out of existence.

Merger of A Ltd. and B Ltd. with C Ltd. A Ltd. and B Ltd. go out of existence.

Merger of A Ltd. and B Ltd. into a newly incorporated company C Ltd. A Ltd. and B

Ltd. go out of existence.

Merger of A Ltd., B Ltd. and C Ltd., into a newly incorporated company D Ltd. In the

case, A Ltd., B Ltd. and C Ltd. are amalgamating companies, while D Ltd. is an

amalgamated company.

For a merger to qualify as an "amalgamation" for the purpose of the Income-tax Act, it has to

satisfy the following three conditions—

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1. All the properties of the amalgamating company immediately before the

amalgamation should become the property of the amalgamated company by virtue of

the amalgamation

2. All liabilities of the amalgamating company immediately before the amalgamation

should become the liabilities of the amalgamated company by virtue of the amalgam-

ation

3. Shareholders holding not less than three-fourths shares in the amalgamating company

should become shareholders of the amalgamated company by virtue of the

amalgamation.

For example where A Ltd. merges with B Ltd., in a scheme of amalgamation, and

immediately before the amalgamation, B Ltd. held 20 per cent of the shares in A Ltd., the

above-mentioned condition 3 will be satisfied if shareholders holding not less than 3/4 (in

value) of the remaining 80 per cent of the shares in A Ltd., ie., 60 per cent thereof (3/4 C 80),

become shareholders of B Ltd., by virtue of the amalgamation. Where, however, the whole

share capital is held by another company, the merger of two companies will as an

amalgamation within section 2(1B), if the other two conditions are fulfilled.

For the purpose of condition (3), "shareholders" may be equity shareholders or preference

shareholders. Consequently, persons holding at least 75 per cent of the equity and preference

shares (in value) in the amalgamating company should become shareholders (by holding

equity or preference shares or both) in the amalgamated company.

11.2 EXCEPTIONS

Section 2(1B) specifically provides that in the following two cases there is no "amalgam-

ation" for the purpose of the Income-tax Act, though the element of merger exists:

(i) where the property of the company which merges is sold to the other company and the

merger is actually a result of sale

(ii) where the company which merges is wound up in liquidation and the liquidator

distributes its proceeds to the other company.

11.3 TAX INCENTIVES FOR AMALGAMATION

Some tax incentives have been provided for amalgamation of a company under income tax

Act to the:

1. amalgamating company;

2. shareholders of the amalgamating company; and

3. amalgamated company.

1. Tax incentives to Amalgamating Company (a) Exemption from Capital gains tax. There shall be no liability for capital gains tax on the

transfer of capital assets by the amalgamating company if the amalgamated company is

an Indian company. [Sec. 47(vi)]

(b) Tax Concession to foreign Company: There shall be no liability for capital gains tax on

the transfer of shares of an Indian company by a foreign company to another foreign

company in a scheme of amalgamation between the two foreign companies, if

(i) at least 25% of the shareholders of the amalgamating foreign company continue to

remain shareholders of the amalgamated foreign company;

(ii) such transfer does not attract tax on capital gains in the country in which the

amalgamating company is incorporated. [Sec. 47(via)]

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(c) Exemption from tax liability on transfer of licence to operate telecommunication

services etc: There shall be no tax liability on transfer of a licence to operate

telecommunication services (u/s 35ABB) or on transfer of a business of prospecting for or

extraction or production of petroleum and natural gas (u/s 42) by the amalgamating

company if the amalgamated company is an Indian company.

2. Tax incentives to Shareholders of Amalgamating Company (a) Period of holding of shares of the amalgamated company: Where shares in an Indian

Company, which become the property of the assessee in consideration of shares transferred in

case of amalgamation, it shall be included the period for which the shares in the

amalgamating company were held by the assessee. [Sec. 2(42A)(C)]

(b) Exemption from tax on exchange of shares. The shareholders of the amalgamating

company are not liable to capital gains tax, when they are allotted shares by the Indian

amalgamated company in lieu of shares held by them in the amalgamating company.

[Sec. 47(vii)]

3. Tax incentives to Amalgamated Company (a) Capital expenditure on scientific research: Where a company is amalgamated before

claiming full deduction in respect of capital expenditure on scientific research, the

amalgamated company (being an Indian company) is entitled to claim deduction of such

unabsorbed amount. [Sec. 35(5)]

(b) Expenditure incurred to obtain licence to operate telecommunication services. Where a company is amalgamated before claiming full deduction in respect of expenditure to

obtain licence to operate telecommunication services, the amalgamated company (being an

Indian company) is entitled to claim deduction in respect of remaining instalments of such

expenditure. [Sec. 35ABB]

(c) Preliminary expenses. Where an Indian company is amalgamated before claiming full

deduction in respect of certain preliminary expenses, the amalgamated company (being an

Indian company) is entitled to claim deduction in respect of remaining instalments of such

expenses. [Sec. 35D(5)]

(d) Expenses on amalgamation. Where an Indian company incurs expenditure wholly and

exclusively for the purposes of amalgamation, it shall be allowed a deduction @ 20% of such

expenditure for each of five successive previous years beginning with the previous year in

which amalgamation tookes place. (Sec. 35DD)

(e) Expenses incurred under voluntary retirement scheme. Where an Indian company is

amalgamated before claiming full deduction in respect of expenses incurred under voluntary

retirement scheme the amalgamated company (being an Indian company) is entitled to claim

deduction in respect of remaining instalments of such expenses.

[Sec. 35DDA(2)]

(f) Expenses on prospecting etc. of certain minerals. Where an Indian company is

amalgamated before claiming full deduction in respect of expenditure incurred on

prospecting for, or extraction or production of certain minerals, the amalgamated company

(being an Indian company) is entitled to claim deduction in respect of remaining instalments

and unabsorbed amount of such instalments. [Sec. 35E(7)]

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(g) Capital expenditure on family planning. Where a company is amalgamated before

claiming full deduction in respect of capital expenditure incurred for the purpose of

promoting family planning amongst its employees, the amalgamated company (being an

Indian company) is entitled to claim deduction in respect of remaining instalments and

unabsorbed amount of such instalments. [Sec. 36(l)(ix)]

(h) Expenses on prospecting etc. of petroleum and natural gas. Where a company is

amalgamated before claiming full deduction in respect of expenditure incurred on

prospecting for or extraction or production of petroleum and natural gas, the amalgamated

company (being an Indian company) is entitled to claim deduction in respect of such

expenditure. (Sec. 42)

(i) Bad debts. Where a part of debts taken over by the amalgamated company from the

amalgamating company becomes bad subsequently, such bad debts are allowed as a

deduction in computing the income of the amalgamated company.

(j) Actual cost of an asset. Where, in a scheme of amalgamation, any capital asset is

transferred by the amalgamating company to amalgamated company and the amalgamated

company is an Indian company the actual cost of the transferred capital asset to the

amalgamated company shall be taken to be the same as it would have been if the

amalgamating company had continued to hold the capital asset for the purpose of its own

business. [Sec. 43(1)]

(k) Actual Cost of depreciable assets. Where in any previous year, any block of assets is

transferred by an amalgamating company to the amalgamated company in a scheme of

amalgamation, and the amalgamated company is an Indian Company, then the actual cost of

the block of assets transferred to the amalgamated company shall be the book value of the

assets to the amalgamating company in the immediately preceding previous year as reduced

by the amount of depreciation actually allowed in relation to the said preceding previous

year, [Sec. 43(6)]

(l) Deduction in respect of profits from undertaking engaged in infrastructure

development or other than infrastructure development. Certain deductions are allowed

from gross total income under sections 80IA 80-IAB or 80-IB or 80-IC or 80-IE on fulfilment

of certain conditions. If the amalgamated company fulfils those conditions it is entitled to

these deductions resulting in reduction of its tax liability zione is transferred to another unit.

(m) Special Economic Zone. Where an unit of SEZ is transfered to another unit in a scheme

of amalgamation, the exemption shall be allowed to the other unit for the unexpired period.

[Sec. 10AA(5)]b

(n) Tonnage Scheme. Where there has been an amalgamation of a qualifying company with

another company, the provisions relating to the tonnage tax scheme shall apply to the

amalgamated company if it is a qualifying company.

However where the amalgamated company is not a tonnage tax company, it can exercise an

option for tonnage tax scheme within three months from the date of the approval of the

scheme of amalgamation. (Sec. 115VY)

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11.4 ACCUMULATED NON-SPECULATIVE BUSINESS LOSSES AND

UNABSORBED DEPRECIATION:

Where a company owning an industrial undertaking or ship or hotel amalgamates with

another company, or a banking company amalgamates with a specified bank, or one or more

public sector company or companies engaged in the business of operation of aircraft

amalgamates with one or more public sector company or companies engaged in similar

business, the accumulated loss and the unabsorbed depreciation of the amalgamating

company shall be deemed to be the loss or unabsorbed depreciation of the amalgamated

company of the previous year in which the amalgamation. Thus, the amalgamated company

will be entitled to carry-forward and set-off the loss and unabsorbed depreciation of the

amalgamating company as if these were the losses or unabsorbed depreciation of the

amalgamated company itself. It is important to note thatthe amalgamated company has the

right to carry-forward and set-off the balance of business loss for a period of eight assessment

years immediately succeeding the assessment year relevant to the previous year in which the

amalgamation was effected and unabsorbed depreciation till it is fully absorbed. (Sec. 72A)

Conditions:

1. For amalgamating company:

(a) It has been engaged in the business, in which the accumulated loss occurred or

depreciation remains unabsorbed, for three or more years.

(b) It has held continuously as on the date of amalgamation at least three-fourth of the book-

value of fixed assets held by it two years prior to the date of amalgamation.

2. For amalgamated company:

(a) The amalgamated company holds at least 75% of book value of fixed assets, of the

amalgamating company acquired as a result of amalgamation, for five years from the

effective date of amalgamation.

(b) The amalgamated company continues the business of the amalgamating company for at

least five years from the effective date of amalgamation.

(c) The Central Government may notify such other conditions as may be necessary.

3. Conditions prescribed by the Government:

(a) The amalgamated company, owning an industrial undertaking of the amalgamating

company by way of amalgamation, shall achieve the level of production of at least fifty

percent of the installed capacity of the said undertaking before the end of four years from the

date of amalgamation and continue to maintain the said minimum level of production till the

end of five pears from the effective date of amalgamation.

However, the, Central Government, on an application made by the amalgamated company,

may relax the condition of achieving the level of production or period of production or both

having regard to the genuine efforts made by the amalgamated company to attain the

prescribed level of production and the circumstances preventing such efforts from achieving

the same.

(b) The amalgamated company shall furnish to the Assessing Officer a certificate in Form

No. 62, duly verified by a Chartered Accountant, with reference to the books of accounts and

other documents showing particulars of production, along with the return of income for the

assessment year relevant to the previous year during which the prescribed level of production

is achieved and for subsequent assessment years relevant to the previous years falling within

five years from the date of amalgamation. For the purposes of this rule 'Installed capacity'

means the capacity of production existing on the date of amalgamation.

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Non-fulfillment of conditions. If the above specified conditions are not fulfilled that part of

carry forward loss and unabsorbed depreciation remaining to be utilised by the amalgamated

company shall lapse, and such loss or depreciation as has been set-off shall be treated as the

income of the year in which the failure to fulfill the conditions occurs.

11.5 TAX LIABILITY OF AMALGAMATED COMPANY

1. Where an allowance or deduction has been made in respect of loss, expenditure or liability

to the amalgamating company and subsequently during any previous year the amalgamated

company has obtained any amount (in cash or otherwise) in respect of aforesaid loss or

expenditure or some benefit in respect of trading liability by way of remission or cessation

thereof, it is taxed in the hands of the amalgamated company. [Sec.41(1)]

2. Amalgamation is treated as a case of succession to business. The tax liability of the

amalgamating company in respect of income for the previous year in which the succession

took place up to the date of succession and for the previous year preceding that year can be

recovered from the amalgamated company if it cannot be recovered from the amalgamating

company. [Sec. 170(3)] Hence, the tax liability for the aforesaid period of the amalgamating

company should carefully be ascertained.

11.6 AMALGAMATION OF BANKING COMPANY : (SEC. 72AA)

(Sec.72AA) Provides carry forward and set-off of accumulated loss and unabsorbed

depreciation allowance of a banking company against the profits of a banking institution

under a scheme of amalgamation sanctioned by the Central Government. [Section 72AA]

Conditions:

1. There is an amalgamation of a "banking company" with any other "banking institution".

Banking company for this purpose means a company which transacts the business of banking

in India. A manufacturing or trading company which accepts deposits of money from the

public merely for the purpose of financing its business shall not be deemed to transact the

business of banking. A banking institution for this purpose means any banking company and

includes State Bank of India or other scheduled banks.

2. The amalgamation is sanctioned and brought into force by the Central Government under

section 45(7) of the Banking Regulation Act, 1949.

Consequences if the above conditions are satisfied- If the above conditions are satisfied, the accumulated loss and unabsorbed depreciation of the

amalgamating banking company shall be deemed to be the loss or the allowance for

depreciation of the banking institution for the previous year in which the scheme of

amalgamation is brought into force.

For this purpose, "accumulated loss" means so much of the loss of the amalgamating banking

company under the head "Profits and gains of business or profession" which such

amalgamating banking company, would have been entitled to carry forward and set off under

the provision of section 72 if the amalgamation had not taken place. It does not, however,

include speculative business Losses. Unabsorbed depreciation" means so much of the

depreciation of the amalgamating banking company which remains to be allowed and which

would have been allowed to such banking company if amalgamation had not taken place.

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11.7 TAX PLANNING:

1. Where some assets or liabilities are not proposed be taken over by the amalgamated

company, the same may be disposed of or paid-off by the amalgamating company before the

scheme of amalgamation effected.

2.'Where shareholders holding more than 25% shares of the amalgamating company are not

willing to become shareholders of the amalgamated company, the shares of some of the

dissenting shareholders may be purchased by the other shareholders or amalgamated

company before amalgamation, so that the condition shareholders holding at least 75% of the

shares of the amalgamating company become shareholders of amalgamated company is

fulfilled.

3. Where the amalgamation does not satisfy the conditions laid down in section 72A, the

benefit of set-off unabsorbed depreciation and carry forward business losses are not available

to the amalgamated company. In such a case it is better that a profit-making company merges

with the loss incurring company rather than vice-versa. It would help in continuing to carry-

forward and set-off the unabsorbed depreciation and losses against the profits derived from

the business of the profit-making company.

4. The amalgamated company should not give composite consideration (shares and

debentures or shares and cash) to the shareholders of the amalgamating company in lieu of

shares held by them in the amalgamating company. They should be given only shares in lieu

of share held by them in amalgamating company. In case of composite consideration the tax

incentive u/s 47(vii) will not be available.

Example 1. From the following information determine whether there is an amalgamation for income tax

purposes :

(i) All the assets and liabilities of company 'A' are transferred to company 'B';

(ii) The position of shareholders is as under :

(a) 40% shares in value of company 'A' are held by company B';,

(b) 60% shares in value of company 'A' are held by other shareholders.

The other shareholders holding 40% shares in value of company 'A become the shareholders

of company 'B'.

Solution: Following conditions should be fulfilled order to constitute a valid amalgamation for income

tax purposes.

(i) All the assets and all the liabilities of amalgamating company must be transferred to the

amalgamated company; (ii) Shareholder holding at least 75% value of the amalgamating

company (excluding shares held by the amalgamated company or its nominee or its

subsidiary company) become the shareholders of the amalgamated company.

In the given case first condition is satisfied but the second condition is not satisfied, i.e.,

shareholders holding 75% shares of 60% shares i.e. 45% shares in company A do not become

the shareholders of company 'B'. Hence, there is no amalgamation.

Example 2.

Company A is proposed to be merged with company B in 2017. The following are the

particulars of the company A.

(i) unabsorbed depreciation Rs. 50 lakh

(ii) unabsorbed business loss Rs. 30 lakh

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(iii) unexpired period for deduction under section 80IB 3 years

Consider which of the benefits can be availed by company B if:

(a) the merger is not 'amalgamation'

(b) the merger is 'amalgamation' but does not satisfy conditions of Sec. 72A;

(c) the merger satisfies conditions of amalgamation as well as Sec. 72A.

Solution: (a) When merger of company A is not an amalgamation u/s 2(1B);

(i) Company B cannot carry-forward and set-off the unabsorbed depreciation and

unabsorbed business loss of company A;

(ii) Company B cannot avail deduction u/s 80IB for unexpired period of three years.

[Sec. 80IB(12)]

(b) When merger of company A is amalgamation u/s 2(1B) but does not satisfy conditions of

Sec. 72A, company B can claim deduction u/s,80IB for unexpired period of three years.

However, company B cannot carry forward and set-off the unabsorbed depreciation and

unabsorbed business loss of company A.

(c) When merger of company A is amalgamation u/s 2(1B) and it satisfies the conditions of

Sec. 72A as well, company B can :

(i) claim the deduction u/s '80IB for unexpired period of three years;

(ii) set of and carry-forward and set-off business loss against its business income within

8 years from the end of previous year in which amalgamation takes place;

(iii) set off or carry-forward and set-off unabsorbed depreciation against any income till

it is fully absorbed.

11.8 MEANING OF DEMERGER [SECTION 2(19AA)]:

"Demerger", in relation to companies, means the transfer, pursuant to a scheme or

arrangement under sections 391 " to 394 of the Companies Act, 1956 by a demerged

company of its one or more undertakings to any resulting company in such a manner that—

(i) all the property of the undertaking, being transferred by the demerged company,

immediately before the demerger, becomes the property of the resulting company by

virtue of the demerger;

(ii) all the liabilities relatable to the undertaking, being transferred by the demerged

company, immediately before the demerger, becomes the liabilities of the resulting

company by virtue of the demerger;

(iii) the property and the liabilities of the undertaking or undertakings being transferred by

the demerged company are transferred at values appearing in its books of account

immediately before the demerger.

(iv) the resulting company issues, in consideration of the demerger, its shares to the

shareholders of the demerged company on a proportionate basis;

(v) the shareholders holding not less than three-fourths in value of the shares in the

demerged company (other than shares already held therein immediately before the

demerger, or by a nominee for, the resulting company or, its subsidiary) become

shareholders of the resulting company or companies by virtue of the demerger,

otherwise than as a result of the acquisition of the property or assets of the demerged

company or any undertaking thereof by the resulting company;

(vi) the transfer of the undertaking is on a going concern basis;

(vii) the demerger is in accordance with the conditions, if any, notified under subsection

(5) of section 72 A by the Central Government in this behalf.

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11.9 IMPORTANT POINTS FOR CONSIDERATION FOR DEMERGER

(a) Meaning of undertaking being transferred [Explanation to Section 2(19AA)]: For the

purposes of this clause, "undertaking" shall include any part of an undertaking, or a unit or

division of an undertaking or a business activity taken as a whole, but does not include

individual assets or liabilities or any combination thereof not constituting a business activity.

(b) Meaning of liabilities referred to in sub-clause (ii) of section 2(19AA): For the

purposes of this clause, the liabilities referred to in sub-clause (ii), shall include—

(i) the liabilities which arise out of the activities or operations of the undertaking;

(ii) the specific loans or borrowings raised, incurred and utilised solely for the activities

or operations of the undertakings; and

(iii) in cases, other than those referred to in clause (a) or clause (b), above so much of the

amounts of general or multipurpose borrowings, if any, of the demerged company as

stand in the same proportion which the value of the assets transferred in a demerger

bears to the total value of the assets of such demerged company immediately before

the demerger.

(c) Value of the property of the undertaking being transferred: Section 2(19AA)

specifies that the value of the property and the liabilities of the undertaking being transferred

by the demerged company should be at book value appearing in books immediately before

demerger. This is also required that any change in the value of assets consequent to

revaluation shall be ignored.

(d) Benefit of demerger also available to certain authorities or Boards: For the purposes

of this clause, the splitting up or the reconstruction of any authority or a body constituted or

established under a Central, State or Provincial Act, or a local authority or a public sector

company, into separate authorities or bodies or local authorities or companies, as the case

may be, shall be deemed to be a demerger if such split up or reconstruction is as per the

conditions, if any, specified by the Central Government.

(e) Shares to be issued on a proporttoriate basis: Under the provision of section 2(19AA)

the resulting company should issue shares on a proportionate basis to the shareholders of

demerged company.

11.10 MEANING OF DEMERGED COMPANY [SECTION 2(19AAA)|:

"Demerged company" means the company whose undertaking is transferred, pursuant to a

demerger, to a resulting company.

11.11 MEANING OF RESULTING COMPANY [SECTION 2(41A)]:

"Resulting company" means one or more companies (including a wholly owned subsidiary

thereof) to which the undertaking of the demerged company is transferred in a scheme of

demerger and, the resulting company in consideration of such transfer of undertaking, issues

shares to the shareholders of the demerged company and includes any authority or body or

local authority or public sector company or a company established, constituted or formed as a

result of demerger.

Example 3. ‘A’. Ltd., transferred its fertilizer business to a new company 'B' Ltd., by way of

demerger with effect from appointed date of 1.4.2015 after satisfying the conditions of

demerger. Further information are also given.

(a) Book Value of the entire block of plant and machinery held by 'A' Ltd. as on 1.4.2015 is

Rs. 100 crores;

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(b) Out of the above (a), WDV of block of plant and machinery of fertilizer division is 70

crores;

(c) 'A' Ltd. has unabsorbed depreciation of Rs.50 lakhs as at 31.3.2015; On the basis of above

facts:

(i) You are required to explain the provisions of the income-tax as to the allow ability of

depreciation, in the hands of' 'A' Ltd. and 'B' Ltd. on at 31.3.2016. (ii) State how the

unabsorbed depreciation has to be dealt with for the assessment year 2016-17.

Solution:

(A) As the conditions laid down in section 2(19AA), have been satisfied the depreciation

claim will be subject to the following provisions:

1. Where there is a demerger of a company the resulting company will be entitled to

depreciation on the written down value of the block of assets transferred to it, which will be

the written down value of the transferred assets of the demerged company .immediately

before the demerger [Explanation 2B to section 43(6)].

2. Where there is a demerger of a company the written down value of the block of assets in

the hands of the demerged company shall be the written down value of the block of assets of

the demerged company for the immediately preceding previous year as reduced by the

written down value of the assets transferred to the resulting company pursuant to the

demerger. [Explanation 2A to section 43(6)].

3. Depreciation on plant and machinery in the hands of 'A' Ltd. and 'B' Ltd. will be computed

as under:

WD V of plant and machinery 'A" Ltd. 'B' Ltd.

Rs. (in crores) Rs. (Crores)

As at 1-4-2015 " 30.00 70.00

Less: Depreciation® 15% 4.50 10.50

WDV as at 31-3-2016 25.50 59.50

(ii) Set-off of unabsorbed depreciation:

In case of demerger section 72A(4) provides as under:

(a) the unabsorbed depreciation directly relatable to the resulting company is allowed to

be carried forward and set off in the hands of the resulting company.

(b) where such unabsorbed depreciation is not directly relatable to the undertaking

transferred to the resulting company, it has to be apportioned between the demerged

company and the resulting company in the same proportion in which the assets of the

undertakings have been retained by the demerged company and transferred to the

resulting company.

(c) the demerged company and the resulting company would be allowed to carry toward

and set-off their respective share of unabsorbed depreciation, as calculated above, for

indefinite period as per section 32(2). However, brought forward business loss can be

carried forward for the unexpired period of 8 years only.

11.12 TAX CONCESSION/INCENTIVES IN CASE OF DEMERGER:

If any demerger takes place within the meaning of section 2(19AA) of the Income-tax Act,

the following tax concession shall be available to various parties:

(A) Tax concessions to demerged company.

(B) Tax concessions to shareholders of demerged company.

(C) Tax concessions to resulting company.

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These concessions are on similar lines as are available in case of amalgamation discussed

earlier. However some concessions available in case of amalgamation are not available in

case of demerger of companis.

1. Tax concession to demerged company:

(i) Exemption from Capital gain Tax: According to section 47(vib) where there is a transfer

of any capital asset in a scheme of demerger by the demerged company to the resulting

company, such transfer will not be regarded as a transfer for the purpose of capital gain

provided the resulting company is an Indian company.

(ii) Tax concession to a foreign demerged company [Section 47(vic)]: Where a foreign

company holds any shares in an Indian company and transfers the same, in a scheme of

demerger, to another resulting foreign company, such transaction will not be regarded as

transfer for the purpose of capital gain under section 45 if the following conditions are

satisfied:

(a) at least seventy-five per cent of the shareholders of the demerged foreign company

continue to remain shareholders of the resulting foreign company; and

(b) such transfer does not attract tax on capital gains in that country, in which the

demerged foreign company was incorporated.

(iii) Reserves for shipping business: Where a ship acquired out of the reserve is transferred

in a scheme of demerger, even within the period of eight years of acquisition there will be no

deemed profits to the demerged company.

2. Tax concessions to the shareholders of the demerged company [Section 47] Any

transfer or issue of shares by the resulting company, in a scheme of demerger to the

shareholders of the demerged company shall not be regarded as a transfer if the transfer or

issue is made in consideration of demerger of the undertaking.

Existing shareholders: the existing shareholder of the demerged company will now hold:

shares in resulting company; and shares in demerged company, and in case the shareholders

transfers any of the above shares subsequent to the demerger, the cost of such shares shall be

calculated as given below:—

Cost of acquisition of shares in the resulting company [Section 49(2C). It shall be; he

amount which bears to the cost of acquisition of shares held by the assessee in the demerged

company the same proportion as me net book value of the assets transferred in a demerger

bears to the net worth of the demerged company immediately before such demerger.

In other words Cost of acquisition of the shares in the resulting company = cost of acquisition

of share held by the assessee in the demerged company × Net book value of the assets

transferred to resulting company Net worth of the demerged company immediately before

demerger.

Cost of acquisition of shares in the demerged company [Section 49(2 D)]: The cost of

acquisition of the original shares held by the shareholder in the demerged company shall be

deemed to have been reduced by the amount as so arrived at under section 49(2C) above.

For the above purpose net-worth means the aggregate of the paid up share capital and general

reserves as appearing in the books of account of the demerged company immediately before

the demerger.

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3. Period of holding of shares of the resulting company: [Section 2(42A)(g)]: In the case

of a capital asset, being a share or shares in an Indian company, which becomes the property

of the assessee in consideration of a demerger, there shall be included the period for which

the share or shares held in the demerged, company by the assessee.

11.13 TAX CONCESSION TO THE RESULTING COMPANY:

The resulting company shall be eligible for tax concessions only if the following two

conditions are satisfied:

(i) The demerger satisfies all the conditions laid down in section 2(19AA); and

(ii) The resulting company is an Indian company.

The following concessions are available to the resulting company in a scheme of demerger:

1. Expenditure for obtaining licence to operate telecommunication services [Section

35ABB(7)]: Where in a scheme of demerger, the demerged company sells or otherwise

transfers its licence to the resulting company (being an Indian company), the provisions of

section 35ABB which were applicable-to the demerged company shall become applicable in

the same manner to the resulting company, therefore:

(i) The expenditure on acquisition of licence, not yet written off, shall be allowed to the

resulting company in the same number of balance instalments.

(ii) Where such licence is sold by the resulting company, the treatment will be same as would

have been in the case of demerged company.

2. Treatment of preliminary expenses [Section 35D(5A)]: Where the undertaking of an

Indian company which is entitled to deduction of preliminary expenses in transferred before

the expiry of deduction period to another company in a scheme of demerger, the preliminary

expenses of such undertaking which are not yet written off shall be allowed as deduction to

the resulting company in the same manner as would have been allowed to the demerged

company. The demerged company will not be entitled to the deduction thereafter.

3. Treatment of expenditure on prospecting, etc. of certain minerals [Section 35E(7A)]\

Where the undertaking of an Indian company which is entitled to deduction on account of

prospecting of minerals, is transferred before the expiry of period of 10 years to another

company in a scheme of demerger, such expenditure of prospecting, etc. which is not yet

written off shall be allowed as deduction to the resulting company in the same manner as

would have been allowed to the demerged company. The demerged company will not be

entitled to the deduction thereafter.

4. Treatment of bad debts [Section 36(l)(vii)]: Where due to demerger the debts of the

demerged company have been taken over by the resulting company and subsequently any

such debt or part of debt becomes bad such bad debt will be allowed as a deduction to the

resulting company. This is based upon the decision of the Supreme Court in the case of K.

Koteswara Rao & Co. (1985) 155 1TR 152 (SC) which was decided in the case of

amalgamation of companies.

5. Amortisation of expenditure in case of demerger [Section 35DD}: (1) Where an

assessee, being an Indian company, incurs any expenditure, on or after 1-4-1999, wholly and

exclusively for the purposes of demerger of an undertaking, the assessee shall be allowed a

deduction of an amount equal to one-fifth of such expenditure for each of the five successive

previous years beginning with the previous year in which the demerger took place.

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6. Carry forward and set off of business losses and unabsorbed depreciation of the

emerged company [Section 72A(4) & (5)]: The accumulated loss and unabsorbed

depreciation in a demerger, should be allowed to be carried forward by the resulting company

if these are directly relatable to the undertaking proposed to be transferred. More it is not

possible to relate these to the undertaking, such loss and depreciation shall be apportioned

between the demerged company and the resulting company in proportion of the assets

coming to the share of each company as a result of demerger.

7. Deduction available under section 80-1AB or 80-IB or 80-IC or 80-IE: Where an

idertaking which is entitled to deduction under section 80-IAB/80-IB/80-IC/80-IE is

ansferred in the scheme of demerger before the expiry of the period of deduction under action

80-IAB or 80-IB or 80-IC or 80-IE, then—

(i) no deduction under section 80-IAB/80-IB/80-IC/80-IE shall be available to the demerged

company for the previous year in which amalgamation takes place; and

(ii) the provisions of section 80-IAB/80-IB/80-IC/80-IE shall apply to the resulting company

in such manner in which they would have applied to the demerged company.

11.14 OTHER IMPORTANT POINTS

1. "Actual cost" of assets to the resulting company: Where, in a merger, any capital asset

is transferred by the demerged company to the resulting company and the resulting company

is an Indian company, the actual cost of the is transferred capital asset to the resulting

company shall be taken to be the same as it would have been if the demerged company had

continued to hold the capital asset for the pose of its own business.

2. "Written down value" of assets to the resulting company. Where in previous year, any

asset forming part of a block of assets is transferred by a demerged company to the resulting

company, then, the written down value of the block of assets in the case of the resulting

company shall be the written down value of the transferred assets as appearing in the books

of account of the demerged company immediately before the demerger.

3. "Written down value" of assets to the demerged company: Where in any previous year,

any asset forming part of a block of assets is transferred by a demerged company to the

resulting company, then, the written down value of the block of assets of the demerged

company for the immediately preceding previous year shall be reduced by the written down

value of the assets transferred to the resulting company pursuant to the demerger.

4. Apportionment of depreciation between the demerged company and resulting

company [Proviso 5 to section 32] If in any previous year there is any demerger then for the

purpose of computing depreciation for that previous year it will be first assumed as if no

demerger had taken place and thereafter depreciation so computed shall be apportioned

between the demerged company and the resulting company in the ratio of the number of days

for which the assets were used by them.

5. Recovery of any allowance/deduction earlier allowed to the demerged company [Section 41(1)\: Where a demerged company was earlier allowed any allowance/deduction in

respect of loss, expenditure, or trading liability and subsequently the resulting company has

obtained/recovered whether in cash or in any other manner any amount in respect of which

any allowance/deduction was allowed to the demerged company, such amount shall be

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deemed to be the profits and gains of business or profession of the resulting company of the

previous year in which it is recovered.

11.15 DISTINCTION BETWEEN AMALGAMATION AND DEMERGER

(i) An amalgamation has a reference to a company as a whole whereas a demerger has a

reference to an undertaking of the company.

(ii) The amalgamating company will lose its identity in amalgamation whereas the demerged

company may continue to exist after demerger.

(iii) Demerger stipulates a transfer under sections 391 to 394, whereas there is no such

requirement in case of amalgamation.

(iv) Demerger requires transfer of undertaking on going-concern basis whereas there is no

such explicit requirement in case of amalgamation.

11.16 SLUMP SALE

'Slump Sale'. [Sec. 2(42C)] It means transfer of one or more undertakings as a result of the

sale for a lump-sum consideration without values being assigned to the individual assets and

liabilities in such slump sales.

Explanation-1. 'Undertaking' shall include any part of an undertaking or a unit or division of

an undertaking or a business activity taken as a whole, but does not include individual assets

or liabilities or any combination thereof not constituting a business activity.

Explanation-2. The determination of the value of an asset or liability for the sole purpose of

payment of stamp duty, registration fees or other similar taxes or fees shall not be regarded as

assignment of values to individual assets or liabilities.

1. Computation of Capital Gains in case of Slump Sale (Sec. 50B)

Any gains arising from the slump sale effected in the previous year shall be chargeable as

long-term capital gains of the previous year in which the transfer took place.

However, gains on slump sale of capital asset being one or more undertakings owned and

held by the assessee for not more than 36 months immediately preceding the date of its

transfer shall be deemed to be short-term capital gains.

2. Cost of acquisition and cost of improvement in case of slump sale The net worth' of an undertaking or division transferred by way of slump sale shall be

deemed to be the cost of acquisition and improvement for purposes of sections 48 and 49. It

is to be noted that indexed cost of acquisition of long-term capital asset shall not be

considered in slump sale.

The assessee shall furnish in the prescribed form along with the return of income, a report of

Chartered Accountant, indicating the computation of net worth of the undertaking or division

and certifying that the net worth has been correctly arrived at in accordance with the

provisions of this section.

Explanation-1. Net worth shall be the aggregate value of total assets of the undertaking or

division as reduced by its liabilities as appearing in books of account. However, any change

in the value of the assets on account of revaluation of assets shall be ignored for computing

the net worth.

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Explanation-2. For computing net worth, the aggregate value of total assets will be

computed as under:

(a) in the case of depreciable assets, the written down value of the block of assets as

determined u/s 43(6)(c)(i)(C)];

(b) in the case of capital assets in respect of which the whole of the expenditure has been

allowed or is allowable as a deduction u/s 35AD, nil; and

(c) in the case of other assets, the book value of such assets.

3. Determination of Written down value for slump sale [Sec. 43(6)(c)(i)(C)]

Actual cost of the asset shall be reduced by :

(a) the amount of depreciation actually allowed to the assessee upto assessment year 1987-88;

and

(b) the amount of depreciation that would have been allowable to the assessee for any

assessment year commencing on or after 1st day of April, 1988 as if the asset was the only

asset in the relevant block of assets.

11.17 CONVERSION OF SOLE PROPRIETARY CONCERN/ PARTNERSHIP FIRM

INTO COMPANY

1. Conversion of Partnership Firm into a Company

[Sec. 47(xiii)]

Where a firm is succeeded by a company in the business carried on by it as a result of which

the firm sells or otherwise transfers any tangible asset or intangible asset to the company it is

not regarded as a transfer and capital gains, if any, are not chargeable to tax. The exemption

will be allowed if the following conditions are satisfied :

(a) All the assets and liabilities of the firm relating to the business immediately before

succession become the assets and liabilities of the company.

(b) All the partners of the firm immediately before succession become shareholders of the

company in the same proportion in which their capital accounts stood in the books of the firm

on the date of succession.

(c) The partners of the firm do not receive any consideration or benefit, directly or indirectly,

in any form or manner, other than by way of allotment of shares in the company.

(d) The aggregate of the shareholding in the company of the partners is not less than 50% of

total voting power in the company for at least five years from the date of succession.

2. Conversion of Sole Proprietary Concern into a Company [Sec. 47(xiv)]

Where a sole proprietary concern is succeeded by a company in the business carried on by

him as a result of which the concern sells or otherwise transfers any tangible asset or

intangible asset to the company it is not regarded as a transfer and capital gains, if any, are

not chargeable to tax. The exemption will be available if the following conditions are

satisfied:

(a) All the assets and liabilities of the concern relating to the business immediately before

succession become the assets and liabilities of the company.

(b) The shareholding of the proprietor in the company is not less than 50% of the total voting

power in the company for at least five years from the date of succession.

(c) The proprietor does not receive any consideration or benefit, directly or indirectly, in any

form or manner, other than by way of allotment of shares in the company.

Important Notes:-

(1) The above exemption is available in case of business and not in case of profession.

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(2) The exemption is available in case of transfer of capital assets. Stock-in-trade is not a

capital asset, hence, gains on its transfer shall be business profits and liable to tax.

(3) Regarding cost of acquisition of the assets for the .company nothing has been given

specifically. Hence, the cost of acquisition of the assets shall be the price at which the assets

have been transferred to the company by the firm/sole proprietor.

(4) Where the aggregate of the shareholding of the partners or the shareholding of the sole

proprietor, as the case may be, in the company does not remain 50% of the total voting power

at any time during a period of five years from the date of succession, the capital gains

exempted at the time of succession shall be chargeable to tax in the hands of successor

company for the previous year in which such requirement is not complied with.

3. Carry forward and set-off of accumulated loss and unabsorbed depreciation in case

of succession. [Sec. 72A(6), (7)(a)(b)] Where a sole proprietary concern or firm is succeeded by a company which fulfils the

conditions laid down in sec. 47(xiii/47(xiv), the accumulated loss and unabsorbed

depreciation of predecessor firm/proprietary concern shall be deemed to be the loss and

unabsorbed depreciation of the successor company for the previous year in which business

reorganisation was effected. The provisions of the Act relating to set-off and carry-forward

loss and unabsorbed depreciation shall apply accordingly.

If any of the conditions laid down in sec. 47(xiii)/47(xiv) are not complied with, the set-off of

loss or allowance of depreciation made in any previous year in the hands of the successor

company, shall be deemed to be the income of the company chargeable to tax in the year in

which such conditions are not complied with.

'Accumulated loss' means so much of the loss of the predecessor firm/proprietary concern

under the head 'Profits and Gains of Business or Profession' (not being speculative loss)

which the predecessor would have been entitled to carry forward and set-off u/s 72 if the

reorganisation of business had not taken place.

'Unabsorbed depreciation' means so much of the depreciation allowance of the predecessor

firm/proprietary concern which remains to be allowed and which would have been allowed to

the predecessor under this Act, if the reorganisation of business had not taken place.

Example 4: The following is the Balance Sheet of a firm as on 31.3.2016 :

Liabilities Rs. Assets Rs.

Capital Accounts Land at cost (Acquired on

A 6,00,000 10.6.2009) 4,00,000

B 3,00,000 Building W.D.V. 6,00,000

C 3,00,000 Plant W.D.V. 3,00,000

Creditors 4,00,000 Debtors 2,00,000

Other liabilities 2,00,000 Stock 3,00,000

18,00.000 18,00.000

The partners share profit/loss in the ratio of 2:1:1,

The firm wants to convert into a company on 1.4.2016. Discuss what steps the firm and

company should take to avoid the tax on capital gains.

The firm revalued its assets as under for transfer to the company:

Rs.

Land 15,00,000

Building 9,00,000

Plant & Machinery 4,00,000

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Debtors 2,00,000

Stock 4,00,000

The liabilities will be transferred at the book value

Solution:

All the partners (A, B and C) should become shareholders of the company in the same

proportion in which their capital accounts stood in the books of the firm on the date of

succession. The capital accounts will be :

Other Stock

Assets Rs. Rs.

Transfer price 30,00,000 4,00,000

Less : Book-value 15,00,000 3,00,000

Profit on transfer 15.00.000 1.00.000'

Partners' Capital Accounts after succession:

A B C

Rs. Rs. Rs.

Capital 6,00,000 3,00,000 3,00,000

Add: Profit in 2:1:1 8,00,000 4,00,000 4,00,000

Capital on the date of succession 14.00.000 7.00.000 7.00.000

4. The company should allot shares worth Rs. 28,00,000 to A, B and C in the capital ratio. No

consideration should be paid by the company in any form or manner except allotment of

shares.

5. The voting power of partners should not be less than 50% of the total voting power of the

company.

6. The partners should hold in aggregate at least 50% of total voting power in the company

for at least five years from the date of successions.

11.18 CONVERSION OF A PRIVATE COMPANY OR AN UNLISTED PUBLIC

COMPANY INTO A LIMITED LIABILITY PARTNERSHIP (LLP)

Exemption of Capital Gains Where capital assets or intangible assets are transferred by a private company or an unlisted

public company (company) to a LLP or shareholder transfers shares held in such company, it

will not be regarded as transfer [u/s 47 (xiii b)] for the purposes of capital gains (u/s 45) the

following conditions should be satisfied :

(a) All assets and liabilities of the company become the assets and liabilities of the LLP.

(b) All the shareholders of the company become partners of the LLP in the same proportion

as their share-holding in the company.

(c) The total sales, turnover or gross receipts in business of the company do not exceed sixty

lakh rupees in any of the three preceding previous years.

(d) No consideration other than share in profit in the LLP arises to partners.

(e) The shareholders of the company continue to be entitled to receive at least 50% of the

profit of the LLP for a period of five years from the date of conversion.

(f) No amount is paid, directly or indirectly, to any partner out of accumulated profits of the

company for a period of three years from the date of conversion.

1 Taxation of Capital Gains. If the above mentioned conditions are not complied with, the

benefit of exemption of capital gains availed by the company shall be deemed to be the

capital gains of the LLP and chargeable to tax for the previous year in which the

conditions are not complied with.

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2 Carry forward and set-off of Losses and unabsorbed depreciation Where a private/unlisted company is succeeded by a LLP, which fulfils the above

mentioned conditions, the accumulated Losses and unabsorbed depreciation of predecessor

company shall be deemed to be the Losses and unabsorbed depreciation of the successor

LLP for the previous year in which business reorganisation was effected. The provisions of

the Income Tax Act relating to set-off and cany-forward Losses and unabsorbed

depreciation shall apply accordingly.

If any of the conditions mentioned above are not complied with, set-off of Losses or

unabsorbed depreciation made in any previous year in the hands of the successor LLP,

shall be deemed to be the income of the LLP chargeable to tax in the year in which such

conditions are not complied with.

3 Actual cost, (i) Actual cost of the assets to the LLP shall be the WDV of the block of

assets of the predecessor company on the date of conversion.

(ii) The cost of acquisition of the asset for the successor LLP shall be deemed to be the

cost for which the predecessor company acquired it.

Cost of acquisition of Capital asset being rights of a partner in the Limited Liability

Partnership [Sec 49(2AAA)] Where a private company or unlisted public company is converted into a limited liability

partnership, the cost of acquisition of above mentioned capital asset to the partner shall be

deemed to be the cost of acquisition of shares in the company immediately before its

conversion.

No Tax Credit to LLP. The tax credit, (u/s 115 JAA) available to a company regarding

minimum tax paid (u/s 115 JB) shall not be allowed to the successor LLP.

11.19 TRANSFER OF ASSETS BETWEEN HOLDING AND SUBSIDIARY

COMPANIES

Transfer of assets between holding and subsidiary companies:

1. Transfer of assets from holding company to subsidiary company [Sec. 47(iv)]:

Any transfer of capital asset by a company to its subsidiary company is not regarded

as transfer, if:

a. The parent company or its nominees hold the whole of the share capital of the

subsidiary company, and

b. The subsidiary company is an Indian Company.

2. Transfer of assets from subsidiary company to holding company [Sec. 47(v)]:

Any transfer of capital asset by a subsidiary company to Holding Company is not

regarded as transfer, if:

a. The whole of the share capital of the subsidiary company is held by the holding

company, and

b. The holding company is an Indian Company.

Notes –

1. Exception:

Any transfer of a capital asset covered in sections 47(iv) and 47(v) shall be treated as

transfer if the transfer is made after February 29, 1988, as stock in trade.

2. Withdrawal of exemption [Sec. 47A]:

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If at any time before the expiry of 8 years from the date of transfer of a capital asset

referred to in sections 47(iv) and 47(v):

a. Such capital asset is converted by the transferee company into, or is treated by it as

stock in trade of its business, or

b. The parent company (or its nominee) or the holding company ceases to hold the

whole of the share capital of the subsidiary company,

then, the amount of capital gain exempted from tax shall be deemed to be the income of

transferor company chargeable under the head ‘capital gains’ of the year in which such

transfer took place.

3. Amendment of assessment order [Sec. 155(7B)]:

Where the profits or gains arising from the transfer of a capital asset are not charged to

tax under section 45 [by virtue of section 47(iv) or (v)] but such profits or gains are

deemed under section 47A to be income chargeable under the head ‘Capital Gains’ the

Assessing Officer may, make an order of amendment at any time before the expiry of 4

years from the end of the previous year in which the relevant capital asset was

converted in to, or treated as, stock in trade or, as the case may be, the parent company

ceased to hold the entire share capital of subsidiary company.

4. Cost of acquisition of an asset where capital gains are exempt:

Where a capital asset has been transferred between holding and subsidiary companies,

the cost of acquisition of the asset shall be the aggregate of the following:

a. the cost for which the previous owner of the property acquired it, and

b. the cost of any improvement of the asset incurred by the previous owner or the

assessee, as the case may be.

5. Cost of acquisition of an asset where capital gains are chargeable under section 47A:

The cost of acquisition of such asset to the transferee company shall be the cost for

which such asset was acquired by it.

6. Period for which the capital asset is held by the assessee:

Where the capital asset becomes the property of the assessee there shall be included the

period for which the asset was held by the previous owner.

Other points –

1. The provisions of indexation and adoption of market value as on 01-04-1981 were

made effective only w.e.f. assessment year 1993-94.

2. From the assessment year 1985-86 onwards, the conversion of capital asset into stock-

in-trade of a business carried on by the taxpayer (it may be a new business or an

existing business) is treated as a transfer within the meaning of section 2(47).

3. However, section 45(2) provides that although such a conversion of capital asset into

stock-in-trade will be treated as a transfer of the previous year in which the asset is so

converted, but the notional capital gain will not arise in the previous year in which the

asset is converted; it will arise in the previous year in which such converted asset is

sold or otherwise transferred.

4. Indexation of cost of acquisition and improvement, if required, will be done till the

previous year in which such conversion took place. Further, the fair market value of

the capital asset, as on the date of such conversion, shall be deemed to be full value of

the consideration of the asset.

5. The sale price minus market value as on the date of conversion shall be treated as

business income and taxed under the head “Profits and gains of business or

profession”.

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Example 5:

S Ltd. is a wholly-owned subsidiary of A Ltd. Both are Indian companies and maintain books

of account on the basis of financial year. On April 10, 1984 (relevant to the assessment year

1985-86), S Ltd. transfers a capital asset (i.e., shares) to A Ltd. (acquired on April 6, 1981 for

Rs. 50,000) for Rs. 1,50,000. A Ltd. sells the asset on May 10, 2015 for Rs. 6,40,000.

Determine the assessable profits of A Ltd. and S Ltd. under the following situations:

a. Before the sale of asset, A Ltd. has not converted it into stock-in-trade and it does not

cease to hold entire share capital of S Ltd.

b. A Ltd. has converted the capital asset into stock-in-trade before its sale on May 10,

2015 (date of conversion: June 10, 1987, fair market value: Rs. 3,10,000).

c. Though A Ltd. does not convert capital asset into stock-in-trade, it ceases to hold

entire share capital of S Ltd. on June 10, 1988 when 5% shareholding in S Ltd. is

transferred by way of sale to the public.

The CII for 1984-85 is 125, for 1987-88 is 150, for 1988-89 is 161 and for 2015-16 is 1081.

Solution:

Situation 1:

S Ltd.:

Transfer between A Ltd. and S Ltd. will not be treated as transfer under section 47(v).

Consequently, nothing will be taxable in the hands of S Ltd. in the assessment year 1985-86.

A Ltd.:

A Ltd. will, however, be taxable in respect of capital gain for the assessment year 2016-17

computed as under:

Amount (Rs.)

Sale consideration 6,40,000

Less: Indexed cost of acquisition

(50,000/100*1081) 5,40,500

LTCG 99,500

Cost inflation index of 1981-82 i.e., 100 has been taken because it is the year in which the

asset was acquired by the previous owner.

Situation 2:

S Ltd.:

Since A Ltd. has converted the capital asset into stock-in-trade within 8 years from April 10,

1984, exemption granted by section 47(v) will not be available and, consequently, Rs.

1,00,000* (i.e., Rs. 1,50,000 – Rs. 50,000) will be treated as long-term capital gain (by virtue

of section 47A) of S Ltd. for the assessment year 1985-86 86 and taxed according to the

provisions applicable at that time..

* It is to be noted the provisions of indexation of cost and adoption of market value as on 1-4-

1981 were made effective only w.e.f. the assessment year 1993-94.

A Ltd.:

Capital gain for the assessment year 2016-17 will be determined as under:

Amount

(Rs.)

Full value of consideration received [Fair market value on the date

of conversion of capital asset into stock-in-trade under section 45(2)] 3,10,000

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Less: Indexed cost of acquisition (1,50,000/125*150) 1,80,000

Long-term capital gain (notional) 1,30,000

1987-88 (CII: 150) is the year in which capital asset ceased to exist.

Besides, Rs. 3,30,000 (i.e., Rs. 6,40,000 – Rs. 3,10,000) will be chargeable to tax under

section 28(i) as business profits for the assessment year 2016-17.

Situation 3:

S Ltd.:

Since A Ltd. has transferred the shareholding in S Ltd. before the expiry of 8 years from

April 10, 1984, the exemption granted by section 47(v) will not be available and,

consequently, Rs. 1,00,000* (i.e., Rs. 1,50,000 – Rs. 50,000) will be treated as long-term

capital gain (by virtue of section 47A) of S Ltd. for the assessment year 1985-86 and taxed

according to the provisions applicable at that time.

* It is to be noted the provisions of indexation of cost and adoption of market value as on 1-4-

1981 were made effective only w.e.f. the assessment year 1993-94.

A Ltd.:

Capital gain for the assessment year 2016-17 will be determined as under:

Amount (Rs.)

Sale consideration 6,40,000

Less: Indexed cost of acquisition (1,50,000/125*1081) 12,97,200

Long-term capital gain (6,57,200)

Other than the income of capital gains in assessment year 2016-17, there will be no other

income in the year in which it ceases to be wholly owned subsidiary company.

Example 6:

S Ltd. is a wholly owned subsidiary of H Ltd. Both companies are Indian companies. H Ltd.

purchased a piece of land in May 2006 at Rs. 3,00,000. In June 2009, H Ltd. transferred the

land to S Ltd. at Rs. 5,62,000. In August 2015, S Ltd. sold the land at Rs. 12,00,000.

Compute capital gain/business profit in the following cases:

a. Before the sale of land by S Ltd., neither H Ltd. ceases to hold 100% shares of S Ltd.

nor does S Ltd. convert land into stock-in-trade.

b. In July 2015, S Ltd. converted the land into stock-in-trade, when the fair market value

of land was Rs. 7,50,000.

c. In May 2015, H Ltd. sold 10% shares of S Ltd. to the public.

The CII in 2006-07, 2009-10, 2012-13 and 2015-16 were 519, 632, 852 and 1081

respectively.

Solution:

Situation 1:

H Ltd.:

Transfer between H Ltd. and S Ltd. will not be treated as transfer under section 47(iv).

Consequently, nothing would be taxable in the hands of H Ltd.

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S Ltd.:

S Ltd. will, however, be taxable in respect of capital gain for the assessment year 2016-17

computed as under:

Amount (Rs.)

Sale consideration 12,00,000

Less: Indexed cost of acquisition

(3,00,000/519*1081) 6,24,855

LTCG 5,75,144

Cost inflation index of 2006-07 i.e., 519 has been taken because it is the year in which the

asset was acquired by the previous owner.

Situation 2:

H Ltd.:

Since the land has been converted into stock-in-trade in July 2015, which falls within 8 years

of the original transfer date (i.e., June 2009), there will be capital gains to H Ltd. and its

assessment of assessment year 2010-11 (i.e., previous year 2009-10) will be rectified under

section 155 as under:

Amount (Rs.)

Consideration price 5,62,000

Less: Indexed cost of acquisition (3,00,000/519*632) 3,65,318

LTCG 1,96,682

The long-term capital gain of Rs. 1,96,682 will be included in the total income for the

assessment year 2010-11 and taxed according to the provisions applicable at that time.

S Ltd.:

Although the land was converted into stock-in-trade in July 2015, which will be regarded as

transfer, but capital gain on such a transfer will be taxable in the previous year in which such

converted asset is sold. Indexation of cost, will, however, be done till the year of conversion.

The cost of acquisition in this case will be the value at which the asset was transferred to it.

Capital gain for the assessment year 2016-17 will be determined as under:

Amount

(Rs.)

Full value of consideration received [Fair market value on the date

of conversion of capital asset into stock-in-trade under section 45(2)] 7,50,000

Less: Indexed cost of acquisition (5,62,000/632*1081) 9,61,269

Long-term capital gain (notional) (2,11,269)

Besides, business income for the assessment year 2016-17:

Amount (Rs.)

Sale price 12,00,000

Less: Market value on the sale of conversion 7,50,000

Business income 4,50,000

Situation 3:

H Ltd.:

Since holding company ceases to hold 100% share capital of subsidiary company before the

expiry of 8 years from the date of transfer of the asset, there will be capital gains to H Ltd.

195

and its assessment of assessment year 2010-11 (i.e., previous year 2009-10) will be rectified

under section 155 as under:

Amount (Rs.)

Consideration price 5,62,000

Less: Indexed cost of acquisition (3,00,000/519*632) 3,65,318

LTCG 1,96,682

The long-term capital gain of Rs. 1,96,682 will be included in the total income for the

assessment year 2010-11 and taxed according to the provisions applicable at that time.

S Ltd.:

There will be no income in the year in which it ceases to be wholly owned subsidiary

company. Since the asset has been sold in August 2015, there will be capital gain to S Ltd. on

such a transfer for the assessment year 2016-17.

Capital gain for the assessment year 2016-17 will be determined as under:

Amount (Rs.)

Sale consideration 12,00,000

Less: Indexed cost of acquisition (5,62,000/632*1081) 9,61,269

Long-term capital gain 2,38,731

Example 7:

S Ltd. is a wholly owned subsidiary of H Ltd. Both companies are Indian companies. H Ltd.

purchased a piece of land in May 2001 for Rs. 6,00,000. In June 2007, H Ltd. transferred the

land to S Ltd. at Rs. 12,00,000. In August 2015, S Ltd. sold the land at Rs. 20,00,000.

Compute capital gain/business profit in the following cases:

a. Before the sale of land by S Ltd., neither H Ltd. ceases to hold 100% shares of S Ltd.

nor does S Ltd. convert land into stock-in-trade.

b. In July 2014, S Ltd. converted the land into stock-in-trade, when the fair market value

of land was Rs. 16,00,000.

c. In May 2015, H Ltd. sold 10% shares of S Ltd. to the public.

The CII in 2001-02, 2007-08, 2014-15 and 2015-16 were 426, 551, 1024 and 1081

respectively.

Solution:

Situation 1:

H Ltd.:

Transfer between H Ltd. and S Ltd. will not be treated as transfer under section 47(iv).

Consequently, nothing would be taxable in the hands of H Ltd.

S Ltd.:

S Ltd. will, however, be taxable in respect of capital gain for the assessment year 2016-17

computed as under:

Amount (Rs.)

Sale consideration 20,00,000

Less: Indexed cost of acquisition

(6,00,000/426*1081) 15,22,535

LTCG 4,77,465

Cost inflation index of 2001-02 i.e., 426 has been taken because it is the year in which the

asset was acquired by the previous owner.

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Situation 2:

H Ltd.:

Since the land has been converted into stock-in-trade in July 2014, which falls within 8 years

of the original transfer date (i.e., June 2007), there will be capital gains to H Ltd. and its

assessment of assessment year 2008-09 (i.e., previous year 2007-08) will be rectified under

section 155 as under:

Amount (Rs.)

Consideration price 12,00,000

Less: Indexed cost of acquisition (6,00,000/426*551) 7,76,056

LTCG 4,23,944

The long-term capital gain of Rs. 4,23,944 will be included in the total income for the

assessment year 2008-09 and taxed according to the provisions applicable at that time.

S Ltd.:

Although the land was converted into stock-in-trade in July 2014, which will be regarded as

transfer, but capital gain on such a transfer will be taxable in the previous year in which such

converted asset is sold. Indexation of cost, will, however, be done till the year of conversion.

The cost of acquisition in this case will be the value at which the asset was transferred to it.

Capital gain for the assessment year 2016-17 will be determined as under:

Amount

(Rs.)

Full value of consideration received [Fair market value on the date

of conversion of capital asset into stock-in-trade under section 45(2)] 16,00,000

Less: Indexed cost of acquisition (12,00,000/551*1024) 22,30,127

Long-term capital gain (notional) (6,30,127)

2014-15 (CII: 1024) is the year in which capital asset ceased to exist.

Besides, business income for the assessment year 2016-17:

Amount (Rs.)

Sale price 20,00,000

Less: Market value on the sale of conversion 16,00,000

Business income 4,00,000

Situation 3:

H Ltd.:

Since holding company ceases to hold 100% share capital of subsidiary company before the

expiry of 8 years from the date of transfer of the asset, there will be capital gains to H Ltd.

and its assessment of assessment year 2008-09 (i.e., previous year 2007-08) will be rectified

under section 155 as under:

Amount (Rs.)

Consideration price 12,00,000

Less: Indexed cost of acquisition (6,00,000/426*551) 7,76,056

LTCG 4,23,944

The long-term capital gain of Rs. 4,23,944 will be included in the total income for the

assessment year 2008-09 and taxed according to the provisions applicable at that time.

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S Ltd.:

There will be no income in the year in which it ceases to be wholly owned subsidiary

company. Since the asset has been sold in August 2015, there will be capital gain to S Ltd. on

such a transfer for the assessment year 2016-17.

Capital gain for the assessment year 2016-17 will be determined as under:

Amount (Rs.)

Sale consideration 20,00,000

Less: Indexed cost of acquisition (12,00,000/551*1081) 23,54,265

Long-term capital gain (3,54,265)

Questions

1. What do you mean by amalgamation? What are various modes of amalgamation.

2. Discuss the provisions u/s 72AA regarding carry forward and set off of accumulated

loss and unabsorbed depreciation of a banking company.

3. What are tax incentive to an amalgamated company.

4. Define demerger as per Income Tax Act and discuss process of demerger.

5. What are the conditions for exemption of capital gain in the case of conversion of sole

proprietorship into private limited company or LLP.

6. Write note on slump sale and determination of capital gains in the case of slump sale.

7. Discuss the tax implications to a resulting company in the scheme of demerger.

8. Explain in the conditions which should be satisfied to claim exemption of capital

gains in the case of conversion of a firm into a private limited company.

9. Define the status of transfer of assets between holding and subsidiary company. What

are the cases when profits and gains arising from such transfer will be charged to

capital gains tax?

10. Discuss the tax implications in case of transfer of assets between holding and

subsidiary companies. When are profits and gains from such transactions chargeable

to capital gains tax?