MF0003-Unit-05-Profits and Gains of Business or Profession Unit 5 Profits and Gains of Business or Profession

Structure:

5.1 Introduction

Objectives

5.2 General principles

5.3 Adjustments to P&L account

5.4 Alternative method

5.5 Specific deductions

Self assessment Questions I

5.6 Other deductions

5.7 General deductions

5.8 Expenses expressly disallowed

5.9 Expenses not deductible

Self assessment questions II

5.10 Deductions allowable only on actual payment

5.11 Depreciation

· Block of assets

· Methods of depreciation

· Additional depreciation

· Rates of Depreciation

· Unabsorbed depreciation

Self assessment Questions III

5.12 Summary

5.13 Terminal Questions

5.14 Answers to SAQ and TQ

5.1 Introduction

Meaning of Business Sec. 2(13)

Business means and includes any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture. It is not necessary that there should be a series of transactions in a business and that it should be carried on permanently. Even profit of an isolated transaction is also taxable under this head, provided that it is a venture in the nature of business or trade. In this connection, it is important that the intention of purchase or manufacture should be to sell at a profit

Meaning of Profession or vocation. Sec.2 (36)

Profession means the activities for earning livelihood which require intellectual skill or manual skill, e.g., the work of a lawyer, doctor, auditor, engineer and so on, are in the nature of profession. Profession includes vocation. Vocation means activates which are performed in order to earn livelihood, e.g., brokerage, insurance agency, music, dancing etc. As the rules for the assessment of business, profession or vocation are the same, there is no importance of making any distinction between them for income tax purposes.

Learning Objectives:

After studying this unit you will be able to:

· Understand the meaning of business, profession.

· Know various deductions admissible under the Act.

· The rates and method of depreciation followed for tax purposes

· Compute the business or professional income for tax purpose.

5.2 General Principles:

General Principles Followed in the Assessment of Profits and Gains of Business or Profession

1. Business or Profession carried on by the assessee. Tax is chargeable from the person who carries on the business or profession. The essential requirement is that he should be entitled to carry on the business.

2. Tax is chargeable on the aggregate income from all businesses or professions carried on by an assessee. The profits and gains of different business or professions carried on by an assessee are not taxable separately; but tax is chargeable under one head on the aggregate income from all businesses or professions carried on by the assessee. The essence of this rule is that, if in a year he earns profit in one business and sustains loss in the other, he can set-off his loss of one business against the profits of the other, and the balance of amount shall be income of the assessee under this head.

3. Profits and Losses of speculation business are kept separate. if there is a loss in a speculation business it can be set-off only against profits of speculation business and not against profits of any other business.

4. No tax is payable on anticipated or notional profits.

5. Tax is payable on the income of every business or profession whether legal or illegal. Expenses concerned with illegal business are to be allowed as deduction out of the income earned from illegal business. However, penalties levied for violation of law and expenses incurred in defense of criminal proceedings are not allowed.

6. General commercial principles to be kept in view while determining the real profits of a business.

7. Sums previously allowed as deduction are taxable, if recovered during the previous year e.g. bad debts recovered, disallowed earlier.

8. Only those expenses and losses are allowed as deductions which were incurred or sustained during the relevant previous year.

9. These losses and expenses should be incidental to the operation of the business. Only the expenses incurred in connection with the business of the assessee are allowed as deductions.

10. If a business has been discontinued before the commencement of the previous year, its expenses cannot be allowed as deduction against the income of any other running business of the assessee.

11.There are some essential expenses though neither expressly allowed nor disallowed, but are deductible while computing the profits of business or profession on the basis of general commercial principles provided these are not expenses or losses of a capital nature or personal nature.

12. Any expenditure incurred in consideration of commercial expediency is allowed as deduction.

13. Deduction can be made from the income of that business only for which the expenses were incurred. The expenses of one business cannot be charged against the income of any other business.

14. The value of any benefit or perquisite, whether convertible into money or not, arising from business or exercise of a profession is taxed under this head.

5.3 Adjustment to Profit and Loss Account prepared by the assessee

The Profit and Loss account prepared by the assessee may not be correct from the income tax point of view, because:

· several such expenses are charged to it may be wholly or partly inadmissible under the Income Tax Act,

· some admissible expenses might be omitted from it,

· some taxable incomes may not be credited to it, and

· Some such incomes might be credited which are either neither taxable under the head ‘Profits and Gains of Business or Profession’ or nor taxable at all. Hence, this profit and loss account has to be adjusted from the income tax point of view, so that the profit taxable under the head “Business or Profession’ is determined correctly.

The following are the rules for adjustment of the Profit and Loss Account:

i. Those expenses or losses which are charged to Profit and Loss Account but are not allowed under the Income Tax Act, should be added to the profit, as shown by the Profit and loss Account prepared by the assessee. If any expense is partly disallowed, only the disallowed part of it shall be added to the profit.

ii. If any admissible expenses are omitted from Profit and Loss Account, they should be deducted from the above profit.

iii. If some taxable incomes are omitted from the Profit and Loss Account they should be added to the above profit.

iv. If some such incomes have been credited to the Profit and Loss Account which are either not taxable under the head ‘Business or Profession’ or are not taxable at all, they should be deducted from the above profits.

5.4 Alternative method

Second Method of Computing the taxable profits or losses of business or profession. In this method a fresh profit and loss account or income and expenditure account is prepared to determine the profit or loss. The format of this method may be as under:

(1) All taxable incomes under this head which relate to the previous year are aggregated.

(2) All admissible expenses under this head which relate to the previous year concerned

(3) Deduct admissible business losses

(4) The balance will be taxable profits or losses of business or profession.

Second method is generally used in case of professions

5.5 Specific Deductions

Expenses in respect of business premises (Sec. 30)

The following deduction is allowed in respect of rent, rates, taxes repairs and insurance for premises used for the purpose of the business or profession.

(a) Where the premises are occupied by the assessee:

(i) as a tenant, rent paid for such premises: and further if he has undertaken to bear the cost of repairs to the premises, the amount paid on account of such repairs;

(ii) As a landlord, the amount paid by him on account of current repairs to the premises. Current repairs are those repairs which are done to maintain the building.

Any sum paid on account of land revenue, local taxes or municipal taxes.

(b) The amount of any premium paid in respect of insurance against risk of damage or destruction of the premises.

Repairs and insurance of machinery, plant and furniture (Sec. 31).

In respect of repairs and insurance of machinery, plant and furniture used for the purposes of the business or profession the following deductions are allowable:

The amount of any premium paid in respect of insurance against risk of damage of destruction of these assets.

Depreciation allowance: Sec. 32 Discussed separately

Expenditure on Scientific Research (Sec. 35)

The following deductions shall be allowed in respect of expenditure on scientific research.

Revenue expenditure incurred by the assessee himself [Sec. 35(1)(i)].

Where the assessee himself carries on scientific research in relation to his own business any revenue expenditure made by the assessee on scientific research during the previous year shall be allowed in full.

Further, any such expenditure incurred during the three years immediately preceding the commencement of the business on:

(1) Payment of salary to an employee engaged in such scientific research or

(2) On the purchase of materials used in such scientific research;

The aggregate of the expenditure so incurred shall be deemed to have been incurred in the previous year in which the business commenced and shall be deductible in that previous year.

Contribution made to outsiders

Sums paid for Scientific Research to an approved Scientific Research Association or a University, College or other Institution [Sec.35 (1)(ii)]. If the assessee himself does not carry on the scientific research; but contributes any sum to an approved scientific research association or to an approved university, college or other institution to be used for scientific research it is allowed as a deduction 125% of the amount so paid, whether it is related or unrelated to the business of the assessee.

Capital Expenditure on Scientific Research incurred by the assessee himself: Any expenditure of a capital nature on scientific research related to the business carried on by the assessee is allowed in full for the relevant previous year.

No deduction shall be admissible in respect of any expenditure on the acquisition of any land after 29th February, 1984.

If any capital expenditure has been incurred during the three years immediately preceding the commencement of the business the aggregate of the expenditure so incurred shall be deemed to have been incurred in the previous year in which the business commenced.

Depreciation on Capital Expenditure: If any deduction is allowed in respect of any capital expenditure on scientific research, no deduction for depreciation will be allowed in respect of that asset.

Expenditure on in-house research: only to company assesses engaged in biotech, pharmaceuticals, computer, telecommunication, chemicals etc.

A weighted deduction of an amount equal to one and one- half times of expenditure incurred by a company on in-house research and development facility shall be allowed.

It is, however, not admissible if expenditure is incurred on land or building;

Admissibility of expenditure on eligible project or scheme: Sec. 35AC a deduction is allowed for an eligible project for promoting social and economic welfare or upliftment of the public.

Payment to associations & institutions for carrying out Rural Development Programmes is fully allowed: Sec. 35CCA

Amortization of preliminary expenses: Sec. 35D Expenditure in connection with preparation of feasibility report, project report, market survey, expenses on issue of shares and debentures etc.: One fifth of the qualifying amount is allowed in each of five successive years beginning with the year in which the business commences or the extension of the undertaking is completed.

The qualifying amount cannot exceed:

5% of the cost of the project or 5% of capital employed whichever is less in case of corporate assesses, 5% of cost of project in case of non-corporate assesses.

Expenditure on voluntary retirement (Sec. 35 DDA).

Where an assessee pays any sum to an employee in any previous year in connection with his voluntary retirement, he shall be allowed a deduction of 20% of such expenditure for each of five successive previous years beginning with the year in which the expenditure was incurred.

Self assessment Questions I

Answer the following statements whether true or false:

1) Sums paid for social and scientific research to an approved university etc., is allowed to the extent of 125% 0f sums paid.

2) Capital expenditure on scientific research incurred by the assessee is not allowed to be deducted.

3) Sums previously allowed as deduction are taxable if recovered during the previous year.

4) Income of illegal business or profession is not taxable

5.6 Other Deductions: Under section 36:

The following other deductions are permissible while computing profits of business or profession.

· Insurance Premium, The amount of any premium paid in respect of insurance against risk of damage or destruction of stocks or stores used for the purpose of business or profession, is allowed as deduction.

· Insurance premium for Cattle paid by a federal milk co-operative society. The amount of any premium paid by a federal milk co-operative society on the life of the cattle owned by a member of a primary milk co-operative society affiliated to the federal milk co-operative society is allowed as deduction.

· Premia for insurance on health of employees

· Bonus or Commission to employees for services rendered .

· Interest on borrowed capital.

· Contribution to Provident Fund, Approved Gratuity Fund, Employee’s Contribution to Provident Fund

· Bad debts.

· Expenditure on family planning. Any expenditure incurred by a company for the purpose of promoting family planning amongst its employees is allowed as a deduction. If such expenditure is of a capital nature it shall be allowed as a deduction in five equal annual installments commencing from the previous year in which the expenditure is incurred.

· Banking cash transaction tax( applicable from assessment year 2006-07)

5.7 General deduction [Sec. 37(1)

It is a residuary section:

Under section 37(1), the following conditions should be fulfilled, in order that a particular item of expenditure may be deductible under this head:

· The expenditure should not be of the nature described in section 30 to 36.

· It should be in respect of a business or profession carried on by the assessee and the profits and gains of which are to be computed and assessed.

· It should not be in the nature of personal expenses of the assessee

· It should have been paid out or expended wholly and exclusively for the purpose of such business or profession.

· It should not be in the nature of capital expenditure

· It should relate to the previous year concerned

The following are the few examples of admissible general deduction under sec 37:

1) Expenses incurred in the purchase, manufacture and sale of goods.

2) General expenses incurred in the day to day running to the business.

3) Expenses incurred in defending a case for damages for breach of contract.

4) Amount of sales-tax paid and expenses incurred in connection with sales-tax proceedings including appeals.

5) Compensation paid to an undesirable employee for the retrenchment of his services or to a director to get rid of his services.

6) Contribution made to provident fund maintained for the benefit of employees under an Act and with the previous approval of a state Government may not be allowable u/s 36(1)(iv) but allowable u/s 37(1).

7) Commission, etc. paid for securing orders for the business.

Compensation paid to employees in connection with injury sustained by them or accident met by them while on duty.

9) Royalties paid in connection with mines.

10) Insurance premium paid under a policy insuring its employees against injury or against liability for compensation in respect of accident to its workmen.

11) Reasonable expenses incurred on the occasion of Dussehra, Diwali, commencement of the business, etc.

12) Compulsory subscription or a subscription given to an association in the interest of the business.

13) Legal expenses incurred in connection with the business or profession.

14) Legal expenses incurred by a director of a company in defending a suit brought against him to challenge the validity of his election as a director; as it is incurred to save his income from the source.

15) Interest on unpaid purchase price of any business assets purchased by an assessee and put to use will be allowed.

16) Expenditure incurred to oppose nationalization or to prevent extinction of business.

17) Under executive instructions, cost of installing new telephone.

18) Normal advertisment expenditure incurred to maintain the sales.

19) Penalty paid by the assessee for saving from confiscation the good which he purchased from a third party without knowing that they had been illegally imported.

20) Amount paid by a director of a company in liquidation for compounding misfeasance proceeding started against him by the liquidator.

21) Welfare expenditure incurred by the assessee.

22) Payment of excise duty.

23) Guarantee fee paid to he Government for loan obtained for purchase of machinery.

24) Expenditure incurred in connection with alterations made in the Memorandum or Articles of Association of a company if therse alterations are warranted by the changes made in Companies Act.

25) If an asseessee stand ss surety for the debt of another and it is usual in this trade to guarantee debts, any payment made as a result of such guarantee may be allowed as a business losss.

26) Professional tax levied by local authorities the payment of which is a necessary condition for the carrying on the business within the area of a local authority.

27) Rebate granted by co-operative stores to their members on the value of the purchases made by them.

28) The interest payable on arrear of cess is in the nature of compensation paid to the Government of delay in the payment of cess and not as penalty, hence it is deductible. Similarly, interest paid for delay in payment of municipal taxes is also allowable as deduction.

29) Amount spent by an assessee in purchasing loom hours is deductible as revenue expenditure.

30) Amount paid as damages to the Government Department for delay in the execution of contracts was held to be allowable deduction, if the delay was inherent in the nature of business carried on by the assessee.

31) Annual listing fee paid to Stock Exchange by public limited company is allowable.

32) Interest levied for failure to pay installment of the assets purchased on hire-purchase basis is allowable.

33) Expenditure incurred on inauguration ceremony is allowable.

34) Expenditure incurred on foreign tour of director for purposes of expansion of business of the managed company is allowable.

35) Wife of chairman-cum-managing director accompanying him for fulfilling social aspects. Expenses incurred on foreign tour of wife are deductible.

36) Liability to pay debenture premium is to be spread over the years between date of issue and date of redemption.

37) Payment towards Flat Day Fund is deductible.

38) Cash shortage found in business at the end of the day.

39) Deposit made under ‘own your telephone’ scheme.

40) Expenses in connection with income tax, sales tax proceedings

5.8 Expenses Expressly Disallowed

The following expenses are expressly disallowed by the Act while computing income chargeable under the head’ profits and gains of business or profession’.

Expenditure on advertisement in any souvenir, etc. published by a political party in the case any assessee

(i) Payments outside India. Royalty, fees for technical services, etc. which tax is deductible at not been paid during the previous year or in prescribed time. shall not be allowed as a deduction.

(ii) Payments to residents. any interest, commission or brokerage, fees for professional services or feeds for technical and such tax has not been deducted or, after deduction.

· Any sum paid on account of securities transaction tax.

· Any sum paid on account of fringe benefit tax .

· Wealth tax. chargeable under Wealth Tax Act.

· Tax on Profits and Gains. Any sum paid on account of any tax levied on the profits and gains of any business or profession

· Salaries Payable outside India or to a non-resident, if tax has not been paid thereon nor deducted at source.

· Payment to P.F., etc. Any payment to a provident or other funds shall not be allowed as a deduction unless it is ensured that tax shall be deducted at source from any payment made from the fund provided it is chargeable to tax

· Tax on perquisites of employee.

5.9 Expenses not deductible in certain circumstances

· Excessive payments. of an expenditure to a relative it to be excessive or unreasonable to be disallowed.

· Payments in cash: Any expenditure in respect of which payment is made exceeding Rs. 20,000 otherwise that by a crossed cheque drawn on a bank or by crossed bank draft will be disallowed to the extent of 20%.Further, the limit of Rs. 20,000 applies to the payment made to a party at a time and not the aggregate of the payments made to a party in the course of a day.

· No deduction shall be allowed in respect of any sum paid by the assessee as an employer towards the setting up of, or as contribution to, any unapproved fund.

· Drawings of proprietor or partners.

· Personal expenses of the proprietor for partners.

· Capital expenditure.

· Any provision or transfer to reserve except transfer to reserves as provided in the Act.

· Amounts paid as charity or presents.

· Past losses charged to Profit & Loss Account.

· Any expenditure not incurred wholly and exclusively for the purposes of the business or profession.

· Income tax, wealth tax and other taxes on income

· Expenditure incurred to buy off competition, e.g., a sum paid by a company to a retiring director or a managing agent in consideration of their agreement not to complete with the company.

· Penalties paid by the assessee for infringement of law.

· Payments made by an assessee in the nature of sharing the profits to the sole selling agents under an agreement are not deductible.

· Contribution to a political party where there is no direct relationship between contribution and the business of the assessee.

· Insurance premia paid by a firm on life insurance policies of its partners

· Expenditure incurred in violating of another statute.

· Gift made on occasion of marriages in the families of friends and others with whom assessee has business dealing cannot qualify as business expenditure even on grounds of commercial expediency.

Self Assessment Questions II

State whether following expenses are deductible:

1) Drawings of proprietor.

2) Past losses charged to P/L account

3) Professional tax levied by local authorities, the payment of which is necessary condition for the carrying on the business within the area of a local authority

4) Reasonable expenses on Dussehra, Diwali etc.

5.10 Deduction Allowable only on Actual Payment

The following deductions are allowable only on actual payment: Sec. 43B:

If the tax payer maintains books of accounts on mercantile basis, following expenses are deductible on accrual basis, provided the payment is actually made on or before the due date of submission of return of income.

(a) Any sum payable by the assessee by way of tax, duty, cess or fee

(b) Any sum payable by him as an employer by way of contribution to any provident fund, superannuation fund or gratuity fund or any other fund for the welfare of employees.

(c) Any sum payable to an employee as bonus or commission for services rendered, where such sum would not have been payable to him as profit or dividends if it had not been paid as bonus or commission.

(d) Any sum payable by the assessee as interest on any loan or borrowings from any Public Financial Institution or a State Financial Corporation or a State Industrial Investment Corporation.

(e) Any sum payable by the assessee as interest on any loan or borrowing from any Public Financial Institution or a State Financial Corporation or a State Industrial Investment Corporation

(f) Any sum payable by the assessee as interest to a scheduled bank on any loan or advance from a scheduled bank.

(g) Any sum payable by the assessee in lieu of earned leave.

If the amount is paid after the due date of furnishing the return, the deduction will be allowed in the year of payment.

5.11 Depreciation

Depreciation means a diminution in the value of assets due to wear and tear, obsolescence etc. caused by their use over a period of time. Its cost is spread over its life by charging depreciation every year against the profits of business.

Assets eligible for depreciation:

A. Tangible assets: (i) Building, (ii) Machinery or Plant, and (iii) Furniture.

B. Intangible assets: (i) Patents, (iii) Copyrights, (iv) Trademarks, (v) Licenses, (vi) Franchises, (vii) any other business or commercial rights of similar nature.

Other assets such as investments, goodwill, etc., do not qualify for depreciation allowance

Building means only the superstructure and does not include the land on which it is constructed, as the land does not depreciate by use. Building includes roads, bridges, culverts, wells and tube wells. The term ‘plant’ includes ships, vehicles, books scientific apparatus etc.

Conditions for allowance of depreciation:

(i) Asset should be owned, wholly or partly by the assessee

(ii) It should be used for the purpose of the assessee’s business or profession.

(iii) Depreciation is allowed on the block of assets:

=>Block of Assets

The term ‘Block of Assets’ means a group of assets falling within a class of assets comprising:

-tangible assets, being building, machinery, plant or furniture,

-intangible assets, being know-how, patents, copyrights, trademarks, licenses,

Franchises or any other business or commercial rights of similar nature, acquired on or after 1.4.1998, in respect of which the same percentage of depreciation is prescribed.

=> Methods of Depreciation:

(i) In the case of assets of an undertaking engaged in generation or generation and distribution of power, depreciation may be claimed at the prescribed rates on the actual cost thereof, i.e., on the basis of Straight Line Method.

(ii) in any other case on any block of assets at the prescribed rates on the written-down value of such block of assets.

Assets acquired and put to use during the previous year:

In the case of an asset acquired and put to use in the business during the previous year, only 50% of the normal depreciation will be allowed if it is used in the business for less than 180 days during the previous year.

Tax Planning: As for as possible, the assessee should purchase and put to use the net asset on which depreciation is allowed upto 2nd October in the previous year. This will entitle to him full depreciation for the relevant previous year.

Meaning of Written down Value of an asset

Written-down value’ means:

(a) in the case of asset acquired in the previous year the actual cost to the assessee; and

(b) In the case of assets acquired before the previous year, the actual cost to the assessee less depreciation actually allowed to him.

The amount of unabsorbed depreciation carried forward is treated as depreciation actually allowed’.

(c) Depreciation is calculated on the block of asset instead of individual assets. In the case of any block of assets, the written-down value shall be computed as under:

(i) The aggregate of the W.D.V. of all the assets falling within a ‘block’ which were acquired during the previous year.

(ii) Add to it the actual cost of any asset falling in that block which was acquired during the previous year.

(iii) The sum arrived at in (ii) shall be reduced by the moneys receivable together with scrap value in regard to any asset falling within that block which is sold, discarded, demolished or destroyed during the previous year. The amount of such reduction cannot exceed the amount arrived at as per (ii) above. If it exceeds the written-down value will be taken as nil.

(iv) The balance under (iii) shall be the W.D.V. for computation of depreciation for that previous year.

If the full block of the assets is transferred and the monies payable is less than the W.D.V. under (iii), the loss shall be treated as short term capital loss. When the money payable in respect of a full block of assets or its part is more than written down value under (iii), the excess shall be treated as short term capital gains.

=>Additional depreciation on plant or machinery (I.e. 2006-07)

On new plant or machinery (other than ships and aircraft), which has been acquired and installed after 31.3.2005, by an assessee engaged in business of manufacture or production of any article or thing, additional depreciation shall be allowed @ 20% @ 10% if the asset is put to use for less than 180 days in the year in which it is acquired) of the actual cost of it:

However, the deduction shall not be allowed in respect of:

(a) any machinery or plant which, before its installation by the assessee, was used either within or outside India by any other person; or

(b) any machinery or plant installed in any office premises or any residential accommodation, including accommodation in the nature of a guest house; or

(c) any office appliances or road transport vehicles or

(d) any machinery or plant, the whole of the actual cost of which is allowed as a deduction (whether by way of depreciation of otherwise) in computing the income chargeable under the head “Profit and gains of business or profession” of any one previous year.

=>Rates of Depreciation

Rates of Depreciation on Written-down Value Method

I. Building Rates % of W.D.V.

A. Buildings which are used mainly for residential purposes except hotels and boarding houses

5

B. Building other than those used mainly for residential purposes 10

C. Building acquired after 31.8.2002 for installing machinery and plant forming part of water supply project or water treatment system and which is put to use for the purposes of business of providing infrastructure facilities

100

D. Purely temporary erections such as wooden structure 100

II. Furniture and Fittings: 

Furniture and fittings including electrical fittings 10

‘Electric-fittings’ include electrical wiring, switches, sockets, other fittings and fans etc.

 

III. Machinery and Plant: 

A General Rate applicable to all machinery or plant

Other than certain specified machines and plants15

B. Special Rate: 

1. Motor Buses, motor lorries and motor taxies used in a business of running them on hire

30

2. Motor-cars (other than those used in a business of running them on hire) acquire or put to use on or after Ist April, 1990

15

(3) Energy Saving Devices 80

(4) Machinery relating to environment protection and pollution control

100

(5) Books for professional purposes: 100

(i) Books being annual publications 100

(ii) Other books 60

6. Books owned by assessee carrying on business in running lending libraries

100

7. Containers made of glass or plastic used in refills 50

8. Computers including computer software 60

9. Plant and machinery acquired and installed after 31.8.2002 in a water supply project or a water treatment system and which is put to use for the purpose of business of providing infrastructure facility

100

IV. Ships: 

1. Ocean-going ships 20

2. Vessels ordinarily operating on inland water not being speed boats

20

3. Vessels ordinarily operating on inland waters being speed boats

20

Intangible Assets

Know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature w.e.f. A.Y. 1999-2000).

25

=>Unabsorbed Depreciation

Depreciation allowance for a particular previous year is first deductible from the profits and gains of the business or profession. If the profits and gains of the same business or profession are insufficient for this purpose, the balance of the amount of current depreciation allowance is deductible from the profits of any other business or profession of the assessee. If the profits of any other business or profession are also unable to absorb the whole amount of depreciation allowance, the balance of such allowance which remains unabsorbed can be set-off against any other taxable income of the same year. If

still, the whole amount of current depreciation allowance is not deductible on account of the insufficiency of the other taxable income, the remaining unabsorbed amount is called “Unabsorbed Depreciation”.

If unabsorbed depreciation cannot be wholly set-off, the amount of depreciation not set-off shall be carried forward to the following assessment year.

The unabsorbed depreciation shall be added to the depreciation allowance for the following previous year or for the succeeding previous years till such time it is fully deducted. In other words the unabsorbed depreciation shall be treated as part of the current year’s depreciation.

Illustration

The following are the particulars of the assets of a limited company as on Ist April, 2008;

 Actual cost

W.D.V. on

1.4.2008Rate of Dep.

Buildings:

Ananth

Bhagvan

10,00,000

16,00,000

8,10,000

15,04,800

10%

5%

The company sold the following assets during the financial year 2008-09

Buildings:

Ananth

Bhagvan

Rs.

9,00,000

19,00,000

Date of Sale

15.3.2009

1.7.2008

Plants Machinery:

Rathna

Queen

4,50,000

5,00,000

1.9.2008

1.2.2009

Compute the written-down value and the amount of depreciation for the Assessment year 2009-10. Assessee is entitled to additional depreciation on machinery on which depreciation is allowable @ 15%.

Solution:

Computation of W.D.V. and Depreciation allowance

I Block-Building (Rate of Depreciation 10%)

II Block – Building (Rate of Depreciation 5%) Rs

Written-down value of Bhagvan on 1.4.2008 15,04,800

Add: Cost of Building Chandra acquired during the year on 1.5.2008

3,00,000

Less: Sale consideration of Building Bhagvan sold during the year (not to exceed Rs. 18,04,800)

18,04,800

18,04,800

Balance

Since the sale consideration exceeds the W.D.V. in the II block, the excess Rs. (19,00,000 less 18,04,800) 95,200 will be the short term capital gain taxable under section 50 (1)

NIL

III Block-Plant & Machinery (Rate of Depreciation 15%) Rs.

Aggregate amount of W.D.V. of Plant & Machinery Prikrithi and Rathna

6,37,500

Add: Cost of Plant & Machinery Shanthi acquired during the year on 1.12.2008

3,00,000

 9,37,500

Less: Sale consideration of Plant & Machinery Rathna sold during the year

4,50,000

W.D.V. for A.Y. 2009-10 4,87,500

Less: (i) Depreciation n Rs. 1,87,500 @ 15% 28,125

(i) Depreciation on Rs. 3,00,000 @ 7.5% (one-

half normal depreciation as the machinery is acquired

and used in the business for less than 180 days

during the Previous Year) 22,500

 

(III) Additional depreciation on Rs. 3,00,000 @ 10% 30,000 80,625

Balance 4,06,875

IV Block-Plant & Machinery (Rate of Depreciation 40%)

Tax planning

Capital assets may be purchased even on the last day to claim 50% of normal depreciation. Business assets if are to be purchased during Sept. or Oct., one may see that it is used for a minimum period of 180 days to claim full depreciation allowance. Since no depreciation on the assets sold during the previous year is allowed, the sale of the asset may be postponed to the beginning of the next year.

Illustration

The following is the profit and loss account of the United Plastic for the

P.Y. 2008-09

 Rs.

 Rs.

To Op. Stock 30,000 By Sales 6,10,000

“ Purchases 1,59,000 “ Dividends (Gross) 6,000

“ Wages and Salaries 50,000 “ Rent from staff quarters

7,000

“ Rent 20,000“ Interest on Govt.

Securities50,000

“ Reserve for bad debts

10,000 Closing. Stock 25,000

Advertisement 5,000 Income from Smuggling 10,000

Depreciation on Machinery

5,000 “ Dividend from Foreign Co. (net)

2,000

“ Wealth tax 7,000   

“ Interest

* Reserve for IT

7,000

7,000

   

“ Sales Tax 15,000   

“ Insurance 2,000   

“ Donation 25,000   

“ Loss on sale of old Typewriters

3,000   

“ Computer 45,000   

“ Staff Welfare Fund 40,000   

“ Net Profit 2,80,000   

 7,10,000

 7,10,000

You are required to compute taxable income for the assessment year 2009-10 after taking into account the following information:-

a) Both opening and closing stocks are undervalued by 10%

b) Bad debts amounted to Rs. 2000

c) Purchases include Rs. 25,000 paid in cash.

d) Traced embezzlement by an employee in business Rs. 3,000

e) Allowable depreciation amounted to Rs. 4,000, excluding computer.

f) Interest of Rs. 7,000 includes interest on loan taken to buy shares: Rs. 3,000

g) Donations charged above paid in cash are deductible u/s 80 G.

Solution

Computation of Business income for the assessment year 2009-10

Statement showing Total Income for the assessment year 2009-10

Note: Payment exceeding Rs. 20,000 in cash is completely disallowed

Loss on sale of typewriter cannot be set off against other incomes.

Depreciation on computers is allowed at 60%

Dividend from foreign companies is taxable without grossing up

Illustration

Mr. Shantharam (age: 66 years), a resident individual, furnishes the following particulars relevant for the assessment year 2009-10:

Profit and Loss Account for the year ending March 31, 2009

 Rs.

 Rs.

Salary to staff 34,000 Gross profit 1,86,000

General expenses 48,000 Commission and discount

2,17,200

Bad debts written off 15,000 Sundry receipts 43,000

Reserve for losses 2,000 Short-term profit on sale of investment

31,000

Fire insurance premium (office premises)

3,700   

Advertisement 2,400

Add: Outstanding 1,6004,000

   

Interest on X’s capital 3,500   

interest on bank loan 500   

Interest on bank loan 14,500   

Expenditure on acquisition of a patent right acquired and put to use on June 30,2006

17,000   

Lump sum consideration for acquiring know-how on

March 3,2007

60,000   

Depreciation on plant and machinery

28,000   

Provision for outstanding sales tax and excise duty

13,000   

Net Profit 2,34,000   

 4,77,200

 4,77,200

Other information:

1. Depreciation on plant and machinery according to income-tax provision comes to Rs. 29,700.

2. Salary to staff includes payment Rs. 8,000 to a relative which is unreasonable to the extent of Rs. 3,000

3. General expenses include (a) expenditure Rs. 4,800, incurred by Shantharam on training of his employees, (b) commission of Rs. 10,000 for securing a business order, and (c) compensation of Rs. 6,000 paid to an employee while terminating his service in the business interest.

4. Out of outstanding sales tax and excise duty, Rs. 3,000 is paid on July 10,2009 and Rs. 8,000 is paid on October 3, 2009. The balance is not paid as yet. Due date of filling return of income is July 31,2009.

5. Income of Shantharm from company deposit is Rs. 12,000, which is not shown in the above Profit and Loss Account.

Determine the taxable income and tax liability of Shantharam for the assessment year 2009-10.

Solution:

Notes:

· Expenditure on training of employees is a deductible expenditure Likewise, commission for securing a business order is deductible.

· Advertisement expenditure (being expenditure of revenue nature) is fully deductible under section 37(1).

· Compensation payable for terminating service of an employee is deductible.

· It is assumed that the evidence of payment of sales tax on July 10,2007 is submitted along with return of income

Illustration

Mr. Nagaraja (age: 26 years), a leading tax consultant, who maintains books of account on cash basis furnishes the following particulars of income and expenditure for the assessment year 2009-10.

Receipt and Payment Account for the year ending March 31, 2009.

 Rs. Rs.

Balance brought down 12,400 Purchase of a typewriter 6,000

Fees from clients: 

Car expenses 18,000

2009-102,30,500 Office Expenses 40,000

2008-0911,500 Salary to staff:

 

2010-1113,000 of 2009-10 32,000

Presents from clients 24,000 of 2010-11 11,000

Interest-free loan from a client

 Expenses in respect of let out property

 

for purchase of a car 2,38,000 municipal tax: 2,000 

Winnings from lottery 46,000repairs: 1,000

insurance 3,0006,000

Interest from UTI (received on September 11,2008)

12,000   

   Car purchased on December 10,2008

2,40,000

Rent of a let out property 60,000 Repairs of office 12,000

Share of income from a firm

15,000 Interest on loan 10,000

   Income-tax payment 2,000

   Life insurance premium 8,000

   Balance carried down 2,77,400

 6,62,400

 6,62,400

Car is party used for official purposes (40%) and partly for private purposes (60%)

Determine the taxable income and tax liability of X for the assessment year 2009-10.

Solution:

Note: As books of account are maintained on the basis of cash system, income is taxable on “receipt” basis and expenditure are deductible on “payment” basis.

Illustration

From the Profit and Loss Account of Sriram (age : 31 years) for the year ending March 31, 2009, ascertain his total income and tax liability for the assessment year 2009-10.

 Rs. Rs.

General expenses 13,400 Gross profits 3,15,500

Bad debts 22,000 Commission 8,600

Advance tax 21,000 Brokerage 37,000

Insurance 600 Sundry Receipts 2,500

Salary to staff 26,000 Bad debt recovered (earlier allowed as deduction

11,000

Salary to Sriram 32,000 Interest on debentures (i.e. net amount Rs. 22,450 + tax deducted at source: Rs. 2,550)

25,000

Interest on overdraft 4,000 Interest on deposit with a company

13,000

Interest on loan to Mrs Sriram

42,000 (non-trade) (net interest : Rs. 11,674 + tax deducted at source: Rs. 1,326)

 

Interest on Capital of Sriram

23,000   

Depreciation 48,000   

Advertisement expenditure

7,000   

Contribution to

employees recognised provident fund

13,000   

Net profit 1,60,600   

 4,12,600

 4,12,600

Other information:

1. The amount of depreciation allowable is Rs. 37,300 as per the income-tax Rules. It includes depreciation on permanent sign board.

2. Advertisement expenditure includes Rs. 3,000, being cost of permanent sign board fixed on office premises.

3. Income of Rs. 4,500, accrued during the previous year, is not recorded in the profit and Loss Account.

4. Sriram pays Rs. 6,000 as premium on own life insurance policy Rs. 70,000.

5. General expenses include (a) Rs.500 given to Mrs. Sriram for arranging a party in honor of a friend who has recently come from Canada (b) Rs. 1,000 being contribution to a political party.

6. Loan was taken from Mrs. Sriram for payment of arrears of income-tax.

7. Interest on debentures is paid to Sriram on December 31, 2008.

Solution

 Rs. Rs.

Net profit as per Profit & Loss Account 

1,60,000

Add: Inadmissible expenses:   

Expenses for arranging personal party 500 

Contribution to a political party 1,000 

Advance tax 21,000 

Salary to Sriram 32,000 

Interest on capital to Sriram 23,000 

Interest on loan taken for payment of income-tax 42,000 

Capital expenditure on advertisement 3,000 

Excess depreciation (i.e. Rs.48,000-Rs. 37,300) 10,700 1,33,200

   2,93,800

Add: Income not recorded in the Profit and Loss Account 

4,500

Less: income credited to the Profit and Loss Account but not chargeable under the head “profit and gains of business or profession”.

   

Interest on debentures 25,000 

Interest on company deposit 13,000 38,000

Business Income 

2,60,300

COMPUTATION OF NET INCOME OF SRIRAM   

Profit and gains of business or profession 

2,60,300

Income from other sources (interest on debentures and  

38,000

company deposit)

Gross total income 

2,98,300

Less: Deductions under section 80C (payment of insurance premium)

6,000 

Deduction under section 80GGC (being contribution to a political party)

1,000 7,000

Net Income 

2,91,300

Tax on net income 

14,130

Add: Surcharge  

Nil

Tax and surcharge 

14,130

Add: Education cess (2% of tax and surcharge) + SHEC at 1% of tax and surcharge

 424

Tax 

14,554

Less: Pre-paid tax (i.e., advance tax + tax deducted at source) (21,000 + 2,550 + 1,326 )

 24,876

Tax refund  

10,322

Note: Expenditure on sales tax proceeding is allowable

Self Assessment Questions III

1) Payment of Rs. 50,000 for purchase of materials in Bombay made in cash is deductible only to the extent of Rs. ————–.

2) Excise duty of the year 2006-07 paid on 23rd April 2009 is deductible in the assessment year ——–

3) Sales tax liability of 2008-09 paid on 23rd April 2009 is deductible in the assessment year ———.

4) Depreciation for the asset purchased on 23rd Dec. 2008 is allowed to the extent of ————– during the previous year 2008-09

5.12 Summary

Business or profession head is the biggest source of revenue to the Govt. The admissibility of expenditure as deduction is generally governed by the general principles. Hence there are chances of claiming personal expenses as business expenses, outstanding dues as expenses paid during the year. Hence restrictions are placed for some expenditure, allowed to be deducted on payment basis only. This unit briefly explains as to how a business or professional income can be calculated for tax purposes, in the light of income tax provisions.

5.13 Terminal questions

1. Mr. Vikas is a practicing accountant. He also took 40 lectures in a college at Rs. 100 per lecture. His receipts and payments a/c is given bellow:

 Rs. Rs.

To bal b/d 9,500 By Office expenses 25,000

“ Audit Fees 1,60,000 “ Municipal taxes 500

“ Remuneration for lectures

4,000 “ Personal expenses 5,000

“ Examiner’s fees 1,500 “ Membership fees 500

“ Interest on securities 1,550 “ LI Premium 2,000

“ Rent from LOP 3,000 “ Scooter Purchased 24,500

“ Royalty on a book 5,000 “ Scoter expenses 12,000

   “ Balance c/d 1,15,050

 1,84,550

 1,84,550

a) Office expenses include Rs. 500 paid as typing charges for preparing manuscript of his book.

b) ½ of the scooter expenses relate to personal use.

c) Scooter being P & M, depreciation is allowed @ 15%.

d) Interest of securities includes Rs. 774 being interest on Tax Free Government Securities.

Compute his total income.

2. What are the expressly disallowed expenses while computing income under the head’ profits and gains from business or profession?

3. State with reasons whether the following are admissible as deductions in the case of business:

a) Wealth tax, b)income tax, c)expenses in connection with income tax proceedings, d) advance income tax paid, e) sales tax.

4. Write a note on: Block of the assets, additional depreciation, and unabsorbed depreciation.

5.14 Answers to SAQ and TQ

SAQ I

1. True

2. False

3. True

4. False

SAQ II

1. Not allowed

2. Not allowed

3. Deductible

4. Deductible

SAQ III

1. NIL

2. 2009-10

3. 2009-10

4. 50% of normal depreciation

Terminal Questions:

1. Hints: 80C 2,000; 80 QQB:4,500; Int. on securities: 1,550-775=775×100/79.6=974; lectures income and examiners fees treated professional income.

(Ans.: Income from house property: Rs. 1,750; Prof. income Rs. 1,32,662; other sources Rs. 5,474; TTI: Rs. 1,31,636)

2. Refer to section 5.8

3. a) not allowed b) not allowed c) allowed d) not allowed

e) allowed

4. Refer to sections 5.11.1, 5.11.3, and 5.11.5