SOME IMPORTANT FAQs WITH CASE LAWS FROM INCOME FROM BUSINESS OR PROFESSION :–
1. Can the assessee treat shares held in subsidiary company, which is ordered to be wound up, as trading loss?
Relevant Case Law – CIT v. H. P. Mineral and Industrial Development Corporation Ltd. (2008) 305 ITR 111 (HP)
Relevant Section – 28
- One of the assessee’s subsidiary companies was ordered to be wound up and the assessee decided to write off the value of the shares held by it in the subsidiary company.
- The lower authorities decided in favour of the assessee holding that there was no question of selling off the shares as the subsidiary company had gone into liquidation.
- The High Court held that once a company had been ordered to be wound up, there was no question of any party dealing in the shares of that company.
- The Tribunal had come to a finding that the shares were stock-in-trade and had therefore allowed the loss. The loss had to be treated as a trading loss. The mere fact that the shares were not sold was of no significance since in fact the shares could not have been sold and had become worthless.
2. Whether the amount transferred to the reserve fund account as per the provisions of section 67 of the Gujarat Co-operative Societies Act, 1962, was diversion of income at source by overriding title or could such transfer be treated as business expenditure deductible either under section 28 or section 37?
Relevant Case Law – CIT v. Mehsana District Co-op. Milk Producers’ Union Ltd. (2008) 307 ITR 83 (Guj.)
Relevant Section – 28
- The assessee contended that under sub-section (2) of section 67 of the Gujarat Co-operative Societies Act, 1962, at least one-fourth of the net profits of the society were required to be carried to the reserve fund every year, and hence there was a diversion at source by virtue of the provisions of section 67 which operates as an overriding title.
- Hence, it was submitted that the amount transferred to the reserve fund could not be charged as income liable to tax under the Act. Alternatively, it was pleaded that the amount of profits transferred to the reserve fund would constitute a charge on the taxable income under the provisions of section 28 of the Income-tax Act, 1961, or an expenditure having the characteristics of business expenditure under section 37. The Assessing Officer rejected the contention and this was upheld by the Tribunal.
- The High Court held that it was only in the event the society did not choose to use the reserve fund for the business of the society that the question about investing the reserve fund in the specified category of investments and thereafter utilizing the same for the objects specified by the State Government could arise.
- Hence, not only was there no diversion of income by overriding title but in fact there was no outgoing of funds from the domain of the assessee society. In fact, the profits at the specified percentage were set apart so as to be available to the society for use in the business of the society at a later point of time.
- Once the society was in a position to use the funds lying in the reserve fund for the business of the society as and when the society so chose, there could be no question of keeping out such profits from the purview of taxation.
- The Tribunal was right in law in holding that the amount transferred to the reserve fund account as per the provisions of section 67 of the Gujarat Co-operative Societies Act, 1962, was not diversion of income at source by overriding title nor could such transfer be treated as business expenditure deductible either under section 28 or section 37.
3. Whether the amount received by the assessee under a lease agreement is income from other sources or business income?
Relevant Case Law – East West Hotels Ltd. v. DCIT (2009) 309 ITR 149 (Kar.)
Relevant Section – 28
- The assessee was engaged in the hotel business activities. The assessee by an agreement with IHC gave one of its hotels on lease for an initial period of 33 years with an option to renew for a further period of 33 years.
- The assessee claimed that the amount received from IHC had to be treated as its business income. The claim was rejected by the Assessing Officer on the ground that the assessee was not getting any business income as the hotel had been leased out by the assessee to IHC and any amount received by the assessee from such company had to be treated as income from other sources and not business income.
- The Commissioner (Appeals) as well as the Tribunal held that the income received by the assessee from such hotel building was income from other sources.
- The High Court held that the clauses in the agreement were more in the nature of a lease deed and not a licence given for a particular period with no intention to resume its business of hotel in the premises.
- It could not be said that the assessee had been managing the hotel through IHC. Therefore, the amount received from IHC had to be treated as income from other sources and not as business income.
4. Whether the swapping premium is profit derived from the business of providing long term finance in terms of section 36(1)(viii) of the Income-tax Act, 1961 ?
Relevant Case Law – Rural Electrification Corporation Ltd., In re (2009) 308 ITR 321 (AAR)
Relevant Section: 36(1)(viii)
- The main object of the applicant, a public sector undertaking, was to provide long-term finance, primarily to State Electricity Boards, for the purpose of transmission, distribution and generation of electricity to enable industrial, agricultural and infrastructure development.
- The applicant was filing income-tax returns right from the beginning and the Department had all along, in the past, allowed deduction under section 36(1)(viii) of the Income-tax Act, 1961, in respect of the special reserve created and maintained for providing long-term finance for industrial or agricultural development or development of infrastructure.
- For the assessment year 2004-05, the applicant credited Rs.170.85 crores as “swapping premium” received and claimed deduction thereon under section 36(1)(viii). “Swapping premium” was a scheme under which long-term finance given at a higher percentage of interest was converted to a lower rate of interest.
- The applicant itself had declared the swapping premium receipt in its balance-sheet as “Other income” and not income from lending operations. The Assessing Officer held that the applicant forfeited the claim for allowance of deduction under section 36(1)(viii) in respect of the “swapping premium”.
- The Commissioner (Appeals) agreed with the Assessing Officer. The applicant appealed to the Appellate Tribunal but withdrew the appeal. Meanwhile, the applicant obtained permission of the Committee on Disputes to pursue the matter before the Authority.
- The Authority ruled:
(i) That the applicant was an eligible entity, i.e., a financial corporation as laid down in section 36(1)(viii).
(ii) That the applicant was engaged in the business of providing long-term finance to its clients for rural electrification which paved the way for industrial, agricultural and infrastructural development. The availability of electricity contributed significantly to the overall development of the country including that of industry, agriculture and infrastructure. The provision of electricity was essential for modernization and growth of agriculture and also catered to the requirements of industry including small and medium industries, agro-industries, Khadi and village industries, etc. The applicant had been providing finance for industrial and agricultural development and, keeping in view these very goals, the Government of India had granted approval to the applicant for deduction under section 36(1)(viii). The applicant could be said to be engaged in providing longterm finance for industrial and agricultural development in India.
(iii) That the long-term loan financed by the applicant to its clients in the beginning had not been tampered with on rescheduling of the interest and no fresh loan agreements had also been drawn.
(iv) That clause (e) of the Explanation to section 36(1)(viii) defined long-term finance as “any loan or advance where the terms under which moneys are loaned or advanced provide for repayment along with interest thereon during a period of not less than five years”. In this case, the loans had been advanced in the beginning for five years and those loan amounts had not undergone any change, so the period of five years had to be counted from the date of advancing the initial loans and not from the date of rescheduling the interest rates.
(v) That the “swapping premium” was nothing but discounted interest and had “originated” in the long-term finance initially advanced. The premium was actually traced to the original source and was not a step removed from the business of providing long-term finance. No fresh agreement had been entered into for advancing long-term financing and the one-time measure for rescheduling the interest had been actuated by business expediency. The swapping premium was simply a compensation received for agreeing to a lesser amount as against a higher fixed rate of interest initially fixed. The business of providing long-term finance was the immediate and effective source of the swapping premium received.
(vi) That the swapping premium could not be termed as compensation for breach of contract because neither party had breached the contract. The disclosure of the swapping premium in the balance-sheet as “Other income” instead of business income was also immaterial since entries in the books of account are not determinative of the true character of a receipt.
(vii) That, therefore, the applicant was entitled to deduction under section 36(1)
(viii) in respect of the swapping premium received.
5. Whether the payments made by the assessee to its employees under the nomenclature ‘Good work reward’ constitute bonus within the meaning of section 36(1)(ii) of the Income-tax Act, 1961 or were allowable as normal business expenditure under section 37 ?
Relevant Case Law – Shriram Pistons and Rings Ltd. v. CIT (2008) 307 ITR 363 (Del.)
Relevant Section – 37
- The “good work reward” that was given by the assessee to some employees on the recommendation of senior officers of the assessee did not fall in any of the categories of bonus specified under the industrial law.
- There was nothing to suggest that the good work reward given by the assessee to its employees had any relation to the profits that the assessee may or may not make. The reward had relation to the good work done by the employee during the course of his employment and at the end of the financial year on the recommendation of a senior officer of the assessee, the reward was given to the employee.
- Consequently, the “good work reward” could not fall within the ambit of section 36(1)(ii) of the Income-tax Act, 1961. The “good work” reward was allowable as business expenditure under section 37(1) of the Act.
6. Whether the Tribunal was justified in deleting the addition of an amount represented rate difference payment in the purchase of milk paid by the assessee even though the said payment was paid at the end of the previous year?
Relevant Case Law – CIT v. Solapur Dist. Co-Op. Milk Producers and Process Union Ltd. (2009) 315 ITR 304 (Bom.)
Relevant Section – 37
- The assessee-societies were federal milk societies and their members were primary milk cooperative societies. The business of the assessee was to purchase milk from its members and other producers of milk at the rate, i.e., similar to both the members and outside milk producers and sell the milk to various parties.
- The rate of purchase price was fixed by the board of the assessee-societies. The purchase price was linked to the fat content of milk and also varied according to seasons. For instance, the rate for purchase of milk in the lean season was different from the flush seasons.
- The assessee-societies fixed the rate of processing of milk at the beginning of the year on the basis of the price declared by the Government of Maharashtra and the price which other buyers paid to the vendors. These rates were revised from time to time. It was made always clear that the rates were provisional and the final milk rate difference was determined in the month of March every year and the difference was paid subsequently in the following year.
- The primary milk society also in turn made payment of the final rate difference to the individual milk producers around Diwali. The assessees claimed deduction of the final rate difference. The Assessing Officer refused to exclude the final rate difference paid from the total amount paid by the assessee. The Commissioner (Appeals) upheld the order. The Tribunal allowed the appeal and allowed deductions of the final rate.
- The High Court held that the amount to be paid was not out of the profits ascertained at the annual general meeting. It was not paid to all shareholders. The amount which was the subject-matter was paid to members who supplied milk and in some case also to nonmembers.
- The payment was for the quantity of milk supplied and in terms of the quality supplied. The commercial expediency for payment of this price was the market conditions and the need to procure more milk from the members and non-members to the assessee.
- Therefore, the amount paid could not be said to be dividend to the members or shareholders or payment in the form of bonus as bonus also had to be paid from the accrued profits. It was deductible.
7. Whether the expenses incurred by the assessee for promotion films, slides, advertisement films is capital expenditure?
Relevant Case Law – CIT v. Geoffrey Manners and Co. Ltd. (2009) 315 ITR 134 (Bom.)
Relevant Section – 37
- The assessee incurred expenditure on film production by way of advertisement for the marketing of products manufactured by it. The Assessing Officer disallowed the expenses incurred by the assessee for promotion films, slides, advertisement films and treated it as capital expenditure.
- The Commissioner (Appeals) held that the films were in the form of advertisement whose life term could not be ascertained. Therefore, they could not be held as capital expenditure. The Tribunal upheld the order of the Commissioner (Appeals).
- The High Court held that if the expenditure is in respect of an ongoing business of the assessee and there is no enduring benefit it can be treated as revenue expenditure. If the expenditure is in respect of business which is yet to commence then it cannot be treated as revenue expenditure since the expenditure is on a product yet to be marketed.
- Hence, the expenditure incurred in respect of promoting ongoing products of the assessee was revenue expenditure.
8. Whether the expenditure incurred by the assessee in the machinery repairs could be treated as revenue expenditure though this related to the cost of motors and other items resulting in an enduring benefit to the assessee and was in the nature of capital expenditure?
Relevant Case Law – CIT v. Hero Cycles P. Ltd (2009) 311 ITR 349 (P&H)
Relevant Section – 37
- The assessee claimed expenditure of Rs. 73,180 on purchase of motors and certain other items of machinery. The Assessing Officer rejected the claim for treating the amount as revenue expenditure on the ground that the items purchased by the amount were not spare parts but independent items and the amount had, thus, to be treated as capital expenditure.
- On appeal, the plea of the assessee that most of the items purchased were electric motors for replacement of existing machinery, was upheld. The Tribunal affirmed the order and held that occasional replacements were necessary having regard to the machinery installed.
- The High court held that the Tribunal was right in law in allowing expenditure of Rs.73,180 shown by the assessee in the machinery repairs account as revenue expenditure.
9. Whether the fine paid for belated payment of excise duty is a allowable business expenditure?
Relevant Case Law – CIT v. Hoshiari Lal Kewal Krishan (2009) 311 ITR 336 (P&H)
Relevant Section – 37
- The assessee claimed deduction of Rs. 31,433 paid as fine for belated payment of the excise duty instalment. This was disallowed by the Assessing Officer as well as the appellate authority but the Tribunal allowed it.
- The Supreme Court in Prakash Cotton Mills P. Ltd. v. CIT  201 ITR 684, observed that whenever any statutory impost paid by an assessee by way of damages or penalty or interest is claimed as an allowable expenditure under section 37(1) of the Income-tax Act, the assessing authority is required to examine the scheme of the provisions of the relevant statute providing for payment of such impost notwithstanding the nomenclature of the impost as given by the statute, to find whether it is compensatory or penal in nature.
- The authority has to allow deduction under section 37(1) of the Income-tax Act, wherever such examination reveals the concerned impost to be purely compensatory in nature.
- Hence, in the present case, the High Court held that it had been clearly found that though termed as fine, the payment was not in the nature of punishment but was by way of compensation. The payment was deductible.
10. Whether section 40(b) of the Income-tax Act, 1961, is applicable to the amount of salary and bonus paid by the assessee-firm to its partners for their individual service as against their Hindu undivided family character?
Relevant Case Law – CIT v. Unimax Laboratories (2009) 311 ITR 191 (P&H)
Relevant Section – 40(b)
- The Assessing Officer made an addition under section 40(b) of the Income-tax Act, 1961, on account of salary and bonus paid by the assessee-firm to its four working partners. Those partners were partners in their representative capacity as karta of their Hindu undivided families.
- Since these partners represented their respective Hindu undivided families, they were treated to be partners for the purpose of disallowance of benefits under section 40(b) of the Act by the Assessing Officer.
- However, on appeal the addition was deleted on the ground that the salary and bonus were paid to these persons as individuals and in these circumstances section 40(b) of the Act had no application.
- The High Court held that the Tribunal was right in allowing the amount of salary and bonus paid by the firm to partners for services rendered by them on the ground of having technical qualification and expertise, though they represented their Hindu undivided families and section 40(b) of the Act was not attracted.
11. Whether the amount written back by the assessee to the credit of its profit and loss account during the accounting period under consideration constituted income of the assessee-company under section 41(1) of the Income-tax Act 1961?
Relevant Case Law – Jay Engineering Works Ltd. v. CIT (2009) 311 ITR 299 (Del.)
Relevant Section: 41(1)
- The assessee had written back in its accounts unclaimed balances totalling Rs.1,16,240. The Inspecting Assistant Commissioner added back this amount to the income of the assessee. This was upheld by the Commissioner (Appeals) as well the Tribunal.
- The High Court held that the amounts were not statutory liabilities but contractual liabilities. These amounts were unilaterally written off by the assessee. Therefore, the unclaimed liability written off by the assessee was taxable as income.
12. Whether the amount transferred to profit and loss account in case of waiver of loan taken by assessee for business purposes assessable as business income under section 41(1) of the Income-tax Act, 1961?
Relevant Case Law – Solid Containers Ltd. v. DCIT (2009) 308 ITR 417 (Bom.)
Relevant Section: 41(1)
- The assessee had taken a loan for business purposes which was written back and directly credited to the reserves account, as a result of consent terms arrived at in a suit.
- The assessee claimed this amount as capital receipt, even though it had offered the interest on the said loan as its income by crediting the same to its profit and loss account.
- The Assessing Officer added the amount to the total income of the assessee as its income and this was upheld by the Tribunal.
- The High Court held that it was a loan taken for trading activity and ultimately, upon waiver the amount was retained in the business by the assessee. The amount had become the assessee’s income and was assessable.
13. Is depreciation under section 32 allowable in respect of emergency spares of plant and machinery, which though acquired during the previous year, have not been put to use in that year?
Relevant Case Law – CIT v. Insilco Ltd. (2009) 179 Taxman 55 (Del.)
Relevant Section – 32
- On this issue, the Delhi High Court observed that the expression “used for the purposes of business” appearing in section 32 also takes into account emergency spares, which, even though ready for use, yet are not consumed or used during the relevant period.
- This is because these spares are specific to a fixed asset, namely plant and machinery, and form an integral part of the fixed asset. These spares will, in all probability, be useless once the asset is discarded and will also have to be disposed of. In this sense, the concept of passive use which applies to standby machinery will also apply to emergency spares.
- Therefore, once the spares are considered as emergency spares required for plant and machinery, the assessee would be entitled to capitalize the entire cost of such spares and claim depreciation thereon.
Note – One of the conditions for claim of depreciation is that the asset must be “used for the purpose of business or profession”. In the past, courts have held that, in certain circumstances, an asset can be said to be in use even when it is “kept ready for use”.
For example, depreciation can be claimed by a transport company on spare engines kept in store in case of need, though they have not actually been used by the company. Hence, in such cases, the term “use” embraces both active use and passive use. However, such passive use should also be for business purposes.
14. What is the tax treatment of pre-payment premium paid by the assessee-company to IDBI for restructuring its debt?
Relevant Case Law – CIT v. Gujarat Guardian Ltd. (2009) 177 Taxman 434 (Del.)
Relevant Section – 43B
- The assessee-company paid pre-payment premium to IDBI during the relevant previous year for restructuring its debts and reducing the rate of interest. It claimed the full payment as business expenditure in that year on the reasoning that it was an upfront payment representing the present value of the differential rate of interest that would have been due on the loan if the restructuring of loan had not taken place.
- The Assessing Officer and Commissioner (Appeals) were of the view that the premium has to be amortised over 10 years, and accordingly allowed only 1/10th of the premium as deduction for the relevant previous year. The Tribunal, however, concurred with the assessee’s view and held that in terms of section 36(1)(iii) read with section 2(28A), the deduction for pre-payment premium was allowable.
- The issue under consideration is whether the deduction has to be allowed in one lump-sum as claimed by the assessee or should the same be deferred over a period of time as opined by the Assessing Officer and Commissioner (Appeals).
- The Delhi High Court concurred with the Tribunal’s view that the deduction has to be allowed to the assessee-company in one lump sum according to the provisions of section 43B(d).
- Section 43B(d) provides that any sum payable by the assessee as interest on any loan or borrowing from any public financial institution shall be allowed to the assessee in the year in which the same is paid, irrespective of the period or periods in which the liability to pay such sum is incurred by the assessee according to the method of accounting regularly followed by the assessee. As there was no dispute that the pre-payment premium paid represented interest and that it was paid to a public financial institution
- IDBI, the Court held that, as per the provisions of section 43B(d), the assessee’s claim for deduction has to be allowed in the year in which the actual payment was made i.e. the previous year relevant to the assessment year under consideration.
Note – Section 36(1)(iii) provides for deduction of interest paid in respect of capital borrowed for the purposes of business or profession. Section 2(28A) defines interest to include, inter alia, any other charge in respect of the moneys borrowed or debt incurred. Section 43B provides for certain deductions to be allowed only on actual payment. From a combined reading of these three sections, it can be inferred that –
(i) pre-payment premium represents interest as per section 2(28A);
(ii) such interest is deductible as business expenditure as per section 36(1)(iii);
(iii) such interest is deductible in one lump-sum on actual payment as per section 43B(d).
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