Yash Shah

Yash Shah1. There is a prevailing practice of a businessman taking loan of stock from another businessman and returning the same. Since he may have to pay for replacement at a higher price for return of loan of stock, can a provision made for the extra cost be deductible?

Answer. The issue had come up in Welding Rods Manufacturing Co. vs. CIT, where it was found that the price rise at the time of closure of accounts in respect of outstanding loan of stock could be recognised and the provision therefore would be allowed as a deduction. In coming to the conclusion the High Court followed the decision in Calcutta Co. Ltd. vs. CIT.

In this context, one may refer to the statutory provision in section 47(xv) in respect of capital gains on stock lending, whereby tax on capital gains is spared on such stock lending, if the guidelines issued by Securities and Exchange Board of India had been followed. The provision, however, is only for exemption from capital gains and the mere act of lending of securities in pursuance of stock lending scheme. It cannot have application for dealers in shares. Similarly, the final outcome of the transaction even in the case of an investor may have to be recognised for capital gains tax purposes under the law as exemption is at the stage of lending and not at the stage when the contractual obligation gets discharged. 

2. Does a liability arise under excise law on show cause notice, which makes a special recognition for show cause notice, where such notice has been issued?

Answer. Notwithstanding the effect of a show cause notice, it does not create a demand for payment by itself, so as to justify the amount covered by the notice as statutory liability, on the basis of the decision in Kedarnath Jute Mfg. Co. Ltd. vs. CIT. It was so pointed out in CIT vs. Morarji Goculdas Spg. & Wvg. Co. Ltd.

3. Should the right to deduction await final result of any claim?

Answer. Courts have not taken a uniform view. Ordinarily when a final decision is awaited, deduction could be made only in the year in which the matter gets resolved as in the case of requirement of approval from the authorities following the decision in Nonsuch Tea Estate Ltd. vs. CIT . But in a case on converse facts, it was held that in the accrual concept in mercantile system of accounting, a mere requirement of approval, when it has become available at the time of assessment or even in appeal, such delay in approval need not bar assessment in the year of receipt as was held in CIT vs. Jai Hind Travels (P) Ltd. , where the concept of the doctrine of relating back was adopted for accrual system.

Such a view cannot be treated as non-controversial. Deduction need not be denied, where ex post facto approval is a formality. It is difficult to draw a line in such cases. It is for the taxpayer to make a provision in such cases in the year of claim, so that even if it is disallowed, it can be claimed in the year of payment. Failure to make the claim in an earlier year may lose the right, if revenue decides that the claim could be allowed only in the first year.

4. Is it open to the Revenue to disallow a portion of electricity charges paid with reference to the refund claim made during the year, but given in a subsequent year?

Answer. Receipt of refund in a subsequent year cannot be taken as a ground for not allowing a deduction at the time, when it was payable as was held in Travancore Chemical and Mfg. Co.Ltd. Vs. CIT following the decision in CIT vs. Bharat Iron and Steel Industries, The High Court pointed out that the need for section 41(1) to tax amounts that had been remitted or waived would not have  arisen, f allowance due for an earlier year could be modified with reference to the later waiver or  remission.

5. Is it possible to value stock by methods other than cost, market value, or cost or market value,whichever is lower?

Answer. Any method which is consistently followed and is not likely to distort the income and is consistent with accounting principles should be acceptable. Lower valuation for slow moving goods in the view that future carrying cost would require to be taken into consideration was approved in India Motor Parts and Accessories P. Ltd. vs. CIT. The method, it was pointed out, had been suggested as a proper valuation in Industrial Accountants Hand Book edited by Wyman P Firke of John A. Beckett. Such a view had also the approval of Delhi High Court in CIT vs. Bharat Commerce and Industries Ltd. . 

6. How is the work in progress valued? Should the overheads be treated as part of cost?

Answer. Work-in-progress is generally valued at cost. The issue as to whether the overheads should be taken into consideration by adoption of “on-cost” basis or whether only direct cost should be taken was considered in Duple Motor Bodies Ltd. vs. Inland Revenue Commissioner, where it was found that either method can be adopted but where the assessee has adopted one method, it is not open to him to change it.

Where an assessee had followed a method of accounting, which excluded over-heads in valuation of work-in-progress on the ground that the goods under manufacture may not result in marketable commodities, the Tribunal rejected the change mainly on the ground that there was no evidence of possible deterioration of work-in-progress. The High Court, however, found that since the assessee had followed the same method in earlier years, it was entitled to continue the same practice. The Supreme Court in CIT vs. British Paints India Ltd. decided on the short point that merely because a system has been consistently followed, it does not mean that Revenue is bound by it, if it finds that it is not consistent with accounting principles. If the income could xiot be rightly deduced from the system followed, it was open to the Assessing Officer to reject the same, since there is no estoppel in such matters. According to this decision, the cost ordinarily has to reckon overheads as well. The distinction between finished stock and work-in-progress was however not appreciated in this case, when it reversed the decision of the Calcutta High Court. But it is still an authority for the view that the method followed should be consistent with accounting principles. A scientific method of valuation of work-in-progress is probably only the retrievable value or a value which makes an allowance for a situation, if the goods turn out to be non-marketable. In other words, valuation at less than the cost or market value for work-in-progress should be permissible in certain lines of manufacture, where there is possible wastage before completion of the manufacture of the product, if such valuation is consistently followed.

7. An assessee had the practice of accounting receipts from contract only when the bills raised by it were passed by the contractee. Where such a method is regularly followed, can it be rejected by the Assessing Officer?

Answer. Yes. It was so held in CIT vs. Shaik Mohd Rowther Shipping and Agencies (P) Ltd., where it was pointed out that the method is not consistent with any accounting principles. The work has been done on the basis of which bills were raised. 90% of the amount was also received, the balance pending for passing of the bills. Merely because the amount received is shown as advance, it is not possible to postpone recognition of revenue. The mere fact that the Assessing Officer had not disturbed the system in earlier years does not prevent him from correcting the same as the principle of res judicata can have no application to tax cases as was pointed out in CIT vs. Brit.

Q.8. Which is the best head of income from tax point of view, where there is a possible choice?

Answer. The best head is business as it is eligible for a list of deductions and reliefs.

Q.9. A business executive has purchased and sold shares through a stock broker. Will the loss, if any,be assessable under the head “business” or “capital gain”?

Answer. The mere fact that he has purchased and sold shares through a broker does not entitle the assessee to treat the income as business income. There should be a continuous activity. Moreover, if the interval between purchase and sale is short, profit will be referred under the head “Short Term Capital Gains” without any advantage.

Q.10. A piece of land acquired five years before is plotted out and sold. What is the head of income?

Answer. To treat the sale of land as a business transaction more facts are required. There should be facts to suggest that the land was converted to a business asset and dealt with as such and the sale is not just for the sake of realisation of appreciation in value.

Q.11. Can what is “accrued but not due” ever be treated as accrued for tax purposes? What is the correct treatment of interest from cumulative deposits in the hands of payer and payee?

Answer. This depends on the system of accounting. An assessee might choose with advantage to declare that income from year to year on accrual basis. However, the payer will deduct tax on the accumulated interest at the time of payment accords to section 194A in which case the assessee may have to ask for a refund.

Q.12. How far are income Computation,and disclosure standards relevant in computation of business income?

Answer. Income for income-tax purposes is computed under ordinary principles of commercial accounting. Income Computation and disclosure Standards lay down such principles accepted by the profession and have even been made mandatory for purposes of company law. Hence they have great persuasive value.

Q.13. A taxpayer has changed his method of stock valuation. Statutory auditors did not agree to the change and have qualified the balance sheet. Assessing Officer relies upon the decision of Supreme Court in British Paint’s case for rejecting the change. Is he justified in doing so?

Answer. What is required is that the change in the method of valuation should be bona fide and thereafter followed continuously. In Karnataka State Forest Industries Corporation Ltd. vs. CIT High Court found that the Income-tax Officer cannot reject a change in the method of valuation of stock merely because statutory auditors objected to it.

Q.14. A firm replaces defective TV sets long after the guarantee period was over with a view to maintain goodwill of the firm. Cost of replacement is disallowed by the Assessing Officer. Is he right?

Answer. Since the outlay was incurred on grounds of commercial expediency the claim is admissible. The paragraph under “commercial expediency” (supra) would give necessary authorities for the same.

Q.15. Is a payment made to Life Insurance Corporation of India towards group gratuity fund deductible under section 36(1 )(v), though it has not been routed through an approved gratuity fund?

Answer. The deduction need not be denied merely because a direct payment has been made as long as it is towards account of group gratuity fund. It was so decided in CIT vs. Textool Co. Ltd. In fact this would have even otherwise been allowed under Sec. 37.

Q.16. Can dumpers used in contract work be classified as earth moving machinery?

Answer. Yes. They are entitled to depreciation and extra depreciation as earth moving machinery as held in CIT vs. Abdulkarim Stone Contractor . They are not road transport vehicles.

Q.17. What is meant by block asset?

Answer. Certain types of assets are grouped into one block and additions to the same will be treated as part of the block. 

Q.18. What are the changes brought about by bringing in the concept of ‘block asset’ in evaluating cost for depreciation?

Answer. Each item of machineries is not separately considered for depreciation. Where a particular capital asset or assets forming part of the block is sold, the difference between the full  value of the consideration on one hand and the WDV of the block asset, plus expenditure incurred in the transfer, plus value of any asset added to the block on the other hand is treated as Short-term Capital Gains.(Sec. 50) The idea was to give up the profit under section 41(2) as it stood then which  represented the amount of depreciation actually received. Earlier this amount was added as income and any excess above the depreciation was to be treated as capital gains as held in CIT vs. Artex Manufacturing Co. However section 41(2) has now been reintroduced with effect from 1.4.1998.

19. The assessee has a project report for a new venture carried out at the cost of ` 5 lakhs. Assessing Officer disallows the same as the venture re-lates to a new business. Is the assessee eligible for deduction and if not, is he eligible for depreciation?

Answer. If the project report relates to an existing business for its expansion, it will be a revenue expenditure. But if it relates to a new business, it will be a capital expenditure eligible for depreciation as decided in CIT vs. Harsha Tractor Ltd.’ following the decision in Scientific Engineering House P. Ltd. vs. CIT. After amendment to section 32(1) allowing depreciation on intangible assets from 1.4.1998, it is a matter of statutory right for the assessee to get depreciation not merely by treating such project report as a plant as under the pre-existing law but as an intangible asset on par with other tangible assets, so that the cost is entitled to depreciation like other intangible assets like know-how, patents, copyrights, trademarks, licence, franchise or any other business or commercial rights of similar nature. 

Q.20. Where an air-conditioning plant is fixed in a bus, would such air-conditioner and bus be eligible for rates respectively applied to them?

Answer. Air-conditioning plant, which is an integral part of bus would not be entitled to rate of depreciation different from what is available for motor vehicles, where they are installed.

Q.21. Can fencing be treated as a plant?

Answer. No, it can be treated only as a building.

Q.22. It is the normal practice of revenue to deduct all depreciation allowed including initial depreciation in arriving at the WDV. Is this correct?

Answer. According to Gujarat High Court, depreciation is referable to wear and tear. Initial depreciation being in the form of an incentive is not to be deducted. 

Q.23. Where a wholly owned subsidiary company acquires depreciable assets from the holding company at market value, is it eligible for depreciation on such market value?

Answer. No. Explanation 6 to section 43(1) provides that in the case of acquisition of assets by a wholly owned subsidiary from its holding company, the written down value of the holding company will be the actual cost to the subsidiary as held in Dalmia Ceramic Industries Ltd. vs. CIT.

Q.24. Could a road in a factory building used exclusively for industrial purpose be treated as a plant for purposes of depreciation?

Answer. Road could not be treated as a plant, but only as a building for purposes of depreciation.

Q.25. Where the assessee undertook gratuity liability of the vendor of the business as per agreement for sale, such liability is also consideration, so that it could be treated as part of the cost of assets entitled to depreciation. Is this correct?

Answer. Since the assessee has undertaken only a future liability, it cannot form part of the cost so as to be entitled to depreciation.

Q.26. Is it possible to capitalise expenditure as cost of the asset for purposes of depreciation?

Answer. Expenditure which has nexus with the asset can be treated as part of the cost of the asset.Cost of temporary electricity connection, power line and inspection fee relating thereto were held to be part and parcel of cost of machinery for purposes of depreciation.

Q.27. Are computers office equipments so as to be ineligible for investment allowance or additional depreciation?

Answer. ‘Office equipment’ has not been defined in the statute. What is barred is plant and machinery installed in office premises. Office premises have also not been defined. In case of a doctor, a clinic may be his office, but at the same time, it is also his place of practice. A computer is not ordinarily an office equipment like a typewriter or a duplicating machine. Computers are, therefore, eligible for investment allowance, when it was in vogue and additional depreciation.

(For Queries Author can be reached at yashshah299@gmail.com)

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0 responses to “Tax Planning for Business Expenditure”

  1. Manish says:

    Good Article, keep them coming

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