WIRC - ICAISeminar

OnTaxation of Business Income

Classification of Income As Business IncomeAND

Allowances & Deductions in Computing Business Income

By CA Vinod Kumar Jain

21st March 2009

Flow of the Presentation

I. Conditions for Business Income

II. Allowances and Deductions

I. Basic Concepts

II. Specific Provisions Of Disallowances

III. Expenditures allowed under specific provisions

Profits and Gains of Business Income

Conditions classifying Income as “Business

Income”1. There should be a business

– Business vs Profession– Barendra Prasad Ray’s Case (1981) 2 SCC 693 – Sec 9(1)– G.K. Choksi & Co. vs v. CIT (2007) 295 ITR 376 (SC) - Sec 32 (1)(iv)

2. Business should be in existence- Income before set-up and after-close; not chargeable

Profits and Gains of Business Income

3. Profits or gains should not be chargeable under other headsa) Income from house property (even if letting his business)

• Commercial Property Let Out (Sheetal Khurana) [2009] 308 ITR (AT) 396 (Amritsar)

• Shambhu Investment vs v. CIT (2003) 263 ITR 143 (SC)• If ‘A’ is owner or enjoys lease rights >12 years• PFH Mall vs v. ITO (2008) 298 ITR (AT) 371 Kolkata TRIB

b) Dividend income(even if shares held as stock)

c) Capital gains v/s business income

• Compensation for giving up right to get commission • CIT vs Prabhu Dayal 82 ITR 804 (SC)• CBDT Circular No. 4/2007, dt. 15th June 2007

4. Certain profits or gains are specifically chargeable under business head Certain incentives in case of Exporters Income derived by a Trade, profession or similar association Interest, Remuneration, Commission due or received by a partner Non Competing fee Sum received under Key man Insurance policy Recovery of bad debts Remission or cessation of a liability allowed earlier as deduction Speculative Transactions

Profits and Gains of Business Income

Recent CBDT Circulars C.B.D.T. Circular No. 4/2007, dated 15.6.2007: Distinction

between Shares held as investment (Capital asset) and shares held as Stock-in-trade (trading asset). – CBDT has referred following judgements in this circular:

• CIT vs. Associated Industrial Dev. Co. [1971] 82 ITR 586 (SC)

• CIT vs. H. Holck Larsen [1986] 160 ITR 67 (SC)

• The Authority for Advance rulings (AAR) [2007] 288 ITR 641

– It is possible for a tax payer to have two portfolios – No single principle would be decisive and the total effect of all the

principles should be considered

Basic Concepts1. Onus to prove admissibility of expenditure is on the assessee

2. Expenditure should relate to the previous year

3. Business should be carried on during the previous year

4. Expenditure should have been incurred in connection with

assessee’s own business

5. Expenditure should not be in the nature of capital expenditure

6. Expenditure should not be personal expenditure of the assessee

7. Expenditure should have been incurred in the previous year.

8. Business / Trading Loss

Basic Principles1. Onus to prove admissibility of expenditure is on the

assessee Prove that a particular deduction is admissible in his case Mather & Platt Ltd. vs. CIT 168 ITR 493 (Cal.) – identity & nexus

2. Expenditure should relate to the previous year Method of accounting viz. Cash or Mercantile CIT v. Southern Cables [2007] 289 ITR 167 (Ker) – damages of earlier year Benefit extended beyond – Creative Expenditure

3. Business should be carried on during the previous year S.3 Provides beginning with date of setting up of the Business First Purchase. Manufacturer undertakes first of several activities ESPN Software [2008] 301 ITR 368 (Delhi)- Date of License Chhabda & Sons 65 ITR 638 (Supreme Court) – Discontinued Business

4. Expenditure should have been incurred in connection with assessee’s own business

Revenue V/s Capital Amway India Enterprises v. DCIT [2008] 301 ITR (AT) 1 (Delhi)(SB) - Enduring Benefit, Ownership Test, Functional Test CIT v. Southern Roadways Ltd.[2007] 288 ITR 15 (Mad) –

- Upgradation of computer expenditures is revenue CIT vs General Insurance Corporation (2006) 286 ITR 232 (SC

- expenditure in connection with issue of bonus shares is revenue CIT vs First Leasing Company [2008] 304 ITR 67 (MAD)

- expenditure in connection with issue of debentures is revenue DCIT vs Core Health Care [2009] 308 ITR 263 (GUJ)

- attachment expense to create Brand Image Expenses in respect of discarded projects CIT v. JK synthetics Ltd. [2009] 309 ITR 371 (Delhi)

- pad for process and technical knowhow, supply of technicians & training CIT v. Ponni Sugars [2008] 306 ITR 392 (SC)

-Character of receipt of subsidy

Expenditure should not be in the nature of capital expenditure

Basic Principles Continued…

Expenditure should not be personal expenditure of the assessee What is personal expense? Company distinct assessee – than directors

- vehicles used by directors, not personal- Sayaji Iron vs. CIT (253 ITR 749 Guj)

Expenditure on higher studies- [CIT vs. Kohinoor Paper 226 ITR 220 (M.P.)] - nexus- [CIT vs. Hindustan Hosiery 209 ITR 383] - no nexus

Medical expenses of senior management personnel- 106 ITR 758 (Bom) – allowable- 243 ITR 695 (Mad) – not allowable

Expenditure should have been incurred in the previous year Incurring of the liability should be certain Capable of being estimated Bharat Earth Movers Vs CIT 245 ITR 428 (SC)

Business / Trading Losses

Specific Provisions of Disallowances

a. S.14A: Expenditure in relation to earning tax free incomesb. S.37(1) :Penalty for infraction of lawc. S.37(1) : Expenditure against public policyd. S.37(2B) : Payment to Political partiese. S.40 (a) : Payment outside India / Non Resident without TDSf. S.40a(ia): TDS non deduction / late payment. Retrospective

amendmentg. S.40 A(3) :Disallowance cash payments > Rs.20,000h. S.41 (1): Remission or Cessation of trading liabilityi. S.43B : Certain deductions to be only on actual payments

Specific Provisions of disallowances

Section 14A : Notification No. S.O. 547(E), dated 24.3.2008

– Income Tax Rule 8D i. Amount of expenditure directly relating to exemptii. Interest not directly attributable –

- Amount computed with formula: A x B/C

iii. ½% of the average of the value of investment generating exempt income

ITO vs Daga Capital Management [2008] 119 TTJ (Mumbai) (SB) 289- Section 14 A applies to all heads of Income

- Rule 8D applicable retrospectively

- Section 14 A applies even if shares held as stocks in trade

Specific Provisions of disallowances

S.37(1) :Penalty for infraction of law

CIT vs S.A Builders Pvt Ltd [2008] 299 ITR 88 (P&H).- Compensation paid on account of breach of Contract

S.37(1) : Expenditure against public policy

S.37(2B) : Payment to Political parties- on advertisement in any souvenir, brochure published by political party

S.40 (a) : Payment outside India / Non Resident without TDS- any interest, royalty, fees or other sum chargeable under the Act.

Specific Provisions of disallowances – 40 (a)(ia)

Particulars of TDS made

Particulars of TDS payment

Year of deduction inComputing business income

April to Feb of previous year

(Say year 1)

Any day up to last dayof previous year

(Year 1)

Previous year(Year 1)

In last monthOf previous year

(Year 1)

On or before due dateOf filing return of income

Specified u/s. 139 (1)

Previous year(Year 1)

April to Feb of previous year

(Say year 1)

After end of previous yr(Subsequent previous yr)

(Year 2)

Previous year (Year 2)In which tax is paid

In last monthOf previous year

(Year 1)

After due date of filing Return of income

Previous year (Year 2)In which tax is paid

Specific Provisions of disallowancesS.40 (a)(ia) TDS non deduction / late payment. Retrospective amendment

Kotak Securities Ltd. vs ACIT 25 SOT 440 (Mumbai)- Transaction fees paid to Stock Exchange is not for technical services

CIT vs Bharti Cellular Limited [2008] 220 CTR (DL) 258- Interconnect charge / Telephone line paid to MTNL is not fees for technical services

S.40A(3) : Disallowances in respect of cash payments > Rs. 20,000- New Amendment w.e.f AY 2009-10 Payment made in a single day- Allowances in earlier year, subsequent cash paid, taxable in subsequent year.

When income is estimated by applying GP rate, 40A(3) could not be invoked- CIT v. Smt. Santosh Jain 159 Taxman 392 (P & H)

S.41(1) : Remission or cessation of trading Liability- explanation 1 – Unilateral act by writing off liability taxable

Costal Corp’n Ltd. vs JCIT [2008] 307 ITR (80) 71 (Vishakapatnam) waiver of Principal portion of Loan – 41(1) not attracted

Specific Provisions of disallowances Section 43B: Employer’s Contribution to PF

CIT vs. Vinay Cement Ltd [2007] 213 CTR 268 (SC). - Amendment for allowance if paid before due date – Retrospective

S. 43B: Deduction for tax, duty etc. DCIT vs. Glaxo Smithkline [2008] 299 ITR (AT) 1 (Chandigarh) (SB) - Advance payment of Excise be treated as actual payment of duty- Incurring of a specific liability not necessary “a deduction otherwise allowable” - Unexpired modvat credit can not be treated a advance payment of excise

CIT vs. Raj and San Deeps Ltd. [2007] 293 ITR 12 (P&H: - Excise duty payable as soon as goods are manufactured - Amount kept in “Account Current” cannot be disallowed

CIT v. Kerala Solvent Extractions [2008] 306 ITR 54 (Ker) - Payment towards advance sales tax not entitled to 43B- Opening words of 43B : deductions otherwise allowable

43B(f): Allowance of leave encashment only on actual payment: - Exide Industries Ltd. vs. UOI [2007] 292 ITR 470 (Cal)- Constitutionally not valid: struck down

III EXPENDITURE ALLOWED UNDER SPECIFIC PROVISIONS:

S. 31: Repairs and insurance of machinery, plant and furniture

S. 35 (1) (iia) : Expenditure on Scientific research S. 35D: Amortisation of Preliminary Expenses S. 36(1) (vii): Bad Debts S. 36 (1) (iii): Interest on Borrowed Capital S. 36 (1)(xv) & 36(1)(xvi) : STT and CTT now business

expense S. 37(1): Expenditure wholly and exclusively for the

purpose of business

EXPENDITURE ALLOWED UNDER SPECIFIC PROVISIONS:

Section 31: Repairs and insurance of machinery, plant and furniture - Expln.– Current repairs shall not include nature of Capital Exp (F. Act 2003)

CIT vs. Saravana Spinning Mills P Ltd. [2007] 293 ITR 201 (SC) - Replacement of machine in textile mills may not fall in “current repairs”

Section 35 (1) (iia): Expenditure on Scientific research- wef AY 2009 -10: Weighted deduction for payment to a Co. for S. R.

Section 35D: Amortisation of Preliminary Expenses- wef AY 2009 -10: Amortisation for non industrial entities

CIT v. Neha Proteins Ltd. [2008] 306 ITR 102 (Raj) - Interest on share Appln. money can be set off against public issue exp. - Application money could not be used S. 73(3) and (3A) of Co. Act

EXPENDITURE ALLOWED UNDER SPECIFIC PROVISIONS:

S. 36 (1) (iii): Interest on Borrowed Capital Where Loans & advances given to associates / subsidiaries free of interest S.A Builders Ltd. v. CIT appeals [2007] 288 ITR 1 – No businessman need be compelled to maximise the profit. – “Commercial expediency” is one of wide import and includes such

expenditure as a prudent business- man incurs for the purpose of business

– Expression “for the purpose of business” is wider in scope than the expression “for the purpose of earning profits”

– Whether the amount was advanced as a measure of commercial expediency and not from the point of view whether the amount was advanced for earning profits

– Nexus between the expenditure and purpose of the business (which need not necessarily be the business of the assessee itself) the same needs to be allowed.

Specific Provisions of disallowances Section 36(1) (vii): Bad Debts

- Bombay High Court held w.e.f. 1.4.89 writing off is sufficient - It is not necessary to prove that debt has become bad.

S. 36(1)(xiii): BCTT paid is allowed as deduction.

S. 36 (1)(xv) &(xvi): STT & CTT now considered business expense

S. 37(1): Expenditure should have been laid wholly and exclusively for the purpose of business or profession- Nexus between expenditure and the business to be established - Commercial Expediency even if it may bring a benefit to a third party.- No ceiling of any expenditure it has to be genuine incurred for business - Reasonableness of expenditure from point of view of businessman- Reasonableness of exp. applies u/s. 40A(2)

Stock Valuations

In export business where the stock was valued at cost or market price, whichever is lower, the adoption of this method with reference to the quotation in London market, which was lower than the cost price, was found to be unjustified, because there was no exports during the year- Hindustan Zinc Ltd. v. CIT [2007] 291 ITR 391 (SC)

Valuation of obsolete stock at 10% of the cost could not be

treated as an under valuation - CIT vs. Alfa Laval (India) Ltd. [2007] 295 ITR 451(SC)

Thank You