corporate tax planning_font

DIRECTORATE OF DISTANCE &ONLINE EDUCATION

Corporate TaxPlanning

Corporate Tax Planning

Developed by: Dr. P.K. Sinha

© 2015

For private circulation Students’ Study Material of ADDOE.

All rights reserved. No part of this book may be reproduced, stored in a retrieval system, or copied in any form or byany means, electronic, mechanical, photographic or otherwise, without the prior written permission of the authorand the publisher.

Published by: Himalaya Publishing House Pvt. Ltd., for Amity Directorate of Distance & Online Education, Noida

Syllabus

Corporate Tax Planning

Course Objective:At the end of the course, the students should be able to understand Indian Accounting Standards and the

impact of USGAAP on Financial Statements. To create an understanding of the accounting of Mergers andAcquisitions and Valuation of goodwill and shares.

In addition to Corporate Accounting, the students should be able to demonstrate an understanding of the taxprovisions enabling them to make use of legitimate tax shelters, deductions, exceptions, rebates and allowances;with the ultimate aim of minimizing the corporate tax liability.

Course Contents:Module l: Accounting Norms

Various Accounting Standards in India and comparison with International Accounting Standards andUS.GAAP.

Module II: Accounting for Merger and Acquisitions

Accounting for Acquisitions of Business, Calculation of Purchase consideration and Profit (Loss)Prior to Incorporation. Accounting for Amalgamation in the nature of Merger and in the nature ofPurchase.

Module III: Valuation of Goodwill and Shares

Valuation of Goodwill – Different Methods of Valuation of Goodwill, Valuation of Shares – Net AssetBacking Method and Yield Method.

Module IV: Basic Concepts of Income Tax

Introduction to Income Tax Act, 1961. Residential Status, Exempted Incomes of Companies. Anoverview of various provisions of Business and profession and Capital gains – applicable tocompanies

Module V: Assessment of Companies

Computation of taxable income, MAT, Set-off and carry forward of losses in companies, Deductionsfrom Gross total income applicable to companies. Tax planning with reference to newprojects/expansions/rehabilitation plans including mergers, amalgamation or demergers ofcompanies, Concepts of avoidance of double taxation.

Examination Scheme:

Component Codes H1 H2 H3 EE1Weightage (%) 10 10 10 70

Contents

Unit 1: Accounting Norms 1 – 381.1 Introduction to Accounting Standards1.2 List of Accounting Standards in India1.3 Comparison between Indian GAAP, IFRS and US GAAP1.4 The Roadmap for Implementation of Ind AS1.5 Summary1.6 Check Your Progress1.7 Questions and Exercises1.8 Key Terms1.9 Check Your Progress: Answers

1.10 Case Study1.11 Further Readings

Unit 2 : Accounting for Mergers and Acquisitions 39 – 472.1 Introduction2.2 Definitions2.3 Types of Amalgamations and its Accounting2.4 Accounting for Amalgamation in the books of Transferee Company – (i) The Pooling of Interests

Method and (ii) The Purchase Method2.5 Accounting for Amalgamation in the Books of Transferor Company2.6 Treatment of Reserves2.7 Disclosure2.8 Limited Revisions to AS 14 of Accounting Standard 14 – Accounting for Amalgamation2.9 Companies Act, 1956 and AS 14

2.10 AS 14 and International Accounting Standards2.11 Summary2.12 Check Your Progress2.13 Questions and Exercises2.14 Key Terms2.15 Check Your Progress: Answers2.16 Case Study2.17 Further Readings

Unit 3: Valuation of Goodwill and Shares 48 – 773.1 Introduction to Goodwill3.2 Factors Affecting Value of Goodwill3.3 Need for Valuation of Goodwill3.4 Method of Valuing Goodwill3.5 Introduction to Valuation of Shares3.6 Major Reasons for Valuation of an Enterprise3.7 Analysis and Estimate of Value3.8 Valuation Methods3.9 Summary

3.10 Check Your Progress3.11 Questions and Exercises3.12 Key Terms3.13 Check Your Progress: Answers3.14 Case Study3.15 Further Readings

Unit 4: Basic Concepts of Income Tax 78 – 2224.1 Introduction to Income Tax4.2 Residential Status4.3 Exempted Incomes of Companies4.4 Profits and Gains from Business or Profession4.5 Income under the Head Capital Gains4.6 Exemptions from Capital Gains4.7 Hints for Tax Planning4.8 Problems4.9 Summary


Unit 5: Assessment of Companies 223 – 3215.1 Assessment of Companies5.2 Provisions Relating to Minimum Alternate Tax (MAT)5.3 Set-off and Carry Forward of Losses5.4 Tax Planning with Reference to New Projects/Expansion/Rehabilitation Plans5.5 Tax Planning in Respect of Amalgamation, Merger or Demerger of Companies5.6 Concept of Avoidance of Double Taxation5.7 Summary5.8 Check Your Progress5.9 Questions and Exercises

5.10 Key Terms5.11 Check Your Progress: Answers5.12 Case Study5.13 Further Readings

Accounting Norms 1

Amity Directorate of Distance and Online Education

Notes

Unit 1: Accounting Norms

Structure:1.1 Introduction to Accounting Standards1.2 List of Accounting Standards in India1.3 Comparison between Indian GAAP, IFRS and US GAAP

1.3.1 Presentation of Financial Statements1.3.2 Statement of Cash Flows1.3.3 Non-current Assets Held for Sale and Discontinued Operations1.3.4 Changes in Accounting Policy, Estimates and Correction of Errors1.3.5 Assets1.3.6 Borrowing Costs1.3.7 Investment Property1.3.8 Intangible Assets1.3.9 Impairment (Other than Financial Assets)

1.3.10 Inventories1.3.11 Leases1.3.12 Provisions, Contingent Liabilities and Contingent Assets1.3.13 Taxation1.3.14 Revenue General1.3.15 Revenue — Long-term Contracts/Construction Contracts1.3.16 Employee Benefits1.3.17 Share-based Payments

1.4 The Roadmap for Implementation of Ind AS1.5 Summary1.6 Check Your Progress1.7 Questions and Exercises1.8 Key Terms1.9 Check Your Progress: Answers

1.10 Case Study1.11 Further Readings

Objectives

After studying this unit, you should be able to:● Various accounting standards operating in India● Comparison of Indian AS with International Accounting standards and US GAAP

1.1 Introduction to Accounting Standards

Financial statements summarize the end-result business activities of an enterpriseduring an accounting period in monetary term. Business activities are varied. It isstrenuous task to present the facts intelligibly, in a summarized form, and yet withminimum loss of information. In order that the methods and principles adopted by various

Corporate Tax Planning2


Notes reporting enterprises are coherent, not misleading – and to the extent possible areuniform and comparable – standards are evolved.

The term “Standards”, denote a discipline, which provides both guidelines andyardsticks for evaluations. As guidelines, they provide uniform practices and commontechniques. As yardsticks, standards are used in comparative analysis involving morethan one subject matter.

Accounting Standard is an authoritative pronouncement of code of practice of theregulatory accountancy body to be observed and applied in the preparation andpresentation of financial statements.

World over, professional bodies of accountants have the authority and the obligationto prescribe “Accounting Standards”. International Accounting Standards (IASs) arepronounced by the International Accounting Standards Committee (IASC). The IASCwas set up in 1973, with headquarters in London (UK).

In India, the Institute of Chartered Accountants of India (ICAI) had established in1977 the Accounting Standards Board (ASB). The composition of ASB includes:(i) elected, (ii) ex-officio and (iii) co-opted members of the Institute, nominees of RBI,FICCI, Assocham, ICSI, ICWAI and special invitees from UGC, ICWAI, and specialinvitees from UGC, SEBI, IDBI and IIM.

ASB is entrusted with the responsibility of formulating Standards on significantaccounting matters, keeping in view: (a) international developments as also (b) legalrequirements in India. According to the preface to the Statement on Accounting Standardsissued by the ICAI, Accounting Standards will be issued by the ASB constituted for thepurpose of harmonizing the different and diverse accounting policies and practices in use inIndia and propagating the Accounting Standards and persuading the concerned enterpriseto adopt them in the preparation and presentation of financial statement.

1.2 List of Accounting Standards in India

Accounting Standards (AS) Title of the Accounting Standards

AS 1 Disclosure of Accounting Policies

AS 2 (Revised) Valuation of Inventories

AS 3 (Revised) Cash Flow Statements

AS 4 (Revised) Contingencies and Events Occurring after the Balance SheetDate

AS 5 (Revised) Net Profit or Loss for the Period, Prior Period Items andChanges in Accounting Policies

AS 6 (Revised) Depreciation Accounting

AS 7 (Revised) Accounting for Construction Contracts

AS 9 Revenue Recognition

AS 10 Accounting for Fixed Assets

AS 11 (Revised 2003) The Effects of Changes in Foreign Exchange Rates

AS 12 Accounting for Government Grants

AS 13 Accounting for Investments

AS 14 Accounting for Amalgamations

AS 15 Accounting for Retirement Benefits in the FinancialStatements of Employers

Accounting Norms 3


NotesAS 16 Borrowing Costs

AS 17 Segment Reporting

AS 18 Related Patty Disclosures

AS 19 Leases

AS 20 Earnings Per Share

AS 21 Consolidated Financial Statements

AS 22 Accounting for Taxes on Income

AS 23 Accounting for Investment in Associates in ConsolidatedFinancial Statements

AS 24 Discontinuing Operations

AS 25 Interim Financial Reporting

AS 26 Intangible Assets

AS- 27 Financial Reporting of Interest in Joint Ventures

AS 28 Impairment of Assets

AS 29 Provisions, Contingent Liabilities and Contingent Assets

1.3 Comparison between Indian GAAP, IFRS and US GAAP

Comparison between Indian GAAP, IFRS and US GAAP is to help readers identifythe significant differences and similarities between Indian GAAP, IFRS, as issued by theIASB, and US GAAP. Primary focuses only on recognition and measurement principlesand certain presentation requirements. This comparison includes only those keysimilarities and differences that are more commonly encountered in practice in India.

Indian GAAP comprises of Accounting Standards notified by the MCA, Schedule VIto the Companies Act, 1956 and selected Guidance Notes issued by the Institute ofChartered Accountants of India (ICAI) applicable to companies other than SMEs for thefinancial year ending on March 31, 2014.

It also considers only IFRS and US GAAP standards that are mandatory for thefinancial year ending on March 31, 2014; standards issued but not yet effective orpermitting early adoption have not been considered.

The Comparison does not address industry-specific guidance for industries such asfinancial institutions including banks, not-for-profit organizations and retirement benefitplans. In particular, the following IFRS and corresponding Indian GAAP and US GAAPguidance have not been included in this due to their specialised nature:

IAS 26, Accounting and Reporting by Retirement Benefit Plans IAS 41, Agriculture IFRS 4, Insurance Contracts IFRS 6, Exploration For and Evaluation of Mineral Resources IFRIC 12, Service Concession Arrangements IFRIC 20, Stripping Costs in the Production Phase of a Surface Mine

The comparison also does not include the principles for first-time adoption of IFRSor IFRS for SMEs.

This comparison is only a summary guide; for details of Indian GAAP, IFRS and USGAAP requirements.



Notes Overall Financial Statement Presentation

1.3.1 Presentation of Financial Statements

Indian GAAP IFRS US GAAP

Primary guidance: AS 1,Schedule VI

Primary guidance: IAS 1 Primary guidance: ASC 205,ASC 210, ASC 215, ASC 220,ASC 225, ASC 235, ASC 505,Regulation S-K, S-X

Selection of Accounting Policies

Entities preparing firstfinancial statements incompliance with IndianGAAP are required to complywith all accounting standards.

Entities preparing firstfinancial statements incompliance with IFRS applyoptional exemptions andmandatory exceptions inIFRS 1 to the retrospectiveapplication of IFRS.

Similar to Indian GAAP.

Non-compliance withaccounting standards or theCompanies Act is prohibitedunless permitted by otherregulatory framework.

IFRS may be overridden inextremely rare circumstanceswhere compliance would beso misleading that it conflictswith the objective of financialstatement set out in the IFRSframework and thus,departure is needed toachieve fair presentation.

Unlike IFRS, US GAAP doesnot permit an entity to departfrom generally acceptedaccounting principles.

Entities meeting theconditions to qualify as Smalland Medium Sized Companyhave certain exemption orrelaxation in complying withthe accounting standards.

IFRS for SMEs is aself-contained set ofaccounting principles that arebased on full IFRS, but thathave been simplified to theextent suitable for SMEs. TheIFRS for SMEs and full IFRSare separate and distinctframeworks.

Unlike Indian GAAP and IFRS,there is no exemption orrelaxation in complying with USGAAP requirements exceptcertain relaxations fornon-public companies. Theaccounting standards may havediffering date of implementationfor public entities andnon-public entities.

There is no requirement tomake an explicit andunreserved statement ofcompliance with IndianGAAP in the financialstatements.

Entities should make anexplicit and unreservedstatement of compliance with

IFRS as issued by IASB inthe notes to financialstatements.


There is no specific guidancewhen Indian GAAP does notcover a particular issue.

In the absence of specificIFRS requirement,management considers ahierarchy of alternativesources provided in IAS 8.

US GAAP is divided intoauthoritative andnon-authoritative literature.

Components of Financial Statements

The requirements for thepresentation of financial

A complete set of financialstatements comprises of a

Similar to IFRS except that astatement of changes in equity

Accounting Norms 5


Notesstatements are set out inStatutes that governs theentity. For instance,Schedule VI to theCompanies Act sets outfinancial statementrequirements in case ofcompanies; Schedule III tothe Banking Regulation Act,1949 (for banks) sets outfinancial statementrequirements in case ofbanks.In general, the financialstatements comprises ofbalance sheet; statement ofprofit and loss; cash flowstatement, if applicable andnotes to the financialstatements includingsummary of accountingpolicies.A statement ofcomprehensive income is notrequired to be prepared.A statement of changes inequity is not required.Movement in share capital,retained earnings and otherreserves are presented in thenotes to the financialstatements.

statement of financialposition, a statement ofcomprehensive income; astatement of changes inequity; a statement of cashflows and notes to thefinancial statements includingsummary of accountingpolicies.

may be presented in the notesto the financial statements.

Presentation of Consolidated Financial Statements

Only listed entities with oneor more subsidiaries arerequired to presentconsolidated financialstatements.

Entities with one or moresubsidiaries are required topresent consolidatedfinancial statements unlessspecific criteria are met.

Generally, there are noexemptions. However, USGAAP does provide limitedexemptions from consolidationin certain specialized industries.

Comparatives

Comparative information isrequired for preceding periodonly.

Similar to Indian GAAPhowever, entities makingprior period adjustment orreclassifications or applyingaccounting policyretrospectively shouldpresent a statement offinancial position as at thebeginning of the earliestcomparative period.

No comparative information isrequired in case of non-publicentities. In case of publicentities,comparative informationis required for two precedingyears except for the statementof financial position which isrequired only for the precedingperiod.Unlike IFRS, there is norequirement to present astatement of financial position



Notes as at the beginning of theearliest comparative periodunder any circumstances.

Classification of Items of the Statement of Financial Position

All items are classified aseither current or non-current.

Similar to Indian GAAPexcept that an entity shallpresent all assets andliabilities in order of liquiditywhen a presentation basedon liquidity providesinformation that is reliableand more relevant.

Generally, entities are requiredto present items in thestatement of financial positionas either current or non-current.

Deferred income tax assetsand liabilities are classifiedand presented asnon-current.

Similar to Indian GAAP. Unlike Indian GAAP and IFRS,deferred tax assets andliabilities are classified as eithercurrent or non-current based onthe classification of the relatedasset or liability.

In case of minor default ofloan covenants resulting intoloan becoming callable, anentity classifies the loan asnon-current provided thelender has not recalled theloan before the date ofapproval of financialstatements.

A liability that is payable ondemand because certainconditions are breached isclassified as current even ifthe lender has agreed, afterthe end of the reportingperiod but before the financialstatements are authorised forissue, not to demandrepayment.

Unlike IFRS, such a liability isnot classified as current if thelender subsequently has lostthe right to demand repaymentor has waived after the end ofthe reporting period, the right todemand repayment for morethan 12 months from the end ofthe reporting period. Further,the loan can be classified asnon current if the entity has agrace period to cure breach ofconditions and it is probable thatviolation will be cured within thatgrace period.

Refinancing subsequent tobalance sheet date is notconsidered while determiningthe appropriate classificationof the loan

Similar to Indian GAAP. Unlike Indian GAAP and IFRS,refinancing subsequent tobalance sheet date isconsidered in determining theappropriate classification of theloan.

Offsetting of Financial Assets and Financial Liabilities

There is no specificguidance.

Entities are required to set offfinancial assets and financialliabilities in the balance sheetwhen the criteria for set offare met.

Unlike IFRS, offsetting iselective. Further, criteria foroffset differ as compared toIFRS.

Classification of Expenses

Expenses are classified bynature.

Expenses are classifiedeither by nature or function.Certain additional disclosuresare required in the notes to

Generally classified by function.Public entities are required toclassify the expenses byfunction only. Similar to Indian

Accounting Norms 7


Notesthe financial statementsdepending on thepresentation choice electedby the entity.

GAAP and unlike IFRS, thereare no additional disclosuresrequired in the financialstatements depending on thepresentation choice elected.

Extraordinary Items

Extraordinary items aredisclosed separately in thestatement of profit and lossand are included in thedetermination of net profit orloss for the period. Does notuse the term exceptional itembut requires separatedisclosure of items that are ofsuch size, incidence onnature that require separatedisclosure to explain theperformance of the entity.Revised Schedule VIspecifically requiresdisclosure as a separate lineitem on the face of theincome statement.

Entities are not permitted topresent any item of income orexpense as extraordinary.Similar to Indian GAAPexcept that disclosure maybe on the face of the incomestatement or in the notes.

Similar to Indian GAAP but israrely seen in practice.However, the criteria fordetermining an income orexpense as extraordinary differas compared to Indian GAAP.

The term exceptional items isnot used, but significant itemsare disclosed separately on theface of the income statementwhen arriving at income fromoperations, as well as beingdescribed in the notes.

Presentation of OCI or Similar Items

There is no concept of OCI(other comprehensiveincome). All incomes,expenses, gains and lossesare presented in the incomestatement except certainitems are required to bedirectly recognized inreserves. For e.g.,revaluation surplus andforeign currency translationreserve.

OCI items may be presentedin a single statement ofcomprehensive income or aseparate statement.

OCI items may be presented aspart of the income statement orin a separate statement.

Presentation of Profit or Loss Attributable to Non-controlling (Minority) Shareholders

Profit or loss attributable tonon-controlling shareholdersis disclosed as a deductionfrom the profit or loss for theperiod as an item of incomeor expense.

Profit or loss attributable tonon-controlling interestholders and equity holders ofthe parent entity is disclosedas allocation of profit or lossand total comprehensiveincome for the period.


Disclosure of Estimation Uncertainty and Critical Judgments

No specific requirement Entities should disclose in thefinancial statements aboutkey sources of estimationuncertainty and judgments

Unlike IFRS, only public entitiesare required to provide similardisclosure.



Notes made in applying entity’scritical accounting policies.

New Pronouncement Issued But Not Yet Effective

No specific requirement todisclose information aboutnew pronouncement issuedbut not yet effective.

Entities are required todisclose the impact of newIFRS issued but is not yeteffective as at the reportingdate.

Unlike IFRS, only public entitiesare required to provide a similardisclosure.

1.3.2 Statement of Cash Flows

Primary guidance: AS 3,AS 24

Primary guidance: IAS 7,IFRS 5

Primary guidance: ASC 230,ASC 830

Definition of Cash and Cash Equivalents

Cash and cash equivalentcomprises of cash andshort-term, highly liquidinvestments that are readilyconvertible to knownamounts of cash and subjectto insignificant risk ofchanges in value.Generally investments withoriginal maturities of threemonths or less from the dateof acquisition qualify as cashequivalent. Bank overdraftsare excluded.

Similar to Indian GAAPexcept that cash equivalentincludes bank overdraft incertain situations.

Unlike IFRS, bank overdraftsare included in liabilities andexcluded from cash equivalents.Changes in overdraft balancesare financing activities.

Classification of Cash Flow

The statement of cash flowspresents cash flows duringthe period classified intooperating, investing andfinancing activities.

Similar to Indian GAAP. Similar to Indian GAAP andIFRS.

Methods of Presenting Operating Cash Flows

Listed entities in India shouldpresent operating cash flowsusing indirect method. Otherentities can present operatingcash flows either using directmethod or indirect method.Entities presenting operatingcash flows using directmethod need not reconcile thenet income to net cash flowsfrom operating activities.Under both methods, cashflows from interest and incometaxes paid should each bedisclosed separately.

Similar to Indian GAAPexcept that listed entities alsohave a choice of the directmethod.

Similar to IFRS except thatentities presenting operatingcash flows using direct methodshould reconcile the net incometo net cash flows from operatingactivities.

Accounting Norms 9


NotesGross versus net reporting

Generally all financing andinvesting cash flows arereported gross. Cash flowsmay be reported on net basisonly in limited circumstances.


Classification of Income Tax Cash Flows

Income tax cash flows areclassified as operating unlessspecifically identified withfinancing or investingactivities.

Similar to Indian GAAP. Income tax cash flows areclassified as operating activities.

Classification of Interest and Dividend

Interest paid and dividendpaid Financial entities:Interest paid is classified asoperating activities anddividend paid is classified asfinancing activities. Otherentities: Both are classifiedas financing activities.Interest received anddividend received Financialentities: Interest received isclassified as operatingactivities and dividendreceived is classified asinvesting activities. Otherentities: Both are classifiedas investing activities.

Cash flows from interest anddividends can be classifiedas either operating, financingor investing cash flows in aconsistent manner fromperiod to period.

Interest received and interestpaid are classified as operatingcash flows. Dividend received isgenerally classified as operatingcash flows. Dividends paid areclassified as financing activities.

Disclosure of Cash Flows Pertaining to Discontinued Operations

Entities are required todisclose in the notes the netcash flows attributable toeach of operating, financingor investing activities ofdiscontinued operations.

Similar to Indian GAAPexcept that entities canpresent such information onthe face of the cash flowstatement.

Unlike Indian GAAP and IFRS,an entity is not required todisclose cash flows pertainingto discontinued operationsseparately in the statement ofcash flows.

Cash Flows from Extraordinary Items

Cash flows arising fromextraordinary items should beclassified as arising fromoperating, investing orfinancing activities asappropriate and separatelydisclosed.

Presentation of extraordinaryitems is not permitted.Hence, the cash flowstatement does not reflect antitems of cash flow asextraordinary.


Reconciliation of Cash and Cash Equivalent in the Statement of Cash Flows to theStatement of Financial Position

Entities should present thereconciliation of the amounts

Similar to Indian GAAP. Cash and cash equivalent in thestatement of cash flows is



Notes generally the same as similarlytitled line items or sub-totals inthe statement of financialposition.

Foreign Currency Cash Flows

Foreign currency cash flowsare translated at theexchange rates at the datesof the cash flows (or a ratethat approximates the actualrate when appropriate).Foreign currency cash flowsare translated at theexchange rates at the datesof the cash flows (or a ratethat approximates the actualrate when appropriate).


1.3.3 Non-current Assets Held for Sale and Discontinued Operations

Primary guidance AS 10, AS24

Primary guidance: IFRS 5 Primary guidance: ASC 205,ASC 230, ASC 360

Introduction

There is no standard dealingwith non-current assets heldfor sale. However, AS 10deals with assets held fordisposal. Items of fixedassets retired from active useand held for disposal arestated at the lower of their netbook value and net realizablevalue. Any expected loss isrecognized immediately inthe statement of profit andloss.

Non-current assets to bedisposed off are classified asheld for sale when the assetis available for immediatesale and the sale is highlyprobable. Depreciationceases on the date when theassets are classified as heldfor sale. Non-current assetsclassified as held for sale aremeasured at the lower of itscarrying value and fair valueless cost to sell.

Similar to IFRS.

An operation is classified asdiscontinued at the earlier of:• a binding sale agreement

for sale of operations• on approval by the board

of directors of a detailedformal plan andannouncement of the plan.

An operation is classified asdiscontinued when it haseither has been disposed of,or is classified as held forsale and:• represents a separate

major line of business orgeographical area ofoperations

• is part of a singlecoordinated plan todispose of a separatemajor line of business orgeographical area ofoperations; or

A component of an entity shouldbe classified as a discontinuedoperation if all the followingconditions have been met:• it has been disposed of or

classified as held for sale• the operations and cash

flows of the component havebeen (or will be) eliminatedfrom the ongoing operationsof the entity as a result of thedisposal transaction

• the entity will not have anysignificant continuinginvolvement in the operations

Accounting Norms 11


Notes• is a subsidiary acquiredexclusively with a view toresale.

of the component after thedisposal transaction.

Presentation and Disclosure

Items of fixed assets retiredfrom active use and held fordisposal are shownseparately in the financialstatements.

Non-current assets classifiedas held for sale are shownseparately in the financialstatements.

Similar to IFRS.

The amount of pre-tax profitor loss from ordinaryactivities attributable to thediscontinuing operationduring the current financialreporting period, and theincome tax expense relatedthereto and the amount of thepre-tax gain or lossrecognised on the disposal ofassets or settlement ofliabilities attributable to thediscontinuing operation isrequired to be presented onthe face of profit and loss.Following information isrequired to be disclosed innotes for discontinuedoperations: for periods up toand including the period inwhich the discontinuance iscompleted:the carrying amounts, as ofthe balance sheet date, of thetotal assets to be disposed ofand the total liabilities to besettled; the amounts ofrevenue and expenses inrespect of the ordinaryactivities attributable to thediscontinuing operationduring the current financialreporting period; andthe amounts of net cashflows attributable to theoperating, investing, andfinancing activities of thediscontinuing operationduring the current financialreporting period.

A single amount comprisingthe total of the post-tax profitor loss of discontinuedoperations and the post-taxgain or loss recognised onthe measurement to fairvalue less costs to sell or onthe disposal of the assets ordisposal group(s) constitutingthe discontinued operation ispresented in the statement ofcomprehensive income. Ananalysis of the same isrequired which may bepresented in the notes orseparately in the statement ofcomprehensive income.The net cash flowsattributable to the operating,investing and financingactivities of discontinuedoperations is required to bepresented either in notes orseparately in the financialstatements.

Similar to IFRS. However, cashflow information is not requiredto be disclosed separately.



Notes Comparative information forprior periods that ispresented in financialstatements prepared after theinitial disclosure event shouldbe restated to segregateassets, liabilities, revenue,expenses, and cash flows ofcontinuing and discontinuingoperations.

Similar to Indian GAAP, theamounts related todiscontinued operations arere-presented for prior periodsexcept that information oncarrying amounts of relevantassets and liabilities, ifpresented, is not restated.

Similar to IFRS except that cashflow information is restated onlyif cash flow information fordiscontinued operations ispresented separately.

1.3.4 Accounting PoliciesChanges in Accounting Policy, Estimates and Correction of Errors

Primary guidance: AS 5 Primary guidance: IAS 1,IAS 8, IAS 33

Primary guidance: ASC 250,ASC 260, SEC SAB Topic 11:

Change in Accounting Policy

Accounting policy is changedin response to new or revisedaccounting standards or on avoluntary basis if the newpolicy is more appropriate.


Requires prospectiveapplication (unless anaccounting standard requiresotherwise) together with adisclosure of the impact ofthe same, if material.Cumulative effect of thechange is recognised incurrent year profit and loss.Further, unlike IFRS and USGAAP, change indepreciation method isconsidered a change inaccounting policy.

Requires retrospectiveapplication by adjustingopening equity andcomparatives unlessimpracticable.

Similar to IFRS.

A statement of financialposition at the beginning ofthe earliest comparativeperiod is not required underany circumstances.

When an entity applies anaccounting policyretrospectively or makes aretrospective restatement ofitems in its financialstatements or when itreclassifies items in itsfinancial statements, entityshould present a statement offinancial position at thebeginning of the earliestcomparative period.

Similar to Indian GAAP;however the effect is required tobe separately disclosed.

Correction of Errors

Prior period errors areincluded in determination of

Prior period errors arecorrected by adjusting

Similar to IFRS with noimpracticability exemption.

Accounting Norms 13


Notesprofit or loss for the period inwhich the error is discoveredand are separately disclosedin the statement of profit andloss in a manner that theimpact on current profit orloss can be perceived.

opening equity and restatingcomparatives, unlessimpracticable.

Change in accounting estimates

Requires prospectiveapplication of a change inaccounting estimates.


1.3.5 AssetsProperty Plant and Equipment (PPE)

Indian GAAP IFRS US GAAPPrimary guidance: AS 6, AS10, AS 16, AS 28

Primary guidance: IAS 16,IAS 23, IAS 36

Primary guidance: ASC 360,ASC 410, ASC 835

Initial RecognitionCost includes all expendituredirectly attributable inbringing the asset to thepresent location and workingconditions for its intendeduse.


PPE purchased on deferredsettlement terms are notexplicitly dealt with in AS 10.Cost of fixed assets includepurchase price for deferredpayment term unless interestelement is specificallyidentified in the arrangement.

Difference between thepurchase price under normalcredit terms and the amountpaid, is recognised asinterest expense over theperiod of the financing.

Similar to IFRS.

There is no specific referenceon whether cost of an item ofPPE includes costs of itsdismantlement, removal orrestoration, the obligation forwhich an entity incurs as aconsequence of installing theitem.

The cost of an item of PPEincludes such costs.

Similar to IFRS.

Cost of major inspections andoverhauls are generallyexpensed when incurred,unless that increases thefuture benefits from theexisting asset beyond itspreviously assessed standardof performance.

Cost of major inspections andoverhauls are capitalised onlywhen it is probable that it willgive rise to future economicbenefits.

Major inspections andoverhauls may be expensed asincurred (direct expensingmethod) or capitalized andamortized to the next majorinspection or overhaul (built-inoverhaul and deferral methods).



Notes Subsequent Costs

Subsequent expendituresrelated to an item of PPEshould be capitalised only ifthey increase the futurebenefits from the existingasset beyond its previouslyassessed standard ofperformance.


Revaluations

Revaluation is permitted. Nospecific requirement onfrequency of revaluation.

Subsequent measurement ofPPE may be based on therevaluation model, for a classof assets. Revaluation isrequired to be carried out atsufficient regularity such thatthe carrying amount is notmaterially different from thefair value at the end of thereporting period.

Revaluation is not permitted.

Depreciation

The Companies Act specifiesthe minimum depreciationrates to be used for differentcategories of assets.Component accounting ispermitted but is rarely followedin practice.

Depreciation is based on the‘component’ approach;depreciation is charged overthe estimated useful life of theasset. Depreciation methodshould reflect the pattern ofthe future economic benefitsassociated with the asset.

Similar to IFRS.

There is no specificrequirement to reassessdepreciation method, residualvalue and useful life at eachbalance sheet date.

Depreciation method,residual value and useful lifeare reassessed at eachbalance sheet date.

Depreciation method, residualvalue and useful life arereassessed only when events orchanges in circumstancesindicate a possible change inthe estimates.

ARO (Asset Retirement Obligation)—Recognition and Measurement


Provisions for the estimatedcost of dismantling andremoving an asset andrestoring a site shall berecognised and measured inaccordance with theprovisions in IAS 37.When a present valuetechnique is used to estimatethe liability, the discount ratewill be a pretax rate thatreflects current marketassessments of the timevalue of money and the risks

A liability for an ARO shall berecognised at fair value in theperiod in which it is incurred if areasonable estimate of fairvalue can be made. If areasonable estimate of the fairvalue of the liability cannot bemade in the period theobligation is incurred, a liabilityshall be recognised when areasonable estimate of fairvalue can be made.When a present valuetechnique is used to estimate

Accounting Norms 15


Notesspecific to the liability. the liability, the discount rate willbe a risk-free interest rateadjusted for the effect of theentity’s credit standing.


If the obligation was incurredduring a period in which thePPE was used to produceinventory, the ARO would beadded to the carrying amountof the inventory.

Unlike IFRS, the ARO is addedto the carrying amount of therelated long-lived asset.

ARO — Changes in Measurement


The ARO should be adjustedfor changes in the estimate ofexpected undiscounted cashflows or discount rate as ofeach balance sheet date. Theentire obligation should ber-remeasured using anupdated discount rate thatreflects current marketconditions as of the balancesheet date.

Period-to-period revisions toeither the timing or amount ofthe original estimate ofundiscounted cash flows aretreated as separate layers of theobligation. Upward revisions arediscounted using the currentcredit-adjusted risk-free rate.Downward revisions arediscounted using the originalcredit-adjusted risk-free rate.

1.3.6 Borrowing Costs


Primary guidance AS 16 Primary guidance: IAS 23 Primary guidance: ASC835-20

Definition of Qualifying Asset

A qualifying asset is an assetthat necessarily takessubstantial period of time to getready for its intended use orsale. A period of twelve monthsis considered a substantialperiod unless a shorter or longerperiod can be justified.

Similar to Indian GAAP.However, unlike IndianGAAP, there is no bright linefor the term ‘substantialperiod’.

Similar to IFRS.

Equity method investeecannot be a qualifying asset.

Similar to Indian GAAP. Unlike Indian GAAP and IFRS,equity method investee can bea qualifying asset.

Definition of Borrowing Costs

Borrowing costs are interestand other costs that an entityincurs in connection with theborrowing of funds.Borrowing costs includeexchange differences arisingfrom foreign currencyborrowings to the extent thatthey are regarded as anadjustment to interest costs.

Similar to Indian GAAP. Unlike Indian GAAP and IFRS,borrowing costs are generallylimited to interest cost inconnection with the borrowings.For e.g., foreign-currency gainsor losses, are not regarded asan adjustment to interest costs.



Notes Recognition of Borrowing Costs

Borrowings costs attributableto qualifying asset form partof the cost of that asset.Other borrowing costs areexpenses as incurred.


Income earned on thetemporary investments of theborrowings specific to aqualifying asset is reducedfrom the borrowing costs forcapitalisation.

Similar to Indian GAAP. Unlike Indian GAAP and IFRS,income earned on thetemporary investments of theborrowings is not reduced fromthe costs for capitalisation andis shown on gross basis asincome in the profit or loss.

1.3.7 Investment Property

Primary guidance: AS 13 Primary guidance: IAS 40 Primary guidance: SeeSection 4.1, ‘Property, Plantand Equipment’

Introduction

Investment property isproperty (land or building) notintended to be occupiedsubstantially for use by, or inthe operations of, theinvesting enterprise.

Investment property isproperty (land or abuilding—or part of abuilding—or both) held toearn results or for capitalappreciation, or both.

Unlike IFRS and Indian GAAP,there is no specific definition ofinvestment property; suchproperty is accounted for asproperty, plant and equipment.

Property held by a lesseeunder an operating lease isnot recognised in the balancesheet.

Property held by a lesseeunder an operating leasemay be classified asinvestment property if thedefinition of the investmentproperty is met and thelessee measures all itsinvestment property at fairvalue.


Measurement at Initial Recognition

Investment property initiallyrecognised at cost.


Measurement Subsequent to Initial RecognitionMeasured at cost lessaccumulated depreciationless other-than-temporaryimpairment loss, if any.

Measured using either fairvalue (subject to limitedexceptions), with change infair value recognised in profitor loss or at cost lessaccumulated depreciationless impairment loss, if any.If the investment propertymeasured at cost lessaccumulated depreciationless impairment loss, if any,

All investment properties aremeasured using cost lessaccumulated depreciation lessimpairment loss, if any.

Accounting Norms 17


Notesan entity should disclose thefair value of its investmentproperty.

1.3.8 Intangible AssetsNote: This section does not cover goodwill. AAP IFUS GAAP

Primary guidance: AS 26 Primary guidance: IAS 38,IFRS 3, SIC 32

Primary guidance: ASC 340,ASC 350, ASC 720, ASC 730,ASC 805, ASC 985

Definition

An intangible asset is definedas an identifiablenon-monetary asset withoutphysical substance. An assetis identifiable if it isseparable—capable of beingsold, transferred, licensed,rented, or exchanged orarises from contractual orlegal rights.


The cost of separatelyacquired intangible assetsincludes the following:Purchase priceDirectly attributable costs toget the asset ready for itsintended use.

No guidance on determiningthe cost of intangible assetwhen acquired with a groupof other assets.


If an intangible asset isacquired with a group of otherassets (but not thoseacquired in a businesscombination), the cost of thegroup shall be allocated tothe individual identifiableassets and liabilities on thebasis of their relative fairvalues at the date ofpurchase. Such a transactionor event does not give rise togoodwill.

Similar to Indian GAAP andIFRS.

Similar to IFRS.

Internal Research and Development

Research expenditure isexpensed as incurred.Development expenditure iscapitalised if specific criteriaare met.

Similar to Indian GAAP. Generally expensed asincurred.

Subsequent Measurement

Intangible assets areamortised over theirexpected useful lives. Theuseful life may not beindefinite. There is arebuttable presumption thatthe useful life of the

Intangible assets with finiteuseful lives are amortisedover their expected usefullives.Intangible assets withindefinite useful lives are not

.Similar to IFRS except thatintangible assets cannot berevalued. An entity has anoption of performing aqualitative assessment forimpairment tests.



Notes intangible asset will notexceed ten years from thedate when the asset isavailable for use.

amortised but tested forimpairment at least annually.Intangible asset may berevalued to fair value only ifthere is an active market.

Advertising and Promotional Expenditure

Expensed as incurred. Similar to Indian GAAP. Direct-response advertising iscapitalised if specific criteria aremet. Other advertising andpromotional expenditure isexpensed as incurred ordeferred until the advertisementfirst appears.

1.3.9 Impairment (Other than Financial Assets)

Primary guidance: AS 28 Primary guidance: IAS 36 Primary guidance: ASC 350,ASC 360

Frequency of Impairment Testing

An entity should test theassets or a cash generatingunit (CGU) for impairment atthe end of each reportingperiod if the impairmentindicators exist. However, anentity should test thefollowing assets forimpairment annuallyirrespective of whether theimpairment indicators existsor not:an intangible asset not yetavailable for use; andan intangible asset with anestimated useful life of morethan ten years.CGU is defined as thesmallest identifiable group ofassets that generates cashinflows that are largelyindependent of the cashinflows from other assets orgroups of assets.

Similar to Indian GAAP.However, an entity shouldtest the following assets forImpairment annuallyirrespective of whether theimpairment indicators existsor not:an intangible asset not yetavailable for use;an intangible asset with anindefinite useful life; andgoodwill acquired in abusiness combinationSimilar to Indian GAAP.

Similar to IFRS.

The terminology ‘asset groups’is similar to CGU used in IndianGAAP and IFRS.A reporting unit is an operatingsegment or one level below anoperating segment (referred toas a component).

Level of Impairment Testing

Tested at CGU level. Similar to Indian GAAP. Similar to Indian GAAP andIFRS except that goodwill istested for impairment atreporting unit level and specificguidance is applied todetermine the level ofimpairment testing of intangible

Accounting Norms 19


Notesassets not subject toamortisation.

Measurement of Impairment Loss on GoodwillThe recoverable amount ofthe CGU (higher of fair valuesless costs to sell and value inuse, which is based on thenet present value of futurecash flows) is compared withthe carrying amount of theCGU.The impairment loss isallocated by first reducingany goodwill of the CGU andthen reducing the carryingvalue of other assets of theCGU on a pro rata basis,subject to certain constraints.

Similar to Indian GAAP. Theimpairment test is a one-stepprocess. If the recoverableamount is below the carryingamount, an impairment lossis recognised. Recoverableamount is the higher of valuein use and fair value lesscosts to sell. Value in use isfuture discounted cash flowsfrom an asset orcash-generating unit.

An entity may first assess onlyqualitative factors to determinewhether it is necessary toperform the two-step goodwillimpairment test. If an entitydetermines that it is more likelythan not that the fair value of areporting unit is less than itscarrying amount, the followingprocess is followed:The first step compares the fairvalue of the reporting unit withthe carrying amount.Goodwill is impaired if thereporting unit’s fair value is lessthat its carrying amount. Ifgoodwill is impaired, then thesecond step is performed todetermine the amount ofimpairment measured as thedifference between goodwill ’simplied fair value and itscarrying amount.

Measurement of Impairment Loss for Other Non-financial Assets

Impairment loss isrecognised if the asset’s orCGU’s carrying amountexceeds its recoverableamount of the CGU (higher offair values less costs to selland value in use, which isbased on the net presentvalue of future cash flows).

Similar to Indian GAAP. Impairment loss is recognised ifthe carrying amount of the assetexceeds its fair value.For intangible assets that areamortized and other long-livedassets, an entity first comparesif the carrying amount exceedsthe sum of the undiscountedcash flows expected from theuse and eventual disposition toassess if there is an impairment.For indefinite-lived intangibleassets, an entity may firstperform a qualitativeassessment to determinewhether it is necessary toperform the quantitativeimpairment test.

Reversal of Impairment Loss

Reversal of impairment lossis recognised in profit andloss. An impairment lossrecognised for goodwillshould not be reversed in a

Reversal of impairment ispermitted except for thoserelating to goodwill.

Reversal of impairment loss isnot permitted.



Notes subsequent period unlesscertain conditions aresatisfied.Measurement of reversal ofimpairment loss:Entity should increase thevalue of the asset to itscurrent recoverable amount.However, current recoverableamount should not exceedthe carrying amount of theasset that would have existedif no impairment loss hadbeen recognised.


1.3.10 Inventories

Primary guidance: AS 2 Primary guidance: IAS 2 Primary guidance: ASC 330

Measurement of inventories

Measured at the lower of costand net realisable value.Net realisable value is theestimated selling price lessthe estimated costs ofcompletion and sale.

Similar to Indian GAAP. Unlike Indian GAAP and IFRS,measured at the lower of costand market. ‘Market’ meanscurrent replacement cost.However, Market shall notexceed net realisable value andshall not be less than netrealisable value reduced by anallowance for an approximatelynormal profit margin. Netrealisable value is similar toIndian GAAP and IFRS.

Cost of Inventories

The cost of inventoriescomprises of all costs ofpurchase, costs ofconversion and other costsincurred in bringing theinventories to their presentlocation and condition.


Inventories purchased ondeferred settlement terms arenot explicitly dealt with inAS 2. Cost of inventoriesinclude purchase price fordeferred payment termunless interest element isspecifically identified in thearrangement.

Difference between thepurchase price for normalcredit terms and the amountpaid, is recognised asinterest expense over theperiod of the financing.

Similar to IFRS.

Cost Formulas

FIFO and weighted averagecost are acceptable

Similar to Indian GAAP. Similar to Indian GAAP andIFRS except that cost of

Accounting Norms 21


Notesaccounting method fordetermining the cost ofinventories. Specificidentification may be used incertain situations. The LIFOmethod is not permitted.

inventories can also bedetermined using LIFO.

The same cost formula isapplied for all inventorieshaving similar nature and useto the entity.

Similar to Indian GAAP. Unlike IFRS and Indian GAAP,the same cost formula need notbe applied to all inventorieshaving a similar nature and useto the entity.

Reversal of write down of inventory

There is no specificguidance. However,reversals may be permittedas AS 5 requires this to bedisclosed as a separate lineitem in the statement of profitand loss.

Reversal of write-down ofinventory is permitted. Theamount of reversal is limitedto the original write down.

Unlike Indian GAAP and IFRS,reversal of a write-down ofinventory is not permitted.

Liabilities

1.3.11 Leases

Primary guidance: AS 19 Primary guidance: IAS 17,IAS 40, SIC 15, SIC 27,IFRIC 4

Primary guidance: ASC 840

ScopeA lease is an arrangementwhereby the lessor conveysto the lessee in return for apayment or series ofpayments the right to use anasset for an agreed period oftime. Lease agreement touse land is not accounted aslease transaction.There is no specific guidanceon whether an arrangementcontains a lease. Paymentsunder arrangements whichare not in the form of leasesare generally recognised inaccordance with the nature ofexpense incurred.


Lease arrangement to uselands are accounted as leasetransaction.Arrangements that do nottake the legal form of a leasebut fulfillment of which isdependent on the use ofspecific assets and whichconvey the right to use theassets may have to beaccounted for as leases.

Similar to Indian GAAP andIFRS, except that leaseaccounting guidance appliesonly to property, plant andequipment.

Similar to IFRS.

Similar to IFRS.

Lease ClassificationA lease is classified as eitheran operating or a financelease at the inception of thelease.

Similar to Indian GAAP Similar to Indian GAAP andIFRS. Finance lease is referredas capital lease. In respect oflessors, capital leases arecategorised as direct financingleases and sale-type leases,



Notes which differ in certain respectsfrom IFRS and Indian GAAP.

The lease classificationdepends on whethersubstantially all of the risksand rewards incidental toownership have beentransferred from the lessor tothe lessee.

Similar to Indian GAAP. The classification of a leasedepends on whether the leasemeets certain criteria. Lease ofland is generally classified asoperating lease unless the titletransfers to the lessee.

Separation of Lease ElementsThere is no specific guidanceon separation of leases ofland and buildings.

Land and buildings elementsare classified and accountedfor separately unless the landelement is not material.

Land and building elements areclassified and accounted for asa single unit unless landrepresents more than 25percent of the total fair value ofthe leased property.

Accounting Treatment

Operating leases:Lease rentals: Lease rentalsshall be expensed by thelessee and lease revenueshall be recognised by thelessor on a straight-line basisover lease term unlessanother systematic basis isrepresentative of the timepattern of the user’s benefits.There is no specific guidanceon lease incentives.


Lease incentives (such asrent-free period) arerecognised by both the lessorand the lessee as a reductionin rental income andexpense, respectively, overthe lease term

Similar to Indian GAAP andIFRS.

Similar to IFRS.

Finance leases:The lessor recognises afinance lease receivable andthe lessee recognises theleased asset and a liability forfuture lease payments.

Similar to Indian GAAP..

Similar to Indian GAAP andIFRS

1.3.12 Provisions, Contingent Liabilities and Contingent Assets

Primary guidance: AS 29 Primary guidance: IAS 37,IFRIC 1

Primary guidance: ASC 410,ASC 420, ASC 450

Recognition

A provision is recognised fora present obligation arisingfrom past event, if the liabilityis considered probable and

Similar to Indian GAAPexcept that constructiveobligations are alsorecognised.

Similar to IFRS.

Accounting Norms 23


Notescan be reliably estimated.Probable means more likelythan not.Constructive obligations arenot recognized.

Measurement

The amount recognised as aprovision should be the bestestimate of the expenditurerequired to settle the presentobligation at the balancesheet date.

The amount of a provision isnot discounted to its presentvalue.


Where the effect of the timevalue of money is material,the provision shall bediscounted at a pre-taxdiscount rate that reflectscurrent market assessmentsof the time value of moneyand the risks specific to theliability.

Similar to Indian GAAP andIFRS. However, when thereasonable estimate of the lossis a range and some amountwithin the range appears at thetime to be a better estimate thanany other amount within therange, that amount is accrued. Ifno amount within the range is abetter estimate than any otheramount, the minimum amount inthe range is accrued.

Accruals for loss contingenciesprovisions are not discountedunless the timing of the relatedcash flows is fixed or reliablydeterminable.

Reimbursement Right

A reimbursement right isrecognised as a separateasset only when its recoveryis virtually certain. Theamount recognised for thereimbursement should notexceed the amount of therelated provision.

Similar to Indian GAAP. Unlike Indian GAAP and IFRS,recovery should be probableand need not be virtuallycertain.

Contingent Liability

A contingent liability is notrecognised. However, it isdisclosed, unless thepossibility of an outflow ofresources is remote. Inextremely rare cases,exemption from disclosure ofinformation that may beprejudicial to an entity ispermitted.



Disclosure is required for losscontingencies that are notrecognised if it is reasonablypossible that a loss may havebeen incurred.

Unlike Indian GAAP and IFRS,there is no such exemption.

Contingent Asset

A contingent asset is:● recognised when the

realisation is virtually

Similar to Indian GAAP,except that the disclosure ismade in the financial

Contingent assets are notrecognised until they arerealised.



Notes certain; and● disclosed in the Director’s

report when therealisation is probable.

statements.

Restructuring Costs

Recognised if the recognitioncriteria for a ‘provision’ is met.

Similar to Indian GAAP. Unlike Indian GAAP and IFRS,a liability for a cost associatedwith an exit or disposal activityis recognised when thedefinition of a liability is met.

Onerous Contracts

An onerous contract isdefined as a contract wherethe unavoidable costs tomeet the obligations exceedthe expected economicbenefits.If an entity has an onerouscontract, the presentobligation shall berecognised and measured asa provision.

Similar to Indian GAAP Unless specific codificationtopic/subtopic requires,obligations for onerouscontracts are not recognised

1.3.13 Taxation

Primary guidance: AS22 Primary guidance: IAS 12 Primary guidance: ASC 740

Introduction

Deferred taxes arerecognised for the estimatedfuture tax effects of timingdifferences and unused taxlosses carried forward.Unused tax credits carriedforward is considered aprepaid tax asset providedthe definition of asset is met.Timing differences are thedifferences between taxableincome and accountingincome for a period thatoriginate in one period andare capable of reversal in oneor more subsequent periods.

Deferred taxes arerecognised for the estimatedfuture tax effects oftemporary differences,unused tax losses andunused tax credits carriedforward.

Temporary differences aredifferences between the taxbase of an asset or liabilityand its carrying amount in thestatement of financialposition.

Although US GAAP also followsan asset and liability approachfor calculating deferred taxes,there are some differences inthe application of the approachfrom IFRS.

Definition of temporarydifferences is similar to IFRS.

Current Tax—Recognition and Measurement

Tax expense comprises ofcurrent tax and deferred taxwhich should be included inthe determination of the netprofit or loss for the period.Current tax should be


Accounting Norms 25


Notesmeasured at the amountexpected to be paid to(recovered from) the taxationauthorities in respect oftaxable profit (loss), using theapplicable tax rates and taxlaws.

Deferred Tax—Recognition and Measurement

Deferred tax assets andliabilities should be measuredusing the tax rate and taxlaws that have been enactedor substantively enacted atthe balance sheet date. Inpractice, deferred tax ismeasured based on theexpected manner ofsettlement of liability orrecovery of an asset.

Similar to Indian GAAPexcept that IAS IAS 12specifically requires deferredtax to be measured based onthe expected manner ofsettlement of liability orrecovery of an asset.

Unlike Indian GAAP and IFRS,deferred tax assets andliabilities should be measuredusing tax rates and tax laws thathave been enacted at thereporting date. Further, deferredtax is measured on theassumption that the underlyingasset or liability will be settled orrecovered in a mannerconsistent with its current use inthe business.

Deferred tax assets shouldbe recognized and carriedforward when it is reasonablycertain that future taxableprofit will be available forreversal of the deferred taxassets. However, where anentity has unabsorbeddepreciation or carry forwardof losses under tax laws,deferred tax assets should berecognised only when thereis virtual certainty supportedby convincing evidence thatsufficient future taxableincome will be availableagainst which such deferredtax asset can be realised.

Deferred tax assets isrecognised to the extent it isprobable that taxable profitwill be available againstwhich deductible temporarydifferences and unused taxlosses and unused tax creditscarried forward can beutilised.

Unlike Indian GAAP and IFRS,deferred tax assets arerecognised in full and reducedby a valuation allowance if it ismore likely than not that someportion or all of the deferred taxassets will not be realised.

Deferred Tax on Unused Tax Credits

Unused tax credits carriedforward are considered asprepaid tax assets providedthe definition of asset issatisfied on a continuingbasis.Deferred tax assets andliabilities should not bediscounted to their presentvalue.

Unlike Indian GAAP, unusedtax credits carried forwardare considered as deferredtax assets.


Similar to IFRS

Similar to Indian GAAP andIFRS.Indian GAAP IFRS US GAAP



Notes Exceptions from Accounting for Deferred Taxes

Deferred taxes are notrecognised for permanentdifferences.

Deferred taxes are notrecognised for the followingitems:the initial recognition ofgoodwillthe initial recognition of anasset or liability in atransaction that is not abusiness combination and atthe time of the transactionneither accounting profit nortaxable profit (tax loss) isaffected.

Deferred taxes are notrecognised if it arises from theinitial recognition of goodwill.However, unlike IFRS, USGAAP does not have a similarexception in respect of initialrecognition of an asset orliability in a transaction that isnot a business combination andat the time of the transactionneither accounting profit nortaxable profit (tax loss) isaffected.

Deferred Tax on Investments in Subsidiaries, Branches, Associates and Interest in JointVentures

No deferred tax isrecognised.

Deferred tax should not berecognised for temporarydifferences in respect ofinvestment in subsidiaries,branches, associates andinterest in joint ventures ifcertain conditions aresatisfied.

Similar to IFRS. However, theseconditions are different fromIFRS. Further, unlike IFRS,deferred tax is alwaysrecognised in respect ofbranches and associates.

Deferred Tax on Unrealised Intragroup Profits

Deferred tax on unrealisedintra group profits is notrecognised. deferred taxexpense is an aggregationfrom separate financialstatements of each groupentity and no adjustment ismade on consolidation.

Unlike Indian GAAP, deferredtaxes on elimination ofintragroup profits and lossesare calculated with referenceto the tax rate of the buyer atthe end of the reportingperiod.

Unlike Indian GAAP and IFRS,current tax on unrealised intercompany profits and losses(calculated with reference to thetax rate of the seller) is deferredand subsequently, recognisedas current tax in the year of saleto an external party.

Uncertain Tax Positions

The recognition andmeasurement provisions ofAS 29 are relevant becausean uncertain tax position maygive rise to a liability ofuncertain timing and amount.

Similar to Indian GAAP, therecognitionand measurementprovisions of IAS 37 arerelevant because anuncertain tax position maygive rise to a liability ofuncertain timing and amount.

Unlike Indian GAAP and IFRS,US GAAP uses a two-stepprocess to recognise andmeasure the financial statementeffects of a tax position. Anentity initially recognises thefinancial statement effects of atax position when it is morelikely than not (likelihood of >50percent), based on the technicalmerits, that the position will besustained on examination. A taxposition that meets the morelikely than not threshold is theninitially and subsequentlymeasured as the largest

Accounting Norms 27


Notesamount that is greater than 50percent likely of being realisedon settlement with a taxingauthority.

Business Combinations

There is no specific guidanceprovided under Indian GAAPon accounting for a change inthe acquirer’s deferred taxasset as a result of abusiness combination. Inpractice, such a change isaccounted in profit or loss.

Similar to Indian GAAPexcept that IFRS specificallyrequires such a change to beaccounted in profit or loss.

Similar to IFRS.

Share-based Payment

There is no specific guidance Deferred taxes are recordedfor the difference betweenthe amount of the taxdeduction (or future taxdeduction) and cumulativeremuneration expenserelated to share-basedpayment awards.Deferred tax assets areadjusted each period to theamount of tax deduction thatthe entity would receive if theaward was tax deductible asof the reporting date basedon the current market price ofthe shares.

Deferred tax assets are basedon the amount of compensationcost recorded.Unlike IFRS, the deferred taxadjustment for current shareprice is recorded on settlement.

Presentation and Disclosure

An entity should offset assetsand liabilities representingcurrent tax if it has a legallyenforceable right to set offthe recognized amounts andintends to settle the assetand the liability on a netbasis.

Similar to Indian GAAP. Similar to Indian GAAP andIFRS except that intentions tonet settle is not required.

There is no requirement fordisclosing the relationshipbetween the tax expense andaccounting profit.

All entities should disclose anexplanation of therelationship between taxexpense and accountingprofit using a numericalreconciliation.

Public entities-Similar to IFRS.Nonpublic entities shoulddisclose the nature of significantreconciling items but may omit anumerical reconciliation.



Notes Income and Expenditure

1.3.14 Revenue General


Primary guidance: AS 9;Guidance Note onaccounting for Dot-comcompanies

Primary guidance: IAS 18,IFRIC 13, IFRIC 15, IFRIC18, SIC 31

Primary guidance: ASC 605,ASC 845, Industry topics, SECSAB Topic 13

Definition

Revenue is the gross inflowof cash, receivables or otherconsideration arising in thecourse of the ordinaryactivities from the sale ofgoods, from the rendering ofservices and from the use byothers of entity resourcesyielding interest, royaltiesand dividends.

Revenue is the gross inflowof economic benefits duringthe period arising in thecourse of the ordinaryactivities of an entity whenthose inflows result inincreases in equity, otherthan increases relating tocontributions from equityparticipants.

Revenue is defined as inflowsor other enhancements ofassets of an entity orsettlements of its liabilities (or acombination of both) fromdelivering or producing goods,rendering services, or otheractivities that constitute theentity’s ongoing major or centraloperations.

Principal versus Agent

There is no specific guidanceon whether an entity is actingas a principal or an agent.

Unlike Indian GAAP, specificguidance exists.

Similar to IFRS except thatguidance under US GAAP ismore comprehensive.

Recognition

Recognition criteria dependon the category of revenuetransaction. In generalcriteria includes no significantuncertainty exists regardingthe amount of theconsideration that will bederived from the sale ofgood/rendering of service.

Revenue is recognised onlywhen it is probable that anyfuture economic benefit willflow to the entity and such abenefit can be measuredreliably.

Revenue is generallyrecognised when it is realised orrealisable and earned. USGAAP includes specific revenuerecognition criteria for differenttypes of revenue generatingtransactions. For manytransactions, criteria differ fromIndian GAAP and IFRS.

Measurement

Revenue is recognised at theconsideration received orreceivable

Revenue is recognised at thefair value of the considerationreceived or receivable. Fairvalue is determined bydiscounting all future receiptsusing an imputed rate ofinterest. The differencebetween the fair value and theconsideration is recognised asinterest income using theeffective interest method.

Similar to IFRS.

Specific Industry and Other Guidance

Revenue recognition ismainly based on general

Similar to Indian GAAP. Unlike Indian GAAP and IFRS,US GAAP has comprehensive

Accounting Norms 29


Notesprinciples that are applied todifferent types oftransactions.

guidance specific to industryand type of revenuearrangement. For e.g., thereexists comprehensive guidanceon software revenuerecognition.

Multiple Element Arrangements


To present the substance of atransaction appropriately, itmay be necessary to applythe recognition criteria to theseparately identifiablecomponent of a singletransaction. However, Thereis no specific guidance formaking this assessment.

Unlike IFRS, US GAAPprovides detailed guidance onmultiple-element revenuearrangements and establishesdetailed criteria for determiningwhether each element may beseparately considered forrecognition.

Customer Loyalty Program

There is no specific guidanceon accounting for customerloyalty programs.

IFRIC 13 indicates thatcustomer loyalty programsare deemed multiple-elementrevenue transactions and thatthe fair value of theconsideration receivedshould be allocated betweenthe components of thearrangement.

Similar to Indian GAAP, there isno specific guidance thataddresses customer loyaltyprograms. The facts andcircumstances of the programare considered to determine theappropriate accounting. Althoughcustomer loyalty programs arenot in the scope of ASC 605-25,some companies apply thatguidance by analogy andallocate revenue to the awardcredits. Others may follow anincremental cost approach inwhich the cost associated withthe award credit is accrued.

Rendering Services

Completed service contractmethod or proportionatecompletion method ispermitted.

Revenue is recognised usingpercentage of completionmethod.

Revenue from service isgenerally recognised using theproportional performance orstraight-line method rather thanthe completed service contractmethod or proportionatecompletion method (cost 5241,completion method is notpermitted).

Interest Income

Interest is recognised on atime proportion basis takinginto account the amountoutstanding and the rateapplicable.

Interest income is recognisedusing the effective interestmethod.

Similar to IFRS.



Notes 1.3.15 Revenue – Long-term Contracts/Construction Contracts

Primary guidance: AS 7,Guidance Note onAccounting for Real EstateDevelopers

Primary guidance: IAS 11,IFRIC 15

Primary guidance: ASC605-35

Construction Contracts (Other than Real Estate Sales)

Revenue is recognisedbased on the percentage-of-completion method.However, when thepercentage-of-completionmethod is deemedinappropriate (e.g., when theoutcome of the contractcannot be estimated reliably),revenue is recognised to theextent that costs have beenincurred, provided that thecosts are recoverable. Thecompleted- contract methodis not permitted.

Probable losses arerecognised as an expenseimmediately.

Similar to Indian GAAP Revenue is recognised basedon the percentage-of-completion method, providedthe entity has an ability to makedependable estimates relatingto the extent of progress towardcompletion, contract revenuesand contract costs. If otherwise,the completed contract methodis used. Similar to Indian GAAPand IFRS, probable losses arerecognised as an expenseimmediately.

Contract revenue and contractcosts are recognised byreference to the stage ofcompletion of work.

Contract revenue andcontract costs are recognisedby reference to the stage ofcompletion of work.

Similar to Indian GAAP. Unlike Indian GAAP and IFRS,the revenue to be recognisedcan also be determined byreference to the gross marginearned. Gross profit earned ona contract is computed bymultiplying the total estimatedgross profit on the contract bythe percentage of completion.

Construction contracts aresegmented or combined, asthe case may be, whencertain criteria are met.


Real Estate Sales

There is specific guidance.Application of this guidancemay result in revenue beingrecognised on a percentage-of-completion basis, acontinuous delivery basis, orat a single point in time.

There is specific guidance.Application of this guidancemay result in revenue beingrecognised on a percentage-of-completion basis, acontinuous delivery basis, orat a single point in time.However, the guidancediffers from the guidanceunder Indian GAAP.

There is detailed guidance onaccounting for real estate sales.Application of this guidanceresults in revenue beingrecognised under full accrualmethod, the installment method,the cost recovery method, thepercentage of completionmethod, or the deposit method.

Accounting Norms 31


Notes1.3.16 Employee Benefits

Primary guidance: AS 15 Primary guidance: IAS 19IFRIC 14

Primary guidance: ASC 710,ASC 715

Post-employment Defined Benefits—Actuarial Gains and Losses

Projected unit credit methodis used to perform actuarialvaluations. All actuarial gainsand loss are recognisedimmediately in profit or loss.

Similar to Indian GAAP,except re-measurements arerecognized immediately inother comprehensive income.These are subsequently notreclassified to incomestatement

Unlike Indian GAAP and IFRS,the actuarial method useddepends on the type of plan.Immediate recognition in othercomprehensive income is notpermitted, however an entitymay adopt policy of immediaterecognition in incomestatement; corridor method isalso permitted.

Post-employment Defined Benefits—Recognition of Prior Service Costs

Prior service costs arerecognized immediately ifthey are related to vestedbenefits; otherwise, they arerecognized over the vestingperiod.

An entity recognises priorservice cost as an expense atthe earlier of the followingdates:When the plan amendment orcurtailment occurs;When the entity recognisesrelated restructuring costs ortermination benefits.

Prior service costs arerecognised initially in othercomprehensive income, andboth vested and unvestedamounts amortised over theaverage remaining serviceperiod.However, if all or almost all ofthe plan participants areinactive, prior service cost areamortised over the remaininglife expectancy of thoseparticipants.

Measurement Frequency

Detailed actuarial valuation todetermine present value ofthe benefit obligation iscarried out at least once inevery three years, and fairvalue of plan assets aredetermined at each balancesheet date.

No explicit requirement on howfrequently the defined benefitobligation and the plan assetsare measured. However, theyshould be measured regularlyenough that the amountrecognised is not materiallydifferent from the amount thatwould be determined on thereporting date.

Measurement should beperformed at least onceannually, or more often whencertain events occur.

Discount Rate

Market yield on governmentbonds as at the balancesheet date is used asdiscount rates.

Market yield on high qualitycorporate bonds as at thebalance sheet date is used.In countries where there is nodeep market in such bonds,the market yield ongovernment bonds is used.

Rates of return on high-qualityfixed-income investmentscurrently available andexpected to be available duringthe period to maturity of thepension benefits is used.Circumstances in which there isno deep market in high-qualitycorporate bonds are notspecifically addressed.



Notes Curtailments

Gains and losses on thecurtailment of a definedbenefit plan are recognisedwhen the curtailment occurs.

Curtailment gains and lossesare recognized when anentity is demonstrablycommitted and a curtailmenthas been announced.

A curtailment loss is recognisedwhen it is probable that acurtailment will occur and theeffects are reasonablyestimable. A curtailment gain isrecognised when the relevantemployees are terminated orthe plan suspension oramendment is adopted, whichcould occur after the entity isdemonstrably committed and acurtailment is announced.

Termination Benefits

Recognised if the transactionmeets the definition of a‘Provision’.

Recognised when anemployer is demonstrablycommitted to pay.

Termination benefits arerecognised on the basis of thetype of benefits.For special termination benefits,a liability and a loss isrecognised when the employeeaccepts the offer and theamount of benefits can bereasonably estimated. Forcontractual termination benefits,a liability and a loss isrecognised when it is probablethat the specified event thattriggers the termination willoccur and the amount ofbenefits can be reasonablyestimated.

Compensated Absences

The plan is segregatedbetween short term and otherlong term employee benefits.The expected cost ofaccumulating short termcompensated absences isrecognised on an accrualbasis. Liability for long-termcompensated absences ismeasured on actuarial basis.

Similar to Indian GAAP. Unlike Indian GAAP and IFRS,compensated absences arerecognised on an accrual basis.

1.3.17 Share-based Payments

Primary guidance:Guidance Note by the ICAIand SEBI Guidelines

Primary guidance: IFRS 2 Primary guidance: ASC 718,ASC 505-50

Share-based Payments to EmployeesOption to measure based onthe grant date fair value or

Measured based on thegrant-date fair value of the

Similar to IFRS. However,unlike IFRS, intrinsic value

Accounting Norms 33


Notesintrinsic value of the equityinstruments issued.

equity instruments issued.Intrinsic value approach ispermitted only when the fairvalue of the equityinstruments cannot beestimated reliably.

approach can be followed bynon-public companies forshare-based awards classifiedas liabilities.

Grant DateGrant date is the date onwhich the entity and theemployee have a sharedunderstanding of the termsand conditions of thearrangement.

Similar to Indian GAAP. Unlike Indian GAAP and IFRS,grant date is the date: (i) atwhich an employer andemployee reach a mutualunderstanding of the key termsand conditions of a share-basedpayment award and (ii) that anemployee begins to benefitfrom, or be adversely affectedby, subsequent changes in theprice of the employer’s equityshares.

Share Based Payments to Non-employees


Generally, measured basedon the fair value of the goodsor services received.

Unlike IFRS, equity-settledshare based paymenttransactions with non-employees are accounted forbased on the fair value of theconsideration received or thefair value of the equity-basedinstruments issued, whicheveris more reliably measurable.

Graded Vesting

Entity may choose tomeasure on a straight-linebasis as a single award or anaccelerated basis as thougheach separately vestingportion of the award is aseparate award.

Unlike Indian GAAP, awardswith graded vesting ismeasured as, in substance,multiple awards.


1.4 The Roadmap for implementation of Ind AS

On 16th February 2015, the Ministry of Corporate Affairs (MCA) notified theCompanies (Indian Accounting Standards) Rule, 2015 (the Rules) (pending publication inthe Gazette of India). The Rules specify the Indian Accounting Standards (Ind AS)applicable to certain class of companies and set out the dates of applicability.

The key requirements of the Rules with regard to the class of companies that will berequired to follow Ind AS and the date of adoption by such companies are as under:

Voluntary AdoptionCompanies may voluntarily adopt Ind AS for financial statements for accounting

periods beginning on or after 1 April 2015 with the comparatives for the periods ending



Notes 31 March 2015 or thereafter. Once a company opts to follow the Ind AS, it will be requiredto follow the same for all the subsequent financial statements.

Mandatory Adoption

For the accounting periods beginning on orafter 1 April, 2106

For the accounting periods beginning on orafter 1 April, 2107

The following companies will have to adopt IndAS for financial statements from the abovementioned date

(i) Companies whose equity and/or debtsecurities are listed or are in the processof listing on any stock exchange in Indiaor outside India (listed companies) andhaving net worth of ` 500 crore or more

(ii) Unlisted companies having net worth of` 500 crores or more

(iii) Holding subsidiary, joint venture orassociate companies of the listed andunlisted companies covered above

The following companies will have to adopt IndAS for financial statements from the abovementioned date

(i) Listed companies having net worth ofless than ` 500 crore.

(ii) Unlisted companies having net worth of` 250 crore or more but less than ` 500crore

(iii) Holding subsidiary ,joint venture orassociate companies of the listed andunlisted companies covered above

Comparative for these financial statements willbe periods ending 31 March 2016 or thereafter.

Comparative for these financial statements willbe periods ending 31 March 2016 or thereafter.

The road map will not be applicable to: Companies whose securities are listed or in the process of listing on SME

exchanges. Companies not covered by the road map in the “Mandatory adoption”

categories above. Insurance companies banking companies and non-banking finance

companies.These companies should continue to apply existing Accounting standards

prescribed in the Annexure to the Companies (Accounting Standards) Rules, 2006unless they opt for voluntary adoption. Insurance companies, banking companies andnon-banking finance companies cannot voluntarily adopt the Ind AS.

1.5 Summary

The unit has covered the following:(i) Introduction to various accounting standards operating in India

Financial statements summarize the end-result business activities of anenterprise during an accounting period in monetary term. In order that themethods and principles adopted by various reporting enterprises are coherent,not misleading – and to the extent possible are uniform and comparable –standards are evolved. Accounting Standard is an authoritativepronouncement of code of practice of the regulatory accountancy body to beobserved and applied in the preparation and presentation of financialstatements.World over, professional bodies of accountants have the authority and theobligation to prescribe “Accounting Standards”. International AccountingStandards (IASs) are pronounced by the International Accounting StandardsCommittee (IASC). The IASC was set up in 1973, with headquarters in London

Accounting Norms 35


Notes(UK). In India, the Institute of Chartered Accountants of India (ICAI) hadestablished in 1977 the Accounting Standards Board (ASB).

List of Accounting Standards in India

Accounting Standards (AS) Title of the Accounting Standards

AS 1 Disclosure of Accounting Policies

AS 2 (Revised) Valuation of Inventories

AS 3 (Revised) Cash Flow Statements

AS 4 (Revised) Contingencies and Events Occurring after the Balance Sheet Date

AS 5 (Revised) Net Profit or Loss for the Period, Prior Period Items and Changes inAccounting Policies

AS 6 (Revised) Depreciation Accounting

AS 7 (Revised) Accounting for Construction Contracts

AS 9 Revenue Recognition

AS 10 Accounting for Fixed Assets

AS 11 (Revised 2003) The Effects of Changes in Foreign Exchange Rates

AS 12 Accounting for Government Grants

AS 13 Accounting for Investments

AS 14 Accounting for Amalgamations

AS 15 Accounting for Retirement Benefits in the Financial Statements ofEmployers

AS 16 Borrowing Costs

AS 17 Segment Reporting

AS 18 Related Patty Disclosures

AS 19 Leases

AS 20 Earnings Per Share

AS 21 Consolidated Financial Statements

AS 22 Accounting for Taxes on Income

AS 23 Accounting for Investment in Associates in Consolidated FinancialStatements

AS 24 Discontinuing Operations

AS 25 Interim Financial Reporting

AS 26 Intangible Assets

AS- 27 Financial Reporting of Interest in Joint Ventures

AS 28 Impairment of Assets

AS 29 Provisions, Contingent Liabilities and Contingent Assets

(ii) Comparison of Indian AS with International Accounting standards and USGAAP with reference to the following:Overall financial statement presentation—Presentation of Financial Statements,Statement of cash flows; Non-current assets held for sale and discontinuedoperations,Accounting Policies with reference to—Changes in accounting policy,estimates and correction of errors; Assets, Borrowing costs, Investment



Notes property, Intangible assets, Impairment (other than financial assets),Inventories, Leases, Provisions, contingent liabilities and contingent assets,Taxation;Income and Expenditure—Revenue General,. Revenue—long-term contracts/construction contracts, Employee benefits, Share-based payments

(iii) The Road map for implementation of Indian AS—voluntary and mandatory

1.6 Check Your Progress

I. State Whether the Following Statements are True or False1. IFRS are the Financial Reporting Standards issued by IASB.2. The objective of IFRS is to ensure that financial statements report high quality

information.3. IFRS enhances uniformity in the accounting principles.4. Due to IFRS, cost of raising funds in the foreign market will be higher.5. Investors will rely on financial statements prepared as per IFRS.6. ICAI has decided to have convergence of AS with IFRS in July 2011.7. A core group is constituted by MCA.8. The first phase of implementation of IFRS was for those companies having net

worth over 1,000 crores.

II. Multiple Choice Questions1. IFRS are issued by __________.

(a) IASB(b) ICAI(c) FASB(d) IASC

2. The ICAI has decided to adopt IFRS w.e.f. __________.(a) 1-4-2015(b) 1-4-2016(c) 1-4-2014(d) 1-1-2016

3. IFRS are the __________.(a) Sets of financial reporting standards(b) Rules of accounting(c) Sets of auditing standards(d) None of the above

4. The objective of IFRS is to __________.(a) ensure preparation of financial statements(b) ensure that the financial statements contain high quality information.(c) ensure uniformity in financial statements at national level(d) none of the above

5. IFRS will facilitate __________.(a) better access and reduction in cost of capital raised from global market.(b) easy borrowing from Indian capital market.(c) improvement in comparability of financial information.(d) (a) + (c)

Accounting Norms 37


Notes6. IFRS are applicable to All the entries having net worth in excess of__________.(a) ` 500 crores(b) ` 1000 crores(c) ` 100 crores(d) ` 10,000 crores

7. Convergence of Indian Accounting Standards with IFRS implies that__________.(a) Indian Accounting Standards will be known as IFRS(b) IFRS will adopt Indian Accounting Standards(c) Indian Accounting Standards I will be known as IFRS 1.(d) Indian Accounting Standards will achieve harmony in relation to IFRS

1.7 Questions and Exercises

1. Can you draw comparison between Ind.AS, IFRS and US GAAP with referenceto __________.(a) Selection of accounting policies(b) components of financial statements.

2. With regard to Cash Flows prepare comparative analysis between Ind AS,IFRS and US GAAP with reference to __________.(a) Definition of cash and cash equivalents,(b) Classification of cash flows(c) methods of presenting operating cash flows.

3. With regard to changes in accounting policy, estimates and correction of errors,prepare comparative analysis between Ind AS, IFRS and US GAAP.

4. Can you draw comparison between Ind AS, IFRS and US GAAP with referenceto Property, Plant and Equipment?

5. With regard to Borrowing costs and its impact of cost of asset, preparecomparative analysis between Ind AS, IFRS and US GAAP.

6. With regard to Intangible assets (excluding goodwill), prepare comparativeanalysis between Ind. AS, IFRS and US GAAP.

7. With regard to Inventories prepare comparative analysis between Ind AS, IFRSand US GAAP with reference to:(a) cost formula(b) measurement of inventories(c) reversal of write down inventory

1.8 Key Terms

IAS: International Accounting Standards, IASB: International Accounting Standards Board, ICAI: Institute of Chartered Accountants of India, IFRS: International Financial Reporting Standards, Indian GAAP: Accounting principles generally accepted in India, US GAAP: Accounting principles generally accepted in the US,



Notes 1.9 Check Your Progress: Answers

I. True or False1. True2. True3. True4. False5. True6. False7. True8. False

II. Multiple Choice Questions1. (a) IASB2. (b) 1-4-20163. (d) none of the above4. (d) none of the above5. (d) (a) + (c)6. (a) ` 500 crores7. (d) Indian Accounting Standards will achieve harmony in relation to IFRS

1.10 Case Study

1. PQR Ltd. shows its inventory at cost in the financial statements. In the currentyear, the realizable value of a portion of inventory has gone down below thecost of goods. Comment.

2. RST Ltd. shows its inventory at the lower of cost or net realizable value. Forthis purpose, the cost is ascertained by applying the LIFO method and the netrealizable value is taken as equal to the current market price of purchasing ofthese inventories. Comment.

3. M Ltd. values its finished goods at prime cost (FIFO) or net realizable value,whichever is less. Comment.

4. ABC Ltd. purchased on credit, an asset costing ` 5,00,000 during the year2004. It charges depreciation @ 15% WDV on this types of asset. During theyear, it has paid ` 2,20,000 to the supplier, including the interest for thedelayed payment. ` 3,00,000 together with interest will be payable next year.The amount of depreciation provided for the year is ` 33,000, i.e., 15% of` 2,20,000. Comment.

1.11 Further Readings

1. Indian Accounting Standards and GAAP by Dolphy D’ Souza, Snow WhitePublications.

2. Accounting Standards by Rustagi R.P., Golgotia Publications, Website:www.icai.org

■■■■

Accounting for Merger and Acquisitions 39


Notes

Unit 2: Accounting for Merger and Acquisitions

Structure:2.1 Introduction2.2 Definitions2.3 Types of Amalgamations and its Accounting2.4 Accounting for Amalgamation in the Books of Transferee Company – (i) The

Pooling of Interests Method and (ii) The Purchase Method2.5 Accounting for Amalgamation in the Books of Transferor Company2.6 Treatment of Reserves:

2.6.1 Statutory Reserves2.6.2 Amalgamation after the Balance Sheet Date

2.7 Disclosure2.8 Limited Revisions to AS 14 of Accounting Standard 14 – Accounting for

Amalgamation2.9 Companies Act, 1956 and AS 14

2.10 AS 14 and International Accounting Standards2.11 Summary2.12 Check Your Progress2.13 Questions and Exercises2.14 Key Terms2.15 Check Your Progress: Answers2.16 Case Study2.17 Further Readings

Objectives

After studying this unit, you should be able to:● Quite often, two or more companies separately incorporated under the Companies

Act, 1956 are merged together and resulting in winding up of one or morecompanies. In this process, there may arise goodwill or capital reserve (being thedifference between the purchase price paid and the net assets acquired) in thebooks of the accounting company.

● AS 14 aims to provide for accounting treatment of mergers and also the treatmentof goodwill/capital reserve arising there from. The Standard does not deal withacquisitions where an investor acquires whole or part of capital of some othercompany and does not result in dissolution of the acquired entity.

2.1 Introduction

The direct relationship between good accounting practices and better economicoutcomes is widely recognized. There are numerous instances in India and around theworld of bad accounting practices leading to corporate failures. With so much activityhappening on the acquisition front by Indian companies in cross-border markets, it is an



Notes opportune time to evaluate whether within the framework of accounting standards thestructuring of the M&A transaction can be done.

2.2 Definitions

The following terms are used in this Standard:(i) Amalgamation means an amalgamation pursuant to the provisions of the

Companies Act 1956.(ii) Transferor company means the company which is amalgamated into another

company.(iii) Transferee company means the company into which a transferor company is

amalgamated.(iv) Reserve means the portion of earnings, receipts or other surplus of an

enterprise (whether capital or revenue) appropriated by the management for ageneral or specific purpose other than a provision for depreciation or diminutionin the value of assets of for a known liability.

(v) Amalgamation in the nature of merger is an amalgamation which satisfies allthe following conditions:● All the assets and liabilities of the transferor company become, after

amalgamation, the assets and liabilities of the transferee company.● Shareholders holding not less than 90% of the face value of the equity

shares of the transferor company become equity shareholders of thetransferee company by virtue of the amalgamation

● The consideration for the amalgamation receivable by those equityshareholders of the transferor company who agree to become equityshareholders of the transferee company, is discharged by the transfereecompany wholly by the issue of equity shares in the transferee company,except that cash may be paid in respect of fractional shares.

● The business of the transferor company is intended to be carried on, afterthe amalgamation, by the transferee company.

● No adjustment is intended to be made to the book value of the assets andliabilities of the transferor company when they are incorporated in thefinancial statements of the transferee company except to ensureuniformity of accounting policies.

(vi) Amalgamation in the nature of purchase is an amalgamation which does notsatisfy any one or more of the conditions specified above.

(vii) Consideration for the amalgamation means the aggregate of the shares andother securities issued and the payment made in the form of cash or otherassets by the transferee company to the shareholders of the transferorcompany.

(viii) Fair value is the amount for which an asset could be exchanged between aknowledgeable, willing buyer and a knowledgeable, willing seller at an arm’slength transaction.

2.3 Types of Amalgamations and its Accounting

As per AS 14, there are two types of amalgamations:(i) Amalgamation in the nature of merger; and(ii) Amalgamation in the nature of purchase



Notes2.4 Accounting for Amalgamation in the Books of TransfereeCompany

There are two methods of accounting for amalgamation:(i) The pooling of Interests Method: Under the pooling of interests method, the

assets, liabilities and reserves of the transferor company are recorded by thetransferee company at their existing carrying amounts in the financialstatements of the transferred company. This method is applicable in the booksof transferee company in case of amalgamation in the nature of merger

(ii) The Purchase Method: Under the purchase method, the transferee companyrecords the amalgamation by incorporating the assets and liabilities taken over,at their fair values at the date of amalgamation.

The difference between the purchase consideration and the fair value of identifiableassets and liabilities is recorded as Goodwill or Capital Reserve. The asset and liabilitiesnot taken over by transferee company are disposed off by transferor company. Thismethod is applicable in the books of transferee company in case of amalgamation in thenature of purchase.

2.5 Accounting for Amalgamation in the Books of TransferorCompany

AS 14 is silent on the accounting for amalgamation in the books of transferorcompany. It has given accounting treatment only for the transferee company. Therefore,accounting for amalgamation in the books of transferor company should be recorded asper normal principles and practices of accounting, whether it is amalgamation in thenature or merger or in the nature of purchase.

2.6 Treatment of Reserves

In case of amalgamation in the nature of merger, the identity of the reserves oftransferor company is preserved and they appear in the financial statements of thetransferee company in the same form in which they appeared in the financial statementsof the transferor company. The General Reserve, the Capital Reserve and theRevaluation Reserve of the transferor company becomes the General Reserve, theCapital Reserve and the Revaluation Reserve of the transferee company. The differencebetween the consideration payable (in term of share capital of the transferee company orcash or otherwise) and amount of the share capital of the transferor company should beadjusted in the reserves of the transferee company.

In case of ‘amalgamation in the nature of purchase’, the identity of the reserves,other than the statutory reserves is not preserved. The amount of the consideration isdeducted from the value of the net assets of the transferor company acquired by thetransferee company. If the result of the computation is negative, the difference is creditedto Capital Reserve.The goodwill/capital reserve, so created, appears in the balancesheet of the transferee company.

2.6.1 Statutory ReservesStatutory reserves are those reserves, which are required and created as per the

provisions of some law, and generally, there is a restriction on the utilization of thisreserve. If a Statutory Reserve is appearing in the balance sheet of the transferor



Notes company, then it should appear in the balance sheet of Transferee Company also, afteramalgamation. This can be ensured as follows:

(a) In case of amalgamation in the nature of merger: As already stated, in caseof merger, all the reserves of the transferor company are shown in the balancesheet of the transferee company, the Statutory Reserves will appear togetherwith other reserves in the balance sheet of transferee company. So, noseparate treatment is required for Statutory Reserves in case of amalgamationin the nature of merger.

(b) In case of amalgamation in the nature of purchase: In case of purchase, thetransferee company is required to record the Statutory Reserves of transferorcompany and for this purpose, a separate entry is required as follows:

Amalgamation Adjustment A/c Dr.To Statutory Reserves A/c

The Amalgamation Adjustment A/c will appear under the heading‘Miscellaneous Expenditures’, and Statutory Reserves would appear under theheading ‘Reserves and Surplus’ in the balance sheet of transferee companyafter amalgamation.Later on, when the identity of the Statutory Reserves is not to be maintained orrequired, both these accounts should be contra-cancelled by the followingentry:

Statutory Reserves A/c Dr.To Amalgamation Adjustment A/c

2.6.2 Amalgamation after the Balance Sheet DateWhen an amalgamation is effected after the balance sheet date but before the

issuance of the financial statements of either party to the amalgamation, disclosureshould be made in accordance with AS 4, contingencies and events occurring after theBalance Sheet date, but the amalgamation should not be incorporated in the financialstatements.

2.7 Disclosure

The following disclosures should be made in the first financial statements after theamalgamation:

(a) names and general nature of business of amalgamating companies;(b) effective date of amalgamation for accounting purposes(c) the method of accounting used to reflect the amalgamation(d) the amount of any difference between the consideration paid and the net

assets acquired, and the treatment thereof; and(e) description and number of shares issued and ratio for exchange of shares

2.8 Limited Revisions to AS 14 of Accounting Standard 14 –Accounting for Amalgamation

The Council of the Institute of Chartered Accountants of India has decided to makethe following limited revisions to Accounting Standard (AS) 14, Accounting forAmalgamations.

It has been decided to substitute paragraph 42 of AS 14 by the following paragraph(modifications made are shown as underlined):



Notes“42. Where the scheme of amalgamation sanctioned under a statute prescribes thetreatment to be given to the reserves of the transferor company after amalgamation, thesame should be followed. Where the scheme of amalgamation sanctioned under astatute prescribes a different treatment to be given to the reserves of the transferorcompany after amalgamation as compared to the requirements of this Statement thatwould have been followed had no treatment been prescribed by the scheme, thefollowing disclosures should be made in the first financial statements following theamalgamation

(a) A description of the accounting treatment given to the reserves and thereasons for following the treatment different from that prescribed in thisStatement.

(b) Deviations in the accounting treatment given to the reserves as prescribed bythe scheme of amalgamation sanctioned under the statute as compared to therequirements of this Statement that would have been followed had notreatment been prescribed by the scheme.

(c) The financial effect, if any, arising due to such deviation.”The limited revisions come into effect in respect of accounting periods commencing

on or after 1-4-2004.

2.9 Companies Act, 1956 and AS 14

The Companies Act, 1956 does not specify any disclosure of amalgamation in thefinancial statements. Schedule VI annexed to the Act, is also silent on this point. On theother hand, AS 14 provides for accounting for amalgamation as well as disclosurerequirements about amalgamations in the balance sheet of the transferee company,prepared after amalgamation. So, the disclosure requirements of AS 14 are appropriatefrom the point of view of shareholders and readers of financial statements.

2.10 AS 14 and International Accounting Standards

AS 14 is based on IAS 22 and US GAAP, still there are many differences betweenthem.

Under AS 14, in case of purchase method, the transferee company can record theassets acquired either at the carrying amounts in the books of transferor company or atthe fair value. However, in case of IAS 22 and US GAAP, only fair values have beenprovided.

In case of amalgamation in the nature of purchase, the transferee company mayintend to effect changes in the activities of the transferor company. AS 14 necessitatesthat in such a case, the transferee company should create specific provision for theexpected costs of say, employee termination, plant relocation, etc. However, IAS 22 andUS GAAP provide for detailed provisions for recognition of such liability.

Regarding goodwill, which arises in case of purchase method, there are varyingprovisions. AS 14 says that it should be written off over a period of 5 years unlesssomewhat longer periods can be justified. IAS 22 provides for a maximum period of 20years, while US GAAP says that goodwill need not be written of unless impaired.

AS 14 provides for two types of amalgamation i.e. in the nature of merger and in thenature of purchase. However under IAS 22 and US GAAP, the pooling of interest methodhas been made redundant.



Notes AS 14 does not provide for treatment of merger related expenses. However IAS 22and US GAAP state that the merger expense should be charged to the Profit and LossA/c of the merged entity (i.e., the transferee company).

2.11 Summary

Accounting Standard 14 deals with Accounting for Amalgamation. It givesaccounting to be made in the books of the transferee company. This standard is notapplicable when one company acquires or purchases the shares of another company.The acquired company is not dissolved and its separate entity continues to exist.Accounting for mergers can be handled by:

(i) Pooling of interest method: Under the pooling of interests method, the assets,liabilities and reserves of the transferor company are recorded by thetransferee company at their existing carrying amounts in the financialstatements of the transferred company, and

(ii) Purchase method: The transferee company records the amalgamation byincorporating the assets and liabilities taken over, at their fair values at the dateof amalgamation.

The method of calculating consideration are lump sum method, net asset method,net payment method and intrinsic method.

AS 14 is silent on the accounting for amalgamation in the books of transferorcompany. It has given accounting treatment only for the transferee company. Therefore,accounting for amalgamation in the books of transferor company should be recorded asper normal principles and practices of accounting, whether it is amalgamation in thenature or merger or in the nature of purchase


I. State Whether the Following Statements are True or False1. Under pooling of interest method, the reserves of the transferor company

should be recorded at their existing carrying amounts in the same form as atthe date of amalgamation.

2. The consideration for the amalgamation should include any non-cash elementat fair value.

3. The scheme of amalgamation may provide for an adjustment to theconsideration contingent on one or more future events.

4. When the purchasing company decides to compensate, the selling companyon the basis of agreed value of assets and liabilities, the method for calculatingpurchase consideration is called ‘Net Payments’ Method.

5. When one existing company takes over the business of another company orcompanies, it is known as absorption.

II. Multiple Choice Questions1. Under the net payments method, purchase consideration is arrived at by

adding up the payments made to _________ in the vendor company.(a) debt holders(b) shareholders(c) liabilities(d) assets



Notes2. When there are one or more liquidations and no formation, it is known as________.(a) amalgamation(b) merger(c) takeover(d) acquisition

3. When an existing company takes over the business of existing company/companies, it is known as ________.(a) amalgamation in the nature of merger(b) amalgamation in the nature of purchase(c) takeover(d) acquisition

4. Items in the nature of accumulated profits or losses in the books of the vendorcompany should be transferred to _________.(a) transferor company(b) transferee company(c) both transferee company and transferor company(c) in neither s’ books

5. If preference shareholders or debenture holders are to receive more or less inliquidation, such amount should be adjusted through _________.(a) Amalgamation adjustment(b) Miscellaneous expenditure(c) Capital Reserve(d) Realization Account


1. What is Amalgamation of Companies? And What are the types ofAmalgamation as per AS 14?

2. What is Merger and what is purchase of business?3. What do you mean by Transferor Company and Transferee Company?4. How is Purchase Consideration calculated as per (i) Net Asset method and

(ii) Net Payment Method?5. What do you mean by Accumulated Profits? Mention any five items of

Accumulated Profits.6. Which funds are strictly liabilities and which funds are accumulated profits?7. How are realization expenses treated in Amalgamation of Companies and how

is the claim of Equity Shareholders settled?8. Mention disclosures required under AS 14.

2.14 Key Terms

● Amalgamation: Means an amalgamation pursuant to the provisions of theCompanies Act,1956.

● Transferor company: The company which is amalgamated into anothercompany.



Notes ● Transferee company: Means the company into which a transferor company isamalgamated.

● Amalgamation in the nature of merger is an amalgamation which satisfies allthe following conditions:

– All the assets and liabilities of the transferor company become, afteramalgamation, the assets and liabilities of the transferee company.

– Shareholders holding not less than 90% of the face value of the equityshares of the transferor company become equity shareholders of thetransferee company by virtue of the amalgamation.

– The consideration for the amalgamation receivable by those equityshareholders of the transferor company who agree to become equityshareholders of the transferee company, is discharged by the transfereecompany wholly by the issue of equity shares in the transferee company,except that cash may be paid in respect of fractional shares.

– The business of the transferor company is intended to be carried on, afterthe amalgamation, by the transferee company.

– No adjustment is intended to be made to the book value of the assets andliabilities of the transferor company when they are incorporated in thefinancial statements of the transferee company except to ensureuniformity of accounting policies.

● The Pooling of Interests Method: Under the pooling of interests method, theassets, liabilities and reserves of the transferor company are recorded by thetransferee company at their existing carrying amounts in the financialstatements of the transferred company. This method is applicable in the booksof transferee company in case of amalgamation in the nature of merger.

● The Purchase Method: Under the purchase method, the transferee companyrecords the amalgamation by incorporating the assets and liabilities taken over,at their fair values at the date of amalgamation.

2.15 Check Your Progress: Answers

I. True or False1. True2. False3. False4. True5. False

II. Multiple Choice Questions1. (b) Shareholders2. (b) Merger3. (a) amalgamation in the nature of merger4. (b) Transferee company5. (a) amalgamation adjustment



Notes2.16 Case Study

1. The following are the Balance Sheets as on 31/12/2014 of X Co. Ltd. and Y Co. Ltd.:Liabilities X Ltd. Y Ltd. Assets X Ltd. Y Ltd.

Equity share capital(` 100 per share)

10,00,000 6,00,000 Land and BuildingsPlant and Machinery

3,00,00011,00,000

–5,00,000

10% Debentures of` 10 each

2,00,000 – Stock 1,60,000 80,000

Reserve Fund 3,40,000 – Debtors 1,40,000 90,000Div Equalization FundEmployees ProvidentFund

40,00030,000

––

Cash 30,000 10,000

Trade Creditors 1,00,000 80,000Profit and Loss Account 20,000

17,30,000 6,80,000 17,30,000 6,80,000

The two companies agree to amalgamate and for a new company called Z Ltd.which takes over assets and liabilities of both the companies. The authorized capital ofZ Ltd. is ` 100,00,000 consisting of 10,00,000 equity shares of ` 10 each.

The assets of X Ltd. are taken over at a reduced valuation of 10% with the exceptionof Land and Buildings which are accepted at book value.

Both companies are to receive 5% of the net valuation of their respective businessas goodwill. The entire purchase price is to be paid by Z Ltd. in its fully paid shares. Inreturn for debentures in X Ltd. debentures of the same amount and denomination are tobe issued by Z Ltd.

Calculate purchase consideration for both the companies. Give journal entries toclose the books of X Ltd. and Y Ltd. and show the opening balance sheet of Z Ltd.

Hints: Calculation of purchase considerationParticulars X Ltd. Y Ltd.

Assets are per Balance sheetLess: 10% reduction for X Ltd. excluding land and buildings and cash

17,30,0001,40,000

6,80,000

80,0000

Less: Liabilities taken over10% Debentures 2,00,000Employees PF 30,000Sundry creditors 1,00,000

15,90,000

3,30,00012,60,000 6,00,000

Add: Goodwill 5% of net valuation 63,000 30,000Purchase consideration 13,23,000 6,30,000


1. Mergers, Restructuring and Corporate Control by J. Fred Weston, K. Wang,S. Chung and Susan E. Hoag, Prentice-Hall of India Private Ltd.

2. M&A and Corporate Restructuring by Patrick A. Gaughan, Wiley FinanceSeries.

3. AS 14 from icai.org website

■■■■



Notes

Unit 3: Valuation of Goodwill and Shares

Structure:3.1 Introduction to Goodwill3.2 Factors Affecting Value of Goodwill3.3 Need for Valuation of Goodwill3.4 Method of Valuing Goodwill3.5 Introduction to Valuation of Shares3.6 Major Reasons for Valuation of an Enterprise3.7 Analysis and Estimate of Value3.8 Valuation Methods

3.8.1 Market Approaches3.8.2 Asset Based Approaches3.8.3 Income Approaches3.8.4 Market Based3.8.5 Earnings Based Valuation3.8.6 Comparative Ratios

3.9 Summary3.10 Check Your Progress3.11 Questions and Exercises3.12 Key Terms3.13 Check Your Progress: Answers3.14 Case Study3.15 Further Readings

Objectives

After studying this unit, you should be able to:● Definition of goodwill and the methods of valuing goodwill● The significance of business valuation● The different approaches to business valuation

3.1 Introduction to Goodwill

Good will is the present value of the firm’s excess earnings.The word ‘excess’ gives indication as to its valuation which is equal to earnings

attributable to rate of return on tangible assets and intangible assets (other than goodwill)over and above the normal rate of return of return earned by representative firms in thesame industry. ‘Excess’ earnings also reflect various advantages which a firm may enjoyin comparison with its competitors such as general public patronage and encouragementdue to its local position, common celebrity, reputation for skill, affluence, punctuality,accidental circumstances and necessities or even from partialities or prejudices.

Valuation of Goodwill and Shares 49


NotesLord Eldon says “Goodwill is nothing more than the probability that the oldcustomers will resort to the old place”.

According to Lord Macnaghten, “It is a thing easy to describe, very difficult to define.It is the benefit and advantage of the good name, reputation and connection of abusiness. It is the attractive force which brings in customers. It is one thing whichdistinguishes and old established business from a new business at its first start.”

3.2 Factors Affecting Value of Goodwill

There are several factors which contribute to the goodwill of the business and theimportant ones are listed below:

(1) Quality of the management team.(2) Market share s for the product.(3) Productivity levels of the workers.(4) Research and development efforts.(5) Effective advertising to establish brand popularity(6) Good industrial relations.(7) Training and development programmes for workers, supervisors, and

executives at various levels.(8) Locational factors and proximity to markets.(9) Effective tax planning.

(10) Favorable attitude of government to the industry in general and the particularbusiness in special.

(11) Popularity of products in terms of quality and effective after sales service.(12) Customers’ favorable attitude and customer satisfaction.(13) Corporate image among the general public(14) Assured supplies and relation with suppliers.(15) The longevity of the enterprise.(16) The position of the business in relation to its competitors(17) The profit position over years.(18) Technical collaborators with established companies

3.3 Need for Valuation of Goodwill

The need for valuation of goodwill depends on the form of business organization. Inthe case of sole trader, it is usually valued at the time of selling the business, so as todetermine the amount payable by the buyer towards goodwill. In the case of partnership,there are several circumstances when goodwill has to be valued. They are:

(a) when a new partner is admitted(b) when a partner retires or dies.(c) When there is a change in the ratio of profit-sharing and(d) When there is dissolution either by sale to a company or amalgamation with

another firm In the case of limited companies(e) When two or more companies amalgamate.(f) When one company takes over another(g) When a company wants to acquire controlling interest in another company, and(h) When government takes over the business.



Notes 3.4. Method of Valuing Goodwill

Each business has its own particular characteristics and its special set ofcircumstances and these factors make it difficult to lay down a general formula, whichcovers all cases. Three points require emphasis, viz.:

1. The most important consideration is that the method of computing goodwillshould if possible; take into account the earning capacity of the business. Aperson buying a business, for example, is concerned with the question as towhether it will maintain its profits in future.

2. Unless the goodwill can be transferred for valuable consideration no value canbe said to attach to it. Thus, the personal knowledge and skill (such as thatpossessed by a barrister) cannot be sold and should the “goodwill” of thepractice of such a person be made up wholly of such factor, then nocommercial value attaches to it.

3. A prospective purchaser will be vitally concerned with the question of possiblefuture taxation liability. The purchaser of goodwill expects to recoup what hehas paid for it out of the future profits.

The following are the main bases and methods adopted in valuing goodwill:1. Arbitrary Assessment: Under this method, a valuation is made by one of the

parties (vendor or purchaser) to which the other agrees, or an independentparty may be called in to give his opinion.

2. Capitalization of Expected Future Net Profits: The necessary steps to betaken in computing goodwill by this method are as follows:(a) Ascertain the average net profits, which it is expected, will be earned in

the future.(b) Capitalize the net profit at the rate, which is considered a suitable return

on capital invested in a business of the type under consideration.(c) Find the value of the net tangible assets used in the business (i.e., assets

less external liabilities)(d) Deduct the net tangible assets as per (c) from the capitalized profit earned

in (b) and the difference in goodwill.Past profits generally provide the basis for ascertaining the average net profit, which

is expected to be earned in future. A reduction is made for remuneration of proprietorsand in the case of a limited company income tax payable on such profits. If it is knownthat certain expenses will not recur or that some increased expenses are likely to beincurred, then due allowance should be made for these. The main difficulty of this methodis the determination of appropriate return on capital in such type of business.

Illustrative Example I:A company desirous of selling its business to another company has earned an

average profits in the past of ` 150,000 p.a. Such average profit fairly represents theprofit likely to be earned in the future, except that:

1. Director’s fees’ ` 10,000, charged against such profits will not recur in future.2. Rent @ ` 20,000 p.a. that had been paid by the vendor company will not be a

charge in the future.The value of the net tangible assets of the vendor company at the proposed date of

sale was ` 1900,000 and it was considered that a reasonable return on capital investedfor the type of company is 8%.



NotesThe profits of the vendor company would in no way be affected by the sale of itsbusiness to the purchasing company and goodwill existed and was to be paid for on thebasis that the vendor company was a continuing enterprise. Calculate the value of thegoodwill:

Solution:Average net profits ` 150,000

Add: Non-recurring charges for: `

Directors fees 10,000Rent 20,000 30,000

Estimated future maintainable profits 180,000

Future profits capitalized at 8%8

100180,000 = ` 2250,000

Less: Net Tangible Assets 1900,000Goodwill 350,000

Illustrative Example 2:From the following information, value the goodwill of XY Co. Pvt. Ltd. carrying on

business as retail traders:

` `

Bank O/D 11,670 Plant & Equip at cost less dep. 20,000

Spares 18,100 Land & buildings at cost 22,000

Prov. for tax 3,900 33,670 Goodwill at cost 5,000 47,000

Paid up capital 50,000 Sundry debtors less provn.for doubtful debts 18,000

P & L Approp. A/c 11,330 61,330 Stock on hand 30,000

95,000 95,000

Profits earned before tax, have been as follows (Tax @ 30%)Year I ` 8,200Year 2 ` 8,800Year 3 ` 10,300Year 4 ` 11,600Year 5 ` 13,000

Reasonable return on capital invested for such type of business is 12.5%

Solution:Total profits for 5 years (year1 to 5) ` 51,900Less: Income tax @ 30% 15,570

36,330Average profits 7,266

Capitalized at 12.5% =12.5

1007266 = ` 58,128

Total Assets: ` 95,000



Notes Less: Goodwill (computed separately) 5000External liabilities 33670 ` 38,670Net Tangible Assets ` 56,330Now Capitalized Profits ` 58,128Less: Net Tangible Assets ` 56,330Goodwill 1,7983. Purchase of Past Profits: This method is widely practiced. It is calculated as

follows:1. The profits for an agreed number of years preceding the valuation are

averaged, so as to arrive at the average annual profit earned during the period.2. The goodwill is then estimated on so many years purchase of such average

profit. The number of years selected is presumed to bear relation to the numberof years’ benefit to be derived from the past association.The profit referred may be either net profit or gross profit according to what isagreed upon by the parties.

Illustrative Example 3:X, Y and Z are partners sharing profits and losses in the ratio of 2 : 2 : 1. It was

provided in the partnership agreement that on the death or retirement of a partner,Goodwill to be calculated on the basis of four years’ purchase of the average net profitsfor the preceding seven years. Z retires on 30th June. Calculate the amount of Goodwilldue to Z. Net profits for the seven years are:

Year 1 ` 16,000Year 2 ` 20,000Year 3 ` 36,000Year 4 ` 32,000Year 5 ` 16,000Year 6 ` 40,000Year 7 ` 36,000

Solution:Total profits for preceding 7 years = ` 1,96,000Average Profits = 1,96,000 ÷ 7 = ` 28,0004 years’ purchase of average profits = 28,000 × 4 = ` 1,12,000Zs share of goodwill =1,12,000 ÷ 5= ` 22,4004. Valuation based on Turnover: This method is similar to previous one except

that instead of profit it is based on turnover. The purchaser in other words, paysfor goodwill on one or more years’ purchase of ‘Gross takings”. This method isparticularly suitable for certain professional practices.

5. Purchase of Super Profits: In this method, the attention is focused uponsuper profits, which are those profits remaining after deducting from theestimated annual future profits:

Illustrative Example 4:The B Co. Ltd. is to be absorbed by the D Co. Ltd. and in order to decide upon the

purchase consideration, it is necessary to value the Goodwill attached to the business of



NotesG Co. Ltd. The two companies agree that Goodwill to be computed shall be three yearspurchase of the average annual super profits, the profits being averaged over five yearsand subject to whatever adjustments you, as the accountant making the valuation,consider necessary.

The profits of the G Co. Ltd. for the last 5 years (before charging corporate tax at say25%) are as follows:

` 20,000, ` 24,800, ` 17600, ` 28,000, ` 21,600The above profits does not consider services rendered by the directors of G Co. and

who will be retained in future for ` 4,000.The average capital invested in net tangible assets over the period is ` 104,800 and

it is considered that the normal return to be expected from the particular type of businesscarried on by G Co. Ltd.

Calculate the Goodwill of G Co. Ltd. based on the above.

Solution:Total profits for 5 years = ` 1,12,000Average profits 1,12,000 ÷ 5 = 22,400Less: Director’s fees 4,000

` 18,400Less: Corporate Tax at 25% ` 4,600

1,38,00Less: Return on capital invested (10% on ` 104,800) 10,480

` 3,320Goodwill = 3 years purchase of super profits 3,320 × 3 = ` 9,9606. The Annuity Method: This method of calculating Goodwill is similar to the

previous one except that the super profits when arrived at is not multiplied by a figurerepresenting a certain number of years’ purchase of such super profits. Instead it isconsidered that if the super profits is to continue over an estimated period, then goodwillis to be calculated by finding the present worth of an annuity (paying the super profit peryear) over the estimated period, discounted at the appropriated rate of interest.

In other words, we have to ascertain the amount of cash it is necessary to pay outnow in order

(i) to obtain the right to receive the amount of super profits annually for theestimated number of future years and

(ii) to allow for the fact that the money would earn its appropriate rate of interest ifinvested. It can be calculated by the formula

Q =R/100

-nr/100)(1-1

where Q = the present value of an annuity of ` 1 for a year at r %r = the rate percent p.a. ; n = the no. of years

Illustrative Example 5:Super Profit = ` 20,000No. of years over which super profit is to be paid = 3Rate percent per annum = 10%Calculate the value of Goodwill by the Annuity Method.



Notes Solution:The present value of an annuity ` 1 under these conditions:

=10/100

-310/100)(1-1

=0.1

1/1.33110.1

-3(1.10)-1

1.0

3)10.1(181

=0.13310.331

0.11.3310331

= 2.4868

Goodwill (being present value of an annuity of ` 20,000) = 20,000 × 2.4868 = ` 49736Alternatively: One can compensate from the present value table cumulative

against 10% rate of interest and year 3, the cumulative PV factor is 2.4868.

3.5. Introduction to Valuation of Shares

Valuation of shares one of the most complex of the accounting problems, involvesthe use of financial and accounting data, but much depends on the valuer’s judgment,experience and knowledge. Any valuation based purely on quantitative data is also notrealistic. Thus, share valuation is an intricate exercise involving accounting as well asnon-accounting data, objective and subjective consideration and balancing of theinterests of the parties involved in it Valuation is closely linked to the purpose of valuation

3.6. Major Reasons for Valuation of an Enterprise

1. Amalgamation or merger with another enterprise.2. Closure and sale of assets due to liquidation or other reasons.3. Assessment of fund raising capacity and required rating by lenders.4. Issue of shares.5. Partial or full privatization.6. The enterprise’s own internal exercise for the knowledge of owners and top

executives.7. Group restructuring exercise leading to mergers and demergers inside the

group.8. Strategic alliances and joint ventures with domestic and international partners.9. Sale (or exchange) of a few assets, brands and other claims.

10. Governmental requirements for taxation, securitization. etc.11. Rehabilitation of a sick or dying enterprise. Significant change is to be made in

the value-chain, knowing the independent strength of various value-driverscontributing to the value-chain of the enterprise.

12. Converting key employees into entrepreneurial employees and then into equalpartners in the enterprise.

13. Valuation of goodwill for its presentation in the Balance Sheet or for chargingroyalty to dealers, representatives, group-members. etc.

14. Partial valuation of certain divisions and product lines, for partial restructuring.



Notes3.7 Analysis and Estimate of Value

Valuation Process

● Decide on business valuation method to be used

● Analyze the company information in conjunction with the industry andcomparable company data

● Normalization of Financial Statements

The most common normalization adjustments fall into the following four categories:(i) Comparability Adjustments: The valuation may adjust the subject company’s

financial statements to facilitate a comparison between the subject companyand other business in the same industry or geographical location Theseadjustments are intended to eliminate differences between the way thatpublished industry data is presented and the way that the subject company’sdata is presented in its financial statements.

(ii) Non-operating adjustments: It is reasonable to assume that if a businesswere sold in a hypothetical sales transaction (which is the underlying premiseof the fair market value standard), the seller could retain any assets which werenot related to the production of earnings or price those non-operating assetsseparately .For this reason non-operating assets (such as excess cash) areusually eliminated from the balance sheet.

(iii) Non-recurring adjustments: The subject company’s financial statement smay be affected by events that are not expected to recur, such as the purchaseor sale of assets, a law suit or an unusually large revenue or expense. Thesenon-recurring items are adjusted so that the financial statements will betterreflect the management’s expectations of future performance.

(iv) Discriminatory adjustments: The owners of private companies may be paidat variance from the market level of compensating that similar executives in theindustry might command. In order to determine fair market value, the owner’scompensation, benefits, perquisites and distributions must be adjusted toindustry standards. Similarly, the rent paid by the subject business for the useof property owned by the company’s owners individually may be scrutinized.

3.8 Valuation Methods

Three different approaches are commonly used in business valuation–(i) the market approach(ii) the asset-based approach and the income approach.The market approaches determine value by comparing the subject company to

other companies in the same industry, of the same size, and/or within the same region.The asset-based approaches determine value by adding the sum of the parts of

the business. The income approach determine value by calculating the net presentvalue of the benefit stream generated by the business.

In determining which of these approaches to use, the valuation professional mustexercise discretion. Each technique has advantages and drawbacks which must beconsidered when applying those techniques to a particular subject company. Mosttreaties and court decisions encourage the valuator to consider more than one technique,which must be reconciled with each other to arrive at a value conclusion. A measure ofcommon sense and a good grasp of mathematics is helpful.



Notes 3.8.1 Market ApproachesIt is similar in many respects to the “comparable sales” method that is commonly

used in real estate appraisal. The market price of the stocks of publicly traded companiesengaged in the same or a similar line of business, whose sales are actively traded in afree and open market, can be a valid indicator of value when the transactions in whichstocks are traded are sufficiently similar to permit meaningful comparison The difficultylies in identifying public companies that are sufficiently comparable to the subjectcompany for this purpose.

Guidelines Public Company MethodGuideline Public Company method entails a comparison of the subject company to

publicly traded companies The comparison is generally based on publish data regardingthe public companies’ stock price and earnings, sales, or revenues, which is expressedas a fraction known as a “multiple”. If the guideline public companies are sufficientlysimilar to each other and the subject company to permit a meaningful comparison thentheir multiples should be nearly equal. In another variation of this method, the valuatormay determine market multiples by reviewing published data regarding actualtransactions involving either minority or controlling interests in either publicly traded orclosely held companies. In judging whether a reasonable basis for comparison exists, thevaluator must consider: (1) the similarity of qualitative and quantitative investment andinvestor characteristics; (2) the extent to which reliable data is known about thetransactions in which interests in the guideline companies were bought and sold: and(3) whether or not the price paid for the guidelines was in an arm-length transaction, or aforced or distressed sale.

Discounts and PremiumsThere are three common levels of value: controlling interest, marketable minority,

and non-marketable minority The intermediate level, marketable minority interest, islesser than the controlling interest level and higher than the non-marketable minorityinterest level. The marketable minority interest level represents the perceived value ofequity interests that are freely traded without any restrictions. These interests aregenerally traded in stock exchanges where there is a ready market for equity securities.These values represent a minority interest in the subject companies-small block ofshares that represent less than 50% of the company’s stock and usually less than 50%.Controlling interest level is the value that an investor would be willing to pay to acquiremore than 50% of a company’s stock, thereby gaining the attendant prerogatives ofcontrol. Some of the prerogatives of control include electing directors, hiring and firing thecompany’s management and determining their compensations; declaring dividends anddistribution, determining the company’s strategy and line of business, and acquiring,selling or liquidating the business. This level of value generally contains a controlpremium over the intermediate level of value, which typically ranges from 25% to 50%.An additional premium may be paid by strategic investors who are motivated bysynergetic motives. Non-marketable minority level is the lowest level on the chart,representing the level at which non-controlling equity interests in private companies aregenerally valued or traded. This level of value is discounted because no ready marketexists in which to purchase or sell interests. Private companies are less “liquid” thanpublicly traded companies, and transactions in private companies take longer and aremore uncertain. between the intermediate and lowest levels of chart, there are restrictedshares of publicly-traded companies. Publicly traded stocks have grown more liquid inthe pat decade due to rapid electronic trading, reduced commissions, and governmentderegulation.



NotesDiscount for Lack of ControlMinority interest discount (MID) are the inverse of control premiums to which the

following mathematical relationship can be applied: MID=1 – [1/(1 + CP)]. The mostcommon source of data regarding control premiums is the Control Premium Study,published annually by Mergerstat since 1972. Mergerstat defines the “control premium”as the percentage difference between the acquisition price and the share price of thefreely traded public shares five days prior to the announcement of the M&A transaction.

Discount for Lack of MarketabilityMarketability is defined as the ability to convert the business interest into cash

quickly with minimum transaction and administrative costs, and with a high degree ofcertainty as to the amount of net proceeds. There is usually a cost and a time lagassociated with locating interested and capable buyers of interests in privately heldcompanies, because there is no established market of readily-available buyers andsellers. All possible factors being equal, an interest in a publicly traded company is worthmore because it is readily marketable Conversely, an interest in a private-held companyis worth less because no established market exists. The concept has been establishedthat investors prefer an asset which is easy to sell, that is liquid. It is the valuationprofessional task to quantify the lack of marketability of an interest in a privately-heldcompany. Several empirical studies have been published that attempt to quantify thediscount for lack of Marketability. These studies indicate an average discount of 35% to50%.

Restricted Stock StudiesRestricted stocks are equity securities of public companies that are similar in all

respects to the freely traded stocks of those companies except that they carry arestriction that prevents them from being traded on the open market for a certain periodof time, which is usually one year. Restricted stock can be traded in private transactionsand usually do so at a discount. Studies have revealed that average discount variesbetween 26% and 45% and this has full support from valuation professionals and thecourts.

Option PricingUS publicly traded companies are able to sell stock to offshore investors (SEC

Regulations, enacted in 1990) without registering the share with the securities andexchange commission. The offshore buyers may resell these shares in the US, stillwithout having to register the shares after holding them for just 40 days Typically theseshares have been reported with discounts of 20% to 30% below the publicly traded shareprice.

Pre-IPO StudiesAnother approach to measure the marketability discount is to compare the prices of

stock offered in initial public offerings (IPOs) to transactions in the same company’sstocks prior to the IPO. Companies that are going public are required to disclose alltransactions in their stocks for a period of three years prior to the IPO. The pre-IPOstudies are alternative to the restricted stocks in quantifying the marketability discount

Applying the StudiesThe study confirm what the marketplace knows intuitively. Investors cover liquidity

and loather obstacles that impair liquidity. Prudent investors buy illiquid investments onlywhen there is sufficient discount in the price to increase the rate of return to a level which



Notes brings risk-reward back into balance. The referenced studies establish a reasonablerange of valuation discounts from the mid-30% to the low 50%. The more recent studiesappeared to yield a more conservative range of discounts than older studies, which mayhave suffered from smaller sample sizes.

3.8.2. Asset Based ApproachesThe value of asset based analysis of a business is equal to the sum of its part.

Pursuant to accounting convention, most assets are reported on the books of the subjectcompany at their acquisition value, net of depreciation where applicable. These valuesmay be adjusted to fair market value wherever possible. The value of a company’sintangible assets, such as goodwill, is generally impossible to determine apart from thecompany’s overall enterprise value. For this reason, the asset based approach is not themost probative method of determining the value of going business concerns. In thesecases, the asset based approach yields a result that is probably lesser than the fairmarket value of the business. In considering an asset based approach, the valuationprofessional must consider whether the shareholder whose interest is being valuedwould have any authority to access the value of the assets directly. Shareholders’ ownshares in a corporation, but not its assets, which are owned by the corporation. Acontrolling shareholder may have the authority to direct the corporation to sell all or partof the assets it owns and to distribute the proceeds to the shareholder(s). Thenon-controlling shareholders, however, lacks this authority and cannot assess the valueof the asset. As a result, the value of a corporation’s assets is rarely the most relevantstandard of value to a shareholder who cannot avail itself of that value. Adjusted net bookvalue may be the most relevant standard of value where liquidation is imminent orongoing; where a company earnings or cash flow are nominal, negative or worth lessthan its assets; where net book value is standard in the industry in which the companyoperates. None of these situations applies to the company which is the subject of thisvaluation report. However, the adjusted net book value may be used as a ‘sanity check’when compared to other methods of valuation such as the income and marketapproaches.

Different Methods of Asset Based Valuation

● Valuation in relation to book value, which is the difference between the netassets and the outstanding liabilities of the firm. The book value of a firm isbased on the balance sheet value of the owner’s equity. It is determineddividing net worth by the no. of equity shares outstanding. The book value isbased on historical costs of the assets of the firm and do not bear a relationshipeither to the value of the firm or to its ability to generate earnings. Book valuemay represent a fair and equitable basis of value in determination of purchaseprice of the target company. For negotiated mergers, book value could betaken into consideration.

● Valuation as a function of liquidation, or breakup, value. Breakup value can bedefined as the difference between the market value of the firm's assets and thecost to retire all outstanding liabilities. The difference between book value andliquidation value is that the book value of assets, taken from the firm's balancesheet, are carried at historical cost. Liquidation value involves the current, ormarket, value of the firm's assets.

● Open Market Value: Open market value refers to a price of the assets of thecompany which could be fetched or realized by negotiating sale provided thereis a willing seller, property is freely exposed to market, sale could be



Notesmaterialized within a reasonable period and throughout this period orders willremain static and without interruption from any extraordinary purchaser givinghigher bid. The assets of the company which are not subject to regular salecould be assessed on depreciated or replacement cost. Each asset of thecompany is normally valued on the basis of liquidation as a resale item ratherthan on going-concern basis. This takes care of undervalued assets to beproperly assessed. Besides, intangible assets like goodwill will also beassessed as per normal practices of the business firms and recognizedconventions.

● Replacement Cost: Some valuations, particularly for individual business unitsor divisions, are based on replacement cost. This is the estimated cost ofduplicating or purchasing the assets of the division at current market prices.Obviously, some premium is usually applied to account for the value of havingexisting and established business in place.

● Reproduction Cost: Reproduction cost method is based on assessing thecurrent cost of duplicating the properties or constructing similar enterprise indesign and material. It does not take into account the intangible assets fornegotiations to settle the bargain price of assets; but it is a good method ofvaluation for preliminary negotiations.

● Substitution Cost: Substitution cost is the estimate of the cost of theconstruction of the undertaking or enterprise in the same utility and capacity.Itneed not necessarily be similar in design to one being substituted. This methodis good for valuation when plant, machinery and other assets are importantconsiderations in acquisition bargaining. This method is also good fornegotiated bargaining.

● Investment Value: Investment value signifies the cost incurred to establish anenterprise. These cost include the original investment plus the interest accruedthereon. This determines the sale price of the target company which theacquirer may be asked to pay for the negotiated merger where it could betaken into consideration for valuation.

Asset Backing Method: The Asset Backing Method (sometimes termed theBalance Sheet Method) is concerned with the asset backing per share and may be based,either:

(a) on the view that the company is a continuing concern or(b) on the fact that the company is being liquidatedCompany as continuing concern: Two approaches are available, viz.:(i) to value the shares on the net tangible asset basis (excluding goodwill). By this

method, the total of net tangible assets (assets less liabilities) is divided by the number ofissued shares – to give the asset backing for each issued share. For instance if theassets total ` 50,000 and the liabilities ` 10,000, the net assets ` 40,000 divided by thenumber of shares of 20,000 will give the asset value of each share ` 2. That means if allassets are disposed off and all liabilities are paid there will be available for eachshareholder ` 2/- for each share held.

In valuing shares under this method, the following need to be done:1. The figures representing the assets are sound, that intangible assets (unless

represented by such items as trade marks, patterns etc). having a definitevalue and preliminary expenses are eliminated and all liabilities are taken into



Notes account, not forgetting of course, accrued item (including taxation) andprovisions.

2. Specific provisions for depreciation and doubtful debts normally deducted fromthe asset concerned to arrive at correct valuation

3. Items that represent shareholders funds such as reserves are not included inthe amount deducted from assets.

4. Different considerations to be given in cases where there is more than oneclass of shares issued, e.g., ordinary and preference shares and regard mustbe had to the respective rights of the shareholders. The preferenceshareholders may be entitled to return of their capital in priority to the ordinaryshareholders or on the other hand the preferential right may extend only todividends. So that they share pro rata with the ordinary shareholders in thereturn of capital.

In our above example, if we assume that capital of the company is composed of10,000 preference shares (preferential as to capital) and 10,000 ordinary shares it wouldbe said that preference shares had an asset backing of ` 4 each. The ordinary shares willlikewise be affected and would have an asset backing of ` 3. This is arrived at bydeducting the preference shares from the net assets (` 40,000 less ` 10,000) anddividing the result by the total number of ordinary shares (10,000)

2. Asset Backing (including goodwill): In many cases, goodwill needs to bevalued even if there is some figure in the balance sheet or not. It is generally consideredthat the value of fixed assets of the company depends on their ability to earn profits, i.e.,on the goodwill attaching to them. In such cases, Goodwill should be included with theother tangible assets for valuation purposes. Sometimes, goodwill attaches to thebusiness of a company even though the company is being liquidated as for example, inthe case of an amalgamation where one company is liquidated and its balance sheet soldto another company.

3.8.3. Income ApproachesThe income approaches determine fair market value by multiplying the benefit

steam generated by the subject company times a discount or capitalization rate. Thediscount or capitalization rate converts the stream of benefits into present value. Thereare several different income approaches, including capitalization of earnings or cashflows, discounted future cash flows (DCF), and the excess earnings method (which is ahybrid of asset and income approaches). Most of the income approaches consider thesubject company’s historical data; only the DCF method requires data for multiple futureperiods. The discount or capitalization rate must be matched to the type of benefit streamto which it is applied. The result of the value creation under this method is generally thefair market value of a controlling, marketable interest in the subject company, since theentire benefit stream of the subject company is most often valued, and the capitalizationand discount rates are derived from statistics concerning public companies.

Discount or Capitalization rates: A discount or capitalization rate is used todetermine the present value of the expected returns of a business. The discount rate andcapitalization rate are closely related to each other but distinguishable. Generallyspeaking, the discount rate or capitalization rate may be defined as the yield necessaryto attract investors to a particular investment, given the risks associated with thatinvestment. The discount rate is applied only to discounted cash flow (DCF) valuations,which are based on projected business data over multiple periods of time. In DCFvaluations, a series of projected cash flows is divided by the discount rate to derive thepresent value of the discounted cash flows. The sum of the discounted cash flows is



Notesadded to a terminal value, which represents the present value of business cash flows intoperpetuity. The sum of the discounted cash flows and the terminal value is the value ofthe business. On the other hand, a capitalization rate is applied in methods of businessvaluation that are based on historical business data for a single period of time.. The aftertax cash flow capitalization rate is equal to the discount rate minus the long termsustainable sustainable growth rate. The future tax cash flow of the business is dividedby the capitalization rate to derive the present value. Capitalization rates may be modifiedso that they may be applied to after tax net income or pretax cash flows or income. Thereare several different methods of determining the appropriate discount rates. The discountrate is composed of two elements: (1) the risk-free rate which is the return that aninvestor would expect from a secure, practically risk-free investment, such asgovernment bond plus (2) a risk premium that compensates an investor for the relativerisk associated with a particular investment in excess of the risk free rate. Again, theselected discount or capitalization rate must be consistent with stream of benefits towhich it is to be applied.

Build Up Method: The Built-up method is a widely recognized method ofdetermining the after-tax net cash flow discount rate, which in turn yields thecapitalization rate. The method is called a “built-up” method because it is the sum of risksassociated with various classes of assets. It is based on the principle that investors wouldrequire a greater return on classes of assets that are more risky. The first element is riskfree rate which is the rate of return for long-term government bonds. Investors who buylarge cap equity stocks, which are inherently more risky than long-term governmentbonds, require a greater return so the next element of Build-up method is the equity riskpremium. In determining a company’s value, the long horizon equity risk premium is usedbecause the Company’s life is assumed to be infinite. Similarly investors who invest insmall cap stocks, which are riskier than blue-chip stocks, require a greater return, calledthe “size premium”. By adding the first three elements of a Build-up discount rate, we candetermine the rate of return that investors would require on their investments in smallpublic company stocks. These three elements of the Build-up discount rate are knowncollectively as the “systematic risks”. In addition, the discount rate include “unsystematicrisks” which include two categories “industry risk premium” and “specific company risk”.Information on industry specific risks can be obtained. No specific published data isavailable to quantify specific company risks. Instead, specific company risks aredetermined by the valuation professional based upon the specific characteristics of thebusiness and the professional’s reasonable discretion applied to appropriate criteria. Thecapitalization rate for small, privately-held companies is significantly higher than thereturn that an investor might expect to receive from other common types of investments,such as money market accounts, mutual funds, or even real estate. Those investmentsinvolve lower levels of risk than an investment in a closely held company. Depositoryaccounts are insured up to certain limits; mutual funds are composed of publicly-tradedstocks for which risk can be substantially minimized through portfolio diversification; andreal estate almost invariably appreciates in value for long time horizons. Closely heldcompanies, on the other hand frequently fail for variety of reasons too numerous to name.The risk of investing in a private company can be reduced through diversification andmost businesses do not own the type of hard assets that can ensure capital appreciationover time. This is why investors demand a much higher return on their investment inclosely-held businesses; such investments are inherently much more risky.

Capital Asset Pricing Model (CAPM): The Capital Asset Pricing model is anothermethod of determining the appropriate discount rate in business valuations. Like theBuild-up method, the CAPM method derives the discount rate by adding a risk premiumto the risk-free rate. In this case, the risk is derived by multiplying the equity risk premium



Notes times “Beta”, which is a measure of stock price volatility. Beta is published by varioussources for particular industries and companies. Beta is associated with systematic riskof an investment. One of the criticisms of CAPM method is that Beta is derived from thevolatility of prices of publicly traded companies which is likely to differ from privatecompanies in their capital structures, diversification of products and markets, access tocredit markets, size, management depth, and may other respects. Where privatecompanies can be shown to be sufficiently similar to public companies, however, theCAPM model may be appropriate.

Weighted Average Cost of Capital (WACC): WACC is the third approach todetermine a discount rate. The WACC method determines the subject company’s actualcost of capital by calculating the weighted average of the company’s cost of debt andcost of equity. One of the problems with this method is that the valuer may elect tocalculate WACC according to the subject company’s existing capital structure, theaverage industry capital structure, or the optimal capital structure.

Once the capitalization or discount rate is determined, it must be applied to anappropriate benefit streams: pretax cash flow, after-tax cash flow, pretax net income,after tax net income, excess earnings, projected cash flows, etc.

3.8.4. Market Based

● Market capitalization for listed companies. Market value does not exactlydepict the real worth of the company because it does not take intoconsideration various intangible factors like abilities of management, prospectsof industry in which the company operates and strategic values possessed bythe company on account of patents, technical collaborations, locationalbenefits, institutional finance, etc. To arrive at a fair value, it may be ensuredthat temporary factors causing volatility or fluctuations are eliminated byaveraging the quotations over a period of time. Market value alone is notconsidered as a good measure of valuation unless there is broad market for thecompany’s securities. But it is relied upon along with the valuation arrived at onthe basis of net assets or earnings. In hostile takeovers, the acquirer pays onlymarket value.

● Market multiples of comparable companies for unlisted company. Herethe procedure is to calculate a representative P/E ratio of a group of quotedcompanies after suitable adjustments. Generally for small companies whichare not quoted and are closely held or private companies—a discount isapplied for valuation to the prevalent P/E ratio of comparable listed company.This discount increases the earnings yield but reduces the capitalization rateand consequently the valuation to the size of discount will vary depending uponthe quantum of voting rights being acquired. Higher the voting rights, lower isthe discount rate to be applied and the discount rate as such will differ between0% to 50%. In case there are restrictions on transfer of shares in the Articles ofAssociation of the company, the discount rate applied in such cases is higher.Generally, as per practices in vogue in European nations, P/E ratio of a quotedcompany is reduced to half for private unquoted company.

3.8.5 Earnings Based Valuation

● Historical earnings valuation: Valuation based on earnings is a popularmethod of valuation, the pre-determined rate of return expected by investor oninvestment is used which is equal to simple rate of return on capital employed.



NotesFrom the earnings last declared by the company, items such as tax, preferencedividends are deducted and net earnings are taken for calculation. But thisvaluation invites criticism, as it is based on past performance. Whereas for fairvaluation, reliable forecasts of future earnings is necessary Another viewpointis that instead of using the accounting rate of return for valuation, the priceearning (P/E) ratio could be used .

● Future maintainable earnings valuation: This method of valuing shares isalso known as Profit valuation or Earning Capacity Method or Yield Basis. Themethod of valuation takes into account the company’s earning capacity and thenormal rate of interest or dividend that is current on outside investments. Theconcept is that an investor is primarily concerned with the possible return onthe capital he invests. The class of the company whether it is well establishedor speculative, as well as the type of share (preference, ordinary) is importantfactors.

The following are the steps for a yield – based valuation –1. Ascertain the future maintainable profits2. Ascertain the normal rate of return3. Determine the capitalization factor or the multiplier, which is 100 divided by the

normal rate of return. If the normal rate of return is 12.5%, multiplier will be 100÷ 12.5 = 8

4. Ascertaining the capitalized value of maintainable profits by multiplying thefuture maintainable profits with capitalization factor.

5. The yield value of the shares will be ascertained by dividing the capitalizedvalue of maintainable profits by the number of equity shares.

Example: H holds 5000 shares in Hindustan Ltd. The nominal and paid up capital ofwhich is ` 300,000 in ` 10 shares divided into 10,000 5% Preference Shares of ` 10 eachand 20,000 ordinary shares of ` 10 each. It is ascertained that:

(a) The normal annual net profit of such company is ` 50,000 and(b) The normal return by way of dividend on the paid up value of share capital for

the type of business carried out by company is 8%You are required to value H’s holding.

Solution:Net Profit for the Company ` 50,000Less: Dividend to be paid to preference shareholders@ 5% on ` 10,000 5,000Profit available to equity shareholders ` 45,000

This profit of ` 45,000 to be capitalized @ 8% =8

10045,000 = ` 5,62,500

The value of each ordinary shares therefore =20,000

5,62,500 = ` 28.125 per share

Value of 5,000 shares held by H = 28.125 × 5000 = ` 1,40,625In the above case, it has been assumed that the preference shares do not

participate further in the profits and therefore as the profits earned by them is normal,they are valued at par.



Notes If the preference shares are participating preference shares how the valuation are tobe done for preference shares and equity shares are given in the following example:

Example: Assume the following details relating to the capital of a certain company.10,000, 5% Participating Preference shares of ` 10 each20,000 ordinary shares of ` 10 eachThe preference shares are entitled to participate in the share of the profits to the

extent of a further 4% after payment of a dividend of 10% to the ordinary shareholders.Any further excess is available to ordinary shareholders.

The normal average profits less tax of the company are ` 40,000 p.a. The normalreturn applicable to the particular type of company is 8% on the nominal value of theordinary shares and 8% on preference shares, which are participating.

You are required to find the value of each of the classes of shares.

Solution:Profits available to Preference shareholders5% on ` 100,000 50004% on ` 100,000 4000 9000Profits available to ordinary shareholders10% on ` 200,000 20,000Plus balance of profits 11,000 31000

40000Value of Preference shares:Profits of ` 9000 capitalized at 8% 112500Value of preference shares = 112,500 ÷ 10000 = ` 11.25 per shareValue of Ordinary SharesProfits of ` 31000 capitalized at 8% ` 387500Value of Ordinary Shares = 387, 500 ÷ 20,000 = ` 19.374Let us now discuss certain concepts used in this regard:Maintainable future profits: There are three steps involved in estimating the future

maintainable profits. They are:(1) Computing past average earnings after tax. The period selected must not

be remote. Since the earnings of such period may not have any bearing on thefuture. In arriving at the past average the following adjustments should bemade:(a) Any exceptional events of non-recurring nature on the profits of the

company should be eliminated.(b) Only profits of routine operations should be considered. Profits and losses

on non-trading assets should be eliminated.(c) Managerial Remuneration should be fair and reasonable, undercharging

or overcharging should be adjusted(d) Inadequate provision for tax, bad debts, gratuity, depreciation, etc. should

be adjusted. Improper valuation of stocks should be avoided.(e) Tax provision should be made based on latest tax provision and

adjustments for future should be accordingly made.



Notes(2) Projections for future profits: If business is contemplating any expansion,diversification, discontinuance of any segment, change in the policy, the pastaverage profits must be adjusted suitably. Sometimes, there may be change inGovernment policy towards the particular industry or general change such asthe current deregulation and opening up of the economy, which may havesignificant impact on business. Such impact must be considered to adjustthese profits for the future.

(3) Adjustment of preferred rights: Since we are computing share valuation forequity shareholders, full provision must be made for interest on debt holdersand loan, and maximum dividends payable to preference shareholders as perterms of issue.

Normal rate of return: Share valuation on yield basis hinges on the normal rate ofreturn chosen. The normal rate of return should be equal to risk free return plus premiumto cover the risk involved in the particular business. Risk free rate refers to the interestearnings on investments, which are completely, risk free such as Treasury Bills. However,it is not an easy task to measure the risk associated with a particular business anddetermine the additional earnings expected to compensate such risk. Normally theprinciple is higher the risk, higher would be the premium expected. In the case of equityshares, the risk differs according to industry and in each industry according to the specificunit; companies, which are managed well, will carry a lower risk because of stability.

● Earnings Before Interest Taxes Depreciation and Amortization (EBITDA)valuation (Capitalization of Cash flow): The adjusted cash earnings may becapitalized in arriving at a value for the firm.This method may be suitable for aservice business.

ExampleAdjusted Cash Earnings ` 100,000X Capitalization Factor (25%) × 4Capitalization of cash Flow 400,000Less Liabilities Assumed 50,000Capitalization of Cash Flow Earnings 350,000

● The Free Cash Flow (FCF) Basis for Valuation

The following steps are necessary:(a) Earnings are the basis for estimating cash flows.

Year wise cash inflow = Year wise accounting profit of the company orbusiness units after tax + Depreciation/Amortization + All other non-cashexpenses – Non-cash revenue

(b) Further cash flows are to be estimated for the next 3 to 5 years based on longterm strategic plans.

(c) Determine free cash flow – Free cash flow is the cash flow available to allinvestors in the company – both shareholders and bond holders afterconsidering taxes, capital expenditure and working capital investment.

(d) At the end of 3 or 5 years, the terminal value (just like the project or the asset)of the business unit (or the company) is to be estimated.



Notes There are four approaches for calculating terminal value:Approach I: Terminal value is a growing perpetuity

For Terminal value =rate growth – rate capital of Cost

rate) growth(1flow cash Free

Approach 2: Terminal value is a stable perpetuity

Terminal value =capital) of (Cot rate Discount

flow cash Free

Approach 3: Terminal value as a Multiple of Book value. The terminal value can beestimated by multiplying the forecasted book value of capital by anapproximate market – to book ratio. Normally, the current market/bookvalue ratio is taken as proxy for future.

Approach 4: Terminal value as a Multiple of earnings – the terminal value underthis method is established by multiplying the forecasted terminal yearprofits by an approximate price minus the earning multiple. As usual,the current price/earnings multiple can be used as proxy for future.

Illustration:The cash flows of a division of a company are given below:

(` Crores)

Year 1 Year 2 Year 3 Year 4 Year 5

Net operating profit after tax (1) 65 70.20 75.40 80.6 87.10

Depreciation expenses (2) 20 22 24 26 28

Capital expenditure (3) 30 32 35 37 40

Working capital (4) 20 22 23 25 27

Free cash flow (5) = (1) + (2) – (3) – (4) 35 38.20 41.40 44.60 48.10

Cash flows are expected to grow at 5% after 5th year.Cost of capital is 15% and assets employed ` 325 crores.Evaluate the performance of Division A.

Solution:

Year 1 Year 2 Year 3 Year 4 Year 5

Free cash flow terminal value 35 38.20 41.40 44.60 48.10505.05

Discount factor @ 15% 0.870 0.756 0.658 0.572 0.497

Discounted cash flow 30.45 28.88 27.24 25.51 274.91

Total of Discounted Cash Inflow 386.99Less: Capital employed 325.00NPV 61.99IRR of the Division (approx) 20%(i.e., the discount factor or the cost of interest the unit can bear)

Note: Terminal value =0.05–0.151.0548.10 =

0.05–0.1550.505 = ` 505.05 crores



Notes3.8.6 Comparative RatiosThe following are two examples of the many comparative metrics on which acquiring

companies may base their offers:

● Price-Earnings Ratio (P/E Ratio): With the use of this ratio, an acquiringcompany makes an offer that is a multiple of the earnings of the targetcompany. Looking at the P/E for all the stocks within the same industry groupwill give the acquiring company good guidance for what the target's P/Emultiple should be. Earnings per share (EPS) are obtained by dividing theearnings with the number of equity shares. Comparison is made betweenaverage earnings per share and earnings per share of the specific company toobtain the value of the share. This may be expressed in a formula.Value of share on EPS basis =

EPS Average shareequity of value up Paidcompany the of EPS

In the illustration given earlier, the EPS of ordinary shares works out to be` 31,000 ÷ 20,000 = ` 1.55 per share

Normal EPS for equity shares = 8% i.e.108

× ` 10 = ` 0.8 per share

Hence value of shares =0.8

1.55 ×10 = ` 19.375 per share

● Dividend basis of Yield Value: Yield value can be determined by takingdividend as the basis. Yield value of a share = Expected rate of dividend/Normal rate of Dividend x paid up value per share.Yield value can be calculated by taking dividend as the basis. For example,10% is the normal dividend in an industry and 20% is the dividend paid by aparticular company, the value of the shares will be twice its paid up amount.Conversely, if the particular company pays a dividend of 5%, the value of itsshare will be only 50% of the paid up amount. This can be expressed by way offormula :

Yield value of a share =dividend of rate Normal

share per value up paid dividend of rate Expected

This method and the earlier method will give the same result if all the earningsare distributed as dividend. In other words, the company is adopting a dividendpayout ratio of 100% (i.e., whatever profit is earned after tax it is paid by way ofdividend).

● Enterprise-Value-to-Sales Ratio (EV/Sales): With this ratio, the acquiringcompany makes an offer as a multiple of the revenues, again, while beingaware of the price-to-sales ratio of other companies in the industry. Thisapproach may be used when earnings are questionable.Here are some Indian examples of the amount paid for acquisition. UdayanBose’s (Chairman, Lazard Credit Capital) “thumb rule for buying a consumerproduct company is to offer 1 to 1.5 times the turnover”. Coca Cola’s offer toParle was equal to the Indian company’s turnover. The Khaitans paid 1.7 timesthe turnover— ` 290 crore—for Union Caebide (UCIL), and Heinz paid ` 210crore for Glaxo’s food business, 2.1 times the turnover.



Notes ● Discounted Cash Flow (DCF): A key valuation tool in M&A, discounted cashflow analysis determines a company's current value according to its estimatedfuture cash flows. Forecasted free cash flows (net income + depreciation/amortization – capital expenditures – change in working capital) are discountedto a present value using the company's weighted average costs ofcapital (WACC). Admittedly, DCF is tricky to get right, but few tools can rivalthis valuation method. First, the present value of the equity of the target firmmust be established. Next, the present value of the expected synergies fromthe merger, in the form of cost savings or increased after-tax earnings, shouldbe evaluated. Finally, summing the present value of the existing equity with thepresent value of the future synergies results in a present valuation of the targetfirm.

● An expected earnings multiple: First, the expected earnings in the first yearof operations for the combined or merged firm should be estimated. Next, anappropriate price-earnings multiple must be determined. This figure will likelycome from industry standards or from competitors in similar business lines.Now, the PE ratio can be multiplied by the expected combined earnings pershare to estimate an expected price per share of the merged firm's commonstock. Multiplying the expected share price by the number of sharesoutstanding gives a valuation of the expected firm value. Actual acquisitionprice can then be negotiated based on this expected firm valuation.

● Marakon Approach based on market to book-value approach: According tothe Marakon model, the market-to-book values ration is a function of the returnon equity, the growth rate of dividends (as well as earnings), and the cost ofequity

g-k

g-rBM

Where, M = market value of equityB = book value of equityr = return on equityg = growth rate of dividendsk = cost of equity

From the above equation, it is evident that (M/B) > 1 only when r > k. Putdifferently, value is created only when there is a positive spread between thereturn on equity and the cost of equity. Further, when r > k, the higher the g thehigher the M/B ratio. This means that when the spread is positive, a highergrowth rate contributes more to value creation.

● EVA and Valuation: Conceptually, the value of a firm or a division thereof isequal to the current economic book value of assets plus the present value ofthe future EVA stream expected from it: EVA valuation = Economic book valueof assets + Present value of EVA stream associated with it.Example: Global Ltd. is interested in acquiring the foods division of RegionalCompany. The forecast of the free cash flow for the proposed purchase, asdeveloped by G Ltd. is shown below. It is based on the following assumptions:

(i) The growth rate in assets, revenues and profit after tax will be 20% for thefirst 3 years, 12% for the next 2 years and 8% thereafter.



Notes(ii) The ratio of net profit after tax to net assets would be 0.12. Theopportunity cost of capital for the proposed acquisition is 11%.

Free Cash Flow

Year 1 2 3 4 5 6

Asset valueNet operating profit after taxNet investmentFree cash flowGrowth rate (%)Discount factor at 11%Discounted Free cash flowDiscounted terminal value at theend of six years = 4.33 × 1.08/(0.11 – 0.08) = 155.88 × 0.535

50.00

6.0010.00(4.00)

200.901

(3.604)

60.00

7.2012.00( 4.80)

200.812

(3.898)

72.00

8.6414.40(5.76)

200.731

( 4.216)

86.40

10.3710.37

–12

0.659

–

96.77

11.6111.61

–12

0.593

–

108.38

13.008.674.33

80.535

2.31683.08

Hence, the total of present value of free cash flow = 73.678Let us now value the foods division of Regional Company using EVA approach.

EVA Projection

Year 1 2 3 4 5 6

Beginning capital 50.00 60.00 72.00 86.40 96.77 108.38

Net operating profit after taxCost of capital (%)Capital chargeEVAGrowth rate (%)Discounted EVA @ 11%Terminal value 1.08 × 1.08/(0.11 – 0.08)Discounted terminal value

6.0011

5.500.5020

0.451

7.2011

6.600.6020

0.487

8.6411

7.920.7212

0.563

10.3711

9.500.8712

.0.573

11.6111

10.640.97

80.575

13.0011

11.921.08

80.57838.8820.801

The present value of EVA stream = 24.028Given the beginning capital of 50, the EVA valuation is 50 + 24.028 = 74.028 This is

same as DCF – the minor difference is due to rounding off.

Problems1. Assume the following details relating to the capital of a certain company.10,000, 5% Participating Preference shares of ` 10 each 20,000 ordinary shares of

` 10 each.The preference shares are entitled to participate in the share of the profits to the

extent of a further 4% after payment of a dividend of 10% to the ordinary shareholders.Any further excess is available to ordinary shareholders.

The normal average profits less tax of the company are ` 40,000 p.a. The normalreturn applicable to the particular type of company is 8% on the nominal value of theordinary shares and 8% on preference shares, which are participating.

You are required to find the value of each of the classes of shares.



Notes Solution:Profits available to Preference shareholders5% on ` 100,000 50004% on ` 100,000 4000 9000Profits available to ordinary shareholders10% on ` 200,000 20,000Plus balance of profits 11,000 31000

40000Value of Preference shares:Profits of ` 9000 capitalized at 8% 112500Value of preference shares = 112,500 ÷ 10000 = ` 11.25 per shareValue of Ordinary SharesProfits of ` 31000 capitalized at 8% ` 387500Value of Ordinary Shares = 387,500 ÷ 20,000 = ` 19.3742. The P Ltd has paid the following dividends per share-

Year Dividend per share Year Dividend per share

123

` 2.002.102.24

456

` 2.402.582.80

Assuming a 16% required, and ` 3 per share dividend in year 7, Compute the valueof the share.

SolutionThe dividend of ` 2.00 has grown to ` 2.80 in 5 years, i.e., total growth of 2.80/2.00 =

1.40. Hence, average growth of (1.40)-5 =6.96%, i.e., 7%

Hence, price of the share in 7th year =0.09

37%-16%

3.00 = ` 33.33

3. FTL creates leading-edge technologies for fast growing market Its reportedearnings and dividends per share were ` 11.50 and ` 2.40 respectively in 2009. For thenest 5 years, the projected earnings growth is 30.1%. It is expected to decline linearly to8% after 5 years. The dividend payout ratio is likely to remain stable during 2009-14. Itwould rise linearly after that and reach 21% in 2019-20. The shares of FTl are expectedto have a beta of 1.18 in the next 5 years but is expected to decline linearly over thefollowing 5 years to reach 1 by the time the FTL reaches its steady level of growth (8%) in2019. The risk free rate is currently 8% and may be assumed to remain constant in theforeseeable future. The market risk premium may be assumed to be 4%. Compute thevalue of FTL share, using dividend discount valuation model.

Solution:Present dividend payout ratio = 2.40/11.50 = .2087 rounded to 0.209 to remain

stable during 2009-14Return on equity % as of today = 8% + 1.18 × 4 = 12.72% and remain same during

2009 to 2014Return on equity as on 2019 = 8% + 1 × 4 = 12%, hence from 12.72% in 2014 it will

decline to 12% steadily, i.e., 0.72/5 = 0.144 per year



NotesEarnings growth rate from 2014 for the next 5 years to decline linearly to 8.0%, i.e.,(30.1 – 8)/5 = 4.42% per annum

Year 09 10 11 12 13 14 15 16 17 18 19 20 Total

Earningsgrowth

– 30.1 30.1 30.1 30.1 30.1 25.68 21.26 16.84 12.42 8.0 8.0

Earnings 11.50 14.96 19.46 25.32 32.94 42.86 53.87 65.32 76.32 85.80 92.67 100.08

Payoutratio

0.209 0.209 0.209 0.209 0.209 0.209 0.209 .209 .209 0.209 0.21 0.21

Dividend 2.40 3.12 4.06 5.28 6.87 8.95 11.25 13.64 15.94 17.92 19.46 21.02

Beta 1.18 1.18 1.18 1.18 1.18 1.18 1.14 1.11 1.07 1.04 1.00 1.00

Return onequity

12.72 12.72 12.72 12.72 12.72 12.72 12.58 12.43 12.29 12.14 12.0

Compounded return

12.72 12.72 12.72 12.72 12.72 12.72 12.70 12.66 12.61 12.56 12.50

PV atcomp rate

1.0 0.89 0.79 0.70 0.62 0.56 0.49 0.43 0.39 0.34 0.31

PV ofdividend

– 2.77 3.21 4.25 4.26 5.01 5.52 5.87 6.22 6.09 6.03 49.23

Share price at the end of 2019 = 21.02/(12% – 8%) = 525.5 × discount factor 0.31 = 162.91

Share value at the end 2009 = 212.14

4. H Ltd. is growing at an above average rate. It foresees a growth rate of 20% perannum in free cash flows to equity holders in the next 4 years. It is likely to fall to 12 % inthe next 2 years. After that, the growth rate is expected to stabilize at 5% per annum. Theamount of free cash flow (FCFE) per equity share at the beginning of the current year is` 10. Find out the maximum price at which an investor, follower of free cash flowapproach will be prepared to buy the company’s shares as on date, assuming an equitycapitalization of 14%.

Solution:Maximum price of equity shares will be sum of (i) PV of FCFE during 1-6 years and (ii)

PV of expected market price at the end of year 6, based on a constant growth rate of 5%.Present value of FCFE (years 1-6)

Year FCFE per share ` PV factor (0.14) Total PV `

123456

10 × (1 + 0.20) 1212 × (1 + 0.20) 14.4014.40 × (1 + 0.20) 17.2817.28 × (1 + 0.20) 20.7420.74 × (1 + 0.12) 23.2323.23 × (1 + 0.12) 26.02

0.8770.7690.6750.5920.5190.456

10.5211.0711.6612.2812.0611.86

Total PV of FCFE 69.45

Market price of share at year-end 6 =gKe7FCFE

=

5%-14%)26.02(1.05 =

9%27.321 = ` 303.57

PV of ` 303.57= ` 303.57 × .456 = ` 138.43Maximum price of share = 69.45 + 138.43 = ` 207.88



Notes 3.9 Summary

In this unit, various methods of valuing goodwill and a business enterprise havebeen covered

Valuation of Goodwill: The following are the various methods used–1. Arbitrary Assessment: A valuation is made by one of the parties (vendor or

purchaser) to which the other agrees, or an independent party may be called into give his opinion.

2. Capitalization of Expected Future Net Profits: The necessary steps to betaken in computing goodwill by this method are as follows:(a) Ascertain the average net profits, which it is expected, will be earned in

the future.(b) Capitalize the net profit at the rate, which is considered a suitable return

on capital invested in a business of the type under consideration.(c) Find the value of the net tangible assets used in the business (i.e., assets

less external liabilities)(d) Deduct the net tangible assets as per (c) from the capitalized profit earned

in (b) and the difference in goodwill.3. Purchase of Past Profits: This method is widely practiced. It is calculated as

follows:(a) The profits for an agreed number of years preceding the valuation are

averaged, so as to arrive at the average annual profit earned during theperiod.

(b) The goodwill is then estimated on so many years purchase of suchaverage profit. The number of years selected is presumed to bear relationto the number of years’ benefit to be derived from the past association.

(c) The profit referred may be either net profit or gross profit according towhat is agreed upon by the parties.

4. Valuation based on turnover: This method is similar to previous one exceptthat instead of profit it is based on turnover. The purchaser in other words, paysfor goodwill on one or more years’ purchase of “Gross takings”. This method isparticularly suitable for certain professional practices.

5. Purchase of Super Profits: In this method, the attention is focused uponsuper profits, which are those profits remaining after deducting from theestimated annual future profits:

6. The Annuity Method: This method of calculating Goodwill is similar to theprevious one except that the super profits when arrived at is not multiplied by afigure representing a certain number of years’ purchase of such super profits.Instead it is considered that if the super profits is to continue over an estimatedperiod, then goodwill is to be calculated by finding the present worth of anannuity (paying the super profit per year) over the estimated period, discountedat the appropriated rate of interest.

In other words, we have to ascertain the amount of cash it is necessary to pay outnow in order to obtain the right to receive the amount of super profits annually for theestimated number of future years and to allow for the fact that the money would earn itsappropriate rate of interest if invested.

Major reasons for valuation of an enterprise are:1. Amalgamation or merger with another enterprise.



Notes2. Closure and sale of assets due to liquidation or other reasons.3. Assessment of fund raising capacity and required rating by lenders.4. Issue of shares.5. Partial or full privatization6. The enterprise’s own internal exercise for the knowledge of owners and top

executives7. Group restructuring exercise leading to mergers and demergers inside the

group.8. Strategic alliances and joint ventures with domestic and international partners.9. Sale (or exchange) of a few assets, brands and other claims.

10. Governmental requirements for taxation, securitization etc.11. Rehabilitation of a sick or dying enterprise. Significant change is to be made in

the value-chain, knowing the independent strength of various value-driverscontributing to the value-chain of the enterprise.

12. Converting key employees into entrepreneurial employees and then into equalpartners in the enterprise.

13. Valuation of goodwill for its presentation in the Balance Sheet or for chargingroyalty to dealers, representatives, group-members, etc.

14. Partial valuation of certain divisions and product lines, for partial restructuringValuation Methods for Enterprise(i) The market approaches determine value by comparing the subject company to

other companies in the same industry, of the same size, and/or within the sameregion.(a) Market multiples of comparable companies for unlisted company

Comparative Ratios: The following the many comparative metrics on whichacquiring companies may base their offers:

● Price-Earnings Ratio (P/E Ratio)● Enterprise-Value-to-Sales Ratio (EV/Sales)● Discounted Cash Flow (DCF)● An expected earnings multiple● Marakon Approach based on market to book-value approach● EVA and Valuation

(ii) The asset-based approaches determine value by adding the sum of the partsof the business. These are as follows:● Valuation in relation to book value (which is the difference between the

net assets and the outstanding liabilities of the firm)● Valuation as a function of liquidation, or breakup, value. Breakup value

can be defined as the difference between the market value of the firm'sassets and the cost to retire all outstanding liabilities.

● Open Market Value: Open market value refers to a price of the assets ofthe company which could be fetched or realized by negotiating saleprovided there is a willing seller, property is freely exposed to market, salecould be materialized within a reasonable period and throughout thisperiod orders will remain static and without interruption from anyextraordinary purchaser giving higher bid.

● Replacement Cost: Some valuations, particularly for individual businessunits or divisions, are based on replacement cost.



Notes ● Reproduction Cost: Reproduction cost method is based on assessingthe current cost of duplicating the properties or constructing similarenterprise in design and material.

● Substitution Cost: Substitution cost is the estimate of the cost of theconstruction of the undertaking or enterprise in the same utility andcapacity.

● Investment Value: Investment value signifies the cost incurred toestablish an enterprise. These cost include the original investment plusthe interest accrued thereon.

Asset Backing Method:The Asset Backing Method (sometimes termed the Balance Sheet Method) is

concerned with the asset backing per share and may be based, either:(a) on the view that the company is a continuing concern or(a) on the fact that the company is being liquidated.

(iii) The income approach determine value by calculating the net present value ofthe benefit stream generated by the business through one of the ratescomputed as(a) Discount or Capitalization rates(b) Build Up Method(c) Capital Asset Pricing Model (CAPM)(d) Weighted Average Cost of Capital (WACC)

Different methods used under income approach are as:● Earnings Before Interest Taxes Depreciation and Amortization (EBITDA)

valuation (Capitalization of Cash flow)● The Free Cash Flow(FCF) basis for Valuation


I. State Whether the Following Statements are True or False1. Super profit is the increase in current year’s profit over the average profits of

the preceding three years.2. Normal rate of return is the rate of return which the investors in general expect

on their investments in a particular industry having regard to the risk-free rateof interest and the business and financial risks associated with the investment.

3. In the calculation of goodwill, past profits will have to be adjusted ,in order todetermine the future expected profits.

4. Fair value of a share is the weighted average of intrinsic value and yield value.5. Normal rate of return and PE ratio are one and the same.6. For calculating the market value of shares, one should take into account the

rate of earning and not the rate of dividend, if the shares are acquired forcontrol purpose.

II. Multiple Choice Questions1. A business is having adjusted net profits of` ` 100,000 and capital employed of

` 600,000. If goodwill is taken at 3 years purchase of super profits and theexpected rate of return is 10%, the value of goodwill will be __________.



Notes(a) ` 3,00,000(b) ` 500,000(c) ` 1,20,000(d) ` 180,000

2. A company is having 40,000 equity shares of ` 15 paid. If the dividend pershare is Re. 1 and the expected rate of return is 12%, the market value ofshare will be __________.(a) ` 12(b) ` 8.33(c) ` 10(d) ` 12.5

3. For calculating market value using PE ratio, it is necessary to know__________.(a) Earnings per share(b) Rate of dividend(c) Average profits(d) Super profits

4. The relationship between normal rate of return and PE ratio is __________.(a) Inverse(b) Direct(c) Irregular(d) None of these


1. Define goodwill. Distinguish between purchased goodwill and inherent goodwill.Describe briefly the contributing factors of goodwill.

2. Discuss with examples various methods for valuation of goodwill.3. What are the reasons for valuation of a business?4. What valuation base does one adopt while valuing a business as a going

concern?5. Explain briefly the relative advantages and disadvantages of valuation of

business following:(i) Capitalisation of future maintainable profit method(ii) Present value of future earnings and(iii) Present value of future cash flows method.

6. Why does valuation of a business differ if it does in isolation as compared tothat when in combination of another business? What is meant by control?

7. What are the four equivalent ways of calculating EVA?8. What are the three components of EVA calculation?9. Discuss the adjustments for calculating EVA?

10. In the most recent financial year, the firm reported depreciation of ` 20 croresand earnings before interest and taxes (operating income) of ` 100 crores onrevenue of ` 1000 crores, the tax rate is 40%. The capital invested in the firmwas ` 400 crores. The firm expects to maintain the return on capital inperpetuity. The firm expects to reinvest 60% of its after tax operating income



Notes back into the business entity every year for the next 5 years. The cost of capitalis 10% in perpetuity and the expected growth rate after year 5 will be 4%.

11. From the under mentioned facts determine the cost of equity of Company X(i) Current market price of a share = ` 150(ii) Cost of floatation per share on new shares ` 3(iii) Dividend paid on the outstanding shares over the past five years:

Year Dividend per share123456

` 10.5011.0211.5812.1612.7613.40

(iv) Assume a fixed dividend pay out ratio(v) Expected dividend on the new shares at the end of the current year is `

14.10 per share12. FTL creates leading-edge technologies for fast growing market Its reported

earnings and dividends per share were ` 11.50 and ` 2.40 respectively in 2009.For the nest 5 years, the projected earnings growth is 30.1%. It is expected todecline linearly to 8% after 5 years. The dividend pay-out ratio is likely to remainstable during 2009-14. It would rise linearly after that and reach 21% in 2019-20.The shares of FTl are expected to have a beta of 1.18 in the next5 years but is expected to decline linearly over the following 5 years to reach 1 bythe time the FTL reaches its steady level of growth (8%) in 2019. The risk freerate is currently 8% and may be assumed to remain constant in the foreseeablefuture. The market risk premium may be assumed to be 4%. Compute the valueof FTL share, using dividend discount valuation model.

3.12 Key Terms

● Goodwill: It is the benefit and advantage of the good name, reputation andconnection of a business. It is the attractive force which brings in customers. Itis one thing which distinguishes an old established business from a newbusiness at its first start.

● Value of shares: Valuation of shares involves the use of financial andaccounting data, but much depends on the valuer’s judgement, experience andknowledge. The share valuation is an intricate exercise involving accounting aswell as non-accounting data, objective and subjective consideration andbalancing of the interests of the parties involved in it. Valuation is closely linkedto the purpose of valuation

● Net asset backing: The value of asset based analysis of a business is equalto the sum of its part. Pursuant to accounting convention, most assets arereported on the books of the subject company at their acquisition value, net ofdepreciation where applicable. These values may be adjusted to fair marketvalue wherever possible.

● Income approach: The income approaches determine fair market value bymultiplying the benefit steam generated by the subject company times adiscount or capitalization rate. The discount or capitalization rate converts thestream of benefits into present value. There are several different incomeapproaches, including capitalization of earnings or cash flows, discounted



Notesfuture cash flows (DCF), and the excess earnings method (which is a hybrid ofasset and income approaches).

● Yield method: Yield value can be determined by taking dividend as the basis.Yield value of a share = Expected rate of dividend/Normal rate of dividend ×Paid-up value per share.

3.13 Check your Progress: Answers

I. True or False1. False2. True3. True4. False5. False6. True

II. Multiple Choice Questions1. (c) ` 1,20,000;2. (d) ` 12.53. (a) earnings per share4. (a) Inverse,

3.14 Case Study

1. H Ltd. is growing at an above average rate. It foresees a growth rate of 20%per annum in free cash flows to equity holders in the next 4 years. It is likely tofall to 12% in the next 2 years. After that, the growth rate is expected tostabilize at 5% per annum. The amount of free cash flow (FCFE) per equityshare at the beginning of the current year is ` 10. Find out the maximum priceat which an investor, follower of free cash flow approach will be prepared tobuy the company’s shares as on date, assuming an equity capitalization of14%.


1. Mergers, Restructuring and Corporate Control by J. Fred Weston, K. Wang,S. Chung and Susan E. Hoag, Prentice-Hall of India Private Ltd.

2. M&A and Corporate Restructuring by Patrick A. Gaughan, Wiley FinanceSeries.

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Notes

Unit 4: Basic Concepts of Income Tax

Structure:4.1 Introduction to Income Tax

4.1.1 Introduction4.1.2 Direct and Indirect Tax4.1.3 History of the Income Tax Act4.1.4 Overall View of the Legal System4.1.5 Charging Section – Section 4 of the Act4.1.6 Rates of Tax4.1.7 Important Terms Used in the Income Tax Act4.1.8 Coverage under Gross Total Income4.1.9 Rounding off of Total Income (Sec. 288A)

4.1.10 Computation of Tax Liability on Total Income4.1.11 Method of Accounting and Accounting Standards for Computing Income

(Section 145 of the Act)4.2 Residential Status

4.2.1 Definition of Total Income [Section 2(45)]4.2.2 Meaning of Total Income in the Context of Residential Status [Sec. 5(1)]4.2.3 Residential Status4.2.4 Scope of Total Income and Incidence of Tax4.2.5 Income Deemed to be Received in India [Sec. 7]4.2.6 Section 8: Inclusion of Dividend as Defined u/s 2(22) in the Total

Income of a Person4.2.7 Section 9: Income Deemed to Accrue or Arise in India4.2.8 Other Points

4.3 Exempted Incomes of Companies4.3.1 Income of Foreign Companies Providing Technical Services in Projects

Connected with the Security of India [Section 10(6C)]4.3.2 Section 10AA: Special Provisions in Respect of Newly Established

Units in Special Economic Zones4.3.3 Income from Property Held for Charitable Purposes

4.4 Profit and Gains from Business or Profession4.4.1 Introduction and Incomes Chargeable under this Head as per the

Provisions of Section 284.4.2 Computation of Income under the Head [Section 29]4.4.3 Deductions under Sections 30 to 37(i)4.4.4 Expenses Not Deductible4.4.5 Miscellaneous Provisions

4.5 Income under the Head Capital Gains4.5.1 Introduction4.5.2 Basis of Charge [Sections 45 and 46]

Basic Concepts of Income Tax 79


Notes4.5.3 Transactions not Regarded as Transfer [Sections 46 and 47]4.5.4 Withdrawal of Exemption in Certain Cases [Section 47A]4.5.5 Computation of Capital Gains [Sections 48 to 51]4.5.6 Cost of Improvement [Section 55(1)(b)]4.5.7 Cost Inflation Index

4.6 Exemptions from Capital Gains4.6.1 Capital Gains Exempt from Tax [Sections 54, 54B, 54D, 54EC, 54F,

54G, 54H, 54GA]4.6.2 Tax on Short-term Capital Gains in Certain Cases [Section 111A]4.6.3 Tax on Long-term Capital Gains [Section 112]

4.7 Hints for Tax Planning4.8 Problems4.9 Summary


Objectives

After studying this unit, you should be able to:● To gain knowledge about the basic provisions of the Income Tax Law which have a

bearing upon liability under that tax● To determine the residential status of the assessee and its bearing on the income

to be included for computation of the total income

● To gain knowledge about incomes which do not form part of total income. Theseincomes being tax-free offer a great scope for tax planning to the assesseeswherever suitable circumstances exist

● to aware of the provisions of Income Tax regarding computation of income underthe head ‘Profits and Gains from Business/Profession’

● To gain knowledge about computation of income under the head Capital Gains

4.1 Introduction to Income Tax

4.1.1 IntroductionAs the first step towards understanding income tax law in India, it would be

appropriate to begin with acquiring knowledge about the structure of the tax regime in thecountry. Taxes are the basic source of revenue for the government. Revenue so raised isutilised for meeting the expenses of the government as well as to carry outdevelopmental works.

4.1.2 Direct and Indirect TaxThere are basically two types of taxes, Direct and Indirect taxes. Direct taxes are

collected by the government directly from the taxpayer through levies such as income tax,wealth tax and interest tax. Whereas, indirect taxes are collected indirectly as a part of



Notes the prices of goods and services on which these are levied. In India these compriseexcise duty, sales tax, customs duty and value added tax. While direct taxes form 30%of the government’s revenue, indirect taxes contribute a large chunk of the left over 70%.Gift tax and estate duty were part of the direct tax revenue. As an ongoing process ofsimplification and rationalisation of the direct tax structure in India, the governmentrepealed the Gift Tax Act in 1998 and the Estate Duty Act in the late eighties.

4.1.3 History of the Income Tax Act1857 – The Great Liberation Movement. British rule called this movement as the

Great Revolt. In order to recover the expenses/loss of this great revolt, theBritish Government, introduced ‘Law of Taxation on Income’.

1886 – After few experiments in implementation, the Income Tax Act, 1886became a permanent guest to this country.

1918 – Again, due to financial difficulties of the First World War, a rigorous 53section act – Income Tax Act, 1918 replaced the previous one.

1922 – The two acts, levying income tax and super tax, were replaced by aconsolidated Act – the Indian Income Tax Act, 1922.

1947 – Soon after independence, the ruling party felt the ever-increasing need formoney. By that time, too many amendments and changes were made in the1922 Act and there was a need to replace the said Act. The Direct TaxesAdministration Enquiry Committee was constituted in the year 1958,under the Chairmanship of Shri Mahabir Tyagi.

1961 – Ultimately, the Income Tax Bill, 1961 successfully presented and theIncome Tax Act, 1961 received the accent of the President on September13, 1961 and came into force from 1st April 1962 replacing the 1922 Act.

4.1.4 Overall View of the Legal System(a) The Income Tax Act, 1961 and the Annual Finance Acts: The Indian

Constitution has empowered only the Central Government to levy and collectIncome Tax. The Income Tax Act was enacted in 1961. The act came intoforce from the April 1, 1962 and extends to the whole of India. The expression‘whole of India’ also includes the territorial waters up to 12 nautical miles fromthe nearest point of the appropriate base line. It consists of over 400 sectionsand 12 schedules. The Income Tax Act determines which persons are liable topay tax and in respect of which income. The various sections lay down the lawof income tax and the schedules elucidate certain procedures and give certainlists, which are referred to, in the sections. However, the act does not prescribethe rates of Income Tax. These rates are prescribed every year by the FinanceAct (popularly known as “The Budget”). This is done mainly to:

– keep the rates of tax under annual review by the government and thereby,provide flexibility to the government in terms of the amounts to becollected by the way of income tax revenue.

– leave the main framework of the income tax relatively untouched, i.e., tomake adjustment through the annual finance act, so that the law onincome could adjust with the times.

(b) Income Tax Rules, 1962 (amended up-to-date): Every act normally givespower to an authority, responsible for implementation of the Act, to make rulesfor carrying out purposes of the Act. Section 295 of the Income Tax Act hasgiven power to the Central Board of Direct Taxes to make such rules, subject tothe control of Central Government, for the whole or any part of India. These



Notesrules are made applicable by notification in the Gazette of India. These ruleswere first made in 1962 and are known as the Income Tax Rules, 1962. Sincethen many new rules have been framed or existing rules have been amendedfrom time to time and the same have been incorporated in the aforesaid rules.

(c) Circulars and Clarifications by the Central Board of Taxes: At the time ofdrafting of the act, many situations and circumstances remain unseen. Manytimes the legislature wants the administrators of the Act to make provisions tosuit their requirements. The legislature has left many things to be decided bythe department and mention of these is made in the relevant sections of theIncome Tax Act, 1961. The administration of all the Direct Taxes is looked afterby the Board known as the Central Board of Direct Taxes (CBDT). The CBDTin exercise of the powers conferred on it under Section 119 has been issuingcertain circulars and clarifications from time to time, which have to be followedand applied by the Income Tax Authorities. However, these circulars are notbinding on the assessee or Commissioner (Appeal) or the ITAT or on thecourts.

(d) Decisions: Decisions of the tax tribunals and courts on disputes pertaining toaspects of the income tax law form case laws. Case laws result in the formationof precedents in law, i.e., in case a similar dispute arising in future, the decisionof the court on that point may be used to decide the current dispute. Thedecisions of the Supreme Court, however, are binding on all the lower courtsand tax authorities in India. High Court decisions are binding only in thosespecific states which are within the jurisdiction of that particular High Court.However, decision of one High Court has the persuasive power over other HighCourts when deciding similar issues.

4.1.5 Charging Section – Section 4 of the ActIncome tax is charged under the above components of legal scheme for charge of

that tax. The basis for the levy of income tax is spelt out in Section 4 of the Income taxAct, 1961. It provides that:

1. Income Tax shall be charged at the rate prescribed for the year by the AnnualFinance Act.

2. The charge is on every person including the assessable entities specified inSection 2 (31).

3. The income taxed is that of the previous year and not of the year ofassessment (subject to exceptions provided by Sections 172, 174, 174A, 175and 176).

4. The levy of tax shall be made on the total income of the assessable entitycomputed in accordance with and subject to the various provisions for the levyof additional Income Tax contained in the Act.

5. It also provides that, in respect of the income chargeable under the aboveproviso, the Income Tax shall be deducted at source or paid in advance, whereit is so deductible or payable under any provision of the Act.

This section provides the foundation for the levy of tax on all incomes. Income Tax isan annual tax on income levied by the Central Government. This tax is charged inrespect of the income of the financial year (known as the previous year) in the nextfinancial year (known as the assessment year) at the rates fixed for such an assessmentyear in the Finance Act passed each year by the Parliament.



Notes 4.1.6 Rates of TaxIncome tax is to be charged at the rates fixed for the year by the Annual Finance Act.

The Finance Act consists of three schedules at the end of it. The last schedule consistsof four parts.Part I – Consists of the rates of tax applicable to the income of various types of

assesses for the current assessment year, for e.g., the Finance Act, 2012 hasgiven rates for the assessment year 2013-14 and the Finance Act, 2013 hasgiven rates for the assessment year 2014-15.

Part II – Consists of the rates of deduction of tax at source from the income earned inthe current financial year, for e.g., Finance Act, 2012 has given rates at whichtax is to be deducted at source in the Financial Year 2012-13. Similarly, theFinance Act, 2013 shall give the rates of TDS on the income earned during theFinancial Year 2013-14.

Part III – Consists of the rates for deduction of tax from salary and also for computingadvance tax, for e.g., Finance Act, 2012 has given rates for the computation forthe assessment year 2013-14. Similarly, the Finance Act, 2013 shall give therates of advance tax for the assessment year 2014-2015.

Part IV – It gives rules for computation of Net Agricultural Income.When Finance Act 2013 is passed by the Parliament, Part III of the Firstschedule of Finance Act 2012 will become Part I of Finance Act 2013. Rates ofincome tax are normally fixed as percentage of total income.

4.1.7 Important Terms used in the Income Tax ActThe Income Tax Act is a self-contained Act. Sections 2 and 3 define the

terms/expressions used in Income Tax Act. The word ‘means’, ‘includes’ and ‘means andincludes’ are used in the definitions and the significance of these terms need to beunderstood.

When a definition uses the word ‘means’ the definition is self-explanatory, restrictiveand in a sense exhaustive. It implies that the term or expression so defined means onlyas to what it is defined as and nothing else. For example, the terms ‘Agricultural Income’,‘Assessment year’, ‘Capital Asset’, are exhaustively defined.

When the legislature wants to widen the scope of the term or expression and wherean exhaustive definition cannot be given, it uses the word ‘includes’ in the definition.Hence, the inclusive definition provides an illustrative meaning and not an exhaustivemeaning. In practical application, the definition could include what is not specificallystated or mentioned in the definition as long as the stipulated criteria are satisfied. Toillustrate, reference is drawn to the definition of the terms ‘inclines,’ ‘person’, ‘transfer’.

When the legislature intends to define a term or expression to mean something andalso intends to specify certain items to be included, both the words ‘means’ as well as‘includes’ are used. Such a definition is not only exhaustive but also illustrative. Forexample, the terms ‘assessee’, ‘Indian company’, ‘recognised Provident Fund’.

IncomeThough the term income is not defined in an exhaustive manner under the act,

generally speaking, it includes receipts in the shape of money or money’s worth whicharise with certain regularity or expected regularity from a definite source. The expression‘income’, according to the dictionary, means ‘a thing that comes in’. Income may also bedefined as the gain derived from land, capital or labour or any two or more of them.‘Income’ in this act connotes a periodical monetary return ‘coming in’ with some sort of



Notesregularity or expected regularity, from definite sources – CIT vs. Shaw Wallace and Co. 6ITC 178 (PC)/Padmaraje R. Kadambande vs. CIT [1992] 195 ITR 877 (SC). The word‘income’ is not limited by the words ‘profits’ and ‘gains’. Anything which can properly bedescribed as ‘income’, is taxable under the act unless expressly exempted –Maharajkumar Gopal Saran Narain Singh vs. CIT [1935] 3 ITR 237 (PC).

Though the dictionary meaning of the term ‘income’ is ‘a thing that comes in’, everyreceipt of a person is not considered as income and therefore, not taxed under the act.‘Income’, for the purposes of taxation, has an element of gain or profit as distinguishedfrom the corpus or principal. An analogy can be drawn of a house and the rent receivedon letting of that house or a machine and the profit obtained on sale of productiongenerated out of that machine. A house owned by a person becomes a source of income,whereas rent received on letting that house constitutes income from that house.Accordingly, receipt from the sale of the house which is a source of income, does notconstitute income by itself, but rent received from that house becomes income of theowner of that house. In the same way, receipt from the sale of a machine is not incomebut from the sale of the produce brought out from the machine is income. Receipt in theformer case is called as capital receipt and the receipt in the later case is called asrevenue receipt. In these cases, however, if a person deals in purchase and sale ofhouse properties or machines, these assets do not remain a source and the profit derivedfrom these activities of purchase and sale becomes income. The source need notnecessarily be tangible as the return for human exertion is also income.

Section 2(24) gives a statutory meaning of the term ‘Income’. The section does notdefine the term income, but merely describes the various receipts that can be known asincome. At present the following items of receipts are included in Income u/s 2(24).

1. Profits and Gains2. Dividends3. Voluntary contributions received by a trust/institution created wholly or partly

for charitable or religious purposes or by an association or institution coveredby Section 10 (21) or (23) or (23-C) (iv) or (v).or by a fund or trust or institutionreferred to in sub clause(iv) or sub clause(v) or by any university or othereducational institution referred to in sub-clause (iiiad) or sub clause (vi) or byany hospital or other institution referred to in sub-clause (iiiae) or sub-clause(via) of clause (23C) of section 10 or by an electoral trust

4. The value of any perquisite or profit in lieu of salary taxable and Section 17.5. Any special allowance or benefit other than the perquisite included above,

specifically granted to the assessee to meet expenses wholly, necessarily andexclusively for the performance of the duties of an office or employees of aprivate firm.

6. Any allowance granted to the assessee to meet his personal expenses at theplace where the duties of his employment of profit are ordinarily performed byhim or at a place where he ordinarily resides or to compensate him for theincreased cost of living.

7. The value of any benefit or perquisite whether convertible into money or not,obtained from a company either by a director or by a person who has asubstantial interest in the company or by a relative of the director or suchperson and any sum paid by any such company in respect of any obligationwhich, but for such payment would have been payable by the director or otherperson aforesaid.

8. The value of any benefit or perquisite, whether convertible into money or not,which is obtained by any representative assessee mentioned in clauses (iii)



Notes and (iv) of Section 160(1) or by any beneficiary or any amount paid by therepresentative assessee for the benefit of the beneficiary which the beneficiarywould have ordinarily been required to pay.

9. Value of any benefit or perquisite, whether convertible into money or not arisingfrom a business or exercise of profession.

10. Any sum chargeable to income tax under Section 41 and Section 59.11. Any sum chargeable to income tax under (ii), (iii), (iii-a), (iii-b), (iii-c), (iv) and (v)

of Section 28.12. Any sum chargeable to tax u/s 28(v) [interest, salary, bonus, commission or

remuneration to a partner of a firm].13. Any capital gains chargeable under Section 45.14. The profits and gains of any insurance carried on by a Mutual Insurance

Company or by a cooperative society.15. The profits and gains of any business (including providing credit facilities)

carried on by a cooperative society with its members.16. The profit and gains of any business of banking (including providing credit

facilities ) carried on by a co-operative society with its members17. Any winnings from lotteries, cross-word puzzles, races including horse races,

card games and other games of any sort or from gambling or betting of anyform or nature what so ever.

For the purpose of this sub-clause:1. ‘Lottery’ shall include winnings from prizes awarded to any person by draw of

lots or by chance or in any other manner whatsoever under any scheme orarrangement by whatever name called;

2. ‘Card game and other game of any sort’ shall include any game show, anentertainment programme on television or electronic mode, in which peoplecompete to win prizes or any other similar game.

3. Any sum received by the assessee from his employers as contributions to anyprovident fund or superannuation fund or employees state insurance fund orany other fund for the welfare of such employees.

4. Any sum received under a lump sum insurance policy including sum allocatedby way of bonus in such a policy.

5. Any sum received/receivable as specified in Sec. 28 (v-a) [i.e., sum received incash or kind under an agreement for not carrying out any activity in relation tobusiness or not to share any know-how patent etc.].

6. Any sum referred to in Section 56(2)7. any consideration received for issue of shares as exceeds the fair market

value of the shares referred to in clause (viib) of sub section(2) of section 56.The definition of ‘income’ of an individual or HUF will now include any sum received

from any person in cash or cheque or by any other mode or credit, otherwise than asconsideration for goods or services. However, this would not include the following:

– Amounts received by an individual from a relative out of natural love andaffection. The term ‘relative’ has been specifically defined for this purpose.

– Amounts received by an individual or HUF under a will or by way of aninheritance.

– Amounts received by an employee/dependent of a deceased employee froman employer by way of bonus, gratuity or pension or insurance or any othersum solely in recognition of services rendered.



Notes– Amounts received in contemplation of death of an individual or ‘karta’ ormember of HUF.

– Any income exempt under Section 10 or otherwise or which is excluded fromthe total income.

– Amounts received on transactions not regarded as ‘transfer’ for the purpose ofcapital gains.

● A general exemption of ` 50,000 per year in the aggregate will be available inrespect of the receipts/credits mentioned above. In addition, gifts received onmarriage will be exempt.

● The income of the nature described above will be taxable under the head‘income from other sources’.

● Based on the above, gifts received on any occasion other than marriage,unless specifically excluded, will be treated as income.

Some Interesting Facets of ‘Income’ under the Income Tax Act1. Form of Income: The income received by the assessee need not be in the

shape of cash only. It may also be some other property or right which hasmonetary value. [CIT vs. Central India Industries Ltd. (1971) 82 ITR 555 (SC)].Wherever income is received in kind, like perquisites, then their value has to befound as per the rules prescribed and this value shall be taken to be theincome.

2. Tainted/Illegal Income: Income is income, though tainted. For the purpose ofincome tax, there is no difference between legal and tainted income. Evenillegal income is taxed just like any legal income.

3. Application of Income vs. Diversion: Where an assessee applies anincome to discharge an obligation after the income reaches the hands of theassessee, it would be an application of income and this would result in taxationof such income before it reaches the hands of the assessee, it cannot betreated as an income of the assessee.

4. Disputed Income: Any dispute regarding the title of the income cannot hold upthe assessment of the income in the hands of the recipient. The recipient is,therefore, chargeable to tax though there may be rival claims to the source ofincome.

5. Basis of Income: Income can be taxed on receipt basis or on accrual basis.In case of income from business or income from other sources, the taxabilitywould depend upon the method of accounting adopted by the assessee; whilein other cases, it would generally be taxed on receipt or accrual basis,whichever happens earlier. However, a contingent income, i.e., an incomewhich may or may not arise cannot be taxed unless and until such contingencyactually occurs and the income arises to the assessee.

6. Lump sum receipts: If a receipt has an income, then whether it is received inlump sum or in instalment, would not affect is taxability. For example, if aperson receives arrears of salary in a lump sum amount, it would still be hisincome.

Capital and Revenue ReceiptsThe Income Tax Act charges tax on income and not on capital and hence, it is very

essential to distinguish between capital and revenue receipts. The Income Tax Act doesnot define the term ‘capital receipts’ and ‘revenue receipts’. Therefore, whether a certainreceipt is capital or revenue would be a mixed question of law and fact. It is to be



Notes determined on the basis of the particular facts and circumstances of each case.Following are some of the important rules which guide in making a distinction betweenthem.

1. A receipt referable to fixed capital would be a capital receipt, whereas areceipt referable to circulating capital would be a revenue receipt.Circulating capital is the capital which is turned over and in the process ofbeing turned over yields profit or loss, for e.g., fixed capital is also involved inthis process but remains unaffected by the process. A capital asset in thehands of one person may be a trading asset in hands of another. Thus, whiledetermining the nature of receipt one has to consider the nature of trade inwhich the asset is employed.

2. A receipt in substitution of a source of income is a capital receipt,whereas a receipt in substitution of an income is a revenue receipt.Compensation for loss of employment is a capital receipt; whereascompensation for temporary disablement is a revenue receipt. Compensationreceived from the government in respect of stock in trade destroyed ordamaged by enemy action constitutes revenue receipts. On the contrary,compensation paid for the acquisition of land or property which constitutedcapital asset in the hands of a lessee would be a capital receipt.

3. An amount received as a compensation for the surrender of certain rightsunder an agreement is a capital receipt. For e.g., if a director/partnerreceives an amount from the company in consideration of giving up his right tocarry on competitive business similar to that of company/firm it will be a capitalreceipt. An amount received as a compensation for loss of future profits is arevenue receipt.

4. Receipt to be of a revenue nature need not necessarily be repetitive orrecurring. Thus, a bulk purchase followed by bulk sale or a series of saleswould constitute an adventure in the nature of trade and consequently, theincome arising there from would be taxable.

5. Nature of receipt in the hands of the recipient: In the case of CIT v. KamalBehari Lal Singha (SC), the Supreme Court held that it was a well settledprinciple that to find out whether a receipt is a capital or a revenue receipt, onehad to see what its nature is in the hands of the receiver and not in the hands ofpayer. The easiest example to understand is the case of a builder. If he sells aparticular property or a flat, he would be receiving the money on revenueaccount, as it constitutes his stock in trade, whereas it does not matter that theperson making the payment would consider the payment on capital account.

6. Annuity: In case of annuities, which are, payable in specified sums at periodicintervals of time the receipt would be of a revenue nature. The fact that annuityis contingent or variable in amount does not in any way affect its character asincome. An annuity received from an employer is taxable as ‘income fromsalaries’, whereas all other annuities are chargeable under the head ‘incomefrom other sources’ irrespective of the fact whether or not they are payable:(1) under a deed of family arrangement (ii) under a deed of separation to a wifeor (iii) under a degree for alimony or (iv) to the estate of a deceased partner bythe remaining partners for the use of the firm’s name and goodwill.Annual payments (i.e., annual instalments) as distinguished from annuities inthe nature of capital. Thus, the amount of instalment received by the assesseewould be of capital nature and hence, not liable to tax. In order to ascertain,



Noteswhether a certain payment is an annuity or annual instalments regard must behad to the true nature and character of a transaction, for e.g.;

(a) if the sale of the property/business is for a price which is to be paid ininstalments, the instalments would be capital receipts.

(b) if the property is sold for an annuity payable regularly, the propertydisappears and the annuity assumes the character of definite income andhence, chargeable to tax.

7. Lump sum receipts: In order to determine whether a receipt is capital orrevenue in nature, the fact that it is a lump sum payment, large payment orperiodic payment is not relevant. A lump sum paid in commutation of salaries,pensions, royalties or other periodic payments would be income, taxable underthe respective heads. Similarly, royalties received for the use of patents,whether paid in lump sum or in instalments of fixed or varying amounts wouldbe taxable as income. However, if the payment received were in lieu of the totalor partial assignment of the patent under which, the owner ceases to own thepatent as a capital asset it would constitute a capital receipt.

Receipts Bereft of the Revenue ElementIncome Tax is a tax on income. All receipts are not income. Particular receipts

cannot be taxed because they cannot be proved to be a taxable income at all. Knowledgeof such receipts is essential to understand the meaning of term ‘Income’.

1. Surplus arising to mutual concerns (concept of mutuality): One cannotmake a profit from dealing with oneself. Income should be received fromoutside. If a person revalues his goods/assets and shows a higher value inbooks, he cannot be considered as having sold the goods and made a profitthereon. Similarly, in the case of mutual concerns (clubs, associations andsocieties) if the subscription from the members exceeds its expenditure on itsmembers, the excess cannot be treated as taxable income.

2. Pin Money: Pin money received by wife for her dress/personal expenses andsmall savings made by a woman out of the money received from her husbandfor meeting household expenses is not treated as her income [Rani AmruitKanvir v. CIT – SC].

Person [Sec. 2(31)]The term ‘person’ includes:(i) An individual(ii) A Hindu Undivided Family(iii) A company(iv) A firm(v) An association of persons or body of individuals whether incorporated or not(vi) A local authority and(vii) Every artificial juridical person not falling within any of the preceding

categories.The aforesaid definition is inclusive and not exhaustive. Therefore, any person not

falling in the above seven categories may still fall in the term person and accordingly,may be liable to Income Tax.

(i) Individual: The expression ‘individual’ as an unit of assessment refers only toa natural person, i.e., a human being, deities and statutory corporations are



Notes assessable as ‘juridical person’. An individual also includes a minor and aperson of unsound mind.

(ii) Hindu undivided family: Family connotes a group of people related by bloodor marriage. According to the ‘Shorter Oxford English Dictionary, 3rd Edition’,the word ‘family’ means ‘the group consisting of parents and their children,whether living together or not; in a wider sense, all those who are nearlyconnected by blood or affinity; a person’s children regarded collectively; thosedescended or claiming descent from a common ancestor; a house, kindred,lineage; a race; a people or group of people’. The word family always signifiesa group. Plurality of persons is an essential attribute of a family. A singleperson, male or female, does not constitute a family. He or she would remain,what is inherent in the very nature of things, an individual, till per chance he orshe finds a mate. The expression ‘Hindu joint family’ in the Income Tax Act isused in the sense in which a Hindu joint family is understood under the variousschools of the Hindu law. The word ‘Hindu’ preceding the words ‘undividedfamily’ signifies that the undivided family should be of those to whom the Hindulaw applies.

(iii) Company: Under Sec. 2(17), the expression ‘company’ is defined to mean thefollowing :(a) an Indian company or(b) any corporate body incorporated under the laws of a foreign country or(c) any institution, association or a body which is assessed or was

assessable as a company for any assessment year, commencing on April1, 1970 or

(d) any institution, association or a body, whether incorporated or not andwhether, Indian or non-Indian which is declared by the general or specialorder of the Central Board of Direct Taxes to be a company.

(iv) Firm: ‘Firm’ is a collective noun, a compendious expression to designate anentity, not a person. Under the Income Tax Act, ‘firm’, ‘partner’ and‘partnership’ have been given the same meaning as assigned to them in theIndian Partnership Act. But the expression ‘partner’ has been extended toinclude any person who, being a minor, has been admitted to the benefits of apartnership. Only the members who have entered into a partnership are to beregarded as partners and collectively a firm and the name under which theirbusiness is carried on, is called the firm’s name.

(v) Association of Persons (AOP): The word ‘associate’ means, according to theOxford Dictionary, ‘to join in the common purpose or to join in an action’.Therefore, an association of persons must be one in which two or morepersons join in a common purpose or common action and as the word occursin Section 3 of the 1922 Act, which imposes a tax on income, profits or gains,the association must be such that the one object of which is to produce income,profits or gains. An ‘association of persons’ can be formed only when two ormore individuals voluntarily combine together for a certain purpose. Even aminor can join an ‘association of persons’ if his lawful guardian gives hisconsent. An association of persons does not mean any and every combinationof persons. It is only when they associate themselves in an income-producingactivity that they become an association of persons.

(vi) Body of Individuals: The expression ‘body of individuals’ includes acombination of individuals who have a unity of interest but who are notactuated by a common design and one or more of whose members produce or



Noteshelp to produce income for the benefit of all. The absence of a common designis what principally distinguishes a ‘body of individuals’ from an ‘association ofpersons’. Another distinguishing feature is that the one refers to persons andthe other to individuals.Distinction between an Association of Persons and a Body of Individuals:1. An association of persons may consist of non-individuals but a body of

individuals has to consist of individuals only. If two or more persons (likefirms, company, HUF, individual etc.) join together, it is called anassociation of persons. For example, where X, ABC Ltd. and PG & Co. (afirm), join together for a particular venture that they may be referred to asan association of persons. If X, Y and Z join together for a particularventure, but do not constitute a firm, then they may be referred to as abody of individuals.

2. An association of persons implies a voluntary getting together for acommon design or combined will to engage in an income producingactivities, whereas, a body of individuals may or may not have such acommon design as well.

(vii) A Local Authority: A local authority means:(i) A Panchayat as referred to in Article 243(a) of the Constitution.(ii) A Municipality as referred to in Article 243 P of the Constitution.(iii) A Municipal Committee and District Board legally entitled or entrusted by

the government with the management of municipal or local funds.(iv) A Cantonment Board as defined in Sec. 3 of the Cantonment Act, 1924.

(viii) An Artificial Person: Artificial persons are entities which are not naturalpersons but are separate entities in the eyes of the law. Though they may notbe sued directly in a court of law, but they can be sued through the personsmanaging them, for e.g., gods, idols and deities are artificial persons. However,under the Income Tax Act, they have been provided exemption from thepayment of tax under separate provisions of the act, if certain conditionsmentioned therein are satisfied.Similarly, all other artificial persons will also fall under this category if they donot fall under any of the preceding categories of persons. For e.g., theUniversity of Pune is an artificial person, as it does not fall in any of the sixcategories mentioned above.

Assessee [Sec. 2(7)]An assessee is a person by whom any tax or any other sum of money (for example,

interest, penalty, fine etc.) is payable under the Income Tax Act and includes:(a) A person in whose respected proceedings for determining income or for

assessment of fringe benefits or of the income of any other person in respect ofwhich he is assessable or of the loss sustained by him or by such other personor of the amount of refund due to him or to such other person have beencommenced by the Income Tax Department. Thus, a person may become anassessee even if no amount is payable by him under the Income Tax Act.

(b) A deemed assessee, i.e., a person who is himself not an assessee but istreated as an assessee for the purposes of the Income Tax Act. For example,the trustee of a trust is deemed as an assessee in respect of the trust. Theincome earned is the income of the trust but is assessed in the hands of thetrustee as his income.



Notes (c) An assessee in default, i.e., a person on whom certain obligations have beenimposed under the Income Tax Act but who has failed to carry out thoseobligations. For example, any person who employs another person to deductincome tax at source from the taxable salary of the employee and pay the taxdeducted at source to the government within the prescribed time as income taxpaid on behalf of the employee. In case the employer fails to carry out theseobligations, he becomes an assessee in default.

Assessment Year (AY) [Sec. 2(9)]Assessment Year (AY) means the financial year (1st April to 31st March of the next

year) in which the income is taxed or assessed. Income of the previous year is taxed inthe assessment year (next year) at the rates prescribed by the relevant finance act, fore.g., income earned during the previous year 2012-13 is taxable in the assessment year2013-14 at the rates prevailing by the relevant Finance Act.

Previous Year [Sec. 2(34) and Section 3]Previous Year (PY) means the financial year immediately proceeding the

assessment year. In case of a business or profession which is newly started, theprevious year commences from the date of commencement of the new business orprofession up to the next 31st day of March.

Relationship between the Previous Year and Assessment Year is such that theincome, which is earned in the previous year, is charged to income tax in the assessmentyear at the rates applicable for that assessment year. Thus, if an income of ` 1,00,000 isearned in PY 2014-15 (which commences on 1.4.14 and ends on 31.3.15), this income ischarged to income tax in the AY 2015-16 at the rates applicable for that AY.

Uniform previous yea: From the assessment year 1989-90 onwards, all assessesare required to follow financial year (i.e., April 1 to March 31) as the previous year. Thisuniform previous year has to be followed for all sources of income. This has beenillustrated in the following example.

Illustration: For the assessment year 2015-16, the income earned by X Ltd. duringthe previous year 2014-15 (i.e., April 1, 2014 to March 31, 2015) is chargeable to tax. It isnot necessary that X Ltd. maintains a book of account on the basis of financial year, itcan maintain in any other basis but for the purpose of income tax, income of the previousyear 2014-15 (i.e., April 1, 2014 to March 31, 2015) is taxable for the Assessment year2015-16 Suppose X Ltd. maintains books of account in the calendar year basis (1stJanuary to 31st December), the taxable income will be computed as follows.

Accounting year Income as per books ofaccount

Quarter wise break-up of income

January to March April to December

2013 ` 120,000 ` 36,000 ` 84,000

2014 ` 140,000 ` 52,000 ` 88,000

2015 ` 180,000 ` 42,000 ` 1,38,000

Taxable Income

Assessment Year Previous Year Income

2014-15 2013-14 84,000 + 52,000 = ` 1,36,000

2015-16 2014-15 88,000 + 42,000 = ` 1,30,000



NotesIllustration of a newly started business or source of income:X joins an Indian company on Dec. 21, 2012. Prior to this, he is not in employment

nor has any other source of income. What are the previous years for the assessmentyear 2013-14 and 2014-15 ?

Solution:Previous year for the assessment years 2013-14 and 2014-15 will be as follows

Assessment Year Previous Year

2013-14 Dec. 21, 2012 to March 31, 2013

2014-15 April 1, 2013 to March 31, 2014

A financial year plays a double role – It is a previous year as well as an assessmentyear.

Illustration:

Financial Year Previous Year Assessment Year

2013-14 (April 1, 2013 toMarch 31, 2014)

2013-14 is previous year forthe income received oraccrued during April 1, 2013to March 31, 2014.

2014-15 is the assessment yearfor the income received oraccrued in the immediatelypreceding previous year (1stApril 1, 2013 to March 31, 2014).

2014-15 (April 1, 2014 toMarch 31, 2015)

2014-15 is the previous yearfor the income received oraccrued during April 1, 2014to March 31, 2015.

2015-16 is the assessment yearfor the income received oraccrued in the immediatelypreceding previous year (April 1,2014 to March 31, 2015).

4.1.8 Coverage under Gross Total Income

Gross Total IncomeAs per Section 14, income of a person is computed under the following five heads:1. Salaries2. Income from house property3. Profits and gains of a business or profession4. Capital gains5. Income from other sources.

The aggregate income under these heads is termed as the ‘gross total income’. Inother words, gross total income means total income computed in accordance with theprovisions of the Act before making any deduction under Chapter VI A. (Section 80C to80U).

Further Section 14A provides that no deduction shall be made in respect ofexpenditure incurred by the assessee in relation to the income that does not form part ofthe total income under the Act.

IncomeThe total income of an assessee is a gross total income as reduced by the amount

permissible as deduction under Sections 80C to 80U.



Notes How to Compute Total Income?The steps in which the total income for any assessment year is determined are as follows:1. Determine the residential status of the assessee to find out which income is to

be included in the computation of his total income (residential status and needfor determining residential status are given in the next chapter).

2. Classify the income under each of the following five heads. Compute theincome under each head after allowing deductions prescribed for each head ofincome as given below :

(a) Income from salariesIncome by way of allowances _________Taxable value of perquisites _________Gross salary _________Less: Deductions u/s 16 _________Entertainment allowancesProfessional taxNet taxable income from salary _________

(b) Income from House PropertyNet annual value of house property _________Less: Deduction under section 24 _________Income from house property _________

(c) Profits and gains of business and professionNet profit as per P & L A/c _________Less/Add: Adjustments requiredto be made to the profit as per provisions of Income Tax Act ________Net profit and gains of business and profession ________

(d) Capital gainsCapital gains as computedLess: Exemptions u/s 54/54B/54D etc.Income from capital gain

(e) Income from other sources:Gross income ________Less: Deductions ________Net income from other sources ________Total [(a) + (b) + (c) + (d) + (e)]Less : Adjustment on account of set off and carryforward of lossesGross total incomeLess : Deductions available under Chapter VIASections 80C to 80U) ________Total Income or net income [Rounded off]

Computation of Tax LiabilityTax on net income ________Add: Surcharge ________Tax and surcharge ________



Notes4.1.9 Rounding off of Total Income (Sec. 288A)The total income as computed above shall be rounded off to the nearest multiple of

ten rupees (part of the rupee consisting of paise to be ignored). Thereafter, if the lastfigure is 5 or more, it should be grossed up to the next higher multiple of 10 and if it islower than 5 it should be grossed up to the next lower multiple of 10.

4.1.10 Computation of Tax Liability on Total IncomeOn the total income, tax is to be calculated according to the rates prescribed under

the relevant Finance Act.A rebate u/s 88E, if any, in respect of securities transaction tax to an assessee

dealing in securities shall be allowed from the tax so computed.The amount arrived at, after allowing the rebate shall be increased by a surcharge if

applicable and education cess (at present 3%) and the amount so arrived at is the taxliability of the person for that year.

Rounding off of tax (Sec. 288B) – The amount of tax (incl. TDS, Advance Tax,penalty, fine or others) should be rounded off to the nearest multiple of ten rupees.

4.1.11 Method of Accounting and Accounting Standards for Computing Income(Section 145 of the Act)1 Income chargeable under the head ‘Profits and gains of business or profession’

or “Income from other sources” shall be computed only in accordance witheither the cash or the mercantile system of accounting, regularly employed byan assessee.

2. The Central Government has been empowered to prescribe by notification inthe official gazette the accounting standards which an assessee have to followin computing his income under the head ‘Profits and gains of business orprofession’ or ‘Income from other sources’. The government would consultexpert bodies, like The Institute of Chartered Accountants of India, while layingdown such standards.

The government has notified the ‘Accounting Standard I’, relating to disclosure ofaccounting policies and the ‘Accounting Standard II’ relating to disclosure of prior periodand extra ordinary items and charges in accounting policies.

Method of accounting irrelevance in case of income chargeable under the heads‘Salaries’, ‘Income from House Property’ and ‘Capital gains’. Since for calculating taxableincome under these heads one has to follow the statutory provisions of the Income TaxAct, which expressly provide whether revenue (or expenditure) is taxable (or deductible)on ‘accrual basis’ or ‘cash basis’.

Method of Accounting in Certain Cases (Section 145A of the Act)Notwithstanding any thing to the contrary contained in section145,the valuation of

purchase and sale of goods and inventory for the purpose of determining the incomechargeable under the head “Profit and gains of business or profession” shall be:

(a) in accordance with the method of accounting regularly employed by theassessee, and

(b) further adjusted to include the amount of any tax, duty, cess (by whatevername called) actually paid or incurred by the assessee to bring the goods tothe place of its location and condition as on the date of valuation



Notes Explanation: For the purpose of this section, any tax, duty, cess (by whatever namecalled)under any law for the time in force, shall include all such payment notwithstandingany right arising as a consequence to such payment.

Residential Status and Chargeability

4.2 Residential Status

Residential status of an assessee is important in determining the scope of theincome on which income tax has to be paid in India. Broadly, an assessee may be aresident or non-resident in India in a given previous year. An individual or HUF assesseewho is a resident in India may be further classified into: (1) resident and ordinarilyresident and (2) resident but not ordinarily resident.

Under the Income Tax Act, the incidence of tax is highest on a resident andordinarily resident and lowest on a non-resident. Therefore, it is in the interest of anassessee that he claims non-resident status if he satisfies the conditions for becoming anon-resident.

4.2.1 Definition of Total Income [Section 2(45)]Total income means the total amount of income referred to in Section 5, computed

in the manner laid down in the Income Tax Act. As already mentioned in the last chapter,total income is computed under five heads of income. Income computed under eachhead is thereafter aggregated and the aggregate amount is known as Gross TotalIncome. From Gross Total Income, certain deductions are allowed under section 80C to80U and the balance income after deductions is known as Total Income. Section 5 of theact provides the meaning of total income in relation to resident status of the assesseesince, the incidence of tax depends upon its residential status.

4.2.2 Meaning of Total Income in the context of Residential Status [Sec. 5(1)]According to Section 5(1), incidence of tax in case of a resident and ordinary

resident – the total income of a resident assessee – would consist of all income fromwhatever source derived which

1. is received or deemed to be received in India in the relevant previous year byor on behalf of such person; or

2. accrues and arises or is deemed to accrue or arise in India during the relevantprevious year; or

3. Income which accrues or arises outside India even if it is not received orbrought into India during the relevant previous year.

Provision to Section 5(1): Incidence of tax in case of a resident but notordinarily resident: The computation of income of a person who is resident but notordinarily resident would be the same as in case of resident stated above, except that theincome accruing or arising to him outside India shall not be so included unless it isderived from a business controlled wholly or partly from India or from a profession set upin India.

Section 5(2): Incidence of tax in case of a non-resident: A non-resident’s totalincome of any previous year includes all income from whatever source derived which:

1. is received or is deemed to be received in India during the previous year (placeor date of accrual being immaterial);or

2. Income which accrues or arises or is deemed to accrue or arise in India (placeor date of receipt being material).



NotesTable 4.1: Taxability of Income based on Residential Status

Sr. No. Status Income liable to Tax

1 Resident and ordinarily resident Global or world income

2 Resident but not ordinarilyresident

(a) All incomes realised within India (i.e., received/deemed to be received and accrued/deemedto accrue in India).

(b) Income from a business or profession outsideIndia, if this business is controlled in orprofession set up in India.

3 Non-resident All income realised within India (i.e.,received/deemed to be received andaccrued/deemed to be accrued in India).

Important Points related to Taxable Income:1 Income accruing or arising outside India shall not be deemed to be received in

India, by reason only of the fact that it is taken into account in a balance sheetprepared in India [Expl. 1 to Section 5].

2. It is to be noted that income which has been included in the total income of aperson on the basis that it has accrued or arisen or is deemed to have accruedor arisen to him shall not again be so included on the basis that it is received ordeemed to be received by him in India [Expl. 2 to Section 5] merely because ithas been remitted to India during the previous year.

3. Income should pertain to the previous year. The income to be taxed in aparticular assessment year is the income which is earned or which arisesduring the relevant previous year. Therefore, if an income which was earnedduring an earlier year but which could not be taxed in India due to any reasonmay be because of the fact that the assessee was a non-resident in that year,will not become taxable.

4. Any income is to be included in the total income only if it is taxable as per theprovisions of the income tax act and shall be computed as per the provisions ofthe act. Exempt income shall not form part of the total income.

5. In the case of a resident, if the income earned outside India is charged to tax inthat country then the application of Sections 90 and 91 in respect of doubletaxation relief has to be looked into. If a double taxation avoidance agreementhas been entered into between Government of India and the government ofthat country (in which he has earned income) then the agreement will belooked into for deciding the taxability of such incomes arising or accruingoutside India.If an agreement with a foreign country does not exist, then in respect of theincome earned outside India, the tax paid on such income in the foreigncountry (ascertaining the average rate of tax and applying such rate on the saidincome) or the Indian rate of tax, whichever is lower, is deductible from the totaltax payable by the assessee on his total income including such foreign income.

6. The terms (a) income deemed to be received, (b) dividend income whenreceived, (c) income deemed to accrue or arise in India have beenexplained/classified in Section 7, 8 and 9 respectively.



Notes Residential Status and Scope of Taxable Income Relatable to that Status:Having established the source of income of a person and the related head of

Income, the next step is to define the residential status and determine the scope oftaxable income relatable to that status.

4.2.3 Residential Status

Resident Status of an IndividualUnder Section 6(1) an individual is said to be resident in India in any previous year if

he satisfies any one of the following two basic conditions:(a) He is in India for a period or periods amounting in all to 182 days or more in the

previous year;(b) He is in India for a period or periods of atleast 60 days during the relevant

previous year and atleast 365 days during the four years preceding thatprevious year.The aforesaid rule of residence is subject to the following exceptions :

1. Where an individual, who is a citizen of India, leaves India in any year for thepurpose of employment (or where an individual, who is a citizen of India, leavesIndia as a member of the crew of an Indian ship), he is not to be treated asresident in India in that year unless he has been in India for a period or periodsin that year for atleast 182 days (note that the period of 60 days in condition b.is substituted).

2. Where an Indian citizen or a person of Indian origin, who has settled abroad,comes on a visit to India in the previous year, he is not to be treated as residentin India in that year unless he has been in India in that year for atleast 182 days(note that the period of 60 days in condition b. is substituted).

In other words, such individuals do not become residents of India, if they are lessthan 182 days in India. For such individuals, the conditions mentioned in clause (b)above do not apply. Therefore, such individuals may stay in India up to 181 days in agiven previous year without becoming residents of India for that previous year. Anindividual who does not satisfy any condition, neither condition (a) nor condition (b) isnon-resident for that previous year.

A resident individual may either be an ‘ordinary resident’ or ‘not ordinarily resident’ inIndia for a given previous year. In order to determine whether a resident individual isordinarily resident (ROR) or not ordinarily resident (RNOR), the tests laid down undersection 6(6) have to be applied. A resident individual is treated as ‘not ordinarily resident’in India in a given previous year, if he satisfies the following additional conditions:

(a) He has been non-resident in India in atleast 9 out of 10 previous yearsimmediately preceding the relevant previous year.

(b) He has been in India for a period or periods amounting in all to 729 days or lessin 7 previous years preceding the relevant previous year.

An individual who is resident in India but does not satisfy either or both the additionalconditions is RNOR for that previous year.



NotesFlow Chart Showing the Residential Status of an Individual

Important Points1. It is not essential that the stay should be at the same place. Similarly, place or

purpose of the stay is not material.2. Where a person is in India for a part of the day, the calculation of physical

presence in India in respect of such broken period should be made on anhourly basis. A total of 24 hours of stay spread over a number of days is to becounted as a stay of one day.

3. The stay in a ship or boat moored in the territorial waters in India would betreated as his presence in India.

Illustration:Residential status of an individual can be illustrated with the help of the following

examples:(a) Mr. A, resident of Mumbai left India for the first time for USA for higher studies

on June 7, 2012 and returned on March 25, 2013. For the previous year2012-13 (Assessment Year 2013-14), A was in India for 73 days (from April 1,2012 to June 6, 2012 and March 26, 2013 to March 31, 2013). A has satisfiedthe condition of being at least 60 days in India in P.Y. 2012-13 and of being atleast 365 days in the preceding four previous years (i.e., P.Y. 2008-09,2009-10, 2010-11 and 2011-12). Therefore, he is resident in India for previousyear 2012-13. Since he has gone outside India for the first time, he satisfies theadditional two conditions also for becoming ROR. Accordingly, he is ROR inIndia for P.Y. 2012-13.

(b) Mr. X, a citizen of India goes abroad for employment on August 15, 2012 andcomes back on June 10, 2013. For the previous year 2012-13, X was in Indiafor 136 days (From April 1, 2012 to August 14, 2012). Since X was not in Indiafor atleast 182 days in P.Y. 2012-13, he is non-resident in India for P.Y.2012-13. The second condition of 60 days in the relevant P.Y. And 365 days in

Individual

Does he satisfy any one of theconditions of Sec. 6(6)

NoNon Resident

Yes

Resident

Does he satisfy both ofThe conditions of Sec. 6(6)

No Resident but notOrdinarily resident

Yes

Resident and OrdinarilyResident



Notes the preceding four previous years is not applicable to him since he is an Indiancitizen who has gone abroad for employment.

The following points are very important in determining the residential status of anassessee:

(i) The residential status may change from year to year depending on whether thecondition for residency is satisfied in that year or not.

(ii) The residential status under the Income Tax Act, 1961 has no connection withthe provisions for residency under the Foreign Exchange Regulation Act or anyother law in India. A person may be resident under FERA and yet benon-resident under the Income Tax Act and vice versa.

(iii) Residential status must not be confused with the nationality or citizenship ofthe assessee. These are entirely different concepts.

Residential Status of a Hindu Undivided Family, Partnership Firms or Associationof Persons

A Hindu Undivided Family, partnership firm or an association of persons are said tobe resident in India in any previous year in every case except where, during the year, thecontrol and management of its affairs is situated wholly outside India. In other words, itwill be non-resident in India if no part of the control and management of its affairs issituated in India.

When isHUFsaid to be a resident but not ordinarily so in India? [Section 6(6) (b)] :A HUF, which is resident in India is said to be resident but not ordinarily resident in

India during the relevant previous year, if the manager (Karta) of the HUF does notsatisfy any one or both, of the conditions mentioned in clause (a) and (b) above or inother words, the Karta satisfies any of the following two conditions:

(1) He has been non-resident in India in 9 out of 10 previous years immediatelypreceding the relevant previous year,

(2) He has been in India for a period of 729 days or less in 7 previous yearsimmediately preceding the relevant previous year.

Excepting individual and HUF, all other persons are classified as resident ornon-resident. They are not to be further classified as ordinarily resident or as notordinarily resident.

Residential Status of a CompanyA company is said to be resident in India in any previous year if :(i) It is an Indian company, or(ii) During the relevant previous year, the control and management of its affairs is

situated wholly in India.

Residential Status of ‘Every Other Person’Every other person is resident in India if the control and management of his affairs is

wholly or partly situated within India during the relevant previous year. On the other hand,every other person is non-resident in India if the control and management of its affairs iswholly situated outside India.

4.2.4 Scope of Total Income and Incidence of Tax(a) As already mentioned, the coverage of income tax is highest in the case of

ROR and lowest in case of NR. While the residential status of an assessee willdetermine the scope of his income liable to income tax, the status as a type of



Notesperson (i.e., individual, HUF, firm, company, AOP etc.) will determine the rateof income tax applicable to the assessee.

(b) The following table indicates the tax incidence on income in different situationsdepending on the residential status of the assessee.

Table 4.2 : Income Tax in Different Situations

Place of Income Taxability under Income Tax in respect of

Resident andordinarilyresident(ROR)

Resident but notordinarily resident

(RONR)

Non-resident(NR)

Income received or deemed to bereceived in India whether earnedin India or elsewhere.

Yes Yes Yes

Income accruing or arising in Indiawhether received in India orelsewhere.

Yes Yes Yes

Income deemed to accrue or arisein India whether received in Indiaor elsewhere.

Yes Yes Yes

Income received/accrued outsideIndia from a business controlledfrom India.

Yes Yes No

Income which accrues or arisesoutside India and received fromoutside India from any othersource.

Yes No No

Income which accrues or arisesoutside India and received outsideIndia during the years precedingthe previous year and remitted toIndia during previous year.

No No No

Connotation of the receipt of income: Income received in India is taxable in allcases irrespective of the residential status of an assessee. The following points are worthmentioning:

● Receipt vs. Remittance:The receipt of income refers to the first occasion when the recipient gets the money

under his control. Once an amount is received as income, any remittance or transmissionof the amount to another place does not result the ‘receipt’ at the other place.

Illustration: An assessee receives $ 10,000 in USA on May 16, 2013. Out of thatamount, he remits ` 50,000 to India on May 18, 2013. In this case, income is receivedoutside India on May 16, 2013.

Conclusion: An assessee after receiving income outside India cannot say thatmoney has again been received in India because of remittance. The position remains thesame if the income is received outside India by an agent of the assessee (may be a bankor some other person) who later on remits the same to India. Income after the first receiptmerely involves movement as a remittance of money. The same income cannot bereceived by the same person twice, once outside India and again within India.



Notes ● Cash vs. Kind: It is not necessary that the income should be received in cash.It may be received in cash or in kind. For instance, value of free residentialhouse provided to an employee is taxable, as salary in the hands of theemployee through the income is not received in cash.

● Receipt vs. Accrual: Receipt is not the sale test of chargeability to tax. If anincome is not taxable on a receipt basis, it may be taxable on accrual basis.

● Actual Receipt vs. Deemed Receipt: It is not necessary that the incomeshould be actually received in India in order to attract tax liability.

4.2.5 Income deemed to be received in India [Sec. 7]This term refers to the income which is not actually received in the hands of the

assessee but is nevertheless his income and is to be treated as if it has been actuallyreceived by him. The following incomes are deemed to have been received in India:

(a) Income tax deducted at source from the income received by the assessee.(b) Annual accretions to the balance of an employee – an assessee with a

recognised Provident Fund to the extent such accretions are taxable. Anycontribution by the employer in excess of 12% of the employee’s salary to thePF and interest credited on the balance to the credit of the employee at a rateexceeding a rate fixed by the Central government (at present is 9.5%).

(c) The transferred balance in a Recognised Provident Fund.(d) Deemed Profit u/s 41 and 59.(e) The contribution made by the Central Government to the account of the

employee under a pension scheme referred to in Sec. 80CCD.(f) Undisclosed income/unexplained investments u/s 68, 69, 69a, 69B, 69C, 69D.Connotation of accrual income – How is it understood?Income accrued in India is chargeable to tax in all cases, irrespective of the

residential status of an assessee. The words ‘accrue’ and ‘arise’ are used in contradictionto the word ‘receive’. Income is said to be received when it reaches the assessee; whenthe right to receive the income becomes vested in the assessee, it is said to accrue orarise – CIT v. Ashokbhai Chiman Bhai [1965] 56 ITR 42.

4.2.6 Section 8: Inclusion of Dividend as Defined u/s 2(22) in the Total Income of aPerson

Any interim dividend shall also be deemed to be income of the previous year, if suchdividend is unconditionally made available by the company during that previous year.

4.2.7 Section 9: Income Deemed to Accrue or Arise in IndiaCertain incomes are deemed to accrue or arise in India under Section 9 even

though they may actually accrue or arise outside India. This section applies to all theassesses irrespective of their residential status, nationality, domicile, place of business,relationship with persons in India. Thus, the scope of this section is to shift the place ofaccrual of the income.

Implications of this section are of utmost importance to all non-resident tax payersand persons who are not ordinarily residents in India, who in the absence of this provisionwould exempt from tax in respect of their foreign income. The categories of income whichare deemed to accrue or arise in India are covered in the paragraphs that follow.



NotesSection 9(1)(i):Income from Business Connection: The Income Tax Act does not define the term

‘business connection’. A business connection involves a relation between a businesscarried on by a non-resident that yields profits and gains and some activity in India whichcontributes directly or indirectly to the earning of those profits and gains. It implies anintimate relation between trading activity carried on outside India and trading activitywithin India and such relation is contributing to the earning of profit by non-residents. Toillustrate the term ‘business connection’, following are some instances:

1. Maintaining a branch office, factory, agency receivership or management forthe purchase and sale of goods or transacting any other business.

2. Appointing an agent in India for the systematic and regular purchase of rawmaterials or other commodities or for sale of the non-resident’s goods forbusiness purposes or for securing orders in India.

3. Erecting a factory in India where the raw products purchased locally is workedinto a form suitable for export abroad.

4. Forming a local subsidiary company to sell the products of the non-residentparent company.

5. Having financial association between a resident and non-resident company.6. Granting a continuing license to a resident to exploit for profit an asset

belonging to a non-resident even if the transaction might be disguised as outand out sale.

In B.P. Ray v. ITO, the Supreme Court held that the expression ‘businessconnection’ u/s 9(1)(i) would refer to ‘Professional Connection’ also.

Exception to Section 9(1)(i):In the case of a non-resident, no income shall be deemed to accrue/arise in India in

the following situations:1. Where the business connection is confined only to the purchase of goods in

India for the purpose of exports. (This exception is made to encourageexports).

2. Where the business connection is confined only to collection of news andviews in India for transmission out of India.

3. Where the business connection is confined to the shooting of anycinematography firm in India. (This exception is also available to a firm andcompany which does not have any partner/shareholder who is a citizen of Indiaor who is resident in India).

4. Where all operations of a business are not carried out in India, the extent ofincome of the business relating to operations not carried out in India.

Section 9(1)(i):Income from Property, Asset and Source of Income: The term property includes

both movable and immovable property and the term asset includes all intangible rights,i.e., interests, dividend, patents, copyrights, royalty, rent etc. Income arising in a foreigncountry from or through the property, assets and sources of income shall be deemed toaccrue or arise in India.



Notes Section 9(1)(i):Income from the transfer of any capital assets situated in India: Any capital

gain, within the meaning of Section 45, earned by a non-resident by transfer of anycapital asset situated in India is deemed to accrue or arise in India.

Section 9(1)(ii):Income under the head salaries if it is earned in India: Income under the head

salaries if it is earned in India is deemed to accrue or arise in India if it is earned in India.Salary or Pension is said to be earned in India if services are rendered in India and therest period or leave period which is preceded or succeeded by services rendered in Indiaand form part of the service contract of employment.

Exception: [Section 9(2)]: Pensions payable outside India by the government togovernment officials and judges, who permanently reside outside India, shall not bedeemed to accrue or arise in India.

Section 9(1)(iii):Salary paid by the government outside India to an Indian citizen for the services

rendered outside India would be deemed to accrue or arise in India. It is important to notethat this provision is not applicable to a salary paid by the government to the citizen ofother countries.

Section 9(1) (iv):Dividend paid by an Indian company outside India is deemed to accrue or arise in

India.

Section 9(1)(v):Income by way of interest is deemed to accrue or arise in India if it is payable by:1. The Government, whether Central or State.2. A person who is resident in India. (However, if interest relates to a debt used

for a business or profession carried outside India or for the purpose of earningany income from any source outside India, the interest so paid shall not bedeemed to accrue in India), or

3. A person who is non-resident, only if interest rates to debt used for a business/profession carried on by such person in India.

Section 9(1)(vi):Income by way of royalty is deemed to accrue or arise in India if it is payable by:1. The Government whether Central or State2. A person who is resident in India except where the royalty is payable in respect

of its right/property utilised for the business or profession carried outside Indiaor for the purpose of earning any income outside India or

3. A non-resident, if royalty is in respect of any right/property utilised for thebusiness/ profession carried in India or any other source of his income in India.

Exceptions to the above provisions are mentioned below:1. Royalty received shall not be deemed to accrue/arise in India if following

conditions are fulfilled:(a) Royalty is received in lump sum,(b) Royalty is received by a non-resident from a resident,



Notes(c) Royalty is received for transfer of any/all right(s) of computer softwarealong with computer hardware under any scheme approved under thePolicy on Computer Software Export, Software Development and Training,1986 of the Government of India.

2. If Royalty is payable under an approved agreement made before April 1, 1976.Lump sum payment outside India in respect of any data, documentation,drawing or specification to a patent etc. shall not be income deemed to accrueor rise in India, if such income is payable pursuance of an agreement madebefore April 1, 1976 and the agreement is approved by the CentralGovernment. In this connection, ‘Explanation 1’ specifies the followingconditions where under even an agreement made on or after April 1, 1976 shalldeemed to have been made before that date :(i) In the case of taxpayer other than a foreign company, if the agreement is

made in accordance with proposals approved by the Central Governmentbefore that date.

(ii) In the case of a foreign company, if the condition referred to in (i) above issatisfied and the foreign company exercises an option by furnishing adeclaration in writing to the Income Tax Officer that the agreement may beregarded as having been made before the April 1, 1976. The option in thisbehalf will have to be exercised before the expiry of the time allowedunder Section 139(1).

Section 9(1)(vii):Income by way of fees for Technical Services: This is deemed to accrue or arise

in India and it is payable by:1. A Government or2. A resident person except where the fees are payable in respect of services

utilised in a business or profession carried outside India or for the purpose ofearning income outside India or

3. A non-resident, if fees are in respect of services utilised in a business orprofession carried on in India or any other source of his income in India.

Exception: Explanation with effect from 1/6/1976 occurring after subsection (2)namely

For the removal of doubts, it is hereby declared that for the purposes of this section,income of a non-resident shall be deemed to accrue or arise in India under clause (v) orclause (vi) or clause (vii) of subsection (1) and shall be included in the total income of thenon-resident, whether or not −

(i) the non-resident has a residence or place of business or business connectionin India; or

(ii) the non-resident has rendered services in India.

4.2.8 Other PointsIncome accruing, organising outside India will not be deemed to be received in India,

merely because it has been included in the balance sheet in India. Once income includedon accrual basis cannot be included against a receipt basis on the same or subsequentyears.



Notes Exception to the Rule that Income of P.Y. is assessed to Tax in A.Y. :Exceptions to the general rule that tax is chargeable only on the income of the

previous year the Assessment Years are contained in sections 172, 174, 175, 176. Theobject of these exceptions is to see that interest of revenue is not jeopardized. In all thesefour exceptions, there will be assessments – the normal assessment and the summaryassessment. The exceptions are explained below.

Section 172: Shipping Business of a Non-resident: This section taxes theincome of ships belonging to non-residents which occasionally call at Indian ports and forwhich there is no account in India from whom tax can be recovered. The rate of tax is

%217 of the net income of the accruing in India for that particular voyage. The tax is

enforced by providing that the ships shall be permitted to sail only on payment of tax atthat rate on the amount paid or payable to the owner on account of carriage of goodssince its arrival at an Indian port.

Section 174: Person leaving India: When any individual who has no intention toreturn is about to immigrate from India, the Assessing Officer may initiate summaryproceedings for assessing such a person and compute his total income for the periodcommencing from the end of the previous year up to the probable date of his departure.He can also levy and collect the tax before he leaves India in addition to normalassessment for the previous year.

Section 174A: Assessment of an Association of Persons or a Body ofIndividuals or Artificial Juridical Person formed for a Particular Event or Purpose:Where it appears to the Assessing Officer that any association of persons or a body ofindividuals or an artificial juridical person formed or established or incorporated for aparticular event or purpose is likely to be dissolved in the assessment year in which suchassociation of persons or body of individuals or artificial juridical person, for the periodfrom the expiry of the previous year for that assessment year up to the date of itsdissolution, shall be chargeable to tax in that assessment year.

Section 175: Persons Likely to Transfer Property to Avoid Tax: When theAssessing Officer feels that a person is likely to sell or transfer or otherwise part with anyof his assets in order to avoid paying any tax liability, the officer may start emergencyproceedings to compute his total income from the end of the previous year up to the dateof commencement of the proceedings. He can also determine the tax thereon andrecover the same even before the previous year ends.

Section 176: Discontinued Business: This last exception provides for a situationwhere a business or profession is discontinued in any financial year. In such cases, theincome for the period commencing from the end of the previous year up to the date ofdiscontinuance will be calculated and the tax levied during the course of the year ofdiscontinuance itself. The question may arise as to how the tax authorities know when aparticular business is being discontinued. The same section also imposes on theassessees an obligation to notify the Assessing Officer that a particular business is beingdiscontinued.

In all these four exceptional situations, there will be two assessments; the normalassessment and the summary assessment. In both these assessments, the rate of taxapplied would be that applicable for the relevant Assessment Year. The exceptions areonly to see that the interests of the revenue are not jeopardized in the circumstancesenvisaged in these sections just because the normal provision is to tax the income of theprevious year in the Assessment Year.



NotesProblems on Incidence of Tax:1. For the assessment year 2013-14 (previous year 2012-13), X is employed in India

and receives ` 24,000 as salary (net of standard deduction). His income from othersources includes:

Dividend received in London on June 3, 2012: ` 31,000 from a foreign company;share of profit received in London on Dec. 15, 2012 from a business situated in Sri Lankabut controlled from India; ` 60,000 remittance from London on Jan. 15, 2013 out of partuntaxed profit of 2009-10 earned and received there ` 30,000 and interest earned andreceived in India in May 11, 2013 ` 76,000.

Find out his Gross Total Income, if he is (a) resident and ordinarily resident (b) residentbut not ordinarily resident and (c) non-resident for the Assessment Year 2013-2014.

Solution:If X is resident and ordinarily resident :Gross total income will be ` 115,000 (i.e., ` 24,000 + 31,000 + 60,000)If X is resident and not ordinarily resident :Gross total income will be ` 84,000 (i.e., 24,000 + 60,000)If X is a non-residentHis gross total income will be ` 24,000.Important Points:1. Remittance from London of ` 30,000 is not taxable in the previous year

2012-13 because it does not amount to the receipt of income.2. Although interest of ` 76,000 earned and received in India is taxable but not

included in total income of the Assessment Year 2013-14 as it is not earnedand received in the previous year 2012-13. It will be included in the totalincome of X for the Assessment Year 2014-15 (previous year 2013-14).

2. X furnishes the following particulars of his income earned during the previousyear relevant to the assessment year 2013-14.

No. Particulars Amount(`)

1 Interest on German Development Bonds (2/5th received in India) 60,000.00

2 Income from agriculture in Bangladesh received there but later on ` 50,000 isremitted to India (agricultural activity is controlled from Bangladesh)

1,81,000.00

3 Income from property in Canada received outside India (` 76,000 is usedin Canada for meeting educational exp. of X’s daughter in USA and` 10,000 is later on remitted to India)

86,000.00

4 Income earned from business in Kampala (Uganda) which is controlledfrom Delhi (` 15,000 is received in India)

65,000.00

5 Dividend paid by a foreign company but received in India on 10.4.2012 46,500.00

6 Past untaxed profit of 2003-04 brought to India in 2012-13 10,43,000.00

7 Profits from business in Chennai and managed from outside India 27,000.00

8 Profit on sale of a building in India but received in Sri Lanka 14,50,000.00

9 Pension from a former employer in India received in Rangoon (net ofstandard deduction)

36,000.00

10 Gift in foreign currency from a relative received in India on 20-1-2013 80,000.00



Notes 2. Find out the gross total income of X if he is:(i) Resident and ordinarily resident in India(ii) Resident but not ordinarily resident in India(iii) Non-resident for the AY 2013-14.

Solution:

Resident andordinarilyresident

Resident butNot ordinarilyresident

Non-resident Remark

Interest on German DevelopmentBonds

– 2/5th taxable on receipt basis

– 3/5th taxable on accrual basis24,000.00

36,000.00

24,000.00

–

24,000.00

–

See Note 1

See Note 2

Income from agriculture inBangladesh – income accrued andreceived in India

1,81,000.00 – – See Note 3

Income from property in Canadareceived outside India – incomeaccruing and arising outside India

86,000.00 – – See Note 2

Income accruing or arising outsideIndia

● Taxable on receipt basis

● Balance non-taxable in case ofnon-resident

15,000.00

50,000.00

15,000.00

50,000.00

15,000.00

–

See Note 1

See Note 4

Dividend paid by a foreign company

● Income received in India 46,500.00 46,500.00 46,500.00 See Note 1

Past untaxed profit brought to India

● Not an income of the previous year2012-13 relevant for the AY 2013-14,hence not taxable

– – – See Note 5

Profits from a business in Chennai andmanaged from outside India

● Income accrued in India 27,000.00 27,000.00 27,000.00 See Note 6

Profit on sale of a building in India butreceived in Sri Lanka

● Income deemed to accrue or arise inIndia

14,80,000.00 14,80,000.00 14,80,000.00 See Note 7

Pension from an Indian formeremployer received in Rangoon

● Income deemed to accrue or arise inIndia

36,000.00 36,000.00 36,000.00 See Note 8

Gift from a relative – it is taken as anincome 80,0000.00 80,000.00 80,000.00 See Note 9



NotesImportant Points:1. It is Indian income. It is always taxable.2. It is received as well as accrued outside India. It is not business income or

income from profession. It is taxable only in the case of resident and ordinarilyresident.

3. It is received outside India (remittance of ` 50,000 to India is not ‘receipt’ ofincome in India). It is therefore taxable in India only in the case of a residentand ordinarily resident taxpayer.

4. It is accrued outside India. It is received outside. It is foreign income. It is nottaxable in the case of a non-resident. Since it is business income and businessis controlled from India, it is taxable in the hands of a resident but not ordinarilyresident taxpayer.

5. It is an income of the previous year 2003-04 and cannot be taxed at the time ofremittance 2012-13.

6. As the income is accrued in India, it is an Indian income and taxable in allcases.

7. As the building is situated in India, income is deemed to accrue in India.Consequently it is an Indian income and chargeable to tax in all cases.

8. Service was rendered in India. Pension income is deemed to accrue in India. Itis Indian income and chargeable to tax in all cases.

9. If the aggregate amount of gifts received by an individual/HUF from all persons(not being relatives) during a financial year exceeds ` 50,000 it is taxable asincome.

3. A has the following income during financial year 2012-13. Compute his taxableincome if he is (i) ROR (ii) RNOR (iii) NR for that year.

(a) Interest from Bank Deposit in UK (1/3 received in India) – ` 6,000.(b) Rent from property in UK received in India – ` 12,000.(c) Pension from a former Indian employer received in UK – ` 50,000.(d) Income earned from a business set up in UK and controlled from UK –

` 25,000.(e) Income earned from a business set up in UK and controlled from India –

` 50,000.

Solution:

Particulars of income Resident andordinarily resident

Resident and notordinarily resident

Non-resident

Interest from bank deposit in UK 6000 2000 2000

Particulars of income Resident andordinarily resident

Resident and notordinarily resident

Non-resident

Rent from property in UK 12000 0 0

Pension from Indian Employer 50000 50000 50000

Income from business in UK andcontrolled from UK

25000 0 0

Income from business in UK butcontrolled from India

50000 50000 0

Total Income 143000 102000 52000



Notes Scope and Orbit of ‘Business Connection’ in the Case of a Non-resident:In the case of income deemed to accrue or arise in India, the scope and ambit of

‘business connection’ of a non-resident can be explained with the help of followingillustrative instances.

(a) Maintaining a branch office in India for the purchase or sale of goods ortransacting other business.

(b) Appointing an agent in India for the systematic and regular purchase of rawmaterials or other commodities or for sale of the non-resident’s goods or forother business purposes.

(c) Erecting a factory in India, where the raw produce purchased locally is workedinto a form suitable for export abroad.

(d) Forming a local subsidiary company to sell the products of the non-residentparent company.

(e) Having financial association between a resident and a non-resident company.Following clarifications regarding applicability of provisions of Section 9 are

made in respect of certain specified situations:● Non-resident exporters selling goods from abroad to an Indian importer: No

liability will arise on accrual basis to the non-resident on the profits made by him wherethe transactions of sale between the two parties are on a principal-to-principal basis. Ifthe non-resident makes over the shipping documents to a bank in his own country whichdiscounts the documents and sends them for collection to the bankers in India, whopresent the sight or issuance draft to the resident importer and deliver the documents tohim against payment or acceptance by the latter, the non-resident will not be liable to taxon the profit arising out of the sales on receipt basis.

● Non-resident company selling goods from abroad to its Indian subsidiary: Insuch a case, if the transactions are actually on a principal-to-principal basis and are at anarm’s length and the subsidiary company functions and carries business on its own,instead of functioning as an agent of the parent company, the mere fact that the Indiancompany is a subsidiary of the non-resident company will not be considered a validground for invoking Section 9 for assessing the non-resident. Where a non-residentparent company sells goods to its Indian subsidiary, the income from the transaction willnot be deemed to accrue or arise in India under Section 9, provided that (a) the contractsto sell are made outside India, (b) the sales are made on a principal-to-principal basisand at arm’s length, and (c) the subsidiary does not act as an agent of the parentcompany.

● Sale of plant and machinery to an Indian importer on instalment basis:Where the transaction of sale and purchase is on a principal-to-principal basis and theexporter and the importer have no other business connection, the fact that the exporterallows the importer to pay for the plant and machinery instalments will not, by itself,render the exporter liable to tax on the ground that the income is deemed to arise to himin India.

● Foreign Agents of Indian Exporters: Where a foreign agent of an Indianexporter operates in his own country and his commission is usually remitted directly tohim and is, therefore, not received by him or on his behalf in India. Such an agent is notliable to income tax in India on the commission.

● Non-resident person purchasing goods in India: A non-resident will not beliable to tax in India on any income attributable to operations confined to the purchase ofgoods in India for export, even though the non-resident has an office or an agency inIndia for this purpose.



Notes● Sales by a non-resident to Indian customers either directly or throughagents: Where a non-resident allows an Indian customer the facilities of extended creditfor payment, there would be no assessment merely for this reason provided that: (i) thecontracts to sell were made outside India; and (ii) the sales were made on aprincipal-to-principal basis. Where a non-resident has an agent in India and makes salesdirectly to Indian customers, Section 9 of the Act will not be invoked, even if the residentpays his agent an overriding commission on all sales to India, provided that (i) the agentneither performs nor undertakes to perform any service directly or indirectly in respect ofthese direct sales; (ii) the contracts to sell are made outside India; and (iii) the sales aremade on a principal-to-principal basis. Where a non-resident’s sales to Indian customersare secured through the services of an agent in India, the assessment in India of theincome arising out of the transaction will be limited to the amount of profit which isattributable to the agent’s services, provided that (i) the non-resident principal’s businessactivities in India are wholly channelled through his agent, (ii) the contracts to sell aremade outside India, and (iii) the sales are made on a principal-to-principal basis. Where anon-resident principal’s business activities in India are not wholly channelled through hisagent in India, the assessment in India will be on the sum total of the amount of profitattributable to his agent’s activities in India and the amount of profit attributable to his ownactivities in India, less the expenses incurred in making the sales.

● Extent of the profit assessable under Section 9: If a non-resident has abusiness connection in India, it is only that portion of the profit which can reasonably beattributed to the operations of the business carried out in India, which is liable to IncomeTax – Circular No. 23 [F. No. 7A/38/69-IT(A-II)], dated 23.07.1969.

● Agency engaged in activity of purchase of goods for export: The mereexistence of an agency established by a non-resident in India will not be sufficient tomake the non-resident liable to tax, if the sole function of the agency is to purchasegoods for export – Circular No. 163 [F. No. 488/23/73-FTD], dated 29.5.1975.

● Foreign company engaged in re-insurance with Indian companies:Regarding taxability of a foreign company on its profits of re-insurance with companies inIndia no uniform principle could be laid down which will be applicable in all cases. TheITO will have to be examined each case in the light of its facts and decide, where taxliability is attracted and what portion of the income from the re-insurance should beassessed – Circular No. 35(XXXIII – 7) of 1956 [F. No. 51(5)-IT 54], dated 3.9.1956.

● Pensions received in India from abroad: Pensions received in India fromabroad by pensioners residing in this country, for past services rendered in the foreigncountries, will be income accruing to the pensioners abroad and will not, therefore beliable to tax in India on the basis of accrual. These pensions will also not be liable to tax inIndia on receipt basis, if they are drawn and received abroad in the first instance andthereafter remitted or brought to India. While the pension earned and received abroad willnot be chargeable to tax in India if the residential status of the pensioner is either‘non-resident’ or ‘resident but not ordinarily resident’, it will be so chargeable if theresidential status is ‘resident and ordinarily resident’ – Circular No. 4 [F. No. 73A/2/69-IT(A-II)], dated 20.02.1969.

● Shares allotted to non-residents in consideration for machinery and plant:Where shares in Indian companies are allotted to non-residents in consideration formachinery and plant, the income embedded in the payments would be received in Indiaas the shares in the Indian companies are located in India and would accordingly attractliability to income tax as income received in India – Circular No. 382 [F. No.484/12/78-FTD], dated 4.5.1984.



Notes 4.3 Exempted Incomes of Companies

4.3.1 Income of Foreign Companies Providing Technical Services in ProjectsConnected with the Security of India [Section 10(6c)]

Any income arising to a notified foreign company by way of fees for technicalservices rendered in pursuance of an agreement entered into with the government forproviding service in or outside India in projects connected with the security of India, shallbe exempt from tax.

4.3.2 Section 10AA: Special Provisions in Respect of Newly Established Units inSpecial Economic Zones

Subject to the provisions of this section, a deduction of such profits and gainsderived by an assessee being an entrepreneur from the export of articles or things orproviding any service, as the case may be, from his unit shall be allowed from the totalincome of the assessee.

Notes:1. The deduction under this section is available for the unit and not the assessee.2. Meaning of Entrepreneur: ‘Entrepreneur’ means a person who has been

granted a letter of approval by the development commission under section 15(9)[Section 2(j) of the Special Economic Zone Act, 2005].

Essential conditions to claim deduction: The deduction shall apply to an undertakingwhich fulfills the following condition:

1. It has begun or begins to manufacture or produce articles during the previousyear, relevant to the assessment year commencing on or after 1-4-2006 in anySpecial Economic Zone.

2. It should not be formed by the splitting up or reconstruction of a businessalready in existence.

3. It should not be formed by the transfer of machinery or plant, previously usedfor any purpose, to a new business.

4. The exemption shall not be admissible unless the assessee furnishes in theprescribed form [Form No. 56F] along with the return of income, the report ofthe chartered accountant certifying that the deduction has been correctlyclaimed as per provisions of this section.

Notes:1. Manufacture means to make produce, fabricate, assemble, process or bring into

existence, by hand or by machine, a new product having a distinctive name, character oruse and shall include processes such as refrigeration, cutting, polishing, blending, repair,remaking, re-engineering and includes agriculture, aquaculture, animal husbandry,floriculture, horticulture, pisciculture, poultry, sericulture, aviculture and mining [Section2(f) of the Special Economic Zone [Section 2(za) of the Special Economic Zones Act,2005].

Period for Which Deduction is AvailableThe deduction under this section shall be allowed as under for a total period of

15 relevant assessment years.



Notes1 For the first 5 consecutive assessment yearsbeginning with the assessment year relevantto the previous year in which the unit beginsto manufacture such articles or things orprovide services.

100% of the profits and gains derived fromthe export of such articles or things or fromservices.

2 Next 5 consecutive assessment years. 50% of such profits or gains.

3 Next 5 consecutive assessment years. So much of the amount not exceeding 50%of the profits as is debited to profit and lossaccount of the previous year in respect ofwhich the deduction is to be allowed andcredited to Special Economic Zone.Reinvestment Reserve Account to becreated and utilised for the purpose of thebusiness of the assessee in the manner laiddown in subsection (2) below.

Conditions to be Satisfied for Claiming Deduction for Further 5 Years (After 10 Years)[Section 10AA(2)]

1. The amount credited to the Special Economic Zone Reinvestment ReserveAccount is to be utilised−(i) For the purpose of acquiring machinery or plant which is first put to use

before the expiry of a period of 3 years following the previous year inwhich the reserve is created; and

(ii) Until the acquisition of this machinery or plant as aforesaid, for thepurposes of the business of the undertaking other than for distribution byway of dividends or profits or for remittance outside India as profits or forcreation of any asset outside India.

2. The particulars as may be prescribed in this behalf, should be furnished inForm 56FF, by the assess in respect of machinery or plant along with thereturn of income for the assessment year relevant to the previous year in whichsuch plant or machinery was first put to use.

Consequences of Misutilisation/Non-utilisation of Reserve [Section 10AA(3)]Where any amount credited to the Special Economic Zone Re-investment Reserve

Account:(a) has been utilised for any purpose other than the purchase of machinery or

plant as mentioned above, the amount so utilised shall be deemed to be theprofits of the year in which it was so utilised and shall be charged to tax; or

(b) has not been utilised before the expiry of the aforesaid period of 3 years, theamount no so utilised shall be deemed to be the profits of the year immediatelyfollowing the period of said 3 years and charged to tax.

How to compute profit and gains from exports of such undertakings [Section10AA(7)]: If the aforesaid conditions are satisfied, the deduction u/s 10AA may becomputed as under:

Profits from business of the undertaking being the unit ×

assesseethebycarriedbusinestheofturnoverTotalservicesorthigs/articlessuchofgundertakintheofoverturnExport



Notes For this purpose, ‘export turnover’ means the consideration in respect of export bythe undertaking of articles or things or services received in, or brought into India by theassessee but does not include freight, telecommunication charges, or insuranceattributable to the delivery of the article or things outside India, or expenses, if any,incurred in foreign exchange in rendering of services (including computer software)outside India.

The profits and gains derived from on-site development of computer software(including services for development of software) outside India shall be deemed to be theprofits and gains derived from the export of computer software outside India.

Ban on Enjoyment of Other Tax BenefitsThe following allowances or expenditure shall be deemed to have been allowed and

absorbed during the course of the relevant assessment years ending before 1-4-2006:(i) Depreciation allowance under section 32(ii) Expenditure on scientific research under section 35; and(iii) Expenditure relating to family planning under section 36(1)(ix)The aforesaid expenditure/allowance even if unabsorbed during the assessment

years ending before 1-4-2006, shall be deemed to have been fully claimed and allowed.However, unabsorbed depreciation, unabsorbed expenditure on scientific research andcapital expenditure on family planning pertaining to assessment year 2006-07 or anysubsequent assessment years shall be allowed to be carried forward and set off.

No portion of the losses pertaining to business under section 72(1) or capital gainsunder section 74(1) or section 74(3) with respect to any assessment year ending before1-4-2006 forming part of the tax holiday period, to the extent pertaining to the undertaking,being the unit shall be claimed in any assessment year subsequent to the last of theassessment year forming part of the tax holiday. However, losses referred to in Section72(1) or Section 74(1) and (3) in so far as such losses relate to the business of theundertaking being the unit, pertaining to the assessment year 2006-07 or anysubsequent assessment year shall be allowed to be carried forward and set off.

WDV after Tax Holiday PeriodIt shall be presumed that during the tax holiday period under section 10AA, the

assessee had claimed and had been allowed depreciation allowance, and hence thewritten down value of the depreciable assets shall be computed accordingly, after theconclusion of the tax holiday period.

4.3.3 Income from Property Held for Charitable PurposesThe following sections of the Income Tax Act deal with the subject of exception of

income from property held for charitable or religious purposes:Section 11: Exemption of income from property held in trust or other legal obligation

for religious or charitable purposes.Section 12: Exemption of income derived by such a trust from voluntary

contributions made with a specific direction that they shall form of the corpus of the trustor institution.

Section 12 A: Prescribes the conditions for registration of a trust.Section 12 AA: Prescribes the procedure for registration.Section 13: Enumerates the circumstances under which exemption available under

Sections 11 and 12 will be denied.



NotesTable 4.3 : Exempt Income in Case of a Charitable or Religious Trust

No. Nature of income To what extentexempt fromallowed

Conditionsapplicable

Relevantprovisions

Remarks, ifany

A Income derived from

property held under trust

wholly for charitable or

religious purposes

To the extent such

income is applied in

India for such

purposes

Accumulation allowed

up to 15% of such

income

Section 11(i)(a) Accumulation

treated as

applied for

such

purposes

Accumulation in

excess of 15% allowed

subject to certain

conditions being

satisfied

Section 11(2) - do -

B Income derived from


which is applied in part only

for charitable or religious

purposes

To the extent such

income is applied in

India for such

purposes

(i) Do

(ii) Trust should have

been created before

1.4.62

Section

11(1)(b)

- do -

C Income derived from


i Created on or after 1.4.52

for charitable purposes

outside India (Religious

trusts not covered)

To the extent such

income is applied to

such purposes

outside India

The purpose of the

trust is to promote

international welfare in

which India is

interested. Further

general or special

order of Board for

exemption is

necessary. No

accumulation allowed

Section

11(1)(c)(1)

Accumulation

not exempt

Ii Created before 1.4.1952 for

charitable or religious

purpose to be used for such

purposes outside India

To the extent such

income is applied

outside India for such

purposes

No condition

applicable but general

or special order of the

Board for exemption is

necessary

Section

11(1)(c)(ii)

Accumulation

not exempt.

D Income in the form of

voluntary contribution

forming part of corpus

100% exempt with

no condition of

application or

accumulation

There should be

specific direction that

such contribution to

form part of corpus of

the trust or institution

Section 11(i)(a)

E Capital gain arising from

transfer of a capital asset,

held under trust wholly for


purposes

(i) The whole of the

capital gain

(i) If the net

consideration is

utilised for purchasing

new capital asset

Section

11(IA)(a)

(ii) To the extent of

capital gain as is

equal to the amount

if any, by which the

If a part of the net

consideration is

utilised for requiring

capital asset



Notes amount so utilised

exceeds the cost of

the transferred asset

F Capital gain arising from

transfer of a capital asset

held under trust, partly used

for charitable or religious

purpose

(i) the whole of the

appropriate fraction

of such capital gain

(to the extent such

asset was used for


purpose)

(i) If the net

consideration is

utilised for providing

new capital asset

Section

11(IA)(b)

(ii) So much of the

appropriate function

of the capital gain as

is equal to the

amount if any by

which the

appropriate fraction

of the amount used

for acquiring new

asset exceeds the

extent of cost of

transferred asset

(ii) If a part of the

net consideration is

utilised for acquiring.

4.4 Profit and Gains from Business or Profession

4.4.1 Introduction and Incomes Chargeable under this Head as per the Provisionsof Section 281. Income from business or profession is taxed under this head of income.2. Business includes any trade, commerce, manufacturing unit or any adventure

or concern in the nature of trade, commerce or manufacture Section 2(13). Theword ‘business’ normally connotes some real, substantial and systematic ororganised course of activity or conduct with a set purpose. In taxing statutes, itis used in the sense of an occupation or profession, which occupies the time,attention and labour of a person, normally with the object of making profit. Toregard an activity as business, there must be a course of dealings, eitheractually continued or contemplated to be continued with a profit motive and notfor sport or pleasure. A single transaction also can constitute a business,depending upon the circumstances of the case. Whether a person carries onbusiness in a particular commodity normally depends upon the volume,frequency, continuity and regularity of transactions of purchase and sale in aclass of goods and the transaction must ordinarily be entered into with a profitmotive. Business is an activity capable of producing a profit which can be taxed.The expression ‘business’ in ordinary parlance means any trading activityaccompanied by regularity of transactions intended for the purpose of makingprofit. Generally speaking, business is an activity of a commercial nature andmeans practically anything which is an occupation as distinguished from apleasure. If the transaction is a trading transaction or an adventure in thenature of trade, it will amount to business, no matter whether it results in loss orprofit. It also includes adventure in the nature of trade.



Notes3. Under this head, any income from the exercise of any profession is also taxed.A profession as a specialised nature of business normally refers to thoseactivities which particularly involve greater degree of personal skill, such asoccupations in the field of law, medicine or engineering, accountancy,management etc., which require considerable training and specialised study ofthe subject for exercising that occupation. According to Section 2(36),profession includes ‘vocation’.

4. Income from an illegal business such as smuggling is also taxable under theIncome Tax Act, i.e., taxability of income has no connection to whether theincome is legal or illegal. In CIT v. Piara Singh, the Supreme Court has heldwhere income from an illegal business is assessed to tax as such, the lossarising directly in the course of business is deductible as business expenditure.

5. More particularly following are the incomes, which are chargeable under thishead, as per provisions of Section 28.(a) Profits or gains from any business or profession carried on by the

assessee at any time during the previous year.(b) Income derived from sale of an import license or any export incentive

received, such as cash compensatory support or drawback of duty or anyother export incentive.Compensation or other payment due to or received by any person holdingan agency in India for any part of the activities relating to the business ofany person at or in connection with the termination or modifications ofterms and conditions compensation or other payment due to be receivedby any person from or in connection with the resting of the Government orin any corporation owned or controlled by the Government under any lawof the management of the presents or any business, any sum, whetherreceived or receivable in cash or in kind for not carrying out any activity inrelation to any business or not showing any know-how, patent, copyright,trademark, license, franchise or any other business or commercial rightsetc., likely to assist in the manufacture or processing of goods or provisionfor services. Exception if received on account of transfer of right tomanufacture etc. will be chargeable under the head of ‘capital gains’.

(c) Income derived by any trade association or professional association orany other similar association from specific services rendered to itsmembers. For example, income earned by the Chambers of Industriesfrom conference organised by them.

(d) Export incentives which include profit on sale of import licenses, dutydrawbacks of customs and central excise duties, cash assistance, anyprofit on the transfer of the Duty Entitlement Pass Book Scheme and profiton the transfer of the Duty Free Replenishment Certificate.

(e) Any income from speculative transactions like buying and selling of shareswithout giving or taking actual physical delivery.

(f) The value of any benefit or perquisite, whether convertible into money ornot, arising from the business or from the profession such as giftsreceived in the course of business.

(g) Any interest, salary, bonus, commission or remuneration received by apartner of a partnership firm from the partnership firm.

(h) Any sum received under Keyman Life Insurance Policy including bonus onsuch policy, if such sum is not to be taxed as salary income.



Notes (i) Any amount received by a person who is in charge of the management ofan affair of an Indian Company or any other company for agreeing to thetermination or modification or relinquishment of his management powersor authority.

(j) Any sum, whether received or receivable, in cash or kind on account ofany capital asset (other than land or goodwill or financial instrument)being demolished, destroyed, discarded or transferred, if the whole of theexpenditure on such capital asset has been allowed as a deduction undersection 35AD.

(k) Any sum, whether received or receivable, in cash or kind under anagreement for not carrying out activity in relation to any business or notsharing any know-how, patent, copyright, trade mark, license, franchise orany other business or commercial right of similar nature or information ortechnique likely to assist in the manufacture or processing of goods orprovision of services.

(l) Profits and gains of managing agency; and(m) Income form speculative transaction.

6. Apart from the above-mentioned incomes, any income which is in the nature ofbusiness income or professional income will be chargeable to tax under thishead. Interest income is either assessed as ‘Business Income’ or as ‘Incomefrom other sources’ depending upon the activities carried on by the assessee.If the investment yielding interest were part of the business of the assessee,the same would be assessable as ‘Business Income’, but where the earning ofthe interest income is incidental to and not the direct outcome of the businesscarried on by the assessee, the same is assessable as ‘Income from othersources’. Business implies some real, substantial and systematic or organisedcourse of activity with a profit motive. Interest generated from such an activity isconsidered as ‘Business Income’. Otherwise, it would be interest from othersources.

7. For charging the income under the head ‘Profits and Gains of Business’, thefollowing conditions should be satisfied:

(a) There should be a business or profession.(b) The business or profession should be carried on by the assessee.(c)The business or profession should have been carried on by theassessee at any time during the previous year.(d) The charge is in respect of the profits and gains of the previous yearof the business or profession.(e) The charge extends to any business or profession carried on.

Exceptions to the Business to be Carried on During the Previous YearCertain receipts are taxable as ‘Income from business’ though no business is

carried on by the assessee in the year of receipt −(i) Recovery against any loss, expenditure or trading liability earlier allowed as a

deduction [Section 41(1)].(ii) Balancing charge in case of electricity companies [Section 41(2)].(iii) Sale of capital asset used for scientific research [Section 41(3)].(iv) Recovery against bad debts. [Section 41(4)](v) Annual amount withdrawn from Special Reserve [Section 41(4A)].



Notes(vi) Receipt of discontinued business under cash system of accounting [Section176(3A)(4)].

(vii) Sum received for restrictive covenant [Section 28(va)].

4.4.2 Computation of Income under the head [Section 29]Section 29 lays down that the income referred to in Section 28 shall be computed in

accordance with the provisions contained in Section 30 to Section 43D. It may be addedthat the provisions of Sections 44 to 44D are also to be taken into account in this contextas they make certain special provisions regarding the computation of profits anddeductions of expenditure in certain cases.

It is important to note that specific allowances and deductions stated in thesesections are not exhaustive. Besides these deductions, other deductions are alsoavailable on the general commercial framework while computing ‘Profits and Gains ofBusiness/Profession’. Following general commercial principles, losses of a capital naturewhich are incidental to the trade and arise expectedly in the regular course of businesswould be deductible, even though there may not be a specific provision in the act for suchdeductions. Examples of such losses are embezzlement of cash, theft of cash, robbery,destruction of assets, loss of stock in transit by fire or ravages of white ants or by enemyaction during war etc.

Further profits chargeable under the head ‘Profits and Gains of Business/Profession’ should be computed in accordance with the method of accounting regularlyemployed by the assessee – accrual basis or receipt basis or a mixture of the two.

1. The profit of a trade or business is the surplus by which the receipts from thetrade or business exceed the expenditure necessary for the purpose of earningthose receipts. The tax is upon income, profits or gains; it is not a tax on thegross receipts. From the charging provisions of the act, it is discernible that thewords ‘income’ or ‘profits and gains’ should be understood as including lossesalso, so that, in one sense ‘profits and gains’ represent ‘plus income’, whereaslosses represent ‘minus income’. In other words, loss is negative profit. Bothpositive and negative profits are of a revenue character. Both must enter intocomputation, wherever it becomes material, in the same mode of the taxableincome of the assessee.

2. The general rule of determining taxable business or professional income is that,from the gross income or gross receipts or gross sales, expenses incurred forearning that income will be allowed as a deduction. The balance of profitremaining after claiming all the allowable expenses as a deduction will be thetaxable income from the business.

3. Expenses will be allowed as a deduction from gross receipts only if they havebeen incurred in the relevant previous year. Expenses incurred before settingof the business will not be allowed except where specifically provided by law.

4. Typical steps for computation of income under this head can be listed asbelow :(a) Find out Profit as per the P & L A/c.(b) Deduct those expenses, which are not claimed but are allowable as

deductions under Sections 30 to 37.(c) Add those expenses that have been debited to the Profit & Loss A/c but

are not allowable as deduction u/s 40, 40A and 43B.(d) Deduct those incomes which have been credited to the Profit & Loss A/c

but which are not chargeable to income tax.



Notes (e) Add those incomes which have not been credited to the Profit & Loss A/cbut which are taxable as business income under Section 28 describedabove.

5. As stated above, Sections 30 to Section 37 deal with the various expenseswhich will be allowed as a deduction in getting the amount of taxable businessor professional income. These are explained in the paragraphs as follows.

Method of Accounting [Section 145]The profits from business and profession and income under the head ‘Income from

other sources’ are to be computed in accordance with the method of accounting regularlyemployed by the assessee. There are three methods of accounting, i.e., (i) mercantilesystem; (ii) cash system and (iii) mixed or hybrid system. However, as per Section 145 ofthe Income Tax Act, only one of the two methods of accounting can be followed:

(a) Mercantile system(b) Cash system.If the assessee is carrying on more than one business, he can follow the cash

system of accounting for one business and mercantile system of accounting for anotherbusiness. Similarly, if he has more than one source of income under the head from othersources, he can follow cash system of accounting for one source and mercantile systemof accounting for other sources.

Further, the profits from business and profession will have to be computed inaccordance with the accounting standards which may be prescribed by the CentralGovernment from time to time. The Central Government has since notified the followingtwo accounting standards to be followed by all assesses who are following mercantilesystem of accounting, w.e.f. 1-4-1996:

(A) Accounting Standard 1 relating to the disclosure of accounting policies.(B) Accounting Standard 2 relating to the disclosure of prior period and

extraordinary items and changes in accounting policies.

4.4.3 Deductions under Sections 30 to 37 (i)

Rent, Rates, Taxes, Repairs and Insurance for Building [Section 30]If the assessee is the owner of the premises and uses the premises for his business

purpose, no notional rent would be allowed under this section. He can claim only thefollowing expenses under this section:

– Local rates, municipal taxes, land revenue etc. However these are allowablesubject to provisions of Section 43B, i.e., if these expenses are claimed on duebasis, the payment of the same must be made on or before the due date offurnishing the return of income.

− Insurance premium covering the risk of the damage or destruction of premises.− Current repairs to the building [not including expenditure in the nature of capital

expenditure].If assessee is a tenant, he can claim rent paid under this section. Besides this, he

can claim all expenses which he has undertaken to bear, for e.g. – the cost of repairs [notincluding expenditure in the nature of capital expenditure], local rates, municipal taxes,land revenue, insurance, etc.

Important Points:1. Where assessee is a firm and business premises belonging to a partner of the

firm, the rent payable to the partner would be an allowable deduction. On the



Notesother hand, the income from such a building would be computed under thehead ‘Income from House Property’ in the hands of the partner.

2. If the assessee has taken the building on rent for business purpose and sub-leta part of it, in such a case the deduction allowable u/s 30 would be a sum equalto the difference between the rent paid by the assessee and the rent collectedfrom the sub-tenant.

3. If assessee occupies the premises otherwise than as tenant or owner, i.e., as alessee, licencee, mortgagee with possession then he is entitled to a deductionunder this section in respect of current repairs of the premises.

4. Where the premises are used partly for the business and partly for otherpurposes, only a proportionate part of the expenses attributable to the part ofthe premises used for the purposes of business will be allowed as a deduction(Section 38).

5. Where assessee pays ‘Salami’ in acquiring a lease of the business premises, itwill not be admissible as a charge because, it is a capital expenditure. Similarly,if the expenditure on repairs is of a capital nature, no allowances can be made.

6. Where the assessee has paid rent for residential accommodation for temporarystay of employees while on duty, the rent so paid and amount spent on repairs(if any) is deductible u/s 30.

Repairs and Insurance of Machinery, Plant and Furniture [Section 31]An assessee can claim the following deductions under this section:(a) Insurance Premium paid (or payable by the assessee under mercantile

system) deduction for insurance of machinery, plant or furniture is allowable u/s 31subject to the following conditions:

(i) The assets must be used by the assessee for the purpose of hisbusiness/profession during the accounting year.

(ii) Insurance must be against the risk of damage or destruction of the machinery,plant or furniture.

Premium may take the form of contribution to a trade association which mayundertake to indemnify and insure its members against loss; such premium orcontribution would be deduction as an allowance under this section even if a part of it isreturnable to the insured in certain events.

(b) Repairs to Plant and Machinery are allowable subject to the followingconditions:

(i) Plant, machinery, furniture must have been used by the assessee for thepurpose of his own business or profession. This deduction is available even ifthe assessee is not the owner. What is essential is that the assets must havebeen used by the assessee in his own business during the previous yearthough not continuously, i.e., even if an asset is used for a part of theaccounting year, the assessee is entitled to the deduction of the full amount ofexpenses on repairs and insurance charges and not merely an amountproportionate to the period of this use.

(ii) Under this section only current repairs are deductible. Current repairs refer tothe expenditure incurred with a view to preserve and maintain an existing assetand not with a view to bringing a new asset into existence or obtaining any newor fresh advantage. The term ‘repairs’ under this section does not mean pettyrepairs. It includes renewal or renovation of an asset but not replacement orreconstruction. Following points are noteworthy in this connection:



Notes – This section is applicable to current repairs but not arrears of repairs for earlieryears [though arrears of repairs are deductible u/s 37(1)].

– This section is not applicable to cost of replacing or reconstruction.

Depreciation [Section 32]Depreciation is the diminution in the value of an asset due to normal wear and tear

and due to efflux of time or obsolescence.Deduction under this section is allowable subject to the following conditions:1. The following are the three kinds of depreciation allowances that are

allowed under the Income Tax Act:(i) Normal depreciation for block of assets [Section 32(1)(ii)];(ii) Additional/extra depreciation in case of any eligible new machinery or

plant (other than ship or aircraft) which has been acquired and installedafter 31-3-2005 by an assessee engaged in the business of manufactureor production of any article or things [Section 32(1)(iia)];

(iii) Normal asset-wise depreciation for an undertaking engaged in generationor generation and distribution of power [Section 32(1)(i)].

2. The depreciation is allowed on specified assets as given below:(a) Buildings, machinery, plant and furniture being tangible assets; and(b) Know-how patents, copyrights, trademarks, licenses, franchises or any

other business or commercial rights of similar nature being intangibleassets acquired after 1-4-1998.

Depreciation is not allowed in the following cases:(a) In respect of any machinery or plant if the actual cost thereof is allowed as a

deduction in one or more years under an agreement entered into by the CentralGovernment under Section 42 (this section relates to deduction in case ofbusiness for prospecting for mineral oil).

(b) No depreciation on an imported car acquired after 28-2-1975 but before1-4-2001 unless used for a specified purpose.

Building refers only to the superstructure but not the land on which it has beenerected. Obviously, depreciation cannot be claimed on the cost of the land. Buildingincludes roads, bridges, culverts, wells and tube-wells.

Plant as defined by Section 43(3) included ships, vehicles, scientific apparatus,surgical equipments, books (including technical know-how reports) used for the purposeof business or profession but does not include tea bushes or livestock or buildings orfurniture and fittings.

On the basis of cases decided by the courts, the following are also included underthe term ‘Plant’:

(a) In the case of a hotel, pipe and sanitary fittings [CIT v. Taj Mahal Hotel (SC)].(b) In the case of an electric supply company; mains, service lines and switch

gears.(c) In the case of manufacture of oxygen, gas-cylinder for storing gas.(d) Technical know-how (Scientific Engineering House (P) Ltd. v. CIT).(e) Drawings, designs, plans, processing data, books [Scientific Engineering

House (P) Ltd. v. C.I.T. (SC)].(f) Drawings and patterns acquired from a foreign collaborator [CIT v. Elecon

Engineering Co. Ltd. (SC)]



Notes(g) Safe deposit vaults in banks [CIT v. Union Bank of India].(h) Air-conditioning equipments, air-conditioners and plants installed in the office

premises.(i) Fencing around a refinery.(j) Any installation facilitating production is a ‘plant’. Internal telephone system

constitutes a ‘plant’. However, plant does not include a harbour bed, humanbody or stock-in-trade.

Books: Each book by itself constitutes a ‘plant’. Where a book runs into more thanone volume all the volumes taken together constituted a book. Periodicals are alsotreated as books, but in their case if they are arranged in parts of a volume and eachvolume is given a specific number, each volume is treated as a separate book, for e.g.,I.T.R. which is published weekly is divided into parts of a volume in a year. Here, theissues of one year will be treated as six books or six plants (as per CBDT Instructions).

3. Assessee must be the owner of the assets: In case of the buildings, theassessee must own the super structure and not necessarily land. It is importantto note that, depreciation would also be allowable to the owner in respect ofassets which are actually worked/utilised by another person, for e.g., lessee orlicensee; therefore, if the assessee has let out on hire his building, machinery,plant or furniture and letting out of such asset is his business, he can claimdepreciation u/s 32. In other cases, where the letting out of such asset does notconstitute the business of the assessee, the deduction on account ofdepreciation can be claimed u/s 57(ii).

Exception to the general rule that the assessee must be the owner:(a) If the assessee carries the business in a rented or leasehold premises and

if he incurs any capital expenditure for the purpose of the business orprofession, on construction of any structure or renovation or improvementto the building then he can claim depreciation on such capital expenditureas if the structure/work is a building owned by him [Explanation I to Section32(i)(i)].

(b) Depreciation is allowed on the machinery acquired on hire purchaseagreement as if the assessee is the owner of such an asset.

4. Assets must be used for business/profession carried on by the assesseeduring the relevant previous year: If the asset is partly used for the business orprofession and partly used for some personal purpose, cost of the assetattributable to the business use, shall be taken as a base for computation ofdepreciation.

5. Depreciation on actual cost or written down value: In the case of any blockof asset, the depreciation is allowable at a prescribed percentage of writtendown value of the block as defined in Section 43(6) as on the last day of theprevious year. Due to the block concept, the actual cost of the asset broughtinto use during the year will be added to the existing block, if any. However, incase of power generating undertakings, it may be claimed at a certainpercentage of the actual cost.

6. 50% depreciation only: If the asset is acquired during the year and used forthe period of less than 180 days, depreciation shall be allowed to the extent of50%.

7. No depreciation is allowed on land.8. No deduction under this section is allowable if:

1. The assessee is not the owner.



Notes 2. The assessee is not the user.3. The asset is sold during the year.4. The asset is an imported car which is purchased after 28/2/75 but before

1/4/2001. However, if such an imported motorcar is used in a business ofrunning it on hire for tourists, the depreciation is allowable. Also if theimported motorcar is used outside India in the business carried on by theassessee in another country, depreciation will be allowed on the same.

5. The asset is used for scientific research.6. The asset is used for exploration of mineral oil u/s 42.

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

of −(a) Tangible assets being buildings, machinery, plant or furniture;(b) Intangible assets being know-how, patents, copyrights, trademarks, licenses;

in respect of which the same percentage of depreciation is prescribed.

Class of Assets:Assets eligible for depreciation have been classified into five classes, i.e.:(a) Building;(b) Furniture;(c) Plant and machinery;(d) Ships;(e) Intangible assets of the type discussed above.Each class of assets other than intangible assets may have different blocks or

groups on which separate rates of depreciation are prescribed and for each such rate, aseparate block will be formed.

In the case of intangible assets there will be one block as only one rate, i.e., 25%has been prescribed for all such intangible assets.

Table 4.4: Blocks Formed on the Basis of the Class of Assets andtheir Rates of Depreciation

BuildingsBlock 1

Block 2

Block 3

Buildings which are used for residential purposes except hotels and boardinghouses.Buildings other than those used mainly for residential purposes and notcovered by Blocks 1 and 3.(i) Purely temporary erections such as wooden structure.(ii) Buildings acquired on or after September 1, 2002 for installing machinery

and plant forming part of water supply project or water treatment systemand which is put to use for the purpose of business of providinginfrastructure facilities under Section 80-1A(4)(i).

5%

10%

100%

Furniture and FittingsBlock 4 Furniture and fittings including electrical fitting. 10%

Machinery and PlantBlock 5 Plant and machinery—Any plant or machinery [not covered by block 6,

7,8,9,10,11 or 12], motor cars (other than those used in a business of runningthem on hire) acquired or put to use on or after April1, 1990. 15%



NotesBlock 6 Plant and machinery-ocean-going ships, vessels ordinarily operating oninland waters and including speed boats.

Block7 Plant and machinery(i) Motor buses, motor Lorries and motor taxis used in a business of

running them on hire(ii) Moulds used in rubber and plastic goods factories(iii) Machinery and plant, used in semi-conductor industry(iv) Life saving medical equipment

30%

Block 8 Plant and machinery(i) Aeroplanes – Aero Engines(ii) Specified life saving medical equipment(iii) New Commercial vehicles acquired after 30-9-1998 but before

1-4-1999 and put to use before 1-4-1999(iv) Plant and machinery which satisfy conditions of rule 5(2)

40%

Block 9 Plant and machinery(i) New Commercial vehicles acquired during 2001-02 and put to use

before 31-3-2002 for the purpose of business or profession.(ii) Machinery/plant used in weaving, processing and garment sector of

textile industry which is purchased under Technology Upgradation FundScheme during April 1, 2001 and March 31, 2004 and put to use up toMarch 31, 2004; and

(iii) New Commercial vehicles acquired after 1-1-2009 andSeptember 30, 2009 1-4-1999 and put to use before October 1, 2009 forthe purpose of business or profession.

50%

Block 10 Plant and machinery(i) Computers including computer software.

(ii) Books (other than books, (a) being annual publications or (b) booksowned by assessees carrying on business in running lending libraries).

(iii) New Commercial vehicles acquired in replacement of condemnedvehicle of 15 years of age which is put to use before April 1, 1999(if acquired during October 1, 1998 and March 31, 1999) or beforeApril1, 2000 (if acquired during 1999-2000) and used for the purpose ofbusiness or profession.

(iv) Gas-cylinders; plant used in field operations by mineral oil concerns;direct fire glass melting furnaces.

60%

Block 11 Plant and machineryRollers used in flour mills, rolling mill rolls used in iron and steel industry,rollers used in sugar works.

80%

Block 12 Plant and machinery(i) Machinery and plant acquired and installed on or after 1-9-2002 in a

water supply project or a water treatment system and which is put touse for the purpose of business of providing infrastructure facility undersection 80-1A(4)(i).

(ii) Wooden parts used in artificial silk manufacturing machinery.(iii) Cinematograph films-bulbs of studio lights.(iv) Match factories (wooden match frames).(v) Tubs, winding ropes, haulage ropes and sand stowing pipes and safety

lamps used in mines and quarries.(vi) Salt works – Saltpans, reservoirs and condensers, etc. made of earthy,

sandy or clayey material or any other similar material.

100%



Notes (vii) Books owned by the assessees carrying on a profession, being annualpublications.

(viii) Books owned by the assessees carrying on business in running lendinglibraries.

(ix) Air pollution control equipment, water pollution control equipment, solidwaste control equipments, solid waste recycling and resource recoverysystems.

Block 13 Intangible assets (acquired after March 31,1998) Know-how, patents,copyrights, trademarks, licenses, franchises or any other business orcommercial rights of a similar nature.

25%

Block 14 (i) Ocean going ships including dredgers, tugs, barges, survey launchesand other ships used mainly for dredging purposes and wishing vesselswith wooden hull

(ii) Vessels ordinarily operating on inland waters,not covered by sub-item(c) below

(iii) Vessels ordinarily operating on inland waters being speed boats

20%

Meaning of certain terms relevant for the computation of depreciation:1. Block of Assets: The term ‘block of assets’ has been defined under Section

2(11) to mean a group of assets falling within a class of assets, being buildings,machinery, plant or furniture in respect of which the same percentage ofdepreciation is prescribed. Thus, under each of the five types of assets (viz.,buildings, furniture and fittings, plant and machinery, ships and intangibleassets) several blocks of assets shall be formed on the basis of percentage ofdepreciation.

2. Written Down Value for charging depreciation Section 43(6): Written downvalue of a block of assets for the purpose of charging depreciation of thecurrent year means:

(i) In the case of assets acquired before the previous year, the actual cost to theassessee of all the assets falling within the block minus all the depreciationactually allowed to him;

(ii) In the case of assets acquired in the previous year, the actual cost to theassessee.However, if any asset of the block is sold during the year, the written downvalue of a block of assets shall be computed in the following steps:

Step 1 - Aggregate of WDV of the block of assets at the beginning of the year.Step 2 - Actual cost of any asset falling within the block acquired during the year.Step 3 - From Step 1 + Step 2, deduct the money received/receivable in respect of

that asset (falling within a block of assets) which is sold, discarded, demolished ordestroyed during the year.The resulting amount is the WDV of the block of assets at the end of the year.

WDV in case of Slump Sale:Step 1 – Find out the depreciated value of the block on the first day of the previous year.Step 2 – To this add, the actual cost of the asset acquired during the previous year.Step 3 – From the resultant figure, deduct money received/receivable (together with

scrap value) in respect of that asset (falling within the block of assets) which issold, discarded, demolished or destroyed during the previous year.



NotesStep 4 − In the case of a slump sale deduct the actual cost of the asset falling within thatblock as reduced:

(i) By the amount of depreciation actually allowed to him in respect of anyprevious year relevant to the A.Y.s, and

(ii) By the amount of depreciation that would have been allowable to the assesseefor the AY onwards as if that asset was the only asset in the relevant block ofassets.So, however, that the amount of such decrease does not exceed the writtendown value (i.e., the amount computed as per Step I + Step II - Step III).

Step 5 – The resultant figure, i.e., Step1 + Step II – Step III – Step IV shall be the WDVfor the purpose of charging the current year depreciation of the block left withthe assessee after the slump sale.

Illustration: Compute the WDV from the following information for the A.Y. 2011-12.Plant A, B and C 15% WDV as on 1.4.2010 ` 10, 40,000Plant H 15% Purchased on 11.5.2010 ` 18,000Plant B (Sold on Dec. 20, 2010) for ` 25,10,900

Solution:Plant and Machinery (rate of depreciation 15%)Opening WDV as on 1.4.2010 10,40,000Add: Plant H `18,000Total 10,58,000Less: Sale proceeds of Plant B (although sale proceedsof plant B is more than ` 10,58,000, amount to bededucted is restricted to ` 10,58,000) ` 10,58,000WDV as on 31.3.2011 NIL

Notional Written Down Value:(i) Succession in business or profession: When in the case of succession, the

assessment is to be made on the successor, depreciation is to be calculatedtaking the WDV of the block of assets as if there had been no change in theownership at all.

(ii) Transfer between the holding and the subsidiary company: Where anyblock of assets is transferred by a holding company to its wholly ownedsubsidiary company or vice versa (transferee company being an IndianCompany), then the actual cost of the block of assets in the case of transfereecompany shall be WDV of the block of assets of the transferor company forthe immediately preceding previous year as reduced by the depreciationactually allowed in relation to the said previous year.

(iii) Transfer in a scheme of amalgamation: In such a case, the actual cost of theblock of assets in the case of an amalgamated company shall be the WDV ofthe block of assets as in the case of the amalgamating company for theimmediately preceding previous year as reduced by the amount of depreciationactually allowed in relation to the said previous year.

(iv) WDV when assets are transferred in demerger: In such a case, the WDV ofthe block of assets of the demerged company for the immediately precedingyear shall be reduced by the WDV of assets transferred to the resultingcompany in order to get WDV in the hands of the demerged company.



Notes (v) WDV in the hands of the resulting company: In such a case, the WDV of theone block of assets in case of the resulting company shall be the WDV of thetransferred assets appearing in the books of account of the demergedcompany immediately before the de-merger.

(vi) WDV in case of corporatisation of a recognised stock exchange in India(applicable from 2002-03): Where in the previous year any asset forming partof a block of assets is transferred by a recognised stock exchange in India to acompany under a scheme for corporatisation, the WDV of the block of assets inthe case of such a company shall be the WDV of the transferred assetsimmediately before such a transfer.

(3) Actual Cost [Section 43(1)]: Actual cost means the actual cost of the assets tothe assessee, reduced by the portion of the cost of the asset, if any, as has been metdirectly or indirectly by any other person or authority.

The actual cost of the assets would include all the expenses incurred in theacquisition of the asset, like expenses on freight for bringing the asset, travellingexpenses of the staff engaged in purchasing the asset, installation expenses of the assetetc.; the provisions regarding the treatment of interest, travelling expenses, etc. for thepurchase/construction of the asset have been discussed separately.

If any part of the cost of the asset is met by any other person or authority then thecost is to be reduced to that extent, for e.g., X purchases a generator set for ` 2,00,000and receives a subsidy of 25% from the State Government. The cost of the asset to Xwould be taken at ` 1,50,000.

Notional Actual Cost [Explanations to Section 43 (1)]: In the following cases, theactual cost for purposes of depreciation shall be a notional cost to the assessee.

(i) Assets used for scientific research [Explanation 1]: When an asset is usedin the business after it ceases to be used for scientific research, the actual costof the asset to the assessee will be the actual cost as reduced by the amount ofany deduction allowed u/s 35, on account of expenditure on scientific research,i.e., it will be nil because the entire cost is written off u/s 35.

(ii) Assets acquired by way of gift or inheritance [Explanation 2]: Where anasset is acquired by the assessee by way of gift or inheritance, the actual costof the asset to the assessee shall be the actual cost to the previous owner asreduced by:

(a) The amount of depreciation actually allowed on the asset in respect of anyprevious year relevant to the assessment year commencing before April 1,1988, i.e., depreciation actually allowed up to assessment year 1987-88;and

(b) The amount of depreciation that would have been allowable to theassessee for any assessment year commencing on or after April 1, 1988as if the asset was the only asset in the relevant block of assets.

(iii) Assets transferred to reduce the tax liability [Explanation 3]: Where, beforethe date of acquisition by the assessee, the assets were at any time used by any otherperson for the purposes of business or profession and the Assessing Officer is satisfiedthat the main purpose of the transfer of such assets, directly or indirectly to the assessee,was the reduction of a tax liability (by claiming excess depreciation with reference to anenhanced cost), the actual cost to the assessee shall be such an amount as isdetermined by the assessing officer, with the previous approval of the JointCommissioner.



NotesExample: An asset which has been used by R for several years was transferred toG, his brother for ` 3,00,000 although the market value at the time of the transfer was` 1,20,000. In this case, the Assessing Officer is entitled to estimate the actual cost of theasset at ` 1,20,000 if he is satisfied the main purpose of the transfer was the reduction oftax liability of G. However, in this case, he has to take prior approval of the JointCommissioner. However, R will have to pay Capital Gain Tax on such a transfer andconsideration price for this transfer shall remain at ` 3,00,000.

(iv) Assets which are reacquired by the assessee [Explanation 4]: Where anasset which had once belonged to the assessee and had been used by him for thepurpose of his business or profession and thereafter, ceased to be his property by reasonof transfer or otherwise, is reacquired by him, the actual cost to the assessee shall be:

(a) The actual cost to him when he first acquired the asset as reduced by:(i) The amount of depreciation actually allowed to him in respect of any

previous year relevant to the assessment year commencing before April 1,1988, and

(ii) The amount of depreciation that would have been allowable to theassessee for any assessment year commencing on or after the first day ofApril 1988, as if the asset was the only asset in the relevant block ofassets (in other words, WDV at the time when the asset is sold,considering it to be the only asset in the block).

OR(b) The actual price for which the asset is reacquired by him, whichever is less.(v) Sale and lease back transactions [Explanation 4A]: Where before the date

of acquisition by the assessee (hereinafter referred to as the first mentioned person), theassets were at any time used by any other person for the purpose of his business orprofession and depreciation allowance has been claimed in respect of such assets, in thecase of the second mentioned person and such person acquired on lease, hire orotherwise assets from the first mentioned person, then notwithstanding anythingcontained in Explanation 3, the actual cost of the transferred assets, in the case of firstmentioned person (who is the legal owner), shall be the same as the written down valueof the said assets at the time of transfer thereof by the second mentioned person w.e.f.01.10.1996.

Example: R has been using an asset for his business and its written down value ason 1.4.2013 was ` 2,00,000. He sold this asset to G for ` 4,00,000 and G leased backthis asset to ‘R’, i.e., R reacquires that asset from G by way of lease, hire or otherwise. Inthis case, the cost of this asset to ‘G’ (who is the legal owner) for the purpose of chargingdepreciation shall be ` 2,00,000, i.e., the written down value of this asset at the time oftransfer by R to G and not ` 4,00,000 for which he acquired the asset.

1. If Explanation 4A is applicable then Explanation 3 shall not be applicable. However,where Explanation 4A is not applicable, Explanation 3 shall be applicable, for e.g., ifthe asset acquired by G from R is not leased back to R, Explanation 4A shall not beapplicable but Explanation 3 shall be applicable, i.e., in this case, the actual cost shallbe an amount as determined by the Assessing Officer.

2. It is clarified that if there are one or more intermediate sale between the point of firstsale and its reacquisition by the assessee by way of lease/hire or otherwise, then theactual cost shall be WDV at the time of first sale. Even if the asset forms part of ablock of assets, the individual written down value has to be worked out separately togive effect to this provision.



Notes (vi) Building brought into use for business purposes subsequent to itsacquisition [Explanation 5]: Where a building previously owned by the assessee isbrought into use for the purpose of the business or profession, the actual cost to theassessee shall be the actual cost of the building to the assessee, as reduced by anamount equal to the depreciation calculated at the rate in force on that date which wouldhave been allowable had the building been used for the purpose of the business sincethe date of its acquisition.

Illustration: R purchased a building for ` 500,000 on1.12.2011 which was used byhim as a dwelling place w.e.f. 5-2-2014 he uses his building as an office of his profession,the actual cost to R for the purpose of charging depreciation in the previous year2013-2014 shall be computed as under:

Actual cost of building on 1.12.2011Depreciation for previous year2011-12@5% of 5,00,000WDV as on 1.4.2012Less: Depreciation for previous year 2012-13 @ 10%

` 5,00,00025,000

4,75,00047,500

4,27,500

Actual cost to R for the purpose of charging depreciation ` 4,27,500.(vii) Assets transferred by a holding company to its subsidiary company

[Explanation 6]: Where an asset is transferred by a holding company to its 100%subsidiary company or vice versa, then, if the transferee company is an Indian company,the actual cost of the transferred capital asset to the transferee company shall be thesame as it would have been if the transferor company had continued to hold the capitalasset for the purpose of its business.

Illustration: R Ltd., a holding company, transfers two assets to its 100% subsidiarycompany G Ltd. for ` 3, 00,000 although the written down value to the holding companyat the beginning of the year was ` 1,40,000. In this case, the actual cost to G Ltd. shall be` 1,40,000 (being the written down value to the holding company). If the assets aretransferred for ` 1,00,000, the actual cost to G Ltd. shall remain as ` 1,40,000.

(viii) Assets transferred under a scheme of amalgamation [Explanation 7]:Where, in a scheme of amalgamation, any capital asset is transferred by theamalgamating company to the amalgamated company and the amalgamated company isan Indian company, the actual cost of the transferred capital asset to the amalgamatedcompany shall be taken to be the same as it would have been if the amalgamatingcompany had continued to hold the capital asset for the purposes of its business.

(ix) Actual cost in case of demerger [Explanation 7A] has been inserted toprovide that, in case of demerger, the actual cost of the transferred capital asset to theresulting company shall be taken to be the same as it would have been if the demergedcompany has continued to hold the capital asset for the purpose of its own business.

(x) Interest [Explanation 8]: Any amount paid or payable as interest in connectionwith the acquisition of an asset and relatable to a period after the asset is first put to usewill not form part of the actual cost of the asset.

(xi) Actual cost of Cenvatable goods [Explanation 9]: Where an asset is or hasbeen acquired on or after 1.3.1994 by an assessee, the actual cost of the asset shall bereduced by the amount of duty of excise or additional customs duty (also known ascountervailing duty) leviable under Section 3 of the Customs Tariff Act, 1975 in respect ofwhich a claim of credit has been made and allowed under the Central Excise Rules, 1944.In other words, if the assessee has taken Modvat Credit (Cenvat Credit now) of CentralExcise or countervailing duty of Customs paid on such purchase of the asset under the



NotesCentral Excise Rules, the actual cost of the asset shall be reduced by the amount of sucha Cenvat Credit.

Example: If an assessee has purchased a machine whose sale price (withoutexcise duty) was ` 1,00,000 and was charged 10.3% central excise duty and 2% CST.The actual cost of the asset in this case was, 1,00,000 + 10,300 + 2206 (2% CST on` 1,10,300) = 1,12,506 but if he takes Cenvat credit of excise of ` 10,300 on capitalgoods purchased by him, then the actual cost for the purpose of depreciation shall be` 1,12,506-10,300 (Cenvat credit taken) = ` 1,02,206.

(xii) Actual cost of Subsidised assets [Explanation 10]: Where a portion of thecost of an asset acquired by the assessee has been met directly or indirectly by theCentral or State Government or any authority established under any law or by any otherperson, in the form of subsidy or grant or reimbursement, then in a case where thesubsidy is directly relatable to the asset, such subsidy shall not be included in the actualcost of the asset. In a case where such subsidy or grant or reimbursement is of such anature that it cannot be directly relatable to any particular asset, the amount so receivedshall be apportioned in a manner that such asset bears to all the assets in respect of orwith reference to which the subsidy or grant or reimbursement is so received and suchsubsidy shall not be included in the actual cost of the asset.

(xiii) Asset acquired by non-resident outside India [Explanation 11]: The actualcost of the asset which was acquired by a non-resident outside India and is brought byhim to India and used for the purpose of his business and profession shall be the actualcost to the assessee minus the depreciation that would have been allowed, had the assetbeen used in India from the date of acquisition.

(xiv) Transfer in the case of Corporatisation of a Recognised Stock Exchange[Explanation 12]: Where any capital asset is acquired by the assessee under a schemeof corporatisation of recognised stock exchange in India the actual cost of the asset shallbe deemed to be the amount which would have been regarded as actual cost had therebeen no such corporatisation.

(4) Additional Depreciation on new machinery or plant [Section 32(iia)]: With aview to give boost to the manufacturing sector, an additional depreciation shall beallowed to an industrial undertaking subject to the provisions given below. Suchadditional depreciation shall be in addition to the normal depreciation which is beingallowed to all assesses.

(A) Who can claim additional depreciation: An assessee engaged in thebusiness of manufacture or production of any article or thing can claim additionaldepreciation.

(B) Asset which qualifies for additional depreciation: Any plant and machinery,other than ships and aircrafts, which has been acquired or installed after March 31, 2005by an assessee is qualified for additional depreciation.

(C) Assets which are expressly not eligible for additional depreciation:(i) Plant and Machinery, which before its installation by the assessee was used

either within or outside India by any other person.(ii) Plant and Machinery which is installed in any office premises or residential

accommodation, including guesthouse.(iii) Office appliances or road transport vehicles.(iv) Plant and Machinery, whole of the actual cost of which is allowed as a

deduction (whether by way of depreciation or otherwise), in computing theincome chargeable under the head ‘Profits and Gains of Business/Profession’of any one previous year.



Notes (D) Rate of Additional Depreciation:(i) If the asset is put to use for less than 180 days

in the year in which it is acquired 10% of actual cost(ii) In any other case 20% of actual cost(E) Year in which additional depreciation is available: In case of a new industrial

undertaking, additional depreciation is available during the previous year in which itbegins to manufacture or produce any article on or after 31.3.2005.

(F) Certificate from a Chartered Accountant: Additional depreciation will not beavailable unless the assessee furnished details of machinery and plant and increase ininstalled capacity in a prescribed form along with the return of income and a report of aChartered Accountant certifying that the deduction has been correctly claimed.

Unabsorbed Depreciation [Section 32(2)]:Step 1: Depreciation allowance of the previous year is first deductible from income

under the head ‘Profits and Gains of Business/Profession’.Step 2: If the depreciation allowance is not fully deductible under the head ‘Profit

and Gain of Business/Profession’ because of the absence or inadequacy of profits, it isdeductible from the income chargeable under another head of income for the same A.Y.

Step 3: If the depreciation allowance is still unabsorbed it can be carried forward tothe subsequent Assessment Year by the same assessee (no time limit is fixed for carryforward).

Note: In the subsequent years, unabsorbed depreciation can be set off against anyincome whether chargeable under the head ‘Profits and Gains of Business/Profession.Under any other head in the following priority minus the current depreciation, B/f ofbusiness loss, unabsorbed depreciation. (2) Continuity of business is not relevant for setoff and carry forward.

Depreciation on Straight-line basis in the case of Power Units: An undertakingengaged in generation or generation and distribution of power can claim depreciation (inrespect of assets acquired after March 31, 1997) according to nay one of the followingmethods−

Straight-line basis: Depreciation can be claimed according to straight line basis inthe case of tangible assets at the percentage specified in Appendix IA to the Income-taxRules on the actual cost of the individual asset. The aggregate depreciation cannotexceed the ‘actual cost’.

Written down basis: Alternatively such undertaking can claim depreciation at itsoption according to written down value method like any other assessee. The option forthis purpose shall be exercised before the due date of furnishing return of income. Oncethe option is exercised, it shall be final and shall apply to all the subsequent years.

Terminal Depreciation (i.e., Loss on transfer) or Balancing charge (in the caseof gain) in the case of power units: When a depreciable asset (on which depreciationis claimed on Straight line basis) of a power generating unit is sold, discarded,demolished or destroyed in a previous year, then terminal depreciation (in case of loss) isdeductible on balancing charge (in case of gain) is taxable.

Terminal depreciation is calculated as follows−Step one: Find out the written down value of the depreciable asset on the first day

of the previous year in which such asset is sold, discarded, demolished or destroyed.Step two: Find out the actual money (received or receivable in cash or by cheque or

draft) and it does not include nay other thing or benefit which can be converted in termsof money



NotesIf the amount calculated under Step two is less than the amount of Step one, thenthe deficiency is deductible as terminal depreciation. The following points should benoted−

1. When the asset is sold, discarded, etc. in the previous year in which it is firstput to use, any loss arising there from is not allowed as terminal depreciationbut it is treated as capital loss.

2. Terminal depreciation allowance cannot be claimed if the asset is not used forthe purpose of business or profession of the assessee at least for sometimeduring the previous year in which the sale takes place.

3. Terminal depreciation is allowed only if it is actually written off in the books ofthe assessee.

Balancing charge under section 41(2) and capital gain under section 50A. If theamount calculated under Step two is more than the amount of Step 1, the tax treatmentof such surplus is as follows:

1. So much of the surplus which is equal to the amount of depreciation alreadyclaimed, is taxable as balancing charge under section 41(2) as businessincome.

2. The remaining surplus (if any) is taxable according to the provisions of section45 under the head “Capital Gains”.

Other points: The following points should be noted−1. Where an asset is sold, discarded etc. in the previous year in which it is first put

to use, any profit arising there from will not be chargeable to tax as balancingcharge but will be treated as capital gains and chargeable to tax under section45 under the head “Capital Gains”.

2. Balancing charge is taxable under section 41(2) in the previous year in whichsale price, insurance, salvage or compensation money becoming due (whetherthe business is in existence in that year or not). In case of compulsoryacquisition, it is taxable in the year of receipt of additional compensation.

Tea Development Account, Coffee Development Account and RubberDevelopment Account [Section 33 AB]

An assessee carrying on business of growing and manufacturing tea or coffee inIndia is entitled for deduction to the extent of least of the following:

(a) amount deposited in special A/c with NABARD maintained by the assesseewith that bank in accordance with and for the purpose specified in a schemeapproved in this behalf by the Tea Board or the Coffee Board or the RubberBoard within a period of 6 months from the end of the previous year or beforedue date of furnishing return of income, whichever is earlier.

(b) 40% of profits of such business as computed before making deduction u/s33AB and before adjusting brought forward business loss u/s 72.

How to compute profits from such business?: If separate accounts are notmaintained in respect of business of growing and manufacturing tea or coffee or rubber inIndia, it shall be profits from such business before claiming deduction under this section.In case separate accounts are not maintained it will be calculated as under:

usinessbsassessee' theofturnoverTotalbercoffee/rubteaingmanufacturandgrowingofbusinessofturnoverTotal

businesstheofProfits



Notes 1. For claiming deduction u/s 33AB, assessee must get accounts audited by aChartered Accountant and furnish the report of such audit in prescribed formalong with his return of income.

2. The amount standing to the credit of special account with NABARD is to beutilized as per the specified scheme of Tea Board.In no case, it shall be utilized for the purpose of the following:(a) Any machinery/Plant installed in any office premises/residential

accommodation including guest house.(b) Any office appliances (other than computer).(c) Any machinery or plant entitled for 100% write off by way of depreciation

or otherwise.(d) Any new machinery or plant installed for production of any low priority

item specified in the Eleventh Schedule.3. Deduction allowed under this provision will be withdrawn if the asset acquired

in accordance with the scheme, is sold or otherwise transferred within 8 yearsfrom the end of the previous year in which it was acquired. However, it shall notbe withdrawn in the following cases:− Transfer to Government, Local Authority or Statutory Corporation or

Government Co.− In case of Sale of business by partnership firm to a company, if Company

has taken over all assets and liabilities of the firm and all the shareholdersof the company were partners of the firm before such sale.

4. Assessee is however, allowed to withdraw any amount standing to his credit inspecial account with NABARD in the following circumstances:(a) Closure of business(b) Dissolution of firm(c) Death of an assessee(d) Partition of a HUF(e) Dissolution of a Company

Where the withdrawal is made in the circumstances stated above in (a) and (b), theamount withdrawn such business shall be taxable as business profit of that Previous year,as if the business had not been closed or the firm had not been dissolved.

Site Restoration Fund [Section 33ABA]This section has been inserted to allow deduction to an assessee who is carrying on

business consisting of the prospecting for or extraction or production of petroleum ornatural gases or both in India.

Essential conditions:1. This deduction will be allowed to any assessee who is carrying on business

consisting of prospecting for or extraction or production of petroleum or naturalgas or both in India and in relation to which the Central Government hasentered into an agreement with such assessee for such business.

2. The assessee has before the end of the previous year−(a) Deposited with the State Bank of India any amount(s) in a special account

maintained by the assessee with that bank, in accordance with and for thepurposes specified in, a scheme approved in this behalf by the Ministry ofPetroleum and Natural Gas of the Government of India; or



Notes(b) Deposited any amount in the Site restoration Account opened by theassessee in accordance with, and for the purpose specified in a schemeframed by the aforesaid Ministry. This scheme is known as DepositScheme.

3. The assessee must get its accounts audited by a Chartered Accountant andfurnish the report in the prescribed form (Form No. 3AD) along with the return ofincome. In a case where the assessee is required by or any other law to get itsaccounts audited, it shall be sufficient compliance if such assessee gets theaccount of such business audited under such law and furnishes the report ofthe audit as required under such other law and a further report in the formprescribed.Profits from business in this case is to be calculated in the same manner as is

mentioned in section 33AB.Quantum of deduction: Quantum of deduction shall be–(a) The amount deposited in the scheme referred to above; or(b) 20% of the profit of such business computed under the head “profits and gains

of business or profession”, whichever is less.The profits are to be computed before making any deduction under this section, i.e.,

Section 33ABA and before making adjustment for brought forward losses under Section72.

Restriction on utilization of the amount deposited: The amount standing to thecredit of the assessee, in the Special Account of State Bank of India or the SiteRestoration Account, is to be utilized for the business of the assessee in accordance withthe scheme specified. However, no deduction shall be allowed in respect of any amountutilized for the purchase of−

(a) Any machinery or plant to be installed in any office premises or residentialaccommodation, including any accommodation in the nature of a guest house;

(b) Any office appliances (not being computers);(c) Any machinery or plant, the whole of the actual cost of which is allowed as a

deduction (whether by way of depreciation or otherwise) in computing theincome chargeable under the head “Profits and gains of business orprofession” of any one previous year;

(d) Any new machinery or plant to be installed in an industrial undertaking forpurposes of business of construction, manufacture or production of any articleor thing specified in the list in the Eleventh Schedule.

Consequence if new asset is transferred within 8 years: Same as in Section33AB.

Withdrawal of deposits: Any amount deposited in the special account maintainedwith State Bank of India or the Site Restoration Account shall not be allowed to bewithdrawn, except for the purposes specified in the scheme, or as the case may be, inthe deposit scheme.

Where any amount standing to the credit of the assessee in the special accountor in the Site Restoration Account is utilized by the assessee for the purpose of anyexpenditure in connection with such business not in accordance with the scheme orthe deposit scheme, such expenditure shall not be allowed in computing the incomechargeable under the head Profit and gains of business or profession, i.e., DoubleDeduction is not possible.



Notes Expenditure on Scientific Research [Section 35]The expression scientific research means, “activities for the extension of knowledge

in the fields of natural or applied science including agriculture, animal husbandry orfishery.”

Besides scientific research, donation for research in social sciences like humanbehaviour and marketing research work are also covered under this section.

Scientific research may be carried on:(a) by the assessee, relating to his business; or(b) by making payment to outside agencies engaged in scientific research work.(A) Where the assessee carries Scientific Research relating to his business:1. Before the commencement of business: If the assessee incurs any

expenditure within three years immediately preceding the commencement ofhis business, on:− Payment of salary to research personnel engaged in scientific research,

and− Material inputs for such scientific research.

Such expenditure will be allowed as deduction in the year in which thebusiness is commenced. The deduction will be limited to the amount certifiedby the prescribed authority. Similarly, Capital Expenditure (except, Acquisitionof Land after 29/4/84) incurred during three years immediately preceding thedate of commencement of the business shall be deemed to be the expenses ofthe previous year of the commencement of the business and allowed in thatyear.

2. After commencement of the business: Any revenue as well as capitalexpenditure, except for Acquisition of Land after 29.4.84, on scientific researchrelating to his business is deductible in full.

Important Points:1. Carry forward of unabsorbed capital expenditure: Capital expenditure on

scientific research, which cannot be absorbed on account of insufficiency ofprofits in any accounting year, can be carried forward for an indefinite periodand can be set off against income under the head ‘Profits and Gains ofBusiness/Profession’ and under any other head.

2. Use of the asset for some other purposes: If the capital asset used forscientific research purposes is used in the business for some other purposes,no further depreciation can be allowed u/s 32.

3. Sale of asset: If any asset used for scientific research purpose, is sold, thenthe price realised for the same shall be taxable u/s 41(3).

4. Amalgamation: Where amalgamating company transfers to the amalgamatedcompany, (being an Indian company), any asset representing capitalexpenditure on scientific research, provisions of Section 35, would apply to theamalgamated company as if the amalgamating company had not transferredthe asset.

Payment to outside agencies: Payment may be made for−1. Scientific research [Section 35(1)(ii) and (iia): Any payment made to outside

agencies for scientific research whether related to the business of theassessee or not, is allowed as weighted deduction @ 175 the amount so paidin the previous year in which payment is made. The deduction is allowable ifthe payment is made to any of the following agencies:



Notes(a) scientific research association which has the object of undertakingscientific research;

(b) a university, college or other institutions to be used for scientific research.2. Research in social science or statistical research [Section 35(1)(iii)] :

Payment made by the assessee to a university, college or other institution to beused for research in social sciences or statistical research shall also be eligiblefor deduction @ 125% of the amount so paid whether such research is relatedto the business of the assessee or not.The deduction mentioned in clause (1) and (2) above shall be allowed only ifthe association, university, college or other institution mentioned in clause (a)or (b) above−

(A) Is for the time being approved, in accordance with the guidelines, in themanner and subject to such conditions as may be prescribed.

(B) Such association, university, college or other institution is specified as such bynotification in the Official Gazette, by the Central Government.

Weighted deduction on contribution to National Laboratory [Section 35(2AA)]:(i) The payment is made to National Laboratory, or, University; or Indian Institute

of Technology; or, specified person as approved by the prescribed authority.(ii) The above payment is made under a specific direction that it should be used by

the aforesaid person for undertaking scientific research programme approvedby the prescribed authority.

If the aforesaid conditions are satisfied, the tax payer is eligible for weighteddeduction which is equal to 200%.

Weighted deduction on ‘in-house’ research and development to a companyassessee in certain cases [Section 35(2AB)]:

Weighted deduction of 200% will also be allowed to a company which−(a) is engaged in any business of manufacture or production of any article or thing

not being an article or thing specified in the list of the Eleventh Schedule of theAct, and

(b) has incurred expenditure (except on land and building) on in-house scientificresearch and development facility approved by the prescribed authority.

No company shall be entitled to this deduction unless it enters into an agreementwith the prescribed authority for cooperation in such research and development facilityand for the audit of the accounts maintained for that facility.

Notes:(i) If expenditure is allowed under this section, it will not be allowed under any

other provision of the Act.(ii) The expenditure incurred on the acquisition of building(excluding cost of land)

shall be allowed @ 100% under section 35(1)(iv) read with Section 35(2).(iii) The expenditure incurred on scientific research by the above company after

31-3-21012 shall not be eligible for weighted deduction extended to 31-3-2017by the Finance Act, 2012.

(iv) The deduction u/s 35(2AB) shall not be allowed to a company who has themain object the scientific research and development.

Contribution to a Company to be Used by Such Company for ScientificResearch [Section 35(1)(iia)]

Section 35(1)(iia) is applicable from the AY 2009-10 if the following conditions aresatisfied−



Notes 1. The taxpayer is any person (may be an individual, HUF, firm, company or anyother person.

2. The tax payer has paid any sum to a company to be used by the payee forscientific research.

3. The scientific research may or may not be related to the business of thetaxpayer.

4. The payee-company is registered in India and has as its main object thescientific research and development

5. The payee-company is for the time being approved by the prescribed authorityand fulfills such conditions as may be prescribed.

Amount of deduction: If the above conditions are satisfied, then the tax payer canclaim a weighted deduction of 125 per cent of the amount paid by him to the payeecompany.

Expenditure on Acquisition of Patent Rights and Copyrights [Section 35A]: Nodeduction is available u/s 35A.

Expenditure for Obtaining License to Operate Telecommunication Service [Section35ABB]

Where any capital expenditure is incurred by the assessee for acquiring any right tooperate telecommunication services either before the commencement of the business tooperate a telecommunication service or thereafter, any time during any previous yearand for which payment has actually been made to obtain a license, a deduction will beallowed in equal instalments over the period for which the license remains in force,subject to the following:

(a) If the fee is paid for acquiring any right to operate telecommunication servicesbefore the commencement of such business, the deduction shall be allowed forthe previous years beginning with the previous year in which such businesscommenced.

(b) If the fee is paid for acquiring such rights after the commencement of suchbusiness the deduction shall be allowed for the previous years beginning withthe previous year in which the license fee is actually paid.

Sale of License:(a) Where the entire license is transferred

(i) If the sale proceeds and the deductions already allowed are less than thecost of acquisition, such deficiency shall be allowed as deduction in theyear in which the license is transferred.

(ii) If the sale proceeds and the deductions already allowed exceed the costof acquisition of the license, then the amount of such excess or theaggregate of the deductions already allowed in the past, whichever is less,shall be taxable as business income of the year in which the license istransferred.

(b) Where a part of the license is transferred.(i) Where a part of the license is transferred for a sum less then the written

down value of the total license, the balance amount not yet written offshall be allowed as deduction in the balance number of equalinstallments.

(ii) If part of the license is transferred for a sum exceeding the written downvalue of the license, the sale proceeds minus the written down value ofthe full license shall be the profit from such sale. Out of such profit, an



Notesamount equal to the amount already written off in the earlier years shallbe deemed to be the business income.

It may be mentioned that the license constitutes a capital asset and as such there willbe capital gain/loss on sale of the entire part of the license.

Notes:1. In the case of amalgamation and demerger, the amalgamated company or the

resulting company, as the case may be, shall be allowed to writ off the balanceamount of license which was not written off by the amalgamating company orde-merged company as the case may be.

2. Where a deduction for any previous year under section 35ABB(1) is claimedand allowed in respect of any expenditure referred to in that sub section, nodeduction shall be allowed on account of depreciation under section 32(1) forthe same previous year or any subsequent previous year.

Expenses on Eligible Projects or Schemes [Section 35 AC]Under this section, deduction will be allowed in computing profits of business or

profession chargeable to tax, in respect of the expenditure incurred for an eligible projector scheme for promoting social and economic welfare or uplift of the public as may bespecified by the Central Government on the recommendations of the NationalCommittee.

The deduction will be allowed in cases where the qualifying expenditure is eitherincurred by way of payment to the public sector company, a local authority or to andapproved association or institution for carrying out any eligible project or scheme.Companies will however, be allowed the deduction also in cases where the expenditureis incurred by them directly on an eligible project or scheme.

The claim for deduction should be supported by an audit certificate obtained from apublic sector company, local authority or approved association or institution or from aChartered Accountant in cases where the claim is in respect of expenditure directlyincurred by a company on an eligible project or scheme.

Deduction in respect of Expenditure on Specified Business [Section 35AD]The income tax act provides for profit linked exemption/deduction under various

sections. Some of the exemptions are provided in the following sections:1. Section 10AA2. Section 80-1A, 80-1AB, 80-1B, 80-1C,80-1D and 80-1E

However, from assessment year 2010-11, it has made a departure and now onwardsincentive linked tax incentive(instead of profit linked exemption/deduction, shall beallowed to assessee carrying on certain specified business. In this regard, Section 35ADhas been inserted for specified business.

1. To whom deduction shall be allowed: Deduction u/s 35AD shall be allowedto the assessee which is carrying on the following specified business:(i) setting up and operating a cold chain facility on or after 1.4.2009.(ii) setting up and operating a warehousing facility for storage of agricultural

produce on or after 1.4.2009.(iii) laying and operating a cross-country natural gas or crude or petroleum oil

pipeline network for distribution, including storage facilities being anintegral part of such network on or after 1.4.2007.



Notes (iv) the business of building and operating new hotel of two star or abovecategory, as classified by the Central Government, any where in India and,which starts operating after 1-4-2010.

(v) building and operating anywhere in India, a hospital with at least 100 bedsfor patients on or after 1-4-2010.

(vi) developing and building a housing project under a scheme for slumredevelopment or rehabilitation framed by the central Government or aState Government as the case may be, and notified by the Board in thisbehalf in accordance with the guidelines as may be prescribed on or after1-4-2010.The Finance Act 2011 has also included the following business within thepurview of specified business, if they start functioning on or after1-4-2011.

(vii) on or after 1st April, 2011, where the specified business in the nature ofdeveloping and building a housing project under a scheme for affordablehousing framed by the central Government or a State Government as thecase may be, and notified by the Board in this behalf in accordance withthe guidelines as may be prescribed.

(viii) production of fertilizer in India(ix) on or after 1st April, 2012, setting up and operating inland container depot

or a container freight station notified or approved under the Customs Act,1962.

(x) bee-keeping and production of honey and bees wax on or after 1-4-2012.(xi) in the nature of setting up and operating a warehousing facility for storage

of sugar on or after 1-4-2012.2. Nature and amount of deduction: 100% deduction shall be allowed on

account of any expenditure of capital nature incurred wholly and exclusively forthe purpose of any specified business, shall be allowed as deduction during theprevious year in which he commences operations of his specified business, if−(a) the expenditure is incurred prior to the commencement of its operation;

and(b) the amount is capitalized in the books of account of the assessee on the

date of commencement of its operations.Weighted deduction for certain specified business commencing operations

on or after 1-4-2012 [Section 35AD(IA)]The following specified business commencing operations on or after 1.4.2012 shall

be allowed a weighted deduction of 150% of the capital expenditure incurred underSection 35AD(IA) of the Income Tax Act, namely:

(i) Setting and operating a cold chain facility(ii) setting up and operating a warehousing facility for storage of agricultural

produce(iii) building and operating anywhere in India, a hospital with at least 100 beds for

patients(iv) developing and building a housing project under a scheme for affordable

housing framed by the Central Government or a State Government as the casemay be, and notified by the Board in this behalf in accordance with theguidelines as may be prescribed,and

(v) production of fertilizer in India



NotesConditions to be satisfied:(i) It is not formed by the splitting up or the reconstruction of a business already in

existence.(ii) It is not formed by the transfer to new business of machinery or plant previously

used for any purpose.(iii) Where the business is of laying and operating a cross country natural gas or

crude or petroleum oil pipeline network, etc., it satisfies the following conditionsalso:(a) it is owned by a company formed and registered in India under the

Companies Act, 1956 or by a consortium of such companies or by anauthority or board or a corporation established or constituted under anyCentral or State Act.

(b) it has been approved by the Petroleum and Natural Gas RegulatoryBoard established under sub-section (1) of Section 3 of the Petroleumand Natural Gas Regulatory Board Act, 2006 and notified by the centralGovernment in the Official Gazette in this behalf;

(c) it has made not less than one-third [amended to “such proportion of itstotal pipeline capacity as specified by regulations made by the Petroleumand Natural Gas Regulatory Board established under sub-section (1) ofSection 3 of the Petroleum and Natural Gas Regulatory Board Act, 2006[Finance Bill 2010, to take effect retrospectively from 1.4.2010] of its totalpipeline capacity available for use on common carrier basis by any personother than the assessee or an associated person; and

(d) it fulfills any other conditions as may be prescribed.Notes:(1) The assessee shall not be allowed any deduction in respect of the specified

business under the provisions of Chapter VIA under the heading “C –Deductions in respect of certain incomes” in relation to such specified businessfor the same or any other assessment year.

(2) An associated person in relation to the assessee means a person−(i) Who participates directly or indirectly or through one or more

intermediaries in the management or control or capital of the assessee.(ii) Who holds directly or indirectly, shares carrying not less than twenty-six

per cent of the voting power in the capital of the assessee.(iii) Who appoints more than half of the board of directors or members of the

governing board or one or more executive directors or executivemembers of the governing board of the assessee.

(iv) Who guarantees not less than 10% of the total borrowings of theassessee.

(3) Sum received or receivable on sale or destruction of an asset for whichdeduction under section 35D has been claimed in nay earlier year.If the asset whose cost has been allowed as deduction u/s 35AD is later onsold, demolished or discarded then,–(a) the sale price of such asset to the extent of its original cost shall be

taxable under Section 28 as profit or gains of business and profession.(b) The amount received s compensation from the insurance company on

destruction of such asset shall be taxable u/s 28 as profit or gains ofbusiness and profession.



Notes Payment to Institutions for Carrying Out Rural Development Programmes [Section35CCA]

Any assessee who wants to avail of this section will get a deduction only if he makesa payment to the National Fund for Rural Development and National Urban PovertyEradication Fund which are the only funds which have been notified so far by the CentralGovernment u/s 35CCA(1).

Expenditure on agricultural project [Section 35CCC]: Where an assessee incursany expenditure on agricultural extension project notified by the board in this behalf inaccordance with the guidelines as may be prescribed then, there shall be allowed adeduction equal to one-and-one-half times of such expenditure.

Where a deduction under this section is claimed and allowed for any assessmentyear in respect of any expenditure referred here deduction shall not be allowed in respectof such expenditure under any other provisions of this Act.

Expenditure on skill development project [Section 35CCD]: Where a companyincurs any expenditure (not being in the nature of cost of any land or building) on any skilldevelopment project notified by the Board in this behalf in accordance with the guidelinesas may be prescribed then, there shall be allowed a deduction equal to one and one-halftimes of such expenditure.


Amortisation of Preliminary Expenses [Section 35 D]Where an Indian Company or a resident non-corporate assessee in India incurs any

expenditure of the nature specified either:− before the commencement of the business or− after the commencement of the business, in connection with extension of his

industrial undertaking or setting up a new industrial unit, a deduction u/s 35 D isavailable.

Quantum of Deduction: Amount equal to 1/5 of the eligible expenditure isdeductible over a period of five years beginning with the previous year in which theextension of the industrial undertaking is completed or a new industrial unit commencesproduction or operation.

Eligible Expenditure:(a) Expenditure in connection with:

(i) Preparation of a feasibility report;(ii) Preparation of a project report;(iii) Conducting a market survey or any other survey necessary for the

business of the assessee;(iv) Engineering services relating to the business of the assessee.

(b) Legal charges for drafting any agreement between the assessee and any otherperson for any purpose relating to the setting up or conduct of the business ofthe assessee.

(c) Where the assessee is a company, also expenditure:(i) By way of legal charges for drafting the Memorandum and Articles of the

Association of the Company;(ii) On printing of the Memorandum and Articles of the Association;



Notes(iii) By way of fees for registering the company under the provisions ofCompanies Act, 1956;

(iv) In connection with the issue, for public subscription, of shares in ordebentures of the company, being underwriting commission, brokerageand charges for drafting, printing and advertisement of the prospectus.Expenses incurred in connection with refund of the amount oversubscribed, are entitled to deduction u/s 35D [CIT vs. Shree SyntheticsLtd. (1986)].

(d) Such other items of expenditure as may be prescribed.Limit on eligible expenditure:

In case of non corporate resident assessee – 5% of project cost,In case of Indian Company – 5% of or project cost or 5% of capital employed(at the option of the assessee).

Important Points:1. Cost of the project is the cost of a fixed asset to an assessee as on the last day

of the previous year in which the business commences/extension iscompleted/the new industrial unit commences production or operation.

2. Capital employed is the aggregate of the issued share capital, debentures,long-term borrowing as on the last day of previous year in which the businesscommences/extension is completed/the new unit commences production oroperation.

3. In case of extension/new unit cost of the project/capital employed is consideredin connection with the extension or setting up of a new unit only.

4. In case of transfer of the undertaking, the transferee company (except in caseof amalgamation and demerger) looses the benefit of any deduction for theyears after such transfer.

Amortisation of expenditure in the case of amalgamation/demerger [Section35 DD]: Where an assessee, being an Indian Company incurs expenditure (on or after01.04.1999) wholly and exclusively for the purpose of amalgamation or demerger; theassessee shall be allowed a deduction equal to one-fifth (1/5th) of such expenditure for5 successive previous years beginning with the previous year in which amalgamation ordemerger takes place,w.e.f. A.Y. 2000-01.

Amortisation of expenditure under voluntary retirement scheme [Section35DDA]: Where an assessee incurs any expenditure in any previous year by way ofpayment of any sum to an employee at the time of his voluntary retirement under anyscheme of voluntary retirement 1/5th of the amount so paid shall be deducted incomputing the profits and gains of the business for that previous year and the balance inequal instalments for each of the four immediately succeeding previous years.

Deduction for Expenditure on Prospecting for Minerals [Section 35E]This section has been inserted with a view to encouraging investment in high risk

areas, especially in exploiting amortisation of expenditure incurred wholly and exclusivelyon any operations relating to prospecting for certain specified minerals or groups ofminerals or on developing mines etc. Following points are to be noted:

1. Deduction is available only to an Indian resident or an Indian company but notto any foreign citizen or foreign company.

2. 1/10th of the amount of expenditure would be allowed as a deduction for the10 years beginning with the years in which commercial production starts.



Notes 3. Expenses, to be amortised, will be expenses incurred under the specifiedheads during the five years’ period ending with the year of commercialproduction.

4. If, in any year, income arising out of commercial exploitation of wasting asset isNIL or insufficient to absorb, the allowance under this section the unabsorbedallowance is to be carried forward to the next year(s). However, this process ofcarry forward cannot be continued beyond 10 years as reckoned from the yearof commercial production.

5. Deduction in case of amalgamation/demerger – Where in a scheme ofamalgamation, the Indian company is transferred to another Indian companybefore the expiry of the said period of 10 years, the provisions of this sectionshall, as far as may be, apply to the amalgamated company as they wouldhave applied to the amalgamating company if the amalgamation had not takenplace. Similarly where the undertaking of an Indian company which is entitledto deduction under this section, before the expiry of the period of 10 years toanother company in a scheme of demerger, no deduction shall be admissiblein this case to the demerged company for the previous year in which thedemerger takes place and the provision of this section, as far as may be, applyto the resulting company, if the demerger had not taken place.

Other Deductions under Section 36: There are various other expenses, which areallowed as deduction u/s 36 for obtaining the taxable profits. They are briefly describedbelow:

1. Insurance premium paid for risk or damage or destruction of stock or stores orother inventories or assets used for the business or profession will bedeductible [Section 36(1)(i)].

2. Insurance of life of cattle – Insurance premium paid by a federal milkcooperative society on the life of any cattle owned by any member of a primarymilk cooperative society affiliated to it will be allowed as a deduction [Section36(1)(ia)].

3. Employees Health Insurance Premium paid by cheque by anemployer-assessee to effect or keep in force insurance of the health of hisemployees under an approved scheme will be avowed as a deduction incomputing his business income [Section 36(1)(ib)].

4. Bonus and Commission paid to an employee for services rendered by him, willbe allowed as a deduction, subject to a primary condition that the amount hasnot been distributed by way of profits or dividends and such bonus orcommission has been paid in the relevant previous year or on or before the duedate of filing of the return of income of the assessee [Section 36(1)(ii)].

5. Interest on money borrowed – Interest paid in respect of money borrowed forthe purposes of business or profession is deductible u/s 36(1)(iii), provided thefollowing conditions are satisfied. Pro rata discount on zero coupon bonds alsogets allowed under this category subject to certain conditions:(a) Money must have been borrowed by the assessee.(b) It must be borrowed for the purpose of business or profession.(c) Interest is paid or is payable on such a borrowing.

6. Discount on issue of Zero Coupon Bonds to be allowed as deduction on prorata basis [(Section 36(1)(iiia)] – The pro-rata amount of discount on a zerocoupon bond having regard to the period of life of such a bond calculated in themanner prescribed below.



NotesDiscount means the difference between the amount received or receivable bythe infrastructure capital company or infrastructure capital fund or public sectorcompany issuing the bond and the amount payable by such a company or fundor public sector company on maturity or redemption of such a bond. Period ofthe life of the bond means the period commencing from the date of issue of thebond and ending on the date of maturity or redemption of such a bond.Infrastructure capital company and infrastructure capital fund shall have thesame meanings respectively assigned to them as provided in Explanation I toClause 23G of Section 10.

7. The employer’s contribution to a recognised provident fund or approvedsuperannuation fund is allowed as deduction, subject to the limit laid down forsuch payments and provided these payments have been made on or beforethe due date of making such payments by the employer [Section 36 (1)(iv)].

7a. Employer’s contribution towards a pension scheme referred to in section80CCD [Section 36(1)(iva)].

8. The employer’s contribution to an approved gratuity fund will be allowed as adeduction, provided these payments have been made on or before the duedate of making such payments by the employer [Section 36(1)(v)].

9. The employee’s contribution to approved or statutory staff welfare schemes willbe allowed as a deduction from the income of the employer provided suchamounts have been paid on or before the due date of making such payments[Section 36(1)(va)].

10. Animals written off – In the case of animals used for the purpose of business/profession otherwise than a stock-in-trade, if such animals have died or havebecome permanently useless for the purpose of such business or profession,the difference between their actual cost and the amount realised on sale ofthose animals or their carcasses will be allowed as a deduction [Section36(1)(vi)].

11. Bad Debts [Section 36 (1)(vii)] – Bad debts, which are written off asirrecoverable, can be deducted subject to the following conditions:(a) The debt or loan should be in respect of a business, which was carried on

during the relevant previous year.(b) The debt must have been taken into account in computing the income of

the assessee of the previous year in which such a debt is written off or ofan earlier previous year. [In the case of a banking company, such a debtshould represent money lent in the ordinary course of the business ofbanking or money lending.]

Recovery of bad debt in the subsequent year shall be added to the taxable incomeof the previous year in which recovery is made u/s 41(4).

12. Provision for bad and doubtful debts by commercial banks (other than acooperative bank) [Section 36(1)(viia)].(a) A scheduled or non-scheduled bank may provide for the provision for bad

and doubtful debts up to 7.5% of their total income (before making anydeductions under Chapter VIA) plus an additional 10% of the aggregateaverage advances made by the rural branches of these banks.

(b) Foreign banks may make such provision up to 5% of the total income(before making deduction under Chapter VIA).

(c) Public financial institutions may make such provision up to 5% of the totalincome (before making deductions under Chapter VIA).



Notes Important Points:1. A scheduled bank means the SBI, a subsidiary bank of SBI, a corresponding

new bank constituted u/s 3 of the Banking Companies (Acquisition andTransfer of Undertaking) Act, 1970/1980 of a bank included in the secondschedule to RBI, 1934, but doesn’t include a cooperative bank.

2. Foreign bank refers to the bank incorporated in a foreign country.3. A scheduled bank or non-scheduled bank at its option is allowed a further

deduction in excess of the limits specified, for an amount not exceeding theincome derived from the redemption of securities in accordance with a schemeframed by the Central Government. No deduction, as aforesaid, shall beallowed unless such income has been disclosed in the return of income underthe head ‘Profits and Gains of Business/Profession’).

13. Transfer to a special reserve [Section 36(1)(viii), w.e.f. A.Y. 2008-09]: Apublic financial corporation engaged in long-term finance for industrial oragricultural developments or infrastructure development in India and a publiccompany formed and registered in India with the main object of providinglong-term finance for industrial or agricultural developments or infrastructuredevelopment in India and a public company formed and registered in India withthe main object of providing long-term finance for the construction or purchaseof residential housing in India are entitled for deduction of the amounttransferred by them to a special reserve account subject to a maximum of 20%of profit from such business (computed before making any deductions underChapter VIA). However, where the aggregate amounts carried to suchreserves from time to time exceeds twice the paid-up share capital andreserves, no allowance is further allowed.

14. Family Planning Expenditure [Section 36(1)(ix)]: Any expenditure bona-fideincurred by the company for the purpose of promoting family planning amongthe employees is allowed as a deduction. If such expenditure is of a revenuenature, the entire amount will be allowed as a deduction if it is of a capitalnature (such as, purchase of equipment or construction of a clinic ordispensary). 1/5th of the expenditure will be allowed as a deduction in each ofthe five years from the year in which such expenditure has been incurred inequal instalments.

15. Revenue expenditure incurred by a corporation or body corporate for theobjects and purposes authorised [Section 36(1)(xii)].Any expenditure (not being in the nature of capital expenditure) incurred by acorporation or a body corporate by whatever name called, shall be allowed asdeduction in computing its income under Section 28 of the act, if the followingconditions are satisfied:(a) It is constituted or established by a Central, State or Provincial Act.(b) Such corporation or body corporate, having regard to the objects and

purposes of the act referred to in sub-clause (a) is notified by the CentralGovernment in the Official Gazette for the purposes of this clause; and

(c) The expenditure is incurred for the objects and purposes authorised bythe act under which it is constituted or established.

16. Contributions made by a financial institution to a notified creditguarantee fund trust for small industries [Section 36(1)(xiv)]: Any sumpaid by a public institution by way of a contribution to such credit guaranteefund trust for small industries as the Central Government may, by notification inthe Official Gazette, specified in this behalf, shall be allowed as deduction.



NotesGeneral Deductions under Section 371. General deductions are allowed for expenses which are not covered by any

other section will be allowed as a deduction under Section 37 provided thefollowing conditions are satisfied:(a) Expenditure should not be covered specifically by any of the provisions of

Section 30 to 36.(b) Such expense should be in respect of a business carried out by the

assessee and the profits of which are to be computed and assessed andshould be incurred after the business set up.

(c) It should not be in the nature of personal expenses of the assessee.(d) Such expenses should not be in the nature of capital expenditure.(e) Such expenses should have been incurred only and exclusively for the

purpose of such business.(f) Such expenses should not be incurred for any purpose which is an

offence as prohibited by law.2. Under this section, therefore, expenses by the way of cost of raw materials,

tools, spares, etc. cost of labour, salary and various expenses incurred by theassessee will be allowed as a deduction.

3. Few items of business expenditure covered under Section 37 are as follows:4. Salary/wages for training period: The salaries and wages paid to the

employees for the period of the training in the courses organised by the CentralBoard of Workers’ Education should be allowed as admissible deduction whilecomputing the income of the employers – Letter: F.No.27 (30)-IT/59, dated6-7-1959.

5. Membership fees: The expenditure by the way of membership fee of theIndian Institute of Foreign Trade can be said to be wholly and exclusivelyincurred for the purpose of business of the members. Therefore, suchexpenditure may be allowed as admissible deduction under Section 37(a) inthe hands of the payers in computing their total income from business – Letter:F. No.9/54/64-IT (A-1), dated 2-9-1964 and Letter: F. No.9/56/66-IT (A-I), dated17-1-1967.

6. The expenditure by way of membership fee of the Indian Institute of Packagingcan be said to be wholly and exclusively incurred for the purpose of business ofthe members. Therefore, such expenditure may be allowed as admissiblededuction, under Section 37(1), in the hands of the prayers in computing theirtotal income from business – Letter: F No. 9/23/67-IT (a-1) dated 26.08.1965.

7. Laga contribution – Where laga contribution is made at the customaryrate prevalent in the market, such contribution should be allowed in fullin the assessment of the member-contributors – Circular: No. 5-P (XIV-1)dated 28.09.1963].

8. Share listing expenses: Expenses incurred by a company on getting itsshares listed in a stock exchange should be considered as laid out wholly andexclusively for the purposes of the business and therefore, admissible asbusiness expenditure under Section 37(1) [Letter F. No. 10/67-65-IT (A-1)dated 26.08.1965.

9. Professional Tax: Professional tax paid by a person carrying on business ortrade can be allowed to him as a deduction under Section 37(1) – Circular No.16(F. No. 9/38/69-IT (A-II)], dated 18.09.1969.



Notes 10. Payments under profit sharing scheme: Where the payments made under aprofit sharing scheme are bonafide and not merely a device to reduce taxliability and the sums have actually been paid to the employees, the amountsmay be treated to have been expended wholly and exclusively for the purposesof the employer’s business – Circular No. 64(XI-2) [F. No. 27(10)-IT-51], dated27.10.1951.

11. Rebate/bonus to members by Consumer Cooperative stores:Rebate/bonus (which is in the nature of deferred discount) passed on by theconsumer cooperative stores to their members on the value of the purchasesmade by them during a year should be allowed as a deduction in computing thebusiness income of such a society – Circular No. 117 [F. No. 201/5/73-IT (A-II)],dated 22.08.1973.

12. Remuneration paid by a company to the Registrar: Reasonableremuneration paid by a company to its Registrar for performing duties inconnection with the company’s legal obligations to be discharged under thecompany law should be regarded as revenue expenditure, provided thecompany is not itself maintaining a separate organisation for the performanceof such duties – Letter [F. No. 10/25/63-IT (A-I)], dated 18.06.1964.

13. Expenses allowable to Indian authors/writers: In cases of Indian authors/writers where the amount receivable from royalties/writings is less than` 25,000 and where detailed accounts regarding expenses incurred are notmaintained, claims of expenses to the extent of 25% of such amount or` 5,000, whichever is less, may be allowed in the year of publication of a bookor other publication, including articles. The expenses to the extent mentionedabove will be allowable without calling for any evidence in support of the claim.This circular will not, however, be available in cases of such authors/writerswho are included in the terms of film artistes being storywriters, screenplaywriters and dialogue writers if they are engaged in their professional capacity inthe production of cinematograph film – Letter [F. No. 204/42/77-IT (A-II)], dated28.09.1977.

14. Royalty/dead rent: Royalty and dead rent paid under the Mineral ConcessionRules, 1960 will have to be allowed as revenue deduction – Circular No. 1D(IV-53), dated 20.01.1966.

15. Expenses on sales tax assessments/appeals: The expenses incurred inoriginal proceedings for assessment to sales tax as also in appeals arisingfrom such proceedings should be allowed as a deduction in income taxassessments – Circular No. 2 [C. No. 27(8)-IT/46], dated 8.3.1946.

16. Maintenance expenses on tea garden: All expenditure on the maintenanceof a tea garden, including expenditure on the maintenance of an area that hasnot reached maturity, is an item of revenue expenditure and as such isallowable as deduction for the purposes of computing the income of a teaestate, under the Income Tax Act – Source: Income Tax Circulars published byDirectorate of Inspection (RS and P), 1968 Edition, p. 192.

17. Telephone/conveyance expenses of newspaper agencies: Expenditure onqua telephones and conveyance laid out wholly and exclusively by smallnewspaper agencies for the purposes of the business can be allowed asdeduction, but any expenditure in the nature of personal expenses of suchassessees is not admissible as deduction.

18. In determining the non-business part of such expenditure, the AssessingOfficers need not go into meticulous details regarding each item and the



Notesofficers should adopt a reasonable approach in this respect having regard tothe circumstances of the newspaper business – Letter F. No. 35/5/65-IT (A-I),dated 1.7.1965.

19. Initial installation of fluorescent lights: The initial expenditure on the firstinstallation of fluorescent lights, including the expenditure on wiring and fittings,should be treated as capital expenditure as it creates an asset and allsubsequent expenditure for replacement of the tubes should be treated as of arevenue nature, allowable in lot – Circular No. 69(XIX-3) [F. No. 27(31)-IT/51],dated 27.11.1951.

20. Expenditure on visits to foreign countries: The question of admissibility ofexpenditure on visits to foreign countries should not be approached from thepoint of view as to whether such visits result immediately in the earning ofprofits. All that the law requires is that the expenditure should not be in thenature of capital expenditure or personal expenditure of the assessee andshould be wholly and exclusively laid out for the purposes of the business –Circular No. 4 [C. No. 27(3)-IT/50], dated 19.06.1950.

21. Maintenance expenses of Industrial Home Guard Units: Revenueexpenses incurred by the industrial undertakings in connection with themaintenance of the Industrial Home Guard Units may be treated as deductibleexpenses under Section 37(1) – Letter F. No. 10/80/64-IT (A-1), dated26.02.1965.

22. Interest payable on unpaid purchase price of plant and machinery:Expenditure on interest payable on the unpaid purchase price of plant ormachinery should be allowed as revenue deduction under Section 37(1) –Letter F. No. 10/92/64-IT (A-I), dated 13.09.1965.

23. Labour welfare expenditure: Any expenditure on labour welfare work, not ofa capital nature – actually incurred during the previous year – should beallowed in entirety as deduction in income tax assessments, irrespective of theactual amount of profits for that year available for meeting the expenditure –Circular No. 3 [R. Disc No. 27(50)-IT/46], dated 26.3.1946.

24. Legal expenses for renewal of lease: Legal expenses incurred in connectionwith the renewal of lease should be allowed as an admissible deduction for thepurposes of income tax, provided that the renewal of the lease is for a period ofless than fifty years. Expenditure incurred on the compulsory removal ofbusiness premise, i.e., in cases where the removal has taken place under thedirections of government should, as in the case of air raid precautionsexpenditure, be allowed as a deduction for purposes of income tax – CircularNo. 22 [R. Disc. No. 27(53)- IT/43], dated 23.06.1943.

25. Managerial subsidy to the employees’ cooperative stores: Out of thefinancial assistance to be given by the employers in connection with setting upof consumers’ cooperative stores for industrial workers, the managerial subsidyto meet the establishment cost, such as salaries and rent charges on atapering basis for three years, may be treated as being of the nature ofexpenditure for the welfare of the industrial workers of the employer concernedand can be permitted to be deducted in computing the taxable income of theemployer – Letter F. No. 10/16/63-IT (A-1), dated 14.05.1963.

26. Contribution to a subsidised industrial housing scheme: The contributionsto a fund set up under a subsidised industrial housing scheme cannot beregarded as admissible deduction under Section 37(1) of the Act – Letter F. No.10/8/63-IT (A-1) dated 14.10.1963.



Notes 27. Contribution by members to a ‘cycle export pool’: The contributions madeby members to the ‘cycle export pool’ vide rule 5(c) of the scheme, will beadmissible as a deduction under Section 37(1) of the Act in their assessments.The subsidies received from the pool by the members will be treated as taxableincome in their hands – Letter F. No. (24)-IT/59, dated 19.5.1959.

28. Guarantee commission paid to banks: Commission payable to banks forfurnishing guarantees regarding deferred payments for the import of plant andmachinery is in the nature of a capital expenditure and cannot be allowed asdeduction in computing the total income under the Income Tax Act. The Boardhas, however, no objection to permit such expenditure to be added to the costof the plant and machinery and to allow depreciation thereon at the usualprescribed rates – Letter F. No. 7/33/62-IT (A-I), dated 28.8.1963.

29. Commitment charges on the unused portion of a loan: Commitmentcharge payable by a party on the unused portion of the loan which has notbeen drawn, has to be taken as an expenditure laid out wholly and exclusivelyfor the purposes of the business and therefore, permissible as a revenuededuction under Section 37(1) – Circular No. 2-P (XI-6) [F. No. 10/67/65-IT(A-I)], dated 23.08.1965.

30. Expenses on Diwali and Mahurat: As the expenses incurred on the occasionof Diwali and Mahurat are in the nature of business expenditure, it has beendecided not to lay down any monetary limits for the purpose of theirallowance – Letter F. No. 13A/20/68-IT (A-II), dated 03.10.1968.

31. Incidental expenses on raising loans on short-term basis: Incidentalexpenses incurred for raising other short-term loans from financial institutionsby way of temporary accommodation or ordinary trading facilities can beallowed as deduction in computing the income from business subject to thefollowing conditions:(a) The short-term loan is of a duration of not more than two years, and(b) The total amount of incidental expenses does not normally exceed 1% of

the amount of the loan raised – Letter: F. No. 32/6/62-IT (A-1) dated16.1.1963.

32. Education cess: Education cess is allowable as a deduction. Source: Extractsfrom the minutes of the 16th meeting of CDTAC held on 2.2.1972.

33. Amount paid under OYT Scheme for Telephone: It is open to the subscribereither to claim the entire amount paid under the OYT scheme in the year inwhich the payment is made or proportionately in the years for which anadvance payment of the rent is made. Where the installation of telephone is inthe previous year subsequent to the previous year in which the deposit is made,the deduction for the payment should be allowed in the year of paymentirrespective of the fact whether the telephone has been installed or not –Instruction: No. 943 [F. No. 204/15/76-IT (A-II)], dated 2.4.1976.

34. Amount paid under ‘Tatkal Telephone Deposit Scheme’: Amount paid byan assessee for obtaining a new telephone connection under the ‘TatkalTelephone Deposit Scheme’ can be allowed as revenue expenditure in theyear of payment. The refund of said amount, if any, will be taxed under Section41(1) – Circular No. 671, dated 27.10.1993.

35. Deposit paid for a telex connection: Since the deposit of ` 10,000 for a telexconnection does not earn any interest when the telex machine is installed, atthat stage, this amount may be treated as a revenue expenditure allowable asa deduction, if the assessee makes such a claim. However, when the amount



Notesis returned by the postal authorities when the telex connection is finally closed,the refund of ` 10,000 shall be treated as an income of the assessee of theyear in which the amount is refunded – Circular No. 420 ([F. No. 204/10/83-IT(A-II)] dated 4.6.1985.

36. Expenses abroad on market promotion and similar export promotionalactivities: With regard to the expenses incurred by members of a delegationgoing abroad for exploring new markets for Indian products and similar exportpromotional activities, all reasonable expenditure incurred by the members ofthe delegations should be allowed in the assessment of the membersconcerned – Circular No. 2(40)/6-EAC, dated 16/17.1.1967, issued by theMinistry of Commerce.

37. Training of apprentices: In view of the statutory obligation cast on theemployers under the provisions of the Apprentices Act, 1961, recurringexpenses incurred on imparting of the basic training to the apprentices underthe said act will be allowable as a deduction under Section 37(1).

38. As regards expenses for imparting of practical training under PracticalTraining Stipends Scheme and Programme of Apprenticeship Training(PAT), these expenses will not be covered within the meaning of Section 37(1),as no statutory obligation is cast on the employer under these two trainingschemes – Circular No. 192 [F. No. 204/39/75-IT (A-II)]; dated 10.3.1976.

39. Additional price and year in which deductible: Additional price payable tothe cultivators is to be allowed as a deduction in the year in which the additionalliability arose and not in the year to which it relates as it was ascertained onlyon the date of the order of the price fixation authority – Instruction: No. 745F. No. 228/28/74-IT (A-II), dated 30.8.1974. [Source: 153rd Report (1974-75)of the Public Accounts Committee, p. 66].

40. Interest on delayed payment to SSI ancillary units: For the AssessmentYear 1993-94 and later years, the interest on delayed payments to Small ScaleAncillary Industrial Undertakings Act, 1993 shall be applicable and theAssessing Officers are entitled to disallow the interest inadmissible under thesaid act in the assessment of buyers – Circular No. 651, dated 11.6.1963.

41. VRS ex gratia payments: Ex gratia amount paid by an assessee/employer forgaining enduring benefit or advantage under the Voluntary Retirement Schemeis a capital expenditure – Press release, dated 23.1.2001.

Examples of Expenditure not allowed as Deduction u/s 37(1)1. Expenditure incurred by way of stamp paper, underwriting commission,

registration fees, lawyer’s fees etc. in connection with the issue of debenturesis of a capital nature and cannot in law be allowed as deduction.

2. Incidental expenses incurred for raising short-term loans from financialinstitutions by way of temporary accommodation or ordinary trading facilitiescan be allowed as deduction in computing the income from business subject tothe following conditions:(a) the short-term loan is of a duration of not more than two years and(b) the total amount of incidental expenses does not normally exceed 1% of

the amount of the loan raised.3. Commission payable to banks for furnishing guarantees regarding deferred

payments for import of plant and machinery is in the nature of a capitalexpenditure and cannot be allowed as deduction in computing the total incomeunder the Income Tax Act. The Board has, however, no objection to permit



Notes such expenditure to be added to the cost of the plant and machinery and toallow depreciation thereon at the usual prescribed rates – Letter F. No.7/33/62-IT (A-I), dated 22.08.1963.

4. Fees paid to the Registrar of Companies for bringing about change in theMemorandum and Article is a capital expenditure.

5. The legal expenses incurred in connection with the amalgamation of theassessee company with another company is capital expenditure.

6. Expenditure incurred by the assessee for getting vacant possession of landowned by it is not revenue expenditure.

7. Bank guarantee commission for payment of taxes is capital expenditure.8. Payment for obtaining tenancy rights is in the nature of premium, though the

called contribution is capital expenditure.9. Penalty paid for violation or infringement of any law is not allowable.

10. Expenditure incurred by a company in connection with shifting of his registeredoffice is not allowable.

11. Expenditure incurred in dismantling of building in order to construct a hotel isnot allowed, as these are capital in nature.

12. Pension paid to the widow of the chairman of the board of directors, who wasnot an employee of the company nor was there any agreement for suchpayment between the company and the chairman is not deductible.

13. Assessee made payment to ward off competition of business to a rival. Held itwas capital expenditure.

14. Interest paid for non-payment, less payment, delayed payment, deferment ofadvance tax cannot be allowed as business expenditure nor is it in the natureof payment of other taxes like purchase tax expenditure.

15. Sales tax is a tax on the sale or purchase of goods and not on profits, hence, adeductible expense. But taxes such as income tax, surcharge etc. are notexpenditure laid for the purposes but are paid after the profits are earned,hence, not deductible expenses.

Deduction for the Building Partly Used for Business and Partly Used as DwellingHouse [Section 38]

Where the premises are used partly for the business and partly for other purposes,only a proportionate part of the expenses attributable to the part of the premises used forthe purposes of business will be allowed as deduction.

4.4.4 Expenses Not DeductibleSection 40: Disallows certain amounts specifically while computing

business/professional income, in the following manner :Section 40(a): Disallowance in case of all assessees.Section 40(b): Disallowance in case of Partnership firm.Section 40(ba): Disallowance in case of AOP or BOI Provisions of above sections

are briefly explained as follows.



NotesTable 4.5: Disallowance in the case of AOP or BOI Provisions

Section No. andType ofAssessee

Disallowance under Section 40

All assessesSection 40(a)

1. Wealth tax.2. Income tax.3. Payments outside India : Interest, royalty, fees for technical services or

other sum chargeable outside India, on which tax has not beendeducted at source or after deduction it has not been paid to thegovernment shall not be allowed.

4. Payment in India to a Non-resident (not being a company) or to aforeign company; interest, royalty, fees for technical services on whichtax has not been deducted or after deduction it has not been paid tothe government.

5. Any interest, commission or brokerage, fees for professional servicesor fees for technical services payable to a resident or any amountpayable to a contractor/sub-contractor will not be allowed as adeduction if the income tax has not been deducted and paid.

6. Salary payable outside India or to a Non-resident in India withoutdeducting tax at source or after deducting it has not been paid to theGovernment.

7. Payment to Provident Fund or other fund established for the benefit ofthe employees of the assessee, unless the assessee has made properarrangement to deduct tax at source on the payments made from thefund which are chargeable to tax under the head salaries.

Explanation: Any tax on business assets (other than wealth tax) isdeductible. Hence, tax paid on tea garden lands under UP. Large LandHoldings Tax Act 1937, is deductible (Dehradun Tea Co. Ltd. v. CIT –SC).

8. Tax on perquisites paid by the employer on behalf of the employee(which is exempt u/s 10(10CC) in the hands of the employee is notallowed as a deduction from business income in the hands of theemployer (assessee) via Section 40(a)(v).

9. Any sum paid on account of securities transaction – tax under ChapterVII of Finance Act 2004.

10. Any sum paid on account of fringe benefit tax under Chapter XII.

Section 40 (b)in case of

partnership firm

Deductions on account of interest and remuneration to the partners can beclaimed under section 36 or 37 as the case may be but it will be subject tothe conditions prescribed as under:1. Payment of salary, bonus, commission, or remuneration by whatever

name called, to a non-working partner shall not be allowed asdeduction.

2. Payment of remuneration to working partners and interest to anypartner will be allowed as deduction only when it is authorized by andis in accordance with partnership deed.

3. Payment of remuneration/interest, although authorized by thepartnership deed but which relates to a period prior to the date of suchpartnership deed, shall not be allowed.

4. Interest payable to a partner, although authorized by the partnershipdeed shall be allowed as a deduction subject to a maximum of 12%



Notes simple interest p.a. or as provided by the partnership deed, which everis lower.

5. The remuneration to all working partners shall not exceed the followinglimits (w.e.f.AY 2010-11) :

(a) In case of a firm carrying on business or profession: On the first` 3,00,000 of the book profit (or loss) ` 1, 50,000 or @ 90% of thebook profit, whichever is more

(b) On the balance of book profit ---> @ 60%Explanation:

Such disallowance is not applicable where an individual is a partner inthe capacity of:

– Representative and payment is done in individual capacity. OR– Individual and payment is done in representative capacity

AOP/BOI 40 (ba) Interest payment by AOP/BOI to a member as well as salary/bonus/commission, or remuneration paid by AOP/BOI will not be allowed as adeduction:Explanation:1. If the AOP/BOI pays certain amount of interest to its members and the

member has also paid certain amount of interest to it, only so much ofthe interest paid in excess of amount received from the member shallbe disallowed in computation of income of AOP/BOI.

2. Where the individual is a member of AOP/BOI in a representativecapacity, interest paid by AOP/BOI to such an individual, otherwisethan as a member in representative capacity will not be disallowed.

3. Where an individual is a member of AOP/BOI, otherwise than as amember in representative capacity, interest paid by AOP/BOI to suchindividual will not be disallowed.

Expenses of payments not deductible where such payments are made to relatives[Section 40A(2)]

Where an assessee incurs any expenditure, in respect of which payment has beenmade or is to be made to certain specified persons and the Assessing Officer is of theopinion that such expenditure is excessive or unreasonable having regard to the fairmarket value of the goods, services or facilities for which the payment is made or thelegitimate needs of the business or profession of the assessee or the benefits derived oraccruing to him therefore, so much of the expenditure, as is so considered by him to beexcessive or unreasonable, shall not be allowed as a deduction. Therefore, for anamount to be disallowed under this section, two conditions have to be fulfilled:

(a) The payment is made to a specified person.(b) The payment for the expenditure is considered excessive or unreasonable

having regard to fair market value of the goods, services or facilities.Specified persons: The specified persons are, in case of an assessee who is an

individual where payment is made:(i) any relative (i.e., spouse, any brother, sister, lineal ascendant or descendant)

of such individual;(ii) any person (individual, company, firm AOP, HUF, etc.) having a substantial

interest in the business of the individual (i.e., being entitled to not less than20% of the profit of the business of the individual);



Notes(iii) any person of which a director, partner or member has a substantial interest inthe business of the individual – any relative of any such person given under (ii)or (iii) above.

Company: Where the payment is made to:(i) any director of the company or his relative;(ii) any person (individual firm, company, AOP, HUF etc.) having a substantial

interest (i.e., owning at least 20% voting rights on holding of equity shares) inthe company;

(iii) any person of which a director, partner or member has a substantial interest inthe company;

– any relative of person given as (ii) and (iii).Firm: Where the payment is made to :(i) any partner of the firm or his relative;(ii) any partner of which a director, partner or member has a substantial interest in

the business of the firm;(iii) any person of which a director, partner or member has a substantial interest in

the business of the firm;– any relative of such person; gives in (ii) or (iii) above.

AOP or HUF: Where the payment is made to:(i) any member of the AOP or HUF, as the case may be; or his relative;(ii) any person having substantial interest in the business of the AOP or HUF as

the case may be;(iii) any person of which a directors, partner or member has a substantial interest in

the business of the AOP or HUF, as the case may be;− any relative of person: given in (ii) or (iii) above.

Judicial Decisions:1. Unless it is determined that the expenditure was excessive or unreasonable,

this section would not apply to case [Upper India Publishing House (P) Ltd., v.CIT (1979) 117 ITR 569 (SC)].

2. The words goods, services and facilities, referred to in this section mean thosewhich have some market value and are commercial in character.

Disallowance out of cash expenditure exceeding ` 20, 000 [Section 40A(3)]:Where the assessee incurs any expenditure, in respect of which payment is made, in asum exceeding ` 20,000 otherwise than by a crossed cheque drawn on a bank or acrossed bank draft, 100% of such expenditure shall not be allowed as a deduction.However, there are certain exceptions provided in Rule 6DD, under which expenditure,even exceeding ` 20, 000 shall be allowed as deduction, even though the payment is notmade by a crossed cheque/draft. These exceptions are:

(a) Payments made to banks, including cooperative banks or land mortgage banks,Life Insurance Corporation and financial institutions like IDBI, UTI, StateIndustrial Development Corporations and State Financial Corporations,Primary Agricultural Credit Societies.

(b) Payments made to the Government where such payment is required to bemade in legal tender, for e.g., payment of sales-tax, customs duty, excises dutyetc.

(c) Payments made by way of Letter of Credit, telegraphic transfer, transfer fromone bank account to another or through a Bill of Exchange payable to a bank



Notes (d) Where the payment is made by way of adjustment against the amount of anyliability incurred by the payee for any goods supplied or services rendered bythe assessee to such payee.

(e) Payment for purchases of : (i) agricultural or forest produce, (ii) the produce ofanimal husbandry (including hides and skins), dairy or poultry farming, (iii) fishcultivator, grower or producer of such articles.

(f) Payments made for purchases of products manufactured without the aid ofpower in a cottage industry, if the payment is made to the producer of suchproducts.

(g) Where the payment is made in a village or town, which is not served by anybank, to any person who ordinarily resides or is carrying on any business,profession or vacation in any village or town.

(h) Payment by way of gratuity, retrenchment compensation or similar terminalbenefits made to an employee or his legal heirs, if the income under the headsalary of the employee does not exceed ` 50,000.

(i) Payment made by way of salary to its employees after deducting the IncomeTax from the salary, when such an employee is temporarily posted for acontinuous period of fifteen days or more in a place other than his normal placeof duty or on a ship and the employee does not maintain any account in anybank at such place.

(j) Where the payment is required to be made on a date on which the banks wereclosed, either on account of a holiday or strike.

(k) Payment made by any person to his agent who is required to make paymentsin cash for goods or services on behalf of such a person.

(l) where the payment is made by an authorized dealer or a money changeragainst purchase of foreign currency or travelers cheques in the normal courseof business.

Scope of Disallowance and Cash Payments under Section 40(A)(3)Section 40(A)(3) applies to all categories of expenditure involving payments for

goods or services, which is deductible in computing the taxable income. It does not applyto loan transactions or to payments made by commission agents (arhatiyas) for goodsreceived by them for sale on commission or consignment basis. It does apply topayments made for goods purchased on credit. Hundi transactions entered into inconnection with the advancing of loans or the repaying of loans are outside the scope ofSection 40(A)(3). Payments made to the grower or producer of agricultural products areexcluded from the operation of Section 40(A)(3) even where these have been subjectedto some processing by him. Payments, made in towns having banking facilities forpurchase of goods from a villager whose village does not have banking facilities, are notexcluded from the requirement in Section 40(A)(3) [Press Note: Dated 2.5.1969, issuedby the Ministry of Finance].

The word ‘expenditure’ in Section 40(A)(3) covers expenditure of all categoriesincluding that on purchase of goods and merchandise as also payment for services. Thepayments made in advancing loans and returning the principal amounts of borrowedmoneys are not covered by these provisions of Section 40(A)(3) [Letter: F. No.1(22)/69-TPL (Pt.), dated 18.4.1969].

Return of paid cheques by a bank to its constituents: Banks may now return the paidcheques to their constituents after obtaining a formal undertaking from them to the effectthat they shall retain the returned paid cheques for a period of eight years and produce



Notesthem before the ITO whenever called upon to do so [Circular No. 33 F. No. 9/50/69-IT(A-II), dated 29.12.1969].

Payments made during suspension of clearing operations: Any payment forbusiness expenditure made during the period when the cheque clearing operations aresuspended or other similar circumstances exist, will not be covered by the provisions ofSection 40(A)(3) [Circular No. 250 F. No. 206/1/79-IT (A-II), dated 11.01.1979].

The suspension of cheque clearing and banking operations consequential to thestrike of bank employees will constitute ‘exceptional or unavoidable circumstances’.Accordingly, payments for business expenditure made during this period and until theclearance of cheques is resumed, will be exempted from the operation of Section40(A)(3)* [Letter F. No. 142(14)/70-TPL, dated 28.9.1970].

Illustrative situations of ‘exceptional circumstances’: All the circumstances inwhich the conditions laid down in rule 6 DD (j)* would be applicable cannot be spelt out.However, some of them, which would seem to meet the requirements of the said rule,are :

(a) The purchaser is new to the seller; or(b) The transactions are made at place where either the purchaser or the seller

does not have a bank account; or(c) The transactions and payments are made on a bank holiday or the seller is

refusing to accept the payment by way of crossed cheque/draft and thepurchaser’s business interest would suffer due to non availability of goodsotherwise than from this particular seller; or

(d) The seller, acting as a commission agent, is required to pay cash in turn topersons from whom he has purchased the goods; or specific discount is givenby the seller for payment to be made by way of cash [Circular No. 220 [F. No.206/17/76-IT (A-II)] dated 31.05.1977].

Important Points:1. The provisions of Section 40(A)(3) are attracted only when a payment

exceeding ` 20,000 at a time is made in cash. It is possible that a person maymake different payments at different times during the day to the same personand the aggregate of the payments during the day to the same party mayexceed ` 20,000. In this case, if each payment is below ` 20,000 nodisallowance can be made.

2. The provisions of the section do not cover payments for acquiring capitalassets not for resale.

Provision for Gratuity [Section 40A(7)]:Gratuity actually paid during the year is allowed as a deduction. Provision made for

the payment of gratuity to the employees on retirement or on termination of services willnot be allowed as a deduction in computing taxable profits of the business or profession.However, any provision made by the assessee for the purpose of payment of a sum byway of any contribution towards an approved gratuity fund or for the purpose of paymentof any gratuity that has become payable during the previous year, shall not bedisallowed.

Contribution to Non-statutory Fund [Section 40(A)(9)]:No deduction shall be allowed in respect of any sum paid by the assessee as an

employer towards the setting up of any fund or as contribution to any funds or trustexcept where such sum is paid to a recognised provident fund or an approvedsuperannuation fund or approved gratuity fund.



Notes Table 4.6: Certain Deductions to be made only on Actual Payments [Section 43B]

Expenses When payment should be made toget the deduction

1. Any sum payable by way of tax, duty or fee underany law

2. Any sum payable by the assessee as an employerby way of contribution to any provident fund orsuperannuation fund or gratuity fund or any otherfund for the welfare of employees

3. Any sum payable as bonus or commission toemployees

4. Interest on loans or advances or borrowings fromscheduled banks and public financial institutionsor State Financial Investment Corporation or StateFinancial Corporation like ICICI, IDBI, GIC, UTI,SFC, with the terms and conditions governingsuch loan or borrowing

5. Any sum payable by the assessee as interest onany loan or advance from a scheduled bank inaccordance with the terms and conditions of theagreement governing such loan

During the previous year or on orbefore due date for furnishing return ofincome under Section 139(1).

6. Contribution to provident fund, superannuationfund or any other fund for the welfare of theemployee

As given above

7 Any sum payable by an employer in lieu of leave atthe credit of his employee

As given above

Special Provisions in case of Income of a Public Financial Institution, PublicCompanies etc. [Section 43D]:

1. In the case of a public financial institution or a scheduled bank or a StateFinancial Corporation or a State Industrial Investment corporation, the incomeby way of interest in relation to such categories of bad or doubtful debts as maybe prescribed having regard to guidelines issued by the RBI.

2. In the case of a public company, the income by way of interest in relation tosuch categories of bad or doubtful debts, as may be prescribed, having regardto guidelines issued by the National Housing Bank in relation to such debts,shall be chargeable to tax in the previous year in which it is credited to therespective profit and loss account or as the case may be, the year in which it isactually received by the institution or bank or corporation or company,whichever is earlier.

4.4.5 Miscellaneous Provisions

Profit Chargeable to Tax [Section 41]Recovery of any loss or expenditure [Section 41(1)] : Where any allowance or

deduction has been made in the assessment of any year in respect of loss, expenditureor trading liability and subsequently, during any previous year, any amount received bythe assessee whether in cash or in any other manner in respect of such loss orexpenditure or some benefit for such trading liability by way of remission or cessation



Notesthereof, the amount obtained by him or benefit accruing to him is chargeable to tax asbusiness income.

Important Points:1. Recovery of loss or expenditure is taxable, irrespective of the fact that whether

the business or profession is in existence in that year or not.2. Where the assessee to whom the trading liability may have been allowed has

succeeded in his business, then the successor in business will be chargeableto tax on any amount received in relation to which deduction or allowance hasbeen made. Successor in business means:(a) In case of amalgamation, the amalgamated company;(b) Where a firm is succeeded by another firm, the other firm;(c) Where a person is succeeded by any other person, the other person;(d) Where there has been a demerger, the resulting company.

Balancing Charge [Section 41(2)]: Where any building, machinery, plant orfurniture:

(a) which is owned by the assessee;(b) in respect of which depreciation is claimed under Section 32(1)(i);(c) which was or has been used for the purpose of business;is sold, discarded, demolished or destroyed and the money is payable in respect of

such building, machinery, plant or furniture, as the case may be together with the amountof scrap value, if any, exceeds the written down value, so much of the excess as does notexceed the difference between the actual cost and the written down value shall bechargeable to Income Tax as the income of the business of the previous year in whichthe money is payable for the building, machinery, plant or furniture became due.

If the business is no longer in existence the provisions of Section 41(2) shall apply asif the business is in existence in that previous year.

Sale of Asset used for Scientific Research [Section 41(3)]: If a capital assetused for scientific research is sold without having been used for other purposes and thesale proceeds together with the deduction, allowed u/s 35 exceeds the amount of capitalexpenditure incurred on it, such surplus or the amount of deduction allowed u/s 35,whichever is less, is chargeable to tax as business income of the previous year in whichthe sale took place. If the deduction allowed is less than the aforesaid surplus, the excessof surplus over the deduction allowed is chargeable to tax as capital gain.

Bad Debts Recovered [Section 41(4)] : Where the deduction has been allowed inrespect of a bad debt or part of debt under Section 36(1)(vii) then if the amountsubsequently recovered on such debt (or part) is greater than the difference between thedebt (or part of the debt) and the amount of deduction so allowed, the excess shall bedeemed to be profits and gains of business or profession and chargeable to tax as theincome of the previous year in which the debt is recovered. For this purpose, it isimmaterial whether the business of the assessee is in existence during the P.Y. in whichrecovery is made.

Withdrawal of special reserve created by financial institutions [Section 41(4A)]:Where a deduction has been allowed under Section 36(1)(viii) at the time of creation ofReserve, withdrawal of the same will amount to income.

Set off Losses against Deemed Profits [Section 41(5)]: Deemed profits fromBusiness/Profession u/s 41 can be used to set off business/profession losses, if thefollowing conditions are fulfilled :

1. Business/profession is ceased to exist.



Notes 2. Loss must pertain to the year in which the business/profession ceased to exist.3. It is not possible to set off such loss against any other income of that year.4. Loss is not from speculation business.Recovery after discontinuance of business [Section 176(3A)]: Where any

business is discontinued in any year and any sum is recovered thereafter, it will bedeemed to be income of the recipient and charged to tax in the year of receipt, providedthat it had been chargeable to tax had it been received before the discontinuance of thebusiness.

Special deduction in case of business of exploiting mineral oil including ofpetroleum and natural gas [Section 42] : Special allowance in this regard would bein relation to:

1. expenditure incurred by way of exploration expenses prior to beginning ofcommercial production;

2. expenditure incurred in respect of drilling or exploration activities after thebeginning of commercial production;

3. expenditure incurred in relation to the depletion of mineral oil.Special provision consequential to changes in the rate of exchange of

currency [Section 43A]: Where an assessee has acquired any asset in any theprevious year from a country outside India, for the purpose of his business or professionand in consequence of a charge in the rate of exchange during any previous year afterthe acquisition of such asset, there is an increase or reduction in the liability of theassessee as expressed in Indian currency (as compared to the liability existing at thetime of acquisition of the asset) at the time of making payment:

(a) towards the whole or part of the cost of the asset or(b) towards repayment of the whole or a part of the money’s borrowed by him from

any person, directly or indirectly in any foreign currency specifically for thepurpose of acquiring the asset along with interest, if any.

The amount by which the liability as aforesaid is so increased or reduced duringsuch previous year and which is taken into account at the time of making the payment,irrespective of the method of accounting adopted by the assessee, shall be added to r asthe case may be, deducted for :

1. The actual cost of the asset as defined in Section 43(1).2. The amount of capital expenditure referred to in Section 35(1)(iv) (Scientific

Research).3. Expenditure in the nature of capital expenditure on acquisition of Patent Rights

or copyrights as provided in Section 35A.4. The cost of acquisition of a capital asset (not being a capital asset referred to in

section 50 – computation of capital gains in case of depreciable asset) for thepurpose of mode of computation of capital gains as mentioned in Section 48.

5. The amount of expenditure of a capital nature referred to in Section 36(1)(ix),i.e., promoting family planning amongst its employees and the amount arrivedat after such addition or deduction shall be taken to be the actual cost of theasset or the amount of capital expenditure as the case may be, the cost ofacquisition of the capital asset.

Profits and Gains of Insurance Business [Section 44]: The profits and gains ofany business of insurance carried on by an insurance company or by a mutual insurancecompany or by a cooperative society shall be computed in accordance with the rulescontained in the First Schedule and not in accordance with the provisions of this Act.



NotesIn case of insurance business of a non-resident, the taxable income shall becomputed in the following manner:

Global income × Premium income in India/Total premium income of the company =Total income in India

Maintenance of Accounts by certain persons carrying on profession orbusiness [Section 44AA and Rule 6f]:

A. Person carrying on a specified profession: Every person, carrying onspecified profession, is compulsorily required to maintain prescribed books of accountsand documents if his gross receipts in the profession exceed ` 1,50,000 in all the threeyears immediately preceding the previous year or where the profession has been newlyset up in the previous year, if his gross receipts for that year are likely to exceed the saidamount.

Specified profession: Specified profession include persons carrying on thefollowing professions :

(a) a person carrying on legal, medical, engineering or architectural profession orthe profession of accountancy or technical consultancy or interior decoration orany other profession as is notified by the Board in the Official Gazette.

(b) authorised representatives, film artists and company secretaries have beennotified for this purpose.

Authorised representative means a person, who represents any other person, onpayment of any fee or remuneration, before any Tribunal or Authority constituted orappointed by or under any law for the time being in force, but does not include anemployee of the person so represented or a person carrying on legal profession or aperson carrying on the profession of accountancy.

Film artist, for the aforesaid purpose, means any person engaged in his professionalcapacity in the production of a cinematograph film, whether produced by him or by anyother person as an actor, a cameraman, a director, a music director, an art director, adance director, an editor, a singer, a lyricist, a story writer, a screen play writer, adialogue writer and a dress designer.

The prescribed books and documents under Rule 6F are as follows:(a) A cashbook,(b) A journal, if the accounts are maintained according to the mercantile system of

accounting,(c) A ledger,(d) Carbon copies of machine numbered bills, exceeding ` 25, issued by the

person,(e) Original bills wherever issued to the person and receipts are not issued and the

expenditure incurred does not exceed fifty rupees payment vouchers preparedand signed by the person.

A person carrying on the medical profession shall, in addition to the above books ofaccounts and documents, keep and maintain the following also:

(a) a daily case register in Form 3C;(b) an inventory under broad heads as on the first and the last day of the previous

year, of the stock of drugs, medicines and other consumable accessories usedfor the purpose of his profession.

Persons carrying on specified profession, but whose receipts from the professiondo not exceed the aforesaid amount, are also required to maintain books of accounts,



Notes but in their case, no books have been prescribed. They should maintain such books ofaccounts and other documents and other documents as may enable the AssessingOfficer to compute their taxable income under the Income Tax Act.

B. Person carrying on a non-specified profession or carrying on business:Every other person carrying on a business or non-specified profession, whose totalincome from business or profession exceeds ` 1,20,000 or his total sales or grossreceipts from such business or profession exceed ` 10,00,000 in any of the three yearsimmediately preceding the relevant previous year is required to maintain books ofaccounts. However, in the case of a newly set up business, the assessee will be requiredto maintain accounts compulsorily if, during the relevant accounting year, either his totalincome is likely to exceed ` 1,20,000 or the total sales or gross receipts are likely toexceed ` 10,00,000.

Person falling under the above category is required to maintain such books ofaccounts and other documents as may enable the assessing officer to compute theirtaxable income under the Income Tax Act. No specified accounts books have beenprescribed for this category of persons.

C. Assessees covered under Sections 44AD, 44AE, 44AF, 44BB or 44BBB: Anassessee who is carrying on a business and is covered under Sections 44AD (civilconstructions), 44AE (goods carriages) and 44AF (retail trade) claims that his incomefrom the said business is lower than the deemed profits or gains computed under theabove relevant sections, he shall be required to keep and maintain such books ofaccounts and other documents as may enable the Assessing Officer to compute his totalincome in accordance with the provisions of Income Tax Act. Further in these cases, theassessee will be required to get his accounts audited even if his turnover does notexceed ` 1 crore.

(i) Assessee is carrying on a business or non-specified profession;(ii) The income or total sales or a gross receipt is less than the specified amount;(iii) If he is covered under Sections 44 AD, 44AE, 44AF he should not declare

income lower than that which is prescribed under these relevant sections.Compulsory Audit of Accounts [Section 44AB]:1. Every person carrying on business shall, if his total sales, turnover or gross

receipts in business exceed ` 100,00,000 in any previous year, get hisaccounts of such previous year audited by a Chartered Accountant before thespecified date and furnish by that date the report of such audit in the prescribedform, duly signed and verified, by such accountant.Specified date is November 30 of the relevant Assessment Year in the case ofassessee who has undertaken international transaction as per section 92B orspecified domestic transaction as per newly inserted section 92BA and 30thSeptember of the relevant assessment year in case of any other assessee.

2. In the case of person carrying on a profession, the provisions for compulsoryaudit are applicable if his gross receipts in profession exceed ` 25,00,000 inany previous year.

3. Similarly in case of a person who is carrying on the business and coveredunder Sections 44AD and claims that his income from the said business islower than 8% of the turnover and his income exceeds the maximum amountwhich is not chargeable to income tax in any previous year; he shall get hisaccounts of the previous year audited by a chartered Accountant on or beforethe specified date.



NotesReport of Audit of Accounts (Rule 6G):(a) In the case of a person who carries on business or profession and who is

required by or under any other law to get his accounts audited, be in FormNo. 3CA;

(b) In the case of a person who carries on business or profession, but notbeing a person referred to in clause (a), be in Form No. 3CB.

2. The particulars which are required to be furnished under section 44AB shall bein Form No. 3CD.

Special Provisions for computing profits and gains of business on presumptivebasis [Section 44AD]

The broad features of the scheme are as under:(a) The scheme shall be applicable to an individual, a HUF or partnership firm who

is a resident but not to a Limited Liability partnership firm. The scheme shallalso not be applicable to an assessee who is availing deductions u/s 10AA ordeduction under any provisions of chapter VIA.

(b) This scheme shall not be applicable if the aforesaid gross receipts paid orpayable exceeds an amount of ` 100,00,000.“Gross Receipts” are the amount paid/payable to the assessee by the clientsfor the contract and will not include the value of the material supplied by theclient.

(c) Presumptive taxation is not applicable to a person carrying on profession asreferred to in section 44AA(1); a person carrying income in the nature ofcommission or brokerage income; or, a person carrying on any agencybusiness.

(d) a sum equal to 8% of the total turnover or gross receipts of the assessee in theprevious year on account of such business or as the case may be, a sumhigher than the aforesaid sum claimed to have been earned by the eligibleassessee shall be deemed to be the profits and gains of such business.

(e) Any deduction allowable under the provisions of Sections 30 to 38, shall, forthe purpose of above income, be deemed to have been already given full effectto and no further deduction under those Sections shall be allowed. However,where the eligible assessee is a firm, the salary and interest paid/payable topartners shall be allowed as deduction from the income computed under thisSection. Such deduction shall, however, be subject to the conditions and limitsspecified u/s 40(b).

(e) The written down value of any asset used for the purpose of the business shallbe deemed to have been calculated as if the assessee had claimed and hadbeen actually allowed the deduction in respect of the depreciation for each ofthe relevant assessment years.

(f) an assessee opting for the above scheme shall be exempted from payment ofadvance tax related to such business under the current provisions of theIncome tax Act.

(g) an assessee opting for the above scheme shall be exempted frommaintenance of books of accounts related to such business as required u/s44AA of the Income Tax Act

(h) An assessee with turnover below ` 1 crore, who shows an income below thepresumptive rate prescribed under these provisions, will, in case his totalincome exceeds the taxable limit, be required to maintain books of accounts as



Notes per section 44AA(2) and also get then audited and furnish report of each suchaudit as required under section 44AB

Special Provisions for computing Profits and Gains of Business of Plying,Hiring or Leasing Goods Carriages [Section 44AE]:

Notwithstanding any to the contrary contained in sections 28 to 43C, the scheme u/s44AE also provides for a system for estimating the income of an assessee engaged inthe business of plying, hiring, or leasing of goods carriages. The broad features of thescheme are:

(a) The scheme is applicable to an assessee who owns not more than 10 goodscarriages at any time during the previous year and who is engaged in thebusiness of plying, hiring or leasing of such goods carriages;

(b) The profits and gains of each goods carriage owned by the above assessee inthe previous year shall be estimated as under:

(i) For heavy goods vehicle – ` 5,000 or actual amount earned whichever ishigher for every month or part of a month during which the heavy vehicleis owned by the assessee in the previous year.(ii) For goods carriage other than heavy goods vehicle - ` 4,500 or actualamount for every month or a part of a month in during which the goodscarriage is owned by the assessee in the previous year. The assesseemay declare a higher income than that specified above.

(c) Any deduction allowable under the provisions of Sections 30 to 38 shall, for thepurpose of the above income, be deemed to have been already given full effectto and no further deduction under those Sections shall be allowed.Remuneration and interest paid/payable to partners, shall be allowed asdeduction from the income computed under this Section. Such deduction shall,however, be subject to the conditions and limits specified u/s 40 (b).

(d) The Written Down Value of any asset used for the purpose of the businessshall be deemed to have been calculated as if the assessee had claimed andhad been actually allowed the deduction in respect of the depreciation for eachof the relevant assessment years.

(e) The provisions of Sections 44AA and 44AB shall not apply in so far as theyrelate to this business. And in computing the monetary limits under thoseSections for other business, the gross receipts or, as the case may be, theincome from the said business shall be excluded.

(f) The assessee may choose not to opt for the scheme and may declare anincome lower than the specified amount. In this case, w.e.f. assessment year1998-99 the assessee shall have to maintain books of accounts and get hisaccounts audited by a Chartered Accountant.

Special Notes1. The expression ‘goods carriage’ and ‘heavy goods vehicle’ shall have the

meanings respectively assigned to them in Section 2 of the Motor Vehicles Act,1988. According to Section 2(14) of the Motor Vehicles Act, 1988 theexpression ‘goods carriage’ means:(a) any motor vehicle constructed or adapted for use solely for the carriage of

goods, or(b) any motor vehicle not so constructed or adapted when used for the

carriage of goods and according to Section 2(16) of the Act, theexpression “heavy goods vehicle” means(i) any goods carriage the gross vehicle weight of which, or



Notes(ii) a tractor the unladen weight of which, or(iii) a road roller the unladen weight of which, exceeds 12,000 kilograms.

2. An assessee, who is in possession of a goods carriage, whether taken on hirepurchase or on instalments.

3. And for which the whole or part of the amount payable is still due, shall bedeemed to be the owner of such goods carriage.

4. The income estimated as per Section 44AE, shall be his income from thebusiness of plying, hiring, or leasing goods carriages. This income will beaggregated with the other income of the assessee and deductions u/s 80C to80U, if any, will be available to the assessee, subject to fulfillment of conditionsmentioned therein.

5. Income from vehicles is to be computed for every month or part of the monthduring which these were owned by the assessee even though these are notactually used for business.

6. Provision of section 44AE are not applicable in case the assessee owns morethan 10 goods carriage or where he decides lower profits and gains than theprofits and gains specified in section 44AE.

Special Provisions for Computing Profits and Gains of Retail Business uptoA.Y. 2010-11 only [Section 44AF]:

A special scheme has been introduced for estimating the profits and gains ofassessees engaged in retail trade and the broad features of the scheme are as under:

(a) In the case of an assessee engaged in retail trade in any goods ormerchandise, a sum equal to 5% of the total turnover in the previous year onaccount of such business shall be deemed to be profits and gains of suchbusiness chargeable under the head profits and gains of business orprofession. The assessee can however voluntarily declare a higher income inhis return. The scheme shall not be applicable if the total turnover of such retailtrade exceeds ` 40 lakhs in the previous year.

(b) Any deduction allowable under the provisions of sections 30 to 38 shall for thepurpose of above income be deemed to have been already given full effect toand no further deduction under these sections shall be allowed. However,remuneration to working partner and interest paid or payable to partner shall beallowed as deduction from the income computed under this section. Suchdeduction shall however be subject to conditions and limits specified undersection 40(b).

(c) The written down value of any asset used for the purpose of the business shallbe deemed to have been calculated as if the assessee had claimed and hadbeen actually the deduction in respect of depreciation for each of the relevantassessment years.

(d) The provisions of sections 44AA and 44 AB shall not apply in so far as theyrelate to this business and in computing the monetary limits under thesesections, the total turnover or as the case may be, the income from saidbusiness shall be excluded.

(e) The assessee may choose not to opt for this scheme and may declare anincome lower than the specified amount. In this case, the assessee shall haveto keep and maintain books of accounts as per Section 44AB.

With effect from assessment year 2011-12, section 44AF will be deleted and anew section 44AD shall substitute the existing provision sec. 44AD as the act has



Notes expanded the scope of presumptive taxation to all business. The salient features ofthe presumptive taxation scheme are as under:

(a) The scheme shall be applicable to individuals, HUFs and the partnership firmsexcluding Limited liability partnership firms. It shall also not be applicable to anassessee who is availing deductions under sections 10A, 10AA, 10B, 10BA ordeductions under any provisions of Chapter VIA under the heading“C-deductions in respect of certain incomes” in the relevant assessment year.

(b) The scheme is applicable for any business (excluding a business alreadycovered under section 44AE) which has maximum gross turnover/grossreceipts of ` 40 lakhs.

(c) A sum equal to 8% of the total turnover or gross receipts of the assessee in theprevious year on account of such business or as the case may be, a sumhigher than the aforesaid sum claimed to have been earned by the eligibleassessee shall be deemed to be the profits and gains of such business.

(d) Any deduction allowable under the provisions of sections 30 to 38 shall for thepurpose of above income be deemed to have been already given full effect toand no further deduction under these sections shall be allowed. However,remuneration to working partner and interest paid or payable to partner shall beallowed as deduction from the income computed under this section. Suchdeduction shall however be subject to conditions and limits specified undersection 40(b).

(e) The written down value of any asset used for the purpose of the business shallbe deemed to have been calculated as if the assessee had claimed and hadbeen actually the deduction in respect of depreciation for each of the relevantassessment years.

(f) An assessee opting for the above scheme shall be exempted from payment ofadvance tax related to such business under the current provisions of theIncome Tax Act.

(g) An assessee opting for the above scheme shall be exempted frommaintenance of books of accounts related to such business as required undersection 44AA of the income tax Act.

(h) An assessee with turnover below ` 40 lakh who shows an income below thepresumptive rate prescribed under these provisions, will, in case his totalincome exceeds the taxable limit, be required to maintain books of accounts asper section 44AA(2) and also get them audited and furnish a report of eachsuch audit u/s 44AB.

(i) The existing section 44AF will be made inoperative for the Assessment Yearbeginning on or after 1-4-2011.

Special provisions in the case of shipping business [Section 44B]In the case of an assessee, who is a non-resident and is engaged in the business of

operation of ships, a sum equal to 7.5 percent of the aggregate of the following:(a) The amounts paid or payable whether in or out of India to the assessee on

account of carriage of passengers, livestock, mail or goods shipped at any portin India, and,

(b) Any amount received or deemed to be received in India on account of carriageof passengers, livestock, mail or goods shipped at any port outside India, shallbe deemed to be the profits of such business. The carriage amount will alsoinclude amount paid or payable by way of demurrage charge or any otheramount of similar nature.



NotesSpecial provision for deduction in the case of business for prospecting etc.for mineral oil [Section 42 and 44BB].

Section 42: Special deduction in case of business of exploiting mineral oilincluding of petroleum and natural gas: Special allowance in this regard would be inrelation to:

1. Expenditure incurred by way of exploration expenses prior to beginning ofcommercial production.

2. Expenditure incurred in respect of drilling or exploration activities after thebeginning of commercial production.

3. Expenditure incurred in relation to the depletion of mineral oil.The provision of Section 44BB are given below:Condition:(i) The assessee is non-resident.(ii) The assessee is engaged in the business of providing services and facilities in

connection with or supplying plant and machinery on hire, used or to be used inthe exploration for and exploitation of mineral oils.

Consequences if the above conditions are satisfied:(i) The provisions of sections 28 to 41, 43 and 43A are not applicable.(ii) Income is calculated at the rate of 10% of the amounts given below.(iii) The amount in respect of which the provisions apply are the amounts paid or

payable to the tax payer or to any person on this behalf whether in or out ofIndia, on account of the provision of aforesaid services or facilities or supplyingplant and machinery for the aforesaid purposes. The amount also includes theamounts received or deemed to be received in India on account of suchservices or facilities or supply of plant and machinery.

Special provisions for computing profits and gains of business of operationsof aircraft in the case of non-residents [Section 44BBA]: Notwithstanding anything tothe contrary contained in Sections 28 to 43A, the income of a non-resident engaged inthe business of operation of an aircraft shall be completed at flat rate of 5% of:

(a) the amount paid or payable whether in India or out of India to the assessee orto any person on his behalf on account of carriage of passengers, livestock,mail or goods from any place in India and

(b) The amount received or deemed to be received in India, on account of carriageof such items from a place outside India.

Special provisions for computing profits and gains of foreign companiesengaged in the business of civil construction etc. in certain turnkey power projects[Section 44BBB]: Notwithstanding anything to the contrary contained in Section 28 to44AA in the case of an assessee, being a foreign company, engaged in the business ofcivil construction or the business of erection of plant or machinery or testing orcommissioning thereof, in connection with a turnkey power project approved by theCentral Government in this behalf and financed under international aid programme, asum equal to 10% of the amount paid or payable (whether in or out of India) to the saidassessee or to any person on his behalf on account of such civil construction, erection,testing or commissioning shall be deemed to be profits and gains of such businesschargeable to tax under the head ‘Profits and Gains of Business/Profession’.

Method of Accounting:1. Mercantile system of accounting is compulsory for business, whereas cash

system is permitted for professionals. Accrual principle is followed in mercantile



Notes system which refers to the assumption that revenues and costs are accrued,that is, recognised as they are earned or incurred (and not as money isreceived or paid) and recorded in the financial statements of the periods towhich they relate.

2. The following accounting standards are notified, to be followed by all theassessees following mercantile system of accounting, namely:

3. Accounting Standard I relating to disclosure of accounting policies:I. All significant accounting policies adopted in the preparation and

presentation of financial statements shall be disclosed.II. The disclosure of the significant accounting policies shall form part of the

financial statements and the significant accounting policies shall normallybe disclosed in one place.

III. Any change in an accounting policy which has a material effect in theprevious year or in the years subsequent to the previous years shall bedisclosed. The impact of and the adjustments resulting, from, suchchange, if material, shall be shown in the financial statements of theperiod in which such change is made to reflect the effect of such change.Where the effect of such a change is not ascertainable, wholly or in part,the fact shall be indicated. If a change is made in the accounting policieswhich has no material effect on the financial statements for the previousyear but which is reasonably expected to have a material effect in anyyear subsequent to previous year, the fact of such change shall beappropriately disclosed in the previous year in which the change isadopted.

IV. Accounting policies adopted by an assessee should be such so as torepresent a true and fair view of the state of affairs of the business,profession or vocation in the financial statements prepared and presentedon the basis of such accounting policies. For this purpose, the majorconsiderations governing the selection and application of accountingpolicies are following namely:(a) Prudence: Provisions should be made for all known liabilities and

losses even though the amount cannot be determined with certaintyand represents only a best estimate in the light of availableinformation.

(b) Substance over form: The accounting treatment and presentationin financial statements of transactions and events should begoverned by their substance and not merely by the legal form.

(c) Materiality: Financial statements should disclose all material items,the knowledge of which might influence the decisions of the user ofthe financial statements.

4. If the fundamental accounting assumptions relating to Going Concern,Consistency and Accrual are followed in financial statements, specificdisclosure in respect of such assumptions is not required. If a fundamentalaccounting assumption is not followed, such fact shall be disclosed.‘Consistency’ refers to the assumption that accounting policies are consistentfrom one period to another. ‘Financial Statements’ means any statement toprovide information about the financial position, performance and changes inthe financial position of an assessee and includes balance sheet, profit andloss account and other statements and explanatory notes forming part thereof.‘Going Concern’ refers to the assumption that the assessee has neither the



Notesintention nor the necessity of liquidation or of curtailing materially the scale ofthe business, profession or vocation and intends to continue his business,profession or vocation for the foreseeable future.

5. Accounting Standard II relating to disclosure of prior period and extraordinaryitems and changes in accounting policies.Prior period items shall be separately disclosed in the profit and loss accountas part of taxable income. The nature and amount of each such item shall beseparately disclosed in a manner so that their relative significance and effecton the operating results of the previous year can be perceived.A change in an accounting policy shall be made only if the adoption of adifferent accounting policy is required by statute or if it is considered that thechange would result in a more appropriate preparation or presentation of thefinancial statements by an assessee.Any change in an accounting policy, which has a material effect, shall bedisclosed. The impact of and the adjustments resulting from such change, ifmaterial shall be shown in the financial statements of the period in which suchchange is made to reflect the effect of such change. Where the effect of suchchange is not ascertainable, wholly or in part, the fact shall be indicated. If achange is made in the accounting policies which has no material effect on thefinancial statements for the previous year but which is reasonably expected tohave a material effect in years subsequent to the previous years, the fact ofsuch change shall be appropriately disclosed in the previous year in which thechange is adopted.A change in an accounting estimate that has a material effect in previous yearshall be disclosed and quantified. Any change in an accounting estimate whichis reasonably expected to have a material effect in years subsequent toprevious year shall also be disclosed.

Deduction of Head Office Expenditure in the case of Non-residents [Section44C]: Notwithstanding anything to the contrary contained in Sections 28 to 43A, in thecase of an assessee, being a non-resident no allowance shall be made in computing theincome changeable under the head ‘Profits and Gains of Business/Profession’, in respectof so much of the expenditure in the nature of head office expenditure as is in excess ofthe amount computed as hereunder normally:

(a) an amount equal to five percent of the adjusted total income or(b) the amount of expenditure in the nature of head office expenditure incurred by

the assessee as is attributable to the business or profession of the assessee inIndia, whichever is the least.

Provided that, in a case where the adjusted total income of the assessee is a loss,the amount under clause (a) shall be computed at the rate of five percent of the averageadjusted total income of the assessee during the last three years so that loss of thatparticular year need not be accounted for computing average adjusted total income. H.O.expenses means executive and general administration expenditure incurred by theassessee outside India including rent, rates, taxes, repairs or insurance of any premisesoutside India used for the purpose of business. Salary, wages, annuity, pension, fees,bonus, commission, gratuity, perquisites or profits in lieu of or in addition to salary of anyoffice outside India, travelling by an employee or other persons employed in or managingthe affairs of any office situated outside India, and such other matters connected withexecutive and general administration as may be prescribed.



Notes Special Provisions in the Case of Royalty Income of Foreign Companies[Section 44D]

The provisions are given below:Agreement made before April 1, 1976: Where such income is received under an

agreement before April 1, 1976, the deduction in respect of expenses incurred forearning such income is subject to a ceiling limit of 20% of the gross amount of suchincome, as reduced by the amount, if any, of so much of the royalty income as consists oflump sum consideration for the transfer outside India of, or the imparting of informationoutside India in respect of, any data, documentation, drawing or specification relating toany patent, invention, model, design, secret formula or process or trade mark or similarproperty.

Agreement made after April 1, 1976 not being covered by Section 44DRoyalties and technical service fees received under an agreement made after

31-3-1976 but before 1-6-1997 not being covered by Section 44DA are chargeable to tax@ 30% (+ SC + EC); under an agreement made after 31-5-1997 but before 1-6-2005 @20%; and in pursuance of an agreement made after 31-5-2005 @ 10%; by virtue ofsection 115A in the following four cases–

(a) Where such agreement is with the Government of India; or(b) Where such agreement is with an Indian concern, the agreement is approved

by the Central Government ; or(c) Where such agreement relates to a matter included in the industrial policy, for

the time being in force, of the Government of India, the agreement is inaccordance with that policy; or

(d) Where such royalty is in consideration for the transfer of all or any rights(including the granting of a license) in respect of copyright in any book on asubject referred to in proviso to subsection (IA) of Section 115A to the Indianconcern or in respect of computer software referred to the second proviso toSection 115A(IA) to a person resident in India

Special provision for computing income by way of royalties etc. in the case ofnon-residents in pursuance of an agreement entered into after 31-3-2003 – Section44DA:

The income by way of royalty or fees for technical services received fromgovernment or an Indian concern in pursuance of an agreement made by a non resident(not being a company) or a foreign company with govt. of the Indian concern after 31stday of March 2003, where such non-resident (not being a company) or a foreigncompany carries on business in India through a permanent establishment situatedtherein, or perform professional services from a fixed place of profession situated thereinand the right property or contract in respect of which the royalties or fees for technicalservices are paid is effectively connected with such permanent establishment or fixedplace of profession, as the case may be, shall be computed under the head “Profits andgains of business or profession” in accordance with the provisions of this Act.

Provided that no deduction shall be allowed:1. In respect of any expenditure or allowance which is not wholly and exclusively

incurred for the business of such permanent establishment or fixed place ofprofessions in India or

2. In respect of amounts, if any, paid (otherwise than towards reimbursement ofactual expenses), by the permanent establishments to its head office or to anyof its other offices.



NotesIt may be noted that every non-resident (not being a company) or a foreign companyshall keep and maintain books of accounts and other documents in accordance with theprovisions contained in Section 44AA and get his accounts audited by an accountant asdefined in Section 288(2) and furnish along with the return of income, the report of suchaudit in the “prescribed form” duly signed and verified.

Note: In order to remove the doubts and clarify the distinct scheme of taxation ofincome by way of technical services, it is proposed (by Finance Bill 2010) to amend theproviso to Section 44BB so as to exclude the applicability of section 44BB to the incomewhich is covered under section 44DA. Similarly section 44DA is also proposed to beamended to provide that provisions of section 44BB shall not apply to the incomecovered under section 44DA.

Problems on Computation of Income from Business/ProfessionProblem 1: Dr J.L. Gupta is a renowned medical practitioner who maintains books

on cash basis. The following is the balance sheet of the receipts and payments a/c for thefinancial year 2013-14 in `.

Particulars ` Particulars `

Balance brought forwardConsultation fees

2012-132013-14

Visiting feesLoan from bankSale of medicinesGifts from patientsRoyalties for articles published invarious journalsDividendInterest on GovernmentSecurities

44,000

5,0001,35,000

30,0001,25,000

60,0005,000

6,00010,000

7,000

Rent of clinic2013-142014-15

Water & Electricity BillsPurchase of professional booksHousehold expensesCollection charges for dividendincomeMotor car purchasedSurgical equipment purchasedIncome-taxBanking cash transaction taxSalary to staffLife insurance premiumGift to sonInterest on loanCar expensesPurchase of medicinesBalance c/d

24,8001.2002,000

40,00047,800

1001,30,000

24,8007,0003,000

15,00015,000

5,00011,00015,00040,00045,300

4,27,000 4,27,000

Compute his income from profession for the A.Y. 2014-15 after taking into accountthe following information:

1. Books worth ` 25, 000 were purchased on 15-5-2013, which were annualpublication and the balance on 5-2-2014 which were books other than annualpublications.

2. Car was purchased on 1-1-2014 and the surgical equipment on 4-9-2013.3. It is estimated that 1/3 of the use of car is for his personal use.4. Gifts and presents include ` 2,000 from patients in appreciation of his medical

service and ` 3,000 received as birthday gifts.



Notes 5. Opening and closing stock of medicines amounted to ` 10,000 and ` 6,000respectively.

Solution:

Particulars `

Gross receiptsConsultation fees

2012-132013-14

Visiting feesSale of medicinesGifts from patients

5,0001,35,000

30,00060,000

2,000

2,32,000Less: Expenses:Rent of the clinic

2013-142014-15

Water & Electricity BillsDepreciation booksOn 25000-100%On 15,000-30%

Depreciation on car [15% (1/2 ×130,000 × 2/3)]Depreciation on surgical equipment [15% on 24,800]Banking cash transaction taxSalary to staffInterest on loanCar expenses [2/3 × 15,000]Medicines consumed [40,000 + 10,000 − 6,000]

24,8001,2002,000

25,0004,5006,5003,7203,000

15,00011,00010,00044,000

1,50,720

Income from profession 81,280

Royalty for articles is taxable under the head ‘Income from other sources’

Books which are annual publications are eligible for depreciation @ 100% whereasbooks other than annual publication are eligible for Depreciation @ 60%. Since the bookswhich are not annual publication were purchased on 5-2-2014, depreciation should becharged @ 50% of 60%, i.e., 30%.

Problem 2: R is engaged in the business of civil construction. The profit and lossaccount of the company for the year ending 31-3-2013 is as under:


Opening stock of building materialsSalary to workers and employeesPurchase of building materialsInterest on loanOffice Admin. ExpensesTravelling expensesMunicipal taxes on godownInsurance premium for godown

40,0004,10,000

24,00,0003,20,0002,60,0001,40,000

12,0008,000

Receipts from the business of civilconstruction contractsRent of godownSurplus from insurancecompensation received for loss ofplant and machines by fireInterest on company depositsDividend from companies

37,60,00080,000

2,00,00025,00050,000



NotesDirectors’ remunerationDepreciation on plant and machineryProvision for tax

Current taxDeferred tax

Net profit

2,53,00065,000

1,00,00043,00089,000

Closing stock of building materials 25,000

41,40,000 41,40,000

Some additional information is given below:1. Municipal tax of godown includes ` 3,000 not paid by the company.2. The book value of the plant and machinery, which was insured against fire was

` 4,20,000. The WDV of plant and machinery block under Section 43(6) as on31-3-2012 was ` 1, 85,000.

3. The entire building material was purchased from a firm in which the MD of thiscompany is a partner. The fair market value of materials purchased is` 20,00,000.

4. Interest on loan includes ` 15,000 being interest on loan taken for investment inshares of various companies.

5. Office admin. Expenses include ` 90,000 paid as a donation to charitableorganisation recognised under Section 80G.

6. The prescribed rate of depreciation under the I-T Rules for Plant andMachinery is 15%.

7. The company has decided to follow the presumptive tax provision in respect ofits business income.

Compute the total income of X Ltd. for the A.Y.2013-14. Your answer should includeexplanations of your treatment of various items. Ignore the provision of minimumalternate tax under Section 115JB.

Solution:Computation of income from house propertyRent from godown 80,000Less municipal tax on godown actually paid during P.Y. 2012-13 9,000

71,000Deduction u/s 24Statutory deduction @ 30% 21,300Income from house property 49,700Computation of business incomeIncome from business of civil construction (8% of 37,60,000) 3,00,800

Computation of capital gainsSales consideration 4,20,000 + surplus 2,00,000 6,20,000Less: WDV of plant and machines block as on 1-4-2012(assuming such WDV is after deducting depreciation forprevious year 2011-12) 1,85,000Short-term capital gains 4.35,000



Notes Computation of income from other sourcesInterest on company deposits 25,000Dividend from companies ExemptIncome from other sources 25,000Gross total Income 8,10,500Less: Deduction u/s 80G ` 90,000 but 50% of the adjustedGross total income, i.e., 50% of 81,050 40,525Total income 7,69,975Rounded to the nearest tenProblem 3: A submits to you following profit and loss A/c for the year ending

31-3-2013. The date of furnishing the return of income in his case is 30-9-2013.+3


SalaryBonus 25%Repairs of house propertyMunicipal taxes of house propertyRepairs of machineExpenditure on scientific researchDepreciation @25% on machinepurchased for scientific research for6 monthsDonation to National Lab for ScientificResearchPatents and copyrights (1/10)Amortisation of Preliminary Exp. (2/5)Bad debtsProvision for bad and doubtful debtsExpenses on family planningamongst employeesDonation to approved institution forfamily planningPremia for insurance on health ofemployeesInterest on borrowed capitalContribution to RPF @ 14% ofemployees’ salaryContribution to ESIEntertainment expensesAdvertisement expensesTravelling expensesExpenses on guest house:(a) Repair of guest house(b) Salary to employees(c) Other expensesLoss due to theft of stocks

1,50,00037,50015,00020,00030,00020,000

12,500

10,00014,000

5,0005,000

10,000

12,000

8,000

20,00050,000

−18,000

6,00020,00050,00060,000

5,00012,000

8,00010,000

Gross profitRent of 50% house propertygiven on rentBad debt recovered, earlierallowed as deductionExcise duty recovered, earliernot allowed as deductionReceipts from guests usingguest houseGift from fatherProfit on machine sold

9,08,000

24,000

10,000

5,000

12,00010,00015,000



NotesLife insurance premium of ALoss of stock due to fireSales taxSales tax penaltyInterest for late payment of sales taxDiwali expensesLump sum for technical know-howacquired on 1-1-2011Income-tax paidWealth-tax dueDepr. on machine sold @ 20% for9 monthsDepr. on machine purch. @ 20% for9 monthsDepr. on machine purch. @ 20% for3 monthsDepr. on machine @ 20% for full yearNet Profit

5,00015,00060,00010,000

6,00010,000

30,00030,00020,000

15,000

24,000

6,00025,000

1,20,000

9,84,000 9,84,000

Additional information:1. Salary includes ` 10,000 paid to employees as entertainment allowance.2. Bonus was due on 31-3-2013 which was paid as under:

25-7-2013 ` 30,00030-11-2013 ` 7,500

3. Municipal taxes were due on 31-3-2013. ` 15000 were paid on 29-7-2013. Thebalance is still outstanding. The due date as per municipal laws was 15-4-2013.50% of the house property is used for own business and the balance 50% hasbeen let out to others for business.

4. ` 5,000 paid towards insurance on health of employees was paid in cash.5. Interest includes the following

(a) Interest on money borrowed for purchase of machine during the year put touse immediately ` 20,000. The loan was taken from a financial institution.The interest was due on 31-3-2013 but was paid on 31-12-2013

(b) Interest on money borrowed for purchase of house property ` 30, 000.6. ` 1000 as contribution to ESI by employer, already included in P & L A/c was

due on 31-3-2013 but was paid on 20-11-2013.7. ` 2000 was recovered as contribution by workers on account of PF for the

month of March 2010. It was supposed to be deposited by 15-4-2010 but wasdeposited on 30-4-2010.

8. Entertainment includes:(a) ` 13,000 spent on providing food and beverages to employees at place of

work;(b) ` 6000 spent on providing food and beverages to customers at office.

9. Advertisement expenses include ` 40,000 being cost of 20 brief cases given tocustomers. It also includes ` 5,000 for advertisement given to a political party.

10. Travelling expenses were paid to employees @ ` 2,000 per day.



Notes 11. Sales tax includes a sum of ` 20,000 due on 31-3-2013. The same was paid on31-5-2013. The due date under the sales tax law was 15-5-2013. Further, italso includes ` 25,000 deposited in cash with the State Bank of India.

12. Diwali expenses include ` 2000 gifts given to wife of A on her visit to office onDiwali day.

13. Wealth-tax was due on 31-3-2013 but the same was paid on 30-6-2013.14. Rate of depreciation for machinery as per income tax is 15%.15. Patents were acquired on 5-6-2012 for ` 1, 40,000.16. Preliminary expenses were incurred in the previous year 2009-10.

Solution:

Computation of Gross Total Income of A for the assessment year 2013-14

Net profit as per P & L A/c (`)1,20,000

Less: Income credited to P & L A/c but either taxable under other headsor not taxable

(a) Rent from house property(b) Excise duty recovered(c) Gifts from father(d) Profit on machine sold to be considered under-depreciation

24,0005,000

10,000

15,000 54,000

Add: Expenses inadmissible1. Bonus as paid after due date of return2. Municipal tax 50% on let out portion3. Balance 50% municipal taxes of business, but not paid till the due

date of return of income (` 10,000 − ` 7,500 paid till due date ofreturn)

4. 50% repair of house property, balance allowed under houseproperty

5. Depreciation on machine for scientific research to be consideredseparately.

6. Patents and copyrights7. Preliminary exp in excess of 1/5th8. Provision for bad and doubtful debts9. Expenditure on family planning (allowed only to company

assesses)10. Donation to approved institution for family planning (deduction

allowable from GTI)11. Premia for insurance of health of employees (allowed only if paid

by cheque)12. Interest on financial institution (paid after due date of return)13. Interest on purchase of house property 50% (allowed under house

property)14. Contribution to ESI(deposited after due date of furnishing the

return of income deduction will be allowed in next year as paid on2011-2013.

15. Advertisement to political party

7,50010,000

2,500

7,500

12,50014,000

2,50010,000

12,000

8,000

5,00020,000

15,000

66,000



Notes16. LIP of A17. Sales-tax penalty18. Out of Diwali expenses – Gift to wife19. Lump sum payment for technical know-how20. Wealth tax21. Income tax22. Depreciation on machine for separate consideration

(` 15,000 + 24,000 + 6000 + 25,000)

1,0005,0005,000

10,0002,000

30,00020,00030,00070,000 2,99,500

Less: Amount allowable:(1) 100% cost of machine for scientific research(2) Extra 25% deduction for donation to national Lab(3) Depreciation on machine as per Income Tax Act (as per note),(4) Depreciation on intangible assets (as per note).

1,00,0002,500

51,75038,750

3,65,500

1,93,000

Add Contributions by employees to PF not deposited by due date by theemployer Profits and gains of business or profession

1,72,5002,000

1,74,500

Income from house property

Gross Annual ValueLess: Municipal taxes (not allowed as outstanding even though paidby due date of return)Net Annual valueLess: Deductions u/s 24(1)

Statutory deduction @ 30% 7,200Interest @ 50% 15,000

Gross Total Income

24,000

NIL24,000

22,2001,800

1,76,300

Working Notes:1. Entertainment expenditure will now be allowed in full.2. Calculation of depreciation

(a) WDV of 15% block of machine at the beginning of the year will be:WDV of machine sold (15,000 × 100/20 × 12/9) 1,00,000WDV of machine on which depreciation is charged for full year 1,25,000WDV at the beginning of the year 2,25,000

(b) Asset purchased during the yearUsed for 180 days or moreCost of asset purchased on which 9 months depreciation isCharged (24,000 × 100/20 × 12/9) 1,60,000Used for less than 180 daysCost of asset purchased on which 3 months depreciation isCharged (6,000 × 100/20 × 12/3)(c) Sale price of machine sold during the year

WDV at the beginning of the year 1,00,000



Notes Less: Depreciation charged 15,00085,000

Profit on sale 15,0001,00,000

(d) Depreciation will be charge as under:WDV of the block at the beginning of the year 2,25,000Additions 1,60,000 + 1,20,000 2,80,000Less: Sold during the year 1,00,000

4,05,000Depreciation at 15% × 50% on 1,20,000 9,000Depreciation at 15% on2,85,000 42,750

51,7503. Guesthouse expenses will now be allowed in full.4. Municipal taxes of house property used for business will be allowed on due

basis if the payment of the same is made on or before due date of furnishingthe return of income. However, the municipal taxes due on account of houseproperty, will not be allowed as deduction on due basis if the payment is madeon or before the due date of furnishing the return of income.

5. Cost of assets purchased for scientific research is allowed in full. It does notform part of depreciable assets.

6. Donation to approved institute for family planning will be allowed as deductionfrom GTI u/s 80G.

7. Depreciation on intangible assetsWDV as on 1-4-2012 NilPatents 1,40,000Technical know-how 30,000

1,70,000Less: Sold during the year NILWDV as on 31-3-2013 1,70,000Less: Depreciation (` 140,000 @ 25%) 35,000` 30,000 @ 12.5% used for less than 180 days 3,750

38,750WDV as on 1-4-2013 1,31,250

4.5 Income under the Head Capital Gains

4.5.1 IntroductionUnder this head of income, profits arising from sale of capital assets and how to

compute tax an assessee has to pay in this regard and how can get tax exemption isdiscussed

4.5.2 Basis of Charge [Sections 45 and 46]Transfer of Capital Asset [Section 45(1)]: Any profits and gains arising from the

transfer of a capital asset effected in the previous year shall be deemed to be chargeableto Income Tax under the head ‘Capital Gains’ and shall be deemed to be the income ofthe previous year in which the transfer took place excluding the exemptions provided.



NotesPosition after Insertion of Section 45(1A): Capital gain in case of amountreceived from an insurer on account of damage or destruction of any capital asset:According to this Section, where any person receives at any time during any previousyear any money or other assets under an insurance from an insurer on account ofdamage to or destruction of any capital asset, as a result of:

(i) Flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature;or

(ii) Riot or civil disturbance; or(iii) Accidental fire or explosion; or(iv) Action by an enemy or action taken in combating an enemy (whether with or

without a declaration of war, then, any profits or gains arising from the receiptof such money or other assets shall be chargeable to Income Tax under thehead capital gains and shall be deemed to be the income of such a person ofthe previous year in which such money or other asset was received and for thepurposes of Section 48, value of any money or the fair market value of otherassets on the date of such receipt shall be deemed to be the full value of theconsideration received or accruing as a result of the transfer of such a capitalasset. It shall be deemed to be the income of such a person for the previousyear in which such money or other asset is received.

Conversion of a Capital Asset into Stock in Trade [Section 45(2)]: A person whois the owner of a capital asset may convert the same or treat it as stock in trade of thebusiness carried on by him. Such conversion is transfer under Section 2(47) and profitsor gains arising from such conversion shall be chargeable to tax as his income of theprevious year in which such stock-in-trade is sold or otherwise transferred by him.

For the purpose of computing the capital gains in such cases, the fair market valueof the capital asset on the date on which it was converted into stock in trade shall bedeemed to be full value of the consideration received or accruing as a result of thetransfer of the capital asset.

Total profit on the sale of stock in trade is treated in the following manner:Total Profit = (SP – Cost of Capital Asset)

Capital gains u/s 45(2)(Fair market value – Cost of capital as on conversion)

– Asset SP = Selling Price

Business Income u/s 28SP – Fair market value as

on Conversion

Transfer by a Partner [Section 45(3)]: Where a partner or a member of anassociation of persons or body of individuals, transfers any asset by way of capital,contribution and otherwise to the firm partner/member shall be chargeable to tax as hisincome of the previous year in which such a transfer takes place. The amount recorded inthe books of firm/association, as the value of the asset shall be deemed to be the fullvalue of consideration received or accrued.

Transfer by a Firm [Section 45(4)]: Where a firm or AOP or BOI transfers a capitalasset on its dissolution or otherwise to a partner/member, the gains arising to thefirm/association shall be chargeable to tax as its income of the previous year in whichsuch transfer takes place. The fair market value of the asset on the date of such atransfer shall be deemed to be the full value of consideration received or accrued.

Compulsory Acquisition of an Asset and Enhanced Compensation [Section45(5)]: Sometimes, when a building or other capital asset belonging to a person is takenover by the Central Government by way of compulsory acquisition, capital gains may



Notes arise. Such capital gains are chargeable as the income of the previous year in whichsuch compensation was received.

Enhanced compensation: Many times, persons whose capital assets have beentaken over by the Central Government go to the court of law for enhancement of thecompensation. Enhanced compensation received, if any, is chargeable capital gains inthe year in which the same is received. In this context, the following points are to benoted :

1. The cost of acquisition/improvement shall be taken to be NIL.2. Where an assessee expires or for any other reason, the enhanced

compensation is received by any other person, the other person is liable to paytax on such capital gains.

3. Litigation expenses for getting the compensation enhanced are deductible.4. Where the compensation is subsequently reduced by the court, such assessed

capital gain shall be recomputed.Transfer of Securities by the Depository [Section 45(2A)]: Where any person

has had, at any time during previous year any beneficial interest in any securities, then,any profits or gains arising from transfer made by the depository or participant of suchbeneficial interest in respect of the securities shall be chargeable to Income Tax as theincome of the beneficial owner of the previous year in which such transfer took place andshall not be regarded as income of the depository who is deemed to be the registeredowner of securities by virtue of sub-section (1) of Section 10 of the Depositories Act,1996 and for the purposes of:

(i) Section 48 (Computation of Capital Gains) and(ii) Proviso to Clause 42(A) of the Depositories Act, 1996;the cost of acquisition and the period of holding of any securities shall be

determined on the basis of the first-in-first-out method.In this connection, CBDT vide Circular No. 768, dated 24.6.1998 has clarified that :(a) The FIFO method will be applied only in respect of the dematerialised holdings

because in the case of sale of dematerialised securities, the securities held inphysical form cannot be considered to have been sold as they continue toremain in the possession of the investor and are identified separately.

(b) In the depository system, the investor can open and hold multiple accounts. Insuch a case, where an investor has more than one security account, the FIFOmethod will be applied account wise. This is because in case where a particularaccount of an investor is debited for sale of securities, the securities laying inhis other account cannot be construed to have been sold as they continue toremain in that account.

If in an existing account of dematerialised stock, old physical stock is dematerialisedand entered at a later date, under the FIFO method, the basis for determining themovement out of the account is the date of entry into that account.

Depository means a company registered under the Companies Act and which hasbeen granted a Certificate of Registration under Section 12(1A) of the Securities andExchange Board of India Act. Security means such security as may be specified by theSEBI.

Capital Gains on Distribution of Assets by Companies in Liquidation [Section46(1)]: Where the assets of a company are distributed to its shareholders on itsliquidation, such distribution shall not be regarded as a transfer for the purpose of Section45. There are no capital gains on such distribution. However, if the liquidator sells the



Notesassets of the company resulting in a capital gain and distributes the funds so collected,the company will be liable to pay tax on such gains [Sri Kannan Rice Mill Ltd. v. CIT].

Capital Gains in the hands of the Shareholders in Case of Liquidation ofCompanies [Section 46(2)]: If a shareholder receives money or other assets from thecompany on its liquidation, he is liable to tax under the head ‘Capital Gains’ in respect ofthe market value of the assets received on the date of distribution to the accumulatedprofits of the company which are to be treated as dividend income of the shareholder u/s2(22) (c) and be taxed in his hands as dividend. The balance, if any, is to be taken as thefull value of consideration for the purpose of ascertainment of capital gains.

Capital Gains on the Purchase by a Company of its own Shares or otherSpecified Securities [Section 46(A)]: According to this section, where a shareholder ora holder of other specified securities receives any consideration from any company forthe purchase of its own shares or other specified securities held by such a shareholder ofother specified securities, then, subject to the provisions of Section 48, the differencebetween the cost of acquisition and the value of consideration received by theshareholder or the holder of other specified securities, as the case may be, shall bedeemed to be the capital gains arising to such a shareholder or the holder of otherspecified securities, as the case may be, in the year in which such shares or otherspecified securities were purchased by the company.

For the purposes of this section, ‘Specified Securities’ shall have the meaningassigned to it an explanation to Section 77A of the Companies Act, 1956. According tothe explanation to Section 77A of the Companies Act, 1956, the ‘Specified Securities’include an employee’s stock option or other securities as may be notified by the CentralGovernment from time to time.

In the Charging Sections 45 and 46, the following expressions are important:I. Year of ChargeabilityII. Capital Asset

III. Transfer.I. Year of Chargeability: Capital gains are chargeable to tax on accrual basis. The

actual realisation of the capital gains is immaterial for the purpose of taxation. Thus,when an assessee transfers a capital asset and thereby, some capital gain arises, suchgains are to be included in the income of the previous year in which the asset istransferred whether such gains are realised in a later year or not realised at all.

Exceptions:1. In case of compulsory acquisition, transfer is deemed to have taken place in

the previous year in which the compensation or part thereof is received.2. In case of conversion of a capital asset in to stock in trade, capital gain accrues

in the year of conversion, but taxable in the year in which the stock is sold out.3. Damage or destruction of any capital asset by fire or other calamities.II. Capital Assets [Section 2(14)]: A ‘Capital Asset’ means property of any kind

held by an assessee whether or not connected with his business or profession. Thedefinition of capital asset is very wide. It includes every kind of asset, movable orimmovable, tangible or intangible. Therefore, goodwill, leasehold rights, the right to ashare in the profits of partnership firm, the right to receive shares from a fresh issue by acompany, trees standing on agricultural land, State Development Loan Bonds in thehands of a Financial Corporation are ‘Capital Assets’.

Capital asset as defined u/s 2(14), subject to the following five exceptions:



Notes 1. Any stock in trade, consumable stores or raw material held for the purpose ofbusiness.

2. Personal effects, that is to say, movable property (including wearing appareland furniture, but excluding jewellery) held for personal use by the assessee orany member of his family dependent on him.

3. Agricultural Land in India which does not fall within the jurisdiction of themunicipality or cantonment board having a population of 10,000 or more orwithin the 8 kilometres from the local limits of such a municipality orcantonment board.

4. 6 1/2% Gold Bonds, 7% Gold Bonds or National Defence Gold Bonds, 1980issued by the Central Government.

5. Special Bearer Bonds, 1991 issued by the Central Government.6. Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999.Explanation: Personal effects include only those articles, which are intimately and

commonly used by the assessee or his dependent family member. Thus, a car, any othervehicle, refrigerator, television or other electrical appliances are personal effects.

Jewellery has been specifically excluded from personal effects. ‘Jewellery’includes:

(a) Ornaments made of gold, silver, platinum or any other precious metals,whether or not containing any precious or semi-precious stone and whether ornot worked or sewn into any wearing apparel.

(b) Precious or semi-precious stones, whether or not set in any furniture, utensil orother article or worked or sewn into any wearing apparel.

Types of Capital Assets: For the purpose of taxation, the capital assets have been,divided into:

(a) Short-term capital assets(b) Long-term capital assets(a) Short-term Capital Assets: According to Section 2(42A), a short-term capital

asset means a capital asset held by an assessee for not more than thirty-six monthsimmediately preceding the date of its transfer. Capital Gains arising from the transfer ofshort-term capital assets are called ‘short-term capital gains’, provided that :

(i) In case of company shares (equity or preference) or any other security listed ina recognised stock exchange.

(ii) Units of UTI and Mutual Funds or a zero coupon bond.The provision of this clause will have effect as if for words ‘thirty-six months’ the

words ‘twelve months’ had been substituted.(b) Long-term Capital Assets: Any capital asset other than a short-term capital

asset is termed as a ‘long-term capital asset’. Gains arising from the transfer of along-term capital asset are called ‘long-term capital gains’. The long-term capital gainsqualify for ‘Concessional Tax Treatment’ under the Income Tax Act.

Determination of the Period for which the Asset is held by the Assessee:Generally, the asset is held by the assessee from the date of acquisition to the date oftransfer. But in certain cases, the period for which the asset is held is determined asunder:

(a) In the case of shares held in a company in liquidation, the period subsequent tothe date on which the company goes into liquidation is excluded.



Notes(b) In the case of a capital asset which becomes the property of the assessee inthe circumstances mentioned in Section 49(1) (discussed later), the period forwhich the asset was held by the previous owner is included.

(c) In the case of shares in an Indian company which becomes the property of theassessee in consideration of transfer of shares in a scheme of amalgamation[Clause vii of Section 47], the period for which the shares in the amalgamatingcompany were held by the assessee is included.

(d) In the case of a capital asset being a share or shares in an Indian company,which becomes the property of the assessee in consideration of a transferreferred to in Clause vii of Section 47, there shall be included the period forwhich the share or shares in the amalgamating company were held by theassessee.

(e) In the case of right issue of shares or other securities subscribed to by theassessee on the basis of his rights to subscribe, the counting of the period isfrom the date of allotment.

(f) In case of remuneration of a rights issue, for the person who has acquired therights, the period shall be reckoned from the date of the offer of such rights bythe company or institution.

III. Transfer [Section 2(47)]: The liability to tax on capital gains arises only if thereis a transfer of the capital asset(s). The term ‘transfer’ in relation to a capital asset,includes:

1. Sale, exchange or relinquishment of the capital asset; or2. The extinguishment of any rights therein. [For e.g., where shares are forfeited

by the company, it is extinguishment of the right in the shares. The capital losson forfeiture of shares is deductible.]

3. The compulsory acquisition thereof under any law; or4. Conversion of asset into stock-in-trade.5. Any transaction which has the effect of allowing the possession of any

immovable property in part performance of a contract of the nature referred toin Section 53A of the Transfer of Property Act, 1882; or

6. Any transaction [by way of becoming a member of shareholder in cooperativearrangements] which has the effect of transferring or enabling the enjoyment ofany immovable property.

7. The maturity or redemption of a zero coupon bond.

4.5.3 Transactions Not Regarded as Transfer [Sections 46 and 47]The meaning of transfer is given in Section 2(47), whereas transactions not

regarded as transfers are covered u/s 46 and 47. In the following transactions althoughthere is a transfer, but it is not considered to be transfer for purpose of capital gains.

1. Where the assets of a company are distributed to its shareholders onliquidation of a company, such distribution shall not be regarded as transfer inthe hands of the company [Section 46(1)].

2. Any distribution of capital assets on the total or partial partition of HinduUndivided Family [Section 47(i)].

3. Any transfer of a capital asset under a gift or will or an irrevocable trust [Section47(iii)]. Proviso to Section 47(iii) provides that transfer under a gift orirrevocable trust of a capital asset being shares, debentures or warrantsallotted by a company directly or indirectly to its employees under the ESOPshall be regarded as transfer and be chargeable as capital gain.



Notes 4. Any transfer of a capital asset by a company to its 100% subsidiary company,provided the subsidiary company is an Indian company [Section 47(iv)].

5. Any transfer of a capital asset by a 100% subsidiary company to its holdingcompany, if the holding company is an Indian company [Section 47(v)].

In other words, under items (4) and (5), there must be a transfer of an asset by aholding company to a subsidiary company or vice versa provided the following conditionsare satisfied :

(a) the subsidiary company is a wholly owned subsidiary company and(b) the transferee company is an Indian company.6. Any transfer in a scheme of amalgamation of a capital asset by the

amalgamating company to the amalgamated company, if the amalgamatedcompany is an Indian company [Section 47(vi)].

7. Any transfer in a scheme of amalgamation of shares held in an Indian companyby the amalgamating foreign company to the amalgamated foreign company,if:(a) at least 25% of the shareholders of the amalgamating foreign company

continue to remain shareholders of the amalgamated foreign company,and

(b) such a transfer does not attract capital gains tax in the country, in whichthe amalgamating company is incorporated [Section 47(via)].

8. Any transfer in a demerger, of a capital asset by the demerged company to theresulting company, if the resulting company is an Indian company [Section47(vib)], then(a) The shareholders holding not less than 75% in value of the shares of the

demerged foreign company continue to remain the shareholders of theresulting foreign company, irrespective of the number of suchshareholders.

(b) Such transfer does not attract tax on capital gains in the country, in whichthe de-merged foreign company is incorporated;

Provided that the provisions of Section 391 to 394 of the Companies Act, 1956 shallnot apply in case of de-mergers referred to in this clause [Section 47(vic)].

9. Any transfer in a business reorganisation, of a capital asset by the predecessorco-operative bank to the successor co-operative bank. [Section 47(vica)].

10. Any transfer by a shareholder ,in a business reorganisation of a capital assetbeing a share or shares held by him in the predecessor co-operative bank ifthe transfer is made in consideration of the allotment to him of any share orshares in the successor co-operative bank [Section 47(vicb)].

11. Any transfer or issue of shares by the resulting company, in a scheme ofde-merger to the shareholders of the demerged company if the transfer orissue is made in consideration of demerger of the undertaking [Section47(vid)].

12. Any transfer by a shareholder, in a scheme of amalgamation of shares held byhim in the amalgamating company, if:(a) The transfer is made in consideration of the allotment to him or any share

or shares in the amalgamated company;(b) The amalgamated company is an Indian company [Section 47(vii)];



Notes(c) The consideration received by the shareholder should only be shares. Ifthe consideration includes anything in addition to shares, then it will betreated as a transfer and there will be a capital gain.

13. Any transfer of bonds or Global Depository Receipts referred to in Section115AC(1), i.e., purchased in foreign currency, made outside India by anon-resident to another non-resident [Section 47(viia)].

14. Any transfer of urban agricultural land in India before 1.3.1970 [Section47(viii)].

15. Any transfer of a capital asset, being any work of art, archaeological, scientificor art collection, book, manuscript, drawing, painting, photograph or print, tothe Government or a University or the National Museum, National Art Gallery,National Archives or any such other public museum or institution, as may benotified by the Central Government in the Official Gazette to be of nationalimportance or to be of renown throughout any State or States [Section 47(ix)].

16. Any transfer by way of conversion of bonds or debentures, debenture stock ordeposit certificates in any form, of a company into shares or debentures of thatcompany [Section 47(x)].Transfer by way of conversion of bonds into shares or debentures of anycompany [Section 47(xa)].

17. Any transfer made on or before 31.12.1998 by a person (not being a company)of a capital asset being membership of a recognised stock exchange in India toa company in exchange of shares allotted by that company to the transferor.However, it will be subject to provisions of Section 47A [Section 47(xi)].

18. Any transfer of a capital asset being land of a sick industrial company madeunder a scheme prepared and sanctioned under Section 18 of the SickIndustrial Companies (Special Provisions) Act, 1985 where such sick industrialcompany is being managed by its workers’ cooperative [Section 47(xii)].

19. Where a firm is succeeded by a company in the business carried on by it, as aresult of which, the firm sells or otherwise transfers any capital asset orintangible asset to the company provided the following conditions are satisfied:(a) All the assets and liabilities of the firm relating to the business

immediately before the succession, become the assets and liabilities ofthe company.

(b) All the partners of the firm immediately before the succession become theshareholders of the company in the same proportion in which their capitalaccounts stood in the books of the firm on the date of the succession.

(c) The partners of the firm do not receive any consideration or benefit,directly or indirectly, in any form or manner, other than by way of allotmentof shares in the company; and

(d) The aggregate of the shareholding in the company of the partners of thefirm is not less than fifty percent of the total voting power in the companyand their shareholding continues to be such for a period of five years fromthe date of succession [Section 47(xiii)].Transfer of capital asset being a membership right held by a member of arecognised stock exchange in India [Section 47(xiiia)].Transfer of a capital asset by a private company/unlisted public companyto a limited liability partnership or any transfer of shares held in thecompany by a shareholder in the case of conversion by the company intoa LLP [Section 47(xiiib)].



Notes (e) the demutualisation or corporatisation of a recognised stock exchange inIndia is carried out in accordance with a scheme of corporatisation whichis approved by SEBI

20. Where a sole proprietary concern is succeeded by a company in the businesscarried on by it, as a result of which, the sole proprietary concern sells orotherwise transfers any capital asset or intangible asset to the companyprovided the following conditions are satisfied:(a) all the assets and liabilities of the sole proprietary concern relating to the

business immediately before the succession become the assets andliabilities of the company;

(b) the shareholding of the sole proprietor in the company is not less than fiftypercent of the total voting power in the company and his shareholdingcontinues to remain as such for a period of five years from the date ofsuccession; and

(c) the sole proprietor does not receive any consideration or benefit, directlyor indirectly, in any form or manner, other than by the way of allotment ofshares in the company [Section 47(xiv)].

21. Any transfer in a scheme for lending of any securities under an agreement orarrangement which the assessee has entered into with the borrower of suchsecurities and which is subject to the guidelines issued by the Securities andExchange Board of India, established under Section 3 of the Securities andExchange Board of India Act, 1992 in the regard [Section 47(xv)].Note: Securities Lending Scheme, 1997, lending of shares under this schemewill not be transfer.

22. Any transfer in a scheme of amalgamation of a banking company with abanking institution sanctioned and brought into force by the CentralGovernment under Section 45(7) of the Banking Regulation Act, 1949, of acapital asset by the banking company to the banking institution.A banking company and a banking institution shall have the same meaningassigned under Section 5(c) and Section 45(15) of the Banking Regulation.

23. Any transfer of a capital asset in a transaction of reverse mortgage under ascheme made and notified by the Central Government [Section 47(xvi)].

4.5.4 Withdrawal of Exemption in Certain Cases [Section 47A]As per Section 47 discussed earlier, the following three transactions are not

regarded as transfer for capital gain purposes only when certain conditions are satisfied:1. Transfer of a capital asset by a holding company to its wholly owned subsidiary

company or vice versa [Section 47(iv) and (v)].2. Transfer by a person other than a company having the membership of a

recognised stock exchange to a company in exchange of shares allotted[Section 47(ix)].

3. Transfer where a firm/proprietary concern is succeeded by a company [Section47(xiii) and (xiv)].

If the conditions mentioned, under the respective sections in the above three casesare not complied with, the exemption allowed shall be withdrawn as per Section 47A. Thewithdrawal of exemption in each of the above case shall be as under:

Transfer by a Holding Company to its wholly owned Subsidiary Company orvice versa [Section 47A(1)]: As per Section 47(iv) and (v), any transfer of a capitalasset by a company to its 100% Indian subsidiary company or by a subsidiary company



Notesto its Indian holding company is not treated as a transfer and therefore, the profit or gainarising from such a transfer is not charged as capital gains. However, Section 47Aprovides that the exemption granted shall be withdrawn in the following circumstances:

(i) where at any time before the expiry of a period of 8 years from the date oftransfer of the capital asset by a holding company to its wholly ownedsubsidiary company or vice versa, such a capital asset is converted by thetransferee company into or is treated by it as, stock-in-trade of its business; or

(ii) The parent company, i.e., the holding company or its nominees, ceases to holdthe whole of the share capital of the subsidiary company before the expiry of aperiod of 8 years from the date of transfer of the capital asset.

Treatment in the case of a Transferor Company: In the above two circumstances,the profits or gains arising from the transfer of such a capital asset, which was exempt,shall be deemed to be the income of the transferor company and be chargeable underthe head capital gains of the previous year in which transfer of such a asset to thetransferee company had taken place.

Treatment in the case of Transferee Company is as follows:(a) Where the capital asset is converted into stock-in-trade by the transferee

company within a period of eight years from the date of its transfer, such aconversion shall be treated as transfer of the previous year in which such anasset is converted into stock-in-trade. But the capital gain will arise in theprevious year in which such a converted asset is sold.For the purpose of computation of capital gain as per Section 49(3), the cost ofacquisition of such a asset to the transferee company will be the cost for whichsuch asset was acquired by it, i.e., the price at which it was given to it by thetransferor company [Section 49(3)]. And if it happens to be long- term capitalgain, the indexation of the cost of acquisition will be done till the year ofconversion of such an asset into stock-in-trade. The consideration price will bethe market value of that asset on the date of conversion.

(b) Where the company ceases to be a wholly owned subsidiary company withineight years of the date of the transfer of the capital asset. At this point of time,there will be no income chargeable in the hands of the transferee company at ithas not transferred any asset. But, when this asset is sold or transferred, thecost of acquisition of this asset will be taken as the cost for which such assetwas acquired by it.

4.5.5 Computation of Capital Gains [Sections 48 to 51]Section 48: The income under the head ‘Capital Gains’ shall be computed by

deducting the following from the full value of the consideration received or accrued as aresult of the transfer of the capital asset:

1. expenditure incurred wholly and exclusively in connection with such a transfer;2. the cost of acquisition of the asset and the cost of any improvement thereto.

However, Provision 1 to Section 48 gives special concession to non-residents andProvision 2 gives special concession to residents in respect of long-term capital gains.

Concession to a Non-resident [Provision 1 to Section 48]: In order to giveprotection to non-residents who invest foreign exchange to acquire capital assets,section 48 contains a provision. Accordingly, in the case of non-residents, capital gainsarising from the transfer of shares/debentures of an Indian Company are to be computedas follows :



Notes The cost of acquisition, the expenditure incurred wholly and exclusively inconnection with the transfer and full value of the consideration are to be converted intothe same foreign currency with which such shares were acquired. The aforesaid mannerof computation of capital gains shall be applied for every purchase and sale of shares ordebentures in an Indian company.

Concession to a Resident [Provision 2 to Section 48]: Where long-term gainsarise in the hands of residents, capital gains shall be computed by deducting: (i) indexedcost of acquisition, (ii) indexed cost of improvement and (iii) transfer expenses from fullvalue of the consideration received or accrued as a result of the transfer of the capitalasset.

Provision 3 to Section 48: The long-term gains arising from the transfer of along-term capital asset being bond or debenture other than capital indexed bonds issuedby the Government, the cost of acquisition and improvement will not be indexed.

Provision 4 to Section 48: Where shares, debentures or warrants referred to inProviso to Section 47(iii), ESOP, are transferred under a gift or an irrevocable trust, themarket value on the date of such a transfer shall be deemed to be the full value ofconsideration received or accruing as a result of transfer for the purpose of Section 48 inthe hands of the transferor.

Proviso 5 to Section 48: No deduction shall be allowed in computing the incomechargeable under the head ‘Capital Gains’ in respect of any sum paid on account ofsecurities transaction tax under Chapter VII of the Finance Act, 2004.

Computation of Capital gains:

Computation of Short-term Capital Gains Computation of Long-term Capital Gains

From the full value of consideration, deduct:1. Expenditure incurred wholly and

exclusively.

From the full value of consideration, deduct:1. Expenditure incurred wholly and

exclusively connection with the transfer.

2. Cost of acquisition. 2. Indexed cost of acquisition of asset.

3. Cost of any improvement of asset. 3. Indexed cost of any improvement of anasset.

Meaning of terms used in the context of computation of capital gains is given below:(A) Full Value of Consideration(B) Expenses incurred wholly, exclusively in connection with Transfer(C) Cost of Acquisition(D) Cost of Improvement(E) Cost Inflation Index(F) Indexed cost of Acquisition(G) Indexed cost of Improvement.

Full Value of ConsiderationThe expression “full value” means the whole price without any deduction

whatsoever and it cannot refer to adequacy or inadequacy of price. The consideration forthe transfer of capital asset is what the transferor receives in lieu of the asset he partswith, namely money or money’s worth. It is not necessarily always the market value of theasset on the date of transfer. However, at many places, reference is made to Free MarketValue (FMV). Determination of FMV is required for the following purposes:

(i) Section 45(2) relating to the conversion of capital assets into stock-in-trade fordetermining its consideration price on the date of conversion.



Notes(ii) Section 45(4) relating to distribution of a capital asset by the firm to its partnerson dissolution, for determining sale consideration.

(iii) Section 46(2), relating to distribution of an asset by the company to itsshareholders at the time of its liquidation.

(iv) Section 55 for determining the market value of an asset as on 1.4.1981.Full value of consideration in case of Real Estate Transactions [Section 50C]:

The salient features of Section 50C are as follows:1. Section 50 C is applicable only in the case of transfer of land or building or both.

On transfer of any other asset, Section 50C is not applicable.2. Where, the consideration declared to be received or accruing as a result of the

transfer of land and building or both, is less than the value adopted orassessed by any authority of a State Government for the purpose of paymentof stamp duty in respect of such transfer, the value, so adopted or assessed,shall be deemed to be the full value of consideration and capital gains shall becomputed accordingly under Section 48.

3. Where the assessee claims before any Assessing Officer that, the valueadopted or assessed for stamp duty exceeds the fair market value of theproperty as on the date of transfer and the value so adopted or assessed forstamp duty authority has not been disputed in any appeal or revision or noreference has been made before any other authority, court or High Court, theAssessing Officer may refer the valuation of the capital asset to a ValuationOfficer.

4. Where any such reference is made, the provisions of Sections (2), (3), (4), (50)and (6) of Section 16A, sub-section (1)(i) and sub-sections (6) and (7) ofSection 23A, sub-section (5) of Section 24, Section 34AA, Section 35 and 37 ofthe Wealth Tax Act, 1957 shall with the necessary modifications, apply inrelation to such reference as they apply in to a reference made by theAssessing Officer under Section 16A(1) of that Act. The Valuation Officer shallbe the Valuation Officer as defined in Section 2r of the Wealth Tax Act, 1957.

5. If the market value determined by the Valuation Officer is less than the valueadopted for stamp duty purposes, the Assessing Officer may take such fairmarket value to be the full value of consideration. However, if the fair marketvalue determined by the Valuation Officer is more than the value adopted orassessed for stamp duty purposes. The Assessing Officer shall not adopt suchfair market value and will take the full value of consideration to be the valueadopted or assessed for stamp duty purposes.

6. If the value adopted or assessed for stamp duty purposes is revised in anyappeal, revision or reference to the assessment made shall be amended torecompute the capital gains by taking the revised value as the full value ofconsideration.

Valuation of Capital Assets which can be referred to Valuation Officer: With aview to ascertaining the fair market value, the A.O. may refer the valuation of the capitalasset to a valuation officer in the following cases:

1. Where the value of the asset, as claimed by the assessee, is in accordancewith the estimate made by a registered value and the Assessing Officer is ofopinion that the value so claimed is less than its market value.

2. Where the A.O. is of the opinion that the fair market value of the asset exceedsthe value of the asset by more than ` 25,000 or 15% of the value claimed byassessee, whichever is less.



Notes 3. Where the A.O. is of the opinion that, having regard to the nature of asset andrelevant circumstances, it is necessary to do so.

Expenses incurred wholly and exclusively in connection with such TransferRefer to expenses necessary for effecting transfer, for e.g., brokerage, commission

paid for securing a purchaser, cost of stamp, travelling expenses incurred in connectionwith transfer, litigation expenditure for claiming enhancement of compensation, etc.

Cost of AcquisitionThe cost of acquisition of an asset would normally be taken to be the price at which

the asset was acquired by the assessee. Such a price may include the price paid to thevendor, buying expenses, transportation charges and cost of installation of the asset.Litigation expenses incurred for having the shares registered in his name (as thecompany refused to register the same) is part of the cost of acquisition and that incurredfor gaining better voting rights is cost of improvement [Bengal Assam Investors Ltd. v.CIT].

However, under different circumstances, the cost of acquisition of a capital asset isdetermined in the following manner:

1. Cost to the Previous Owner [Section 49(1)];(a) on any distribution of an asset on the total or partial partition of a HUF;(b) under a gift or will;(c) by succession, inheritance or devolution;(d) on any distribution of assets on the liquidation of the company;(e) under a transfer to revocable or an irrevocable trust;(f) under any transfer by a holding company to its 100% subsidiary or

vice-versa;(g) on any transfer in a scheme of amalgamation of two Indian companies

subject to certain conditions u/s 47(vi);(h) on any transfer in a scheme of amalgamation of two foreign companies

subject to certain conditions u/s 47(via);(i) an any transfer of a capital asset by the banking company to the banking

institution in a scheme of amalgamation of a banking company with abanking institution u/s 47(viaa);

(j) Transfer in a demerger of a capital asset by the demerged company toresulting company u/s 47(vib);

(k) Transfer of shares held in an Indian company by a demerged foreigncompany to the resulting foreign company u/s 47(vic);

(l) on transfer in a business reorganisation of a capital asset by thepredecessor cooperative bank to the successor co-operative bank u/s47(vica);

(m) by conversion by an individual of his separate property into a HUFproperty;

Then the cost of acquisition of the asset shall be deemed to be cost for which theprevious owner of the property acquired it. To this cost, the cost of improvement to theasset incurred by the previous owner or the assessee must be added.

Important Points:(i) Where the cost for which the previous owner acquired the property cannot be

the ascertained cost of acquisition to the previous owner means the fair market



Notesvalue on the date on which the capital asset became the property of theprevious owner.

(ii) Previous owner means the last previous owner of the capital asset whoacquired it through a mode of acquisition other than referred to in clauses (a) to(g) above. In other words, a previous owner means the previous owner whoactually paid for the asset.

2. Cost of acquisition of shares in an Amalgamated Company [Section49(2)]: Where a share or shares in an amalgamated company, which is anIndian company, became the property of the assessee in consideration of atransfer of his share or shares held in the amalgamating company, the cost ofacquisition of the asset (share) shall be deemed to be the cost of acquisition tohim of the share or shares in the amalgamating company.

3. Cost of acquisition of Shares or Debentures [Section 49(2A)]: Cost ofacquisition of shares or debentures of a company acquired in consideration ofconversion of debenture, debenture stock or deposit certificates shall bedeemed to be the cost of original debentures, debenture stock or depositcertificates converted.

4. Cost of acquisition of Specified Securities [Section 49(2B)]: Where thecapital gains arise from the transfer of specified securities referred to in Section17(2(iii)(a) which includes employees stock option and seat equity shares; also,the cost of acquisition of such specified security shall be the fair market valueon the date of exercise of option.Effect of omission of Section 49(2B): In view of omission of Section 49(2B),cost of acquisition of specified securities (ESOP) to the employee shall be thecost of acquisition and not fair market value on the date of exercising of option,in case the employee sells/transfers such securities.

5. Cost of acquisition of the shares in the Resulting Company [Section49(2C)]: It shall be the amount which bears to the cost of acquisition of sharesheld by the assessee in the demerged company, the same proportion as thenet book value of the assets transferred in a demerger bears to the net worth ofthe demerged company immediately before such a demerger.In other words:

demergerbeforeyimmediatel

company demergedthe ofworthNet

demerged aindtransferre assetsthe

of valuebookNet

companydemergedthein assesseethebyheldinsharesof

nacquisitioofCost

companyresultingtheinsharestheof

nacquisitioofCost

6. Cost of acquisition of the original share of the Demerged Company[Section 49(2D)]: It shall be deemed to have been reduced by the amount asso arrived at under sub-section (2C) above ‘Net Worth’ for this section shallmean the aggregate of the paid-up share capital and general reserves asappearing in the books of accounts of the demerged company immediatelybefore demerger.

7. Cost of acquisition of Self-generated Assets: Self-generated assets whichare specifically mentioned in the Income Tax Act are subject to Capital Gains.Such assets are :

(a) Goodwill of the business



Notes (b) Tenancy rights(c) Route permits(d) Loom hours(e) Right to manufacture/produce on article.

Cost of such self-generated assets shall be considered as NIL and accordingly,Capital Gains are to be computed. However, other self-generated assets likegoodwill of a profession, patents and trademarks are not subject to CapitalGains.

8. Cost of acquisition of an asset acquired before April 1, 1981 [Section 55(2)(b)(i)]: Where the capital asset other than an asset on which depreciationhas been allowed (CIT vs. Commonwealth Trust Ltd.) became the property ofthe assessee before April 1, 1981, the cost of acquisition of the asset may, atthe option of the assessee, be taken to be any one of the following :(a) the cost of acquisition of the assessee; or(b) the fair market value of the asset on April 1, 1981.

9. Cost of acquisition of an asset acquired on distribution of capital assetsof a company on its liquidation [Section 55(2)(b)(iii)]: Where the capitalasset became the property of the assessee on the distribution of the capitalassets of a company on its liquidation and the assessee has been assessed toIncome Tax under the head ‘Capital Gains’ in respect of that asset underSection 46, the cost of acquisition to him shall be the fair market value of theasset on the date of distribution.

10. Cost of acquisition on consolidation or conversion of shares [Section55(2)(b)(v)]: Where the capital asset, being a share or a stock of a companybecame the property of the assessee on the consolidation and division ofshares into shares of larger amount than its existing shares or on theconversion or reconversion of any shares, into stock or vice versa or on thesubdivision of any shares into shares of smaller amount or on the conversion ofone kind of shares into another kind, the cost of acquisition shall be taken to bethe cost of the assessee of the original shares or stock held by him.

11. Cost of acquisition of Bonus Shares shall be taken as NIL and the net saleproceeds will be treated as capital gains. The period of holding of such a bonusissue will be reckoned from the date of allotment of such bonus issue.

12. Cost of ‘Right’ shall be taken as NIL: Sale price realised in respect of suchright renounced will be taken as capital gain. The period of holding in the handsof the renounce will be computed from the date of offer made by thecompany/institution to the date of renouncement. Generally, it will be ashort-term capital gain.

13. Cost of Right Shares in the hands of the renounce will be the aggregate of theamount of purchase price paid to the renouncer to acquire the right entitlementand the amount paid by him to the company/institution for subscribing to suchright shares.

14. Cost of Right Shares: The cost of the right shares shall be the price paid forthem.

15. Cost of acquisition of gold on redemption of National Defence GoldBonds: The cost of acquisition of such gold is the market value of the gold onthe date of redemption of such bonds. Whether the gain on sale of goldreceived on redemption of the Gold Bonds, 1980 would be short-term or



Noteslong-term capital gain depends upon the date of redemption of the bonds(27.10.1980) and the date of sale of the gold.

16. Cost of Acquisition in the case of slump sale [Section 50 B]: Section 50Bhas been inserted with effect from the assessment year 2000-01. Provisions ofSection 50B, applicable for the computation of capital gains in the case ofslump sale are given below :

1. Any profits or gains arising from the slump sale affected in the previous yearshall be chargeable as long-term capital gains and shall be deemed to beincome of the previous year in which the transfer took place.Where, however any capital asset being one or more undertakings owned andheld by the assessee for not more than 36 months is transferred under theslump sale, then the capital gain shall be deemed to be a short-term capitalgain.

2. In the case of slump sale of the capital asset being one or more undertaking,the ‘net worth’ of the undertaking shall be taken as the cost of acquisition andcost of improvement. ‘Net worth’ for this purpose is the aggregate value of thetotal assets of the undertaking of division as reduced by the value of liabilitiesof such an undertaking of division or division as appearing in the books ofaccount. Any change in the value of assets on account of the revaluation ofasset of such undertaking or division shall be the written down value of block ofasset determined in accordance with the provisions contained in sub-item (C)of Section 43(6)(c)(i) in the case of depreciable assets and the book value forall other assets.

3. The benefit of indexation will not be available.4. Every assessee, in the case of slump sale, shall furnish along with the return of

income, a report of a Chartered Accountant in form No. 3 CEA indicating thecomputation of the net worth of the undertaking or division as the case may behas been correctly arrived at.

17. Cost of acquisition of share allotted to a shareholder of a RecognisedStock Exchange: Cost of acquisition in relation to a capital asset, being equityshares allotted to a shareholder of a Recognised Stock Exchange in Indiaunder a scheme for corporation approved by SEBI shall be cost of acquisitionof his original membership of the exchange (applicable from A.Y. 2002–03).

18. Computation of Capital Gains in case of Depreciable Assets [Section 50]:Where the capital asset is an asset forming part of a block of assets in respectof which depreciation has been allowed, the provisions of Section 48 and 49shall be subject to the following modifications:(i) Where the full value of consideration received or accruing for the transfer

of the asset plus the full value of such consideration for the transfer of anyother capital asset falling with the block of assets during the previous yearexceeds the aggregate of the following amounts namely:1. Expenditure incurred wholly and exclusively in connection with such

transfer;2. WDV of the block of assets at the beginning of the previous year;3. The actual cost of any asset falling within the block of assets

acquired during the previous year, such excess shall be deemed tobe the capital gains arising from the transfer of short-term capitalassets.

(ii) Where all assets in a block are transferred during the previous year, theblock itself will cease to exist. In such a situation, if the aggregate of



Notes above 3 items exceeds the full value of consideration received/accruingfor the transfer of asset(s), the loss shall be deemed to be short-termcapital loss.

Adjustment of Advance Money received against Cost of Acquisition[Section 51]: It is possible for an assessee to receive some advance in regardto the transfer of a capital asset. Due to the breakdown of the negotiation, theassessee may have retained the advance. Section 51 provides that whilecalculating capital gains, the above advance retained by the assessee must beused to reduce the cost of acquisition.

19. Cost of acquisition in case of reduction of capital: Where the shareholderreceives cash or the market value of the asset, such asset received will begross consideration and from such consideration deemed dividend u/s 2(22)(d)to the extent of accumulated profits shall be reduced to compute netconsideration which will be relevant for capital gain.Example: Suppose the assessee has paid ` 250 per share for 2000 shareswith face value of ` 10 each and on reduction, face value of the share has beenreduced by ` 6, reduction in cost will be computed according to the followingformula:Cost × Reduction in Face Value/Face value before reduction = 250 × 6/10 =` 150 per share. For 200 shares, his cost is ` 3,00,000 which is eligible forindexation and the same will be deducted from net consideration price tocalculate his capital gain.

20. Special provision for full value of consideration for computation ofcapital gains in real estate transaction [Section 50C]: Where theconsideration declared to be received or accruing as a result of the transfer ofland or building or both, is less than the value adopted or assessed orassessable by any authority of a State government (i.e. “stamp valuationauthority”) for the purpose of payment of stamp study in respect of suchtransfer, the value so adopted or assessed or assessable shall be deemed tobe the full value of the consideration, and capital gains shall be computed onthe basis of such consideration under Section 48 of the Income Tax Act.

4.5.6 Cost of Improvement [Section 55(1)(b)]It includes all the expenditure of a capital nature incurred in making any additions or

alterations to the capital asset by the assessee after it became his property. Where acapital asset has become the property of the assessee by any of the modes specified inSection 49(i), the expenditure incurred for the purpose by the previous owner.

It is important to note that where the capital asset became the property of theassessee (or previous owner) prior to 1.4.1981 and FMV of asset on 1.4.81 shall betaken as the ‘Cost of Improvement’. Any such expenditure incurred prior to 1.4.81 shallbe ignored.

4.5.7 Cost Inflation IndexThis is the index as the Central Government may notify in this behalf. The

government has notified the following ‘cost of inflation index’ vide notification datedAugust 5, 1992 as amended till 2004:

Sr. No. Financial Year Cost Inflation Index

1 1981-82 100

2 1982-83 109



Notes3 1983-84 116

4 1984-85 125

5 1985-86 133

6 1986-87 140

7 1987-88 150

8 1988-89 161

9 1989-90 172

10 1990-91 182

11 1991-92 199

12 1992-93 223

13 1993-94 244

14 1994-95 259

15 1995-96 281

16 1996-97 305

17 1997-98 331

18 1998-99 351

19 1999-2000 389

20 2000-2001 406

21 2001-2002 426

22 2002-2003 447

23 2003-2004 463

24 2004-2005 480

25 2005-2006 497

26 2006-2007 519

27 2007-2008 551

28 2008-2009 582

29 2009-2010 632

30 2010-11 711

31 2011-12 785

32 2012-13 852

33 2013-14 939

Computation of indexed Cost of Acquisition :

nacquisitioofyear theofindexinflationofCostaletransfer/sofyeartheofindexinflationofCost

nacquisitioofCost

Notes :1. If the asset is acquired by the assessee before 1-4-1981, he may opt for the

market value as on 1-4-1981 to the cost of acquisition. In this case indexationwill be cost of acquisition or Fair market value as on 1-4-1981 whichever ismore.



Notes 2. Asset acquired from the previous owner in any mode given u/s 49(1) in thiscase, the cost of acquisition is taken as the cost to previous owner and it is thiscost which will be indexed. For the purpose of indexation the year in which theasset was first held by the assessee (not the previous owner) is to beconsidered.

Indexation of cost not allowed:1. Transfer of bonds and debentures of a company or government other than

capital indexed bonds issued by the Government.2. Transfer of shares or debentures acquired by a non-resident to foreign

currency in an Indian company.3. Transfer of undertaking or division in a slump sale.4. Transfer of units of Unit Trust of India or Mutual Fund covered u/s 10(23D).5. Transfer of Global Depository Receipt or Bonds of an Indian company or

shares or bonds of public sector company sold by the government andpurchases in foreign currency by a non-resident.

6. Transfer of GDR purchased in foreign currency by an individual resident inIndia and employee of an Indian Company.

7. Transfer of securities by foreign institutional investors.8. Transfer of foreign exchange asset by a non-resident India.

(G) Indexed Cost of Improvement :

Indexed Cost of Improvement =nacquisitioofyeartheofindexinflationofCost

sold is assetthewhichinyeartheforindexinflationcost

1.4.81aftercurredintimprovemenofCost

4.6 Exemptions from Capital Gains

1. Long-term Capital Gain on Eligible Equity Shares Exempt if the Sharesare Acquired within a Certain Period [Section 10(36)]: Any income arising from thetransfer of a long-term capital asset being an eligible equity share in a company shall beexempt provided these are acquired on or after 1-3-2003 but before 1-3-2004 and heldfor a period of 12 months or more.

Eligible equity share means an equity share in a company being a constituent ofBSE-500 Index of the stock market (and equity share allotted through a public issue on orafter 1-3-2003), Mumbai as on 1-3-2003 and the transactions of purchase or sale of suchequity shares are entered into on a recognised stock exchange in India.

2. Capital Gain on Compulsory Acquisition of Urban Agricultural Land[Section 10(37)]: In the case of an assessee, being an individual or a Hindu UndividedFamily, any income chargeable under the head ‘capital gains’ arising from the transfer ofagricultural land, is exempt from income tax where :

(i) Such land is situated in any area referred to in item (a) or item (b) of sub-clause(iii) of clause (14) of section 2;

(ii) Such land, during the period of two years immediately preceding the date oftransfer, was being used for agricultural purposes by such Hindu undividedfamily or individual or a parent of his;



Notes(iii) Such transfer is by way of compulsory acquisition under any law or a transfer,the consideration for which is determined or approved by the centralgovernment or the Reserve Bank of India;

(iv) Such income has arisen from the compensation or consideration for suchtransfer received by such an assessee on or after the first day of April 2004.

Explanation: For the purposes of this clause, the expression ‘compensation orconsideration’ includes the compensation or consideration enhanced or further enhancedby any court, tribunal or other authority.

3. Long-term Capital Gain on Transfer of Securities covered underSecurities Transactions Tax STT [Section 10(38)]: Any income arising from thetransfer of a long-term capital asset, being an equity share in a company or a unit of anequity oriented fund where – the transaction of sale of such equity share or unit isentered into on or after 1.10.04 and such transaction chargeable to securities transactiontax under that chapter, is exempt from income tax.

Explanation: For the purposes of this clause, ‘equity oriented fund’ means a fund,(i) where the investible funds are invested by way of equity shares in domestic companies tothe extent of more than fifty per cent of the total proceeds of such fund; and (ii) which hasbeen set up under a scheme of a Mutual Fund specified under clause (23D).

Provided that the percentage of equity shareholdings of the fund shall be computedwith reference to the annual average of the monthly averages of the opening and closingfigures.

4.6.1 Capital Gains Exempt from Tax [Sections 54, 54B, 54D, 54EC, 54F, 54G, 54Hand 54GA]Capital Gains Arising from the transfer of Residential House Property [Section

54]: Capital Gains arising from the transfer of a Residential House Property are exemptfrom tax provided the following conditions are satisfied:

1. The house property is a residential house whose income is taxable under thehead ‘Income from House Property’.

2. The house property is owned by an individual or HUF.3. The house property is a long-term capital asset.4. The assessee has purchased a residential house within a period of one year

before the transfer or within two years after the date of transfer.OR, he has constructed a residential house property within a period of three years

after the date of transfer.Important Points:1. Construction of the house should be completed within 3 years from the date of

transfer. The date of commencement of construction is irrelevant.2. Case of allotment of flat under the self-financing scheme of DDA is treated as

construction of house for this purpose.Amount of Exemption: (i) If the amount of the capital gains is less than the cost of

the new house property, the entire amount of capital gains is exempt from tax. (ii) On theother hand, if the amount of capital gains is greater than cost of new house property, thedifference between the new house and the amount of capital gains is chargeable to taxas capital gains.

Withdrawal of Exemption: The new house (purchased or constructed) should notbe transferred within a period of three years of its purchase or construction. If it istransferred within three years, the cost of the new house will be reduced by the amount of



Notes capital gains invested in its purchase/construction and claimed exempt. The capital gainsarising on the transfer of the new house shall be chargeable to tax as the short-termcapital gains of the previous years in which the new house is transferred.

Deposit in Capital Gains Account Scheme, 1988: The amount of capital gainwhich is not appropriated by the assessee towards the purchase or construction of a newasset before the date of furnishing the return of income under Section 139 shall bedeposited by him before furnishing such return in an account in any such bank inaccordance with the New Capital Gains Account Scheme, 1988 and such return shall beaccompanied by proof of such a deposit. The amount already utilised by the assessee forthe purchase or construction of the new asset together with the amount so depositedshall be deemed to be the cost of new asset.

If the amount so deposited is not utilised wholly or partly for the purchase orconstruction of the new asset, the amount not so utilised shall be charged as capital gainunder Section 45 in the previous year in which the period of three years from the date ofthe transfer of the original asset expires. The assessee shall be entitled to withdraw suchan amount in accordance with the scheme.

It may be noted that amendments have been made on similar lines in Sections 54B,54D, 54F and 54G also facilitating investment by way of deposit in the Capital GainsAccount Scheme, 1988, pending utilisation of the capital gains (under Section 54B and54D) and the net consideration (under Section 54F) for the purpose of acquiring thespecified assets. This new scheme would obviate the need for rectification ofassessment of the earlier years.

Section 54B: Capital Gains on Transfer of Agricultural Land: Any capital gainsarising on the transfer of agricultural land situated in an urban is exempt subject to thefollowing conditions:

1. The agricultural land is owned by an individual. If the agricultural land istransferred by a HUF, the family is not entitled to exemption u/s 54B [CIT v.G.K. Devrajulu].

2. The agricultural land must have been used by the assessee or his parents foragricultural purpose during the two years immediately preceding the date of itstransfer.

3. The assessee has purchased within a period of two years from the date oftransfer (and not before sale) any other land for being used for agriculturalpurposes.

Amount of Exemption: The capital gains arising from the transfer of such anagricultural land is exempt to the extent of the cost of the new agricultural land purchasedwithin the period mentioned above. It means, if the whole capital gain is reinvested it isfully exempt from tax.

Withdrawal of Exemption: The new asset (agricultural land) should not betransferred within a period of three years of its purchase. If it is transferred within threeyears, the cost of the new agricultural land will be reduced by the amount of capital gainsinvested in its purchase and claimed exempt. The capital gains, if any, arising on thetransfer of a new asset, shall be chargeable to tax as short-term capital gains of theprevious year in which the new asset is transferred.

The benefit of the Capital Gains Account Scheme, 1988 is available u/s 54B also.Capital Gains on Compulsory Acquisition of Lands and Buildings [Section

54D]: Any capital gain arising on the transfer of land or building or any right in land orbuilding is exempt, subject to the following conditions:

1. The assessee is engaged in an industrial undertaking.



Notes2. The land or building or any right therein should form part of the industrialundertaking.

3. Such asset should have been compulsorily acquired under any law.4. The assessee has used the land or building or any right therein for the

purposes of the business of industrial undertaking in the two years immediatelypreceding the date on which the transfer took place.

5. The assessee has, within a period of three years after such transfer, purchasedany other land or building or any right in any other land or building orconstructed any other building for the purposes of shifting or re-establishing theindustrial undertaking or setting up another industrial undertaking.

6. The capital gain arising from the transfer of such a land or building is exempt tothe extent of the cost of the new land or building – purchased or constructedwithin the period mentioned in (5) – where the amount of the capital gainexceeds the cost of acquisition or construction, only excess shall bechargeable to tax.

The benefit of the Capital Gains Account Scheme, 1988 is available u/s 54B also.Exemption of Long-term Capital Gain in case of investment of Capital Gains in

certain Bonds [Section 54EC]: With effect from 1.4.2000 (Assessment Year 2000-01and onwards), where the capital gain arises from the transfer of a long-term capital asset,it will be exempt if the assessee has invested the capital gain in the long-term specifiedasset subject to the fulfillment of all the conditions given hereunder:

1. The capital gain arises from the transfer of a long-term capital asset (hereafterreferred to as an ‘original asset’).

2. The assessee has, within a period of 6 months after the date of transfer or saleof the original asset, invested whole or any part of capital gains, in a ‘long-termspecified asset’. A ‘long-term specified asset’ is defined to mean any bondredeemable after three years and issued, on or after 1.4.2000, by the NationalBank for Agricultural and Rural Development or by the National HighwaysAuthority of India.

3. The cost of the long-term specified asset is not less than the capital gain inrespect of the original asset. If the cost of the long-term specified asset is lessthan the capital gain, then, the capital gain, proportionate to a part of the capitalgain invested will be exempt. However, the investment made on or after1-4-2007 in the long-term specified asset by the assessee during any financialyear cannot exceed ` 50 lakhs.

After availing the exemption, the assessee has to retain the long-term specifiedasset for a minimum period of three years from the date of its acquisition.

If the long-term specified asset is transferred or converted (otherwise than bytransfer) into money or the assessee takes a loan or advance on the security of such along-term specified asset, at any time within a period of three years from the date of itsacquisition, the amount of exempted capital gain on transfer of the original asset will bedeemed to be long-term capital gain.

(a) of the previous year in which long-term specified asset is transferred/convertedinto money, or

(b) of the previous year in which the loan or advance is taken against security ofsuch a long-term specified asset. It may be noted that irrespective of thequantum of loan or advance taken, the entire exempted amount of capital gainwill be brought to tax.



Notes Capital Gain on the transfer of a Long-term Capital Asset [Section 54F][Exempted if the net consideration is invested in a residential house]: Exemption isgranted if the following conditions are fulfilled:

1. The assessee is either an individual or a HUF.2. The assessee has transferred a long-term capital asset other than a residential

house.3. The assessee purchases within a year before or within a period of 3 years after

the date of transfer, a residential house.4. The assessee does not own more than one residential house except as

mentioned in 3 above.Amount of Exemption:1. If the cost of the new house is more than the net consideration in respect of the

capital asset transferred, the entire capital gain arising from the transfer will beexempt from tax.

2. If the cost of the new house is less than the net consideration in respect of theasset transferred, the exemption from long-term capital gains will be grantedproportionately on the basis of investment of the net consideration, either forpurchase or construction of the residential house (cost of new house X capitalgains/net consideration). The net consideration in respect of the transfer of acapital asset is the full value of the consideration received or accruing as aresult of the transfer of a capital asset after deduction of any expenditureincurred wholly and exclusively, in connection with the transfer.

Withdrawal of Exemption:(a) If the individual sells or transfers the new house within 3 years of its purchase

or construction; or(b) If the individual purchases, within a period of two years of the transfer of the

original asset or constructs, within a period of three years of such an asset, aresidential house other than the new house [annual value of such house shallbe taxable under the head ‘Income from House Property’].

In the aforesaid two cases, the amount of capital gains arising from the transfer ofthe original asset, which was not charged to tax, will be deemed to be the income by theway of long-term capital gains of the year in which a new house is transferred or anotherresidential house (other than the new house) is purchased or constructed, as the casemay be.

Benefit of Capital Gains Account Scheme, 1988 is available u/s 54F also.Capital Gains on the Shifting of Industrial Undertakings from Urban Area

[Section 54G]: Capital gains on the shifting of an industrial undertaking from urban areato non-urban area are exempt if the following conditions are satisfied:

1. The assessee transfers a long-term or short-term capital asset in the nature ofplant, machinery, building or land or any right in building or land. It meansexemption is not available on the capital gains on transfer of other assets, fore.g., furniture.

2. Such an asset should have been used for the purpose of the business ofindustrial undertaking situated in an urban area.

3. The asset should have been transferred in connection with the shifting of theundertaking to a non-urban area.

4. The amount of capital gains should be utilised within a period of one yearbefore or three years after the date of transfer for the following purposes:



Notes(a) purchase of new machinery or plant, acquire land or building orconstruction of building for the purposes of his business in the area towhich the undertaking is shifted; or

(b) incurs expenses on shifting the original asset and transferring theestablishment of the undertaking to such area; or

(c) incurs expenses on such other purposes as may be specified in a schemeframed by the Central Government; the capital gain shall be exempted tothe extent such gain has been utilised for the aforesaid purposes.

Withdrawal of Exemption: Where the new asset is transferred within three years ofits being purchased, acquired, constructed or transferred, the cost of the new asset shallbe taken as NIL. Where the capital gains were more than the cost of the new asset, theunutilised capital gains shall be put to tax u/s 54. Where the cost of the new asset is morethan the capital gains, the cost of the new asset shall be other cost as reduced by theamount of capital gains.

Benefit of the Capital Gains Account Scheme, 1988 is available u/s 54G also.Extension of time limit for acquiring a new asset: Where the transfer of the

original asset is by the way of compulsory acquisition under any law and the amount ofcompensation awarded for such acquisition is not received by the assessee on the dateof such transfer, the period of acquiring the new asset under Sections 54, 54B, 54D,54BC and 54F by the assessee or the period for depositing or investing the amount ofcapital gain shall be extended in relation to such an amount of compensation as is notreceived on the date of transfer. The extended period shall be reckoned from the date oftransfer. The extended period shall be reckoned from the date of receipt of the amount ofcompensation.

Exemption of Capital Gains on the transfer of assets in cases of shifting of anindustrial undertaking from an urban area to any Special Economic Zone [Section54GA]: The benefits under this section are similar to Section 54G. Exemption of capitalgains on the transfer of assets in cases of shifting of an industrial undertaking from anurban area to any special Economic Zone. Such Special Economic Zone may be situatedin urban area or any other area.

The assessee has within a period of one year before or 3 years after the date onwhich the transfer took place:

(a) Purchased machinery or plant for the purposes of business of the industrialundertaking the Special Economic Zone to which the said undertaking isshifted.

(b) Acquired building or land or constructed building for the purposes of hisbusiness in the Special Economic Zone;

(c) Shifted the original asset and transferred the establishment to SpecialEconomic Zone; and

(d) Incurred expenses on such other purpose as may be specified in a schemeframed by the Central Government for the purposes of this section.

Amount of Exemption – If the above conditions are satisfied, then the amount ofexemption is equal to−

(a) the amount of capital gain generated on transfer of capital assets in the case ofshifting of an undertaking as stated above; or

(b) the cost and expenses incurred in relation to all or any of the purposesmentioned in (a) to (d) supra (such cost and expenses being hereinafterreferred to as the new asset), whichever is lower.



Notes Consequences if the new asset is transferred within 3 years – If the new assetis transferred within a period of 3 years from the date of its purchase/construction/acquisition, the amount of exemption given earlier under section 54GA would be takenback.

Scheme of Deposit in respect of exemption under section 54GA – Theseprovisions have been framed on similar lines as given in Sections 54, 54B, etc.

4.6.2 Tax on short-term Capital Gains in certain cases [Section 111A]Where the total income of an assessee includes any income chargeable under the

head “Capital Gains”, arising from the transfer of a short-term capital asset, being anequity share in a company or a unit of equity oriented fund and−

● the transaction of sale of such equity share or unit is entered into on or after1-10-2004;

● such transaction is chargeable to securities transaction tax;● such equity shares are transferred through a recognised stock exchange or

such units are transferred through a recognised stock exchange or sold tomutual fund.

The tax payable by the assessee on the total income shall be aggregate of−● the amount of income tax calculated on such short term capital gains at the

rate of 15%; and (ii) the amount of income-tax payable on the balance amountof total income as if such balance amount were the total income of theassessee.

However, in the case of an individual or a HUF being a resident, where the totalincome as reduced by such short-term capital gains is below the maximum amount whichis not chargeable to income tax, then such short-term capital gains shall be reduced bythe amount by which the total income as so reduced falls short of the maximum amountwhich is not chargeable to income-tax and the tax on the balance of such short-termcapital gains shall be computed at the rate of 15%.

No deduction under Chapter VI: Further, where the gross total income of anassessee includes any short-term capital gains referred to above, the deduction underChapter VIA shall be allowed from the gross total income as reduced by such capitalgains

4.6.3 Tax on Long-term Capital Gains [Section 112]The basic reason for making a distinction between short-term capital gain and

long-term capital gain is that a short-term capital gain (other than short-term capital gainin case of listed equity shares and units of equity oriented mutual fund mentioned aboveunder section 111A), is to be taxed at the normal rates of tax like any other income,whereas, long-term capital gain and short-term capital gain under section 111A aboveare to be taxed at a concessional rate. Further, although, short-term capital gain andlong-term capital gain are part of the total income, but for purpose of computation of taxon long-term capital gain, such long-term capital gain, like short-term capital gain undersection 111A mentioned above, is kept separate from the gross total income due tofollowing reasons:

(i) Deductions permissible under Chapter VIA are not allowed from long-termcapital gains.

(ii) Rate of long-term capital gain will be at concessional rate.(iii) Hence the following steps should be followed for calculation of tax on total

income, where long-term capital gains are included in the total income.



Notes1. Compute the gross total income without including long-term capital gain.2. Allow deductions permissible u/s 80C to 80U from such gross total

income.3. Calculate the income tax at the normal rate of tax on income arrived at in

Step 2.4. Compute the tax at the flat prescribed rates on long-term capital gains.5. The aggregate of the tax computed in step3 and step4 shall be the tax on

net income.6. Add surcharge, if applicable plus education cess plus SHEC on tax so

computed at the rate applicable.Further, where the total income of the resident individual or resident HUF, as

reduced by long-term capital gain is below the maximum amount which is not chargeableto tax, then such long-term capital gains shall be reduced by the amount by which suchtotal income (exclusive of long-term capital gains) falls short of the exemption limit andtax on balance shall be computed at the rate of 20%. For example ,the income of X forthe previous year 2013-14 without long-term capital gains is ` 1,45,000 and the long termcapital gains are ` 70,000.In this case total income excluding long-term capital gain is` 1,45,000 whereas the maximum exemption on which no tax is payable is ` 2,00,000[` 2,00,000 in case of resident woman, ` 2,50,000 in case of resident woman who is ofthe age 60 years or above and ` 5,00,000 in case of resident individual of the age of 80years or more] for assessment year 2014-15. Therefore ` 55,000 will be reduced fromthe long term capital gain of ` 70,000 to claim the full exemption of ` 2,00,000.The tax atthe rate of 20% shall be payable on balance long-term capital agin

However, in case of long-term capital gain covered by sections115AB,115AC,115AD and 115E, the rate of tax is 10%.

Concessions/Special Rates of Income Tax on Long-term Capital Gains

Class of Assessee Rate of tax

1. Resident individual and HUF 20%

2. Domestic companies 20%

3. Other residents like firms, AOPs 20%

Rate of tax on long-term capital gain(a) in case of non-resident (not being a company or a foreign company:

(i) from the transfer of capital asset being unlisted securities @ 10% withoutgiving effect of first and second proviso(indexation)

(ii) from the transfer of capital asset other than (i) above 20%(b) in the case of a resident from transfer of any capital asset 20%Tax on long-term capital gains from listed securities, units etc.Long-term capital gain from the sale of equity shares or units of equity oriented fund

is exempted u/s10(38) if shares are sold through recognized stock exchange or units ofequity oriented funds are either sold through recognized stock exchange or sold tomutual fund and security tax has been paid.

However, in other cases ,the tax payable by the assessee on long-term capital gainfrom securities listed on any recognised stock exchange in India or units of UTI or MutualFunds covered under Section 10(23D) and Zero Coupon bonds shall be minimum of thefollowing two amounts :

1. Tax @ 20% on long-term capital gains computed after indexation of cost ofsuch shares, securities or units. Or



Notes 2. Tax @ 10% on long-term capital gains computed without indexation of its cost.Meaning of listed securities: Listed securities means the securities asdefined in Section 2(h) of the Securities Contracts (Regulation) Act, 1956 andlisted in any recognised stock exchange in India.

As per section 2(h) securities, include: (i) shares, scrips, stocks, bonds, debentures,debenture stock or other marketable securities of a like nature in or of any incorporatedcompany or other body corporate, (ii) Government securities, (iia) such other instrumentsas may be declared by the Central Government to be securities and (iii) rights or interestin securities.

Benefit of lower tax rate of 10% is available in case of bonus shares although itscost is nil and indexation is not possible.

Benefit of 10% rate in case of long-term capital gain also applicable to non-residentwho has bought shares in foreign currency.

Rates of Tax on Long-term Capital Gain from the Transfer of Capital assetBeing Unlisted Securities [Sub-clause (iii) to Clause (c) of Section 112(1) [w.e.f. A.Y.2013-14]

The amount of income-tax on long-term capital gains arising from transfer of acapital asset, being unlisted securities shall be calculated at the rate of 10% on thecapital gains in respect of such asset as computed without giving effect to the first andsecond proviso to section 48

4.7 Hints for Tax Planning

For the purpose of tax planning, the following propositions should be borne in mindeach depending in the context in which they have been made.

1. Since long-term capital gains lower tax burden, taxpayers should so plan as totransfer their capital assets normally only 36 months after acquisition.

2. The assessee should take advantage of exemption under section 54 byinvesting the capital gain arising from sale of residential house property in thepurchase of another house (even out of India)within the specified period.

3. In order to claim advantage of exemption under sections 54B and 54D it shouldbe ensured that the investment in new asset is made only after effectingtransfer of capital assets.

4. In order to take advantage of exemption under sections 54, 54B, 54D, 54EC,54F, 54G and 54GA the tax payer should ensure that the newly acquired assetis not transferred within 3 years from the date of acquisition. Alternatively it willbe advisable that instead of selling or converting assets acquired undersections 54, 54B, 54D, 54F, 54G and 54GA into money, the tax payer shouldobtain loan against the security of such asset(even by pledge) to meet theexigency

5. In the two cases discussed below, surplus arising on sale or transfer of capitalassets is chargeable to tax as short term capital gains by virtue of Section 50.These cases are: (a) when written down value of a block of assets is reducedto nil, though all the assets falling in the block are not transferred, (b) when ablock of assets ceases to exist.Further tax on short term capital gain can be avoided if—(a) another capital asset ,falling in that block of assets, is acquired at any

time during the previous year; or(b) benefit of section 54G is availed



Notes4.8 Problems

Problems in the Computation of Income under the head ‘Capital Gains’:1. A resident of India purchased 1,000 listed equity shares of ` 10 each at ` 115 per

share from a broker on 5-4-1997. He paid ` 2,000 as brokerage. On 2-3-2002 he wasgiven bonus shares by the company on the basis of one share for every 2 shares held.On 24-2-2013, he was given a right to acquire 1,000 right shares @ ` 60 per share. Heacquired 50% of the right shares offered and sold the balance 50% of the right for a sumof ` 60,000 on 3-4-2013. The right shares were allotted to him on 20-4-2013.

All the shares held by him were sold on 24-3-2014 @ ` 350 per share.(a) Compute the capital gains and tax for the A.Y. 2014-15 assuming his income

from other sources is ` 62,000.(b) What shall be your answer, if these shares had been sold through as

recognised stock exchange?

Solution:

Assessment Year 2014-15 Capital Gains on the original shares, i.e., 1000 shares

Full value of consideration (1000 × 350)Less: Indexed cost of acquisition (1,17,000 × 939/ 331)

3,50,0003,31,912

Long-term capital gain after indexationLong-term capital gain without indexation (3,50,000 − 1,17,000)

18,0882,33,000

Capital gains on bonus shares:

Full value of consideration (500 × 350)Less: Indexed cost of acquisition

1,75,000Nil

Long-term capital gain after indexationLong-term capital gain without indexation (1,75,000 − Nil)

1,75,000175,000

Capital gains on right shares:

Full value of consideration (500 × 350)Less: Cost of acquisition (500 × 60)

1,75,00030,000

Short-term capital gain 1,45,000

Capital gains on sale of right:

Full value of considerationLess: Cost of acquisition

60,000Nil

Short-term capital gain 60,000

Tax on long-term capital gain on shares:

@20% (after indexation) @10% (without indexation)1. Original shares2. Bonus shares

361835,000

23,30017,500

Take in each case which ever is minimumThus, it will be ` 3,618 + 17,500 21,118Tax on other income 62,000 + 1,45,000 + 60,000 = 267,000 6,700



Notes Tax 27,818Less: Rebate u/s 87A 2,000

25,818Add: Education cess and SHEC @ 3% 775

26,593Tax rounded off 26,590(B) Since shares are sold through a Recognised Stock Exchange, long-term capital

gains on original shares amounting to ` 18,088 and on bonus shares amounting to` 1,75,000 shall be exempt.

Short-term capital gain on right shares shall be taxable @ 15% but short-termcapital gain on the sale of right shall be taxable at the normal rate and included in otherincome. Thus, tax will be calculated as under:

Tax on short-term capital gain on the sale of right shares (15% of ` 67,000)10,050Tax on other income62,000 + 60,000 + 78,000 (shifted from STCG on sale of right shares) NilTotal Tax 10,050Less rebate u/s 87A 2000Add: Education cess and SHEC (@ 3%) 242Total Tax payable 8292Tax rounded off 82902. R owns two buildings, the depreciated value of the block on 1-4-2010 being 22.50

lakhs. On of the said buildings which had been purchased on 30-4-1997 for ` 18 lakhscompulsorily acquired by the government on 15-5-2010 for which a sum of ` 50 lakhs ispaid as a compensation on 20-3-2011. The said building was being used by the companyas a tenant for about 4 years prior to the date of acquisition of the same by the company.The company purchases a new building on 10-4-2011 for ` 14 lakh, for the purpose ofsetting up another industrial undertaking.

Compute the amount of capital gains for the Assessment Year 2011-12. What wouldbe the capital gains if the new building was purchased on 8-5-2010?

Solution:

Computation of Capital Gains for the Assessment Year 2011-12

Particulars `

Sale considerationLess: Cost of acquisition being the depreciated value of the block on 1-4-2010Short-term capital gains

50,00,00022,50,00027,50,000

Less : Exemption under Section 54DAs the tax payer has purchased a new building for setting up another industrial

undertaking within 2 years from 20-3-2011, the exemption is available u/s 54D,the exemption being ` 14 lakhs

Short-term Capital Gains chargeable to tax for A.Y. 2011-12If the new building is purchased on 8-5-2010, i.e., before the date of acquisition bythe Government, the capital gains shall be determined as follows :

14,00,000

13,50,000

Sale consideration 50,00,000



NotesLess : Depreciated Value of the block on 1-4-2010 plus cost of asset acquiredduring the previous year 2010-11(` 22,50,000 + cost of building purchased during 2010-11 ` 14 lakhs)

Exemption under Section 54DShort-term Capital Gain

36,50,00013,50,000

Nil13,50,000

3. A acquired a plot of land on 15-6-1994 for ` 10,00,000, which was sold on5-1-2011 for ` 44,00,000. The expenses of transfer were ` 1,00,000. A made thefollowing investments on 4-2-2011 from the proceeds of the above plot.

(a) Bonds of Rural Electrification Corporation Ltd. redeemable after a period of3 years ` 12,00,000.

(b) Deposits under Capital Gain Scheme for purchase of a residential house as hedoes not own any house ` 8,00,000.

Compute the Capital Gain chargeable to tax for the A.Y. 2011-12.

Assessment Year 2011-12

` `

Total considerationLess : (i) Expenses on transfer

(ii) Indexed cost of acquisition (10,00,000 × 711/259)

Long-term capital gainLess : Exemption u/s 54EC

Exemption u/s 54F (15,54,826 ( 8,00,000/43,00,000)

Taxable Long-term Capital Gain

1,00,00027,45,174

12,00,0002,89,270

44,00,000

28,45.17415,54,826

14,89,27065,556

4. X Ltd. owns the following assets on April 1, 2010.

Rate of depreciation Depr. Value on 31.03.2010

Plant A 25% 4,05,000

Plant B 25% 1,95,000

Plant C 25% 7,05,700

On June 2010, it acquires Plant D for ` 20,000 (rate of depreciation 25%). Thecompany sells the following assets 2010-11 :

Sale consideration Expenses on transfer

Plant A 2,12,000 12,000

Plant B 6,17,500 –

Plant C 4,30,000 –

Plant D 95,000 200

Determine the amount of depreciation and capital gains for A.Y. 2011-12. Is itpossible to avoid tax on capital gains?



Notes Solution:

Depreciation :First Block: Plant (rate of depreciation 25%)Depreciated value of Plant A + B + C 13,05,700Add: Cost of plant D acquired during the year 20,000

13,25,700Less : Sale consideration of Plants A, B, C and Di.e., 2,12,000 + 6,17,500 + 4,30,000 + 95,000, i.e., 13,54,500Subject to a maximum of 13,25,700WDV NILDepreciation @ 25% on WDV NIL

Capital GainsSale consideration of plant A, B, C and D 13,54,500Less: Cost of AcquisitionDepreciated value as on 1.4.2010 13,25,700Balance 28,800Less : Expenses on Transfer 12,200Short-term capital gain 16,600Important Points :1. Tax on short-term capital gains can be avoided if the company purchases

another plant (eligible for depreciation @ 25%) during the Previous Year2010-11 of ` 16,600 or more.

2. If the plants A, B, C and D are transferred for less than ` 13,25,700, thedeficiency would be treated as short-term capital loss.

4.9 Summary

● The purpose of this part is to enable the students to comprehend basicexpressions used in taxation. Therefore, all the basic terms are explained andsuitable illustrations are provided to define their meaning and scope. Theseterms are : income, rates of tax, person, assessee, assessment year, previousyear, gross total income, total income, computation of tax liability on totalincome

● Tax incidence on an assessee depends on his residential status. All taxableentities are divided in the following categories for the purpose of determiningresidential status: an individual, a Hindu undivided family, a firm or anassociation of persons, a joint stock company and every other person.

● An assessee is either resident in India or non-resident in India. However, aresident individual or Hindu undivided family can be resident and ordinarilyresident or resident but not ordinarily resident. Residential status of anassessee is to be determined in respect of each previous year.Indian income is always taxable in India in respect of the residential status ofthe taxpayer. Foreign income is taxable in the hands of a resident or residentand ordinarily resident (in the case of an individual and a Hindu undividedfamily) in India. Foreign income is not taxable in the hands of a non-resident in



NotesIndia. In the hands of a resident not ordinarily resident taxpayer, foreign incomeis taxable only if it is business income and business is controlled from India orprofessional income from a profession which is set up in India. In any othercase, foreign income is not taxable in the hands of resident but not ordinarilyresident taxpayers.

● This part deals with: (a) Income of foreign companies providing technicalservices in projects connected with the security of India [Section 10 (6C)].(b) Section 10AA: Special provisions in respect of newly established units inSpecial Economic Zones and (c) Income from property held for charitablepurposes [Section 10AA].

● This portion deals with the Profits and Gains from Business/Profession asprovided in the tax statute. The expression in the ordinary parlance means anactivity of a commercial nature capable of producing profit. The chaptersummarises the income that are to be included under the head ‘Profits andGains of Business/Profession’ as distinguished from income from othersources. It also provides for computation of income, deductions that can beclaimed as deductible, income that are not chargeable to tax and expensesthough charged to profit and loss in arriving at the net income but expressly notallowed as per Income Tax Statute. Depreciation allowable as per the IncomeTax Statute are to be separately computed as the assessee has been allowedflexibility to provide depreciation in the books as per broad framework providedin Companies Act. It also deals with maintenance of accounts by certainpersons carrying on business or profession and audit therein. It also coversmethod of accounting to be followed including compulsory adopting ofAccounting Policy.

● In this part, we have discussed basis of charge for capital gains; Transactionnot regarded transfer withdrawal of exemption in certain cases; Computation ofcapital gains; Capital gains exempt from tax; Tax on long term capital gains.

4.10 Check Your progress

I. Fill in the Blanks1. Expenditure incurred by a company after its incorporation and after his

business has been set up, on development of website for conducting itsbusiness partly through website could be considered as _________expenditure.

2. interest on borrowed funds utilized for acquisition of an asset as part ofextension of business could be capitalized till the asset ___________.

3. Subsidy received by a company operating a sugar mill which could be utilizedonly for repayment of term loans taken by it for setting up new units andextension of existing units would be treated as __________.

II. State Whether the Following Statements are True or False1. The definition of transfer u/s 2(47) is applicable only in the case of a capital

asset.2. Compulsory Acquisition of a property by the Government is transfer.3. Redemption of share capital is ‘transfer’.4. Reduction of share capital is not ‘transfer’.



Notes 5. A taxpayer converts his capital asset into stock in trade. There is ‘no transfer’since the person who holds the asset before and after this transaction is thesame.

6. X sells a residential house property. He has received the full consideration andthe possession has been transferred to the buyer as per agreement to sell. Butsince the sale deed is not registered in favour of the buyer, there is no transfer.

7. If the property constitutes to exist after ‘relinquishment’, there is transfer, but ifa property disappears at the time of relinquishment there is no transfer.

III. Multiple Choice Questions1. the benefits of amortization of preliminary expenses under section 35D has

been extended to __________.(a) Manufacturing companies,(b) Post commencement preliminary expenses of service sector units,(c) Non-resident companies, or(d) Non-resident individuals.

2. No disallowance under section 40(a)(ia) shall be made in case of a deductor inrespect of expenditure incurred in the month of March if the TDS on suchexpenditure has been paid before __________.(a) 31st December,(b) 30th September,(c) due date for filling the return, or(d) 30 days from the date of deduction

3. Depreciation on new plant acquired and kept as standby in anticipation of anorder for supply of goods is __________.(a) An allowable expenditure on an asset kept as standby,(b) Not allowable as asset acquired but put to use,(c) partly allowable, or(d) None of the above


1. Explain the meaning of ‘previous year’. What would be the previous year for anew business started during the financial year? Explain with examples.

2. Income tax is assessed on the income of the previous year in the nextassessment year. State the exceptions to this rule.

3. What are the essential features of the term ‘Income’?4. Discuss capital receipts vis-à-vis revenue receipts.5. “Tax rates are not given under the Income Tax Act 1961, but by the Annual

Finance Act.” Discuss.6. “A financial year has a double role to play. It is a previous year as well as an

assessment year”. Do you agree?7. Determine the status of the following under the Income Tax Act, 1961:

(i) Delhi University(ii) L & T Ltd.(iii) Pune Municipal Corporation(iv) Taxman Publication (P) Ltd.



Notes(v) Laxmi Cooperative Bank Ltd.(vi) ABC Group Housing Co-operative Society(vii) X, Y & Co., firm of X and Y(viii) A joint family of X, Mrs. X and their sons A and B(ix) X and Y are legal heirs of Z (Z died in 2004 and X and Y will carry on his

business without entering into partnership).8. Indicate whether the following statements are true or false:

(i) X is a partner of a firm. He is assessable as an ‘individual’.(ii) Y is the managing director of A Ltd. Y is assessable as an individual.(iii) Delhi Municipal Corporation is assessable as ‘artificial juridical person’.(iv) Co-owners (with specific shares in a house property) transfer the property

capital gain generated on the transaction is taxable in the hands ofco-owners as ‘body of individuals’.

9. Discuss whether the following are true or false:(i) On rendering some service to a manufacturing garment unit, X is paid

remuneration in kind (i.e., a silk tie) since he has not received anything incash it is not an income.

(ii) On sale of goods illegally imported from a foreign country, X generates asurplus of ` 25,000. As the income is derived from an illegal activity, it isnot chargeable to tax.

(iii) Out of `15, 000 received by Mrs. X from her husband for householdexpenses, she saves approximately ` 1000 per month which is depositedby her in a bank account. ` 1000 per month is the income of Mrs. X.

(iv) Sale proceeds of a house property is capital receipt, which is howeverchargeable to tax.

(v) Salary paid to B by his employer X Ltd. out of capital reserve is notincome in the hands of B.

(vi) A birthday gift received by Z from his uncle is not taxable as income of Z.(vii) Income under the head ‘Income from house property’ is computed on the

basis of method of accounting adopted by the assessee.10. Which period will be treated as ‘previous year’ for income tax purposes for the

assessment year 2013-14 in the following cases?(a) Sumit starts a new business on 1.11.2012 and prepares final accounts on

30.06.2013.(b) Meenal joined service in a company on 1.1.2012 at ` 20,000/- per month.

His next increment in salary will be in 1.1.2013. Prior to this, he wasunemployed.

(c) Ashish keeps his accounts on the basis of financial year.(d) Abhay Verma is a registered doctor and keeps his income and

expenditure account on calendar year basis.(e) Jyoti Gupta bought a house on 1.8.2012 and let it out at ` 8000 per

month.11. ‘X’ who is a famous singer came to India from America for the first time on

26.01.2013. He gave many performances in India from which he received` 1,00,000. When he was about to return to US, the Income Tax Officer gavehim a notice and asked him to pay Income Tax immediately. He said in hisreply, “My previous year ends on 31.03.2013 and my tax liability will be in theAssessment year 2013-14”. What is your opinion in this regard ?



Notes 12. ‘R’ who has been permanently in India migrated to US on 18.11.2012. Explainhow he will be taxed with regard to income earned between 1.4.2012 and18.11.2012.

13. X Ltd., an Indian company, is engaged in the business of trading goods since1960 (income of trading business for previous years 2011-12 and 2012-13 is` 139,000 and ` 786,000, respectively). On January 6, 2013 it starts aprocessing unit at Pune [income of the period ending on March 31, 2013` 14,600]. Compute the income of X Ltd. chargeable to tax for the assessmentyear 2012-13 and 2013-14.

14. A single letter of enquiry was issued by the Income Tax Dept. to Mr. S of Pune.In this letter, there was no specific mention of any provision of the Income TaxAct. Can Mr. S be treated as an ‘assessee’ under the Income Tax Act?

Residential Status and Chargeability1. “The incidence of income tax depends upon the residential status of an

assessee.” Discuss.2. Discuss the scope of total income of a person who is a resident in India.3. Explain under what circumstances an assessee will be considered

‘non-resident’ for income tax purposes and on what income he will be liable tobe assessed.

4. How would you decide the question of residence of an individual and a Hinduundivided family?

5. Write short note on the following:(a) Income received in India(b) Income deemed to accrue or arise in India(c) Control and management of a business.

6. How would you determine the residential status of a company? Can a companybe ‘Not Ordinarily Resident’ in India?

7. X, a foreign national (not being a person of Indian origin) comes to India for thefirst time on April 15, 2008. During the financial year 2008-09, 2009-10,2010-11, 2011-12 and 2012-13 he is in India for 130 days, 80 days, 13 days,210 days and 75 days respectively. Determine the residential status of X for theassessment year 2013-14.

8. A, an Indian citizen, who is appointed as a senior taxation officer by theGovernment of Nigeria leaves India for the first time September 26, 2010 forjoining his duties in Nigeria. During the previous year 2011-12, he comes toIndia for 176 days. Determine the residential status of A for the assessmentyear 2011-12 and 2012-13.

9. Y an Indian citizen leaves India for the first time on September 20, 2010 fortaking employment outside India. He comes to India for a visit of 146 days onApril 10, 2011. He comes back on May 16, 2012. Find out the residential statusof Y for the Assessment year 2013-14.

10. A Ltd. is an Indian company. It carries on business in New Delhi and London.The entire control and management of A Ltd. is situated outside India. 80% ofthe total income of the company is from the business in London. What is theresidential status of A Ltd. ?

11. From the following information about R, compute his taxable income for theAssessment Year 2013-14 assuming Mr. R is: (i) resident but not ordinarilyresident and (ii) Non-resident.



Notes(a) Remuneration for consultancy service in Japan of ` 1,00,000 but receivedin India.

(b) Income from business in UAE received in Scotland ` 11,500. Thebusiness is however controlled from India.

(c) Pension for services rendered in India but received in China ` 40,000.(d) Fee for technical services payable by G, a resident in India, the payment

relates to a business carried out in India ` 100,000.12. From the following particulars compute the taxable income of R when his

residential status is (i) resident, (ii) resident but not ordinarily resident and(iii) non-resident.(i) Interest for debentures in an Indian company received in London ` 5000.(ii) Interest on a company deposit in India but received in Germany ` 22,000.(iii) Interest on UK Development Bonds, 50% of interest received in India

` 40,000.(iv) Profit on sale of shares in a Indian company received in London ` 24,000.(v) Dividend from British Co. received in London ` 10,000.(vi) Profit on sale of plant at Germany, 50% of the profits are received in India

is ` 60,000.(vii) Income earned from business in Germany which is controlled from Delhi,

` 40,000 is received in India – ` 70,000.(viii) Profits from a business in Delhi, but managed entirely from London

` 45,000.(ix) Rent from property in London deposited in Indian Bank at London brought

to India – ` 50,000.(x) Interest received in London on money but to resident in India in London

but the same money was used in India – ` 46,000.(xi) Fees for technical services rendered in India but received in London –

` 25,000.(xii) Royalty received in London for a right given to non-resident in India to be

used for business in India – ` 34,000.13. In the year 2012-2013 (previous year) a sailor has remained on ship for a

private company owning ocean going ships as follows:1. Outside the territorial waters of India for 183 days.2. Inside the territorial waters of India for 183 days.

Is he considered to be a resident or not for the A.Y. 2013-14 (Previous year2012-13)? Comment.

Exempted Income of Companies1. State the provisions relating to Income of foreign companies providing technical

services in projects connected with the security of India [Section 10 (6C)]2. State the provisions relating to exemption relating to Special provisions in

respect of newly established units in Special Economic Zones – Section 10AA.3. State the provisions relating to exemption relating to Income from property held

for charitable purposes (Sections 11,12,13).

Profit and Gains from Business or Profession1. Discuss the provisions of Section 28(iv) regarding tax incidence in respect of

benefits or perquisites arising from a business or exercise of a profession.



Notes 2. What tests would you apply to determine whether a transaction is an adventurein the nature of trade?

3. A non-resident is engaged in shipping business. The company also operatesits shop in India. Explain how the income from the company’s businessoperation in India is computed.

4. What are the tax consequences in the following situations:(i) A firm of three partners is dissolved. It held stocks valued at ` 4,80,000 on

the date of dissolution, the basis of valuation being cost for settlement ofaccounts between the partner on dissolution, they have adopted` 4,80,000 as the value of stocks.

(ii) The Director of a company was accompanied by his wife on a foreign tourundertaken by him for business purposes. It was claimed that herpresence fulfilled a social purpose and facilitated transaction of business.

(iii) Expenditure incurred in connection with increase of the authorised capitalof a company and issue of bonus shares by it is capital in nature.

5. Discuss the following:(i) Compensation is normally a capital receipt but there are certain receipts

by way of compensation which are taxable as income from business.(ii) State the situation under which WDV of a ‘block of assets’ will be reduced

to Nil.(iii) Describe the provisions of Income Tax Act that deal with the computation

of business income on a presumptive basis in certain cases, in the casesof resident assessees.

(iv) The provisions that relate to amortisation of expenses for obtaining alicense to operate telecommunication services.

(v) The concession available under the Income Tax Act to profits derivedfrom infrastructure business.

6. (i) What are the receipts to be excluded for computing “actual loss of an assetunder Income Tax Act”?

(ii) Discuss Block of Assets concept under the Income Tax Act.(iii) While computing income from business or profession certain deduction

will be allowed only on actual payments. Discuss.7. (i) State the cases when payment exceeding ` 20,000 made otherwise than

by a crossed cheque or by a crossed demand bank draft will not bedisallowed ?

(ii) Income from business or profession is chargeable to tax, only if it iscarried on during the previous year by an assessee. Give five examples ofcases where the income is taxable even if the business or profession isnot in existence during any previous year.

8. (i) Compare and contrast the provisions of tax audit as contained in Section44AB of the Income Tax Act, with the provisions of the audit u/s 142(2A) ofthe Act.

(ii) Anand, is a person carrying on profession as Film Artist. His grossreceipts from profession are as under:

Financial year 2011-2012 ` 1,25,000.00Financial year 2012-2013 ` 1,60,000.00Financial year 2013-2014 ` 1,80,000.00



NotesIs he required to maintain any books of accounts, u/s 44A of the Income Tax Act? Ifso, what are these books?9. (i) State the conditions to be satisfied for claiming deductions u/s 37(1) of the Act.

(ii) What is meant by Speculation Business? What are the transactions notdeemed to be speculative transactions?

(iii) Enumerate the classes of receipts deemed to be profits and gains of businessor profession under Section 41.

10. (i) From the following figures, you are required to ascertain the depreciationadmissible and other liabilities if any, in respect of the previous year relevant tothe A.Y. 2013-14.

Plant and Machinery Building

WDV at the beginning of the year 2,50,000.00 10,00,000.00

Additions during the year 3,00,000.00 NIL

Sales during the year 6,00,000.00 2,00,000.00

(ii) Calculate the deduction admissible u/s 37(2) in respect of entertainmentexpenditure for A.Y. 2013-2014, from the following data :

Expenditure incurred on food provided to employees ` 25,000.00Entertainment allowance paid to Directors ` 10,000.00Other items of entertainment ` 50,000.00

(iii) From he following find out the admissible deduction u/s 37(3) and the rulesthere under in respect of expenditure incurred on advertisement in a souvenir:

Expenditure on advertisement in a souvenir ` 50,000Issued by a political partyExpenditure on presentation articles:Value per article – less than ` 1,000 ` 20,000Value per article – exceeding ` 1,000 ` 10,000Expenditure incurred in cash ` 12,000

11. (a) Atmaram and Co. borrowed ` 20,000 in Hundi by an account payee cheque on1.1.2014. The amount was repaid in cash on 1.10.2014 along with interest of` 3,000. What is the effect of the transaction in the assessment of Atmaramand Co. ?

(b) A manufacturer of goods which are liable to excise duty maintains a separateaccount for excise duty collected and paid by him. The balance remaining inthis account is carried to the balance sheet. The levy of Central Excise wasdisputed by the assessee and being successful, he received a refund of exciseduty to the tune of ` 10 lakhs which was credited to the Central ExciseCollection Account. The Assessing Officer taking the view that the provisions ofSection 41(1) are attracted brought the sum of ` 10 lakhs to tax. The assesseedisputes this levy on the ground that he had not claimed the payment of CentralExcise as a deduction in arriving at his income and therefore the provisions ofSection 41(1) are not attracted. Discuss the comparative merits of the two viewprints.

12. Jardenes Ltd. is an existing Indian company, which sets up a new industrialunit. It incurs the following expenditure in connection with the new unit:Preparation of project report ` 4,00,000Market survey ` 5,00,000



Notes Legal and other charges for issue of additionalCapital required for the new unit ` 2,00,000Total ` 11,00,000The following further data is given :Cost of project ` 30,00,000Capital employed in the new unit ` 40,00,000What is the deduction admissible to the company u/s 35D?

13. From the following data, calculate the depreciation admissible to an individualcarrying on business for the A.Y. 2013-14.(1) Factory Building WDV (10% Depr.) ` 5,00,000(2) Plant and machinery WDV (25% Depr.) ` 8,00,000

Additions 30.6.2012 (15% Depr.) ` 1,00,00031.12.2012 (15% Depr.) ` 1,00,000Sales 01.12.2012 (25% Depr.) ` 6,00,000

(3) Computer (60% Depr.)Addition 1.1.2013 ` 60,000

(4) Furniture and Fixtures WDV (15% Depr.) ` 1,00,000(5) Motor Car WDV (20% Depr.) ` 60,000

14. Discuss the tax implications of the following transactions in the case of a doctorrunning a nursing home :

(i) Amount paid to a scientific research association approved by the CentralGovernment and run by a drug manufacturing company ` 20,000.

(ii) Amount received from the employees as contribution towards PF for themonth of March 2010, paid to PF commissioner on 25.04.2010 ` 25,000.

(iii) Payment made in cash towards purchases of medicines ` 50,000.(iv) Repayment of loan taken from bank for doing a post graduate course in

medicineInstalment ` 50,000Interest ` 10,000

15. The following is the Profit and Loss Account for the year ended 31.3.2013.Compute his taxable income from business for that year:Particulars ` Particulars `

Opening Stock 15,000 Sales 80,000

Purchases 40,000 Closing Stock 20,000

Wages 20,000 Gift from father 10,000

Rent 6,000 Sale of car 17,000

Repairs of car 3,000 Income tax refund 3,000

Wealth tax paid 2,000

Medical expenses 3,000

General expenses 10,000

Depreciation of car 4,000

Advance income tax paid 1,000

Profit for the year 26,000

1,30,000 1,30,000



NotesFollowing further information is given :1. R carries on his business from rented premises half of which is used as his

residence.2. R bought a car during the year for ` 20,000. He charged 20% on the value of

the car. The car was sold during the year for ` 17,000. The use of the car was3/4th for the business and 1/4th for personal purposes.

3. Medical expenses were incurred during sickness of R for his treatment.4. Wages include ` 2500 on account of R’s driver.

16. Shri Batra is the owner of a small manufacturing unit. He gives you thefollowing details from his books of accounts for the year 2012-13:

1. Computed net profit, after charging the following items : ` 27,5002. Provisions and reserves debited to Profit and Loss Account—

(i) Provision for doubtful debts ` 15,000(ii) Depreciation reserve ` 20,000

3. Household expenses ` 30,0004. Donations to Prime Minister National Relief Fund ` 10,000; Other

Charitable Donations ` 20,0005. Cheques issued for purchases ` 60,0006. OY Telephone Deposit ` 5,000

7. Advertisement expenses ` 5,000 spent on Neon Sign given to a customer.Advertisement gifts to 50 customers at a cost of ` 100 each.

8. Audit fee charged ` 20,000, expenses on income tax assessment ` 15,0009. Patent purchased for ` 70,000 during the previous year

10. Market survey expenses ` 8,000, feasibility report expenses ` 12,000 on a newproject of ` 10,00,000 started this year.

11. Incomes credited to Profit and Loss Account were:(i) Bank interest on FD – ` 5,000(ii) Interest on Post Office Savings Bank A/c – ` 3,000(iii) Interest on UTI Units − ` 2,000

12. Opening stock is valued at cost plus 10% basis, whereas closing stock wasvalued at cost minus 10% basis. Opening stock valued was ` 66,000; closingstock valued was ` 72,000. Compute the Net Business Income for the A.Y.2013-14.

17. Find out the gross total income of Sri Syam Lal on the basis of the followingparticulars:

Profit and Loss A/c for the year ended 31.03.2013

` `

Interest 1,800 Gross Profit b/d 1,22,700

Repairs & renewal 2,200 Interest on debentures of aninstitution (Gross)

10,000

Insurance 4,200 Rent from house property 36,000

Depreciation 5,600

___________ 10,200

Law charges 5,100

Labour welfare expenses 3,800



Notes Subscriptions 5,800

Net Profit 1,30,000

1,68,700 1,68,700

Further information provided:(a) (i) Interest include ` 200 on loan taken for purchasing debentures of a company

and ` 300 on loan taken for reconstruction of house property let out.(ii) The expenses relating to house property let out are 40% of the repairs and

renewals expenses.(iii) Depreciation includes ` 1,200 on house property let out.(iv) Compensation was paid to an employee whose dismissal was in business

interest.(v) Insurance includes 30% for fire insurance of the house property let out, 30% for

workers accident insurance and balance for life insurance.(vi) Law charges includes ` 2,000 relation to a petition filed against breach of

contract and the balance regarding sales tax appeal.(vii) Subscriptions include ` 2,000 given for election purposes to political parties.

(b) The amounts not debited to profit and loss A/c are as follows:(i) Expenses incurred on the occasion of Dipawali - ` 500.(ii) Theft of cash from iron safe - ` 1,500.(iii) Expenses for new telephone connection in the business - ` 2,000.

Capital Gains1. What is included and excluded from ‘Capital Assets’ as defined by Section 2(14)

for the A.Y. 2013-14?2. What is the ‘transfer’ of a capital asset as per Section 2(47) of the Act?3. Discuss the provisions of the Income Tax Act, 1961 regarding:

(i) Conversion of capital assets to stock in trade(ii) Computation of capital gains in case of depreciable assets.

4. Write short notes on the following:(i) Capital gains in the case of compulsory acquisition of a capital asset(ii) Reference to valuation officer (u/s 55A of Income Tax Act)(iii) Computation of capital gains in the case of slump sale u/s 50B of the

Income Tax Act, 1961.5. State the provisions relating to the computation of capital gains in the hands of

shareholders of a company on a distribution of assets upon liquidation.6. What are the transactions not regarded as transfer as per Section 47 under the

Income Tax, 1961?7. Arjun was holding 3000 shares in White Light Ltd. purchased by him on August

8, 2006 at ` 60 per share. He gifted these shares to his girlfriend Chitrangadaon 10.02.2013. Arjun married Chitrangada on 1.3.2013. Chitrangada wasallotted bonus shares by the company at the rate of one share for every threeshares held on 10.09.2013. Chitrangada sold all the shares including the bonusshares on 31.03.2014 at ` 150 per share.State in whose hands capital gains on sale of shares is taxable. Also computethe capital gains.



Notes[Hint : Shares have been transferred before marriage, capital gains are taxablein the hands of Chitrangada]

8. Amin is the holder of 1000 debentures of Amin Ltd. having a face value of` 1,000 each. The company has offered an option to the debenture holderseither to redeem the debentures at ` 1,200 each or to convent the debenturesin equity shares of equivalent value. The market value of the shares on thedate of exercising the option is ` 1,200 per share (face value of ` 1,000). Whatwill be the tax consequences of the two options in the hands of the debentureholder Amin ?

9. Discuss giving reasons whether the following are correct :(a) A firm can claim exemption u/s 54, 54B, 54F(b) An individual can claim exemption u/s 54 to 54G(c) A company can claim exemption u/s 54D, 54EC, 54ED and 54G(d) A long-term capital asset is qualified for exemption u/s 54 to 54G but a

short-term capital asset is qualified for exemption only under Sections54B, 54D and 54G.

(e) Multiple exemptions are possible but aggregate exemption underSections 54 to 54G cannot exceed the amount of capital gains.

(f) An individual who owns two residential houses cannot claim exemptionunder Section 54F on transfer of gold

(g) An individual who owns a residential house and a plot of land in aresidential area can claim exemption under Section 54F if he sells goldand constructs a residential house on the plot already owned by him.

10. Mr. P holds 500 shares of ABC Ltd., which were allotted to him on 22.11.1990@ ` 30 per share. On 22nd July 2010, ABC Ltd., made right issue to theexisting shareholders at the rate of one share for every five shares held @` 20/- per share. Mr. P instead of exercising his right to obtain right shares hasexercised his right of renouncement by renouncing the said right entitlement infavour of Mr. Q @ ` 13 per right share entitlement on 4.8.2010. Determine thenature and amount of capital gain, if any, taxable in hands of P. What will bethe cost of acquisition of the shares purchased to Mr. Q?

11. In April 2000, S subscribed to the first equity issue of shares of a Public Ltd. Co.(face value of each share ` 100) to the extent of ` 25,000. In 2,000, thecompany converted the face value of the shares from 100 to ` 10 each. Half ofthe holdings of the shares held by S were sold by him in October 2010 for` 50,000 S had to pay a brokerage of 2% on sale. What is the nature of gainsrealized and compute the same?

12. Kishore Industries owned six machines that were in use in the business inMarch 2009. Depreciation on these machines was available as ‘plant’. TheWDV of these machines at the end of previous year relevant to assessmentyear 2011-12 was ` 6,50,000 (depreciation 15%).A new plant was bought for ` 6, 50,000 on 30.11.2010. Three of the oldmachines were sold on 10.06.2010 for ` 9,00,000. Compute:(i) The claim to depreciation for A.Y. 2011-12.(ii) Capital gains liable to tax for the same A.Y.

13. Mr. Sunder furnishes the following particulars for the previous year ending31.3.2010, and requests you to compute the taxable capital gain(i) He had a residential house, inherited from father in 1974, the fair market

value of which as on 1.4.1981 is ` 5 lakhs.



Notes (ii) In the year 1997-98, further constructions and improvements costed` 6 lakhs.

(iii) On 10.05.2010, the house was sold for ` 50 lakhs. Expenditure inconnection with transfer ` 50,000.

(iv) On 20.12.2010, he purchased a residential house for ` 15 lakhs.Cost of inflation Index1981-82 1001997-98 3312010-11 711

14. Arjun furnishes the following particulars and requests your advice as to theliability to capital gains for the A.Y. 2011-12:

(i) Jewellery purchased by him on 10.3.2002 for ` 1,05,000 was sold by himfor a consideration of ` 2,85,000 on 2.11.2010.

(ii) He incurred expenses (a) at the time of purchase ` 2,000 (b) At the timeof sale (for brokerage) ` 4,000.

(iii) He invested ` 70,000 in bonds with the National Highway Authority ofIndia out of sale consideration are these facts:(a) Compute the capital gains chargeable to tax;(b) Whether Arjun would be entitled to exemption?

4.12 Key Terms

● Income: Section 2(24) of the Income Tax Act,1961 gives a statutory meaningof the term ‘Income’. The section does not define the term income, but merelydescribes the various receipts that can be known as income. At present thefollowing items of receipts are included in Income u/s 2(24).

1. Profits and Gains2. Dividends3. Voluntary contributions received by a trust / institution created wholly or

partly for charitable or religious purposes or by an association orinstitution .

4. The value of any perquisite or profit in lieu of salary taxable.5. Any special allowance or benefit other than the perquisite included above,

specifically granted to the assessee to meet expenses wholly, necessarilyand exclusively for the performance of the duties of an office oremployees of a private firm.

6. Any allowance granted to the assessee to meet his personal expenses atthe place where the duties of his employment of profit are ordinarilyperformed by him or at a place where he ordinarily resides or tocompensate him for the increased cost of living.

7. The value of any benefit or perquisite whether convertible into money ornot, obtained from a company either by a director or by a person who hasa substantial interest in the company or by a relative of the director orsuch person and any sum paid by any such company in respect of anyobligation which, but for such payment would have been payable by thedirector or other person aforesaid.

8. The value of any benefit or perquisite, whether convertible into money ornot, which is obtained by any representative assessee or by any



Notesbeneficiary or any amount paid by the representative assessee for thebenefit of the beneficiary which the beneficiary would have ordinarily beenrequired to pay.

9. Value of any benefit or perquisite, whether convertible into money or notarising from a business or exercise of profession.

10. Any sum chargeable to income tax under Section 41 and Section 59.11. Any sum chargeable to income tax under (ii), (iii), (iii-a), (iii-b), (iii-c), (iv)

and (v) of Section 28.12. Any sum chargeable to tax u/s 28(v) [interest, salary, bonus, commission

or remuneration to a partner of a firm].13. Any capital gains chargeable under Section 45.14. The profits and gains of any insurance carried on by a Mutual Insurance

Company or by a cooperative society.15. The profits and gains of any business (including providing credit facilities)

carried on by a cooperative society with its members.16. The profit and gains of any business of banking (including providing credit

facilities) carried on by a co-operative society with its members.17. Any winnings from lotteries, crossword puzzles, races including horse

races, card games and other games of any sort or from gambling orbetting of any form or nature whatsoever.

● Rates of tax: Income tax is to be charged at the rates fixed for the year by theAnnual Finance Act.

● Person: The term ‘person’ includes:(i) An individual(ii) A Hindu Undivided Family(iii) A company(iv) A firm(v) An association of persons or body of individuals whether incorporated or

not(vi) A local authority and(vii) Every artificial juridical person not falling within any of the preceding

categories.The aforesaid definition is inclusive and not exhaustive. Therefore, any personnot falling in the above seven categories may still fall in the term person andaccordingly, may be liable to Income Tax.

● Assessee: An assessee is a person by whom any tax or any other sum ofmoney (for example, interest, penalty, fine, etc.) is payable under the IncomeTax Act and includes:(a) A person in whose respect proceedings for determining income or for

assessment of fringe benefits or of the income of any other person inrespect of which he is assessable or of the loss sustained by him or bysuch other person or of the amount of refund due to him or to such otherperson have been commenced by the Income Tax Department. Thus, aperson may become an assessee even if no amount is payable by himunder the Income Tax Act.

(b) A deemed assessee, i.e., a person who is himself not an assessee but istreated as an assessee for the purposes of the Income Tax Act. Forexample, the trustee of a trust is deemed as an assessee in respect of the



Notes trust. The income earned is the income of the trust but is assessed in thehands of the trustee as his income.

(c) An assessee in default, i.e., a person on whom certain obligations havebeen imposed under the Income Tax Act but who has failed to carry outthose obligations. For example, any person who employs another personto deduct income tax at source from the taxable salary of the employeeand pay the tax deducted at source to the government within theprescribed time as income tax paid on behalf of the employee. In case theemployer fails to carry out these obligations, he becomes an assessee indefault.

● Assessment year: Assessment Year (AY) means the financial year (1st Aprilto 31st March of the next year) in which the income is taxed or assessed.Income of the previous year is taxed in the assessment year (next year) at therates prescribed by the relevant finance act, for e.g., income earned during theprevious year 2012-13 is taxable in the assessment year 2013-14 at the ratesprevailing by the relevant Finance Act.

● Previous year: Previous Year (PY) means the financial year immediatelyproceeding the assessment year. In case of a business or profession which isnewly started, the previous year commences from the date of commencementof the new business or profession up to the next 31st day of March.

● Gross total income: As per Section 14, income of a person is computed underthe following five heads:

1. Salaries2. Income from house property3. Profits and gains of a business or profession4. Capital gains5. Income from other sources.

The aggregate income under these heads is termed as the ‘gross total income’.In other words, gross total income means total income computed inaccordance with the provisions of the Act before making any deduction underChapter VIA (Section 80C to 80U).Further, Section 14A provides that no deduction shall be made in respect ofexpenditure incurred by the assessee in relation to the income that does notform part of the total income under the Act.

● Total income: The total income of an assessee is a gross total income asreduced by the amount permissible as deduction under Sections 80C to 80U.

● Computation of tax liability: On the total income, tax is to be calculatedaccording to the rates prescribed under the relevant Finance Act.

4.13 Check your Progress: Answers

I. Fill in the Blanks1. Revenue2. Put to use,3. Capital receipt



NotesII. True or False1. True2. True3. True4. True5. False6. False7. False

III. Multiple Choice Questions1. (b) Post commencement preliminary expenses of service sector units,2. (c) due date for filling the return, or3. (a) An allowable expenditure on an asset kept as standby,

4.14 Case Study

1. Atul, a cost accountant has been in service of a company in India for the last10 years. The last pay drawn by him is consolidated amount of ` 38,000 per month.He had never been out of India previously. He receives an offer from a company inPapua New Guinea operating there, for appointment in that country as Chiefaccountant on a salary of ` 70,000 per month. The offer was received sometime inJuly, 2012 with option of join service before end of October 2012. Advise Atul fromtax point of view as to :

(a) Choice of date of his joining service abroad.(b) The manner in which salary should be received by him and the necessary

remittance to India made for requirement of his family out of his salaryincome.

(c) The maximum period for which he can stay in India, if he comes on leaveduring the next year and still remain non-resident.

Solution(a) Explanation to Section 6(1) provides that an Indian citizen who leave India

during the relevant previous year for the purpose of employment, becomesresident in India only if he is in India for at least 182 days during the relevantprevious year. Hence, Atul should plan to leave India on or before 28-9-2012 tojoin the company in Papua New Guinea.

(b) As per Section 5, salary of a non-resident is not taxable in India if the salary isaccrued and received outside India. Hence, Atul should receive the salaryabroad and thereafter he should remit the required amount to his family in India.Subsequent remittance will not bring the salary received abroad to tax in India.

(c) As per Explanation to Section 6(1) of the Income Tax Act, if a citizen of India ora person of Indian origin working abroad comes on a visit to India in anyprevious year, then he shall be considered as resident in India in that previousyear if he stays in India for 182 days or more in that previous year.

2. R, an Indian citizen, joined Oxford School of Economics as a professor on a monthlysalary of US $10,000 on 1-10-2009 on a 6 year contract. He had never been out ofIndia in the past. His wife and two children live in rented house, which is maintainedby him in Delhi. He wants to proceed in India on leave for a period of 10 months to



Notes get his own house constructed in Delhi. But at the same time he wants to be treatedas a non-resident during his stay here so that his salary earned in the UK mayremain totally exempt from tax in India. He does not propose to make any other visitto India during the period of his contract of service in the UK. Suggest the dates as tohow he should plan his 10 months visit to India.

SolutionAn Indian citizen or a person of Indian origin who is outside India and whocomes to visit India during a previous year becomes resident in India if his stayin India exceeds 181 days. Thus, R should plan his stay in India in such amanner so that in any single previous year he is not in India for more than 181days. In other words, he should split his stay in two previous years. He cancome to India for a period of 10 months at any time between 3-10-2012 to28-9-2013.


1. Ahuja, Girish Dr. and Gupta Ravi Dr., Direct Taxes Law and Practice includingTax Planning, Bharat Law House Pvt. Ltd..

2. Singhania Vinod K. Dr. and Singhania Kapil Dr., Direct Taxes Law and Practicewith Special Reference to Tax Planning ,Taxman.

3. Singhania Vinod K. Dr. and Singhania Kapil Dr., Direct Taxes Planning andManagement , Taxman.

■■■■

Assessment of Companies 223


Notes

Unit 5: Assessment of Companies

Structure:5.1 Assessment of Companies

5.1.1 Introduction5.1.2 Assessment of Companies5.1.3 Residence of a Company [Section 6(3)]5.1.4 Scope of Total Income and Incidence of Tax5.1.5 Computation of Total Income5.1.6 Assessment Procedure5.1.7 Problems

5.2 Provisions Relating to Minimum Alternate Tax (MAT)5.2.1 Introduction to MAT5.2.2 Provisions of MAT for Payment of Tax by Certain Companies [Section

115JB(1)]5.2.3 Illustrative Problems5.2.4 Special Provision Relating to Tax on Distributed Profits of Domestic

Companies5.2.5 Special Provisions Relating to Tax on Distributed Amount to Unit Holders

[Sections 115R to 115T]5.3 Set-off and Carry Forward of Losses

5.3.1 Introduction to Set-off and Carry Forward of Losses5.3.2 Set-off of Loss from One Source Against Income from Another Source

under the Same Head of Income [Section 70]5.3.3 Inter-head Adjustment [Section 71]5.3.4 Carry Forward and Set-off of Losses5.3.5 Carry Forward and Set-off of Loss from House Property [Section 71B]5.3.6 Carry Forward and Set-off of Business Losses [Section 72]5.3.7 Carry Forward and Set-off of Speculation Loss (Section 73)5.3.8 Set off and Carry Forward and Set-off of Loss of a Specified Business

Referred to in Section 35AD [Section 73A]5.3.9 Carry Forward of Losses under the head ‘Capital Gains’ [Section 74]:

5.3.10 Carry Forward of Loss from the Activity of Owning and MaintainingRace Horses [Section 74A]

5.3.11 Brought Forward Losses Must be Set Off in the ImmediatelySucceeding Year/Years

5.3.12 Problems on Set-off and Carry Forward of Losses5.4 Tax Planning with Reference to New Projects/Expansion/Rehabilitation Plans

5.4.1 Introduction: Tax Planning with Reference to New Projects Expansion/Rehabilitation Plans

5.4.2 Section 10AA: Special Provisions in Respect of Newly EstablishedUnits in Special Economic Zones

5.4.3 Deduction in Respect of Profits and Gains from Industrial Undertakings orEnterprises Engaged in Infrastructure Development etc. [Section 80IA]



Notes 5.4.4 Deduction in Respect of Profits and Gains from Enterprises Engaged inDevelopment of the Special Economic Zones [Section 80-IAB]

5.4.5 Deduction in Respect of Profits and Gains from Certain IndustrialUndertakings Other than Infrastructure Development Undertakings[Section 80IB]

5.4.6 Deduction in Respect of Profits and Gains from the Business of Hotelsand Convention Centres in Specified Areas [Section 80ID]

5.4.7 Deduction in Respect of Certain Undertakings in North-Eastern States[Section 80IE]

5.4.8 Deduction in Respect of Certain Incomes of Off-shore Banking Unitsand International Financial Service Centres by the Specific EconomicZone Act, 2005 [Section 80LA]

5.4.9 Venture Capital Companies [Section 10(23FB)]5.4.10 Tea Development Account, Coffee Development Account and Rubber

Development Account [Section 33AB]5.4.11 Site Restoration Fund [Section 33ABA]5.4.12 Telecommunication Services [Section 35ABB]5.4.13 Expenditure on Eligible Projects or Schemes [Section 35AC]5.4.14 Deduction in Respect of Expenditure on Specified Business [Section

35AD] [w.e.f. A.Y. 2010-11]5.4.15 Section 35 CCA: Payment to Institutions for Carrying out Rural

Development Programmes5.4.16 Deductions for Expenditure on Prospecting etc. for Certain Minerals

[Section 35E]5.4.17 Special Reserve Created by a Financial Corporation under Section

36(1)(viii)5.4.18 Special Provision for Deduction in the Case of Business for Prospecting

etc. for Mineral Oil [Section 42 and 44BB]5.4.19 Special Provision for Computing Profits and Gains of Civil Construction

[Section 44AD]5.4.20 Special Provisions for Computing Profits and Gains of Business of

Plying, Hiring or Leasing Goods Carriages [Section 44AE]5.4.21 Special Provisions for Computing Profits and Gains of Retail Business

upto A.Y.2010-11 Only [Section 44AF]5.4.22 Special Provisions in the Case of Shipping Business [Section 44B]5.4.23 Special Provisions for Computing Profits and Gains of Business of

Operations of Aircraft in the Case of Non-residents [Section 44BBA]5.4.24 Special Provisions for Computing Profits and Gains of Foreign

Companies Engaged in the Business of Civil Construction etc. inCertain Turnkey Power Projects [Section 44BBB]

5.4.25 Special Provisions in the Case of Royalty Income of ForeignCompanies [Section 44D]

5.4.26 In Respect of the Profits from the Business of Processing ofBiodegradable Waste [Section 80JJA]

5.4.27 In Respect of the Employment of New Workmen [Section 80JJAA]5.4.28 Tax Incentives for Shipping Business – Tonnage Tax [Sections 115V to

115VZC]5.4.29 Problems

5.5 Tax Planning in Respect of Amalgamation, Merger or Demerger of Companies5.5.1 Introduction5.5.2 Meaning of Terms as per Tax Law Amalgamation



Notes5.5.3 Income Tax Implications in Case of Amalgamation or Demerger5.5.4 Tax Concessions Relating to Transfer of Capital Asset in Case of

Amalgamation/Merger/Demerger5.5.5 Carry Forward and Set-off of the Accumulated Losses and Unabsorbed

Depreciation Allowance in Amalgamation or Demerger, etc. (Section72A)

5.5.6 Provisions Relating to Carry Forward and Set-off of Accumulated Lossand Unabsorbed Depreciation Allowance in Scheme of Amalgamationof Banking Company in Certain Cases [Section 72AB]

5.6 Concept of Avoidance of Double Taxation5.6.1 Introduction5.6.2 Source Rule and Residence Rule5.6.3 Effects of Double Taxation on Trade and Services and its Remedy5.6.4 Definition of Double Taxation5.6.5 Necessity of Double Taxation Agreement5.6.6 Avoiding and Alleviating theAdverse Burden of International Double Taxation5.6.7 Salient Features of DTAA5.6.8 Relief under DTAA5.6.9 Models of DTAA Model

5.6.10 Analysis of Tax Treaty5.7 Summary5.8 Check Your Progress5.9 Questions and Exercises

5.10 Key Terms5.11 Check Your Progress: Answers5.12 Case Study5.13 Further Readings

Objectives

After studying this unit, you should be able to:● To understand the salient points regarding the assessment of companies and

computation of total income● To learn provision of minimum Alternate Tax in certain companies and declaration and

payment of dividend● To understand provision relating to set-off and carry forward of losses to subsequent

year● To know Tax Planning with reference to new projects/expansion/rehabilitation plans● To understand tax provisions relating to amalgamation, merger or demerger of

companies so that relevant concessions can be availed through proper tax planning● To know the concept of avoidance of double taxation

5.1 Assessment of Companies

5.1.1 IntroductionA company has been defined as, ‘a juristic person having an independent and

separate legal entity from its shareholders’. Income of the company is computed and



Notes assessed separately in the hands of the company. The company is liable to pay tax at aflat rate like a firm. If any amount is distributed or paid by the company as dividend to theshareholders, the company shall be liable to pay tax on such dividends distributed or paidincluding a surcharge, as applicable. However, the shareholder shall not be liable to payIncome Tax on such dividends.

5.1.2 Assessment of Companies

Definitions:1. Company: As per Section 2(17), a company means:

(i) any Indian company, or(ii) any body, corporate/incorporated by/under the laws of a country outside

India, or(iii) any institution, association or body which was assessed as a company for

any assessment year under the Income Tax Act, 1922 or was assessedunder this act as a company for any assessment year commencing on orbefore 1.4.1970, or(iv) any institution, association or body, whether incorporated or not andwhether Indian or non-Indian, which is declared by a general or specialorder of the CBDT to be a company.

2. A company in which the public is substantially interested: Section 2(18) ofthe Income Tax Act has defined a company in which the public is substantiallyinterested to include:

(i) A company owned by the Government or the Reserve Bank of India.(ii) A company having Government participation, i.e., a company in which not

less than 40% of the shares are held by the Government or the RBI or acorporation owned by the RBI.

(iii) Companies registered under Section 25 of the Indian Companies Act,1956: Companies registered under Section 25 of the Companies Act,1956 are companies which are promoted with the special object, such asto promote commerce, art, science, charity or religion or any such usefulobject and these companies do not have a profit motive. However, if atany time these companies declare dividend, they would loose the statusof a company in which the public is substantially interested.

(iv) A company declared by the CBDT: It is a company without share capitaland which, having regard to its object, nature and composition of itsmembership or other relevant consideration is declared by the board to bea company in which the public is substantially interested.

(v) Mutual Benefit Finance Company, where the principal business of thecompany is acceptance of deposits from its members and which has beendeclared by the Central Government to be a Nidhi or a Mutual BenefitSociety.

(vi) A company having co-operative society participation: It is a company inwhich at least 50% or more equity shares have been held by one or moreof the cooperative societies.

(vii) A Public Limited company: A company is deemed to be a public limitedcompany if it is not a private company as defined by the Companies Act,1956 and is fulfilling either of the following two conditions:(a) Its equity shares were listed on a stock exchange, as on the last day

of the relevant previous year; or



Notes(b) Its equity shares carrying at least 50% of the voting power (in thecase of an industrial company the limit is 40%) were beneficially heldthroughout the relevant previous year by the Government, astatutory corporation, a company in which the public is substantiallyinterested or a wholly owned subsidiary of such a company.

An industrial company means a company whose business consists mainly of the construction ofships or the manufacturing or processing of goods or in mining or in the generation or distributionof electricity or any other form of power.

3. Widely held company: It is a company in which the public is substantiallyinterested.

4. Closely held company: It is a company in which the public is not substantiallyinterested.

5. Indian company [Section 2(26)]: An Indian Company means a companyformed and registered under the Companies Act, 1956 and includes:(i) a company formed and registered under any law relating to the

companies formerly in force in any part of India (other than the State ofJammu and Kashmir and the Union Territories):

(ia) a corporation established by or under a Central, State or Provincial Act;(ib) any institution, association or body which is declared by the Board to be a

company;(ii) in the case of the state of Jammu and Kashmir, a company formed and

registered under any law for the time being in force in that state;(iii) in the case of any of the Union Territories of Dadra and Nagar Haveli, Goa,

Daman and Diu and Pondicherry, a company formed and registeredunder any law for the time being in force in that Union Territory.

Provided that the registered or as the case may be, the principal office of thecompany, corporation, institution, association or body, in all cases is in India.

6. Domestic Company [Section 2(22A)]: A domestic company means an Indiancompany or any other company which in respect of its income, liable to taxunder the Income Tax Act, has made the prescribed arrangements for thedeclaration and payment within India, of the dividends (including dividends onpreference shares) payable out of such an income.

7. Foreign Company [Section 2 (23A)]: Foreign Company means a companywhich is not a domestic company.

8. Investment Company: Investment Company means a company whose grosstotal income consists mainly of income which is chargeable under the heads‘Income from House Property’, ‘Capital Gains’ and ‘Income from Other Sources’.

5.1.3 Residence of a Company [Section 6(3)]A company is said to be a resident in India during the relevant previous year if: (a) it

is an Indian company, or (b) if it is not an Indian company then, the control and themanagement of its affairs is situated wholly in India.

The company is said to be non-resident in India, if it is not an Indian company andsome part of the control and management of its affairs is situated outside India.

5.1.4 Scope of Total Income and Incidence of TaxThe following table indicates the tax incidence on income in different situations

depending on the residential status of the corporate assessee.



Notes Table 5.1: Income Tax in Different Situations

Place of Income Resident Non-resident (NR)

Income received or deemed to be received inIndia whether earned in India or elsewhere.

Yes Yes

Income accruing or arising in India whetherreceived in India or elsewhere.

Yes Yes

Income deemed to accrue or arise in Indiawhether received in India or elsewhere.

Yes Yes

Income received/accrued outside India from abusiness controlled from India.

Yes No

Income which accrues or arises outside Indiaand received from outside India from any othersource.

Yes No

Income which accrues or arises outside Indiaand received outside India during the yearspreceding the previous year and remitted toIndia during previous year.

No No

Further, the term ‘business connection’ needs to be emphasized.

Section 9(1)(i)Income from Business Connection: The Income Tax Act does not define the term

‘business connection’. A business connection involves a relation between a businesscarried on by a non-resident that yields profits and gains and some activity in India whichcontributes directly or indirectly to the earning of those profits and gains. It implies anintimate relation between trading activity carried on outside India and trading activitywithin India and such relation is contributing to the earning of profit by non-residents. Toillustrate the term ‘business connection’, following are some instances:

1. Maintaining a branch office, factory, agency receivership or management forthe purchase and sale of goods or transacting any other business.

2. Appointing an agent in India for the systematic and regular purchase of rawmaterials or other commodities or for sale of the non-resident’s goods forbusiness purposes or for securing orders in India.

3. Erecting a factory in India where the raw products purchased locally is workedinto a form suitable for export abroad.

4. Forming a local subsidiary company to sell the products of the non-residentparent company.

5. Having financial association between a resident and non-resident company.6. Granting a continuing license to a resident to exploit for profit an asset

belonging to a non-resident even if the transaction might be disguised as outand out sale.

In B.P. Ray v. ITO, the Supreme Court held that the expression ‘businessconnection’ u/s 9(1)(i) would refer to ‘Professional Connection’ also.

Exception to Section 9(1)(i)In the case of a non-resident, no income shall be deemed to accrue/arise in India in

the following situations:



Notes1. Where the business connection is confined only to the purchase of goods inIndia for the purpose of exports. (This exception is made to encourageexports).

2. Where the business connection is confined only to collection of news andviews in India for transmission out of India.

3. Where the business connection is confined to the shooting of anycinematography firm in India. (This exception is also available to a firm andcompany which does not have any partner/shareholder who is a citizen of Indiaor who is resident in India).

4. Where all operations of a business are not carried out in India, the extent ofincome of the business relating to operations not carried out in India.

5.1.5 Computation of Total IncomeThe total income of a company is also computed in the manner in which income of

any other assessee is computed.The first and the foremost step in this direction is to ascertain Gross Total Income.Gross Total Income: As per Section 14, income of a person is computed under the

following five heads:1. Salaries2. Income from house property3. Profits and gains of business or profession5. Capital gains6. Income from other sources.

The aggregate income under these heads is termed as “gross total income”. In otherwords, gross total income means total income computed in accordance with theprovisions of the Act before making any deduction under Chapter VIA (Section 80C to80U).

Further, Section 14A provides that no deduction shall be made in respect ofexpenditure incurred by the assessee in relation to income which does not form part ofthe total income under the Act.

How to Compute Total Income?: The steps in which the total income for anyassessment year is determined as follows:

1. Determine the residential status of the assessee to find out which income is tobe included in the computation of his total income.

2. Classify the income under each of the following five heads. Compute theincome under each head after allowing deductions prescribed for each head ofincome:

(a) Income from SalariesSalary/Bonus/Commission, etc. ________Taxable Allowance ________Value of Taxable Perquisites ________Gross Salary _________

Less: Deductions u/s 16 _________Net taxable income from salary _________(b) Income from House Property

Net annual value of house property ________Less: Deduction under section 24 ________



Notes Income from house property _________(c) Profits and gains of business and profession

Net profit as per P&L A/c ________Less/Add: Adjustments required to be made to the profit asper provisions of Income Tax Act

________

Net profit and gains of business and Profession _________(d) Capital gains

Capital gains as computedLess exemptions u/s 54/54B/54D etc. _________Income from capital gain _________

(e) Income from other sources:Gross income ________Less: Deductions ________Net income from other sources _________Gross Total Income [(a) + (b) + (c) + (d) + (e)]Less: Deductions available under Chapter VIA Sections 80C to80U)

_________

Total Income

Income computed under four heads (salary head is not applicable), isaggregated. While aggregating the income, Sections 60 and 61 shall be applicable.Further, effect to set-off of losses and adjustment for brought forward losses will also bedone. From the gross total income so computed, the following deductions of Chapter VIAshould be allowed:

80G Donations to certain funds/charitable institutions, etc.80GGA Certain donations for scientific research or rural development80GGB Contribution to political parties80IA Profits and gains of new industrial undertakings or enterprises engaged in

infrastructural development, etc.80IAB Deductions in respect of profits and gains by an undertakings or enterprises

engaged in development of Special Economic Zone.80IB Profits gains from certain industrial undertakings other than infrastructure

development undertakings.80IC Deductions in respect of certain undertakings or enterprises in certain special

category states [w.e.f. A.Y. 2004-05].80ID Deduction in respect of profits and gains from business of hotels and

convention centres in specified area [w.e.f. A.Y. 2008-09].80IE Deduction in respect of certain undertakings in North Eastern States [w.e.f. A.Y.

2008-09].80JJA Deduction in respect of profits and gains from business of collecting and

processing of bio-degradable waste.80JJAA Deduction in respect of employment of new workmen.80LA Deductions in respect of certain incomes of Offshore Banking Units and

International Financial.



Notes5.1.6 Assessment ProcedureThe principal officer of the company is required to file the return of total income of

the company on or before 31st October of the assessment year. A company is assessedlike any other assessee. However, its liability differs in two respects:

1. No exemption limit: A company does not enjoy any exemption limit.2. Flat Rate of Tax: A company pays income tax at a flat rate instead of slab rate.

Rates of Income TaxThe rates of tax which applicable to companies for the assessment year 2013-14

and 2014-15 are as under:1. Short-term capital gains on equity shares in a company or units of an equity

oriented fund where the transaction is chargeable to securities transaction tax15%

2. Tax on long-term capital gains 10% in case of listed securities and 20% in caseof capital asset

3. Tax on winnings from lotteries, crossword puzzles, races including Horse racesetc. 30%

4. Tax on any other income(a) Domestic company 30%(b) Foreign company 40%

(i) for all income other than given under (ii) below:(ii) Royalty received after 31/3/1961 but before 1/4/1976 or fees for

technical services received by a foreign company or non-residentnon-corporate assessee from an Indian concern or Government after29/2/1964 but before 1/4/1976,. In pursuance of an agreementapproved by the Central Government . 50%

Surcharge for AY 2013-14 and 2014-15 if total income exceeds ` 1 crore– for domestic company 5.00%– for foreign company 2%

However, w.e.f. 2014-15, if the total income of the company exceeds ` 10 crore,surcharge in case of domestic company shall be be 10% (instead of 5%) and 5% (insteadof 2%) in case of foreign company.

5.1.7 ProblemsProblem 1: AB Ltd. is a manufacturing company in which public are substantiallyinterested. For the previous year ending 31.3.2014, it earned a net profit of ` 2,50,000after providing for depreciation of ` 1 lakh as admissible under the Income Tax Act.Compute the total income of the company for the assessment year 2014-15 on the basisof the following information:

(i) The company paid remuneration of ` 1,02,000 to its three whole-time directorsthough articles of association do not provide for such payment.

(ii) The miscellaneous expenses include a sum of ` 15,000 paid towards penaltyfor non-fulfilment of delivery conditions of a contract of sale for reasons beyondcontrol.

(iii) The company received fees of ` 75,000 from an Indian company for supply ofknow how in the installation of machinery in pursuance of contract approved byCBDT. This is credited to P&L Account.



Notes (iv) The travelling expenses included:(a) ` 15,000 in respect of technical director to West Germany to study export

market for chemicals;(b) ` 15,000 in respect of visit of Managing Director to America for purchase

of machinery for the proposed new unit.(v) The other income credited to P&L Account includes dividend received from an

Indian company ` 30,000 (gross).(vi) Donations include:

(a) ` 10,000 to an approved scientific research association.(b) ` 26,750 to an approved charitable trust.

(vii) The interest includes:(a) ` 5,000 paid on the installments granted for sales tax payment.(a) ` 5,000 paid to non-resident outside India without deducting tax at source.

(viii) Salary includes bonus paid amounting to ` 90,000. However, bonus waspayable on 31.3.2014 which was paid on 15.09.2014.

Solution: Total income of the assessee company is computed as follows:` `

(A) Income from businessNet profit as shown: 2,50,000Less: Dividend received from an Indian company to be consideredseparately 30,000

2,20,000Additions/Adjustments:(i) Amount spent on the foreign tour of the Director for purchase of

machinery is disallowed being expenditure of capital nature 15,000(ii) Donations to a charitable trust for separate consideration 40,000(iii) Interest paid to non-resident outside India without deducting tax

at source is not allowable as deduction in view of the provisionsof Section 40(a)(i)

5,000

Less:(iv) Additional deduction for donation to approved scientific

research association

2,80,000

12,500Income from business 2,67,500(B) Income from other sources:

Dividends from Indian company ExemptGross Total Income 2,67,500

Less: Deductions under Chapter VIA u/s 80G [50% of ` 26,750] 13,375Taxable Income ` 254,125 rounded to ` 2,54,130

1. Penalty of ` 15,000 paid for not fulfillment of conditions of a contract of sale isallowable because it is not for breach of any law but for breach of contractualobligation.

2. Donations to approved scientific research association are eligible for deductionu/s 35(1)(ii) @ 125% of the donation.

3. Interest on installments of sales tax is allowable as a deduction.4. Bonus to employees is allowable as it has been paid on 15.9.2014, i.e., before

30.09.2014.



NotesProblem 2: R Ltd. is a company incorporated in India. The balance sheet of the companyon 31-3-2014, discloses the following position:

Liabilities ` Assets `

Preference share capitalEquity share capital issued for cashBonus shares issued in 2006General ReserveProfit and Loss A/c balance on31-3-13Add Profit for year ended 31-3-2014Provision for taxationCurrent liabilities

2,00,0004,00,0002,00,0002,00,000

1,40,00060,000

130,00070,000

Fixed assetsInvestments in shares at cost(market value ` 7 lakhs)Other assets

5,00,000

2,00,0007,00,000

14,00,000 14,00,000

The company distributes the entire investment in shares in species to itsshareholders pro rata in August, 2013. Is G, a holder of 10%t of equity share capital,liable to tax on this receipt ? If so, what is the amount liable to tax?Solution: Section 2(22)(a) provides that any distribution by a company to the extent ofaccumulated profits whether capitalized or not is deemed as a dividend if suchdistribution entails the release by the company to its shareholders of all or any part of theassets of the company.

The accumulated profits can be computed as follows: `

Capitalised profits (Bonus shares issued in 2006) 2,00,000

General Reserve 2,00,000

Profit and Loss Account (including profits of current year) 2,00,000

Total 6,00,000

Thus dividend under Section 2(22)(a) shall be ` 6,00,000 and the company shall paytax 15% plus surcharge of 0% plus EC plus SHEC = 15.45%, G the holder need not payany tax.

5.2 Provisions Relating to Minimum Alternate Tax (MAT)

5.2.1 Introduction to MATWhere in the case of a company through proper tax planning, the income tax

payable on the total income as computed under the Income Tax Act in respect of theprevious year, is less than certain percentage of its book profit, the companies arerequired to pay some minimum income tax which is termed as MAT (Minimum AlternateTax).

5.2.2 Provisions of MAT for Payment of Tax by Certain Companies [Section115JB(1)]

Tax payable for any assessment year cannot be less than 18½% of book profit:Where in the case of a company, the income tax payable on the total income ascomputed under the Income Tax Act in respect of the previous year, is less than 18½% ofits book profit, such book profit shall be deemed to be the total income of the assesseeand the tax payable by the assessee on such total income (book profit) shall be theamount of the income tax at the rate of 18½%.



Notes Example:Suppose the book profits a company for the assessment year 2011-12 are

` 10,00,000 whereas its total income as per provision of income tax is ` 3,00,000. Thenthe tax shall be payable as under:

1. Tax on total income as computed from Income Tax Act (30% of ` 3, 00,000) =90,000

2. Tax @ 1 % on book profit of ` 10, 00,000 = 180,000In the above case, tax payable on total income, i.e., ` 90,000 is less than 18% of the

book profits, i.e., ` 180,000. Hence, in this case, deemed total income shall be` 10,00,000 and the tax payable shall be ` 1,80,000 plus Education cess and SHEC @3% 5400 = ` 185,400.

Allowing tax credit in respect of tax paid on deemed income under MATprovision against tax liability in subsequent years [Section 115JAA]

Section 115JAA provides that where any amount of tax is paid under section115JB(1) by a company for any assessment year beginning on or after 1-4-2006, credit inrespect of the taxes so paid for such assessment year shall be allowed on the differenceof the tax paid under section 115JB and the amount of tax payable by the company on itstotal income computed in accordance with other provisions of the Act.

The amount of tax credit so determined shall be allowed to be carried forward andset off in a year when the tax becomes payable on total income computed under theregular provisions. However, no such carry forward shall be allowed beyond the tenthassessment year immediately succeeding the assessment year in which the tax creditbecomes allowable. The set off in respect of the brought forward tax credit shall beallowed for any assessment year to the extent of the difference between the tax on thetotal income and the tax which would have been payable under section 115JB for thatassessment year. No credit will be allowed in respect of MAT paid in any assessmentyear prior to 2006-07.

However, no interest shall be allowed on the amount of tax credit available undersection 115JAA.

Other provisions of section 115JB – Profit and Loss of the company to be preparedas per provisions of the Companies Act [Section 115JB(2)].

Every company shall for the purpose of this section, prepare its profit and lossaccount for the relevant previous year in accordance with the provisions of Parts II and IIIof Schedule VI to the Companies Act 1956.

Profits and loss account prepared for Section 115JB(2) and annual accountsincluding profit and loss account prepared and placed before AGM should have sameaccounting policies, standards, etc. [Proviso 1 and 2 to Section 115JB(2)].

While preparing the annual accounts including profit and loss account:(i) the accounting policies of the company;(ii) the accounting standards followed by the company for preparing such

accounts including profit and loss account(iii) the method and rates adopted for calculating the depreciation by the company,

shall be the same as have been adopted for the purpose of preparing suchaccounts including profit and loss account as laid before the company at itsannual general meeting in accordance with the provisions of Section 210 of theCompanies Act, 1956.

Further, where the company has adopted or adopts the financial year under theCompanies Act, 1956, which is different from the previous year under the Income Tax Act,



Notesthe above three (i.e., accounting policies, accounting standards and method ofcalculating depreciation) shall correspond to the accounting policies, accountingstandards and the method and rates for calculating the depreciation which have beenadopted for preparing such accounts including profit and loss account for such financialyear or part of such financial year falling with the relevant previous year.

When an Assessing Officer has power to later the net profit: In the followingcases, the Assessing Officer shall have power to rework or rewrite the profit and lossaccount:

(1) Where the profit and loss account submitted is not as per Part II and Part III ofthe Schedule VI of the Companies Act.

(2) Where the accounting policies or accounting standards or rate of depreciationadopted are different from those adopted for the profit and loss prepared for theannual general meeting.

Assessing Officer has no power to scrutinize profit and loss account: Wherethe profit and loss account has been prepared in accordance with Part II and Part III ofthe Schedule VI of the Companies Act and which has been and certified by the statutoryauditors and relevant authorities, the Assessing officer has no power to scrutinize netprofit in profit and loss account except to the extent provided in Explanation to 115J.

How to compute book profits? [Explanation to 115JB (1) and (2)]Step 1: The net profit as shown in the profit and loss account (prepared as per Part

II and III of Schedule VI) for the relevant previous year, shall be increased by thefollowing, if debited to the Profit and Loss Account:

(a) The amount of income tax paid or payable, and the provision therefore; or(b) The amounts carried to any reserves by whatever name called(c) The amount or amounts set aside to provisions made for meeting liabilities,

other than ascertained liabilities; or(d) The amount by way of provision for losses of subsidiary companies; or(e) The amount or amounts of dividends paid or proposed; or(f) The amount or amounts of expenditure relatable to any income to which

Section 10, (other than the provisions contained in clause (38) relating tolong-term capital gain on transfer of shares through a stock exchange, 11 or 12applies (i.e., incomes which are exempt from tax).

(g) The amount of depreciation.(h) The amount of deferred tax and provisions therefore (inserted by the Finance

Act, 2008, w.e.f. assessment year 2001-02).(i) The amount or amounts set aside as provision for diminution in the value of

any asset (inserted by the Finance Act, 2009, w.e.f. assessment year2001-02).

Notes:1. The starting figure is the net profit after tax as per profit and loss account.2. As per clause (a) above only income tax has to be added back. Hence, any tax,

penalty or interest paid or payable under Wealth tax, gift tax, or any penalty orinterest paid or payable under income tax, if debited to profit and loss accountshould not be added back to such net profits. Dividend tax paid or payable asper Section 115-O should be added back. Further, no adjustment is to be donein respect of income tax refund.



Notes 3. Where any amount has been transferred to reserve as per the provisions ofSec. 36(1)(viii), Sec. 80-IA(6), Sec. 80-IAB(6) or Sec. 10(A)(1A) or Sec. 10AAthe same is also to be added back.

4. Any tax or duty which is not allowed as deduction as per provisions of Section43B though debited to profit and loss account shall also not to be added back.

5. Any provision made to meet unascertained liabilities like provisions of gratuityprovisions for future losses, etc. should be added back to such net profit.However, if the provisions for gratuity have been made on the basis of actualvaluation, it becomes an ascertained liability and hence should not be addedback.

6. Every kind of reserve is to be added to net profit to determine book profit.7. Dividend whether on equity or preference share paid or proposed should both

be added.8. Security Transaction Tax and Banking Cash Transaction Tax are not to be

added back as these are not income tax.9. Any expense other than mentioned in clause (5) above should not be added

back even if such expense is not allowable under the Income Tax Act.10. Deferred tax liability as per Accounting Standards is an unascertained liability,

hence to be added back.11. Loss of subsidiary company, if debited to the profit and loss account, should be

added back.12. The provisions of Section 115JB shall not apply to the income accrued or

arising on or after 1-4-2005 from any business carried on, or services rendered,by an entrepreneur or a Developer, in a Unit or Special Economic Zone as thecase may be [Section 115JB(6)].

Step 2: The profit as per the Profit and Loss Account shall be reduced by thefollowing:

1. The amount withdrawn from any reserves or provisions, if any, such amount iscredited to the profit and loss account:

A clarificatory amendment has been made by the Finance Act, 2002, i.e.,assessment year 2001-02 to Section 115JB to provide that the amount withdrawn fromthe reserve or provision, created not out of profits before 1.4.1997, if credited to the profitand loss account, shall not be deducted while computing book profit.

Similarly, the amount withdrawn from the reserve created on or after 1.4.1997 andcredited to the profit and loss account shall not be deducted while computing book profitunless the book profit in the year of creation of such reserve was increased by suchreserve at that time.

(ii) The amount of income to which any of the provisions section 10 (other than theincome referred to in Section 10(38), 11, 12 or 80-IAB applies, if any such amount iscredited to the profit and loss account; or

2. The amount of depreciation debited to the profit and loss account (excludingthe depreciation on account of revaluation of assets); or

(iv) The amount withdrawn from revaluation reserve and credited to profit and lossaccount, to the extent it does not exceed the amount of depreciation on account ofrevaluation of assets referred to in clause (iii) above; or

3. The amount of loss brought forward or unabsorbed depreciation, whichever isless as per books of account. The loss shall, however, not include depreciation.



NotesFurther the provision of this clause shall not apply if the amount of broughtforward loss or unabsorbed depreciation is Nil; or

(vi) The amount of profits of sick industrial company for the assessment yearcommencing from the assessment year relevant to the previous year in which the saidcompany has become a sick industrial company under sub-section (1) of Section 17 ofthe Sick Industrial Companies (Special Provisions) Act, 1985 and ending with theassessment year during which the entire net worth of such company becomes equal to orexceeds the accumulated losses.

For the purposes of this clause, net worth shall have the meaning assigned to it inclause (ga) of sub-section (1) of section 3 of the Sick Industrial Companies (SpecialProvisions) Act, 1985. According to Section 3(1)(ga) of the Sick Industrial Companies(Special Protection) Act, 1985, net worth means the sum total of the paid-up capital andfree reserves.

“Free reserve” means all reserve credited out of the profits and share premiumaccount but does not include reserves credited out of revaluation of assets, write back ofdepreciation provisions and amalgamations.

(vii) The amount of profit derived from the activities of a tonnage tax company [Sec.115VO].

The amount computed after increasing or decreasing the above in Step 1 and Step 2,respectively is known as book-profit.

How much brought forward loss/unabsorbed depreciation are deductible frombook profits?

As per clause (v) above, the amount of loss brought forward or unabsorbeddepreciation as per books of accounts whichever is less is to be deducted from the bookprofits. It has been however clarified that loss however shall not include depreciation. Inthis case, brought forward loss and unabsorbed depreciation as per income tax shallhave no relevance.

It has been clarified that where the value of the amount of either loss broughtforward or unabsorbed depreciation is ‘nil’, no amount on account of such loss broughtforward or unabsorbed depreciation would be reduced from the book profit.

Furnishing of Report of an Accountant [Section 115JB(4) and Rule 40B]: Everycompany to which this section applies, shall furnish a report in Form No. 29B from achartered accountant certifying that the book profit has been computed in accordancewith the provisions of this section along with the return of income filed under section139(1) or along with the return of income furnished in response to a notice under section142(1)(i).

It may however, be noted that the company shall have to file such report even if itfurnishes the return of income under section 139(4) instead of section 139(1) or inresponse to which notice [Section 142(1)(i)].

Unabsorbed Depreciation or Losses which can be Carried Forward [Section115JB(3)]: Although, the assessee is liable to pay tax @ 10% (plus surcharge ifapplicable) of the book profits if its total income computed as per Income Tax Act is lessbut it is entitled to determine unabsorbed depreciation u/s 32(2), business loss u/s 72(1),speculation loss u/s 73 and capital loss u/s 74 and loss u/s 74A and shall be allowed tocarry forward the same to the subsequent years for claiming set off as per the normalprovisions of Income Tax Act.

Are the Provisions of Section 115JB applicable to Foreign Companies?In connection of old Section 115J, the Authority for Advance Rulings held that such

provisions are applicable to foreign companies also and the foreign companies shall



Notes calculate its Indian Profits separately for the purpose of minimum alternate tax [P No.14of 1997 In (1998) 234 ITR 828(AAR)]. However, where a non-resident’s income isassessed on the basis of presumptive income under section 44B, 44BB, 44BBA, etc. orat a flat under Section 115A on royalty and technical fee, the book profit becomesimmaterial for regular assessment and the presumptive income tax will prevail [TimkenIndia Ltd. In re(2005) 273 ITR 67(AAR)].

Other Provisions of the Act shall continue to apply to such Companies[Section 115JB(5)]:

Save as otherwise provided in section 115JB, all other provisions of the Income TaxAct shall apply to such companies. Hence, all other provisions relating to Advance tax,interest chargeable in certain cases shall apply to such companies also.

5.2.3 Illustrative ProblemsProblem 1: R Ltd., a closely held Indian company is engaged in the manufacture ofinsecticides and fertilizers. Its profits and loss account for the year ended 31-3-2013 is asunder:

Profit and Loss Account

Particulars ` in lacs Particulars ` in lacs

To Salaries and wages 7.50 By Sales 48.00

To Depreciation 5.00 By Amount withdrawn fromGeneral Reserve

3.00

To Postage and Telegram 0.40

To Traveling expenses 0.50

To Excise duty dueTo Audit feesTo Director’s remunerationTo Deferred tax liability

1.000.258.001.35

To Provision for future lossesTo Wealth TaxTo Income tax

0.600.104.00

Tp Proposed dividend 0.80

To Loss of subsidiary company 0.50

To Net Profit 21.00

51.00 51.00

Additional information1. The excise duty due on 31.3.2013 was paid on 2-12-2013.2. Customs duty ` 1,20,000 which was due on 31-3-2011 was paid during the

financial year 2012-13.3. Depreciation as per income tax ` 11.43 lakhs.4. The company wants to set off the following losses/allowances:

For Tax purposes For accounting purposes

Brought forward loss of A.Y. 2012-13Unabsorbed depreciation

` 12,00,0003,00,000

` 10,00,0003,00,000



NotesCompute the total income of the assessee and the tax liability for the Assessmentyear 2013-14.

Determine tax payable under section 115JB.Solution: Book Profit under section 115JB:

Particulars ` `

Net profit as per profit and loss account 21,00,000

Add: Amount disallowed

Income taxWealth taxOutstanding Excise dutyProvision for future lossesProposed dividend

4,00,00010,000

1,00,00060,00080,000

Loss of subsidiary companyDeferred tax liabilityDepreciation for separate consideration

Less:Depreciation as per income taxAmount withdrawn form General ReserveCustoms duty of 2010-11 paid

Less: B/f business loss and unabsorbed depr. fully set off

Less deduction under Chapter VIA

50,0001,35,0005,00,000

11,43,0003,00,0001,20,000

13,35,00034,35,000

15,63,00018,72,00015,00,000

3,72,000Nil

Total income 3,72,000

Book profit u/s 115JB:

Particulars ` `

Net profit as per profit and loss account 21,00,000

Add:

Income TaxProvision for future lossesLoss of subsidiary companyProposed dividendDeferred tax liabilityDepreciationLess:Depreciation (same amount)Amount withdrawn from general ReserveUnabsorbed depreciationBook profitComputation of tax liabilityTotal incomeTax on total income @ 30.9%Tax on Book Profit 22,25,000 @ 19.055 (18.5+ surcharge Nil + EC

4,00,00060,00050,00080,000

1,35,0005,00,000

5,00,0003,00,0003,00,000

3,72,000114,950

12,25,00033,25,000

11,00,00022,25,000



Notes + SHEC @ 3%)Therefore, tax payable for the AY 2013-14

4,23,9744,23,970

Problem 2: From the following information, compute the total income of R Ltd. and taxliability for the AY 2013-14.


Particulars ` Lakhs Particulars ` Lakhs

Expenses relating to goods ofspecial Economic ZoneExpenses relating to other businessIT paidInterest on income taxGeneral ReserveProv for contingent liabilityProposed dividendBalance c/d

9.007.001.000.204.001.002.001.60

25.80

Sale of goods of unit in SpecialEconomic ZoneSale of other businessInterest from Bank deposits

15.0010.60

0.20

25.80

Further information:1. B/f loss as per books ` 2.00 lakhs2. B/f depreciation as per books ` 1.60 lakhs3. B/f unabsorbed depreciation as per books ` 4.60 lakhs

Solution:I Computation of total income

Particulars ` `

Profit as per P&L AccountAdd: Expenses disallowedRelating to goods of special Economic Zone [Sec. 10AA]IT paidInterest on income taxGeneral ReserveProv for contingent liabilityProposed dividend

Less:Sale of goods of unit in Special Economic ZoneInterest from Bank depositsStatement of total incomeBusiness incomeLess B/f unabsorbed depreciation ` 4.60 lakhs but allowed tothe extent of Business incomeIncome

9.001.000.204.001.002.00

15.000.20

1.60 lacs

17.2018.80

15.203.603.60

3.60Nil

Income from other sources – Bank interestUnabsorbed depreciationTotal income

0.200.20

NIL



NotesNotes1. B/f unabsorbed depreciation c/f to next year ` 460,00 – 360,000 – 20,000 =

` 80,000.2. The assessee shall be allowed deduction of entire profit of ` 600,000 under Section

10AA while computing total income as per normal provisions of Income Tax Act.II Computation of Deemed Income u/s 115JB

Income as per P&L account ` 1.60 lacsAdd: Disallowable items:IT paid 1.00Interest on income tax 0.20General Reserve 4.00Provision for contingent liability 1.00Proposed dividend 2.00

8.20– 9.80Less: B/f loss as per books of account or B/F depreciationas per books, whichever is less 1.60Book Profit 8.20Income tax liability @ 19.055 (18.55 plus EC and SHEC @ 3% ` 156,251 or tax

computed on total income which is nil. Hence tax liability shall be higher of the two, i.e.,` 1,56,251.

It may be noted that w.e.f. A.Y. 2012-13 undertakings eligible for deduction u/s10AA are covered under MAT provisions.

5.2.4 Special Provision Relating to Tax on Distributed Profits of Domestic Companies(a) Tax on distributed profits of domestic companies [Section 115-0]: Domestic

Company shall, in addition to the income tax chargeable in respect of its total income, beliable to pay additional income tax on any amount declared, distributed or paid by suchcompany by way of dividend (whether interim or otherwise), whether out of current oraccumulated profits. Such additional income tax shall be payable @ 15% plus surcharge@ 10% plus education cess @ 2% plus SHEC @ 1% of the amount so declared,distributed or paid.

Dividend received from subsidiary company to be reduced from the abovedividend to be distributed [Section 115-O(IA)]Notes:

(a) The expression dividend used above shall have the same meaning as is givenin Section 2(22) which shall include Section 2(22)(a), (b), (c), and (d) but shallnot include deemed dividends under section 2(22)(e).

(b) The above additional tax shall be payable by such company on its total income.No tax on distributed profits by an undertaking or enterprise engaged in developing,

operating and maintaining a Special Economic Zone [Section 115-O(6)].(b) Time limit for deposit of additional income tax: Such additional tax will have

to be paid by the principal officer of the domestic company and the company within14 days from the date of declaration of dividend, or distribution or payment of anydividend.



Notes (c) Tax on distributed profits not allowed as deduction: The company or theshareholder shall not be allowed any deduction in respect of the amount which has beencharged to tax or the tax thereon under any provisions of the income-tax Act.

(d) Interest payable for non-payment of tax by domestic companies [Section115P]: In case of default simple interest @ 1% shall be liable for every month or partthereof beginning on the date immediately after the last date on which tax was payableand ending with the date on which the tax is actually paid.

(e) When companies deemed to be in default [Section 115Q]: If the principalofficer of a domestic company and the company does not pay tax on distributed profits inaccordance with the provisions of Section 115-O, then he or it shall be deemed to be anassessee in default in respect of the amount of tax payable by him or it and all theprovisions of the Income Tax Act for the collection and recovery of income tax shallapply.

(f) Penalty under Section 271C: If any persons fails to pay the whole or any part ofthe tax as required u/s 115-O(2), then such person shall be liable to pay, by way ofpenalty a sum equal to the amount of tax which such person failed to pay as aforesaid.

5.2.5 Special Provisions Relating to Tax on Distributed Amount to Unit Holders[Sections 115R to 115T](a) Tax on income distributed to unit holders by the specified company or a

Mutual Fund [Section 115R(2)](I) Where the income is distributed by money market mutual fund or a liquid fund,

additional income tax @ 25% + 10% SC+ 2% EC + 1% SHEC will be liable tobe paid.

(II) Where the income is distributed by a fund other than a money market mutualfund and such income is distributed to–

(i) individual or HUF – additional income-tax @ 12.5% + 10% SC + 2% EC +1% SHEC will be liable to be paid.

(ii) any person other than individual or HUF- additional income tax @ 20% +10% SC + 2% EC + 1% SHEC will be liable to be paid.

(b) Time limit for deposit of additional income tax [Section 115R(3)] within14 days from the date of distribution or payment of such income whichever is earlier

(c) Income charged to tax not allowed as deduction [Section115R(4)] to thespecified company or to a Mutual Fund in respect of which income has been charged totax.

(d) Interest payable for non-payment of tax [Section 115S]: In case of defaultsimple interest @ 1% shall be liable for every month or part thereof beginning on the dateimmediately after the last date on which tax was payable and ending with the date onwhich the tax is actually paid.

(e) When specified company or Mutual Fund shall be deemed to be theassessee in default [Section 115T]: If any person responsible for making payment ofthe income distributed by the specified company or a mutual fund and the specifiedcompany or the Mutual Fund shall be deemed to be an assessee in default in respect ofthe amount of tax payable by him or it and all the provisions of the Income Tax Act for thecollection and recovery of income tax shall apply.

(f) Provisions of Section 115R shall not apply in respect of any income distributed(i) by the Administrator of the specified undertaking to the unit holders; or (ii) to a unitholder of an equity oriented fund (whether open ended or close ended) in respect of anydistribution made from such fund.



Notes(g) Exemption of income in the hands of unit holder [Section 10(35)]: Thefollowing income shall be exempt in the hands of unit holders–

(a) income received in respect of units of a Mutual fund specified under clause23D; or

(b) income received in respect of units from the Administrator of the specifiedundertaking; or

(c) income received in respect of units from the specified company.

5.3 Set-off and Carry Forward of Losses

5.3.1 Introduction to Set-off and Carry Forward of LossesIncome tax is a composite tax on the total income of a person earned during a

period of one previous year. There might be cases where an assessee has differentsources of income under the same head of income. Similarly, he may have income underdifferent heads of income. It might happen that the net result from a particularsource/head may be a loss. This loss can be set off against other source/head in aparticular manner. For example, where a person carries on two business and onebusiness gives him a loss and other profit, then the income under the head ‘profits andgains of business or profession’ will be the net income, i.e., after adjustment of the loss.Similarly, if there is a loss under one head of income, it should normally be adjustedagainst the income from another head of income while computing Gross Total Income.

The provisions for set off or carry forward and set off losses are contained inSections 70 to 80 of Income Tax Act.

5.3.2 Set-off of Loss from One Source Against Income from Another Source underthe Same Head of Income [Section 70]

During any assessment, if the net result in respect of any source under any head ofincome is a loss, the assessee is entitled to have the amount of such a loss set-offagainst his income from any other source under the same head of income. This rule ishowever subject to the following exceptions:

4. Loss in a speculation business can be set-off only against the profit in aspeculation business.

(ii) Loss incurred in a business of owning and maintaining race horses cannot beset-off against income from other sources, except income from such business.

Through speculation, losses and losses from the activity of owning and maintainingracehorses cannot be set-off against other incomes, the vice versa is not applicable. Itimplies that, losses from a non-speculation business can be set-off against income froma speculation business.

5. Winnings in lottery, horse races, crossword puzzles etc. are not available foradjustment of losses under any head.

(iv) Long-term Capital Loss can be set-off against Long-term Capital Gain only.6. Loss from a source which is exempt and loss from a source, income from

which exempt cannot be set-off against income from a taxable source [CIT v.Thyagarajan]. However, short-term capital loss can be set-off from any capitalgain (long-term and short-term).

(vi) Capital Losses: Short term capital losses can be set off from any capital gain(long-term or short-term) but long-term capital loss can now be set off onlyagainst long-term capital gain.



Notes (vii) Loss arising from the purchase and sale of securities not to be allowed incertain cases [Section 94(7)]: Where –(a) any person buys or acquires any securities or unit within a period of three

months prior to the record date; and(b) such person sells or transfers such securities within a period of three

months after such date or transfers such units within a period of 9 monthsafter such record date; and

(c) the dividend or income on such securities or unit received or receivable bysuch person is exempted, then, the loss, if any, arising to him on accountof such purchase and sale of securities or unit, to the extent such lossdoes not exceed the amount of dividend or income received or receivableon such securities or unit, shall be ignored for the purposes of computinghis income chargeable to tax.

(viii) Bonus stripping [Section 94(8)]: Where –(a) a person buys or acquires any units within a period of three months prior

to the record date; and(b) such person is allotted or is entitled to additional units on the basis of such

units without making any payment; and(c) he sells, all or any of such units while continuing to hold all or any of the

additional units within a period of 9 months after such date. Then, the loss,if any, arising to him on account of such purchase and sale of units, shallbe ignored for the purposes of computing his income chargeable to tax.

(ix) Loss from specified business-any loss computed in respect of any specifiedbusiness referred to in Section 35AD shall not be set off except against profitsand gains, if any, of any other specified business (applicable from the A.Y.2010-11 onwards).

5.3.3 Inter-head Adjustment [Section 71]When the net result of the computation made from any Assessment Year in respect

of any head of income is loss, the same can be set-off against the income from otherheads. However, following are the exceptions:

1. loss in a speculation business;2. loss incurred in a business of owning and maintaining race horses,3. winning in lottery, horse races, crossword puzzles, etc. are not available for the

adjustment of losses under any head;4. loss under the head ‘Capital Gains’;5. business loss cannot be set-off against salary income.6. Loss in a specified business under section 35AD – Loss computed in respect of

any specified business referred to in section 35AD cannot be set off exceptagainst any other income.

Loss under the head ‘Capital Gains’: A long-term capital loss can be set-offagainst a long-term capital gain in the same Assessment Year. However, a short-termcapital loss can be set-off against a short-term capital gain or a long-term capital gain (ifthere is no short-term capital gain) in the same Assessment Year. But where the netresult of computation under the head ‘Capital Gains’ is a loss, whether short-term orlong-term, such loss is not allowed to be set-off against income under any other headeven in the same Assessment Year.



Notes5.3.4 Carry Forward and Set-off of LossesIf the losses could not be set-off under the same head or under different heads in

the same Assessment Year, such losses are allowed to be carried forward to be claimedas set-off from the income of the subsequent Assessment Years. All losses are notallowed to be carried forward. The following losses are only allowed to be carried forwardand set-off in the subsequent Assessment Years:

(a) House Property Loss [Sec. 71B];(b) Business Loss [Sec. 72];(c) Speculation Loss [Sec. 73];(d) Capital Loss [Sec. 74];(e) Loss on account of owning and maintaining race horses [Sec. 74A].Compulsory Filing of Loss Returns (Section 80): Although the above losses are

allowed to be carried forward, but the carry forward is allowed only when the assesseehas submitted a return of loss on or before the due date of filing of the returns prescribedunder Section 139(1) and such a loss has been assessed.

Losses cannot be carried forward, if no return of the loss is furnished or it isfurnished after the due date prescribed under Section 139(1).

1. Although submission of the return of loss, on or before the due date mentionedunder Section 139(1) is compulsory for carry forward of losses mentioned inClause (b) to (e) above, but this provision is not applicable for carry forward ofunabsorbed depreciation which is covered under Section 32(2).

2. There are two conditions, which are to satisfy before loss is allowed to becarried forward. Firstly, the return of loss must be submitted on or before thedate and secondly, such loss has been determined by the Assessing Officer.

5.3.5 Carry Forward and Set-off of Loss from House Property [Section 71B]Loss from house property, if could not be set-off in the same Assessment Year from

other heads of income, will be allowed to be carried forward for eight Assessment Yearsto claim it as a set-off in the subsequent years under the head ‘Income from HouseProperty’. Therefore, if the loss of house property of the previous year 2008-09 whichcould not be set-off because of the absence or inadequacy of the income of previousyear 2008-09, it may be carried forward for eight Assessment Years succeeding theAssessment Year 2009-2010 to be set-off from income under the head House Property.

5.3.6 Carry Forward and Set-off of Business Losses [Section 72]Where the loss under the head ‘Profits and Gains of Business/Profession’ other than

loss from speculation business, could not be set-off in the same Assessment Yearbecause either the assessee had not income under any other head or the income wasless than the loss, such loss which could not be set-off in the same against the profits andgains of business or profession subject to the following conditions:

7. Business losses can be adjusted only against business income: The losscan be carried forward to the subsequent Assessment Year and set-off onlyagainst business income of the subsequent year.

It may be observed that in the Assessment Year, loss from a business can beadjusted against income from any other head of income. However, when the loss is to becarried forward to the subsequent year, it can be adjusted only against the businessincome. Business income may be from the same business in which the loss was incurredor may be from any other business.



Notes Certain income, though taxable under other heads, constitutes businessincome for set-off of brought forward business loss: The carried forward businessloss is to be adjusted against income from any business activity. Such an income maygenerally be taxed under the head, ‘Profits and Gains of Business/Profession’. However,in some cases, income from a business activity may be taxed under other heads also.For example, if an assessee, carrying on the business of letting out of house propertiesreceived rent from such house properties, it would be an income from business activitythough the rent would be taxable under the head ‘Income from House Property’.Therefore, a business loss of an earlier year can be set-off against the rental income ofhouse property, although the rental income falls under the head ‘Income from HouseProperty’.

Dividend may be treated as business income: Though the dividend income isassessable under the head ‘Other Sources’, it may be well treated as business incomefor the purposes of set-off of past business losses against such income, if the relevantshares were held as stock in trade and not as investment.

(II) Business in respect of which a loss is incurred need not be continued: Thebusiness or profession, for which the loss was incurred, need not be continued to becarried on by him in the previous year in which such loss is sought to be set-off.

(III) Losses can be set-off only by the assessee who has incurred loss [Section78(2)]: The brought forward business losses can be set-off only by the same assessee.The assessee, who has suffered the loss and in whose hands the loss has beenassessed, is the person who can carry forward the loss and set-off the same against hisbusiness income of the subsequent year. The following are exceptions:

(a) Where a business carried on by one person, is acquired by another personthrough inheritance. For example, X is carrying on a business and there arelosses to the extent of ` 5,00,000 which can be carried forward and set-offagainst the income of the subsequent years. X dies and his son S inherits hisbusiness. The losses inherited by X can be set-off by his son against theincome from a business activity carried by S. However such loss can be carriedforward by the son for the balance number of years for which the father couldhave carried forward the losses.

(b) Business losses of an amalgamating company can be set-off against theincome of the amalgamated company if the amalgamation is within themeaning of Section 72A/72AA of the Income Tax Act.

(c) Where there has been of business, whereby a proprietary concern or a firm issucceeded by a company and certain conditions are fulfilled, the accumulatedbusiness loss and the unabsorbed depreciation of the predecessorfirm/proprietary concern shall be deemed to be the loss or allowance fordepreciation of the successor company for the previous year in which thebusiness was effected and carry forward provisions shall be applicable to thesuccessor company.

(d) De-merger: Loss of the demerged company can be carried forward by theresulting company subject to of certain conditions which the CentralGovernment may for this purpose notify, to ensure that the demerger is forgenuine business purposes. Similarly, certain losses of the demergedcooperative bank can be carried forward by the resulting cooperative bank incertain cases.

(IV) Period of Carry Forward: Each year’s loss is a separate loss and no loss shallbe carried forward for more than eight assessment years immediately succeeding theAssessment Year for which the loss was first computed. Therefore, a loss of previous



Notesyear 2008-09, i.e., Assessment Year 2009-10 can be carried forward till AssessmentYear 2016–2017. However, loss of a ‘specified business’ under Section 35AD can becarried forward without any limit. Besides the above, the following can also be carriedforward for unlimited period:

1. unabsorbed depreciation;2. unabsorbed scientific research expenditure;3. unabsorbed expenditure on family planning.(V) Order of Set-off: Unabsorbed depreciation, unabsorbed capital expenditure on

scientific research and family planning are not a part of business losses and they canalso be carried forward. However, as per Section 72(2), the business loss should beset-off before setting-off unabsorbed depreciation etc. Such carried forward loss will beset-off against a business head only after the current year’s depreciation; current capitalexpenditure on scientific research and capital expenditure on family planning have beenclaimed. Therefore, the order of set-off will be as under:

8. current year depreciation [Section 32(1)];(ii) current year capital expenditure on scientific research and capital

expenditure on family planning to the extent allowed;9. carried forward business or profession losses [Section 72(1)];

(iv) unabsorbed depreciation [Section 32(2)];10. unabsorbed capital expenditure on scientific research [Section 35(4)];

(vi) unabsorbed expenditure on family planning [Section 36(1) (ix)].Rehabilitation of business discontinued due to natural calamities etc. [Proviso

to Section 72(1)]According to this proviso, if there is any loss of a business which is discontinued in

the circumstances specified in Section 33B and it is re-established, reconstructed orrevived by the assessee at any time before the expiry of a period of three years from theend of the previous year in which it was discontinued, then the loss of the previous yearin which such business is discontinued including the brought forward loss:

(a) shall be allowed to be set-off against the profits and gains, if any, of thatbusiness or any other business carried on by him and assessable for thatassessment year, and

(b) if the loss cannot be wholly set-off, the amount of balance loss be carried to thefollowing Assessment Year and so on for seven Assessment Yearsimmediately succeeding, provided such re-established business is continued tobe carried by the assessee.

5.3.7 Carry Forward and Set-off of Speculation Loss (Section 73)If a speculation loss could not be set-off from the income of another speculation

business in the same Assessment Year, it is allowed to be carried forward to be claimedas a set-off in the subsequent year, but only against the income of any speculationbusiness. Such loss is also allowed to be carried forward for four Assessment Yearsimmediately succeeding the Assessment Year for which the loss was first computed. Itmay be observed that it is not necessary that the same speculation business mustcontinue in the Assessment Year in which the loss is set-off. As already discussed, filingof return before the due date is necessary to carry forward such a loss.

1. Where a loss arises from illegal speculative business, it cannot be carriedforward to the subsequent years for set-off against the profits of anotherspeculative business [CIT vs. Kurji Jinabhai Kotecha (1977) 107 ITR 101 (SC)].



Notes 2. The loss in speculation may also include the loss on account of bad debts,irrecoverable profits and interest on borrowings.

3. In respect of unabsorbed depreciation or unabsorbed capital expenditure onscientific research, the effect shall be first given to the provisions of Section 73,i.e., carried forward of speculation loss shall be first set-off.

4. Loss from derivative trading shall be treated as loss from non-speculativebusiness, if transaction of derivatives is done through NSE or BSE.

Companies carrying on business of buying and selling of shares [Explanationto Section 73]

Where any part of the business of the company (whether private or public) consistsof the purchase and sale of shares of other companies, such company shall be deemedto be carrying on a speculation business to the extent to which the business consists ofthe purchase and sale of such shares. This explanation shall not apply to the followingcompanies:

(a) Investment companies i.e., a company whose gross total income consistsmainly of income chargeable under the heads ‘income from HouseProperty’, ’Capital Gains’ and ‘Income from Other Sources’.

(b) A company whose principal business is of banking or granting of loans/advances.

Notes:1. The explanation applies only to a company, it does not apply to individual, HUF,

Firm, AOP etc.2. Explanation does not cover debentures, units of Unit Trust of India or units of

Mutual funds.

5.3.8 Set-off and Carry Forward and Set-off of Loss of a Specified BusinessReferred to in Section 35AD [Section 73A]

The loss of a specified business referred to in Section 36AD of any assessment yearis allowed to be set off only against profit and gains, if any, of any other specifiedbusiness. But if such loss of specified business has not been wholly set off, so much ofas is not so set off or the whole loss where the assessee has no income from any otherspecified business, shall, subject to the other provisions of this chapter, be carriedforward to the following assessment year, and–

11. it shall be set off against the profits and gains, if any, of any specified businesscarried on by him assessable for the assessment year; and

(ii) if the loss cannot be set off the amount of loss not set off shall be carriedforward to the following assessment year and so on.

In other words loss of a specified business can be carried forward indefinitely till it isset off.

5.3.9 Carry Forward of Losses under the Head ‘Capital Gains’ [Section 74]Where in respect of any assessment year, the net result of the computation under

the head ‘Capital Gains’ is a loss to the assessee, whether short-term or long-term, sucha loss shall be carried forward to the following assessment years and set-off against theincome under the head ‘Capital Gains’ of the subsequent years. Such capital losses canalso be carried forward to a maximum of eight Assessment Years, immediatelysucceeding the Assessment Year for which the loss was first computed.



Notes5.3.10 Carry Forward of Loss from the Activity of Owning and Maintaining RaceHorses [Section 74A]

Any loss from the activity of owning and maintaining racehorses is included in thissection. Such a set-off is, however, permitted only if the activity of owning andmaintaining racehorses is carried on by the assessee in the previous year relevant to theAssessment Year in which the loss is sought to be adjusted.

The loss can be carried forward for a maximum of four Assessment Years,immediately succeeding the Assessment Year for which the loss was first computed.Filing of returns before the due date prescribed u/s 139(1) is necessary to carry forwardthe loss. The brought forward losses must be set-off in the intermediate succeedingyear/years.

5.3.11 Brought Forward Losses Must be Set off in the Immediately SucceedingYear/Years

The losses which are eligible to be carried forward must be set-off against theincome/profit of the immediately succeeding year and if there is any balance still to beset-off it should be set-off in the immediately next succeeding year or years within thetime allowed.

Where the losses incurred are not set-off against the income/profit of theimmediately succeeding year/years, as the case may be, they cannot be set-off at a laterdate [Tyresoles (India) v. CIT (1963) 49 ITR 525 (Mad.)].

5.3.12 Problems on Set-off and Carry Forward of LossesProblem 1. X an individual submits the following information for the A.Y. 2014-15:

Particulars Profit`

Loss`

Salary Income computed 142,000

Income from House PropertyHouse AHouse BHouse C

115,000117,000121,000

Profits and Gains of Business/ProfessionBusiness ABusiness BBusiness C (Speculative)Business D (Speculative)

108,000

111,000118,000

123,000

Capital GainsShort term capital gainsShort term capital lossLong-term capital gains on sale of building

106,000

12,500128,000

Income from other sourcesIncome from card gamesLoss from card gamesLoss on maintenance of race horsesInterest on securities

108,000

104,000

107,010106,000

Determine the net income of X for the A.Y. 2014-15



Notes Solution:Step 1: Same head adjustment `

Income from salary 1,42,000Income from house propertyHouse A 1,15,000House B (−)1,17,000House C (−) 1,21,000

(−) 1,23,000Profits and Gains of Business/ProfessionNon-speculative 1,08,000 – 1,18,000 = (−) 10,000Speculative:Business C (+) 1, 11,000Business D (−) 1,23,000To be carried forward to next year (−) 12,000Capital gains:Short-term gains 1,06,000Short-term loss (−) 1,28,000

(−) 22,000Long-term 12,500It will be carried forward to next year (−) 9,500Income from other sources: `

Income from card games (+) 1,08,000(Loss from card game cannot be deducted by virtue of Section 58)Interest on securities (+) 1,04,000

212,000Loss on maintenance of race horses (−) 1,06,000Loss on maintenance of racehorses can be set-off only against income from the

business of owning and maintaining race horses. In the absence of such income, itcannot be set-off. However, it can be carried forward to next year for claiming set-offagainst income from such business.

Step 2: Inter-head Adjustment:Salary 1,42,000Income for other sources 2,12,000Income from house property (−) 1,23,000Profits and Gains of BusinessNon-speculative (−) 10,000Net income 2,21,000Loss which cannot be set-off against other income but which can be carried forward:Profits and Gains of Business/ProfessionSpeculative Business (−) 12,000Capital GainsIncome from Other Sources (−) 9,500



NotesLoss on maintenance of race horses (−) 1,06,000(−) 1,27,500

Loss which cannot be set-off against other income cannot be carried forward.Loss of maintenance of race horses (−) 1,07,010

Problem 2. From the following details, compute the gross total income of A for theAssessment Year 2013-2014.

`

Taxable income from salary 80,000Income from house property:House A – let out (−) 95,000House B – self-occupied (−) 9,000Short-term Capital Gain 12,000Loss from Long-term Assets (−) 25,000Interest on Securities 10,000

Solution:`

Taxable income from salary 80,000Income from house property (–) 95,000 – 9,000 (−) 1,04,000Income from capital gains – short-term 12,000Income from other sources – interest on securities 10,000Gross total income NIL

Important Points:1. Loss under the head ‘Income from House Property’ amounting to ` 2,000 which

could not be set-off against income under other heads of income can be carriedforward to the subsequent A.Y. to be set-off under the head, ‘Income fromHouse Property’.

2. Loss from long-term capital assets cannot be set-off against short-term capitalgain or income under other heads of income. Such a loss can be carriedforward to the subsequent A.Y.

5.4 Tax Planning with Reference to New Projects/Expansion/Rehabilitation Plans

5.4.1 Introduction: Tax Planning with Reference to New Projects/Expansion/Rehabilitation PlansMany factors affect the location and nature of a new business. The impact of tax

incentives within the broad framework of law needs to be considered for determining theviability of the project. These are given in the subsequent paragraphs.

5.4.2 Section 10AA: Special Provisions in Respect of Newly Established Units inSpecial Economic Zones

Subject to the provisions of this section, a deduction of such profits and gainsderived by an assessee being an entrepreneur from the export of articles or things or



Notes providing any service, as the case may be, from his unit shall be allowed from the totalincome of the assessee.Notes:

Meaning of Entrepreneur: ‘Entrepreneur’ means a person who has been granted aletter of approval by the development commission under section 15(9) [Section2(j) of theSpecial Economic Zone Act, 2005].

Essential conditions to claim deduction: the deduction shall apply to an undertakingwhich fulfills the following condition:

1. It has begun or begins to manufacture or produce articles during the previousyear, relevant to the assessment year commencing on or after 1-4-2006 in anySpecial Economic Zone.

2. It should not be formed by the splitting op or reconstruction of a businessalready in existence.

3. It should not be formed by the transfer of machinery or plant, previously usedfor any purpose, to a new business.

4. The exemption shall not be admissible unless the assessee furnishes in theprescribed form [Form No. 56F] along with the return of income, the report ofthe chartered accountant certifying that the deduction has been correctlyclaimed as per provisions of this section.

Notes:1. Manufacture means to make produce, fabricate, assemble, process or bring

into existence, by hand or by machine, a new product having a distinctive name,character or use and shall include processes such as refrigeration, cutting,polishing, blending, repair, remaking, re-engineering and includes agriculture,aquaculture, animal husbandry, floriculture, horticulture, pisciculture, poultry,sericulture, aviculture and mining [section2(f) of the Special Economic Zone[Section 2(za) of the Special Economic Zones Act, 2005].

Period for which deduction is available:The deduction under this section shall be allowed as under for a total period of

15 relevant assessment years.

1. For the first 5 consecutive assessment yearsbeginning with the assessment year relevant to theprevious year in which the unit begins tomanufacture such articles or things or provideservices

100% of the profits and gains derivedfrom the export of such articles orthings or from services

2. Next 5 consecutive assessment years 50% of such profits or gains

3. Next 5 consecutive assessment years So much of the amount not exceeding50% of the profits as is debited to profitand loss account of the previous yearin respect of which the deduction is tobe allowed and credited to SpecialEconomic Zone. ReinvestmentReserve Account to be created andutilized for the purpose of the businessof the assessee in the manner laiddown in sub-section (2) below

Conditions to be satisfied for claiming deduction for further 5 years (after10 years) [Section 10AA(2)]



Notes(1) The amount credited to the Special Economic Zone Reinvestment ReserveAccount is to be utilized–(i) For the purpose of acquiring machinery or plant which is first put to use

before the expiry of a period of 3 years following the previous year inwhich the reserve is created; and

(ii) Until the acquisition of this machinery or plant as aforesaid, for thepurposes of the business of the undertaking other than for distribution byway of dividends or profits or for remittance outside India as profits or forcreation of any asset outside India.

(2) The particulars as may be prescribed in this behalf, should be furnished inForm 56FF, by the assess in respect of machinery or plant along with thereturn of income for the assessment year relevant to the previous year in whichsuch plant or machinery was first put to use.

Consequences of mis-utilization/non-utilization of reserve [Section 10AA(3)]:Where any amount credited to the Special Economic Zone Re-investment ReserveAccount:

(a) has been utilized for any purpose other than the purchase of machinery orplant as mentioned above, the amount so utilized shall be deemed to be theprofits of the year in which it was so utilized and shall be charged to tax; or

(b) has not been utilized before the expiry of the aforesaid period of 3 years, theamount no so utilized shall be deemed to be the profits of the year immediatelyfollowing the period of said 3 years and charged to tax.

How to compute profit and gains from exports of such undertakings [Section10AA(7)]: If the aforesaid conditions are satisfied, the deduction u/s 10AA may becomputed as under:

Profits from business of the undertaking being the unit xExport Turnover of the undertaking of such articles/things or servicesTotal turnover of the business carried on by the assessee

For this purpose, ‘export turnover’ means the consideration in respect of export bythe undertaking of articles or things or services received in, or brought into India by theassessee but does not include freight, telecommunication charges, or insuranceattributable to the delivery of the article or things outside India, or expenses, if any,incurred in foreign exchange in rendering of services (including computer software)outside India.

The profits and gains derived from on-site development of computer software(including services for development of software) outside India shall be deemed to be theprofits and gains derived from the export of computer software outside India.

Ban on enjoyment of other tax benefits: The following allowances or expenditureshall be deemed to have been allowed and absorbed during the course of the relevantassessment years ending before 1-4-2006:

12. Depreciation allowance under Section 32(ii) expenditure on scientific researchunder section 35; and

13. Expenditure relating to family planning under section 36(1)(ix)The aforesaid expenditure/allowance even if unabsorbed during the assessment

years ending before 1-4-2006, shall be deemed to have been fully claimed and allowed.However, unabsorbed depreciation, unabsorbed expenditure on scientific research andcapital expenditure on family planning pertaining to assessment year 2006-07 or anysubsequent assessment years shall be allowed to be carried forward and set-off.



Notes No portion of the losses pertaining to business under section 72(1) or capital gainsunder section 74(1) or Section 74(3) with respect to any assessment year ending before1-4-2006 forming part of the tax holiday period, to the extent pertaining to the undertaking,being the unit shall be claimed in any assessment year subsequent to the last of theassessment year forming part of the tax holiday. However losses referred to in Section72(1)or section 74(1) and (3) in so far as such losses relate to the business of theundertaking being the unit, pertaining to the assessment year 2006-07 or anysubsequent assessment year shall be allowed to be carried forward and set-off.

WDV after tax holiday period: It shall be presumed that during the tax holidayperiod under section 10AA, the assessee had claimed and had been alloweddepreciation allowance, and hence the written down value of the depreciable assets shallbe computed accordingly, after the conclusion of the tax holiday period.

5.4.3 Deduction in Respect of Profits and Gains from Industrial Undertakings orEnterprises Engaged in Infrastructure Development etc. [Section 80IA]

Deduction under section 80IA is available only to the following business carried onby an industrial undertaking:

1. Provision of infrastructure facility [which includes – road, highways, watersupply project, irrigation project, sanitation and sewerage system, watertreatment system, solid waste management system, ports, airports and inlandwaterways]

Conditions:Any enterprise for availing deductions with reference to profits of the business

relating to infrastructure facility, shall fulfill the following conditions:(i) The enterprise should be owned by a company registered in India or a

consortium of such companies or by an authority or aboard or a corporation orany other body established or constituted under any Central or State Act.

(ii) The enterprise should enter into an agreement with Central Government or AState Government or a Local Authority or any other statutory body fordeveloping or operating and maintaining or developing, operating andmaintaining of a new infrastructure facility.

(iii) The enterprise has started its operation and maintenance on or after 1st April1995. For the purpose of this section, ‘Infrastructure Facility’ means –(a) A road including toll road, a bridge or a rail system;(b) A highway project including housing or other activities being an integral

part of the highway project;(c) A water supply project, water treatment system, irrigation project,

sanitation and sewerage system or solid waste management system;(d) A port, airport, inland waterway, inland port or navigational channel in the

sea.2. Telecommunication services

Eligible business:Any undertaking providing telecommunication services, whether basic or cellular

including radio paging, domestic satellite service network or trunking, broad bandnetwork and internet services.

Conditions:The operations of the undertaking should have been started on or after 1st April

1995 but on or before 31st March, 2005.



Notes3. Developing, maintaining etc. an industrial park.Essential Conditions:(i) The undertaking should develop, develop and operate or maintain and operate

an industrial park or special economic zone notified by the central Governmentin accordance with a scheme framed for such purpose.

(ii) The industrial park should begin to operate, develop etc. at any time on or after1-4-1997 but before 1-4-2011.

4. Power generation, transmission and distributionEligible business:(i) An undertaking set up in any part of India for the generation or generation and

distribution of power.(ii) An undertaking which starts transmission or distribution of power by laying a

network of new transmission or distribution lines.(iii) An undertaking which undertakes substantial renovation and of existing

network of transmission or distribution lines.Conditions:(i) In respect of an undertaking set up in any part of India for the generation or

generation or distribution of power the operation of the undertaking shouldhave been started on or after 1st April,1993 but on or before 31st March, 2013.

(ii) In respect of an undertaking which starts transmission or distribution of powerby laying a network of new transmission or distribution lines the operation ofthe undertaking should have been started on or after 1st April, 1999 but on orbefore 31st March, 2013.

(iii) In respect of an undertaking which undertakes substantial renovation andmodernization of existing network of transmission or distribution lines ofoperations of the undertaking should have been started on or after 1st April,2004 but on or before 31st March, 2013. “Substantial renovation and ” shallmean an increase of plant and machinery by at least 50% of the book value ofsuch plant and machinery as on 1-4-2004.

5. Essential conditions for undertaking set up for reconstruction or revival of apower generating plant

1. Such undertaking must be owned by an Indian company.2. Such Indian company is formed before 30-11-2005 with majority equity

participation by public sector companies for purposes of enforcing the securityinterest of the lenders to the company owing the power generating plant.

3. Such Indian company is notified before 30-11-2005 by the central governmentfor the purpose of this clause.

4. Such undertaking begins to generate or transmit or distribute power before31-3-2011.

Common Points Applicable to all the Above Activities:(I) It should be an Indian company.(II) It should be a new Industrial undertaking: The industrial undertaking is not

formed by splitting up, or the reconstruction of a business already in existence.Exception: This condition will not apply where the business is re-established,reconstructed or revived by the same assessee after its discontinuance as a direct resultof:

(i) Flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature or,



Notes (ii) Riot or civic disturbance or(iii) Accidental fire or explosion or(iv) Action by any enemy or action taken in an enemy (with or without declaration of

war)Where transfer is pursuant to splitting up or reconstruction of the State Electricity

Board.(III) It should not be formed by transfer of Machinery or plant previously used for

any purpose.Exceptions:

1. If the value of the old plant and machinery does not exceed 20% of the totalvalue of machinery or plant used in the business, this condition is deemed tohave been satisfied.

2. Any machinery or plant which was used outside India by any other personother than the assessee shall not be regarded as machinery or plant previouslyused for any purpose if following conditions are satisfied:

(i) Such machinery or plant was not, at any time previous to the date of theinstallation by the assessee, used in India.

(ii) Such machinery or plant is imported into India from any country outsideIndia.

(iii) No deduction on account of depreciation in respect of such machinery orplant has been allowed or is allowable under the Act in computing thetotal income of any person for any period prior to the date of theinstallation of the machinery or plant by the assessee.

(IV) Audit Report: Assessee other than a company or a Co-operative Societyshould get its account audited by a chartered Accountant and the audit report isfurnished along with the return of income.

(V) Computation of Profit: For the purpose of determining the quantum ofdeduction under section 80IA for the assessment year immediately succeedingthe initial assessment year or any subsequent assessment year, the profits andgains from the eligible business shall be computed as if such eligible businesswere the only source of income of the assessee during the previous yearrelevant to the initial assessment year and to every subsequent assessmentyear up to and including the assessment year for which the determination is tobe made. Section 80IA(5).

(VI) The assessing officer is empowered in certain cases to recompute profit.(VII) Consequences of Merger/Amalgamation: In case of merger/amalgamation

between two Indian Companies, the deduction will be available to theamalgamated company or resulting company from the year of merger/amalgamation.

(VIII) Double deduction not possible: When deduction under section 80IA isclaimed and allowed then the same profits will not be eligible for deductionunder section 80C to 80U.

(IX) Profits of housing or other activities which are an integral part of theHighway project: Notwithstanding any thing discussed above, where housingor other activities are an integral part of the highway project and the profits ofwhich are computed on such basis and manner as may be prescribed, suchprofit shall not be liable to tax where the profit has been transferred to a specialreserve account and the same is actually for the highway project excluding andother activities before the expiry of three years following the year in which such



Notesamount was transferred to the reserve account, and the amount remainingshall be chargeable to tax as income of the year in which such transfer toreserve account took place.

(X) Where an infrastructure facility is transferred on or after the 1-4-1999 by anenterprise which developed such infrastructure facility to another enterprise forthe purpose of operating and maintaining the infrastructure facility on its behalfin accordance with the agreement with the Central Government, StateGovernment, Local Authority or Statutory body, the provisions shall apply to thetransferee enterprise as if it were the enterprise to which this clause appliesand the deduction from profits and gains would be available to such transfereeenterprise for the unexpired period, during which the transferor enterprisewould have been entitled to the deduction if the transfer had not taken place.

(XI) Where an Industrial Park develops an industrial park on or after 1-4-1999 till1-4-2001 and transfers the operation and maintenance of such industrial park,to another undertaking, the deduction shall be allowed to such transfereeundertaking.

Quantum and Period of Deduction in Case of All Above Undertaking/Enterprises

Undertaking/Enterprises Period and Quantum of Deduction

(1) For all the aboveundertaking/enterprises

100% of profits and gains derived from such business for10 consecutive assessment years out of 15 years * beginning withthe year in which undertaking or the enterprise develops andbegins to operate any infrastructure facility or starts providingcommunication services or develops an industrial park ordevelops a special economic zone or generates power orcommences transmission or distribution of power or undertakessubstantial renovation and modernization of the existingtransmission or distribution lines.Provided that where the assessee develops or operates andmaintains or develops, operates and maintains any infrastructurefacility relating to a road including toll road, a bridge or railsystem ; a highway project including housing or other activitiesbeing an integral part of the highway project; a water supplyproject, water treatment system, irrigation project, sanitation andsewerage system or solid waste management system; theprovision of this clause shall have effect as if for the words” fifteenyears”, the words “twenty years” had to be substituted.

5.4.4 Deduction in Respect of Profits and Gains from Enterprises Engaged inDevelopment of the Special Economic Zones [Section 80-IAB]

The deduction under this section is available where the gross total income of anassessee, being a developer, includes any profit and gains derived by an undertaking oran enterprise from any business of developing a Special Economic Zone, notified on orafter 1-4-2005 under the Special Economic Zones Act, 2005.

Quantum of deduction: The deduction shall be allowed of an amount equal to100% of the profits and gains derived from such business for 10 consecutive assessmentyears.

The deduction may, at the option of the assessee be claimed by him for any10 consecutive assessment years, out of 15 years beginning from the year in which aSpecial Economic Zone has been notified by the Central Government.



Notes Consequences of transfer of the undertaking: Where an undertaking, being aDeveloper who develops a Special Economic Zone on or after 1-4-2005 and transfers theoperation and maintenance of such Special Economic Zone to another Developer, thededuction shall be allowed to such transferee Developer for the remaining period in the10 consecutive assessment years as if the operation and maintenance were not sotransferred to the transferee Developer.

Profits of eligible business – How to compute? For the purpose of determiningthe quantum of deduction for the assessment year immediately succeeding the initialassessment year or any subsequent assessment year, the profits and gains from theeligible business shall be computed as if such eligible business were the only source ofincome of the assessee during the previous year relevant to the initial assessment yearand to every subsequent assessment year up to and including the assessment year forwhich the determination is to be made.

Conditions to be applicable to the undertaking for claiming deduction:These provisions relate to the following in respect of eligible business–1. Audit of accounts.2. Inter unit transfer of goods or services.3. Restriction of double deduction.4. Restriction of excessive profits.5. Power of Central Government to notify undertakings to which Section 80-IAB

shall not apply.6. Deduction allowed to the amalgamating company for the unexpired period in

case of amalgamation.7. Deduction not to be allowed in cases where return is not filed within specified

time limit.

5.4.5 Deduction in Respect of Profits and Gains from Certain IndustrialUndertakings Other than Infrastructure Development Undertakings [Section80IB]

Deduction under section 80IB is available to an assessee whose Gross total Incomeincludes and profits and gains derived from the business of:

(1) an Industrial undertaking set up in the State of Jammu and Kashmir. Provision(except the quantum of deduction) relating to other industrial undertakingshave not been discussed as these new industrial undertakings are now notallowed deduction.

(2) Scientific and industrial, research and development(3) Commercial production and refining of mineral oil(4) Developing and building housing projects(5) Processing, preservation and packaging of fruits and vegetables(6) Integrated business of handling, storage and transportation of food grain units.(7) Operating and maintaining a hospital in a rural area(8) Operating and maintaining a hospital located anywhere in India other than

excluded area.14. Essential conditions for Industrial undertaking:1. It should be a new undertaking.2. It should not be a formed by transfer of machinery or plant previously used for

any purpose.



Notes2. It should not manufacture or produce articles specified in the EleventhSchedule in any part of India or it operates one or more cold storage plant orplants or operates cold chain facility, in any part of India. However, asmall-scale industrial undertaking or an industrial undertaking located in anindustrially backward State specified in the Eighth schedule shall be eligible forthe deduction, even if it manufactures or produces any article/thing which isspecified in the Eleventh Schedule.

4. In case where the industrial undertaking manufactures or produces articles orthings, the undertaking employs 10 or more workers in a manufacturingprocess carried on with the aid of power or employs 20 or more workers in amanufacturing process carried on without the aid of power.

5. The industrial undertaking set up in the State of Jammu and Kashmir begins tomanufacture or produce articles or things during the period 1-4-1993 to31-3-2012.

6. The industrial undertaking in a backward state begins to manufacture orproduce articles or things or to operate its cold storage plant or plants duringthe period beginning on 1-4-1993 to 31-3-2004.

Quantum of deduction

Assessee Period of Deduction(commencing from initial

assessment year)

% of profitseligible fordeduction

1. Industrial undertaking(i) Set up in Jammu & Kashmir(ii) in district of category ‘A”*(iii) operating a cold chain facility15. Owned by a company

(b)Owned by a co-operative society

(c) Owned by any other assessee

First 5 yearsNext 5 yearsFirst 5 yearsNext 7 yearsFirst 5 yearsNext 5 years

100301002510025

2. Industrial undertaking in an industriallybackward district category ‘B’*(a) Owned by a company

(b)Owned by a cooperative society



100301002510025

* Backward districts of category A and Category B have been notified videNotification No.10441, dated 7-10-1997.Initial Assessment year: It means the assessment year relevant to the previousyear in which the industrial undertaking begins to manufacture or producearticles or things or to operate its cold storage plant(s) or the cold chain facility.

(B) Ten year tax holiday for approved companies carrying on scientific research anddevelopment having its main object of scientific and industrial research and development



Notes The deduction is available to a company assessee if such company was approvedby the prescribed authority at any time after 31-3-2000 but before 1-4-2007 and certainother conditions are satisfied.

The company is eligible for deduction of 100% of the profits and gains of suchbusiness for a period of 10 consecutive assessment years, beginning from the initialassessment year.

(C) Industrial undertaking producing or refining Mineral Oils:1. It should be a new undertaking.2. It should not be formed by transfer of machinery or plant previously used for

any purpose.3. It should commence commercial production as follows:

Commercialproduction ofmineral oil

Refining ofmineral oil

Commencing refining ofmineral oil by anundertaking which iswholly owned by a notifiedpublic sector company orany other notifiedcompany in which a publicsector company holds49% of voting right

1. Undertakinglocated inNorth-Eastern Region

Before April 1,1997

– –

2. Undertakinglocated anywhere

in India

After March 31,1997

After September30, 1998 butbefore April, 2009

On or after April1, 2009but before April1, 2012

It should employ 10/20 workers.Quantum of deduction:100% of the profit is deductible for first 7 years commencing with the year in which the

undertaking commences commercial production of mineral oil or refining of mineral oil.(D) Undertaking engaged in Developing and building housing projects:Conditions to be satisfied:1. Allowed to all assessee2. Project should be approved by a local authority before March 31, 20083. Size of plot of land is minimum of one acre. (This condition is not applicable if

the project is in accordance with scheme framed by Central Government orState government and notified by CBDT).

4. The built up area of each residential unit should be subject to the followingmaximum limit:Place where residential unit is situated The maximum built up area of each

residential unit should be as given below

1. Within the cities of Delhi and Mumbai 1000 sq. ft.

2. Within 25 kms from the local limitsof Delhi and Mumbai

1000 sq. ft.

3. At any other place 1500 sq. ft.



Notes5. The built up area of the shops and other commercial establishments includedin the housing project does not exceed five per cent of the aggregate built uparea of the housing project of two thousand square feet, whichever is less;

6 Not more than one residential unit in the housing project is allotted to anyperson not being an individual; and

7. In a case where the residential unit in the housing project is allotted to a personbeing an individual, no other residential unit in such housing project is allottedto any of the following persons, namely:(i) the individual or the spouse or the minor children of such individual,(ii) the Hindu Undivided family in which such individual is the karta;(iii) any person representing such individual, the spouse or the minor children

of such individual or the HUF in which such individual is the karta8. The undertaking commences development and construction of the housing

project after September 30, 1998 and completes the same by the followingdates:(a) in case where a housing project has been approved by the local authority

before 1-4-2004, it should complete on or before 31-3-2008.(b) in a case where a housing project has been, or, is approved by the local

authority on or after 1-4-2004 but not later than 31-3-2005, it shouldcomplete within 4 years from the end of the financial year in which thehousing project is approved by the local authority.

(c) in a case where a housing project has been, or, is approved by the localauthority on or after 1-4-2005 within 5 years from the end of the financialyear in which the housing project is approved by the local authority.

Quantum of Deduction:100% of the profit derived in any previous year relevant to any assessment year

from such housing project is deductible.Other points discussed under section 80-IA are also applicable:(i) Audit Report(ii) Double Deduction is not available(iii) Computation of profit(iv) Re-computation of profit by the Assessing Officer(v) Consequences of merger/amalgamation.(E) Undertaking engaged in the business of processing, preservations and

packaging of fruits or vegetables or integrated handling, storage andtransportation of food grains [Section 80 IB(11A)]:

Deduction is available in the case of an undertaking deriving profit from theintegrated business of handling, storage and transportation of food grains, if theundertaking begins to operate such business after March 31, 2001.

Provided that the deduction shall not apply in respect of an undertaking engaged inthe business of processing, preservation and packaging of meat or meat products orpoultry or marine or dairy products if it begins to operate such business before 1-4-2009.

Amount of deduction: The amount of deduction available under section 80-IB is asfollows:

Enterprises Period of deduction commencingfrom the initial assessment year

% of profit deductible

Owned by a company First 5 years 100



Notes Next 5 years 30Owned by any other person First 5 years

Next 5 years10025

Other points: One should also keep in view the following points:(i) Audit Report(ii) Double Deduction is not available(iii) Computation of profit(iv) Re-computation of profit by the Assessing Officer(v) Consequences of merger/amalgamation.(F) Tax holiday to undertakings operating and maintaining a hospital in a rural

area [Section 80IB(11B)]: The deduction will be available commencing from the year inwhich the hospital begins to provide medical services. The deduction will be availableonly if:

– The hospital is constructed and starts functioning between 1 October 2004,and 31st March 2008.

– The hospital has at least 100 beds;– The hospital is constructed in accordance with the regulations of the local

authority; and– The undertaking submits an audit report in the prescribed form along with its

return of income.– The hospital shall be deemed to have been constructed on the date on which a

completion certificate in respect of such construction is issued by theconcerned local authority.

Quantum and period of Deduction: 100% of the profits and gains of suchbusiness for a period of 5 consecutive assessment years, beginning with the initialassessment year.

(G) Undertaking operating and maintaining hospitals located any where inIndia other than excluded area [Section 80IB(11C)]

Essential conditions(i) Location: The hospital is located anywhere in India, other than excluded area.

The excluded area shall mean an area comprising the urban agglomeration ofGreater Mumbai, Delhi, Kolkata, Chennai, Hyderabad, Bangalore andAhmedabad, the districts of Faridabad, Gurgaon, Ghaziabad, Gautam BudhNagar and Gandhinagar and the city of Secunderabad. The area comprising anurban agglomeration shall be the area included in such urban agglomerationon the basis of 2001 census.

(ii) Construction: The hospital is constructed at any time during 1-4-2008 and31-3-2013.

(iii) Commencement: The hospital should start functioning at any time during1-4-2008 and 31-3-2013.

(iv) Number of beds: At least 100 beds.(v) Municipal bye-laws: The construction is in accordance with the regulation or

bye-laws of the local authority.Amount of deduction100 per cent of the profits and gains derived from the business of hospital shall be

deductible for a period of 5 assessment years beginning with the initial assessment yearin which the business of hospital starts functioning.



NotesOther Points: One should also keep in view the following points:(i) Audit Report(ii) Double Deduction is not available(iii) Computation of profit(iv) Re-computation of profit by the Assessing Officer(v) Consequences of merger/amalgamation

5.4.6 Deduction in Respect of Profits and Gains from the Business of Hotels andConvention Centres in Specified Areas [Section 80ID]

Deduction under this section is available to an assessee whose gross total incomeincludes any profit or gain derived from–

(a) The business of hotel located in the National Capital Territory of Delhi and thedistricts of Faridabad, Gurgaon, Gautam Budh Nagar and Ghaziabad, if suchhotel is constructed and has started or starts functioning at any time during theperiod beginning on 1-4-2007 and ending on 31st July, 2010, or

(b) The business of building, owning and operating a convention centre, located inthe National Capital Territory of Delhi and the districts of Faridabad, Gurgaon,Gautam Budh Nagar and Ghaziabad, if such convention centre is constructedat any time during the period beginning on 1-4-2007 and ending on 31-7-2010.

(c) The business of hotel located in the specified district having a World heritageSite, if such hotel is constructed and has started or starts functioning at anytime during the period beginning on 1-4-2008 and ending on 31-3-2013.

The above business is hereinafter referred to as eligible business.Conditions to be satisfied for claiming deduction:1. The eligible business is not formed by the splitting up or the reconstruction of a

business already in existence.2. The eligible business is not formed by the transfer to a new business of a

building previously used as a hotel or a convention centre, as the case may be.3. The eligible business is not formed by the transfer to a new business of any

machinery or plant previously used for any purpose.However, plant and machinery already used for any purpose, can betransferred to the new industrial undertaking, provided value of such plant andmachinery does not exceed 20% of the total value of plant and machinery ofthe new industrial undertaking.

4. The assessee furnishes along with the return of income, the report of an auditin such form and containing such particulars as may be prescribed, and dulysigned and verified by an accountant.

Quantum of deduction100% of the profit and gains derived from such business for 5 consecutive

assessment years beginning from the initial assessment year.Initial assessment year(i) in the case of hotel, means assessment year relevant to the previous year in

which the business of the hotel starts functioning.(ii) in the case of a convention centre, means assessment year relevant to the

previous year in which the convention centre starts operating on a commercialbasis.



Notes Following points discussed under section 80-IA are also applicable:(i) Double deduction not available.(ii) Computation of Profit.(iii) Inter-unit transfer of goods.(iv) Restriction on excessive profits.(v) Power of central Government to notify undertaking to which section 80-IC will

not apply.

5.4.7 Deduction in respect of certain undertakings in North-Eastern States [Section80IE]

Deduction under this section is allowed to an assessee whose gross total incomeincludes any profits and gains derived by an undertaking which fulfils the followingconditions:

(1) It has during the period beginning on 1-4-2007 and ending before 1-4-2017begun or begins in any of the North-Eastern States:(a) to manufacture or produce any eligible article or thing;(b) to undertake substantial expansion to manufacture or produce any

eligible article or thing;(c) to carry on any eligible business.

(2) It is not formed by splitting up, or the reconstruction, of a business already inexistence

(3) It is not formed by the transfer to a new business of any machinery or plantpreviously used for any purpose.

However, plant and machinery already used for any purpose, can be transferred tothe new industrial undertaking, provided value of such plant and machinery does notexceed 20% of the total value of plant and machinery of the new industrial undertaking;

Eligible business means the business of–hotel (not below two star category)(ii) adventure and leisure sports including ropewaysproviding medical and health services in the nature of nursing home with a minimum

capacity of twenty-five beds;(iv) running an old age home;operating vocational training institute for hotel management, catering and food craft,

entrepreneurship development, nursing and para-medical, civil aviation related training,fashion designing and industrial training;

(vi) running information technology related training centre;manufacturing of information technology hardware; and

(viii) bio-technologySubstantial expansion means increase in the investment in the plant and machinery

by at least 25% of the book value of plant and machinery (before taking depreciation inany year) as on the first day of the previous year in which the substantial expansion isundertaken.

North Eastern States means the States of Arunachal Pradesh, Assam, Manipur,Meghalaya, Mizoram, Nagaland, Sikkim and Tripura.



NotesQuantum of deduction100% of the profits and gains derived from such business for 10 consecutive

assessment years commencing with the initial assessment year.Initial assessment year means assessment year relevant to the previous year in

which the undertaking begins to manufacture or produce articles or things, or completessubstantial expansion.

Following points discussed under section 80-IA are also applicable:Double deduction not available.(ii) Computation of profit of eligible business.Inter-unit transfer of goods.(iv) Audit of accounts.Restriction on excessive profits.(vi) Power of central Government to notify undertaking to which section 80-IC will

not apply.Deduction allowed to the amalgamated company for the unexpired period in case of

amalgamation.

5.4.8 Deduction in Respect of Certain Incomes of Offshore Banking Units andInternational Financial Service Centres by the Specific Economic Zone Act,2005 [Section 80LA]To whom the deduction will be allowed: the deduction will be allowed to an

assessee:(i) Being a scheduled bank (not being a bank incorporated by or under the laws of

a country outside India);(ii) Owning an Offshore Banking Unit in a Special Economic Zone;(iii) A unit of international Financial Services centreIncome in respect of which deduction will be allowed: the deduction will be

allowed on account of the following income included in the gross total income of suchbanks: Any income:

(i) From an Offshore Banking unit in a Special Economic Zone;(ii) From the business, referred to in Section 6(1) of the Banking Regulation Act,

1949, with an undertaking which develops, develops and operates andmaintains a Special Economic Zone

(iii) From any unit of the International Services Centre from its business for which ithas been approved for setting up in such a centre in a Special Economic Zone.

Quantum of deduction:(i) 100% of such income for five consecutive assessment years beginning with the

assessment year relevant to the previous year in which the permission, undersection 23(1)(a) of the Banking Regulation Act, 1949, or permission orregistration under the SEBI Act,1992 or any other relevant law was obtained;

(ii) 50% of such income for the next five consecutive assessment years.Conditions to be satisfied: No deduction under this section shall be allowed

unless the assessee furnishes along with the return of income:(i) In the prescribed form, the report of a Chartered Accountant, certifying that the

deduction has been correctly claimed in accordance with the provisions of thissection; and



Notes (ii) A copy of the permission obtained u/s 23(1)(a) of the Banking Regulation Act,1949.

“Offshore Banking Unit” means a branch of a bank in India located in the specialeconomic zone and has obtained the permission u/s 23(1)(a) of the Banking RegulationAct, 1949.

“International Financial Services Centre” means an International Financial ServicesCentre which has been approved by the Central Government under sub section (1) ofsection 18 of the special Economic Zones Act, 2005.

5.4.9 Venture Capital Companies [Section 10(23 FB)Any income of a VCF or a VCC set up to raise funds for investment in a VCU is

exempt subject to certain conditions.Venture capital company (VCC) means a company which has been granted a

certificate of registration by SEBI and which fulfils the conditions laid down by SEBI withthe approval of the Central Government.

Venture capital fund (VCF) means a fund operating under a trust deed registeredunder the Registration Act, 1988, which has been granted a certificate of registration bySEBI and which fulfils the conditions laid down by SEBI with the approval of the CentralGovernment.

Venture capital undertaking (VCU) means a domestic company whose shares arenot listed in a recognized stock exchange in India and which is engaged in the businessfor providing services, production or manufacture of an article or thing but does notinclude activities or sectors which are specified by SEBI with approval of the CentralGovernment.

5.4.10 Tea Development Account, Coffee Development Account and RubberDevelopment Account [Section 33AB]

An assessee carrying on business of growing and manufacturing tea or coffee inIndia is entitled for deduction to the extent of least of the following:

(a) amount deposited in special account with NABARD maintained by theassessee with that bank in accordance with and for the purpose specified in ascheme approved in this behalf by the Tea board or the Coffee Board or theRubber Board., within a period of 6 months from the end of the previous year orbefore due date of furnishing return of income, whichever is earlier.

(b) 40% of profits of such business as computed before making deduction u/s 33AB and before adjusting brought forward business loss u/s 72.

How to compute profits from such business?: If separate accounts are notmaintained in respect of business of growing and manufacturing tea or coffee or rubber inIndia, it shall be profits from such business before claiming deduction under this section.In case separate accounts are not maintained it will be calculated as under:

business sassessee' the of turnover Total

/rubbertea/coffee ingmanufactur and growing of business of turnover Total business the of Profits

1. For claiming deduction u/s 33 AB, assessee must get accounts audited by aChartered Accountant and furnish the report of such audit in prescribed formalong with his return of income.

2. The amount standing to the credit of special account with NABARD is to beutilized as per the specified scheme of Tea Board.In no case, it shall be utilized for the purpose of the following:



Notes(a) Any machinery/plant installed in any office premises/residentialaccommodation including guest house.

(b) Any office appliances (Other than Computer)(c) Any machinery or plant entitled for 100% write off by way of depreciation

or otherwise(d) Any new machinery or plant installed for production of any low priority

item specified in the Eleventh Schedule.3. Deduction allowed under this provision will be withdrawn if the asset acquired

in accordance with the scheme, is sold or otherwise transferred within 8 yearsfrom the end of the previous year in which it was acquired. However, it shall notbe withdrawn in the following cases:

– transfer to Government, Local Authority or Statutory Corporation orGovernment Co.

– In case of Sale of business by partnership firm to a company, if Companyhas taken over all assets and liabilities of the firm and all the shareholdersof the company were partners of the firm before such sale.

4. Assessee is however, allowed to withdraw any amount standing to his credit inspecial account with NABARD in the following circumstances:(a) Closure of business(b) Dissolution of firm(c) Death of an assessee(d) Partition of a HUF(e) Dissolution of a Company

Where the withdrawal is made in the circumstances stated above in (a) and (b), theamount withdrawn such business shall be taxable as business profit of that Previous year,as if the business had not been closed or the firm had not been dissolved.

5.4.11 Site Restoration Fund [Section 33ABA]This section has been inserted to allow deduction to an assessee who is carrying on

business consisting of the prospecting for or extraction or production of petroleum ornatural gases or both in India.

Essential conditions:1. This deduction will be allowed to any assessee who is carrying on business

consisting of prospecting for or extraction or production of petroleum or naturalgas or both in India and in relation to which the Central Government hasentered into an agreement with such assessee for such business.

2. The assessee has before the end of the previous year–(a) Deposited with the State Bank of India any amount(s) in a special account

maintained by the assessee with that bank, in accordance with and for thepurposes specified in, a scheme approved in this behalf by the Ministry ofPetroleum and Natural Gas of the Government of India; or

(b) Deposited any amount in the Site restoration Account opened by theassessee in accordance with, and for the purpose specified in a schemeframed by the aforesaid Ministry. This scheme is known as DepositScheme.

3. The assessee must get its accounts audited by a Chartered Accountant andfurnish the report in the prescribed form (Form No. 3AD) along with the returnof income. In a case where the assessee is required by or any other law to get



Notes its accounts audited, it shall be sufficient compliance if such assessee gets theaccount of such business audited under such law and furnishes the report ofthe audit as required under such other law and a further report in the formprescribed.

Profits from business in this case is to be calculated in the same manner as ismentioned in Section 33AB.

Quantum of deduction: Quantum of deduction shall be:(a) The amount deposited in the scheme referred to above; or(b) 20% of the profit of such business computed under the head “profits and gains

of business or profession”, whichever is less.The profits are to be computed before making any deduction under this section,i.e., Section 33ABA and before making adjustment for brought forward lossesunder section 72.

Restriction on utilization of the amount deposited: The amount standing to thecredit of the assessee, in the Special Account of State Bank of India or the SiteRestoration Account, is to be utilized for the business of the assessee in accordance withthe scheme specified. However, no deduction shall be allowed in respect of any amountutilized for the purchase of:

(a) Any machinery or plant to be installed in any office premises or residentialaccommodation, including any accommodation in the nature of a guest house;

(b) Any office appliances (not being computers);(c) Any machinery or plant, the whole of the actual cost of which is allowed as a

deduction (whether by way of depreciation or otherwise) in computing theincome chargeable under the head “Profits and gains of business orprofession” of any one previous year;

(d) Any new machinery or plant to be installed in an industrial undertaking forpurposes of business of construction, manufacture or production of any articleor thing specified in the list in the Eleventh Schedule.

Consequence if new asset is transferred within 8 years: Same as in Sec. 33AB.Withdrawal of deposits: Any amount deposited in the special account maintained

with State Bank of India or the Site Restoration Account shall not be allowed to bewithdrawn, except for the purposes specified in the scheme, or as the case may be, inthe deposit scheme.

Where any amount standing to the credit of the assessee in the special account or inthe Site Restoration Account is utilized by the assessee for the purpose of anyexpenditure in connection with such business not in accordance with the scheme or thedeposit scheme, such expenditure shall not be allowed in computing the incomechargeable under the head Profit and gains of business or profession, i.e., DoubleDeduction is not possible.

5.4.12 Telecommunication Services [Section 35ABB]Where any capital expenditure is incurred by the assessee for acquiring any right to

operate telecommunication services either before the commencement of the business tooperate telecommunication service or thereafter any time during any previous year andfor which payment has actually been made to obtain a license, a deduction will beallowed in equal installments over the period for which the license remains in force,subject to the following:



Notes(a) If the fee is paid for acquiring any right to operate telecommunication servicesbefore the commencement of such business, the deduction shall be allowed forthe previous years beginning with the previous year in which such businesscommenced.

(b) If the fee is paid for acquiring such rights after commencement of suchbusiness the deduction shall be allowed for the previous years beginning withthe previous year in which the license fee is actually paid.

Sale of License(b) Where the entire license is transferred

(ii) If the sale proceeds and the deductions already allowed, are less than thecost of acquisition, such deficiency shall be allowed as deduction in theyear in which the license is transferred.

(iii) If the sale proceeds and the deductions already allowed exceed the costof acquisition of the license, then the amount of such excess or theaggregate of the deductions already allowed in the past, whichever is less,shall be taxable as business income of the year in which the license istransferred.

(c) Where a part of the license is transferred(i) Where a part of the license is transferred for a sum less then the written

down value of the total license, the balance amount not yet written offshall be allowed as deduction in the balance number of equalinstallments.

(ii) If part of the license is transferred for a sum exceeding the written downvalue of the license, the sale proceeds minus the written down value ofthe full license shall be the profit from such sale. Out of such profit, anamount equal to the amount already written off in the earlier years shallbe deemed to be the business income.It may be mentioned that the license constitutes a capital asset and assuch there will be capital gain/loss on sale of entire part of the license.

Notes:1. In the case of amalgamation and demerger, the amalgamated company or the

resulting company, as the case may be, shall be allowed to writ off the balanceamount of license which was not written off by the amalgamating company ordemerged company as the case may be.

Where a deduction for any previous year under section 35ABB(1) is claimed andallowed in respect of any expenditure referred to in that sub section, no deduction shallbe allowed on account of depreciation under section 32(1) for the same previous year orany subsequent previous year.

5.4.13 Expenditure on Eligible Projects or Schemes [Section 35AC]Under this section, deduction will be allowed in computing profits of business or

profession chargeable to tax, in respect of the expenditure incurred for an eligible projector scheme for promoting social and economic welfare or uplift of the public as may bespecified by the Central Government on the recommendations of the NationalCommittee.

The deduction will be allowed in cases where the qualifying expenditure is eitherincurred by way of payment to the public sector company, a local authority or to andapproved association or institution for carrying out any eligible project or scheme.



Notes Companies will however, be allowed the deduction also in cases where the expenditureis incurred by them directly on an eligible project or scheme.

The claim for deduction should be supported by an audit certificate obtained fromthe public sector company, local authority, or approved association or institution or fromthe Chartered Accountant in cases where the claims is in respect of expenditure directlyincurred by a company on an eligible project or scheme.

5.4.14 Deduction in Respect of Expenditure on Specified Business [Section 35AD][w.e.f. A.Y. 2010-11]

The income tax act provides for profit linked exemption/deduction under varioussections. Some of the exemptions are provided in the following sections:

(1) Sections 10A,10AA,10B and 10BA(2) Sections 80-1A, 80-1AB, 80-1B, 80-1C,80-1D, and 80-1EHowever, with from assessment year 2010-11, it has made a departure and now

onwards incentive linked tax incentive(instead of profit linked exemption/deduction, shallbe allowed to assessee carrying on certain specified business. In this regard, Section35AD has been inserted for specified business.

1. To whom deduction shall be allowed: Deduction u/s 35AD shall be allowedto the assessee which is carrying on the following specified business:

(i) Setting up and operating a cold chain facility;(ii) On or after 1-4-2012 in the nature of setting up and operating a

warehousing facility for storage of agricultural produce;(iii) On or after 1-4-2007 in the nature of laying and operating a cross-country

natural gas or crude or petroleum oil pipeline network for distribution,including storage facilities being an integral part of such network;

(iv) Finance Bill, 2010 has included the business of building and operatingnew hotel of two star or above category, as classified by the CentralGovernment, any where in India and, which starts operating after1-4-2010.

(v) On or after 1st April,2011, where the specified business in the nature ofdeveloping and building a housing project under a scheme for affordablehousing framed by the central Government; in a new plant or in a newlyinstalled capacity in an existing plant for the production of fertilizers.

(vi) On or after 1st April, 2012, where the specified business in the nature ofsetting up and operating inland container depot or a container freightstation notified or approved under the Customs act,1962.

(vii) On or after 1st April, 2012, where the specified business in the nature ofbee keeping and production of honey and beeswax; in the nature ofsetting up and operating a warehousing facility for storage of sugar;

(viii) On or after 1-4-2009, in all cases not falling under any of the aboveclauses.

2. Nature and amount of deduction: 100% deduction shall be allowed onaccount of any expenditure of capital nature incurred wholly and exclusively forthe purpose of any specified business, shall be allowed as deduction during theprevious year in which he commences operations of his specified business, if –(a) the expenditure is incurred prior to the commencement of its operation;

and



Notes(b) the amount is capitalized in the books of account of the assessee on thedate of commencement of its operations.

2A 150% of the expenditure shall be allowed in respect of specified business asgiven below if it has commenced the operation on or after 1st April, 2012–(i) setting up and operating a warehousing facility for storage of agricultural

produce,(ii) building and operating anywhere in India, a hospital with atleast one

hundred beds for patients,(iii) developing and building a housing project under a scheme for affordable

housing framed by the Central Government; production of fertilizers in India.Conditions to be satisfied:(i) It is not formed by the splitting up or the reconstruction of a business already in

existence.(ii) It is not formed by the transfer to new business of machinery or plant previously

used for any purpose.(iii) Where the business is of laying and operating a cross country natural gas or

crude or petroleum oil pipeline network, etc., it satisfies the following conditionsalso:(a) it is owned by a company formed and registered in India under the

Companies Act, 1956 or by a consortium of such companies or by anauthority or board or a corporation established or constituted under anyCentral or State Act.

(b) it has been approved by the Petroleum and Natural Gas RegulatoryBoard established under sub-section (1) of Section 3 of the Petroleumand Natural Gas Regulatory Board Act, 2006 and notified by the centralGovernment in the Official Gazette in this behalf;

(c) it has made not less than one-third [amended to “such proportion of itstotal pipeline capacity as specified by regulations made by the Petroleumand Natural Gas Regulatory Board established under sub-section (1) ofSection 3 of the Petroleum and Natural Gas Regulatory Board Act, 2006[Finance Bill 2010, to take effect retrospectively from 1.4.2010] of its totalpipeline capacity available for use on common carrier basis by any personother than the assessee or an associated person; and

(d) it fulfills any other conditions as may be prescribed.Notes:

(1) The assessee shall not be allowed any deduction in respect of the specifiedbusiness under the provisions of Chapter VIA under the heading “C –Deductions in respect of certain incomes” in relation to such specified businessfor the same or any other assessment year.

(2) An associated person in relation to the assessee means a person–(i) Who participates directly or indirectly or through one or more

intermediaries in the management or control or capital of the assessee.(ii) Who holds directly or indirectly, shares carrying not less than twenty-six

per cent of the voting power in the capital of the assessee.(iii) Who appoints more than half of the board of directors or members of the

governing board or one or more executive directors or executivemembers of the governing board of the assessee.



Notes (iv) Who guarantees not less than 10% of the total borrowings of theassessee.

5.4.15 Section 35CCA: Payment to Institutions for Carrying Out Rural DevelopmentProgrammes

Any assessee who wants to avail of this section will get a deduction only if he makesa payment to the National Fund for Rural Development and National Urban PovertyEradication Fund which are the only funds which have been notified so far by the CentralGovernment u/s 35CCA(1).

Expenditure on agricultural project [Section 35CCC]Where an assessee incurs any expenditure on agricultural extension project notified

by the board in this behalf in accordance with the guidelines as may be prescribed then,there shall be allowed a deduction equal to one-and-one-half times of such expenditure.


Expenditure on skill development project [Section 35CCD]Where a company incurs any expenditure (not being in the nature of cost of any land

or building) on any skill development project notified by the Board in this behalf inaccordance with the guidelines as may be prescribed then, there shall be allowed adeduction equal to one-and-one-half times of such expenditure.

Where a deduction under this section is claimed and allowed for any assessmentyear in respect of any expenditure referred here deduction shall not be allowed in respectof such expenditure under any other provisions of this Act

5.4.16 Deductions for Expenditure on Prospecting, etc. for Certain Minerals[Section 35E]

This section has been inserted with a view to encouraging investment in high riskareas especially in exploiting of expenditure incurred wholly and exclusively on anyoperations relating to prospecting for certain specified minerals or groups of minerals oron developing mines, etc. Following points are to be noted:

1. Deduction is available only to an Indian resident or an Indian company but notto any foreign citizen or foreign company.

2. 1/10 of the amount of expenditure would be allowed as a deduction for the10 years beginning with the years in which commercial production starts.

3. Expenses to be amortised will be expenses incurred under the specified headsduring the five years period ending with the year of commercial production.

4. If in any year, income arising out of commercial exploitation of wasting asset isNIL or insufficient to absorb, the allowance under this section the unabsorbedallowance is to be carried forward to next year(s). However, this process ofcarry forward cannot be continued beyond 10 years as reckoned from the yearof commercial production.

5. Deduction in case of amalgamation/demerger—Where in a scheme ofamalgamation, the Indian company is transferred to another Indian companybefore the expiry of the said period of 10 years, the provisions of this sectionshall, as far as may be, apply to the amalgamated company as they wouldhave applied to the amalgamating company if the amalgamation had not takenplace. Similarly, where the undertaking of an Indian company which is entitledto deduction under this section, before the expiry of the period of 10 years to



Notesanother company in a scheme of de-merger, no deduction shall be admissiblein this case to the demerged company for the previous year in which thedemerger takes place and the provision of this section, as far as may be, applyto the resulting company, if the demerger had not taken place.

5.4.17 Special Reserve Created by a Financial Corporation under Section 36(1)(viii)A public financial corporation engaged in long-term finance for industrial or

agricultural developments or infrastructure development in India and a public companyformed and registered in India with the main object of providing long-term finance forindustrial or agricultural developments or infrastructure development in India and a publiccompany formed and registered in India with the main object of providing long-termfinance for construction or purchase residential housing in India are entitled for deductionof the amount transferred by them to a special reserve account subject to a maximum of20% of profit from such business (computed before making any deductions underChapter VIA). However, where the aggregate amounts carried to such reserves fromtime to time exceeds twice the paid-up share capital and reserves, no allowance isfurther allowed.

5.4.18 Special Provision for Deduction in the Case of Business for Prospecting, etc.for Mineral Oil [Sections 42 and 44BB]

Section 42: Special deduction in case of business of exploiting mineral oilincluding of petroleum and natural gas: Special allowance in this regard would be inrelation to:

1. Expenditure incurred by way of exploration expenses prior to beginning ofcommercial production.

2. Expenditure incurred in respect of drilling or exploration activities after thebeginning of commercial production.

3. Expenditure incurred in relation to the depletion of mineral oil.The provision of Section 44BB are given below:Condition:16. the assessee is non-resident.(ii) The assessee is engaged in the business of providing services and facilities in

connection with or supplying plant and machinery on hire, used or to be used inthe exploration for and exploitation of mineral oils.

Consequences if the above conditions are satisfied:17. The provisions of Sections 28 to 41, 43 and 43A are not applicable.(ii) Income is calculated at the rate of 10% of the amounts given below.18. The amount in respect of which the provisions apply are the amounts paid or

payable to the taxpayer or to nay person on this behalf whether in or out ofIndia, on account of the provision of aforesaid services or facilities or supplyingplant and machinery for the aforesaid purposes. The amount also includes theamounts received or deemed to be received in India on account of suchservices or facilities or supply of plant and machinery.



Notes 5.4.19 Special Provision for Computing Profits and Gains of Civil Construction[Section 44AD]

A special scheme has been introduced, for estimating the profits and gains ofengaged in the business of civil construction and the broad features of the scheme are asunder:

(a) In the case of an eligible assessee engaged in an eligible business, a sumequal to eight per cent of the gross receipts paid or payable to the assessee inthe previous year on account of such business shall be deemed to be theprofits and gains of such business chargeable to tax under the head “Profitsand gains of business or profession.” The assessee can however voluntarilydeclare higher income in his return.

(b) Any deduction allowable under the provisions of Sections 30 to 38, shall, forthe purpose of above income, be deemed to have been already given full effectto and no further deduction under those Sections shall be allowed. Providedthat where the eligible Assessee is a firm salary and interest paid/payable topartners shall be allowed as deduction from the income computed under thisSection. Such deduction shall, however, be subject to the conditions and limitsspecified u/s 40(b).

(c) The written down value of any asset used for the purpose of the business shallbe deemed to have been calculated as if the assessee had claimed and hadbeen actually allowed the deduction in respect of the depreciation for each ofthe relevant assessment years.

(e) The assessee may choose not to opt for the scheme and may declare anincome lower than 8% of the gross receipts. In this case, the assessee shallhave to keep and maintain books of accounts and get his accounts audited bya Chartered Accountant.

Notes:1. For the purpose of this section, the expression ‘eligible assessee means:

(i) An individual, HUF, or a partnership firm, who is a resident but not alimited liability partnership firm.

(ii) Who has not claimed deduction under any sections 10A,10AA, 10B,10BAor deduction under nay provisions of chapter VIA under the heading “C –Deductions in respect of certain incomes” in the relevant assessmentyear.

2. For the purpose of this section, the expression ‘eligible assessee’ means–(i) any business except the business of plying hiring or leasing goods

carriages referred to in section 44AE; and(ii) whose total turnover or gross receipts in the previous year does not

exceed an amount of one crore rupee.

5.4.20 Special Provisions for computing Profits and Gains of Business of Plying,Hiring or Leasing Goods Carriages [Section 44AE]

Notwithstanding any to the contrary contained in Sections 28 to 43C, the schemeu/s 44AE also provides for a system for estimating the income of an assessee engagedin the business of plying, hiring, or leasing of goods carriages. The broad features of thescheme are:



Notes(a) The scheme is applicable to an assessee who owns not more than 10 goodscarriages at any time during the previous year and who is engaged in thebusiness of plying, hiring or leasing of such goods carriages;

(b) The profits and gains of each goods carriage owned by the above assessee inthe previous year shall be estimated as under:(i) For heavy goods vehicle 5,000 or actual amount earned whichever is

higher, for every month or part of a month during which the heavy vehicleis owned by the assessee in the previous year.

(ii) For goods carriage other than heavy goods vehicle – 4,500 or actualamount earned whichever is higher, for every month or a part of a monthin during which the goods carriage is owned by the assessee in theprevious year. The assessee may declare a higher income than thatspecified above.

(c) Any deduction allowable under the provisions of Sections 30 to 38 shall, for thepurpose of the above income, be deemed to have been already given full effectto and no further deduction under those Sections shall be allowed.Remuneration and interest paid/payable to partners, shall be allowed asdeduction from the income computed under this Section. Such deduction shall,however, be subject to the conditions and limits specified u/s 40(b).

(d) The Written Down Value of any asset used for the purpose of the businessshall be deemed to have been calculated as if the assessee had claimed andhad been actually allowed the deduction in respect of the depreciation for eachof the relevant assessment years.

(e) The provisions of Sections 44AA and 44AB shall not apply in so far as theyrelate to this business. And in computing the monetary limits under thoseSections for other business, the gross receipts or, as the case may be, theincome from the said business shall be excluded.

(f) The assessee may choose not to opt for the scheme and may declare anincome lower than the specified amount. In this case, w.e.f. assessment year1998-99 the assessee shall have to maintain books of accounts and get hisaccounts audited by a Chartered Accountant.

Special Notes1. The expression ‘goods carriage’ and ‘heavy goods vehicle’ shall have the

meanings respectively assigned to them in Section 2 of the Motor Vehicles Act,1988. According to Section 2(14) of the Motor Vehicles Act, 1988 theexpression ‘goods carriage’ means:(a) any motor vehicle constructed or adapted for use solely for the carriage of

goods, or(b) any motor vehicle not so constructed or adapted when used for the

carriage of goods and according to Section 2(16) of the Act, theexpression “heavy goods vehicle” means:(i) any goods carriage the gross vehicle weight of which, or(ii) a tractor the unladen weight of which, or(iii) a road roller the unladen weight of which, exceeds 12,000 kilograms.

2. An assessee, who is in possession of a goods carriage, whether taken on hirepurchase or on instalments.

3. And for which the whole or part of the amount payable is still due, shall bedeemed to be the owner of such goods carriage.



Notes 4. The income estimated as per Section 44AE, shall be his income from thebusiness of plying, hiring, or leasing goods carriages. This income will beaggregated with the other income of the assessee and deductions u/s 80C to80U, if any, will be available to the assessee, subject to fulfillment of conditionsmentioned therein.

5. Income from vehicles is to be computed for every month or part of the monthduring which these were owned by the assessee even though these are notactually used for business.

6. Provision of Section 44AE are not applicable in case the assessee owns morethan 10 goods carriage or where he decides lower profits and gains than theprofits and gains specified in Section 44AE.

5.4.21 Special Provisions for Computing Profits and Gains of Retail Business uptoA.Y. 2010-11 Only [Section 44AF]

A special scheme has been introduced for estimating the profits and gains ofengaged in retail trade and the broad features of the scheme are as under:

(a) In the case of an assessee engaged in retail trade in any goods ormerchandise, a sum equal to 5% of the total turnover in the previous year onaccount of such business shall be deemed to be profits and gains of suchbusiness chargeable under the head profits and gains of business orprofession. The assessee can however voluntarily declare a higher income inhis return. The scheme shall not be applicable if the total turnover of such retailtrade exceeds ` 40 lakhs in the previous year.

(b) Any deduction allowable under the provisions of Sections 30 to 38 shall for thepurpose of above income be deemed to have been already given full effect toand no further deduction under these sections shall be allowed. However,remuneration to working partner and interest paid or payable to partner shall beallowed as deduction from the income computed under this section. Suchdeduction shall however be subject to conditions and limits specified undersection 40(b).

(c) The written down value of any asset used for the purpose of the business shallbe deemed to have been calculated as if the assessee had claimed and hadbeen actually the deduction in respect of depreciation for each of the relevantassessment years.

(d) The provisions of Sections 44AA and 44AB shall not apply in so far as theyrelate to this business and in computing the monetary limits under thesesections, the total turnover or as the case may be, the income from saidbusiness shall be excluded.

(e) The assessee may choose not to opt for this scheme and may declare anincome lower than the specified amount. In this case, the assessee shall haveto keep and maintain books of accounts as per Section 44AB.

With effect from assessment year 2011-12, Section 44AF will be deleted and a newsection 44AD shall substitute the existing provision Section 44AD as the act hasexpanded the scope of presumptive taxation to all business. The salient features of thepresumptive taxation scheme are as under:

(a) the scheme shall be applicable to individuals, HUFs and the partnership firmsexcluding Limited liability partnership firms. It shall also not be applicable to anassessee who is availing deductions under sections 10A, 10AA, 10B, 10BA ordeductions under any provisions of Chapter VIA under the heading “C –Deductions in respect of certain incomes” in the relevant assessment year.



Notes(b) the scheme is applicable for any business (excluding a business alreadycovered under section 44AE) which has maximum gross turnover/grossreceipts of ` 40 lakhs.

(c) a sum equal to 8% of the total turnover or gross receipts of the assessee in theprevious year on account of such business or as the case may be, a sumhigher than the aforesaid sum claimed to have been earned by the eligibleassessee shall be deemed to be the profits and gains of such business.

(d) Any deduction allowable under the provisions of Sections 30 to 38 shall for thepurpose of above income be deemed to have been already given full effect toand no further deduction under these sections shall be allowed. However,remuneration to working partner and interest paid or payable to partner shall beallowed as deduction from the income computed under this section. Suchdeduction shall however be subject to conditions and limits specified undersection 40(b).

(e) The written down value of any asset used for the purpose of the business shallbe deemed to have been calculated as if the assessee had claimed and hadbeen actually the deduction in respect of depreciation for each of the relevantassessment years.

(f) An assessee opting for the above scheme shall be exempted from payment ofadvance tax related to such business under the current provisions of theIncome Tax Act.

(g) An assessee opting for the above scheme shall be exempted frommaintenance of books of accounts related to such business as required undersection 44AA of the Income Tax Act.

(h) An assessee with turnover below ` 40 lakhs who shows an income below thepresumptive rate prescribed under these provisions, will, in case his totalincome exceeds the taxable limit, be required to maintain books of accounts asper section 44AA(2) and also get them audited and furnish a report of eachsuch audit u/s 44AB.

(i) The existing section 44AF will be made inoperative for the Assessment Yearbeginning on or after 1-4-2011.

5.4.22 Special Provisions in the Case of Shipping Business [Section 44B]In the case of an assessee, who is a non-resident and is engaged in the business of

operation of ships, a sum equal to 7.5% of the aggregate of the following:(a) The amounts paid or payable whether in or out of India to the assessee on

account of carriage of passengers, livestock, mail or goods shipped at any portin India, and,

(b) Any amount received or deemed to be received in India on account of carriageof passengers, livestock, mail or goods shipped at any port outside India, shallbe deemed to be the profits of such business. The carriage amount will alsoinclude amount paid or payable by way of demurrage charge or any otheramount of similar nature.

5.4.23 Special Provisions for Computing Profits and Gains of Business ofOperations of Aircraft in the Case of Non-residents [Section 44BBA]

Notwithstanding anything to the contrary contained in Sections 28 to 43A, theincome of a non-resident engaged in the business of operation of an aircraft shall becompleted at flat rate of 5% of:



Notes (a) the amount paid or payable whether in India or out of India to the assessee orto any person on his behalf on account of carriage of passengers, livestock,mail or goods from any place in India and

(b) The amount received or deemed to be received in India, on account of carriageof such items from a place outside India.

5.4.24 Special Provisions for Computing Profits and Gains of Foreign CompaniesEngaged in the Business of Civil Construction, etc. in Certain TurnkeyPower Projects [Section 44BBB]

Notwithstanding anything to the contrary contained in Sections 28 to 44AA in thecase of an assessee, being a foreign company, engaged in the business of civilconstruction or the business of erection of plant or machinery or testing or commissioningthereof, in connection with a turnkey power project approved by the Central Governmentin this behalf and financed under international aid programme, a sum equal to 10% of theamount paid or payable (whether in or out of India) to the said assessee or to any personon his behalf on account of such civil construction, erection, testing or commissioningshall be deemed to be profits and gains of such business chargeable to tax under thehead ‘Profits and Gains of Business/Profession’.

5.4.25 Special Provisions in the Case of Royalty Income Of Foreign Companies[Section 44D]

The provisions are given below:Agreement made before April 1,1976 – Where such income is received under an

agreement before April 1, 1976, the deduction in respect of expenses incurred forearning such income is subject to a ceiling limit of 20% of the gross amount of suchincome, as reduced by the amount, if any, of so much of the royalty income as consists oflump sum consideration for the transfer outside India of, or the imparting of informationoutside India in respect of, any data, documentation, drawing or specification relating toany patent, invention, model, design, secret formula or process or trade mark or similarproperty.

Agreement made after April 1, 1976 not being covered by Section 44D – Royaltiesand technical service fees received under an agreement made after 31-3-1976 butbefore 1-6-1997 not being covered by Section 44DA are chargeable to tax @ 30% (+ SC+ EC); under an agreement made after 31-5-1997 but before 1-6-2005 @ 20%; and inpursuance of an agreement made after 31-5-2005 @ 10%; by virtue of Section 115A inthe following four cases–

(a) where such agreement is with the Government of India; or(b) where such agreement is with an Indian concern, the agreement is approved

by the Central Government ; or(c) where such agreement relates to a matter included in the industrial policy, for

the time being in force, of the Government of India, the agreement is inaccordance with that policy; or

(d) where such royalty is in consideration for the transfer of all or any rights(including the granting of a license) in respect of copyright in any book on asubject referred to in proviso to sub-section (IA) of Section 115A to the Indianconcern or in respect of computer software referred to the second proviso toSection 115A(IA) to a person resident in India.



Notes5.4.26 In respect of the Profits from the Business of Processing ofBio-degradable Waste [Section 80JJA]

Section 80JJA is applicable where gross total income of an assessee includes anyprofits and gains derived from the business of collecting, processing or treating ofbiodegradable waste for generating power or producing bio fertilizers, bio-pesticides orother biological agents or for producing bio-gas or making pellets or briquettes for fuel ororganic manure.

Amount of deduction: The whole of the profits and gains of the above activitiesshall be deductible for a period of five consecutive assessment years beginning with theassessment year relevant to the previous year in which such business commences.

5.4.27 In Respect of the Employment of New Workmen [Section 80JJAA]Conditions: The following conditions should be satisfied to avail deduction under

section:1. The tax payer is an Indian company.2. Income of the tax payer includes any profits and gains derived from any

industrial undertaking engaged in the manufacture or production of article orthing.

3. If the factory is not hived off or transferred from another existing entity oracquired by the assessee company as a result of amalgamation with anothercompany.

4. The assessee furnishes along with the return of income the report ofAccountant giving such particulars in the report as prescribed.

5. The company employs new regular workmen in the previous year.Amount of Deductions: If all the aforesaid conditions are satisfied, then the

amount of deduction will be as follows:1. For the first assessment year: 30% of additional wages (i.e., wages paid to new

workmen in excess of 100 workmen employed during the previous year) paidto new regular workmen employed by the assessee during the previous yearare deductible.

2. For the next two assessment years: The aforesaid deduction will be availablein the next two assessment years.

Other points:1. “Regular workman” does not include–

(a) A casual workman; or(b) A workman employed through contract labour; or(c) Any other workman employed for a period of less than 300 days during

the previous year.2. The aforesaid deduction is available over and above the expenditure on wages

or salary which is otherwise allowable as business expenditure to thecompany.

5.4.28 Tax Incentives for Shipping Business – Tonnage Tax [Sections 115V to115VZC]

To make the Indian shipping industry more competitive, a tonnage scheme oftaxation of shipping profits has been introduced Many maritime nations have introducedtonnage based taxation. Some of the basic features of the tonnage tax scheme are asfollows–



Notes ● It is a scheme of presumptive taxation whereby the notional income arisingfrom the operation of a ship is determined based on the tonnage of the ship

● The notional income is taxed at the normal corporate tax applicable for the year● Tax is payable even if there is loss in an year● A company may opt for the scheme and once such option is exercised, there is

a lock in period of 10 years. If the company opts out, it is debarred fromre-entry for ten years

● Since this is preferential regime of taxation, certain conditions like creation ofreserves, training, etc. are required to be met

● A company may be expelled in certain circumstances.Salient Features- The salient features are as follows–● A company owning at least one qualifying ship may join. A qualifying ship is

one with a minimum tonnage of 15 tons and having a valid certificate. Thecompany has to opt for the scheme by making an application in the prescribedform to the concerned Joint Commissioner who may pass an appropriate order.A new company can make an application within three months of the date of itsincorporation or the date on which it became a qualifying company, as the casemay be.

● Certain types of ships like fishing vessels, pleasure craft, and river ferries, etc,are excluded interims of Section 115VD which gives details of as to what shipswill qualify for the scheme.

● The business of operating qualifying ships is to be considered a separatebusiness and separate accounts are to be maintained. Section115VG gives themanner of computation of the daily tonnage income as follows:

Qualifying ship having net tonnage Amount of daily tonnage income

Up to 1,000Exceeding 1,000 but not more than 10,000

Exceeding 10,000 but not more than 25,000

Exceeding 25,000

` 70 for each 100 tons` 700 plus ` 53 for each 100 tons exceeding 1,000tonnes` 5470 plus ` 42 for each 100 tons exceeding10,000 tonnes` 11,770 plus ` 29 for each 100 tons exceeding25,000 tonnes

The tonnage shall be rounded off to the nearest multiple of 100 tons.The daily tonnage income shall be multiplied by the number of days the ship

operated. The resulting amount would be the annual tonnage from the ships. A companyowning at least one ship may charter subject to certain limits for the purpose of operation.Relevant shipping income, which replaces the actual income from operations is definedin Section 115VL. Section 115VJ gives the treatment of common costs.

● The company opting for the scheme is not allowed any set-off loss nor is anydepreciation allowed. However, both loss and depreciation are deemed to havebeen allowed and notional adjustments are made against the relevant shippingincome. Although depreciation is not allowed, it is necessary to bifurcate thequalifying ships and non-qualifying ships at the time company joins the scheme.Section 115VK lays down the method for allocating the written down valueamongst qualifying and non-qualifying ships. Any income from transfer ofqualifying assets in terms of Section 115VN.

● The profits from the business of operating qualifying ships will not be taken intoconsideration for the purpose of MAT as per Section 115vo.



Notes● Section 115VP lays down the procedure for the option and the manner ofgranting approval. Section 115VQ lays down that once the company opts forthe scheme, the option remains in force for 10 years, except in certaincircumstances. Section 115VS provides for the circumstances in which thetonnage tax company is prohibited from opting the scheme. Such prohibition isfor a period of 10 years. Sections 115VT, 115VU, 115VS and 115VW lay downthe conditions for the applicability of the scheme. In terms of Section 115VT, atonnage tax company has to create a reserve of at least 20% of its book profitsto be for the purpose of acquisition of new ships. As per Section 115VU, atonnage tax company has to comply with the minimum training requirement inaccordance with the guidelines to be issued by the DG (Shipping). Thecompany will be expelled if the training requirements are not met for5 consecutive years. Section 115VV lays down that every company which hasopted for tonnage tax scheme, not more than 49% of the net tonnage of thequalifying ships operated by it during any previous year shall be chartered. Interms of Section 115VW, maintenance of separate books of account and theaudit of same is compulsory for a company opting for the scheme. Section115VX lays down, the details regarding valid certificate which indicates the nettonnage of ships. Section 115VY and Section 115VZ provide for thecontingencies of amalgamation and demerger. Section 115VZB enjoins upon acompany not to abuse the preferential tax regime and Section 115VZCprovides for exclusion of a company in case of abuse.

5.4.29 ProblemsProblem 1: X & Co., a partnership firm, consisting of three partners A, B and C isengaged in the business of civil construction. The firm gets the following by way ofcontract receipts:

Contract work for supply of labour ` 30,00,000Value of materials supplied by Government 8,00,000Total value of contract 38,00,000Each partner of the firm is entitled to draw ` 2,500 per month by way of salary as by

the terms of the partnership deed. Interest of ` 1,00,000 is also paid to partner C on thecapital of ` 5,00,000 contributed by him. The profit as per books of account beforededuction of salary to partners and interest to partner C is ` 250,000. Compute the totalincome of the firm applying the provisions of Section 44AD.Solution: Computation of total income of the firm–

Income from business of civil construction (8% of ` 30,00,000) ` 2,40,000Less expensesSalary and interest paid to partners (` 2500 × 3 × 12 = 90,000 +12% on ` 500,000, i.e., 60,000) 1,50,000Other expenses NilIncome from civil construction 90,000Other income NilGross Total Income 90,000Less deduction u/s 80C to 80U NilNet Income 90,000

Problem 2: X Cine Arts Ltd. of Mumbai is engaged in distribution of cinematographyfilms. It starts construction of multiplex theatre and convention hall in Navi Mumbai in



Notes April 2008 and completes in December, 2008. The profits for the year ending March 31,2009 of all the activities are:

` lakhsDistribution of cinematography films 5Convention centre 2Multiplex centre 1Compute the taxable income for the assessment year 2009-10 with reasons.

Solution:Assessment Year 2009-10 ` LakhsBusiness income 5Distribution of cinematography films 2Convention centre 1Gross total income 8Less deduction under Sec. 80-IB (see note) 1Taxable income 7Note: Deduction under section 80-IB is not available in respect of multiplex theatre

as it is located within the municipal jurisdiction of Mumbai. However in respect of incomefrom convention centre, deduction @ 50% of ` 2 lakhs is available under section 80-IB asthere is no stipulation regarding location of convention centre under section 80-IB.

5.5 Tax Planning in Respect of Amalgamation, Merger or Demergerof Companies

5.5.1 Introduction

Modes of M&A in India

The question may arise “Is merger same as Amalgamation?

5.5.2 Meaning of Terms as per Tax Law – AmalgamationAmalgamation is a blending of two or more existing undertakings into one

undertaking, the shareholders of each blending company becoming substantially theshareholders in the company which is to carry on the blended undertakings. There maybe amalgamation either by transfer of two or more undertakings to a new company, or bythe transfer of one or more undertakings.

M&A

Amalgamations Acquisitions

Demerger Asset Purchase

Slump Sale

Stock PurchaseMerger

Itemized Sale



NotesMerger is not defined under the Income Tax Act, 1961. However, in commonparlance, merger or amalgamation under the Income Tax Act is said to occur when twoor more companies combine into one company. One or more companies may merge withan existing company or they may merge to form a new company. Sec. 2(1B) of theIncome Tax Act 1961 defines amalgamation as the merger of one or more companieswith another company or the merger of two or more companies (called amalgamatingcompanies) to form a new company (called amalgamated company) in such a way thatall assets and liabilities of the amalgamating company or companies become assets andliabilities of the amalgamated company and shareholders holding not less thanthree-fourths in value of the shares in the amalgamating company or companies becomeshareholders of the amalgamated company.

The following cases subject to fulfilling the above conditions fall within the definitionof Section 2(1B)–

● Merger of A Ltd. with X Ltd. (A Ltd. goes out of existence)● Merger of A Ltd. and B Ltd. with X Ltd. (A Ltd. And B Ltd. go out of existence)● Merger of A Ltd. and B Ltd. into a newly incorporated X Ltd. (A Ltd. and B Ltd.

go out of existence)● Merger of A Ltd., B Ltd. and C Ltd. into a newly incorporated X Ltd. (A Ltd.,

B Ltd. and C Ltd. go out of existence)In the aforesaid cases, A Ltd., B Ltd. and C Ltd. are amalgamating companies while

X Ltd. is the amalgamated company.Transactions not treated as ‘amalgamation’ [Section 2(1B)]Section 2(IB) specifically provides that in the following two cases there is no

amalgamation, for the purpose of income tax though, the element of merger exists:(a) Where the property of the company which merges is sold to the other company

and the merger is the result of a transaction of sale.(b) Where the company which merges is wound up in liquidation and the liquidator

distributes its property to another company.Demerger – Sec. 2(19AA): Demerger in relation to companies, means the transfer,

pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act,1956 by a demerged company of its one or more undertakings to any resulting companyin such a manner that–

(i) All the property of the undertaking, being transferred by the demergedcompany, immediately before the de merger, becomes the property of theresulting company by virtue of de merger.

(ii) All the liabilities relatable to the undertaking, being transferred by thedemerged company, immediately before the de merger, become the liabilitiesof the resulting company by virtue of de merger.

(iii) The property and liabilities of the undertaking or undertakings being transferredby the demerged company are transferred at values appearing in the books ofaccounts immediately before the de merger.

(iv) The resulting company issues, in consideration of the de merger, its shares tothe shareholders of the de-merged company on a proportionate basis.

(v) The shareholders holding not less than three-fourths in value of shares in thedemerged company other than shares already held therein immediately beforethe de merger, or by a nominee for, the resulting company or, its subsidiary)become shareholders of the resulting company or companies by virtue of thede merger, otherwise than as a result of the acquisition of the property or



Notes assets of the demerged company or any undertaking thereof by the resultingcompany.

(vi) The transfer of the undertaking is on a going concern basis(vii) The de merger is in accordance with the conditions, if any, notified under

sub-section (5) of Section 72A by the Central Government in this behalf.Explanation 1 - For the purpose of this clause ‘undertaking’ shall include any part

of the undertaking, or a unit or division of an undertaking or a business activity taken as awhole, but does not include individual assets or liabilities or any key combination thereofnot constituting a business activity.

Explanation 2 - Liabilities include (i) the liabilities which arise out of the activitiesor operations of the undertaking (ii) the specific loans or borrowings including debenturesraised, incurred or solely for the activities or operations of the undertaking and (iii) inother cases so much of the amounts of general or multipurpose borrowings, if any, of thede-merged company as stand in the same proportion which the value of the assetstransferred in a demerger bears to the total value of the assets of such demergedcompany immediately before the demerger.

Explanation 3 - Value of the property of the undertaking being transferred –value of the property and the liabilities of the undertaking(s) being transferred by thedemerged company should be at book value appearing in books immediately beforedemerger.

Explanation 4 - Benefit of de-merger also available to certain authorities orBoards: The splitting up or the reconstruction of any authority or a body constituted orestablished under a Central, State or Provincial Act, or a local authority or a public sectorcompany, into separate authorities or bodies or local authorities or companies as thecase may be, shall be deemed to be a demerger if such split up or reconstruction is asper the condition, if any, specified by the Central Government.

Shares to be issued on a proportionate basis to the shareholders of demergedcompany.

Meaning of demerged company – Demerged company means the companywhose undertaking is transferred, pursuant to a demerger, to a resulting company [Sec.2(19AAA)].

Meaning of resulting company: Resulting company means one or morecompanies (including a wholly owned subsidiary thereof) to which the undertaking of thedemerged company is transferred in a demerger and the resulting company inconsideration of such transfer of undertaking, issue shares to the shareholders of thedemerged company and includes any authority or body or local authority or public sectoror a company established, constituted or formed as a result of demerger.

5.5.3 Income Tax Implications in Case of Amalgamation or Demerger

Notional Written Down Value in case of a Capital Asset:1. Transfer in a scheme of amalgamation: In such a case the actual cost of

block of assets in the case of amalgamated company shall be the WDV ofblock of assets as in the case of amalgamating company for the immediatelypreceding previous year as reduced by the amount of depreciation actuallyallowed in relation to the said previous year.

2. WDV when assets are transferred in demerger: In such a case the WDV ofthe block of assets of the demerged company for the immediately precedingyear shall be reduced by the WDV of assets transferred to the resultingcompany in order to get WDV in the hands of the demerged company.



Notes3. WDV in the hands of the resulting company: In such a case the WDV of theone block of assets in case of the resulting company shall be the WDV of thetransferred assets appearing in the books of accounts of the demergedcompany immediately before de merger.

4. Actual Cost (Section 43(1)]: Actual cost means the actual cost of the assetsto the assessee, reduced by the portion of the cost of the asset, if any, as hasbeen met directly or indirectly by any other person or authority.Notional Actual Cost: [Explanations to Section 43(1)]: In the followingcases the actual cost for purposes of depreciation shall be a notional cost tothe assessee.

5. Assets transferred under a scheme of amalgamation [Explanation 7]:Where, in a scheme of amalgamation, any capital asset is transferred by theamalgamating company to the amalgamated company and the amalgamatedcompany is an Indian company, the actual cost of the transferred capital assetto the amalgamated company shall be taken to be the same as it would havebeen if the amalgamating company had continued to hold the capital asset forthe purposes of its business.

6. Actual cost in case of demerger: Explanation 7A has been inserted toprovide that in case of de merger, the actual cost of the transferred capitalasset to the resulting company shall be taken to be the same as it would havebeen if the demerged company has continued to hold the capital asset for thepurpose of its own business.

7. Where the assets transferred form part of the block of assets of thedemerged company [Explanation 2A and 2B to Section 43(6): where in anyprevious year, any asset forming part of the block of assets is transferred by ademerged company to the resulting company, then notwithstanding anythingcontained in Section 43(1), the written down value of the block of assets of thedemerged company for the immediately preceding previous year shall bereduced by the written down value of the assets transferred to the resultingcompany pursuant to the demerger [Explanation 2A].Where in a previous year, any asset forming part of a block of assets istransferred by a demerged company to the resulting company, then,notwithstanding any thing contained in Section 43(1), the written down value ofthe block of assets in the case of resulting company shall be written down oftransferred assets of the demerged immediately before the demerger[Explanation 2B].

Case 1 – R Ltd. was amalgamated with G Ltd. w.e.f. 29-8-2012. The written down valueof the block of assets as on 1-4-2012, the rate of depreciation on each block and thevalues at which the block of assets were transferred by R Ltd. are given below:

Block of Assets Rate ofDepreciation

WDV in the hands ofR Ltd. as on 1-4-2012

Transfer value of GLtd. `

BuildingsPlant and MachineryFurniture

10%15%10%

10,00,00025,00,000

5,00,000

9,00,00024,00,000

4,50,000

You are required to work out the deductions admissible under section 32 by way ofdepreciation to X Co. Ltd. and to Y Co. Ltd. in respect of these assets for the financialyear 2012-13 relevant to the Assessment Year 2013-14. It may be noted thatamalgamation is in terms of Section 2(IB) of the Income Tax Act.Solution: As per proviso 4 to Section 32(I)(ii) in a scheme of amalgamation, thededuction shall be worked out in such a manner that the deduction to the predecessor,



Notes i.e., the amalgamating company and successor, i.e., the amalgamated company shall beapportioned between them in the ratio of the number of days for which the assets wereused by them. Further, the deduction shall not exceed the deduction calculated in theprescribed rates as if the amalgamation had not taken place. The deduction shall be asunder–

1. In case of R Ltd. `

Building – w.d.v. 10,00,000 × 10% × 150/365 41,096Plant and Machinery – w.d.v. 25,00,000 × 15% × 150/365 154,110Furniture – w.d.v. 5,00,000X10% × 150/365 20,54519. In case of G Ltd.Building – Actual cost 10,00,000 × 10% × 215/365 58,904Plant and Machinery – Actual cost 25,00,000 × 15% × 215/365 2,20,890Furniture – Actual cost 5,00,000 × 10% × 215/365 29,452

Case 2 – X Ltd. has two undertakings A and B. The following information is available.

(` in thousands)

Assets Unit A Unit B Total

Rate of depreciationPlants R and S15 per cent

Plants P and Q15 per cent

Depreciated value on April 1, 2008 – 600 600

Add: Actual cost of plants R and S acquired onJune 1, 2008

400 – 400

Less: Sale proceeds of Plant P transferred onNovember 30, 2008

–- 900 900

Written down value on March 31, 2009 400 – 100

Less: Depreciation for 2008-09 60 15

Depreciated value on April 1, 2009 340 85

Less:depreciation for 2009-10 51 12.75

Depreciated value on April 1, 2010 289 72.25

On April 1, 2010, Unit A is transferred to Y Ltd., on Indian company, in a scheme ofdemerger. What will be the written down value and actual cost in the hands of X Ltd. andY Ltd.?Solution:

Written down value in the hands of X Ltd. `

Depreciated value of assets on April 1, 2010 72,250Less: Written down value of assets transferred to Y Ltd. (–) 2,89,000Written down value on April 1, 2010 Nil

Note: By virtue of Section 47(vib), income is not taxable under the head “Capital gains”.In the hands of Y Ltd., the written down value shall be ` 2,89, 000.

Section 35 DD: Amortization of Expenditure in the case of Amalgamation/DemergerWhere an assessee, being an Indian Company incurs expenditure (on or after

01.04.1999) wholly and exclusively for the purpose of amalgamation or demerger; theassessee shall be allowed a deduction equal to one-fifth (1/5th) of such expenditure for



Notes5 successive previous years beginning with the previous year in which amalgamation ordemerger takes place.

Scientific Research [Section 35]Where amalgamating company transfers to the amalgamated company, (being an

Indian Company), any asset representing capital expenditure on scientific research, andprovisions of Section 35 would apply to the amalgamated company as if amalgamatingcompany had not transferred the asset.

Expenditure for obtaining license to operate telecommunication services [Section35ABB(6)]

Where in a scheme of amalgamation, the amalgamating company sells or otherwisetransfer its license to the amalgamated company (being an Indian Company), theprovisions of Section 35ABB which were applicable to the amalgamating company shallbecome applicable in the same manner to the amalgamated company.

Treatment of preliminary expenses [Section 35D(5)]Where an amalgamating company merges in a scheme of amalgamation with the

amalgamated company, the amount of preliminary expenses of the amalgamatingcompany which are not yet written off, shall be allowed as deduction to the amalgamatedcompany in the same manner it would have been allowed to the amalgamating company.

Treatment of expenditure on prospecting, etc. of certain minerals [Section35E(7A)]

Where an amalgamating company merges in a scheme of amalgamation with theamalgamated company, the amount of expenditure on prospecting, etc. of certainminerals of the amalgamating company, which are not yet written off, shall be allowed asdeduction to the amalgamated company in the same manner it would have been allowedto the amalgamating company.

Treatment of capital expenditure on family planning [Section 36(1)(ix)]Where the asset representing the capital expenditure on family planning is

transferred by the amalgamating company to the Indian amalgamated company, in ascheme of amalgamation, the provisions of Section 36(1)(ix) to the amalgamatingcompany shall become applicable, in the same manner, to the amalgamated company.

Treatment of bad debts [Section 36(1)(vii)]Where due to amalgamation, the debts of amalgamated company have been taken

over by the amalgamated company and subsequently such debt or part of the debtbecomes bad, such debt will be allowed as a deduction to the amalgamated company.

Deduction available u/s 80IA or 80-IAB or 80-IB or 80-IC or 80-IEWhere an undertaking which is entitled to deduction under section 80IA/80-IAB/

80-IB/80-IC/80-IE is transferred in the scheme of amalgamation or demerger, before theexpiry of the period if deduction under section 80IA or 80-IAB or 80-IB or 80-IC or 80-IE,then–

(i) no deduction under section 80IA/80-IAB/80-IB/80-IC/80-IE shall be available tothe amalgamating company for the previous year in which amalgamation or thedemerger takes place; and



Notes (ii) the provisions of section 80IA/80-IAB/80-IB/80-IC/80-IE shall apply to theamalgamated or the resulting company in such manner in which they havebeen applied to the amalgamating or the demerged company.

5.5.4 Tax Concessions Relating to Transfer of Capital Asset in Case ofAmalgamation/Merger/DemergerTransfer of capital asset [Section 45(1)]: Any profits and gains arising from the

transfer of a capital asset effected in the previous year shall be deemed to be chargeableto income tax under the head ‘Capital Gains’, and shall be deemed to be the income ofthe previous year in which the transfer took place excluding the exemptions provided.Transfer is defined in Section 2(47) as, “the liability to tax on capital gains arises only ifthere is a transfer of capital asset”.

Section 47: Transaction not regarded as transferAny transfer of a capital asset by a company to its 100% subsidiary company

provided the subsidiary is an Indian company [Section 47(iv)].Any transfer of a capital asset by a 100% subsidiary company to its holding

company if the holding company is an Indian company [Section 47(v)].Any transfer in a scheme of amalgamation of a capital asset by the amalgamating

company to the amalgamated company, if the amalgamated company is an Indiancompany [Section 47(vi)];

Any transfer by a shareholder, in a scheme of amalgamation, of shares held by himin the amalgamating company if–

(a) The transfer is made in consideration of the allotment to him or any share orshares in the amalgamated company, and

(b) The amalgamated company is an Indian company [Section 47(vii)];(c) The consideration received by the shareholder should only be shares. If the

consideration includes anything in addition to shares, then it will be treated as atransfer and there will be a capital gain.

Merger of an Indian company into a foreign company – whether possible inIndia?

● Merger of an Indian company into a foreign company not envisaged by theCompanies Act, 1956.

● Recommendations by J.J. Irani Report on Company Law to allow merger of anIndian company into a foreign company.

Shareholders

F Co I Co

Merger of F Co. into I Co

Merger

Consideration in theform of shares of I Co



Notes● Short term mergers also proposed.● No tax exemption under Income Tax Act, 1961 in the case of amalgamation of

an Indian company into a foreign company wherein the amalgamated companyis a foreign company.

● Such a merger would result in a F Co. having assets or business in India andtherefore may cause a Permanent Establishment of F Co. in India.

Any transfer in a scheme of amalgamation of shares held in an Indian company bythe amalgamating foreign company to the amalgamated foreign company if:

(a) At least 25% of the shareholders of the amalgamating foreign companycontinue to remain shareholders of the amalgamated foreign company, and

(b) Such a transfer does not attract capital gains tax in the country, in which theamalgamating company is incorporated [Section 47(viA)].

Any transfer in a scheme of amalgamation of a banking company with a bankinginstitution sanctioned and brought into force by the Central Government undersub-section (7) of Section 45 of the Banking Regulation Act,1949, of a capital asset bythe banking company to the banking institution [Section 47(viaa)].

Banking company and banking institution shall have the same meaning assignedunder Sec. 5(c) and sec. 45(15) of the Banking Regulation.

Any transfer in a demerger, of a capital asset by the demerged company to theresulting company, if the resulting company is an Indian company [Section 47(vib)];

Any transfer in a demerger, if a capital asset, being a share or shares held in anIndian company, by the demerged foreign company to the resulting foreign company.

(a) The shareholders holding not less than three-fourth in value of the shares ofthe demerged foreign company continue to remain the shareholders of theresulting foreign company, irrespective of the number of such shareholders.

(b) Such transfer does not attract tax on capital gains in the country, in which thedemerged foreign company is incorporated;

Provided that the provisions of section 391 to 394 of the Companies Act, 1956 shallnot apply in case of de mergers referred to in this clause [Section 47(vic)];

Any transfer in a business reorganization, of a capital asset by the predecessorco-operative bank to the successor co-operative bank [Section 47 (vica)];

Any transfer by a shareholder, in a business re-organization, of a capital asset beinga share or shares held by him in the predecessor co-operative bank if the transfer ismade in consideration of the allotment to him of any shares or shares in the successorco-operative bank [Section 47(vicb)];

F Co. 1F Co. 2

I Co.

Merger

Section 47(via) Merger



Notes Any transfer or issue of shares by the resulting company, in a scheme of de mergerto the shareholders of the demerged company if the transfer or issue is made inconsideration of de merger of the undertaking [Section 47(vid)];

Any transfer by a shareholder, in a scheme of amalgamation, of shares held by himin the amalgamating company if:

(a) the transfer is made in consideration of the allotment to him of any share orshares in the amalgamated company, and

(b) the amalgamated company is an Indian company [Section 47(vii)].Note: The consideration received by the shareholder should only be shares. If theconsideration includes any thing in addition to shares, say bonds and debentures then itwill be treated as a transfer and there will be a capital gain [CIT v. Gautam Sarabhai Trust(1988) 173 ITR210(Guj)].

Computation of Capital Gains (Sections 48 to 51)Section 48: The income under the head “Capital Gains” shall be computed by

deducting the following from the full value of the consideration received or accrued as aresult of the transfer of the capital asset:

1. Expenditure incurred wholly and exclusively in connection with such transfer.2. The cost of acquisition of the asset and the cost of any improvement thereto;

Under different circumstances, the cost of acquisition of a capital asset isdetermined in the following manner:

3. Cost to the previous owner: [Sec. 49(1)]:(a) Under any scheme of amalgamation by the amalgamating company

to the amalgamated company;(b) Cost of acquisition of shares in amalgamated company [Sec. 49(2)]:

Where a share or shares in an amalgamated company which is an Indiancompany became the property of the assessee in consideration of atransfer of his share or shares held in the amalgamating company, thecost of acquisition of the asset (share) shall be deemed to be the cost ofacquisition to him of the share or shares in the amalgamating company.

(c) Cost of acquisition of the original share of the demerged company[Section 49(2D)]: It shall be deemed to have been reduced by theamount as so arrived at under Sub-section (2C) above. “Net Worth” forthis section shall mean the aggregate of the paid up share capital andgeneral reserves as appearing in the books of accounts of the demergedcompany immediately before de merger.

4. Cost of Acquisition in the case of slump sale [Sec. 50B]:. Provisions ofSection 50B, applicable for computation of capital gains in the case of slumpsale are given below:

1. Any profits or gains arising from the slump sale affected in the previousyear shall be chargeable as long-term capital gains and shall be deemedto be income of the previous year in which the transfer took place.

Where however, any capital asset being one or more undertakings owned and heldby the assessee for not more than 36 months is transferred under the slump sale, thencapital gain shall be deemed to be short term capital gain.

In the case of slump sale of the capital asset being one or more undertaking, the ‘networth” of the undertaking shall be taken as cost of acquisition and cost of improvement.“Net worth” for this purpose is the aggregate value of total asset of the undertaking ofdivision as reduced by the value of liabilities of such undertaking of division as reduced



Notesby the value of liabilities of such undertaking or division as appearing in the books ofaccounts. Any change in the value of assets on account of revaluation of asset of suchundertaking or division shall be the written down value of block of asset determined inaccordance with the provisions contained in sub-item (C) of Section 43(6)(c)(i) in thecase of depreciable assets and the book value for all other assets.

The benefit of indexation will not be available.Every assessee, in the case of slump sale, shall furnish along with the return of

income, a report of a chartered accountant in Form No. 3 CEA indicating the computationof the net worth of the undertaking or division as the case may be has been correctlyarrived at.Case 3 – X Ltd. has unit C which is not functioning satisfactorily. The details of its fixedassets are:

Asset Date of acquisition Book value ( ` lakhs)

LandGoodwill (raised in books on March 31, 2008)MachineryPlant

Feb. 10, 2007

April 5, 2001April 12, 2007

30104020

The written down value is ` 25 lakhs in case of machinery and ` 15 lakhs in case ofplant. The liabilities on this unit on March 31, 2009 are ` 35 lakhs. There are two options(as on March 31, 2009) –

(a) Slump sale to Y & Co. for a consideration of ` 85 lakhs.(b) Individual sale of assets for the following consideration: Land ` 48 lakhs,

Goodwill ` 20 lakhs, Machinery ` 32 lakhs, Plant ` 17 lakhs.Which option is to be chosen and why? The other units are deriving taxable income

and there are no carry forward of losses or depreciation for the company as a whole, UnitC was started on January 1, 2001.Solution:Option1: Slump saleComputation of net wealth of Unit C ` LakhLand (book value) 30Goodwill (book value)[not to be considered as it is raised in books by book entry] NilMachinery (WDV given) 25Plant (WDV given) 15Total 70Less: Liabilities 35Net Worth 35Computation of capital gainSales consideration 85Less: Net worth 35Long-term capital gain (Unit C started on January 1, 2001) 50Computation of tax liabilityTax on ` 50 lakhs @ 20% 10Add: Surcharge [10% of tax in case net income exceeds ` 1 crore] NilTax and surcharge 10



Notes Add: Education cess 2% +SHEC 1% 0.3Tax liability under option 1 10.3Receipt after tax [i.e., sale consideration ` 85 lakhs – 10.3 lakhs]: ` 74.7 lakhsOption II: Sale of individual assetsComputation of capital gains

Land Goodwill Machinery Plant

Sale considerationLess: Cost of acquisition*/written down value**

4 830*

20 3225**

1715**

Long-term capital gain*/short-term capital gain** 18** 20* 7** 2**

Computation of tax liabilityTax on long-term capital gains 20% on 20 4Tax on short-term capital gains 30% on 18 + 7 + 2 8.1Total 12.1Add: Surcharge [10% of tax in case net income exceeds ` 1 crore] NilTax and surcharge 12.1Add: Education cess 2% +SHEC 1% 0.363Tax liability under Option 2 12.463Receipt after tax [i.e., sale consideration ` 117 lakhs – 12.463 lakhs]: 104.537 lakhsDecision – Option II is better option for X Ltd. as it leads to higher after-tax receipts.

5.5.5 Carry Forward and Set-off of the Accumulated Losses and UnabsorbedDepreciation Allowance in Amalgamation or Demerger, etc. (Section 72A)

Section 72A allows carry forward of business loss and unabsorbed depreciation incase of:

(i) Amalgamation [Section 72A(1), (2) and (3)], or(ii) Demerger [Section 72A(4) and (5)] or(iii) Re-organisation of business [Section 72A(6)]

Carry Forward and Set-off of Accumulated Loss and Unabsorbed Depreciation inCase of Amalgamation [Section 72A(1), (2) and (3)]

As per section 72A(1) where there has been an amalgamation of a company, theaccumulated loss and the unabsorbed depreciation of the amalgamating company shallbe deemed to be loss or as the case may be, allowance for depreciation of theamalgamated company for the previous year in which the amalgamation is effected andthe other provisions of this Act relating to set off and carry forward of loss and allowancefor depreciation shall apply accordingly, if the following conditions are satisfied:

(1) There is an amalgamation of(a) A company owning an industrial undertaking or ship or a hotel with

another company or(b) A banking company referred to in section 5(c) of the Banking Regulation

Act, 1949 with a specified bank, or(c) One or more public sector company or companies engaged in the

business of operation of aircraft with one ore more public sector companyor companies engaged in similar business

(2) The following conditions laid down under section 72A(2) are satisfied:



Notes(a) Conditions to be satisfied by the amalgamated company(i) The amalgamating company has been engaged in the business in

which the accumulated loss has occurred or depreciation remainsunabsorbed, for 3 or more years.

(ii) The amalgamating company has held continuously as on the date ofthe amalgamation at least 75% of the book value of fixed assets heldby it two years prior to the date of amalgamation.

(iii) The amalgamated company continuously for a minimum period offive years from the date of amalgamation at least 75% in the bookvalue of assets of the amalgamating company acquired in thescheme of amalgamation. In this case, book value is to beconsidered on the date of amalgamation;

(iv) The amalgamated company continues the business of theamalgamating company for a period of 5 years from the date ofamalgamation.

(v) The amalgamated company fulfils such other conditions as may beprescribed (See Rule 9C mentioned below) to ensure the revival ofthe business of the amalgamating company or to ensure the revivalof the business of the amalgamating company or to ensure that theamalgamation is for genuine business purposes laid down by section72A(2(b).

If the conditions mentioned under (2)(a) and (2)(b) above are satisfied by both theamalgamating and amalgamated company shall become the business loss andunabsorbed depreciation of the amalgamated company. Such accumulated loss will beallowed to be carried forward by the amalgamated company for fresh 8 years andunabsorbed depreciation can be carried forward indefinitely.

Consequences if the above conditions are not satisfied [Section 72A(3)]:In a case where the conditions laid down under clause (b) above are not complied

with, the set off of loss or allowance of depreciation made in any previous year in thehands of the amalgamated company shall be deemed to be the income of theamalgamated company chargeable to tax for the year in which such conditions are notcomplied with. Further, the balance accumulated loss and unabsorbed depreciation notyet set off shall not be carried forward and set-off.

The carry forward and set-off of loss and unabsorbed depreciation as per the aboveprovisions shall be allowed only when amalgamation is as per the provisions of Section2(1B) of the Income Tax, 1961.

Shareholders

Consideration in theform of shares of I Co.

F Co.

Merger of F Co. into I Co.

I Co.



Notes Conditions for carrying forward or set-off accumulated loss and unabsorbeddepreciation allowable in case of amalgamation [Rule 9C Notified by NotificationNo. 11169 dated 15-12-1999]

The conditions referred to in Section 72A(2)(b)(iii) above shall be the followingnamely:

(a) The amalgamating company, owning an industrial undertaking of the saidamalgamating company by way of amalgamation, shall achieve the level ofproduction of at least fifty per cent of the installed capacity of the saidundertaking before the end of four years from the date of amalgamation andcontinue to maintain the said minimum level of production till the end of fiveyears from the date of amalgamation. However, the Central government, on anapplication, may relax the condition of achieving the level of production or theperiod during which the same is to be achieved or both in suitable cases havingregard to the genuine efforts made by the amalgamated company to attain theprescribed level of production and circumstances preventing such efforts fromachieving the same.

(b) The amalgamated company shall furnish to the assessing officer a certificate inForm No. 62 duly verified by an accountant, with reference to the books ofaccount and other documents showing particulars of production, along with thereturn of income for the assessment year relevant to the previous year duringwhich the prescribed level of production is achieved and for subsequentassessment years relevant to the previous years falling within five years fromthe date of amalgamation.

Carry Forward and Set-off of Accumulated Losses and Unabsorbed Depreciationin Case of Demerger [Sec. 72(3)]

In a case where the conditions laid down under clause (b) above are not compliedwith, the set-off of loss or allowance of depreciation made in any previous year in thehands of the amalgamated company shall be deemed to be the income of theamalgamated company chargeable to tax for the year in which such conditions are notcomplied with.

The carry forward and set-off of loss and unabsorbed depreciation as per theabove provisions shall be allowed only when amalgamation is as per theprovisions of Section 2(1B) of the Income Tax 1961.

Carry forward and set-off of accumulated losses and unabsorbed depreciationin case of de merger [Sec. 72(A)(4) and (5)]:

Notwithstanding anything contained in any other provisions of this Act, in the case ofde merger, the accumulated loss and the allowance for absorbed depreciation of thede-merged company shall:

(a) Where such loss or unabsorbed depreciation is directly relatable to theundertaking transferred to the resulting company, be allowed to be carriedforward and set off in the hands of the resulting company;

(b) Where such loss or unabsorbed depreciation is not directly relatable to theundertakings transferred to the resulting company, be apportioned between thedemerged company and the resulting company in the same proportion in whichthe assets of the undertakings have been retained by the demerged companyand transferred to the resulting company, land be allowed to be carried forwardand set off in the hands of the demerged company or the resulting company, asthe case may be.



NotesThe Central Government may, for the purpose of this Act, by notification in theOfficial Gazette, specify such conditions, as it considers necessary to ensure that the demerger is for genuine business purpose.

The Carry forward and set off of accumulated loss and unabsorbed depreciation asper the above provisions shall be allowed only when de merger as per the provisions ofSection 2 (19AA) of Income Tax Act.

Carry Forward and Set-off of Accumulated Losses and Unabsorbed Depreciationin Case of Re-organisation of Business [Section 72A(6)]

Where there has been re-organisation of business, whereby, a firm is succeeded bya company fulfilling the conditions laid down in clause (xiii) of Section 47 or a proprietaryconcern is succeeded by a company fulfilling the conditions laid down in clause (xiv) orSection 47, the notwithstanding anything contained in any other provisions of this Act, theaccumulated loss and the unabsorbed depreciation of the predecessor firm or theproprietary concern, as the case may be, shall be deemed to be the loss or allowance fordepreciation of the successor company for the purpose of previous year in whichbusiness re-organisation was effected and other provisions of this Act relating to set offand carry forward of loss and allowance for depreciation shall apply accordingly.

Consequences if the conditions laid down under section 47(xiii) and (xiv) arenot complied with [Proviso to section 72A(6)]:

If any of the conditions laid down under section 47(xiii) and (xiv) are not compliedwith, the set-off of loss or allowance of depreciation made in any previous year in thehands of the successor company, shall be deemed to be the income of the companychargeable to tax in the year in which such conditions are not complied.

If under section 47(xiii) and (xiv) are not complied with, the set-off of loss orallowance of depreciation made in any previous year in the hands of the successorcompany, shall be deemed to be the income of the company chargeable to tax in theyear in which such conditions are not complied with:

(vi) Accumulated loss means so much of the loss of the predecessor firm or theproprietary concern or the amalgamating company or the de-merged company,as the case may be,

under the head “Profits and gains of business or profession” (not being a losssustained in a speculation business) which such predecessor firm or the proprietaryconcern or amalgamating company or demerged company, would have been entitled tocarry forward and set off under the provisions of Section 72 if the re-organisation ofbusiness or amalgamation or de merger had not taken place.

(vii) Unabsorbed depreciation means so much of the allowance for depreciation ofthe predecessor firm or the proprietary concern or the amalgamating companyor the demerged company, as the case may be, which remains to be allowedand which would have been allowed to the predecessor firm or the proprietaryconcern or amalgamating company or demerged company, as the case maybe, under the provision of this Act, if the re-organisation of business oramalgamation or de merger had not taken place.

Case – XY Ltd. wants to amalgamate with PQ Ltd. on June 30,2012. You are requestedto find out the tax implication in respect of the following losses/allowances of XY Ltd. Inthe assessments of XY Ltd. (i.e., amalgamating company) and PQ Ltd. (i.e.,amalgamated company)-

Unabsorbed depreciation allowance of the previous year 2005-06 ` 36,000Brought forward business loss 2005-2006 10,00,000



Notes Unabsorbed scientific research expenditure 11,000Bad debts 15,000Capital gains arising on transfer of assets to PQ Ltd. 2,50,000Brought forward capital loss 40,000Also discuss whether PQ Ltd. can claim deduction under section 80-IA or 80-IB in

respect of industrial undertaking taken over from XY Ltd.Solution: The following table highlights the tax implications in respect of various itemsgiven in the problem on the assumption that assets are transferred in a scheme ofamalgamation which satisfies the provisions of Section 2(IB).

Loss/allowances of XY Ltd.before amalgamation

Tax implications in the handsof PQ Ltd.

Tax implications in thehands of XY Ltd.

● Unabsorbed depreciationallowance 2005-06` 36,000

If amalgamation satisfies theconditions of Sec. 72A it isdeductible otherwise notdeductible

As XY Ltd. ceased to existafter amalgamation, it is notentitled for deduction

● Brought forward businessloss 2005-2006` 10,00,000

If amalgamation satisfiescondition of Sec. 72A, it can beset-off and carried forward by PQLtd. Otherwise such right is notavailable

XY Ltd. cannot carry itforward as it has ceased toexist after amalgamation

● Unabsorbed scientificresearch expenditure `11,000

Allowed subject to conditions ofSec. 35

It cannot be carried forward,as XY Ltd. has ceased toexist.

● Bad debts ` 15,000 Allowed It is not allowed asdeduction as XY Ltd. ceasedto exist after amalgamation

● Capital gains arising ontransfer of assets to PQLtd. ` 2,50,000

It is not taxable in the hands of PQLtd. If however, assets areacquired in the scheme ofamalgamation are sold by PQLtd., cost of acquisition for thepurpose of computing capital gainwould be cost to XY Ltd. (indirectly` 250,000 will merge in capitalgain arising at the time of sale ofassets by PQ Ltd.).

It is not taxable, as transferof assets in a scheme ofamalgamation to an Indiancompany, does not amountto ‘transfer’ for the purposeof charging tax on capitalgains

● Brought forward capitalloss ` 40,000

It cannot be set-off and carriedforward by PQ Ltd.

It cannot be carried forwardby XY Ltd. as it ceased toexist after amalgamation

Note – As benefit of deduction under section 80-IA or 80-IB is attached to theundertaking (and not to the assessee), deduction under these sections would beavailable to PQ Ltd. Even if the industrial undertakings are taken over from XY Ltd.Case – Company X which has an accumulated loss of ` 5,00,000 and unabsorbeddepreciation of ` 3,00,000, wants to re-organise its business by amalgamating with a rivalcompany Y, which is engaged in the same line of production but with a smaller capital,but has an efficient management set-up and more modern machinery. Company Y isagreeable to the amalgamation.



NotesWhat are the alternative courses available to the companies for effecting the mergerand how would you advise them as to the best course of action?Solution: The alternatives for merger that are available to X and Y are; (i) merger of Xinto Y, whereby X goes out of existence;(ii) merger of Y into X, whereby Y goes out ofexistence and (iii) merger of X and Y into a new company, whereby a new company, sayZ, is formed and both X and Y go out of existence.

All the three mergers can take place under one of the following situations–(a) If the merger is not an ‘amalgamation’ within the meaning of Section 2(IB).(b) If the merger is an amalgamation within the meaning of Section 2 (IB) though it

does not satisfy provisions of Section 72A.(c) If the merger satisfies the conditions of Sections 2(IB) and 72A.Under the aforesaid situations, the set-off of accumulated loss of ` 5,00,000 and

unabsorbed depreciation of ` 3,00,000 is possible in the following cases:

Whether set-off of unabsorbed loss/depreciation allowance is possible?

Situation (a) Situation (b) Situation (c)

(i) Merger of X into Y, whereby X goes out ofexistence

(ii) Merger of Y into X, whereby Y goes out ofexistence

(iii) Merger of X and Y into a new company,whereby a new company, say Z is formedand both X and Y go out of existence

No

Yes

No

No

Yes

No

Yes

Yes

Yes

Set off losses of a banking company against the profit of a banking institutionunder a scheme of amalgamation [Section 72AA]

Where a banking company has been amalgamated with a banking institution undera scheme sanctioned and brought into force by the central Government under section45(7) of the Banking Regulation Act,1949 then notwithstanding any thing contained inSection 2(IB)(i) to (ii) or Section 72A, the accumulated loss and unabsorbed depreciationof the amalgamating banking company shall be deemed to be the loss or the allowanceor depreciation of the banking institution for the previous year in which the scheme ofamalgamation is brought into force, and all the provisions contained in the Income TaxAct, 1961, relating to set off and carry forward of loss and unabsorbed depreciation shallapply accordingly.

5.5.6 Provisions Relating to Carry Forward and Set-off of Accumulated Loss andUnabsorbed Depreciation Allowance in Scheme of Amalgamation of BankingCompany in Certain Cases [Section 72AB]

Section 72AB allows carry forward of business loss and unabsorbed depreciation incase of:

(viii) Amalgamation of Co-operative Banks: Where the amalgamation of a co-operativebank or co-operative banks has taken place during the previous year, thesuccessor co-operative bank shall be allowed to set off the accumulated loss andthe unabsorbed depreciation, if any, of the predecessor bank as if theamalgamation had not taken place and all the other provisions of this Act relatingto set off and carry forward of loss and allowance for depreciation shall applyaccordingly provided the following conditions are satisfied



Notes (ii) Demerger of a Co-operative Bank: Where any de-merger of any cooperativebank has taken place during the previous year, the resulting cooperative bankshall be allowed to set off the accumulated loss and unabsorbed depreciation,if any, as under:

(a) Where the whole of amount of such loss orunabsorbed depreciation is directly relatable tothe undertaking transferred to the resultingco-operative bank

The whole of such loss or unabsorbeddepreciation

(b) Where such accumulated loss or unabsorbeddepreciation is not directly relatable to theundertaking transferred to the resultingco-operative bank

[Accumulated loss or unabsorbed depreciationof the demerged cooperative bank beforedemerger] X[Assets of the undertaking transferred toresulting cooperative bank]/[Assets of thede-merged co-operative bank before demerger]

(ix) Conditions to be satisfied by the predecessor bank [Section 72AB(2)(a)]The predecessor bank should:(x) have been engaged in the business of banking for 3 or more years, and(ii) have held at least 75% of the book value of fixed assets as on the date of

reorganization, continuously for two years prior to the date of businessorganization.

(xi) Conditions to be satisfied by the successor cooperative bank (amalgamatedcooperative bank or resulting co-operative bank) [Section 72AB(2)(b)]

The successor co-operative bank should:(xii) hold at least 75% in the book value of assets of the predecessor co-operative

bank acquired through business reorganization, continuously for a minimumperiod of five years immediately succeeding the date of business ofreorganization;

(ii) continue the business of the predecessor co-operative bank for a minimumperiod of 5 years from the date of business reorganization; and.

(xiii) fulfil such other conditions as may be prescribed to ensure the revival of thebusiness of the predecessor co-operative bank or to ensure that the businessreorganization is for genuine business purposes.

Accumulated loss means so much of the loss of the amalgamating cooperative bankor the demerged co-operative bank, as the case may be under the head “Profits andgains of business or profession” (not being a loss sustained in a speculative business)which such amalgamating co-operative bank or the demerged co-operative bank, wouldhave been entitled to carry forward and set off under the provisions of Sec. 72 as if thebusiness reorganization had not taken place.

Unabsorbed depreciation means so much of the allowance for depreciation of theamalgamating co-operative bank or the demerged co-operative bank as the case may be,which remains to be allowed and which would have been allowed to such bank if thebusiness reorganization had not taken place.Case – D Ltd. (demerged company wants to transfer one of its undertakings to R Ltd.(resulting company), D Ltd. is the holding company of R Ltd. The two companies areIndian companies.



NotesThe following is the balance sheet of D Ltd. as on March 31, 2012 immediatelybefore merger.

(` in thousands)

Equity share capital 140,00Capital reserve 1,00Share premium 2,99.290General reserve 15,00Revaluation reserveLand of Unit 1 4,00Building of Unit 2 6,00

Loan(taken to purchase plant and machinery ofunit 1) 22,00.710Loan(general) 3,00Current liabilityUnit 1 7,00Unit 2 1,00

Bank overdraft(general) 8,00

210,00

Unit 1Land (acquired in 1990) 30,00Plant and machinery 60,00Stock-in-trade 4,00Sundry debtors 3,00Deferred revenue expenditure 2,00Unit 2Plant and machinery 36,00Building 14,00Stock-in-trade 6,00Sundry debtors 4,00Other assetsLand and building 30,00Investment-Shares in R Ltd. 8,00-Shares in Tac Chem 2,00Cash and bank 10,00Pre-incorporation expense 1,00

210,00

Other information:1. Shareholders list of D Ltd. Is as follows – A 20%, B 40 per cent, C Ltd. 30% and

UTI 10%.2. Accumulated loss for tax purpose of D Ltd. up to the assessment year 2012-13

is ` 45 lakhs.3. D Ltd. wants to transfer Unit1 to R Ltd. on April 1,2012 by satisfying conditions

of section 2(19AA).4. The market value of assets of Unit1 is as follows – Land ` 69 lakhs, and Plant

and machinery ` 49 lakhs.5. After the demerger, the face value of equity shares of D Ltd. will be reduced to

` 6 per share.6. Securities transaction tax is not applicable.

Solution: R Ltd. To take over the following assets and liabilities pertaining to D Ltd.(` in ‘000)

Land (` 30 lakhs minus ` 4 lakhs) 26,00Plant and machinery 60,00Stock 4,00Debtors 3,00Total assets (at book value) 93,00Fewer liabilitiesLoan taken to purchase plant and machinery 22,00.71Current liabilities 7,00Loan (general) – see note 1,41.62



Notes Bank overdraft (general) – see note 3,77.67Consideration 58, 80The following points need to be considered:1. Total assets of D Ltd. are ` 210 lakhs, out of which the following shall be

excluded: Deferred revenue expenditure of Unit 1 –` 2 lakhs, pre-incorporationexpenses ` 1 lakh, revaluation reserve – Unit 1 ` 4 lakhs and Unit 2 ` 6 lakhs.The balance is ` 197 lakhs. The book value of assets of Unit 1 is ` 93 lakhs.Therefore, general loan and bank overdraft shall be allocated to Unit 1 in theratio of 93/197 [i.e., ` 3 lakhs × 93/197; ` 1,41,624 and ` 8 lakhs × 93/197 –` 3,77,665].

2. The total consideration is ` 58,80, 000; it will be paid by R Ltd. by issue ofshares. Suppose shares issued at par, then R Ltd. will issue shares toshareholders of D Ltd. as follows (a person holding 100 shares in D Ltd. will get42 shares in R Ltd.).

Number of shares Face value of shares (`)

A (20%)B (40%)C Ltd. (30%)UTI (10%)

1,17,6002,35,2001,76,400

58,8005,88,000

11,76,00023,52,00017,64,000

5,88,00058,80,000

3. Accumulated loss of D Ltd. which will be set off and carried forward by R Ltd.Under the provision of Section 72A will be ` 21,24,365 (i.e..` 45 lakhs ×93/197).

4. Market value of assets of Unit 1 is not taken into consideration for determiningtotal consideration.

5. Shareholders of D Ltd. Will get share in R Ltd. by virtue of Section 2(22)(v), itwill not be treated as dividend.

6. D Ltd. transfers Unit1 to R Ltd. It is not treated as ‘transfer’ for the purpose ofcapital gains by virtue of Section 47(vib).

7. Shareholders of D Ltd. get shares in R Ltd. in lieu of reduction in share capital.It is not chargeable under the head ’Capital gains’, as it is not taken as ‘transfer’under Section 47(vid).

8. Suppose land acquired from D Ltd. is transferred by R Ltd. on March 1, 2013for ` 80 lakhs, then the amount of capital gain shall be determined as under–

Capital gain in the case of R Ltd. `

Sale proceeds 80,00,000Less cost of acquisition 26,00,000Short term capital gain 54,00,000

In this case the period of holding is taken from April 1, 2012 to March 1, 2013.9. R Ltd. can claim depreciation in respect of plant and machinery acquired from

D Ltd.10. D Ltd. can claim depreciation in respect of remaining assets.



Notes5.6 Concept of Avoidance of Double Taxation

5.6.1 IntroductionIn the current era of cross-border transactions across the world, due to unique

growth in international trade and commerce and increasing interaction among the nations,residents of one country extend their sphere of business operations to other countrieswhere income is earned. One of the most significant results of globalization is theintroduction noticeable impact of one country’s domestic tax policies on the economy ofanother country. This has led to the need for incessantly assessing the tax regimes ofvarious countries and bringing about indispensable reforms. Therefore, the consequenceof taxation is one of the important considerations for any trade and investment decision inany other countries.

5.6.2 Source Rule and Residence RuleWhere a taxpayer is resident in one country but has a source of income situated in

another country, it gives rise to possible double taxation. This arises from two basic rulesthat enable the country of residence as well as the country where the source of incomeexists to impose tax, namely. The source rule holds that income is to be taxed in thecountry in which it originates irrespective of whether the income accrues to a resident ora nonresident The residence rule stipulates that the power to tax should rest with thecountry in which the taxpayer resides. If both rules apply simultaneously to a businessentity and it were to suffer tax at both ends, the cost of operating in an international scalewould become prohibitive and deter the process of globalization. It is from this point ofview that Double taxation avoidance Agreements (DTAA) become very significant.Double Taxation Avoidance Agreements with India.

5.6.3 Effects of Double Taxation on Trade and Services and its RemedyInternational double taxation has adverse effects on the trade and services and on

movement of capital and people. Taxation of the same income by two or more countrieswould constitute a prohibitive burden on the taxpayer. The domestic laws of mostcountries, including India, mitigate this difficulty by affording unilateral relief in respect ofsuch doubly taxed Double income (Section 91 of the Income Tax Act). But as this is not asatisfactory solution in view of the divergence in Taxation the rules for determiningsources of income in various countries, the tax treaties try to remove tax obstacles thatinhibit trade and services Avoidance and movement of capital and persons between thecountries concerned. It helps in improving the general investment climate. AgreementsThe double tax treaties (also called Double Taxation Avoidance Agreements or “DTAA”)are negotiated under public international or “DTAA” law and governed by the principleslaid down under the Vienna Convention on the Law of Treaties. It is in the interest of allcountries to ensure that undue tax burden is not cast on persons earning income bytaxing them twice, once in the country of residence and again in the country where theincome is derived. At the same time sufficient precautions are also needed to guardagainst tax evasion and to facilitate tax recoveries. Double Taxation AvoidanceAgreements with India

5.6.4 Definition of Double TaxationThe Fiscal Committee of OECD in the Model Double Taxation Convention on

Income and Capital, 1977, defines double taxation as: ‘The imposition of comparabletaxes in two or more states on the same tax payer in respect of the same subject matterand for identical periods’. Double Taxation of the same income would cause severe



Notes consequences on the future of international trade. Countries of the world therefore aim ateliminating the prevalence of double taxation. Such agreements are known as "DoubleTax Avoidance Agreements" (DTAA) also termed as "Tax Treaties”. In India, the CentralGovernment, acting under Section 90 of the Income Tax Act, has been authorized toenter into double tax avoidance agreements with other countries.

5.6.5 Necessity of Double Taxation AgreementThe need and purpose of tax treaties has been summarized by the Double OECD in

the ‘Model Tax Convention on Income and on Capital’ in the following words: ‘It isdesirable to clarify, standardize, and confirm the fiscal situation of taxpayers who areengaged, industrial, financial, or any other activities in other countries through theapplication by all countries of common solutions to identical cases of double taxation’.

5.6.6 Avoiding and Alleviating the Adverse Burden of International Double TaxationBy – (1) laying down rules for division of revenue between two countries;

(2) exempting certain incomes from tax in either country; (3) reducing the applicable ratesof tax on certain incomes taxable Double in either countries. Tax treaties help a taxpayerof one country to know with greater certainty the potential limits of his tax liabilities in theother country. Another benefit from the taxpayers point of view is that, to a substantialextent, a tax treaty provides against non-discrimination of foreign taxpayers or thepermanent establishments in the source countries vis-à-vis domestic taxpayers.

DTAAs ensure that countries adopt common definitions for factors that determinetaxing rights and taxable events. Crucial among these is the definition of a permanentestablishment. Most treaties also specify a Mutual Agreement Procedure (MAP) which isinvoked when interpretation of treaty provisions is disputed. To prevent abuse of treatyconcessions, treaties increasingly incorporate restrictions and rules, such as a generalanti-functions of avoidance rule (GAAR), that allow tax authorities to determine if aDTAAs transaction is only undertaken for tax avoidance or not. Benefit limitation testsand controlled foreign corporation (CFC) rules also place limits on claims of residence incountries eligible for treaty concessions. Exchange of tax information on either a routinebasis or in response to a special request is provided for in most treaties to assistcountries counter tax evasion. As of now, there exists 84 Double Taxation AvoidanceAgreements between India and other countries.

5.6.7 Salient Features of DTAAThese treaties are usually between countries with(i) substantial trade or other

economic relations. Most treaties are between pairs of developed countries while, of thebalance, most of them are between developed and developing countries. (2)Providereciprocal concessions to mitigate double taxation, (3) Assign taxation rights roughly inaccordance with that “existing consensus” and Largely though not rigidly follow theOECD Model Tax Convention or, for developing countries, the UN Tax Convention.(DTAAs)

Recent treaties contain new clauses following the OECD Model Tax Conventions of2005 to 2010 which extend areas of cooperation to administrative and information issuesagreements A typical DTA Agreement between India and another country covers onlyresidents of India and the other contracting country who has entered into the agreementwith India. A person who is between India and not resident either of India or of the othercontracting country cannot claim any benefit under the said DTA agreement. Suchagreement generally provides that the laws of the two contracting states will govern the



Notestaxation of income in respective states except when express provision to the contrary ismade in the agreement.

Section 90 – Agreement with foreign countries or specified territories – BilateralRelief. Since the tax treaties are meant to be beneficial and not intended to put taxpayers of a contracting state to a disadvantage, it is provided in Sec. 90 that a beneficialprovision under the Indian Income Tax Act will not be denied to residents of contractingstate merely because the corresponding provision in tax treaty is less beneficial. Section90A - Double taxation relief to be extended to agreements (between specified DTAAsand Associations) adopted by the Central Government.

Section 91 – Countries with which no agreement exists – Unilateral Agreementsrelevant Some Double Taxation Avoidance agreements provide that income by way ofinterest, provisions of royalty or fee for technical services is charged to tax on net basis.This may result in tax deducted at source from sums paid to Non-residents which may beIncome Tax more than the final tax liability. The Assessing Officer has therefore beenempowered under section 195 to determine the appropriate proportion of the amountfrom which tax is to be deducted at source under the Income Tax Act, 1961 There areinstances where as per the Income Tax Act, tax is required to be deducted at a rateprescribed in tax treaty. However this may require foreign companies to apply for refund.To prevent such difficulties Sec. 2(37A) provides that tax may be deducted at source atthe rate applicable in a particular case as per section 195 on the sums payable to non-residents or in accordance with the rates specified in DTA Agreements. Double TaxationAvoidance Agreements with India.

5.6.8 Relief under DTAA(1) Bilateral relief: Under this method, the Governments of two countries can enter

into an agreement to provide relief against double taxation by mutually working out thebasis on which relief is to be granted. India has entered into 84 agreements for reliefagainst or avoidance of double taxation. Bilateral relief may be granted in either one ofthe following methods: (a) Exemption method, by which a particular income is taxed inonly one of the two countries; and (b) Tax relief methods under which, an income istaxable in both countries in accordance with the respective tax laws read with the DoubleTaxation Avoidance Agreements. However, the country of residence of the taxpayerallows him credit for the tax charged thereon in the country of source.

(2) Unilateral relief This method provides for relief of some kind by the homecountry where no mutual agreement has been entered into between the countries.Double Taxation Avoidance Agreements with India.

Exemption Method: One method of avoiding double taxation is for the residencecountry to altogether exclude foreign income from its tax base. The country of source isthen given exclusive right to tax such incomes. This is known as complete exemptionmethod and is sometimes followed Methods of in respect of profits attributable to foreignpermanent establishments or income from immovable property. Indian tax treaties withDenmark, Norway and Sweden embody with respect to certain incomes.

Method 2: Credit Method Taxation: This method reflects the underline conceptthat the resident remains liable in the country of residence on its global income, howeveras far the quantum of tax liabilities is concerned credit for tax paid in the source country isgiven by the residence country against its domestic tax as if the foreign tax were paid tothe country of residence itself.

3. Tax Sparing: One of the aims of the Indian Double Taxation AvoidanceAgreements is to stimulate foreign investment flows in India from foreign developedcountries. One way to achieve this aim is to let the investor to preserve to himself/itself



Notes benefits of tax incentives available in India for such investments. This is done through“Tax Sparing”. Here, the tax credit is allowed by the country of its residence, not only inrespect of taxes actually paid by it in India but also in respect of those taxes India forgoesdue to its fiscal incentive provisions under the Indian Income Tax Act. Thus, tax sparingcredit is an extension of the normal and regular tax credit to taxes that are spared by thesource country, i.e., forgiven or reduced due to rebates with the intention of providingincentives for investments.

5.6.9 Models of DTAA ModelThere are two major types of DTAA Models.1. OECD MODEL: OECD Models are generally adopted by developed nations and

their emphasis is on the residency based taxation.2. UN MODEL: UN Model emphasis is on the source based taxation and generally

adopted by the developing nations. There are also US model Convention and IndianModel Convention too.

5.6.10 Analysis of Tax TreatyAn analysis of any tax treaty would have the following components: (1) The date on

which it come into effect. (2) Applicability – Applies to a person who is resident of one orboth the countries. “Resident” is defined under domestic law of different countiesdifferently. Article 4 expects that it should based upon domicile, physical residence, placeof management or such other criteria but makes it clear that where a person is a residentin both the countries, it is the location of the permanent home or where vital interests arelocated or where there is fixed abode or where he is citizen, in that order, will decide theresidential status. There may be cases, when it has been found that the assessee isresident in both the countries then tie-breaker rule has to apply to determine theresidential status. Item (a) In the case of individual his personal and economic tiesdetermine his residential status of Tax Treaty. (b) In the case of others, it is the place ofeffective management. General Definitions – Article 3 of DTAA generally covers generaldefinition of Person, Company, contracting state, Enterprise of a contracting state,Competent Authority, national etc, which all are applicable to the respective DTAA.Article 4. The Tax which it covers – What kind of tax the treaty covers should be knownas there are different form of tax in different countries and the DTAA will provide the reliefon the specified tax as mentioned in the DTAA. Article 5. The definition which will beapplicable in both countries irrespective of domestic law, as for example on such vitalissues as residence, which may be different from the residential statute in local law withgreater stress on nexus between source and income, definition of certain categories’ liketechnical services etc. (6) Permanent Establishment and its parameters – (a) PE meansa fixed place from where the business of the enterprise is carried on. (b) PE includesplace of management, branch, office, factory, workshop, mine, quarry, an oil or gas well,a construction site for long duration, a service location for a long duration and adependent agency with power to conclude contracts. (7) The definition of concepts likeimmovable property, dividend, business profits, royalty, technical fees, salaries etc. (8)Different ways of tax-sharing depending upon the residential statute, permanentComponents establishment, fixed base or tax sharing with both countries giving agreedpart of relief. (9) Stipulation as to the method of relief either by way of exempting incomeor where it is taxable, taxing it at stipulated rate, which may be lower than the domesticrate, or by unilaterally giving credit for tax paid in the other country. (10) Exchange ofinformation with special reference to the concept of associated enterprises primarily totackle diversion of income to avail treaty benefit or evasion of tax in one or the othercountry. (11) Provision for elimination of double taxation. (12) Provision for non-



Notesdiscrimination etc. (13) Other clauses to suit the requirement of the participatingcountries.

Case Laws: (1) UOI v. Azadi Bachao Andolan (Mauritius) Validity of CBDT CircularNo. 786, providing that Mauritian tax residency certificate was sufficient proof to availbenefits under Indo-Mauritius DTAA, upheld: Supreme Court (2) Aditya Birla NuvoLimited v. ADIT (Italy) Payment made by assessee to an Italian Company (GTA) forDeputing Certain Technicians to India for Supervising erection of Machinery would not bechargeable to tax in India because person who rendered services were not present inIndia for required number of days as envisaged by article 5(j) of DTAA. (3) MicrosoftCorporation v. ADIT (USA ITAT Delhi in the case of Microsoft Corporation held thatpayment made for grant of licence in respect of Copy right by end user is taxable asroyalty as per Sec. 9(1)(vi), domestic tax legislation to override treaty provisions in caseof irreconcilable conflict. (4) Case Laws ADIT v. Chiron Behring Gmbh & Co KG(Germany) Royalty income earned by a resident of Germany from India has to beassessed to tax at the rate of 10% as provided in Article 12 of DTAA. (5) Praxair PacificLtd In RE (Mauritius, 42 DTR (AAR) 177) - Shares held by the applicant as investment inthe books of accounts are treated as capital asset. Applicant is not liable to be taxed inIndia on the proposed transfer of said shares to its wholly –owned subsidiary company inIndia in view of section 47 (iv) or under art 13 of India Mauritius treaties.(6) HindustanPetroleum Corporation Ltd. vs. ADIT [(2010) 130 TTJ 518 (Mum.)] It is not necessary thatunless a person be taxed in the UAE that person cannot claim the benefits of Indo-UAEtax treaty in India, what is really relevant to see is whether or not the recipient wasresident of the UAE.

5.7 Summary

This unit covers the following:(i) A broad view of computation of Total Income and tax liability of companies.(ii) Provision of minimum Alternate Tax in certain companies and declaration and

Payment of Dividend have been covered.(iii) The process of setting off losses and carry forward are covered in the following

steps:Step 1 Inter-source adjustment under the same head of income.Step 2 Inter-head adjustment under the same assessment year, step 2 isapplied only if a loss cannot be set off under step 1Step 3 carry forward of a loss, Step 3 is applied only if a loss cannot be set-offunder Step 1 and 2Includes provisions relating to set-off and carry forward of losses to subsequentyears

(iv) The unit discusses certain business which are granted special tax treatment.Some of them relate to:● Special Provisions in Respect of Newly Established Undertakings in Free

Trade Zones [Section 10A]; Special Provisions in Respect of NewlyEstablished Units in Special Economic Zones – Section 10AA]; SpecialProvisions in Respect of Newly Established Hundred Percent ExportOriented Units [Section 10B]; Special Provisions in Respect of Export ofCertain Articles or Things Section 10BA]; Deduction in respect of Profitsand Gains from Industrial Undertakings or Enterprises engaged inInfrastructure Development etc. [Section 80IA]; Deduction in respect ofProfits and Gains from Enterprises engaged in Development of the



Notes Special Economic Zones [section 80-IAB]; Deduction in respect of Profitsand Gains from certain Industrial Undertakings other than InfrastructureDevelopment Undertakings [section 80IB]; Deduction in respect of Profitsand Gains from the Business of Hotels and Convention Centres inSpecified Areas [Section 80ID]; Deduction in respect of certainundertakings in North-eastern States [Section 80IE]; Deduction in respectof certain incomes of Off-shore Banking Units and International FinancialService Centres by the Specific Economic Zone Act, 2005 [Section 80LA];Newly established undertakings in Free Trade Zones [Section 10A];Newly established undertakings in Special Economic Zones [Section10AA; Newly established 100 Per Cent Export Oriented Units [Section10B]; Income of a Venture Capital Fund [section 10(23FB)], TeaDevelopment Account, Coffee Development Account and RubberDevelopment Account: Section 33 AB, Site Restoration Fund – Section33ABA, Amortisation of telecom license fee [Sec. 35ABB]; Deduction forExpenditure on Prospecting for Minerals: Section 35E; Transfer to aspecial reserve [Sec. 36(1)(viii)]: Special Provisions for computing profitsand gains of business of civil construction – Section 44AD, SpecialProvisions for computing Profits and Gains of Business of Plying, Hiring,or Leasing Goods Carriages Section 44AE, Special Provisions forComputing Profits and Gains of Retail Business Section 44AF, Profitsfrom the Business of Processing of Biodegradable Waste – How todetermine – Section 80JJA: Employment of New Workmen – How toDetermine – Section 80JJAA:. Deduction in respect of certain incomes ofOffshore Banking Units and International Financial Service Centre by theSpecific Economic Zone Act, 2005 – Section 80LA; Tax Incentives forshipping business – Tonnage tax [Secs. 115V to 115VZC]

(v) The part also discussed tax concessions available for business reorganizationsuch as amalgamation/merger of companies, de merger of company.


Provisions relating to Minimum Alternate Tax (MAT)

I. Fill in the Blanks1. Section 2(23A) defines ‘foreign company‘, which is __________ However, all

non-Indian companies are not necessarily __________.2. A loss incurring company and a profit making company may _________ in

order to reduce the overall incidence of __________ under the Income Tax Act,1961.

3. For the assessment year 2013-14 the rate of dividend distribution tax includingsurcharge and cess for Indian companies is __________.(a) 12.5%(b) 14.025%(c) 16.225%(d) 28.325%



NotesII. Multiple Choice Questions1. To be eligible to carry forward and set-off of business losses and unabsorbed

depreciation of demerged company, the resulting company should continue theoriginal business for __________.(a) A minimum period of 5 years(b) 7 years(c) 2 years(d) No specified period

Tax Planning with Reference to New Projects//Expansion/Rehabilitation Plans1. A new factory commences business on 5.4.2013 and has employed w.e.f. that

date.(a) 90 regular workmen(b) 105 regular workmen(c) 105 regular workmen on 5.4.2013,10 regular workmen on 10.5.2013 and

20 workmen on 15.10.2013What shall be the deduction allowable under section 80JJAA

2. As on 31.3.2013, the regular workers employed by a factory were 80. Duringthe previous year the following workers were employed by the company.(a) 7 new regular workmen during the year(b) 9 new regular workmen during the year(c) 25 new regular workmen during the year

Compute the deduction u/s 80JJAA.

Tax Planning in Respect of Amalgamation, Merger or Demerger of Companies1. X Ltd transferred its fertilizer business to a new company Y Ltd. by way of

demerger with effect from appointed date of 1.4.2013 and satisfying theconditions of demerger. Further information given:(a) WDV of the entire block of plant and machinery held by X Ltd. as on

1.4.2013 is ` 100 crores. Out of the above WDV of block of plant andmachinery of fertilizer division is ` 70 crores.

(b) X Ltd as unabsorbed depreciation of ` 50 lakhs as on 31.3.2013.You are required to calculate depreciation post merger in the hands of X Ltd.and Y Ltd as at 31.3.2014. State how the unabsorbed depreciation has to bedealt with the assessment year 2014-15.


XYZ proposes to construct a hospital for its workers. The alternatives open to it are:1. To purchase building worth ` 40 lakhs, the purchase price being payable in two

annual equal instalments.2. To purchase the aforesaid building but instead of paying the price in

instalments, an agreement would be entered into with the vendor of thebuilding to pay him 10% of the net profits of the company for an indefiniteperiod of time



Notes 3. To contribute ` 30 lakhs to the UP Government which will construct a buildingon land owned by it and allow the Company to use it as a hospital for itsworkers though the ownership of the building will vest with the Government.Consider each proposal and advise the company to enable the company tomake the bright choice.

4. For the assessment year 2013-14, a company has currently worked out itsbook profits as per section 115JB as ` 12,45,600. The total income computedas per the provisions is ` 2,87,450. It desires to know how much has to beshown in the final accounts of the company in ‘provision for taxation’

5. Subsequent to demise of Mrs X, her son constituted a firm and ran the samebusiness. Can the firm claim set-off of unabsorbed business loss of late Mrs. X.

Assessment of Companies1. What are the steps required to compute taxable income of a corporate

assessee?2. How the residential status of a company is determined? What role it has in

computing taxable income of the company?3. What will be the treatment of Income tax on the income received from venture

capital companies/venture capital funds?4. A domestic company’s total income was determined at a loss of ` 20 lakhs for

the year ended 31-3-2014. It has distributed the following dividends to itsshareholders in respect of the previous year ended 31-3-2014. The paid-upcapital of the company on that date was ` 50 lakhs.(1) Bonus shares in the ratio 1 : 10 on 30-6-2013(2) Final dividend at 10% on 31-10-2013.

Discuss tax implications.5. A company issued discount coupons to its shareholders which entitled them to

purchase the products of the company at a discount. The assessing officerfeels that this is a disguised dividend. What are the arguments for and againstsuch a treatment?

Provisions Relating to Minimum Alternate Tax (MAT)1. What is the treatment of the following debited to profit and loss account while

calculating book profit?(i) Wealth tax(ii) Provision for doubtful debts(iii) Penalty for non-payment of income-tax.(iv) Dividend tax(v) Banking cash transaction tax(vi) Proposed dividend(vii) Excise duty due, but not paid(viii) Provision for gratuity(ix) Depreciation

2. Are the Provisions of Section 115JB applicable to Foreign Companies?3. Discuss the provisions relate to tax on distributed profits of domestic

companies under section 115O. Is this in addition to normal tax payable by acompany?



Notes4. Discuss the provisions relating to tax on income distributed to unit holders. Isthe recipient of income chargeable to tax?

5. R Ltd., a closely held Indian company is engaged in the manufacture ofinsecticides and fertilizers (value of the plant and machinery owned by thecompany is ` 55 lakhs). Its profits and loss account for the year ended31-3-2013 is as under:



Depreciation 4,16,000 By domestic sales 22,23,900

Salaries and wages 1,34,500 Export sale 5,76,100

Entertainment expenses 10,000 Other receipts 2,00,000

Traveling expenses 36,000

Miscellaneous expenses 5,000

Income tax 3,50,000

Wealth tax 8,000

Outstanding customs duty 17,500

Prov. for unascertained liabilities 70,000

Proposed dividend 60,000

Loss of subsidiary company 30,000

Consultation fees paid to a tax expert 21,000

Salaries and Perquisites to MD 1,80,000

Excise duty of 2010-11 75,500

Net profit 15,86,500

30,00,000 30,00,00

For tax purposes the company wants to claim the following :– Deduction under section 80IB (30% of ` 15, 86,500).– Excise duty pertaining to 2010-11 paid during 2012-13 (amount actually paid

` 75,500).– Depreciation u/s 32 ` 5, 36,000.

The company wants to set off the following losses/allowances –

For tax Purposes For accounting purposes

Brought forward loss of 2010-11 11, 80,000 9, 10,000

Unabsorbed depreciation – 2,45,000

Determine tax payable under section 115JB1. X, an Indian company, furnishes the following particulars of its income for the

previous year 2012-13. Calculate its total income and income-tax liability forthe Assessment Year 2013-14:

Particulars `

Income from businessDividend received during the year:– from Indian company

5,20,000

20,000



Notes – from foreign companyGains from transfer of capital assets– short term capital gains– long term capital gainsAgricultural income in India

5,000

25,00030,00035,000

Additional information:(i) income from business includes ` 1,50,000 profit earned from a new small scale

industry set up on October 1,2002 which is eligible for deduction under section80-IB.

(ii) Business expenses already charged from business income include ` 10,000revenue expenditure and ` 30,000 capital expenditure on family planningprogram for employees.

(iii) Company has debited following donations in the profit and loss account of thebusiness of company:

– Rajiv Gandhi Foundation: ` 50,000, and– Prime Minister’s National Relief Fund: ` 25,000

Set-off and Carry Forward of Losses1. (a) What is meant by inter-source adjustment under the Income Tax Act while

computing the total income of an assessee?(b) Briefly discuss the provision relating to the losses for Speculation

Business.2. (a) State the provisions relating to carry forward and set-off losses from the

activity of owning and maintaining race horses.(b) Discuss about set-off and carry forward of losses under the head ‘Capital

Gains’.3. Write short notes on the following:

(i) Set-off and carry forward of unabsorbed depreciation(ii) Losses under the head ‘Income from House Property’(iii) Set-off of gambling losses.

4. Discuss whether the following are speculative losses :(i) A sells goods to Y, which are to be imported by X. Due to change in

import policy of the Government, the goods could not be imported andfinally X agrees to pay Y damages of ` 5 lakhs for non-fulfilment of thecontract.

(ii) On April 1, 2012, A agrees to supply 1000 ton of rice to B at the rate of` 30,000 per ton, which will be delivered on November 4, 2012. At thetime of entering the contract A does not have rice on his stock, nor doeshe take any step to procure the same from the market. The bank balanceand overdraft limits of B do not permit payment of ` 3 crore to A at thetime of delivery. The market rate of rice on Nov. 4, 2012 is ` 32,000 perton. A pays ` 20 lakhs (i.e., difference in price) to B to settle the contract.[Ans. (i) No (ii) Yes]

5. Mr. Yeshwant submits the following information for the financial year ending onMarch 31, 2013. He desires that you should: (a) compute the Gross TotalIncome and (b) ascertain the amount of losses that can be carried forward; onthe basis of the information given below.

(i) He has two houses :



Notes(a) House No. I – After all statutory deductions net annual value ` 36,000(b) House No. II – Current year loss ` 10,000(c) Brought forward loss of Assessment Year 2010-11 of the second

house representing unadjusted interest on borrowed capital ` 30,000(ii) He has three proprietary businesses:

(a) Textile Business(i) Discontinued from October 31, 2011 – Current Year Loss ` 25,000(ii) Brought forward business loss of the year 2010 – 11 ` 80,000

(b) Chemical Business(i) Discontinued from March 1, 2009 – hence, no profit/loss NIL(ii) Bad debts allowed in earlier year recovered during this year ` 30,000(iii) Carried forward business loss for the A.Y. 2007-08 ` 20,000

(c) Leather Business(i) Profit for the Current Year ` 70,000III (i) Short-term capital gains ` 20,000

(ii) Long-term capital loss ` 15,0006. For the A.Y. 2013-14, X a resident individual furnishes the following particulars

of his income :Income from house property ` 18,000Loss from being (−) 2,000Business income ` 6,000Income from speculative business ` 3,000Short-term Capital Gains ` 15,000Long-term Capital Gains ` 88,000Winning from betting ` 13,000Winning from horse races ` 23,000Besides, X wants to set-off the following allowances/losses of the earlier years:Business loss for the A.Y. 2008-2009 ` 14,000Unabsorbed depreciation allowance of A.Y. 2001-02 ` 2,000Short-term capital loss of the A.Y. 2010-11 ` 74,000Long-term capital loss for the A.Y. 2008-2009 ` 8,000Loss for betting of the A.Y. 2011-12 ` 26,000Loss from the business of owning and maintainingRacehorses of the A.Y. 2009-10 ` 38,000Determine the net income of X for the A.Y. 2013-14.

Tax Planning with Reference to New Projects/Expansion/Rehabilitation Plans

1. Discuss the FollowingAn assessee intending to establish an undertaking for the manufacture and sale of

goods with a distinct export orientation will have both domestic as well as export sales.He seeks your advice as to how he can 2.R and Company started two separate industrialundertakings which prima facie are eligible for deduction under section 80-IB. For the



Notes year ending 31-3-2013, the profit of one unit was ` 6 lakh, while the other unit suffered aloss of ` 2 lakh. The assessing officer has allowed the deduction under section 80-IB onthe net profit of ` 4 lakh Is the action of the assessing Officer justified?

3. A corporate form of organization wants to start a new business in respect of thefollowing in respect of the previous year 2012-13

(a) to manufacture or produce any article not specified in the Eleventh Schedule(b) Producing or refining mineral oil in the North-Eastern Region(c) operating and maintaining a hospital in a Rural area or the City of

Secunderabad(d) business of hotels and convention centres in Jalgaon or Aurangabad(e) Business of collecting and processing of bio-degradable waste for producing

bio-gas.What are the benefits available under the Income Tax Act and what are the

conditions to be complied with.4. The Gross total income of an Indian company includes profits and gains derived

from any industrial undertaking engaged in the manufacture or production of article orthing and the company has employed new workmen during the previous year. Is thereany benefit available to the company under tax statute?

5.A new industrial undertaking commences business on 5-4-2012 and hasemployed w.e.f. that date:

(a) 90 regular workmen(b) 105 regular workmen(c) 105 regular workmen on 5-4-2012, 10 regular workmen on 10-5-2012 and

20 workmen on 15-10-2012What shall be deduction allowable u/s 80JJAA.

Tax Planning in Respect of Amalgamation, Merger or Demerger of Companies1. Explain the term “amalgamation” as defined in Section 2 (IB) of the Income Tax

Act…2. Company A is proposed to be merged with company B. The following are the

particulars of the former company:Unabsorbed depreciation ` 2,50,65,000Unabsorbed business loss 1,15,10,000Consider which of the benefit can be availed of by the company under thefollowing situations-(a) if the merger is not amalgamation within the meaning of Section 2(IB)(b) if the merger is an amalgamation within the meaning of Section 2(IB) but it

does not fulfill conditions of Section 72A; or(c) if the merger satisfies conditions of section 2(IB) as well as Section 72A

3. Amalgamation is ‘tax neutral’ for purposes of income tax. Explain withreference to provisions under income tax in respect of amalgamation.

4. H Ltd. owns the following asset on April 1, 2008–Block of asset Rate of depreciation Written down value on

April 1, 2008

Plants (consisting of Plant A, B and C) 25% (15% from theassessment year 2006-07)

20,50,000



NotesOn June 30, 2008, it sells plant A for ` 6,00,000. It, however, acquires a plant D for` 15,00,000 on March 10,2009. On April 16, 2009 plant B, C and D are transferred by it toS Ltd. (a wholly owned subsidiary of H Ltd.) for ` 3,50,000 or for ` 60,00,000. S Ltd. ownsPlant P whose written down value on April 1, 2009 is ` 2,00,000, besides it purchasesplant Q on May 10, 2009 for ` 1,00,000. In either case, the rate of depreciation is 15%and new acquisitions are not eligible for additional depreciation. Find out the taxconsequence if S Ltd. is an Indian company or foreign company. Additional depreciationis not available.

Concept of Avoidance of Double Taxation1. Give definition of double taxation and what do you know about Source rule and

residence rule.2. What are the effects of double taxation on trade and services and its remedy?3. What is the necessity of Double Taxation agreement?4. What are the steps taken for Avoiding and alleviating the adverse burden of

international double taxation?5. Discuss the salient features of DTAA.6. What are the reliefs contemplated under DTAA?7. Discuss the different Models of DTAA.8. Can you give Analysis of Tax Treaty and its salient features?

5.10 Key Terms

● Amalgamation: Sec. 2(1B) of the Income Tax Act 1961 defines amalgamationas the merger of one or more companies with another company or the mergerof two or more companies (called amalgamating companies) to form a newcompany (called amalgamated company) in such a way that all assets andliabilities of the amalgamating company or companies become assets andliabilities of the amalgamated company and shareholders holding not less thanthree-fourths in value of the shares in the amalgamating company orcompanies become shareholders of the amalgamated company.

● Demerger: Sec. 2(19AA): Demerger in relation to companies, means thetransfer, pursuant to a scheme of arrangement under sections 391 to 394 ofthe Companies Act, 1956 by a demerged company of its one or moreundertakings to any resulting company

● Gross Total Income: As per Section 14, income of a person is computedunder the following five heads:

1. Salaries2. Income from house property3. Profits and gains of business or profession5. Capital gains5. Income from other sources.

The aggregate income under these heads is termed as “gross total income”.● Total Income: Total income means Gross total income computed in

accordance with the provisions of the Act after making deductions underChapter VIA (Section 80C to 80U).

● Domestic Company: A domestic company means an Indian company or anyother company which in respect of its income, liable to tax under the IncomeTax Act, has made the prescribed arrangements for the declaration and



Notes payment within India, of the dividends (including dividends on preferenceshares) payable out of such an income.

● Foreign Company: Foreign Company means a company which is not adomestic company.

● Investment Company: Investment Company means a company whose grosstotal income consists mainly of income which is chargeable under the heads‘Income from House Property’, ‘Capital Gains’ and ‘Income from OtherSources’.

● Residence of a Company: A company is said to be a resident in India duringthe relevant previous year if: (a) it is an Indian company, or (b) if it is not anIndian company, then the control and the management of its affairs is situatedwholly in India.

● Set-off of losses: Income tax is a composite tax on the total income of aperson earned during a period of one previous year. There might be caseswhere an assessee has different sources of income under the same head ofincome. Similarly, he may have income under different heads of income. Itmight happen that the net result from a particular source/head may be a loss.This loss can be set-off against other source/head in a particular manner. Forexample, where a person carries on two business and one business gives hima loss and other profit, then the income under the head ‘profits and gains ofbusiness or profession’ will be the net income, i.e., after adjustment of the loss.Similarly, if there is a loss under one head of income, it should normally beadjusted against the income from another head of income while computingGross Total Income.

● Carry forward of losses: If the losses could not be set-off under the samehead or under different heads in the same Assessment Year, such losses areallowed to be carried forward to be claimed as set-off from the income of thesubsequent Assessment Years.

● Minimum Alternate Tax (MAT): Where in the case of a company throughproper tax planning, the income tax payable on the total income as computedunder the Income Tax Act in respect of the previous year, is less than certainpercentage of its book profit, the companies are required to pay someminimum income tax which is termed as MAT (Minimum Alternate Tax). Taxpayable for any assessment year cannot be less than 18½% of book profit.

● Computation of book profits: Compute book profits [Explanation to 115JB(1)and (2)]

Step 1: The net profit as shown in the profit and loss account (prepared as per PartII and III of Schedule VI) for the relevant previous year, shall be increased by thefollowing, if debited to the Profit and Loss Account:

(a) The amount of income tax paid or payable, and the provision therefor; or(b) The amounts carried to any reserves by whatever name called; or(c) The amount or amounts set aside to provisions made for meeting liabilities,

other than ascertained liabilities; or(d) The amount by way of provision for losses of subsidiary companies; or(e) The amount or amounts of dividends paid or proposed; or(f) The amount or amounts of expenditure relatable to any income to which

Section 10 (other than the provisions contained in clause (38) relating tolong-term capital gain on transfer of shares through a stock exchange, 11 or 12applies (i.e., incomes which are exempt from tax), or



Notes(g) The amount of depreciation, or(h) The amount of deferred tax and provisions therefore (inserted by the Finance

Act, 2008, w.e.f. assessment year 2001-02).(i) The amount or amounts set aside as provision for diminution in the value of

any asset (inserted by the Finance Act, 2009, w.e.f. assessment year2001-02).

Notes:1. The starting figure is the net profit after tax as per profit and loss account.2. As per clause (a) above only income tax has to be added back. Hence, any tax,

penalty or interest paid or payable under wealth tax, gift tax, or any penalty orinterest paid or payable under income tax, if debited to profit and loss accountshould not be added back to such net profits. Dividend tax paid or payable asper section 115-O should be added back. Further, no adjustment is to be donein respect of income tax refund.

3. Where any amount has been transferred to reserve as per the provisions ofSec. 36(1)(viii), Sec. 80-IA(6), Sec. 80-IAB(6) or 10(A)(1A) or 10AA, the sameis also to be added back.

4. Any tax or duty which is not allowed as deduction as per provisions of Section43B though debited to profit and loss account shall also not to be added back.

5. Any provision made to meet unascertained liabilities like provisions of gratuity,provisions for future losses, etc. should be added back to such net profit.However, if the provisions for gratuity have been made on the basis of actualvaluation, it becomes an ascertained liability and hence should not be addedback.

6. Every kind of reserve is to be added to net profit to determine book profit.7. Dividend whether on equity or preference share paid or proposed should both

be added.8. Security Transaction Tax and Banking Cash Transaction Tax are not to be

added back as these are not income tax.9. Any expense other than mentioned in clause (5) above should not be added

back even if such expense is not allowable under the Income Tax Act.10. Deferred tax liability as per Accounting Standards is an unascertained liability,

hence to be added back.11. Loss of subsidiary company, if debited to the profit and loss account, should be

added back.12. The provisions of Section 115JB shall not apply to the income accrued or

arising on or after 1-4-2005 from any business carried on, or services rendered,by an entrepreneur or a Developer, in a Unit or Special Economic Zone as thecase may be [Section 115JB(6)].

Step 2: The profit as per the Profit and Loss Account shall be reduced by thefollowing:

1. The amount withdrawn from any reserves or provisions, if any, such amount iscredited to the profit and loss account:A clarificatory amendment has been made by the Finance Act, 2002, i.e.,assessment year 2001-02 to Section 115JB to provide that the amountwithdrawn from the reserve or provision, created not out of profits before1.4.1997, if credited to the profit and loss account, shall not be deducted whilecomputing book profit.



Notes Similarly, the amount withdrawn from the reserve created on or after 1.4.1997and credited to the profit and loss account shall not be deducted whilecomputing book profit unless the book profit in the year of creation of suchreserve was increased by such reserve at that time.(ii) The amount of income to which any of the provisions Section 10 (other

than the income referred to in Section 10(38), 11, 12 or 80-IAB applies, ifany such amount is credited to the profit and loss account; or

2. The amount of depreciation debited to the profit and loss account (excludingthe depreciation on account of revaluation of assets); or(iv) The amount withdrawn from revaluation reserve and credited to profit and

loss account, to the extent it does not exceed the amount of depreciationon account of revaluation of assets referred to in clause (iii) above; or

3. The amount of loss brought forward or unabsorbed depreciation, whichever isless as per books of account. The loss shall, however, not include depreciation.Further, the provision of this clause shall not apply if the amount of broughtforward loss or unabsorbed depreciation is Nil; or(vi) The amount of profits of sick industrial company for the assessment year

commencing from the assessment year relevant to the previous year inwhich the said company has become a sick industrial company undersub-section (1) of Section 17 of the Sick Industrial Companies (SpecialProvisions) Act, 1985 and ending with the assessment year during whichthe entire net worth of such company becomes equal to or exceeds theaccumulated losses.For the purposes of this clause, net worth shall have the meaningassigned to it in clause (ga) of sub-section (1) of Section 3 of the SickIndustrial Companies (Special Provisions) Act, 1985. According toSection 3(1)(ga) of the Sick Industrial Companies (Special Protection) Act,1985 net worth means the sum total of the paid-up capital and freereserves.“Free reserve” means all reserve credited out of the profits and sharepremium account but does not include reserves credited out ofrevaluation of assets, write back of depreciation provisions andamalgamations.

(vii) The amount of profit derived from the activities of a tonnage tax company[Sec 115VO].The amount computed after increasing or decreasing the above in Step 1and Step 2, respectively is known as book profit.How much brought forward loss/unabsorbed depreciation are deductiblefrom book profits?As per clause (v) above, the amount of loss brought forward orunabsorbed depreciation as per books of accounts whichever is less is tobe deducted from the book profits. It has been, however, clarified that lossshall not include depreciation. In this case, brought forward loss andunabsorbed depreciation as per income tax shall have no relevance.It has been clarified that where the value of the amount of either lossbrought forward or unabsorbed depreciation is ‘nil’, no amount on accountof such loss brought forward or unabsorbed depreciation would bereduced from the book profit.

● Tax on distributed profits of domestic companies: Domestic Companyshall, in addition to the income tax chargeable in respect of its total income, be



Notesliable to pay additional income tax on any amount declared, distributed or paidby such company by way of dividend (whether interim or otherwise), whetherout of current or accumulated profits. Such additional income tax shall bepayable @ 15% plus surcharge @ 10% plus education cess @ 2% plus SHEC@ 1% of the amount so declared, distributed or paid.

● Enterprises engaged in Infrastructure Development, etc.Deduction under section 80IA is available only to the following business carriedon by an industrial undertaking:

1. Provision of infrastructure facility [which includes – road, highways, watersupply project, irrigation project, sanitation and sewerage system, watertreatment system, solid waste management system, ports, airports andinland waterways]

2. Telecommunication services3. Developing, maintaining, etc. an industrial park.4. Power generation, transmission and distribution

Quantum of deduction100% of profits and gains derived from such business for 10 consecutiveassessment years out of 15 years * beginning with the year in whichundertaking or the enterprise develops and begins to operate any infrastructurefacility or starts providing communication services or develops an industrialpark or develops a special economic zone or generates power or commencestransmission or distribution of power or undertakes substantial renovation andmodernization of the existing transmission or distribution lines.Provided that where the assessee develops or operates and maintains ordevelops, operates and maintains any infrastructure facility relating to a roadincluding toll road, a bridge or rail system ; a highway project including housingor other activities being an integral part of the highway project; a water supplyproject, water treatment system, irrigation project, sanitation and seweragesystem or solid waste management system; the provision of this clause shallhave effect as if for the words” fifteen years”, the words “twenty years” had tobe substituted.

● Industrial Undertakings other than Infrastructure DevelopmentUndertakings: Deduction under section 80IB is available to an assesseewhose Gross total Income includes and profits and gains derived from thebusiness of:

1. An Industrial undertaking set up in the State of Jammu and Kashmir.Provision (except the quantum of deduction) relating to other industrialundertakings have not been discussed as these new industrialundertakings are now not allowed deduction

2. Scientific and industrial, research and development3. Commercial production and refining of mineral oil4. Developing and building housing projects5. Processing, preservation and packaging of fruits and vegetables6. Integrated business of handling, storage and transportation of food grain

units7. Operating and maintaining a hospital in a rural area8. Operating and maintaining a hospital located anywhere in India other than

excluded area.



Notes Quantum of deductionAssessee Period of Deduction

(commencing from initialassessment year)

% of profitseligible fordeduction

1.Industrial undertaking(i) set up in Jammu & Kashmir(ii) in district of category ‘A’*(iii) operating a cold chain facility

(a) Owned by a company

(b) Owned by a co-operative society



10030

10025

10025

2. Industrial undertaking in an industriallybackward district category ‘B’*(a) Owned by a company

(b) Owned by a cooperative society



10030

10025

10025

* Backward districts of category A and Category B have been notified vide Notification No.10441, dated 7-10-1997.

● Offshore Banking Units and International Financial Service Centres;To whom the deduction will be allowed: The deduction will be allowed to an

assessee:(i) Being a scheduled bank (not being a bank incorporated by or under the laws of

a country outside India);(ii) Owning an Offshore Banking Unit in a Special Economic Zone;(iii) A unit of international Financial Services centre.Income in respect of which deduction will be allowed: The deduction will be

allowed on account of the following income included in the gross total income of suchbanks: Any income:

(i) From an Offshore Banking unit in a Special Economic Zone;(ii) From the business, referred to in Section 6(1) of the Banking Regulation Act,

1949, with an undertaking which develops, develops and operates andmaintains a Special Economic Zone;

(ii) From any unit of the International Services Centre from its business for which ithas been approved for setting up in such a centre in a Special Economic Zone.

Quantum of deduction:(i) 100% of such income for five consecutive assessment years beginning with the

assessment year relevant to the previous year in which the permission, undersection 23(1)(a) of the Banking Regulation Act, 1949, or permission orregistration under the SEBI Act, 1992 or any other relevant law was obtained;

(ii) 50% of such income for the next five consecutive assessment years.



NotesConditions to be satisfied: No deduction under this section shall be allowedunless the assessee furnishes along with the return of income:

(i) In the prescribed form, the report of a Chartered Accountant, certifying that thededuction has been correctly claimed in accordance with the provisions of thissection; and

(ii) A copy of the permission obtained u/s 23(1)(a) of the Banking Regulation Act,1949.

“Offshore Banking Unit” means a branch of a bank in India located in the specialeconomic zone and has obtained the permission u/s 23(1)(a) of the Banking RegulationAct, 1949.

“International Financial Services Centre” means an International Financial ServicesCentre which has been approved by the Central Government under sub-section (1) ofSection 18 of the Special Economic Zones Act, 2005.

● Amalgamation: Sec. 2(1B) of the Income Tax Act 1961 defines amalgamationas the merger of one or more companies with another company or the mergerof two or more companies (called amalgamating companies) to form a newcompany (called amalgamated company) in such a way that all assets andliabilities of the amalgamating company or companies become assets andliabilities of the amalgamated company and shareholders holding not less thanthree-fourths in value of the shares in the amalgamating company orcompanies become shareholders of the amalgamated company.

● Demerger: Sec. 2(19AA) – Demerger in relation to companies, means thetransfer, pursuant to a scheme of arrangement under sections 391 to 394 ofthe Companies Act,1956 by a demerged company of its one or moreundertakings to any resulting company.

● Double Taxation agreement: The double tax treaties (also called DoubleTaxation Avoidance Agreements or “DTAA”) are negotiated under publicinternational or “DTAA” law and governed by the principles laid down under theVienna Convention on the Law of Treaties. It is in the interest of all countries toensure that undue tax burden is not cast on persons earning income by taxingthem twice, once in the country of residence and again in the country where theincome is derived. At the same time, sufficient precautions are also needed toguard against tax evasion and to facilitate tax recoveries.

● Double Taxation Avoidance Agreements with India: A typical DTAAgreement between India and another country covers only residents of Indiaand the other contracting country who has entered into the agreement withIndia.

● Tax Treaty: These treaties are usually between countries with: (1) substantialtrade or other economic relations. Most treaties are between pairs ofdeveloped countries while, of the balance, most of them are betweendeveloped and developing countries. (2) Provide reciprocal concessions tomitigate double taxation, (3) Assign taxation rights roughly in accordance withthat “existing consensus” and largely though not rigidly follow the OECD ModelTax Convention or, for developing countries, the UN Tax Convention (DTAAs).



Notes 5.11 Check Your Progress: Answers

Provisions Relating to MAT1. not a domestic company; non-domestic companies2. merge; Liability to tax or tax liability.3. 16.225%

Assessment of CompaniesUnder Situation1. company can claim depreciation on ` 40 lakhs;2. The company can claim deduction on account of 10% of the net profits of the

company for an indefinite period of time. If the ownership of the building istransferred to the assessee, it can claim normal depreciation.

3. The ownership remains with the Government the assessee can claimdeduction of ` 30 lakhs but cannot claim depreciation.

Provisions Relating to MAT1. Computation of tax liability under normal provisions 30% plus EC and SHEC

@3% = ` 88,823 rounded to 88,820Computation u/s 115JB 12,45,600 @ 18.5% plus EC and SHEC at 3% ` 2,37,349rounded to ` 2,37,350Therefore tax liability will be ` 237,350

Set-off and Carry Forward of Losses1. (d) No specified period2. The firm can claim set off unabsorbed business loss of late Mrs X

Tax Planning with Reference to New Projects/Expansion/Rehabilitation Plans1.

(a) No deduction as workmen employed are less than 100.(b) Deduction will be allowed @ 30% of the wages paid during the previous

year to 5 workmen employed after initial 100 regular workmen.(c) Deduction will be allowed @ 30% of the wages paid during the previous

year to 15 regular workmen employed after the initial 100 regularworkmen. No deduction under this section will be allowable in respect of20 workers employed w.e.f. 15.10.2013 as they are employed during theprevious year for less than 300 days and hence are not regular workmenfor the previous year 2013-14.

2.(a) and (b) No deduction as the total strength is less than 100.(c) Deduction allowable @30% of the wages paid to 5 workers employed

after initial 10.



NotesTax Planning in Respect of Amalgamation, Merger or Demerger of Companies1. Depreciation on plant and machinery in the hands of X Ltd. and Y Ltd. will be

computed as under:Particulars X Ltd (crores `) Y Ltd (crores `)

As at 1-4-2013Less: Depreciation @ 15%

30.004.50

70.0010.50

WDV as at 31-3-2014 25.50 59.50

The unabsorbed depreciation directly relatable to the undertaking transferred to theresulting company is allowed to be carried forward and set off in the hands of theresulting company. In case it is not directly relatable to the undertaking transferred to theresulting company it has to be apportioned between the demerged company and theresulting company in the same proportion in which the assets of the undertakings havebeen retained by the demerged company and transferred to the resulting company.

5.12 Case Study

1. The net profit as per Profit and Loss Account of R Ltd., a resident company, forthe year ended 31-3-2014 is ` 190 lakhs arrived at after making the followingadjustments:(i) Depreciation on assets ` 100 lakhs(ii) Reserve for currency exchange fluctuations` 50 lakhs(iii) Provision for tax ` 40 lakhs(iv) Proposed dividend ` 120 lakhs

Following further information are also provided by the company:(a) Net profit includes ` 10 lakhs received from a subsidiary company.(b) Provision for tax includes ` 16 lakhs of tax payable on distribution of profits and

of ` 2 lakhs of interest payable on income tax.(c) Depreciation includes ` 40 lakhs towards revaluation of assets(d) Amount of ` 50 lakhs credited to P&L Account was drawn from revaluation

reserve.(e) Balance of profit and loss account shown in balance sheet in the asset side as

at 31-3-2013 was ` 30 lakhs representing unabsorbed depreciation.Compute the income of the company for the year ended 31-3-2014 liable to tax

under MAT.


1. Ahuja. Girish Dr. and Gupta Ravi Dr., Direct Taxes Law and Practice includingTax Planning, Bharat Law House Pvt. Ltd.

2. Singhania Vinod K. Dr. and Singhania Kapil Dr., Direct Taxes Law and Practicewith Special Reference to Tax Planning, Taxman.

3. Singhania Vinod K. Dr. and Singhania Kapil Dr., Direct Taxes Planning andManagement, Taxman.

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