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ISSUES IN BUSINESS DEDUCTIONS GLOBAL TAX ADVISORY SERVICES Urvashi Kaushik Dhinal Shah Chartered Accountant Direct Tax Committe of ICAI Goa Branch of WIRC.

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Presentation on theme: "ISSUES IN BUSINESS DEDUCTIONS GLOBAL TAX ADVISORY SERVICES Urvashi Kaushik Dhinal Shah Chartered Accountant Direct Tax Committe of ICAI Goa Branch of WIRC."— Presentation transcript:

1 ISSUES IN BUSINESS DEDUCTIONS GLOBAL TAX ADVISORY SERVICES Urvashi Kaushik Dhinal Shah Chartered Accountant Direct Tax Committe of ICAI Goa Branch of WIRC of ICAI 30 th October 2010

2 Business Business includes any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture [Section 2 (13)] The above definition is not exhaustive Profession Profession includes vocation [Section 2 (36)] Profession implies professed attainments in special knowledge as distinguished from mere skill. E.g.- tax experts, financial accountants, architects, engineers, etc. Vocation Not defined in the Act Vocation implies natural ability of person for some particular work. B USINESS, P ROFESSION, V OCATION The distinction between business, profession and vocation is however not material since the income from all these activities is taxable under the same head ie PGBP

3 S ECTION 28 Charging section - Scope Profits earned from carrying on business at any time during the previous year Any compensation due to or received by: Any person managing the whole/ substantial affairs of an Indian company; Any person managing the whole/ substantial affairs of any other company in India; Any person holding an agency in India; Where the consideration is for or in connection with termination or modification of terms of the managing directorship/ agency Income earned by any trade/ professional association from specified services provided to members Profits on sale of an import license Cash assistance against exports Customs or excise duty drawback

4 S ECTION 28 Charging section - Scope Profit on the transfer of the Duty Entitlement Passbook Scheme, being Duty Remission Scheme Any benefit or perquisite whether convertible into money or not, arising from business/ profession Any interest, salary, bonus or commission received by partner of a firm from the firm (excluding any part which has not been allowed as a deduction to the firm by reason of being in excess to the specified limits) Any sum received under an agreement for Not carrying out any activity in relation to business; Not sharing any business or commercial rights which are likely to assist in the business (covers basically non-compete fees received under an agreement) Any sum received under a Keyman insurance policy by an employer in respect of insurance of the employee including the bonus allocated on such policy Burden to prove expenditure The burden is on the assessee to prove the claim of expenditure with supporting evidence The reasonableness of expenditure is to be seen from the business point of view

5 L OSS INCURRED IN CARRYING ON BUSINESS Whether it is necessary that the assessee must earn some income to become eligible to claim losses incurred in carrying on business If there is direct and proximate nexus between the business operation and the loss, or if it is incidental to it, then the loss is deductible Whether the loss is incurred in carrying on business is a question of fact and it is important to demonstrate it before tax authorities Examples of losses: embezzlement loss, irrecoverable deposits, exchange loss, loss of inventory etc

6 E XPENDITURE VS L OSS Expenditure relates to disbursement : that means something that a trader pays out indicating a sort of violation on his part. He chooses to pay out some disbursement; it is an expense; it is something which comes out of his pocket. A loss is something different. That is not a thing which he expends or disburses. That is a thing which comes upon him ab extra Finlay J., in Allen v. Farquharson Brothers & Co (17 TC 59) quoted in CIT v S.C Kothari (82 ITR 794) (SC) Indian Molasses Co. (P.) Ltd. v CIT (37 ITR 66) (SC) Business loss and expenditure are different. Explanation to Section 37(1) is applicable only to allowance of business expenditure and not business loss. Hence loss in an illegal business is allowable deduction Dr. T.A. Quereshi (287 ITR 547) (SC) following SC judgment in the case of Piara Singh (124 ITR 40-SC)

7 Issues relating to Setting-up of Business

8 S ET UP OF BUSINESS Significance? When can a business be considered to have been set up? Concept of ready to commence business Time gap between set-up and actual commencement

9 The term set up of business assumes importance in the context of determining the previous year of any company Further, set up is important in the context of section 35D to claim expenses incurred in the pre-operative period Set-up has not been defined in the Act – however reliance is placed on various judicial precedents As per Oxford English Dictionary setting up means to place on foot or to establish. In view of the same, a view may be taken that a business can be said to have been set up when it is established, i.e. when it is ready to commence business S ET UP OF BUSINESS – S IGNIFICANCE ? Expenditure incurred only after the date of setting up business which is of revenue nature is allowed as a deduction in computing business income Pre-setup capitalization of expenditure is allowed only of those expenses that contribute directly or bring the assets to the present location and existence. Hence, pre-setup expenditure which does not satisfy this criteria would neither be capitalized nor allowed as a revenue deduction In short, you cannot claim a deduction for pre-setup revenue expenditure.

10 Business can be said to be set up when it is established and ready to commence business. There may be an interregnum, an interval, between the time when a business is set up and the time when a business has commenced, and all expenses incurred after the setting up of business and before the commencement of business would be permissible deductions - [Western India Vegetable Products Limited vs CIT (26 ITR 151) (SC)] Saurashtra Cement and Chemical Industries Ltd. (91 ITR 170) (Guj HC) - The business would commence when the activity which is first in point of time and which must necessarily precede the other activities is started Ashima Syntex (251 ITR 133) – Trial run A unit cannot be said to have been set up unless it is ready to discharge the function for which it is being set up. If the unit is ready to start functioning, it does not matter that it has not actually started its business on the relevant date. [CIT vs Piem Hotel Pvt Ltd (209 ITR 616)] What is significant about the date of commencement of the commercial production is the date when the plant is ready for commercial production and not the date when the plant actually commences commercial production [Eicher Motors Ltd vs DCIT (94 Taxman 316)] S ET UP OF BUSINESS – WHEN CONSIDERED ?

11 S ET UP IN DIFFERENT BUSINESSES Sr. No. IndustryStage of set up of business 1Manufacturing businessInstallation of plant and machinery, obtaining licenses, power connection, completion of trial runs (even if the product is of sub-standard quality or has some defects) 2Trading businessReadiness of infrastructure like office, warehouse etc, actual purchase of goods 3Manufacturing and trading business (composite business) Commencement of trading activity sufficient even if manufacturing activity has not commenced 4Leasing / Hotel businessProperty (with the required infrastructure) ready for being let out even if not actually let out 5Consultancy services / Software development business Acquisition of place of business, the required assets, recruitment of staff, evidence of clients

12 Issues relation to previous year expenditure

13 PREVIOUS YEAR EXPENDITURE Crystallization of liability Saurashtra Cement and Chemical Ind. Ltd. (213 ITR 523) (Guj HC) Revenue should not dispute such claims when rate of tax is same Nagri Mills Co. Ltd.(33 ITR 681) (Bom HC)

14 Issues relating to Current Repairs

15 Section 30 provides for the following deductions for purpose of carrying on business or profession, provided that these expenses (in respect of building) are revenue in nature Rent and repairs paid by a tenant; Current repairs paid by a person occupying the premises other otherwise than as a tenant; Sums paid on account of land revenue, local rates or municipal taxes; Insurance premium paid. Section 31 provides that current repairs and insurance of plant and machinery and furniture will be allowed as deduction, provided that these expenses are revenue in nature and assets used for the purpose of business Explanation to Section 30 and 31 inserted with effect from AY clarifies that capital expenditure would not be allowed as a deduction under Section 30 and 31 Sarvana Spinning Mills P. Ltd. (293 ITR 201) (SC) - Replacement of old asset with new asset would not constitute current repair Upholding Sarvana Spinning Mills - Bhojraj Textile Mills Ltd. (SC) (larger bench) (2010- TIOL-22-SC-IT-LB) and Sri Mangayarkarasi Mills (P) Ltd (315 ITR 114)(SC) S ECTION 30 & 31

16 D EDUCTIBILITY OF CERTAIN EXPENSES Expenses on leasehold premises Renovation / improvement expenses are deductible subject to following tests: Expenditure not resulting in creation / procurement of capital asset The lease is a short term lease The lessee has undertaken to bear such expenses or are incurred in pursuance of some statutory / regulatory requirement Expenses are incurred for more profitable conduct of business

17 Issues relating to Depreciation

18 D EPRECIATION - S ECTION 32 Depreciation can be claimed on Tangible assets such as buildings, machinery, plant or furniture; Intangible assets such as know-how, patents, copyrights, trade marks, licenses, franchises or any other business or commercial rights of similar nature, (after April 1, 1998) Asset must be wholly or partly owned and used for purposes of the business or profession Depreciation is allowed only to the owner of the assets Use of assets – Active vs Passive Passive User Nirma Credit & Capital Ltd. (220 CTR 537) (SC) Panacea Biotech Ltd. (324 ITR 311) (Delhi HC) Use includes passive use and as long as asset is ready for use it is eligible for depreciation Block of assets Once an asset falls into block of asset, they are eligible for depreciation even if not used for a single day in the year Bharat Aluminum Co Ltd.– (187 Taxman 111) (Delhi HC) and Swati Synthetics (38 SOT 208) (Mumbai ITAT)

19 D EPRECIATION - S ECTION 32 Chapter VIA deduction Depreciation to be considered while computing deduction under Chapter VIA Plastibends India Ltd. (318 ITR 352) (Bombay HC, Larger Bench) Dabur India Ltd. (219 CTR 152) (Delhi HC) Vahid Paper Converters. (98 ITD 165) (Ahd) (SB) Depreciation on goodwill Whether goodwill is an intangible asset eligible for depreciation under Section 32? Whether depreciation is admissible on self-generated goodwill?

20 A RGUMENTS IN FAVOUR OF CLAIMING DEPRECIATION ON GOODWILL Goodwill is an intangible asset Goodwill is property Goodwill could be termed as a bundle of various rights, such as property right, right to carry trade in fixed locality, right to enjoy all advantages of established trade connections, etc Accounting policies recognize goodwill as an intangible asset (like trademark, patents, etc), capable of being amortized

21 A RGUMENTS IN FAVOUR OF NOT CLAIMING DEPRECIATION ON GOODWILL Not specifically included in the intangible assets specified under Section 32 Cannot be treated as any other business or commercial right of a similar nature Depreciation provides for the wear and tear of a capital asset - however, value of goodwill capable of appreciation over a period of time Self generated goodwill does not have a cost of acquisition and accordingly, no depreciation should be admissible Report of the Comptroller and Auditor General of India has observed that depreciation on goodwill should not be allowed

22 D EPRECIATION - S ECTION 32 Case laws on depreciation on goodwill In favour B. Raveendran Pillai v. CIT (7 92) (Kerala High Court) Skyline Caterers, (20 SOT 269) (Mumbai ITAT) Bosch Ltd.(2009-TIOL-736-ITAT-BANG) (Bangalore ITAT) Hindustan Coca Cola Beverages (132 TTJ 602) (Delhi ITAT) Guruji Entertainment Network Ltd. (108 TTJ 180) (Delhi ITAT) Kotak Forex Brokerage Limited. (33 SOT 237) (Mumbai ITAT) A.P. Paper Mills Limited v. ACIT (128 TTJ 596) (Hyderabad ITAT) ACIT v. CLC Global Limited (ITA No. 2288/D/2008) (Delhi ITAT) Against R. G. Keshwani, (120 TTJ 1081) (Mum), Bharatbhai J. Vyas, (97 ITD 248) (Ahd) (AT) Shanmugam Narayanaswamy (279 ITR 15) (AT) (Hyd) Depreciation on other commercial rights Ashoka Info (P) Ltd. – (123 TTJ 77) – (Pune ITAT) and Reliance Ports and Terminals Ltd (unreported) (ITA Nos. 1743, 1744 and 1745/Mum/2007) (Mumbai ITAT) Toll rights are an intangible asset eligible for depreciation Medicorp Technologies India Ltd. (122 TTJ 394) (Madras ITAT) and Real Image Tech. (P) Ltd. (120 TTJ 983) (Madras ITAT) Non compete fees eligible for depreciatio n

23 D EPRECIATION - S ECTION 32 Depreciation on other commercial rights ONGC Videsh Ltd. (127 TTJ 497) (Delhi ITAT) Amount paid for acquisition of exploration license eligible for depreciation Depreciation on Intellectual property rights Modular Infotech P Limited vs DCIT (131 TTJ 243) (Pune ITAT) Depreciation eligible on Intellectual property rights Depreciation on stock exchange membership card Techno Shares and Stocks Ltd (SC) (193 Taxman 248) Depreciation eligible on stock exchange membership card. The said membership right is a business or commercial right. Depreciation on Brand obtained under a scheme of demerger KEC International (41 SOT 43) (Mumbai ITAT) Depreciation eligible on Brand obtained under a scheme of demerger.

24 Issues relating to Bad debts

25 B AD D EBTS After amendment inserted with effect from 1 April 1989, it is not necessary to establish or prove that the debt has become bad. It is enough if the bad debt is written off as irrecoverable in the accounts of the assessee TRF Ltd. (230 CTR 14) (SC) Vijaya Bank (323 ITR 166) (SC) Oman International Bank (313 ITR 128) (Bombay HC) Provision for NPA made in terms of RBI directions is not eligible for deduction under Section 36(1)(vii) as bad debts Southern Technologies Ltd. – (228 CTR 440) (SC) Write off of advances, whether capital or revenue in nature –can be claimed u/s.28 or 37 – if not, u/s.36(1)(vii)

26 B AD D EBT Deduction on write-off Star Chemicals, 11 DTR 311 (Bom) Suresh Gaggal, 11 DTR 345 (HP) Tuskar Dye Chem, 9 DTR 298 (Del) Manner of Write-off – Debit to P & L Account Jindal Sons, 121 TTJ 232(Asr.) Global Capital Ltd. 121 TTJ 218(Del) Position in case of stock broker G.R.Pandya Share Broking Ltd.26 SOT 431(Mum), B.S.Vasa, 26 SOT461 (Mum), Bank of America, 27 SOT 97 (Mum) Bonanza Portfolio Ltd. 226 CTR 468 (Delhi HC) DB (India) Securities Ltd. (226 CTR 466) (Delhi HC) Canon Capital & Finance Ltd (Ahmedabad ITAT) (ITA No. 1119/Ahd/2005) (unreported)

27 Issues relating to 36(1)(iii)

28 A LLOWABILITY OF I NTEREST U / S 36(1)( III ) W.e.f. A.Y by insertion of proviso, interest paid on the capital borrowed for acquisition of asset for extension of existing business, upto the date asset was put to use, no deduction - Implication. Tata Chemicals Ltd. 256 ITR 305 (Mum) (confirmed by S.C). Core Health Care Ltd. 251 ITR 61 (Guj) (confirmed by SC) Advances to subsidiary: Advances / loans to subsidiary – interest cannot be disallowed – For the purpose of business explained. S.A. Builders Ltd. 288 ITR 1 (SC) Interest free loan to sister concern HB Stock Holdings Ltd. (325 ITR 316) (Delhi HC) – Not disallowable as loan given to subsidiary companies before taking loan from bank Mahindra Holdings Ltd., 117 TTJ 721 (Mum) Yamaha Motors India Pvt. Ltd., 118 TTJ 395 (Delhi) Treatment of Pre incorporation interest L. G. Electronics, 12 DTR 263 (Delhi) Winsome Dyeing, 10 DTR 207 (HP) Neha Proteins Ltd., 306 ITR 102 (Raj) Interest on application money Global Capital Ltd., 309 ITR 283 (Delhi) Interest free loan and s. 56(2)(v) Chnadakant H. Shah, 121 TTJ 145(Mum) Overriding effect of s.40(b) on excessive interest Syntholabs Chemicals & Research(Mum)

29 BORROWINGS BY CONSTRUCTION COMPANIES If borrowing is for specific projects, interest will have to be treated as project cost (where completion of contract method is followed) Distinction is drawn between accounting of profit on works in progress method vs. completed contracts method. Lokhandwala Construction (260 ITR 579) (Bom) Wall Street Constructions Ltd. (101 ITD 156) (Mum ITAT) (SB) distinguished on facts

30 Issues relating to 37(1)

31 G ENERAL DEDUCTIONS - S ECTION 37 Residuary section for deduction from the taxable income Conditions to be satisfied under section 37(1): –Expenditure not of the nature described in section 30 to 36 –Incurred in the previous year –It should not be in the nature of personal expenses –It should not be for an offence –It should not be prohibited by law –It should not be in the nature of capital expenditure –It should have been laid out or expended wholly and exclusively for business Some issues Wholly and exclusively laid out Capital vs Revenue Prohibited by Law Other peculiar expenses

32 Principles to decide whether covered (emerging out of judicial precedents): Money expended not merely out of necessity and with a view to a direct and immediate benefit to the business, but voluntarily and on grounds of commercial expediency and in order to indirectly facilitate carrying on of the business Incurred in the assessees character as a trader and not some other character Purpose must be purpose of assessees own business, profits of which are being computed and assessed Generation of profits from expenditure incurred is not per se necessary for purpose of determining whether it is wholly and exclusively laid out. What is required is that expense should have been incurred for the purpose of carrying on the business Mere fact that to some extent expenditure results in benefit to a third party or that person expending obtains some advantage in some character other than that of a trader, cannot in law defeat the effect of the finding as to the whole and exclusivity purpose W HOLLY AND EXCLUSIVELY LAID OUT

33 Capital vs Revenue Capital expenditure is incurred in law and on accounting principles only in the following circumstances: –A new asset is brought into existence –An advantage or enduring benefit is obtained by the assessee –The expenditure relates to the fixed capital as distinct from the circulating capital –The expenditure is of an initial nature to commence a business for the first time –The expenditure incurred is to acquire a concern or a goodwill G ENERAL DEDUCTIONS – S ECTION 37

34 Prohibited by Law - Examples Penalty paid for violation or infringement of any law Penalty or damages for contractual obligation Sum paid as protection money to certain persons by the assessee, a builder, engaged in the construction activities in areas which were vulnerable to such dangers as extortion, haftas, etc Legal vs Illegal business SC Kothari (82 ITR 794) (SC) Piara Singh (124 ITR 40) (SC) Hazi Aziz & Abdul Shakoor (41 ITR 350) (SC) Maddi Venkatraman & Co. (229 ITR 534) (SC) T.A.Querishi (287 ITR 547) (SC) G ENERAL DEDUCTIONS – S ECTION 37

35 Issues relating to Forex losses

36 T AX TREATMENT OF F OREX G AIN / L OSS ParticularsRealized Gain / LossUnrealized Gain / Loss Assets acquired from outside India To be adjusted in the block of assets & depreciation to be claimed* No adjustment in the MAT computation To be adjusted in the block of assets on realization* No adjustment in the MAT computation Assets acquired from within India Capital Receipt / Loss & hence not taxable / deductible No adjustment in the MAT computation Elecon Engineering (SC) (230 CTR 1) Forex loans taken for revenue purpose Mark to market loss on forex forward contracts Realised / unrealised foreign exchange gain / loss on revenue items allowable as deduction under Section 37(1) as business expenditure – Woodward Governor (SC) (312 ITR 254), ONGC Ltd. (SC) Forward contract losses eligible for deduction under Section 37(1) in the year in which it is incurred irrespective of year of payment – IFCI (228 CTR 132) (Delhi HC) Unrealised mark to market losses foreign exchange losses are contingent in nature and hence, not allowable as a business expenditure – CBDT Instruction No. 2/2010, dated March 23, 2010 Realised foreign exchange loss could also be speculative loss in terms of provisions of Section 43(5) - CBDT Instruction No. 2/2010, dated March 23, 2010 Loss on account of valuation of forward contracts on the last day of accounting period is an allowable business loss - Bank of Bahrain & Kuwait (132 TTJ 505) (Mumbai ITAT SB) * To the extent it relates to principal and interest liability as on date of acquisition of the capital asset

37 Mark to market loss on Derivative Transactions

38 MARK TO MARKET LOSS ON DERIVATIVE TRANSACTIONS Derivative Transaction Transactions in futures and options are for a fixed maturity and as per current stock market regulations are settled by cash either before or at their maturity date Accounting Treatment As per AS1 the loss on M2M needs to be recognized in the Profit and Loss Account. As per AS30, the loss or profit on M2M basis in respect of derivative including hedging transactions needs to be recognized in the Profit and Loss Account. Tax Treatment As per provisions of Section 43(5), amended with effect from 1 April 2006, any income arising from derivative transaction on recognized stock exchange would not be a speculative transaction

39 MARK TO MARKET LOSS ON DERIVATIVE TRANSACTIONS Issues Whether losses arising in mark to market derivative transactions could be allowable under the Act Whether it be considered as business loss or capital loss Prior to All the derivative transactions are speculative business transactions as amendment in section 43(5) is not retrospective [Shree Capital Services Ltd (Kolkata ITAT) (318 ITR 1)] Post Business Loss Trading in derivatives is a business Mark to market loss is only notional loss There is no transfer of capital asset on balance sheet date No consideration is received for mark to market loss Capital Loss Derivatives are capital asset Mark to market loss is loss arising on balance sheet date

40 Issues relating to Deductibility of provision for warranties

41 I SSUE Whether provision for warranty created by the manufacturers of goods carrying warranty is in the nature of revenue expenditure allowable as a deduction under Section 37(1) of the Act? Whether provision for warranty can be said to be in the nature of a liability which has been incurred during the relevant previous year? Whether provision for warranty can be said to be in the nature of a provision created for a contingent liability and should hence not be allowed as a deduction under Section 37(1) of the Act?

42 A RGUMENTS IN FAVOUR OF DEDUCTIBILITY Method of accounting Provision for warranty is made in accordance with the principles prescribed by the ICAI - mandatorily required to be followed by companies while preparing their accounts Provision for warranty is created to arrive at the correct profits for the year under the mercantile system of accounting - a method recognized under the provisions of Section 145 of the Act A reasonable method of accounting adopted by the assessee, resulting in the correct determination of profits should not be disturbed (Metal Box Co of India Ltd v their workmen 73 ITR 53)

43 A RGUMENTS IN FAVOUR OF DEDUCTIBILITY Basis of creating the provision for warranty The provision for warranty based on a scientific basis is allowed as a deduction (Rotork Controls India (P) Ltd. (SC) (314 ITR 62) – distinguished by Mumbai ITAT in the case of Hindustan Dorr-Oliver Ltd. (Lexreported) The provision is made on a scientific basis and no ad-hocism is involved (Voltas Ltd v DCIT 61 TTJ 543) The method adopted in creation of the provision is scientific, commercially expedient and in accordance with set principles of accountancy (CIT v Majestic Auto Ltd 204 ITR 14) Estimate of such liability has been made on the basis of past experience (Jay Bee Industries v DCIT 61 TTJ 403 Asr) There is certainty that the expenditure will be incurred and a reasonable approximation of the same is possible (ITO v Wanson India Ltd 5 ITD 102 Pun)

44 C ONCLUSION Provision for warranty should be allowable as a deduction under Section 37(1) if: The provision has been made on a scientific basis and based on past experience The method adopted in creating the provision for warranty has been consistently followed in past and subsequent years The above principles in respect of deductibility of provision for warranty also applicable in respect of other provisions created in the books of account

45 Issues relating to Computer Software

46 S OFTWARE E XPENSES - TYPES System software Application software Platform System study System installation Hardware related Training Maintenance updation

47 S OFTWARE – UNDERSTANDING TILL DATE Ownership & Enduring benefit Empire Jute Co. Ltd., 124 ITR 1 (SC) Alembic Chemical Works, 177 ITR 377 (SC) Purchase & Licenses Copy right & copy righted articles and goods Profit Earning apparatus Transferability Existing operations Quantum of expenses

48 S OFTWARE E XPENSES – PRINCIPLES FOR DETERMINING NATURE OF EXPENSES Software is a tangible asset – goods TCS, 192 CTR 257 (SC) License can be acquisition of asset Copyrighted article can be acquisition All purchases are not capital Technological changes Less than two years test Size of lay out – Central tool Profit earning apparatus Training Centre / Travel Agent Organizational efficiency Degree of organizational changes – Radical changes Maintenance and up-gradation Economic and functional test - paramount

49 S OFTWARE E XPENSES – CURRENT JUDICIAL POSITION Amway Criteria for allowance Ownership Functional Enduring benefit Amway India Ent. 111 ITD 112 (Del.) (SB)

50 R ELEVANT PRINCIPLES BASED ON JUDICIAL PRECEDENTS In support of revenue expenditure Payment towards application software and expenses incurred for replacement of UPS and printer are revenue expenses - Southern Roadways, (304 ITR 84) (Madras HC) Expenses on purchase of computer software are revenue expenses - Varinder Agro Chemicals Ltd., (309 ITR 272) (P & H HC) Expenses on website are revenue expenses - Indian Visits Corpn., (176 Taxman 164) (Delhi HC) Expenses on upgradation of computers by changing certain parts and thereby improving its efficiency are revenue expenses – Southern Roadways Ltd. (282 ITR 379 ) (Madras HC) No degree of durability or permanence attributable to software items and there is no benefit of enduring nature as software needs constant updation given the fast changing technological environment - Citicorp Overseas Software (85 TTJ 87) (Mumbai ITAT) Purchase of MS Office is revenue expenses as its not a customised software - G.E. Capital Services Ltd., (214 CTR 551) (Delhi HC) Expenses incurred on licence fees for use of ORACLE software are revenue expenses - Asahi India Safety (6 SOT 656) (Delhi ITAT) Expenses on acquisition of application software are revenue expenses - IBM India Ltd., (108 TTJ 531) (Bang)

51 R ELEVANT PRINCIPLES BASED ON JUDICIAL PRECEDENTS In support of revenue expenditure Expenses on implementation of ERP package are allowed as revenue expense - Glaxo Smithkline, 112 TTJ 94 (Chd ITAT) [Contrary decision of Pune ITAT in the case of Sudarshan Chemical Industries Ltd. (110 ITD 171) ] Software programme once developed by assessee cannot be said to be of enduring benefit and expenses incurred in developing such software programme will be allowable as revenue expenditure – Business Processing Services (73 ITD 304) (Jaipur ITAT) Being an important tool in bringing about a qualitative improvement in the functioning of an organization, software needs frequent updation due to a fast rate of obsolescence (Media Video Ltd v JCIT 122 Taxman Mag 28) Purchase of software is not an expenditure in the capital field as they become outdated very fast (Bank of Punjab v JCIT 122 Taxman Mag 235)

52 R ELEVANT PRINCIPLES BASED ON JUDICIAL PRECEDENTS In support of capital expenditure Expenditure on acquisition of an asset (other than trading asset) is always capital expenditure Hardware, commonly called as computer (a tangible asset), cannot function without the aid of software Amendment in the rates of depreciation with effect from Assessment Year provides for depreciation on computers (including computer software) at the rate of 60% The amendment indicates that expenditure on purchase of software was always capital expenditure, earlier depreciable at the rate of 25% as intangibles Though expenditure on upgradation and maintenance of software is revenue expenditure, expenditure on acquisition of the software is capital in nature – (Maruti Udyog Ltd., 92 ITD 119, Delhi ITAT) In support of capitalizing under the block intangibles Being akin to know-how, purchase expenditure of software is a capital expenditure (Arawali Constructions co Pvt Ltd 259 ITR 30 Raj)

53 C ONCLUSION Re-consideration of judicial precedents subsequent to the amendment to the depreciation rates schedule The higher rate of 60 percent, prescribed for computer and computer software, factor in the high degree of obsolescence associated with such assets Computer software defined to mean any computer programme recorded on any disc, tape, perforated media or other information storage device Based on the above, the expenses on purchase of software for internal use to be capitalized under the block computers This position gets further augmented if such expenditure is capitalised in the books Software purchased for commercial exploitation assumes the form of an IPR, which are then exploited commercially – such software expenses, being akin to know-how to be classified under the block intangibles

54 Issues relating to 14A

55 B ACKGROUND Expenditure incurred for earning exempt income is not allowable as deduction under section 14A The Assessing Officer (AO) is empowered to determine the amount of expenditure in accordance with method prescribed under Rule 8D if: AO is not satisfied with the correctness of the claim made by assessee or If assessee claims that no expenditure is incurred to earn exempt income

56 R ULE 8D Disallowance prescribed under Rule 8D is sum of : Direct Expenditure incurred for earning exempt income A Proportionate Interest Expenditure = Interest Expense X Average Value of Investments Average Value of Total AssetsB Administrative 0.5% of Average Value of Investments C Total A+B+C

57 R ULING OF M UMBAI S PECIAL B ENCH – D AGA C APITAL Operation of Section 14A is automatic on earning exempt income Computational provisions of Section 14A read with Rule 8D are procedural and clarificatory in nature Rule 8D will apply retrospectively to all pending matters Based on above ruling, the tax authorities applied Rule 8D for all pending assessments.

58 R ECENT RULING OF B OMBAY H IGH C OURT IN CASE OF – G ODREJ & B OYCE The key principles laid down by the High Court are as under: Section 14A will apply to dividend income although dividend has suffered dividend distribution tax The computation method provided by rule 8D is constitutionally valid. Rule 8D notified on 24 March 2008 will not have retrospective effect. Rule 8D cannot be applied mechanically. Only if AO is not satisfied with the claim of tax payer and has recorded reasons he can compute disallowance under section 14A. Upto AY , in absence of rule 8D, AO can compute disallowance under section 14A by reasonable method.

59 R ECENT RULING OF B OMBAY H IGH C OURT IN CASE OF – G ODREJ & B OYCE The facts in Godrejs case as mentioned by the High Court are as under: Major dividend from group companies 95% consisted of bonus shares Most of the shares acquired several years earlier No stage in the past except in last few years has the Department attributed any interest or expenditure towards dividend Reserves of Rs.276 Cr and Capital of Rs.6.55 Cr more than the investments In the relevant year no new investments, but disposal of some old investments

60 S CENARIO UP TO AY Rule 8D notified on 24 March 2008 not to have retrospective effect However, disallowance to be on reasonable basis Could be argued that basis for disallowance to remain the same as made in the past assessments

61 S CENARIO POST AY Rule 8D to be applied only if AO not satisfied with the disallowance made by the tax payer himself and has recorded reasons Responsibility of tax payer to satisfy the AO Justify its claim by robust documentation and sound principles of apportionment Responsibility will shift on the AO, to justify why disallowance computed by the tax payer should not be accepted Could be argued that the basis for disallowance to remain the same as computed in the past

62 CONCLUSION Up to AY Disallowance under section 14A to be computed on a reasonable basis Provide adequate documentation and submissions to minimize the disallowance to be computed on reasonable basis Post AY Could be argued that basis of disallowance to remain same as computed upto AY and not as per Rule 8D Responsibility will shift on the AO, to justify why disallowance computed by the tax payer should not be accepted Difficult for AO to disregard his own satisfaction with the basis of computation made upto AY

63 Issues relating to contribution towards employee welfare funds

64 I SSUES RELATING TO CONTRIBUTIONS TOWARDS EMPLOYEE WELFARE FUND Employers contribution to employee welfare funds – Section 43B(b) Employers contribution to employee welfare funds allowed as a deduction if paid before due date of filing return of income Amendment to Section 43B(b) by omitting the second proviso is retrospective in nature - Alom Extrusions Ltd. (319 ITR 306) (SC) Employees contribution to employee welfare funds – Section 36(1)(va) Employees contribution towards employee welfare funds is treated as income of employer under Section 2(24)(x) Employees contribution is allowed as deduction only if it is paid before due date under respective employee welfare Acts and not before due date of filing return of income However, following judicial precedents have held that deduction under Section 36(1)(va) is allowed even if employee contribution is paid before due date of filing return of income AIMIL Ltd – 229 CTR 418 (Delhi HC) P.M. Electronics Ltd ITR 161 (Delhi HC) Pik Pen Private Limited - ITA No. 6847/Mum/2008 (Mumbai ITAT) following Alom Extrusions


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