AN OVERVIEW OF TAX AUDIT G.

Ramaswamy Council member ICAI

INTRODUCTION

The main objective of the tax audit is to compute the taxable income according to the law and for maintaining transparency in the financial statements filed by the assessees with the Income-tax department. The tax audit u/s. 44A of the Income-tax Act !"#! is significant practice area for $hartered Accountants. %ince the introduction of tax audit& we have been given responsibilities to discharge the duties as tax auditors for the proper compliance of tax law by the assessees.
AUDIT

The Institute of $hartered Accountants of India has defined auditing as follows ' (A systematic and independent examination of data& statements& records& operations and performances )financial or otherwise* of an enterprise for a stated purpose. In any auditing situation& the auditor perceives and recognises the propositions before him for examination& collects evidence& evaluates the same and on this basis formulates his judgment which is communicated through his audit report+. DOCUMENTATION The auditor should document the matters& which are important in providing audit evidence that the audit was carried out in accordance with the basic principles& which are governing audit.
AUDIT EVIDENCE

The auditor should obtain sufficient and appropriate audit evidence& which will enable him to draw reasonable conclusions there from on which base his opinion on the financial information.
CONFIDENTIALIT

The auditor should respect the confidentiality of information ac,uired in the course of his wor- and should not disclose any such information to a third party without specific authority or unless there is a legal or professional duty to disclose.
!"ILL! AND COM#ETENCE

The audit should be performed and the report has to be prepared with due professional care by persons who have ade,uate training& experience and competence in auditing. $%&$A'()OO"! OF ACCOUNT! . oo-s or boo-s of account. include ledgers& day-boo-s& cash boo-s& account-boo-s and other boo-s& whether -ept in the written form or as print-outs of data stored in a floppy& disc& tape or any other form of electro-magnetic data storage device. - Is it necessary to ta-e printouts/
!ECTION

If the assessee has maintained proper boo-s of account& the provisions of %ec !40)!* shall apply and the Income has to be assessed on the basis of the boo-s of account. Thus& unless& the boo-s of account are rejected& or no boo-s of account are maintained& the Income disclosed cannot be disturbed as held in ITO Vs Amar Singh Jain (1992) 43 TTJ (Jp Trib) 11. 1on maintenance of stoc- register 2 non recording of sales with identifiable details was held to be good ground for rejection of account boo-s in Kishan Chand Chella Vs CIT (19 !"114 IT# $ 1) %ystem of Accounting cannot be rejected merely because the disclosed gross profit was low. (Chandra %imber %raders Vs CIT 199$ &4 TTJ &44 'el Tri).

PEER REVIEW

The Institute has issued a statement on 3eer 4eview. The basic objectives of peer review is to enhance the ,uality of the professional wor- by adopting technical standards which includes the following5 Accounting standards issued by the Institute of $hartered Accountants of India. Auditing and assurance standards issued by the Institute of chartered accountants of India. 6ramewor- for the preparation and presentation of financial statement 6rame wor- of statements on standard auditing practices 7uidance notes on related services issued by the Institute of $hartered Accountants of India. $ompliance of the 7uidance 1otes issued by the Institute of $hartered Accountants of India. 1otification/8irections issued by the Institute of $hartered Accountants of India including those of a self-regulatory nature. And $ompliance of the provisions of the various relevant %tatutes and/or 4egulations& which are applicable in the context of the specific engagements being reviewed. Can %he %a( a)di%*r re+ise his %a( a)di% rep*r%, 7uidance notes on 4evision / 4ectification of 6inancial statement& state that the auditor may revise the audit report provided9 he gives it in the manner suggested by the institute. ut normally the report u/s 44A should not be revised. :owever& it may be revised on the following grounds. 4evision of accounts of company after its adoption in the annual general meeting. $hanges in law )eg* retrospective amendment $hange in interpretation )eg* $ 8T circular& judgment etc.& C*an+e o, -a. au/i-or an/ co/e o, e-*ics A chartered accountant in practice cannot accept a position as auditor previously held by another chartered accountant without first

communicating with him in writing. It will be in violation of clause);* of 3art I of 6irst %chedule to the chartered accountants Act !"4". <ven though there is proper communication the incoming auditor should before acceptance must ensure all the undisputed fees must have been paid as per notification no !$A)=>/4#/""dated?;/!>/""of I$AI. The communication must be effective one& hence it should be by registered ac-nowledgement due or by hand delivery with written ac-nowledgement. ACCOUNTING STANDARDS (@hile discharging their attest function it will be the duty of the members of the Institute to ensure that the Accounting %tandards are implemented in the presentation of financial statements covered by the Audit 4eports. In the event of any deviation from the standards& it will be also their duty to ma-e ade,uate disclosures in their reports& so that the users of such statements may be aware of such deviation (. Aandatory accounting standards are also applicable in respect of financial statements audited under %ection 44 A of the Incometax Act& !"#!. The I$AI has issued various accounting standards to harmoniBe the diverse accounting polices and practices in consonance with the International Accounting policies and statements. The corporate and non-corporate entities are subject to these mandatory regulations $0 ( VALUATION OF CLO!ING !TOC"

ACCOUNTING !TANDARD

As per the A%?& stoc- has to be valued at cost or net realisable value whichever is less. %ection !40 of the Income-tax Act& provides that valuation of inventory shall be made on the basis of the method of accounting& regularly employed by the assessee but subject to certain adjustments. The method of valuation of stoc- must be consistently followed from year to year and the method followed must be brought out clearly. 4ef5 CIT Vs -ri%ish .ain%s /%d.0 (1991) 1!! IT# 44(SC) C*rb*r)nd)m 1ni+ersal /%d.0 1 3 IT# &9 (2ad)

The $alcutta :igh $ourt has held in the case of CIT Vs 1CO -an3 (1993) 244 IT# $! (Cal *& that an assessee cannot adopt a system of stoc- valuation notionally for Income-tax purpose& which is different from the one which has been consistently followed by the assessee. As per the A%?& for determining the cost of inventories& loose tools& abnormal waste of materials& labour or other production costs are to be eliminated. The storage cost other than direct production process cost& administration overhead& interest and finance charges& selling and distribution cost are to be excluded. In case of any deviation& the tax auditor has to disclose all the deviations and its impact on the financial statement. The closing stoc- has to be valued either at 6I6C or @eighted Average method. This method will reflect the fairest possible approximation of the cost incurred in bringing the inventories to the present location and condition. The closing stoc- has to be valued at cost or mar-et value whichever is less& but in the following circumstances the valuation of closing stoc- has to be made as stated below. Val)a%i*n *5 s%*63 in 6er%ain 6ir6)ms%an6es. A proprietor wants to contribute his closing stoc- to a firm as a capital contribution for which he adopted cost of the closing stoc- as his contribution. The assessing officer cannot compel the mar-et value as the contribution. If the partners agreed for the particular value there is nothing in law& which would compel them to adopt a method of valuation of stoc- different from the one that they had chosen to adopt. 4efer5 CIT Vs #.Ven3a%a6hariee (1999) 14 TA72A8 43! (2ad) @here in the case of dissolution of the partnership firm by mutual consent or on the death of the partner the closing stoc- has to be valued on the basis of mar-et price only. 4efer5 CIT Vs .aran9*%hi 8adar (1999) 244 IT# 13 (2ad)

@hen a new firm is formed after dissolution and the opening stoc- of the new firm has to be valued at mar-et price 4efer5 V Chandrapra3asa 8adar : C*.0 Vs CIT (1999) 14 Ta(man 31 (2ad). @here in the case of dissolution of the firm on the death of one of the partner and the firm is reconstituted with the remaining partner and the business is continued the closing stoc- has to be valued at cost or mar-et value whichever is less. 4efer5 Sa3%hi Trading C*.0 Vs CIT (2441) 2&4 IT# ! 1 (SC) @here in the case of a dissolved firm& which discontinued the business& the closing stoc- has to be valued at mar-et rate and higher income has to be offered. 4efer5 A/A ;irm Vs CIT (1991) 1!9 IT# 2!& (SC)0 CIT Vs .*p)lar A)%*m*biles (2441) 119 Ta(man $33 (Ker)0 CIT Vs 'i<a =le6%ri6als (1999) 23! IT# 924>(199!) 141Ta(man 4$4 (Ker). %toc- valuation difference between ban- statement and register maintained or stoc- value adopted The stoc- valuation discrepancies between stoc- records and one given to the ban-ers for obtaining the over draft facilities can be considered as income. :owever the tax auditor must satisfy himself by ma-ing proper reconciliation of the two stoc- figures. 4ef5 CIT Vs #)darappan : C*.0 (19!4) 14 IT# 244 (2A')0 CIT Vs -hara% 2ineral Sales C*rp*ra%i*n (2442) 2&3 IT# 419 (Cal) ?he%her s%*63 regis%er 5*rms par% *5 b**3s *5 a66*)n% *r n*%, It is clear from the definition for boo-s of accounts the stocrecord also forms part of the boo-s of account to be maintained by the assessee. The method of maintenance& test chec-s& periodical physical verification conducted by the assessee and other rectifications are to be verified during the tax audit. Cur Institute is also discouraging the method of disclosure of the value closing of stoc- as certified by the management in the audit report. :owever& it is advisable to get the management representation in this regard.

7uidance notes on audit of inventories& stipulates that the tax auditor should obtain management representation from the client& description in detail of location& methods 2 procedures of physical verification and valuation of inventories. The tax auditor shall exercise his professional judgment as to whether the absence of such records would affect his reporting re,uirements.
DI!CLO!URE

Aeasurement of Inventory - costs or net realisable value $ost formula used - 6I6C or weighted average.
ACCOUNTING !TANDARD

1 2 ( REVENUE RECOGNITION

The (4evenue 4ecognition+ deals with the bases for recognition of revenue arising in the course of the ordinary activities of the enterprise from5 The sale of goods The rendering of services and The use by others of enterprise resources yielding interest& royalties and dividends (4evenue+ is the gross inflow of cash& receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods& from the rendering of services& and from the use by others of enterprise resources yielding interest& royalties and dividends. (4evenue+ is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. In an agency relationship& the revenue is the amount of commission and not the gross inflow of cash& receivables or other consideration. 4evenue recognition is mainly concerned with the timing of recognition of revenue in the statement of profit and loss of an enterprise. 1ormally the revenue recognition is determined by agreement between the parties involved in the transaction. @hen uncertainties exist regarding the determination of the amount& or its associated costs& these uncertainties may influence the timing of revenue recognition.

asis for recogniBing revenue5 %ale of 7oods. The following are the -ey criteria for determination for recogniBe the revenue5 %ale of goods between the seller and buyer& The goods must be sold for a consideration& and the ris- and reward must be transferred The transfer of property in goods& in most cases& results in or coincides with the transfer of significant ris-s and rewards of ownership to the buyer. If the transfer of property in goods does not coincide with the transfer of significant ris-s and rewards of ownership& 4evenue in such situations is recognised at the time of transfer of significant ris-s and rewards of ownership to the buyer. At certain stages in specific industries& such as when agricultural crops have been harvested or mineral ores have been extracted& performance may be substantially complete prior to the execution of the transaction generating revenue. In such cases when sale is assured under a forward contract or a 7overnment 7uarantee of where mar-et exists and there is a negligible ris- of failure to sell the goods involved are often valued at net realisable value. %uch amounts while not revenue as defined in this %tatement& are sometimes recognised in the statement of profit and loss and appropriately described. !5 - $ 8T A%-I - 8isclosure of accounting policies A$$CD1TI17 %TA18A48

A%-!

Accounting standard ! of the Institute deals with disclosure of significant accounting policies adopted by the entity. The accounting policies adopted by the entity will have a bearing on its taxable income. Thus& while verifying the disclosure of accounting policies& the auditor will have to bear in his mind the implications in audit report u/s.44A . The accounting standard ! issued under the Income-tax Act& !"#! is similar to the one issued by the Institute.

According to Accounting %tandard !& 8isclosure of Accounting 3olicies& (accrual+ is one of the fundamental accounting assumptions. The %tandard re,uires that if any fundamental accounting assumption is not followed in the preparation and in the presentation of financial statements& the fact should be disclosed. All significant accounting policies should be disclosed as part of the financial statements in one place and any change there of which has a material effect should be disclosed. If fundamental accounting assumptions viB.& going concern& consistency and accrual are not followed& it should be disclosed.
DI!CLO!URE

All significant accounting policies should form part of 6inancial %tatements. If there is a $hange in policies with material impact& it should be disclosed. If 6undamental assumptions are not followed& the fact has to be disclosed.
ACCOUNTING !TANDARD

30 ( C)DT ( A! $

A%-0 deals with prior period items and changes in accounting policies. The Auditor has to decide whether an item is in the nature of prior period after considering the facts of the case. Accounting %tandard - ? has been issued under Income-tax Act& which also deals with prior period items. If there is a conflict between the notified accounting standards of the Income-tax Act and accounting standard of the Institute& the notified accounting standard of the Income-tax Act shall prevail for tax audit purpose. The changes in the accounting estimates is not re,uired for the purpose of treating an item as a prior period item in the tax audit report& though it is a relevant issue in A%-0. As a tax auditor& one has to report on the prior period items debited to profit 2 loss account. In the computation statement& many of the auditors disallow the same& while some allow. This is always a debatable area. The prior period items are mainly because of

omissions or errors of previous years. The expenses relating to earlier years cristalised during the year need not be a prior period item.

DI!CLO!URE

Any material effect should be disclosed @here it is not ascertainable& the fact should be indicated

MET4OD OF ACCOUNTING

The accounting standard of The Institute of $hartered Accountants of India and Accounting %tandard of $ 8T are applicable. The assessee must disclose the following information5 Aethod of computation of stoc-5 8isclosure in financial statements5 Firs- -ime -a. au/i1o tax audit was made in the previous assessment year& the tax auditor of current assessment year must verify previous year methods followed by the assessee. The tax auditor should report the method of accounting followed and if there is any change& it may not be difficult to verify the method of accounting followed in the earlier previous year. :e should apply his professional experience and satisfy that there is no change in the method of accounting employed during the previous year. :ence it is not necessary for him to verify the previous year accounts. @hether addition can be made due to change in the method of accounts/ The 7ujarat :igh $ourt observed that the change in the method of accounting was a bonafide and consistently followed in the subse,uent years. It was held that no addition was warranted as no substantial ,uestion of law was involved. There is no ,uestion of invo-ing 26. '*@els de6isi*n 1&4 IT#. #e5 A CIT Vs S*ma Te(%iles :

Ind)s%ries /%d.0 (2&3 IT# 13 B)9)0 Spe6ial lea+e pe%i%i*n dismissed bC %he SC 2&2 IT# ST $4.
AUDITING AND A!!URANCE !TANDARD!

The auditing and assurance standards are our basic tools to conduct any audit and it has to be followed with out any reservation. asic principles governing an audit -AA% !

$ompliance with the standards to be ensured whenever an audit including a tax audit is carried out. Application of auditing procedures and reporting practices appropriate to the particular situation. Auditor should show integrity& objectivity and independence. Audit should be performed and report prepared with due professional care by persons having training& experience and competence in auditing. Auditor should have specialiBed s-ills and competence to carry out audit. Auditor should ensure that all accounting information that should be recorded has in fact been recorded. Auditor should review and assess the conclusions drawn from audit evidences to arrive at an overall conclusion with regard to the following. )a*6inancial statements have been prepared using acceptable accounting policies. )b*%uch policies are consistently applied. 6inancial information ensure compliance with the relevant provisions of the Income Tax Act& !"#! and other circulars& notifications& Income Tax 4ules and the principles laid down in various judgments. 8ocumentation AA%E

The auditor to document matters important in providing evidence that the audit was carried out in accordance with the basic principles of audit

8ocumentation refers to the wor-ing papers prepared/ obtained and retained by the auditor Audit planning AA% ; Auditor to plan his wor- with a view to conduct )a* An effective audit )b* In a timely and efficient manner 3lan to be based on the -nowledge of the clientFs business. 3lan to cover following )a* Ac,uiring -nowledge of the clientFs accounting system& policies and internal control procedures )b* <stablishing degree of reliance on the internal control. )c* 8etermination and scheduling the nature& timing and extent of audit procedures to be performed. Audit plan to be developed accordingly Na-ure o, Income(assessabil-y.
A74I$DGTD4AG I1$CA< H%-

D%I1<%% I1$CA<

Any person who is performing basic agricultural operation and who sells his products& the income earned there from is an agricultural income. If any person& who has done basic agricultural operation and later on transfers it into saleable conditions li-e transferring into pots etc.& sold in his nursery& is also an agricultural income. The Aadras :igh $ourt in the case of $IT Hs %oundarya 1ursery held this view 1$4 CT# 319 (2A')
A%%<%%A IGITI C6 I1$CA< D/%.

?;- D%I1<%% I1$CA< H% CT:<4 :<A8% At certain times it will be difficult to ascertain under which head the income has to be computed. There are number of cases where the business was leased out to outsiders or properties may be let out by the promoters of the building or there may be no revival of the business but there may be chances for getting only the lease income. The assessability as business income or income from house property

or income from other sources depend upon the lease agreements& facts and circumstances of each case. In the case of Sri. Dan)man S)gar and Ind)s%ries /%d +s CIT E2444F 2$$ IT# 14$ ECalF& it was held that the reason for leasing out the asset was due to financial difficulties faced by the company. The directorFs report also showed that the directors of the assessee company would continue to be associated with the management of the factory in advisory capacity and maintain day to day contacts with the activity of the factory. 4efAE1994F 24& IT# !! ECalF /a3shmi 8araCan -*ard 2ills +s CIT& exploit the asset short tenure. 4ef5 ACIT +s. 'ilna+a<.S. Vari+a E2443F ! I%d 113 E2)mF In the case of CIT +s Bambhir 2al .andeC .. /%d E2444F 2$$ IT# 2 4 E#AJF held& AC revealed that Aill had been given for lease and not for manufacturing during the year !"=E-=4 2 !"=#-==& since no business activities had been carried over by the assessee pertaining to manufacturing and till date the assessee had never ta-en bac- the Aill for same purpose& amount received from lease was treated as income from other sources. 4ef5 1ni+ersal .las%i6s +s CIT E1999F 23 IT# 4&4 ESCF factory let out ' earning income treated as income from other sources. Also 4ef5 Sri Indramani -ai +s ACIT E1993F 244 IT# &94 Income earned from the business center is assessable as business income. The assessee constructs a business complex and leases it to various parties and provides secretarial and other facilities. The department treats it as (income from house property+ ' ACIT +s Sap%harishi Ser+i6es /%d E2444F 2$& IT# 3 9 EB)9F Getting out furnished office premises to various parties and recovering the interest on security advances and collection of amount every month by month itself proves that the assessee is not exploiting the commercial asset& so that the income has to be assessed as+ Income 6rom :ouse 3roperty+- Dela h*ldings E.F /%d +s CIT E2443F 2$3 IT# 129 ECalF
I1$CA< 64CA G<TTI17 CDT 8<H<GC3<4%. DIG8I17% <GC17I17 TC 34CACT<4%

In the case of CIT +s Chennai .r*per%ies : In+es%men%s /%d E2444F 2$$ IT# ESTF $!& E2A'F it was held that income from letting out

buildings belonging to 3roperty 8evelopers has to be assessed as income from house property. The fact of the case was that no precise test could be laid down to ascertain whether income received by an assessee from leasing and letting out of assets would fall under the head Jprofit and gainsF of business or profession. If only few of the business assets are let out temporarily while the assessee is carrying out other business activity then it is a case of exploiting the business assets otherwise than employing them for its own use for ma-ing profit for that business. In case the assessee as owner of building was only exploiting the property as owner by leasing out the same and realiBing income by way of rent& such rental income was liable to be assessed under the head (Income from house property+. 3lease refer CIT +s Karnani .r*per%ies /%d E19 1F !2 IT# &4 ESCF0 CIT +s Indian O+erseas -an3 /%d E2444F 24$ IT# 24$ E2A'F. In #amp)r Ind)s%ries /imi%ed +s CIT E19 1F !2 IT# 23 EAll K& rental income from certain unused godowns derived by a company doing rice milling business has been held to be income from property. In the case of 'elhi Cl*%h : Beneral 2ills C*mpanC /imi%ed E19$$F &9 IT# 1&2 E.)n9F ' residential ,uarters to employees- Income from residential ,uarters is income from business. %ec. ?? does not apply to rent& if any charged for such property. In the case of CIT +s. Vi3ram 6*%%*n 2ills l%d.(19 ) 14$ IT# !29(All) there was a temporary suspension of business for a short period with the object of tiding over the crisis condition. There was never any act indicating that the company never intended to carry on the business in future. The :igh court was right in its view that the income derived by the respondent company by way of lease rent from letting out of its assets was assessable to tax under the head (profits and gains. I1$CA< 64CA A8H<4TI%<A<1T :CA48I17% The above income is treated as income from other sources not as income from property. 4ef in the case of 2)3her9ee =s%a%e E.F /%d +s CIT E244F 244 IT# ECalF.
34C6<%%IC1 C6 I16C4AATIC1 T<$:1CGC7I

A $hartered Accountant after passing I%A or $I%A surrendered his certificate of practice and started his own software consultancy& development and system audit and earned 4s.!0Ga-h as gross receipt - Is he liable for tax audit/ Ies. <ven though he has not been pursuing the profession of accountancy but he can be considered as a professional of information technology if his gross receipts exceeds 4s.!> la-hs attracts tax audit u/s 44A . 4ef 5 .r*5essi*n *5 In5*rma%i*n Te6hn*l*gC n*%i5i6a%i*n 8*.&43!& (=) d%.44"4&"2441. Information technology is a vast area we have to analyse from case to case basis with reference to the nature of service rendered by each person li-e software consultancy& developer& :ardware <ngineer etc.&
@4IT< A$L C6 AACD1T

Though there is a write bac- of liability amounts to gross receipt and if the gross receipt exceeded 4s.4>Ga-hs& will the assessee be liable for tax audit/ 7uidance note on tax audit clarifies that writing bac- of liability may be deemed to be the income u/s 4!)!* of the Act. The amount written bac- is a part of gross receipts for determining the tax audit u/s 44A . PARTNERSHIP FIRMS $onditions5 The amount paid by way of salary& bonus& commission or remuneration by a firm to a wor-ing partner is not deductable in the computation of income of the firm unless the following conditions are fulfilled5 The partnership& is authenticated by an instrument in writing& Individual shares of the partners should be specified in the deed of partnership. A certified copy of the partnership deed signed by all partners should be filed along with the return of income.

In case& there is any change in the constitution& sharing ratio or any other substantial changes effected during the year& a copy of deed of reconstitution should be filed along with the return for the relevant assessment year. There should be an authorisation in the partnership deed& in the case of payment of remuneration& commission and interest to the partners. If the firm has not filed any of the above documents along with the return on income& it has to be assessed only as AC3 up to the assessment year ?>>E-?>>4 The 6inance Act ?>>E& has modified the assessment of firms& by altering %ection !;4 and !;0. :ence& with effect from the assessment year ?>>4->0& for non-filing of the above documents& the firm will be treated as a firm and assessed at the tax rate of E0M after disallowing the partnerFs remuneration& bonus& commission and interest.
:D6 A% A 3A4T1<4

The remuneration paid to a partner who represents& as an :D6 has to be considered in accordance to the definition given for (@C4LI17 3A4T1<4+. As per the <xplanation 4 to %ection 4>)b* (@or-ing partner+ means an individual who is actively engaged in conducting the affairs of the business or profession of the firm& in which he is a partner. %ince the :D6 cannot be treated as an individual for this explanation& the department may disallow the remuneration paid to the representative. In the view of the legislature& :D6& not being a person& is not entitled to enter into contract. :ence :D6 cannot be a partner as was decided in the case CIT Vs Kal) -ab)lal6hand (19&9) 3 IT# 123 (SC) %uch partnership cannot exist even under the rules of :indu law& as was the case in #amla(man S)gar 2ills Vs CIT (19$ ) $$ IT# $13 (SC) 6urther& as held in the case of #ashi3 /al : C*.0 Vs C*mmissi*ner *5 In6*me"%a( (199!) 9$ Ta(man 1$ (SC)0 in the judgment& the %upreme $ourt has considered the firm& as an Association of individuals. It

also considered that partnership with :D6 is e,ual to partnership with other firms. It has been held that& in both the cases the person entered as a partner on behalf of :D6 or another firm will not be considered as a partner. This decision was given with respect to the payment of $ommission made under section 4>)b* of the Income-Tax Act& !"#!. efore the new system of assessment of firms& came into& the payments made to a partner were not allowed as deduction. %alary paid to a partner who is representing his :D6 in the firm& in his individual capacity& is disallowable u/s 4>)b* ' :D6 directly or indirectly cannot become a 3artnership of a 6irm. $IT Hs Aanalal 1. $ho-shi )?>>?* !?0 Taxmann 4#> )7uj* @hether :D6 can be a partner/ @hat should be recitals in the partnership deed with respect to the :D6 partner/ In case of payment of salary or interest )as per the partnership deed* made to the 3artner representing the :D6& in whose hands should it be assessed/ In the hands of the individual or :D6/ !. :D6 can be a partner. Any member of the :D6 can represent it as partner. ?. The recitals in the deed should only be the name of a person. It should not be as N ):D6* or N represents :D6. E. It should be treated as individual& as :D6 cannot be a wor-ing partner. %alary paid should be allowed as regular one. The individual can offer the same as :D6 income. In that case the income will be treated as income from other sources in the hands of the :D6. In various judicial decisions relating to law& prior to >!->4-"E& it was held that the remuneration paid to a partner& because of :D6 funds being invested in the firm has been treated as :D6 income. If the amount was paid with respect to the s-ill& experience etc.& have the partner& it will be treated as individual income.

In a recent decision of the ITAT in the case of ITO +s Veg)nda S)rCa .ra3asha #a* S*ns : 6* E2444F !! IT' 322 E+i<agFF ES2CF & the tribunal has analysed& the various %upreme $ourt decisions& about the impact of remuneration& paid to a partner representing the :D6 and concluded that the remuneration can be allowable as deduction. The ITAT has considered %upreme courtFs decision in the case of #ashi3lal : C* Vs CIT E199!F 229 IT# 4&!0 to support the remuneration claim as allowable u/s. 4>ObK of IT Act. :owever& it is left with the assessing officer to assess the remuneration either in the hands of the individual or in the hands of :D6. 4ef 5 Vans*n Kids S%)55 Vs ACIT0 9 TTJ 1&& Cther cases for reference5 1. CIT Vs KA/1 -A-1/A/CDA8' (19&9) 3 IT# 123 (SC) 2. 2a%h)ra .rasad Vs CIT (19$$) $4 IT# 42! (SC) 3. 2.'han@a%eC Vs CIT (19$!) $! IT# 3!& 4. T*laram -ri9 -)@ar Vs CIT (19 !) 112 IT# &4 (SC) &. T./.Agar@alla Vs CIT (19 !) 114 IT# 4 1 (SC). $. Smr)%hi Trading C*.0 Vs ITO (2441) 11! Ta(man 1&1.

REMUNERATION VS CASH SYSTEM:

Assessee is a firm following cash system of accounting. At the end of the year& it earns profit of 4s.0 la-hs and debit 4s.!&;>&>>>/- by way of journal entry to partnersF remuneration. 3artners do not withdraw the amount. In the second year also it earns a profit of 4s.0 Ga-hs and debit 4s.!&;>&>>>/- by journal entry to partnersF remuneration. In the same year& there are withdrawals by partners of 4s.? Ga-hs. @hat will be the amount of remuneration allowable in the second year/ @hether 4s.!&;>&>>>/- or 4s.E&#>&>>>/-. There are strong points even in the cash system& if the partners account credited with remuneration& it can be considered as payment. :ence each year remuneration can be claimed as expenditure in the hands of the firm.

3A4T1<4% 4<AD1<4ATIC1 H% $GAIA%5

An assessee has borrowed money from outsider for investing in a firm in which he is getting remuneration as a wor-ing partner. :e has paid interest towards the borrowing and claimed it as expenses against the remuneration received. $an it be allowed/ In the case of San%h*sh K)mar Agar@al Vs ACIT ! IT' 394 (S2C) the Aumbai Tribunal allowed the above claim on the basis of %upreme $ourt ruling in CIT Vs #.2.Chidambaram .illai 14$ IT# 292.
T<4A% C6 T:< 3A4T1<4%:I3 8<<8 H% 4<AD1<4ATIC1

A partnership firm consisting of 4 partners in which each partner is entitled to claim 4s. ?>>>>/- as remuneration. 8ue to non availability of profit& the partners have claimed 4s.!=>>>/- per partner as remuneration& in the boo-s. The AC has ta-en the view that remuneration paid is less than the amount specified in the partnership 8eed. :ence it is not in accordance with the 8eed and is not allowable in computing the income of the firm. The firm was able to demonstrate& though there is a clause in the partnership 8eed for higher remuneration& but the allowability under the Act is less than the amounts specified in the 8eed due to over all ceiling specified u/s. 4>ObK OvK. The Tribunal has considered and held that since the overall remuneration paid is within the limits specified under 4>ObK OvK the remuneration paid by the firm was allowable. 4ef 5 B*pal 'ass K)l@an% #ai Vs ITO (2444) !! IT' 44& (Chand) Allowability of remuneration on returned income and assessed income5 @e have seen in number of cases that in the assessment& the returned income is increased by the assessing officer. A partnership firm would have filed its return of income& where it may not be possible to allow the full remuneration as per deed. ut the assessing officer may determine higher income or would not allow loss after disallowing certain deduction. @hether the partner can get full deduction of remuneration based on the assessed income/

Though the income determined by the assessing officer is subject to test before the appellate authorities& which has legal sanctity. Aore over he has to compute the income as per chapter IH 8& hence the assessee is entitled to claim allowable remuneration as per law. $onse,uently it has to be assessed in the hands of the partner as per proviso to section ?;)v* and section ?)?4*)ve* of the Income-tax Act. The assessing officer may option to rectify the partnersF assessments. ut& in certain circumstances the assessing officer may not allow the remuneration on the assessed income as it results in revenue loss& if it is distributed in the hands of partner.
8<AT:/4<TI4<A<1T C6 A 3A4T1<4 8D4I17 T:< 6I1A1$IAG I<A4.

8eath/retirement of a partner during the lifetime of the partnership firm is yet another clause in respect of dissolution/continuance of firm etc.& in partnership deed in the event of the death of a partner amounts to change in constitution of firm and whether section !;=/!;; is attracted or not etc.& The decision in CIT Vs S)rCa -haga@an Vas%ralaCam (A.) helps us to arrive at the following conclusions5 6rom a reading of section !;= 2 !;; it is clear that if there is a change in the constitution of the firm& %ection !;= is attracted and single assessment has to be made on the firm as constituted at the time of ma-ing the assessment and the death of a partner is not treated as a fact for changing the constitution of the firm for purpose of the section. 8epending upon the clauses mentioned in the partnership deed& we have to loo- into& whether a firm stands to continue )or* be dissolved on death or retirement of a partner. This ,uestion is s,uarely covered by a decision of the %upreme $ourt in the case of $IT Hs <mpire <state )!""#* ?!; IT4 E00 in which& the court held that .%ection !;; states that where a firm carrying on a business is succeeded by another firm and the case is not covered by section !;=& separate assessments have to be made on the predecessor firm 2 the successor firm. .change in constitution of the firm is defined for the purpose.

Cther cases ref5 CIT Vs T.8aggi #eddC (1993) 242 IT# 233 (SC) 8a+a Jee+am 1dC*g 2andir (.) /%d.0 Vs CIT (1994) 24 IT# 44 (B)9) In case of death of one of the partner and where the deed is silent regarding the continuance of the firm then there will be two assessments on the firm. 6or the period upto the date of death and the period thereafter. @aBir Ali Hs $IT )!";;* !#" IT4 =# )%$*.
A33GI$ATIC1 C6 %<$.

40)4* - 8issolution Hs reconstitution

The partnership firms with immovable properties are now vulnerable for tax litigation in case of retirement and dissolution in view of section 40)4*. @hile considering applicability of section 40)4*& on distribution of assets by firm to partners& it should be well analysed& if such distribution of assets by the firm to the partners& is a case of distribution of the capital asset of the firm by withdrawal by the partner or sale of the capital asset of the firm to the partner. :ere& distribution will have to be defined and further be understood that no consideration is involved in distribution as was held by the -*mbaC Trib)nal in -)rling%*nGs =(p*r%s Vs CIT (1993) 4& IT' 424. 6or attracting the provisions of %ection 40)4*& mere dissolution alone is not sufficient but& there should be distribution of the assets also. The decision rendered by the Aadras :igh $ourt in CIT Vs Vi9aCala3shmi 2e%al Ind)s%ries (2442) 2&$ IT# &44 (2ad)0 it was held that the dissolution may ta-e place in one year and distribution may be in future. In this case& if two partners carried on the business and one of them expired. 1aturally& by the operation of law the firm was dissolved. There is no distribution of assets though the business continued. As per the wording in section 40)4* .the previous year in which the transfer ta-es place. the capital gain tax liability will arise.

The decision rendered in CIT Vs Therm*5li6s India ( 199 ) $4 IT' &&4 ( Jab"Tri) is important as regards %ec 40)4*. As per this decision& even-though the tax liability under capital gain arising out of dissolution of firms& is taxable& since the word ( Transfer ( as defined by %ec ?)4=* of Income Tax Act !"#! is not amended& the asset distribution and the dissolution will not attract the capital gains tax. In another case& it was held that& as per sec 40)4* which itself& is a charging %ection& so there is no need for a separate amendment in the definition of capital asset. As per the decision rendered in S@amC S%)di* Vs ITO $$ IT' 2 $ (2ad) the tribunal held that ( %ection 40)4* is a separate code by itself& providing for a levy of capital gain tax& on distribution of assets among the partners on dissolution of the firm. $harge of tax and legislative intent cannot be defeated by referring to the definition (Transfer+ given in section ?)4=*& which is a restrictive definition and not applicable to the provisions of section 40)4* because it is a charging section.. The core ,uestion is whether changes resulted in the reconstitution& will be considered as dissolution of the firm. In CIT Vs .ig*% Champan : C*. AI# 19!2 SC. !>;0& it was held that ( It can not be disputed that dissolution and reconstitution are two distinct legal concepts& for& a dissolution brings the partnership while a reconstitution means the continuation of partnership under altered circumstances. i.e. 8isappearance of the original firm and the birth of the new firm (. In the case of Vish@ana%h Se%h Vs CIT (19!4) 14$ IT# 2490 held that (4econstitution without dissolution does not bring into existence a new firm. In case of reconstitution& the same firm continues to exist+. The $alcutta and Aadras :igh $ourts expressed the same view. Cther cases ref5 S*hanlal .a6hisia : C*.0 Vs -ilasraC Khemani AI# (19&4) Cal 1 9 and 2eena3shi A6hi Vs ..S.2.S)bramanian Che%%iCar AIT(19& )2ad !.

The Apex court affirmed the view in CIT Vs A.?.;iggies : C*.0 (19&3) 24 IT# 4>0 and held that (P..The reconstituted firm can carry on its business in the same firmFs name till dissolutionP+ In CIT Vs San% /al Ar+ind K)mar (19!2) 13$ IT# 3 9 & 8elhi :igh $ourt expressed the view that (P.If one can imagine a partnership as an association of persons bound by a legal type or vinculum juris& a change in the constitution of the firm reflects only an adjustment of this legal tie which binds the partners. It is as if there is a belt which encircles all these partners and the belt either shrin-s or expands to accommodate or give effect to an incoming or out going partner. A dissolution& on the other hand& is a brea-ing or a disruption of this legal tiePPP..+ It is thus beyond doubt that under the Indian partnership Act& the same firm continues to exist in spite of change in its constitution and that it ceases to exist only on its dissolution that being so& there is no case of transfer. As per the Tribunal decision 'C. CIT Vs B.K.=n%erprises (2443) 9 TTJ 42 (2ad)0 there is no capital gain tax u/s 40)4* in the case of retirement of a partner from a firm. The decision rendered by the Larnata-a :igh $ourt in CIT Vs 2angl*re Banesh -eedi ?*r3s (2444) 2&$ IT# $&! (Kar) & is an another view relating to the dissolution of a firm and its subse,uent continuance of the business& by the erstwhile partners as AC3& which will not attract %ection 40)4* and no $apital gain tax will arise for the firm or AC3. The Lerala :igh $ourt in the case of CIT Vs K)nnam3)lam 2ills -*ard (2442) 2& IT# &44 (Ker) held that& the retirement of partner from the firm after receiving their credit balances will not be covered u/s 40)4* of the Income-tax Act. In this case the assets have been revalued and the amounts were credited in the partners account. The partners have received larger amounts on their retirement from the firm. The decision rendered by the ombay :igh $ourt in CIT Vs A.8. 8ai3 Ass*6ia%es and an*%her (2444) 2$& IT# 34$ (-*m)0 will create yet another confusion about the word ( otherwise+ in %ection 40)4*.

As per this decision& if the retiring partner receives any property during the subsistence of the firm even without dissolution& %ection 40)4* will attract and the firm is liable to pay capital gain tax.
I1$CA< A$$4D<8 DT @AIH<8 A6T<4 T:< 34<HICD% I<A4-<18%.

@hether the partners& can decide not to charge interest or waive the same/ @hat is the treatment in the hands of the partners/ It should be treated as income in the hands of the partner even though no charge of interest is made in the boo-s of firm and It is only application of income as taxable . 4ef 5 CIT Vs K#2TT. Thiagara9a Che%%C : C*. (19&3) 24 IT# 2&0 S-T Vs CIT 1&! IT# 1420 CIT Vs Shi+a .ra3ash Jana3ra9 : C*.0 (.) /%d.0 222 IT# &!3 #e5 A Saras@a%hi Ins)ran6e C*. /%d.0 Vs CIT 11$ Ta(man 34$ ('el)
CCL 34C6IT

The remuneration to partners depends upon the computation of booprofit of the firm. The allowability will vary with reference to this computation. As per the explanation E to section 4> )b* the .booprofit. means& the net profit as per profit and loss account which has to be arrived in the manner laid down under chapter IH ' 8 of the Income-tax Act. The firm has to compute the taxable income before claiming the remuneration to partners allowable as per section 4> )b*.
$CA3DTATIC1 C6 3A4T1<4% 4<AD1<4ATIC1& $A44I 6C4@A48 GC%%<% 2 D1A %C4 <8 8<34<$IATIC15-

Is it necessary to consider& the carry forward and set off of losses and unabsorbed depreciation& to compute the boo- profit to arrive at the eligible remuneration allowable to the partners/ The carry forward and set off of losses is governed by chapter HI hence it has no bearing on the boo- profit computation under chapter IH8. :owever the unabsorbed depreciation re,uires a different treatment. The old section E?& has been re-incorporated by the finance Act ?>>!. The decision rendered by the %upreme $ourt in $IT Hs

Hiramani Industries )3* Gtd.& )!""0* ?!# IT4 #>= is applicable to the present section E?. The independent operation of section E?)?* in chapter IH8 has to be applied for purpose of computation of booprofit. The unabsorbed depreciation has to be considered as current depreciation. :ence for the purpose of arriving at the boo- profit u/s.4> )b* the unabsorbed depreciation has to be considered w.e.f. the Asst. year ?>>?-?>>E& to determine the allowable remuneration. Another view is that unabsorbed depreciation& need not be treated as current year depreciation& for arriving at the boo- profit of the firm as the same was already adjusted in the earlier years. The brought forward loss precedes unabsorbed depreciation even as specifically provided under section =?)?*. The %upreme $ourt has ta-en the same view in $IT Hs Aother India 4efrigeration Industries O3K Gtd.& )!";0* !00 IT4 =!!)%$*. This conclusion may support the view that the unabsorbed depreciation need not be considered& to arrive at boo- profit.
CCL 34C6IT H% I1$CA<-TAN GIA IGITI

The remuneration fixed on the basis of percentage of net profit is another area of controversy as to whether the net profit arrived for the purpose of business income as per the IT Act has to be ta-en or merely deduct all the expenses including the income-tax liabilities. As per the decision rendered by the Lerala high court in the case of $IT Hs Lajaha $o O?>>4K ?## IT4 !??& the income tax liability need not be deducted both under the general law and under the IT law to arrive at the allowable remuneration on a certain percentage of net profit. I would li-e to draw your attention to this decision with reference to deferred tax liability or asset as per A% ?? which is applicable for non-corporate entities for the assessment year ?>>4?>>0. I1T<4<%T Interest paid to partners on current account whether admissible/

The petitioner& assessee claimed interest paid to partner both in respect of capital account and also in current account. The assessing officer disallowed the claim of interest on current account on the ground that the partnership deed did not authoriBe payment of interest on current account. In the case of 1ovel 8istributing <nterprises Hs 8$IT 2 Anr. ?0! IT4 =>4 OLerK& it was held that& the disallowance was correct because there was no provision in the partnership deed enabling such payment for the partnersF current account.
I1T<4<%T 3AI8 TC 3A4T1<4% I1 8I66<4<1T $A3A$ITI

@hether interest paid to a partner for the amount deposited in different capacity allowable/ <ven though the partner representing in different capacities either an individual or as partner& the interest paid will not be hit by section 4> )b*. 4ef 5 $IT Hs :eralal chagan lal )?>>?* ?0= IT4 ?;! )4aj*. In case& the :D6 is a partner the interest can be assessed in the hands of :D6.
I1T<4<%T TC CT:<4 6I4A

Interest paid by one firm to another firm could not be treated as interest paid to the partners of that firm within the meaning of sec.4> )b* even though the two firms have common partners. $IT H. 1agpur 7olden Transport $o. )!"";* ?EE IT4 E;" )8elhi*
I1T<4<%T 3AI8 CDT C6 C44C@I17 I1 3<4%C1AG 1AA< C6 T:< 3A4T1<4

3artner borrowed loan in his Individual capacity from ban- and advanced the same to the firm. The firm repaid the loan and interest to ban- directly. This cannot be disallowed u/s 4>)b* but allowable as interest paid. 8y. $IT Hs Lamala %han-ar .3 Qoshi 2 $o.& )?>>!* =" IT8 ??" )Aumb- Trib*.
4<HAGDATIC1 C6 T:< A%%<T H% I1T<4<%T 3AIA<1T%

A very interesting issue has been considered by the $handigarh bench of ITAT in the case of A$IT Hs %ant %hoes %tore O?>>4K ;; IT8 0?4 O$:8K O%A$K. In this case a firm& has revalued their assets and the revalued amount has been credited in the accounts of the

partners. The firm has paid interest on the revalued amount credited in the partnersF account. The AC has ta-en the view that the credit entry represents only notional introduction of capital and no actual contribution by the partners. :ence assessing officer& recalculated the interest and disallowed the same to the extent of the revalued amount credited in the partnersF account. The tribunal has ta-en the view that the appreciation in the value of the building which belongs to the partners under general law cannot be ignored. The accretion& increase& profit or gains in any shape and form accruing in the course of the business or during subsistence of the partnership belonging to the partners according to the share in the partnership. :ence the interest on the capital can be allowed as an expenditure in the hands of the firm.
%<T C66 GC%%<%

As per sec. =;O!K while carrying forward the loss and subse,uent by set off care should be ta-en with ref. to the change in constitution of the firm. The change due to retirement or demise of a partner will affect the carry forward loss of the firm since the loss to the extent of the retired or deceased partner has to be reduced for carrying forward to the subse,uent year.
IGG<7AG 6I4A

@hether the assessing officer has power to disallow interest or remuneration or both/ A firm constituted with five partners on the basis of licence in the name of one of the partner. The partners claimed interest and salary. The assessing officer refused to allow the interest and salary and decided that the firm is not a valid firm since there is no licence in the name of the firm and there is a restriction in the licence for the usage other than the person in whose name the licence was approved. In the case of Ab-ari Gaw& Arms Act the %upreme court held that if there is a specific prohibition in law for forming the partnership for the usage the licence the firm will be considered as illegal one. :ence applying this analogy the firm cannot be considered as a valid one

eligible to be treated as firm under Income-tax Act. 4ef5 CIT Vs #agila #am (2442) 2&4 IT# 234 (SC0 -ihari /al Jais@al Vs CIT (199$) 21 IT# 4$ (SC). A ,uestion of allowability of the remuneration and interest paid to partners have to be considered in each case. 3artner of a professional firm received remuneration from firm exceeding 4s.!> Ga-hs p.a- @hether Tax Audit u/s 44A necessary/ Ies. 4ef <xplanation ? to section !0 and %ection ?;)!* @hether material supplied by contractee is to be included in gross turnover of contractor/ In the case of .iCare /al Dari Singh Vs CIT (2441) 11 Ta(man 1>2&2 IT# 39 ('elhi) on the basis of the decision of the %upreme $ourt in -ri9 -h)shan /al .ard)man K)mar Vs CIT (19 !) 11& IT# &24 (SC)0 value of materials supplied by contractee is not to be included in gross turnover of contractor-firm while estimating profits. ut in the case of a single contract consisting of supply of material and construction entered by the contractor with contractee exceeds 4s.4> la-hs& he has to maintain the boo-s of accounts and subject to tax audit as per the instituteRs guidance note. :owever the different views are possible to apply sec.44A8 and 44 A . The A%= applicable for the construction contracts. %ince the percentage of completion contract method& has to be applied the ,uestion will arise whether the gross advance to be ta-en as gross receipt for the purpose of sec.44 A or billed amount should be ta-en into consideration. An assessee owns more than one business. The aggregate annual turnover of all business exceeds 4s.4> la-hs& but the turnover on individual item of business is less than 4s.4> la-hs. @ill tax audit u/s 44A be applicable/ If yes& how 6orm E$ /E$8 shall be furnished& as consolidated or not/ To examine whether an assessee attracts the provisions of %ec 44A . @e have to ta-e into account the gross receipts/sales of all

businesses carried on by him. :ence the assessee should be considered as a unit for all his business receipts for determination of tax audit u/s 44A . An assessee carries on more than one business. 4eport u/s 44A has to be given only in respect of the assessee. 8<34<$IATIC1 J3GA1TF 1CT TC I1$GD8< DIG8I17% C4 6D41ITD4< A18 6ITTI17% %ection 4E)E* has amended expressly and excluded buildings or furniture and fittings from the definition of the word JplantF. %ection 4E)E* defines the word JplantF in an inclusive manner& i.e.& plant includes vehicles& boo-s& scientific apparatus and surgical instruments used for the purpose of business or profession but do not include tea bushes or livestoc-. The words Jbut does not include tea bushes or live stoc-F are being extended by the addition of the words Jbuilding or furniture and fittingsF. This amendment will overcome the difficulty arising because of the interpretation given in certain judgments of the courts relating to plant and machinery. @hether building is treated as plant& when it can be considered as a means of carrying on business/ @here assessee with a definite purpose& considering the nature of business carried on by him& constructs a building with specific re,uired design -eeping in view specified technical re,uirement& without which assesseeFs business cannot be carried out& the building in ,uestion would ,ualify as plant for the purpose of section E? of IT Act. 4ef5 1owrangroy Aetals 3vt Gtd Hs. Q$IT )?>>E* ?#? IT4 ?E!. %upreme $ourt has held that :otel uilding is not a plant. :owever the operation theatre of the hospital is a plant. 4ef 5 $IT Hs Anand Theatres )?>>>* ?44 IT4 )%$*& $IT Hs 8r. .H.4ao ?4E IT4 )%$*. 1ow it is very clear that building etc.& will not constitute as plant @hether the depreciation has been claimed under the cash basis system of accounting/ If& yes on what amount/ Ies. 6ull value.

Is it optional/ The %upreme $ourtFs decision in 2ahendra 2illsHs 6ase was nullified by the 6inance Act ?>>!. It is mandatory on the part of the Assessing Cfficer to allow the depreciation as per the section E? in computing the income. In the tax audit report in 6orm E$8 the auditor has to give details about the depreciation claim& addition and deletion of assets/ In case the assessee does not want to claim depreciation the fact should be mentioned in the report. Is the concept of .used. in the business& shall hold good under law/ 8epreciation can be allowed only on machinery or plant or other asset used in the business. 1ow the bloc- asset concept is in the statute. <ven if any of the assets purchased during the year is not put into use but the existing asset in the same bloc- is used in business it is enough to claim depreciation. ecause& once new plant or machinery is purchased it will be merged with the bloc-. <ven in the earlier law if the assets are ready to use it is eligible for depreciation. ?hi%%le Anders*n /%d.0 Vs CIT (19 1) 9 IT# $13 (-*m) Capi%al -)s Ser+ies (.) /%d.0 Vs CIT (19!4) 123 IT# 444 ('el). Aachineries not used because of labour unrest/ In $IT Hs Hayithri 3lantations Gtd.& )!";!* !?; IT4 #=0 )Aad* @here the machinery was not used because of labour unrest& even then the assessee was held entitled to depreciation because of passive user. Temporary $losure due to crop failure ' eligible for depreciation. 4ef $IT Hs 4efrigerators 2 Allied Industries !#E IT4 4"; )8el* C@1<4%:I3 In Aysore Ainerals Gtd H. $IT ?E" IT4 ==0 )%$*& the assessee is in possession of the building on payment of part of the sale consideration. uilding not registered in the name of the assessee by the :ousing oard. The assessee has dominion over the property and in its own right allotted the building as ,uarters to the staff. The

staff is actually using the building. The assessee is held to be entitled to depreciation as a wide meaning must be given to the term Jowner J used u/s E?. @hether depreciation u/s E?)!* on building is allowable though transfer is not effected by means of registered instrument/ The full bench of the 3unjab 2 :aryana :igh $ourt in ?0! IT4 ;E> held that the Tribunal was right in holding that the assessee was entitled to claim the depreciation on building although the transfer of the building was not effected by means of registered instrument. 2Cs*re 2inerals /%d.0 Vs CIT (1999) 239 IT# & SCI 'almia Cemen% (-hara%h) /%d.0 Vs CIT (2441) 24 IT# 2$ SC
6DGG AACD1T $GAIA<8 A% 4<H<1D<.

8epreciation u/s E? for the assets purchased u/s E0 claimed full deduction ' not permitted. =s6*r%s /%d.0 Vs 1OI 199 IT# 43 (SC)0 CIT Vs DICO .r*d)6%s (.) /%d.0 24 IT# 9 (SC) @hether depreciation is allowable on spare engines -ept by the assessee in store/ Ies. The 3unjab 2 :aryana :igh $ourt held that there is a normal depreciation of value even when a machine or e,uipment is merely -ept in storeroom. Thus actual use of the asset may not be the relevant test in all cases. $IT Hs 3epsu 4oad Transport $orpn. O?>>?K !?! Taxman ?E?. @hether depreciation is admissible for trial run of machinery/ It was held in the case A$IT Hs Ashima %yntex Gtd.& )?0! IT4 !EE 7uj :$* that when there is commencement of business by way of production of articles it can be said that the assessee is entitled to depreciation. @hether Hehicles registered in the name of the partners but firm is claiming depreciation/

In $IT Hs Aohd ux %ho-at Ali )!* )?>>?* ?0# IT4 E00 )4aj* the 4ajasthan :igh court held that the Tribunal allowed the appeal of the assessee and the departmentRs& reference application was rejected on the basis that no ,uestion of law was involved. The :igh $ourt held it as a ,uestion of law. ut in the subse,uent decision for the same assessee in $IT Hs Aohd ux %ho-at Ali )?* on the basis of %upreme $ourt decision in Aysore Ainerals Gtd.& Hs $IT )!"""* ?E" IT4 ==0 )%$* held no ,uestion of law involved. The above decision can be applied for claiming depreciation for the assets in the name of partners. $an the rigs mounted on lorries eligible for higher depreciation/ 1o. The Aadras :igh $ourt disallowed the assesseeRs claim in $IT Hs Arihant Trust )?>>!* ?0! IT4 !4" )AA8* $an the Air $onditioner fitted in the bus forms part of integral part and eligible for higher depreciation available for buses/ Ies. As per the decision rendered by the 8elhi :igh $ourt in $IT Hs 8elhi Airport %ervice )?>>?* ?00 IT4 "! )8el* @hat would be the duty of the tax auditor if the department disallows the claim of depreciation on fixed assets in the earlier year/ If there is any dispute regarding classification& rate of depreciation or etc.& with the department the tax auditor should ma-e suitable disclosure depending upon the fact and circumstance of the case. PERSONAL EXPENSES The usage of the company vehicles by the 8irectors cannot be treated as personal use of the company vehicles and cannot be treated as personal expenses of the company. 4ef 5 SaCa9i Ir*n and =ng. C*. Vs CIT (2442) 2&3 IT# 49 (B)9) The expenses incurred for the partners foreign tour expenses for higher studies was allowed as business expenditure. The partners experience will be utilised for the firm in future.In CIT Vs K*hin**r .aper .r*d)6%s (199 ) 22$ IT# 224 (2.)

@hether expenditure on education abroad of son of partner who is also a partner of the firm is an allowable expenditure/ It was held in the case of A.%ubramaniam ros. Hs $IT )?0> IT4 =#" )?>>!* A8% :$* that the expenditure on the education of the partner of the firm was of personal nature and was not business expenditure. 6inancial 8irectors and his wife travelling and medical expenses incurred allowed as business expenditure. 4ef5 CIT Vs S%eel Ing*% (.) /%d.0 (199$) 224 IT# &&2 (2.) 6oreign tour expenses incurred for the wife of the chief executive is considered as business expenditure. 4ef5 CIT Vs Aspin@all : C*.0 /%d.0 (19&3) 231 IT# 14$ EKerF0 CIT Vs App*ll*% TCre /%d.0 (1999) 23 IT# 4$ EKerF
%<$.E#)!*)III*5 I1T<4<%T C1 C44C@<8 $A3ITAG

- 3<4%C1AG 1ATD4<

In the assessment proceedings the assessing officer may disallow the interest paid to ban-ers and others on account of the following reasons !. Interest free advance made to subsidiary companies. ?. Interest free advance or loan to partners or sister concerns. The assessing officer cannot ma-e any addition merely because of interest free advance or loan. :e must prove the nexus of borrowing and lending otherwise this disallowance cannot be made. 4ef 5 ' : D Se6her*n =le6%r*des (.) /%d.0 Vs CIT (19!3) 142 IT# &2! (2.)0 CIT Vs C*imba%*re Salem Transp*r% (.) /%d.0 (19$$) $1IT# 4!4 (2ad) In Addl. CIT Vs /a(mi Agen%s (.) /%d.0 (19!4) 12& IT# 22 (B)9)0 applied in the present case& it was held that once it is established that the capital was borrowed for the purpose of business& it is immaterial as to how that borrowed capital was applied for the purpose of business& because all that %ection E#)!* )iii* re,uires is that the borrowing on which the interest is paid should be used for the purpose of business.

In CIT Vs Se%hani Indermani Ja%a (19 !) 114 IT# &39 (All)0 not referred in the present case& it was held that the entire interest paid to a ban- on loan ta-en for the business purpose is allowable as deduction though part of loan amount is utilised for advancing interest-free loan to various parties. .a%el India (.)/%d. Vs 'ep)%C C*mmissi*ner *5 In6*me"%a( (1999) $3 TTJ 19. Interest on borrowed funds disallowed to the extent of diversion of funds to sister concerns as interest free advance. Interest disallowance same rate as applicable to the ban- borrowings ' SaraCa S)gar 2ills (.) /%d.0 Vs CIT 124 Ta(man 411 (All)
I1T<4<%T C1 C44C@<8 $A3ITAG

Interest on borrowed capital u/s E#)!*)iii*-when machinery purchased and the machinery has not been put into use in the previous year. @hether such interest is allowable/ I1T<4<%T C1 C44C@I17% ' %<$TIC1 E# )!* )III* 6or the assessment year ?>>4-?>>0 the investment made in plant or machinery or building out of borrowings& re,uire close scrutiny. After the amendment in section E# )!* )iii* if the machinery or plant or building etc.& are not put into use for the current year the interest on borrowings cannot be allowed as deductions.
T<4A GCA1 I1T<4<%T

@hether the conversion of interest due into term loan can be considered as payment u/s 4E / 1o. As per the decision rendered by the Aadras :igh $ourt in Lalpana Gamp and $omponents Gtd.& )?>>?* IT4 4"! )AA8* can not be allowed as payment. It is also not part with the sales tax loan allowed by the state 7overnment. %tatutory payments were made and the assessee issued a che,ue towards statutory payment on E! st Aarch ?>>4 but the realisation was made after !0 days. Is it an allowable claim/ As per the second proviso of section 4E the che,ue should be realised within !0 days. It is not the fault of the assessee. 4ef5 $IT Hs :industan @ire 3roducts Gtd.& )?>>?*!?> Taxman =44 )3un 2

:ar* @hat is the duty of the tax auditor of subcontractor regarding the 36 3ayment made by the main contractor on behalf of him where the liability in this regard is on the main contractor/ The tax auditor certifies only in respect of his assessee accounts and need not report of otherRs liabilities. :as the tax auditor to report about the professional tax deducted from the employees but not paid to the concerned authorities/ The tax auditor need not report as to whether the professional tax deducted by employer from the salary paid to employee has been paid to the credit of the concerned authorities. $A3ITAG C4 4<H<1D< 1ew <xplanation ' for the removal of doubts& it is hereby declared that the amount paid on account of the cost of repairs referred to in sub-clause )i* and the amount paid on account of current repairs referred to in sub-clause )ii*& of clause )a*& shall not include any expenditure in the nature of capital expenditure.
4<3AI4% TC DIG8I17% )%.E>*5

y explanation added in %.E>& it is now provided that cost of repairs and current repairs to building used for business or profession shall not include expenditure in the nature of capital expenditure. This amendment as well as amendments in %.E! and %.E# will invite litigation and will upset the well-settled law on the subject. In spite of this amendment& it will be possible to ta-e the view that renovation of any part of building )%. E>* or replacement of any part of machinery or plant )%. E!* does not amount to expenditure in the nature of capital expenditure. The %upreme court decision in Aadras Auto %ervices )3* Gtd.& clearly held that the building constructed on the leasehold land amount to revenue expenditure and will be applicable for the assessment year ?>>4-?>>0.

4eplacing subsidiary parts of a whole asset is 4evenue expenditure. 4eplacement of machines forming integrated plant will be allowable as deduction. $IT Hs %ri :ari Aills O!"""K ?E= IT4 !;; )Aad* %ection E! 1ew <xplanation ' for the removal of doubts& it is hereby declared that the amount paid on account of current repairs shall not include any expenditure in the nature of capital expenditure. The above two sections deal with the deduction allowable under income from business or profession. The word .current. referred in section E! means expenditure incurred relating to that current accounting period or year. The expenses incurred after such event of repair occurred. As per the $alcutta :igh $ourtRs decision& in D)maC)n .r*per%ies /%d.0 Vs CIT (19$2) 44 IT# 3 (Cal) the current repairs are necessary repairs to maintain the building plant etc.& They are not luxury repairs& the element of need being implicit in the expression. In the case of CIT Vs Ch*@g)le : C*.0 (.) /%d.0 (199&) 214 IT# &23 (-*m) certain& conditions have been fixed to allow deduction u/s E! of the Income-tax Act. As per the decision& the .current repair. means repairs underta-en in the normal course of user for the purpose of preservation& maintenance or proper utiliBation or for restoring plant and machinery to its original condition. $D44<1T 4<3AI4% H% 4<3AI4%5 The Aadras :igh $ourt in CIT Vs Sriram S)gar 2ills /%d.0 21 IT# 191 held that the meaning of the word .current. is not petty expenses but it means .belonging to the present time& prevailing.. In this case the assessee incurred expenditure for replacement of an old boiler by a new one but exactly similar boiler. The expenditure incurred was allowed as revenue expenditure. In the case of Bridhari 'ass : S*ns Vs CIT (19 $) 14& IT# (A//) it was held that the .current repairs. means only such repairs as are

necessitated by the day-to day wear and tear during the relevant previous year only& while .repairs. may mean accumulated repairs of several years. Cn an analysis of Aysore :igh $ourt decision in the case of :anuman Aotor %ervices Hs $IT )!"#=* ## IT4 ;;& it is seen that the result of the expenditure what is being done for the purpose of preserving and maintaining the existing asset is a repair. ut the object of the expenditure is to bring out a new asset as replacement renewal. The replacement of petrol engine by 8iesel engine in buses was held as revenue expenditure (CIT Vs Khalsa 2irbhai Transp*r% C*. /%d.0 (19 1) !2 IT# 41 (.:D) Addl. CIT Vs 'esai -r*@s (199 ) 14! IT# 14 B)9) CIT Vs 2*hd. IshaJ)e 2*hd. B)lam 214 IT# !1 2.. The replacement of old engine by a new one in a motor vehicle was held as revenue expenditure 8a%hmal -an3a%lal .a%ri3 : C*.0 Vs CIT (19!4) 122 IT# 1$! (A.";-) and CIT Vs Ja5erbhai A3bhara%h : -rs. 211 IT# 49$ (-*mb). In the case of CIT Vs C*"*p S)gars /%d.0 (99 Ta(man 93 K=#) (199!) the Lerala :igh $ourt held on the basis of the observation of the %upreme $ourt in the case of Alembi6 Chemi6al ?*r3s C*. /%d.0 Vs CIT (19!9) (1 IT# 3 >43 Ta(man 312 SC) that the end product viB. %ugar would be available only after the entire processing is complete and that would be complete only after the completion of the processing through all the machinery on which the assessee incurred the expenditure. The :igh $ourt thus allowed the entire expenditure on the replacement of entire new machineries as revenue u/s. E=)!* of the IT Act !"#!. The %upreme $ourtFs decision rendered in the case of CIT Vs Alembi6 Chemi6als /%d.0 (19!9) 1 IT# 3 (SC) wherein it was held that the expenditure incurred for advantage of business was a revenue nature. The Lerala :igh $ourt in the $ase of CIT Vs S%eel C*mple( /%d.0 (1999) 23! IT# 14&4 held that expenditure incurred for water

treatment plant and fume extraction plant without increasing the production capacity in allowable as revenue expenditure. 4ef5 CIT Vs 2adras Cemen%s /%d.0 (2442) 2&& IT# 243.0 the decision rendered by the Aadras :igh $ourt in the above case has distinguished the repairs& replacement and current repair. .4epair. implies the existence of a thing which has malfunctioned and can be set right by effecting repairs which may involve replacement of some parts& thereby ma-ing the thing as efficient as it was before or as close to it as possible. The $alcutta :igh $ourt has held in the case of CIT Vs Dind)s%an .il3ings%*n Blass ?*r3s /%d.0 (1994) $ 3 Ta(man $31 (Cal) that the assessee engaged in manufacturing rolled plate glass& demolished old furnace and reconstructed new one claimed as capital expenditure and subse,uently in revised return claimed it as revenue expenditure under current repair. :igh $ourt held that it was not a current repair. In the case of CIT Vs 2ahala3shmi Te(%iles 2ills /%d.0 (19$ ) $$ IT# 14& the %upreme $ourt held that the claim u/s E! on the ground that the new system introduced is not new machinery or plant but amounted to improved version of certain parts. In the case of 2adras Spinners /%d.0 Vs CIT 14 IT# (K=#) the Lerala :igh $ourt has allowed the modernisation programme by the Aill by spending amount on replacing certain parts of the machinery as revenue expenditure. The Lerala :igh $ourt has ta-en the same view in CIT Vs Sree -haga+a%hi Te(%iles /%d.0 24 IT#!2$ (Ker) and als* in Vana9a Te(%ile 2ills /%d.0 Vs CIT 24! IT# (Ker). In both these cases the assessee incurred certain expenditure towards modernisation of machineries for replacing certain parts and converting certain part of plant and machineries to improve the efficiency of their units. As there was no new plant or machinery& which came into existence& it was allowed as revenue expenditure.

The %upreme $ourt in -allimal 8a@al Kish*re Vs CIT 224 IT# 414 held substantial amount spent to convert the ginning factory as capital expenditure. The decision rendered by the Aadras :igh $ourt in Sri Dari 2ills Case is that the modernisation expenditure has been considered and allowed as current repairs. ut there is no reference about the %upreme $ourtRs decision in ??4 IT4 4!4. The 4ajasthan :igh $ourt in CIT Vs 1daip)r 'is%illarC C* /%d (2444) 134 Ta(man $1$ held that& the replacement cost of new transformer is a revenue expenditure even though the old transformer form part of the bloc- assets and not sold or discarded by the assessee. The Aadras :igh $ourt in the case of CIT Vs Bi%an9ali 2ills /%d.0 (2444) 2$& IT# $!10 has allowed the expenditure incurred for the replacement of machineries at a cost of 4s.#E&;>&!E! as revenue expenditure u/s E=. 4ef 5 Any expenditure incurred by assessee for improving the performance of its machines was to be allowed as revenue expenditure u/s E=. :ence the present amendment will not hold good for any expenditure covered u/s E= of the IT Act !"#!.
4<T4C%3<$TIH< <66<$T5

This amendment is not applicable for the pending assessments. This amendment though clarified one but in view of the decision rendered by the Lerala :igh court in CIT Vs Kerala =le6%ri6 /amp ?*r3s /%d.0 (2443) 2$1 IT# 21 (Ker) with reference to 6inance Act ?>>! relating to mandatory re,uirement of claim of depreciation held that these amendments are to be clarified& which are prospective in nature. 4ef5 T)%i6*rin Spinning 2ills /%d. Vs. (2443) 241 IT# 291 (2ad). %ection E? )!* )iia* inserted 5 @hether the amount of li,uidated damages received by the assessee for the delay in delivery of the capital asset& is capital or revenue/ It has been held in $IT Hs %urashtra $ement 2 $hemical Industries Gtd.& )?>>?* !?! Taxman ??E )7uj* that the amount received& was capital in nature since the amount of damages received had a direct nexus with the delay caused in the delivery of the capital asset.

The loan is ta-en at higher rate of interest by assessee company and given to director at lower rate of interest& whether the difference amount of interest can be disallowed/ Ies. In a case :.4. %ugar 6actory 3 ltd !;= IT4 E#E the loan is not for the business purpose @hether fees paid to 4egistrar of $ompanies for enhancement of capital& is an allowable expense u/s E=)!*/ The fees paid to 4C$ for enhancement of $apital is a capital <xpenditure and not deductible u/s E= )!*& 3unjab %tate Industrial 8evelopment $orporation Gtd Hs $IT )%$* ??0 IT4 ="?. ut the expenses incurred on raising finance through borrowers either by issue of debentures or otherwise is deductible as revenue expenditure as per decisions of India $ement ltd Hs $IT #> IT4 0? @hether expenditure on issue of share capital is an allowable expenditure/ The expenditure on issue of share capital treated as capital expenditure and not allowable as business expenditure. 4ef5 roo-e ond India Gtd H% $IT )%$* ??0 IT4 =";. Interest on income during the construction period taxable as per the decision rendered in Tuticorin Al-ali $hemicals 2 6ertiliBers Gtd.& Vs CIT (199 ) 22 IT# 1 2 (SC). Income from guesthouse rent& plant hire charges are not taxable but deductible from the cost of the project. 4ef5 CIT Vs -*3ar* S%eels /%d.0 (1999) 23$ IT# 31&0 -*ngagiga*n #e5inerC *5 .e%r* Chemi6als /%d.0 Vs CIT 2&1 IT# 329 (SC). $52!! an/ s*are a66lica-ion money The recent decision of Qhar-hand :igh $ourt in halotia <ngineering @or-s 3 ltd Hs $IT)?>>0* ?=0 IT4 E"" held that the share application money will attract %ection ?#"%%. TDS

@hen the credit will be given/ Aajority of the assessees who are following cash system of accounting and those who are following mercantile system of accounting face the problem of getting credit for the tax deduction made on their payments. As per section !"" the T8% amount paid to the credit of $entral 7overnment shall be treated as a payment of tax on behalf of the person from whose income the deduction was made. The credit will be given to him in the assessment on production of certificate furnished u/s ?>E. T8% credit for tax paid shall be given for the assessment year for which the corresponding income is assessable. There are number of instances when tax has been deducted but not remitted to the 7overnment. account. The decision of 7auhati :igh $ourt in the case A$IT Hs Cm 3ra-ash 7attani )?>>>* ?4? IT4 #E; where in held that the payee will not have any control on the deductor for the proper remittance to the 7overnment. :ence the payee should not be penalised but the credit should be given to him. Non(/e/uc-ion o, -a. an/ sec-ion 78%a'%ia' The Tax auditor has to ta-e larger burden in discharging his duty in case if the taxpayer failed to deduct or after deduction failed to remit the government account. The new section is very clear that the above failure will render these expenditures as non-deductible.
6IGI17 C6 TAN AD8IT 4<3C4T A18 3<1AGTI D/%

?=!

The tax audit report u/s. 44A has to be filed along with the return of income of the assessee. :owever the audit report may be filed first before the due date of filing even if the return of income is not filed& so as to avoid the penal provisions of section ?=! . If the tax audit report is not filed before the due date of filing of return& then penalty would be levied u/s.?=! . :owever penalty u/s.?=! would not be levied if reasonable causes existed& that prevented the assessee from filing return of income and obtaining audit report u/s.44A .

3enalty u/s.?=! is discretionary and not mandatory. The use of word (may direct+ in section ?=!- indicates the power of the assessing officer. 4ef5 Indian Dandl**m Te(%iles Vs ITO (1999) $! IT'&$40 Ass%. CIT Vs BaCa%ri Traders (199$) &! IT' 121 3enalty u/s. ?=!- is independent from assessment proceedings. It can be initiated even before compliance of assessment. Ass%. CIT Vs 2adani #*%les ;l*)r 2ilss (199 ) 1 IT' 2 4 (Asr) The counsel to whom the audit report u/s.44A handed over could not file in time is a reasonable cause for not filing the report in time. 4ef5 /alla .rasad Cha)rasia Vs (ITO) (1999) 144 Ta(man 114 (Jab) $ompletion of audit delayed due to statutory auditors is a reasonable cause for not filing the report in time. S*lap)ri Killa Vin3ar Saha3ali 5edera%i*n 8iCama% Vs. 'C.CIT (1999) 1 IT' 11 . $hange of auditor not proved for tax audit purpose. Gevy of penalty justified. C.#amas@amC Vs. ITJ (1999)$3 TTJ (2ad) Conclusion