Corporate Tax Planning

Corporate Tax
Planning
DIRECTORATE OF DISTANCE &

ONLINE EDUCATION
Corporate Tax Planning

Developed by: Dr. P.K. Sinha
2015
For private circulation Students Study Material of ADDOE.
All rights reserved. No part of this book may be reproduced, stored in a retrieval system, or copied in any form or by
any means, electronic, mechanical, photographic or otherwise, without the prior written permission of the author
and the publisher.
Published by: Himalaya Publishing House Pvt. Ltd., for Amity Directorate of Distance & Online Education, Noida
Syllabus
Course Objective:
At the end of the course, the students should be able to understand Indian Accounting Standards and the
impact of USGAAP on Financial Statements. To create an understanding of the accounting of Mergers and
Acquisitions and Valuation of goodwill and shares.
In addition to Corporate Accounting, the students should be able to demonstrate an understanding of the tax
provisions enabling them to make use of legitimate tax shelters, deductions, exceptions, rebates and allowances;
with the ultimate aim of minimizing the corporate tax liability.
Course Contents:
Module l: Accounting Norms
Various Accounting Standards in India and comparison with International Accounting Standards and
US.GAAP.
Module II: Accounting for Merger and Acquisitions
Accounting for Acquisitions of Business, Calculation of Purchase consideration and Profit (Loss)
Prior to Incorporation. Accounting for Amalgamation in the nature of Merger and in the nature of
Purchase.
Module III: Valuation of Goodwill and Shares
Valuation of Goodwill Different Methods of Valuation of Goodwill, Valuation of Shares Net Asset
Backing Method and Yield Method.
Module IV: Basic Concepts of Income Tax
Introduction to Income Tax Act, 1961. Residential Status, Exempted Incomes of Companies. An
overview of various provisions of Business and profession and Capital gains applicable to
companies
Module V: Assessment of Companies
Computation of taxable income, MAT, Set-off and carry forward of losses in companies, Deductions
from Gross total income applicable to companies. Tax planning with reference to new
projects/expansions/rehabilitation plans including mergers, amalgamation or demergers of
companies, Concepts of avoidance of double taxation.
Examination Scheme:
Component Codes
H1
H2
H3
EE1
Weightage (%)
10
10
10
70
Contents
Unit 1: Accounting Norms
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
1.10
1.11
Introduction to Accounting Standards

List of Accounting Standards in India
Comparison between Indian GAAP, IFRS and US GAAP
The Roadmap for Implementation of Ind AS
Summary
Check Your Progress
Questions and Exercises
Key Terms
Check Your Progress: Answers
Case Study
Further Readings
Unit 2 : Accounting for Mergers and Acquisitions

2.1
2.2
2.3
2.4
2.5
2.6
2.7
2.8
2.9
2.10
2.11
2.12
2.13
2.14
2.15
2.16
2.17
39 47
Introduction
Definitions
Types of Amalgamations and its Accounting
Accounting for Amalgamation in the books of Transferee Company (i) The Pooling of Interests
Method and (ii) The Purchase Method
Accounting for Amalgamation in the Books of Transferor Company
Treatment of Reserves
Disclosure
Limited Revisions to AS 14 of Accounting Standard 14 Accounting for Amalgamation
Companies Act, 1956 and AS 14
AS 14 and International Accounting Standards
Summary
Check Your Progress
Key Terms
Case Study
Further Readings
Unit 3: Valuation of Goodwill and Shares

3.1
3.2
3.3
3.4
3.5
3.6
3.7
3.8
3.9
1 38
Introduction to Goodwill
Factors Affecting Value of Goodwill
Need for Valuation of Goodwill
Method of Valuing Goodwill
Introduction to Valuation of Shares
Major Reasons for Valuation of an Enterprise
Analysis and Estimate of Value
Valuation Methods
Summary
48 77
3.10
3.11
3.12
3.13
3.14
3.15
Check Your Progress

Key Terms
Case Study
Further Readings
Unit 4: Basic Concepts of Income Tax

4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
4.9
4.10
4.11
4.12
4.13
4.14
4.15
Introduction to Income Tax

Residential Status
Exempted Incomes of Companies
Profits and Gains from Business or Profession
Income under the Head Capital Gains
Exemptions from Capital Gains
Hints for Tax Planning
Problems
Summary
Check Your Progress
Key Terms
Case Study
Further Readings
Unit 5: Assessment of Companies

5.1
5.2
5.3
5.4
5.5
5.6
5.7
5.8
5.9
5.10
5.11
5.12
5.13
78 222
Assessment of Companies
Provisions Relating to Minimum Alternate Tax (MAT)
Set-off and Carry Forward of Losses
Tax Planning with Reference to New Projects/Expansion/Rehabilitation Plans
Tax Planning in Respect of Amalgamation, Merger or Demerger of Companies
Concept of Avoidance of Double Taxation
Summary
Check Your Progress
Key Terms
Case Study
Further Readings
223 321
Accounting Norms
Notes
Unit 1:
Accounting Norms
Structure:
1.1 Introduction to Accounting Standards
1.2 List of Accounting Standards in India
1.3 Comparison between Indian GAAP, IFRS and US GAAP
1.3.1 Presentation of Financial Statements
1.3.2 Statement of Cash Flows
1.3.3 Non-current Assets Held for Sale and Discontinued Operations
1.3.4 Changes in Accounting Policy, Estimates and Correction of Errors
1.3.5 Assets
1.3.6 Borrowing Costs
1.3.7 Investment Property
1.3.8 Intangible Assets
1.3.9 Impairment (Other than Financial Assets)
1.3.10 Inventories
1.3.11 Leases
1.3.12 Provisions, Contingent Liabilities and Contingent Assets
1.3.13 Taxation
1.3.14 Revenue General
1.3.15 Revenue Long-term Contracts/Construction Contracts
1.3.16 Employee Benefits
1.3.17 Share-based Payments
1.4 The Roadmap for Implementation of Ind AS
1.5 Summary
1.6 Check Your Progress
1.7 Questions and Exercises
1.8 Key Terms
1.9 Check Your Progress: Answers
1.10 Case Study
1.11 Further Readings
Objectives
After studying this unit, you should be able to:
Various accounting standards operating in India
Comparison of Indian AS with International Accounting standards and US GAAP
1.1 Introduction to Accounting Standards

Financial statements summarize the end-result business activities of an enterprise
during an accounting period in monetary term. Business activities are varied. It is
strenuous task to present the facts intelligibly, in a summarized form, and yet with
minimum loss of information. In order that the methods and principles adopted by various
Amity Directorate of Distance and Online Education
Notes
reporting enterprises are coherent, not misleading and to the extent possible are
uniform and comparable standards are evolved.
The term Standards, denote a discipline, which provides both guidelines and
yardsticks for evaluations. As guidelines, they provide uniform practices and common
techniques. As yardsticks, standards are used in comparative analysis involving more
than one subject matter.
Accounting Standard is an authoritative pronouncement of code of practice of the
regulatory accountancy body to be observed and applied in the preparation and
presentation of financial statements.
World over, professional bodies of accountants have the authority and the obligation
to prescribe Accounting Standards. International Accounting Standards (IASs) are
pronounced by the International Accounting Standards Committee (IASC). The IASC
was set up in 1973, with headquarters in London (UK).
In India, the Institute of Chartered Accountants of India (ICAI) had established in
1977 the Accounting Standards Board (ASB). The composition of ASB includes:
(i) elected, (ii) ex-officio and (iii) co-opted members of the Institute, nominees of RBI,
FICCI, Assocham, ICSI, ICWAI and special invitees from UGC, ICWAI, and special
invitees from UGC, SEBI, IDBI and IIM.
ASB is entrusted with the responsibility of formulating Standards on significant
accounting matters, keeping in view: (a) international developments as also (b) legal
requirements in India. According to the preface to the Statement on Accounting Standards
issued by the ICAI, Accounting Standards will be issued by the ASB constituted for the
purpose of harmonizing the different and diverse accounting policies and practices in use in
India and propagating the Accounting Standards and persuading the concerned enterprise
to adopt them in the preparation and presentation of financial statement.
1.2 List of Accounting Standards in India

Accounting Standards (AS)
Title of the Accounting Standards
AS 1
Disclosure of Accounting Policies
AS 2 (Revised)
Valuation of Inventories
AS 3 (Revised)
Cash Flow Statements
AS 4 (Revised)
Contingencies and Events Occurring after the Balance Sheet

Date
AS 5 (Revised)
Net Profit or Loss for the Period, Prior Period Items and
Changes in Accounting Policies
AS 6 (Revised)
Depreciation Accounting
AS 7 (Revised)
Accounting for Construction Contracts
AS 9
Revenue Recognition
AS 10
Accounting for Fixed Assets
AS 11 (Revised 2003)
The Effects of Changes in Foreign Exchange Rates
AS 12
Accounting for Government Grants
AS 13
Accounting for Investments
AS 14
Accounting for Amalgamations
AS 15
Accounting for Retirement

Statements of Employers
Benefits
in
the
Financial
Accounting Norms
AS 16
Borrowing Costs
AS 17
Segment Reporting
AS 18
Related Patty Disclosures
AS 19
Leases
AS 20
Earnings Per Share
AS 21
Consolidated Financial Statements
AS 22
Accounting for Taxes on Income
AS 23
Accounting for Investment in Associates in Consolidated

Financial Statements
AS 24
Discontinuing Operations
AS 25
Interim Financial Reporting
AS 26
Intangible Assets
AS- 27
Financial Reporting of Interest in Joint Ventures
AS 28
Impairment of Assets
AS 29
Provisions, Contingent Liabilities and Contingent Assets
Notes
1.3 Comparison between Indian GAAP, IFRS and US GAAP

Comparison between Indian GAAP, IFRS and US GAAP is to help readers identify
the significant differences and similarities between Indian GAAP, IFRS, as issued by the
IASB, and US GAAP. Primary focuses only on recognition and measurement principles
and certain presentation requirements. This comparison includes only those key
similarities and differences that are more commonly encountered in practice in India.
Indian GAAP comprises of Accounting Standards notified by the MCA, Schedule VI
to the Companies Act, 1956 and selected Guidance Notes issued by the Institute of
Chartered Accountants of India (ICAI) applicable to companies other than SMEs for the
financial year ending on March 31, 2014.
It also considers only IFRS and US GAAP standards that are mandatory for the
financial year ending on March 31, 2014; standards issued but not yet effective or
permitting early adoption have not been considered.
The Comparison does not address industry-specific guidance for industries such as
financial institutions including banks, not-for-profit organizations and retirement benefit
plans. In particular, the following IFRS and corresponding Indian GAAP and US GAAP
guidance have not been included in this due to their specialised nature:
IAS 26, Accounting and Reporting by Retirement Benefit Plans

IAS 41, Agriculture
IFRS 4, Insurance Contracts
IFRS 6, Exploration For and Evaluation of Mineral Resources
IFRIC 12, Service Concession Arrangements
IFRIC 20, Stripping Costs in the Production Phase of a Surface Mine
The comparison also does not include the principles for first-time adoption of IFRS
or IFRS for SMEs.
This comparison is only a summary guide; for details of Indian GAAP, IFRS and US
GAAP requirements.
Notes
Overall Financial Statement Presentation

1.3.1 Presentation of Financial Statements
Indian GAAP
Primary guidance: AS 1,
Schedule VI
IFRS
Primary guidance: IAS 1
US GAAP
Primary guidance: ASC 205,
ASC 210, ASC 215, ASC 220,
ASC 225, ASC 235, ASC 505,
Regulation S-K, S-X
Selection of Accounting Policies

Entities preparing first
financial statements in
compliance with Indian
GAAP are required to comply
with all accounting standards.
Entities preparing first

financial statements in
compliance with IFRS apply
optional exemptions and
mandatory exceptions in
IFRS 1 to the retrospective
application of IFRS.
Similar to Indian GAAP.
Non-compliance with
accounting standards or the
Companies Act is prohibited
unless permitted by other
regulatory framework.
IFRS may be overridden in

extremely rare circumstances
where compliance would be
so misleading that it conflicts
with the objective of financial
statement set out in the IFRS
framework and thus,
departure is needed to
achieve fair presentation.
Unlike IFRS, US GAAP does

not permit an entity to depart
from generally accepted
accounting principles.
Entities meeting the

conditions to qualify as Small
and Medium Sized Company
have certain exemption or
relaxation in complying with
the accounting standards.
IFRS for SMEs is a

self-contained set of
accounting principles that are
based on full IFRS, but that
have been simplified to the
extent suitable for SMEs. The
IFRS for SMEs and full IFRS
are separate and distinct
frameworks.
Unlike Indian GAAP and IFRS,

there is no exemption or
relaxation in complying with US
GAAP requirements except
certain relaxations for
non-public companies. The
accounting standards may have
differing date of implementation
for public entities and
non-public entities.
There is no requirement to
make an explicit and
unreserved statement of
compliance with Indian
GAAP in the financial
statements.
Entities should make an

explicit and unreserved
statement of compliance with
There is no specific guidance

when Indian GAAP does not
cover a particular issue.
In the absence of specific

IFRS requirement,
management considers a
hierarchy of alternative
sources provided in IAS 8.
IFRS as issued by IASB in

the notes to financial
statements.
US GAAP is divided into
authoritative and
non-authoritative literature.
Components of Financial Statements

The requirements for the
presentation of financial
A complete set of financial

statements comprises of a
Similar to IFRS except that a

statement of changes in equity
Accounting Norms
statements are set out in
Statutes that governs the
entity. For instance,
Schedule VI to the
Companies Act sets out
financial statement
requirements in case of
companies; Schedule III to
the Banking Regulation Act,
1949 (for banks) sets out
financial statement
requirements in case of
banks.
5
statement of financial
position, a statement of
comprehensive income; a
statement of changes in
equity; a statement of cash
flows and notes to the
financial statements including
summary of accounting
policies.
may be presented in the notes

to the financial statements.
Notes
In general, the financial

statements comprises of
balance sheet; statement of
profit and loss; cash flow
statement, if applicable and
notes to the financial
statements including
summary of accounting
policies.
A statement of
comprehensive income is not
required to be prepared.
A statement of changes in
equity is not required.
Movement in share capital,
retained earnings and other
reserves are presented in the
notes to the financial
statements.
Presentation of Consolidated Financial Statements
Only listed entities with one
or more subsidiaries are
required to present
consolidated financial
statements.
Entities with one or more

subsidiaries are required to
present consolidated
financial statements unless
specific criteria are met.
Generally, there are no

exemptions. However, US
GAAP does provide limited
exemptions from consolidation
in certain specialized industries.
Similar to Indian GAAP

however, entities making
prior period adjustment or
reclassifications or applying
accounting policy
retrospectively should
present a statement of
financial position as at the
beginning of the earliest
comparative period.
No comparative information is
required in case of non-public
entities. In case of public
entities,comparative information
is required for two preceding
years except for the statement
of financial position which is
required only for the preceding
period.
Comparatives
Comparative information is
required for preceding period
only.
Unlike IFRS, there is no

requirement to present a
statement of financial position

as at the beginning of the
earliest comparative period
under any circumstances.
Notes
Classification of Items of the Statement of Financial Position

All items are classified as
either current or non-current.

except that an entity shall
present all assets and
liabilities in order of liquidity
when a presentation based
on liquidity provides
information that is reliable
and more relevant.
Generally, entities are required

to present items in the
statement of financial position
as either current or non-current.
Deferred income tax assets

and liabilities are classified
and presented as
non-current.

deferred tax assets and
liabilities are classified as either
current or non-current based on
the classification of the related
asset or liability.
In case of minor default of

loan covenants resulting into
loan becoming callable, an
entity classifies the loan as
non-current provided the
lender has not recalled the
loan before the date of
approval of financial
statements.
A liability that is payable on

demand because certain
conditions are breached is
classified as current even if
the lender has agreed, after
the end of the reporting
period but before the financial
statements are authorised for
issue, not to demand
repayment.
Unlike IFRS, such a liability is

not classified as current if the
lender subsequently has lost
the right to demand repayment
or has waived after the end of
the reporting period, the right to
demand repayment for more
than 12 months from the end of
the reporting period. Further,
the loan can be classified as
non current if the entity has a
grace period to cure breach of
conditions and it is probable that
violation will be cured within that
grace period.
Refinancing subsequent to
balance sheet date is not
considered while determining
the appropriate classification
of the loan

refinancing subsequent to
balance sheet date is
considered in determining the
appropriate classification of the
loan.
Offsetting of Financial Assets and Financial Liabilities

There is no specific
guidance.
Entities are required to set off

financial assets and financial
liabilities in the balance sheet
when the criteria for set off
are met.
Unlike IFRS, offsetting is

elective. Further, criteria for
offset differ as compared to
IFRS.
Expenses are classified

either by nature or function.
Certain additional disclosures
are required in the notes to
Generally classified by function.

Public entities are required to
classify the expenses by
function only. Similar to Indian
Classification of Expenses
Expenses are classified by
nature.
Accounting Norms
7
the financial statements
depending on the
presentation choice elected
by the entity.
GAAP and unlike IFRS, there

are no additional disclosures
required in the financial
statements depending on the
presentation choice elected.
Entities are not permitted to

present any item of income or
expense as extraordinary.
except that disclosure may
be on the face of the income
statement or in the notes.
Similar to Indian GAAP but is

rarely seen in practice.
However, the criteria for
determining an income or
expense as extraordinary differ
as compared to Indian GAAP.
Notes
Extraordinary Items
Extraordinary items are
disclosed separately in the
statement of profit and loss
and are included in the
determination of net profit or
loss for the period. Does not
use the term exceptional item
but requires separate
disclosure of items that are of
such size, incidence on
nature that require separate
disclosure to explain the
performance of the entity.
Revised Schedule VI
specifically requires
disclosure as a separate line
item on the face of the
income statement.
The term exceptional items is

not used, but significant items
are disclosed separately on the
face of the income statement
when arriving at income from
operations, as well as being
described in the notes.
Presentation of OCI or Similar Items

There is no concept of OCI
(other comprehensive
income). All incomes,
expenses, gains and losses
are presented in the income
statement except certain
items are required to be
directly recognized in
reserves. For e.g.,
revaluation surplus and
foreign currency translation
reserve.
OCI items may be presented

in a single statement of
comprehensive income or a
separate statement.
OCI items may be presented as

part of the income statement or
in a separate statement.
Presentation of Profit or Loss Attributable to Non-controlling (Minority) Shareholders

Profit or loss attributable to
non-controlling shareholders
is disclosed as a deduction
from the profit or loss for the
period as an item of income
or expense.
Profit or loss attributable to

non-controlling interest
holders and equity holders of
the parent entity is disclosed
as allocation of profit or loss
and total comprehensive
income for the period.
Disclosure of Estimation Uncertainty and Critical Judgments

No specific requirement
Entities should disclose in the

financial statements about
key sources of estimation
uncertainty and judgments
Unlike IFRS, only public entities

are required to provide similar
disclosure.

made in applying entitys
critical accounting policies.
Notes
New Pronouncement Issued But Not Yet Effective

No specific requirement to
disclose information about
new pronouncement issued
but not yet effective.
Entities are required to

disclose the impact of new
IFRS issued but is not yet
effective as at the reporting
date.
Unlike IFRS, only public entities

are required to provide a similar
disclosure.
1.3.2 Statement of Cash Flows

AS 24
Primary guidance: IAS 7,

IFRS 5

ASC 830
Definition of Cash and Cash Equivalents

Cash and cash equivalent
comprises of cash and
short-term, highly liquid
investments that are readily
convertible to known
amounts of cash and subject
to insignificant risk of
changes in value.

except that cash equivalent
includes bank overdraft in
certain situations.
Unlike IFRS, bank overdrafts

are included in liabilities and
excluded from cash equivalents.
Changes in overdraft balances
are financing activities.
Similar to Indian GAAP and

IFRS.
Generally investments with

original maturities of three
months or less from the date
of acquisition qualify as cash
equivalent. Bank overdrafts
are excluded.
Classification of Cash Flow
The statement of cash flows
presents cash flows during
the period classified into
operating, investing and
financing activities.
Methods of Presenting Operating Cash Flows

Listed entities in India should
present operating cash flows
using indirect method. Other
entities can present operating
cash flows either using direct
method or indirect method.
Entities presenting operating
cash flows using direct
method need not reconcile the
net income to net cash flows
from operating activities.
Under both methods, cash
flows from interest and income
taxes paid should each be
disclosed separately.

except that listed entities also
have a choice of the direct
method.
Similar to IFRS except that

entities presenting operating
cash flows using direct method
should reconcile the net income
to net cash flows from operating
activities.
Accounting Norms
Gross versus net reporting

Generally all financing and
investing cash flows are
reported gross. Cash flows
may be reported on net basis
only in limited circumstances.
Notes

IFRS.
Classification of Income Tax Cash Flows

Income tax cash flows are
classified as operating unless
specifically identified with
financing or investing
activities.
Income tax cash flows are

classified as operating activities.
Classification of Interest and Dividend

Interest paid and dividend
paid Financial entities:
Interest paid is classified as
operating activities and
dividend paid is classified as
financing activities. Other
entities: Both are classified
as financing activities.
Cash flows from interest and

dividends can be classified
as either operating, financing
or investing cash flows in a
consistent manner from
period to period.
Interest received and interest

paid are classified as operating
cash flows. Dividend received is
generally classified as operating
cash flows. Dividends paid are
classified as financing activities.
Interest received and

dividend received Financial
entities: Interest received is
classified as operating
activities and dividend
received is classified as
investing activities. Other
entities: Both are classified
as investing activities.
Disclosure of Cash Flows Pertaining to Discontinued Operations
Entities are required to
disclose in the notes the net
cash flows attributable to
each of operating, financing
or investing activities of
discontinued operations.

except that entities can
present such information on
the face of the cash flow
statement.

an entity is not required to
disclose cash flows pertaining
to discontinued operations
separately in the statement of
cash flows.
Cash Flows from Extraordinary Items

Cash flows arising from
extraordinary items should be
classified as arising from
operating, investing or
financing activities as
appropriate and separately
disclosed.
Presentation of extraordinary
items is not permitted.
Hence, the cash flow
statement does not reflect ant
items of cash flow as
extraordinary.
Reconciliation of Cash and Cash Equivalent in the Statement of Cash Flows to the
Statement of Financial Position
Entities should present the
reconciliation of the amounts
Cash and cash equivalent in the

statement of cash flows is
10

generally the same as similarly
titled line items or sub-totals in
the statement of financial
position.
Notes
Foreign Currency Cash Flows

Foreign currency cash flows
are translated at the
exchange rates at the dates
of the cash flows (or a rate
that approximates the actual
rate when appropriate).

IFRS.
Foreign currency cash flows

are translated at the
exchange rates at the dates
of the cash flows (or a rate
that approximates the actual
rate when appropriate).
1.3.3 Non-current Assets Held for Sale and Discontinued Operations

Primary guidance AS 10, AS
24
Primary guidance: IFRS 5

ASC 230, ASC 360
There is no standard dealing

with non-current assets held
for sale. However, AS 10
deals with assets held for
disposal. Items of fixed
assets retired from active use
and held for disposal are
stated at the lower of their net
book value and net realizable
value. Any expected loss is
recognized immediately in
the statement of profit and
loss.
Non-current assets to be
disposed off are classified as
held for sale when the asset
is available for immediate
sale and the sale is highly
probable. Depreciation
ceases on the date when the
assets are classified as held
for sale. Non-current assets
classified as held for sale are
measured at the lower of its
carrying value and fair value
less cost to sell.
Similar to IFRS.
An operation is classified as
discontinued at the earlier of:
An operation is classified as
discontinued when it has
either has been disposed of,
or is classified as held for
sale and:
A component of an entity should

be classified as a discontinued
operation if all the following
conditions have been met:
Introduction
a binding sale agreement

for sale of operations
on approval by the board
of directors of a detailed
formal plan and
announcement of the plan.
represents a separate
major line of business or
geographical area of
operations
is part of a single
coordinated plan to
dispose of a separate
major line of business or
geographical area of
operations; or
it has been disposed of or

classified as held for sale
the operations and cash
flows of the component have
been (or will be) eliminated
from the ongoing operations
of the entity as a result of the
disposal transaction
the entity will not have any
significant continuing
involvement in the operations
Accounting Norms
11
is a subsidiary acquired
exclusively with a view to
resale.
of the component after the

disposal transaction.
Notes
Presentation and Disclosure

Items of fixed assets retired
from active use and held for
disposal are shown
separately in the financial
statements.
Non-current assets classified

as held for sale are shown
statements.
Similar to IFRS.
The amount of pre-tax profit

or loss from ordinary
activities attributable to the
discontinuing operation
during the current financial
reporting period, and the
income tax expense related
thereto and the amount of the
pre-tax gain or loss
recognised on the disposal of
assets or settlement of
liabilities attributable to the
discontinuing operation is
required to be presented on
the face of profit and loss.
A single amount comprising

the total of the post-tax profit
or loss of discontinued
operations and the post-tax
gain or loss recognised on
the measurement to fair
value less costs to sell or on
the disposal of the assets or
disposal group(s) constituting
the discontinued operation is
presented in the statement of
comprehensive income. An
analysis of the same is
required which may be
presented in the notes or
separately in the statement of
comprehensive income.
Similar to IFRS. However, cash

flow information is not required
to be disclosed separately.
Following information is
required to be disclosed in
notes for discontinued
operations: for periods up to
and including the period in
which the discontinuance is
completed:
the carrying amounts, as of
the balance sheet date, of the
total assets to be disposed of
and the total liabilities to be
settled; the amounts of
revenue and expenses in
respect of the ordinary
activities attributable to the
reporting period; and
The net cash flows

attributable to the operating,
investing and financing
activities of discontinued
operations is required to be
presented either in notes or
statements.
the amounts of net cash

flows attributable to the
operating, investing, and
financing activities of the
reporting period.
12
Notes

Comparative information for
prior periods that is
presented in financial
statements prepared after the
initial disclosure event should
be restated to segregate
assets, liabilities, revenue,
expenses, and cash flows of
continuing and discontinuing
operations.
Similar to Indian GAAP, the

amounts related to
discontinued operations are
re-presented for prior periods
except that information on
carrying amounts of relevant
assets and liabilities, if
presented, is not restated.
Similar to IFRS except that cash

flow information is restated only
if cash flow information for
discontinued operations is
presented separately.
1.3.4 Accounting Policies

Changes in Accounting Policy, Estimates and Correction of Errors
Primary guidance: AS 5

IAS 8, IAS 33

ASC 260, SEC SAB Topic 11:
Accounting policy is changed

in response to new or revised
accounting standards or on a
voluntary basis if the new
policy is more appropriate.

IFRS.
Requires prospective
application (unless an
accounting standard requires
otherwise) together with a
disclosure of the impact of
the same, if material.
Cumulative effect of the
change is recognised in
current year profit and loss.
Further, unlike IFRS and US
GAAP, change in
depreciation method is
considered a change in
accounting policy.
Requires retrospective
application by adjusting
opening equity and
comparatives unless
impracticable.
Similar to IFRS.
A statement of financial
position at the beginning of
the earliest comparative
period is not required under
any circumstances.
When an entity applies an

accounting policy
retrospectively or makes a
retrospective restatement of
items in its financial
statements or when it
reclassifies items in its
financial statements, entity
should present a statement of
financial position at the
beginning of the earliest
comparative period.
Similar to Indian GAAP;

however the effect is required to
be separately disclosed.
Prior period errors are

corrected by adjusting
Similar to IFRS with no

impracticability exemption.
Change in Accounting Policy
Correction of Errors
Prior period errors are
included in determination of
Accounting Norms
profit or loss for the period in
which the error is discovered
and are separately disclosed
in the statement of profit and
loss in a manner that the
impact on current profit or
loss can be perceived.
13
opening equity and restating
comparatives, unless
impracticable.
Notes
Change in accounting estimates

Requires prospective
application of a change in
accounting estimates.

IFRS.
1.3.5 Assets
Property Plant and Equipment (PPE)
Indian GAAP
IFRS
US GAAP
Primary guidance: AS 6, AS
10, AS 16, AS 28

IAS 23, IAS 36

ASC 410, ASC 835
Cost includes all expenditure

directly attributable in
bringing the asset to the
present location and working
conditions for its intended
use.

IFRS.
PPE purchased on deferred

settlement terms are not
explicitly dealt with in AS 10.
Cost of fixed assets include
purchase price for deferred
payment term unless interest
element is specifically
identified in the arrangement.
Difference between the

purchase price under normal
credit terms and the amount
paid, is recognised as
interest expense over the
period of the financing.
Similar to IFRS.
There is no specific reference

on whether cost of an item of
PPE includes costs of its
dismantlement, removal or
restoration, the obligation for
which an entity incurs as a
consequence of installing the
item.
The cost of an item of PPE

includes such costs.
Similar to IFRS.
Cost of major inspections and

overhauls are generally
expensed when incurred,
unless that increases the
future benefits from the
existing asset beyond its
previously assessed standard
of performance.
Cost of major inspections and

overhauls are capitalised only
when it is probable that it will
give rise to future economic
benefits.
Major inspections and

overhauls may be expensed as
incurred (direct expensing
method) or capitalized and
amortized to the next major
inspection or overhaul (built-in
overhaul and deferral methods).
Initial Recognition
14
Notes

Subsequent Costs

IFRS.
Subsequent measurement of
PPE may be based on the
revaluation model, for a class
of assets. Revaluation is
required to be carried out at
sufficient regularity such that
the carrying amount is not
materially different from the
fair value at the end of the
reporting period.
Revaluation is not permitted.
The Companies Act specifies

the minimum depreciation
rates to be used for different
categories of assets.
Component accounting is
permitted but is rarely followed
in practice.
Depreciation is based on the

component approach;
depreciation is charged over
the estimated useful life of the
asset. Depreciation method
should reflect the pattern of
the future economic benefits
associated with the asset.
Similar to IFRS.
requirement to reassess
depreciation method, residual
value and useful life at each
balance sheet date.
Depreciation method,
residual value and useful life
are reassessed at each
balance sheet date.
Depreciation method, residual

value and useful life are
reassessed only when events or
changes in circumstances
indicate a possible change in
the estimates.
Subsequent expenditures
related to an item of PPE
should be capitalised only if
they increase the future
benefits from the existing
asset beyond its previously
assessed standard of
performance.
Revaluations
Revaluation is permitted. No
specific requirement on
frequency of revaluation.
Depreciation
ARO (Asset Retirement Obligation)Recognition and Measurement

guidance.
Provisions for the estimated

cost of dismantling and
removing an asset and
restoring a site shall be
recognised and measured in
accordance with the
provisions in IAS 37.
When a present value
technique is used to estimate
the liability, the discount rate
will be a pretax rate that
reflects current market
assessments of the time
value of money and the risks
A liability for an ARO shall be

recognised at fair value in the
period in which it is incurred if a
reasonable estimate of fair
value can be made. If a
reasonable estimate of the fair
value of the liability cannot be
made in the period the
obligation is incurred, a liability
shall be recognised when a
reasonable estimate of fair
value can be made.
When a present value
technique is used to estimate
Accounting Norms
guidance.
15
specific to the liability.
the liability, the discount rate will

be a risk-free interest rate
adjusted for the effect of the
entitys credit standing.
If the obligation was incurred

during a period in which the
PPE was used to produce
inventory, the ARO would be
added to the carrying amount
of the inventory.
Unlike IFRS, the ARO is added

to the carrying amount of the
related long-lived asset.
Notes
ARO Changes in Measurement

guidance.
The ARO should be adjusted

for changes in the estimate of
expected undiscounted cash
flows or discount rate as of
each balance sheet date. The
entire obligation should be
r-remeasured using an
updated discount rate that
reflects current market
conditions as of the balance
sheet date.
Period-to-period revisions to
either the timing or amount of
the original estimate of
undiscounted cash flows are
treated as separate layers of the
obligation. Upward revisions are
discounted using the current
credit-adjusted risk-free rate.
Downward revisions are
discounted using the original
credit-adjusted risk-free rate.
1.3.6 Borrowing Costs

Indian GAAP
Primary guidance AS 16
IFRS
US GAAP
Primary
835-20
guidance:
ASC
A qualifying asset is an asset

that necessarily takes
substantial period of time to get
ready for its intended use or
sale. A period of twelve months
is considered a substantial
period unless a shorter or longer
period can be justified.

However, unlike Indian
GAAP, there is no bright line
for the term substantial
period.
Similar to IFRS.
Equity method investee

cannot be a qualifying asset.

equity method investee can be
a qualifying asset.

borrowing costs are generally
limited to interest cost in
connection with the borrowings.
For e.g., foreign-currency gains
or losses, are not regarded as
an adjustment to interest costs.
Definition of Qualifying Asset
Definition of Borrowing Costs

Borrowing costs are interest
and other costs that an entity
incurs in connection with the
borrowing of funds.
Borrowing costs include
exchange differences arising
from foreign currency
borrowings to the extent that
they are regarded as an
adjustment to interest costs.
16
Notes

Recognition of Borrowing Costs
Borrowings costs attributable
to qualifying asset form part
of the cost of that asset.
Other borrowing costs are
expenses as incurred.

IFRS.
Income earned on the

temporary investments of the
borrowings specific to a
qualifying asset is reduced
from the borrowing costs for
capitalisation.

income earned on the
temporary investments of the
borrowings is not reduced from
the costs for capitalisation and
is shown on gross basis as
income in the profit or loss.
Primary guidance: See

Section 4.1, Property, Plant
and Equipment
Investment property is
property (land or building) not
intended to be occupied
substantially for use by, or in
the operations of, the
investing enterprise.
Investment property is
property (land or a
buildingor part of a
buildingor both) held to
earn results or for capital
appreciation, or both.
Unlike IFRS and Indian GAAP,

there is no specific definition of
investment property; such
property is accounted for as
property, plant and equipment.
Property held by a lessee

under an operating lease is
not recognised in the balance
sheet.
Property held by a lessee

under an operating lease
may be classified as
investment property if the
definition of the investment
property is met and the
lessee measures all its
investment property at fair
value.
1.3.7 Investment Property

Introduction
Measurement at Initial Recognition

Investment property initially
recognised at cost.

IFRS.
Measurement Subsequent to Initial Recognition

Measured at cost less
accumulated depreciation
less other-than-temporary
impairment loss, if any.
Measured using either fair

value (subject to limited
exceptions), with change in
fair value recognised in profit
or loss or at cost less
less impairment loss, if any.
If the investment property
measured at cost less
less impairment loss, if any,
All investment properties are

measured using cost less
accumulated depreciation less
impairment loss, if any.
Accounting Norms
17
an entity should disclose the
fair value of its investment
property.
Notes
1.3.8 Intangible Assets

Note: This section does not cover goodwill. AAP IFUS GAAP

IFRS 3, SIC 32

ASC 350, ASC 720, ASC 730,
ASC 805, ASC 985
An intangible asset is defined

as an identifiable
non-monetary asset without
physical substance. An asset
is identifiable if it is
separablecapable of being
sold, transferred, licensed,
rented, or exchanged or
arises from contractual or
legal rights.

IFRS.
The cost of separately

acquired intangible assets
includes the following:

IFRS.
Purchase price
If an intangible asset is
acquired with a group of other
assets (but not those
acquired in a business
combination), the cost of the
group shall be allocated to
the individual identifiable
assets and liabilities on the
basis of their relative fair
values at the date of
purchase. Such a transaction
or event does not give rise to
goodwill.
Definition
Directly attributable costs to

get the asset ready for its
intended use.
No guidance on determining
the cost of intangible asset
when acquired with a group
of other assets.
Similar to IFRS.
Internal Research and Development

Research expenditure is
expensed as incurred.
Development expenditure is
capitalised if specific criteria
are met.
Generally expensed as
incurred.
Intangible assets with finite

useful lives are amortised
over their expected useful
lives.
.Similar to IFRS except that

intangible assets cannot be
revalued. An entity has an
option of performing a
qualitative assessment for
impairment tests.
Subsequent Measurement
Intangible assets are
amortised over their
expected useful lives. The
useful life may not be
indefinite. There is a
rebuttable presumption that
the useful life of the
Intangible assets with

indefinite useful lives are not
18
Notes

intangible asset will not
exceed ten years from the
date when the asset is
available for use.
amortised but tested for

impairment at least annually.
Intangible asset may be
revalued to fair value only if
there is an active market.
Advertising and Promotional Expenditure

Expensed as incurred.
Direct-response advertising is
capitalised if specific criteria are
met. Other advertising and
promotional expenditure is
expensed as incurred or
deferred until the advertisement
first appears.
1.3.9 Impairment (Other than Financial Assets)


ASC 360
Frequency of Impairment Testing

An entity should test the
assets or a cash generating
unit (CGU) for impairment at
the end of each reporting
period if the impairment
indicators exist. However, an
entity should test the
following assets for
impairment annually
irrespective of whether the
impairment indicators exists
or not:
an intangible asset not yet
available for use; and
an intangible asset with an
estimated useful life of more
than ten years.

However, an entity should
test the following assets for
Similar to IFRS.
Impairment annually
irrespective of whether the
impairment indicators exists
or not:
an intangible asset not yet
available for use;
an intangible asset with an
indefinite useful life; and
goodwill acquired in a
business combination
The terminology asset groups

is similar to CGU used in Indian
GAAP and IFRS.
A reporting unit is an operating
segment or one level below an
operating segment (referred to
as a component).
CGU is defined as the

smallest identifiable group of
assets that generates cash
inflows that are largely
independent of the cash
inflows from other assets or
groups of assets.
Level of Impairment Testing
Tested at CGU level.

IFRS except that goodwill is
tested for impairment at
reporting unit level and specific
guidance is applied to
determine the level of
impairment testing of intangible
Accounting Norms
19
assets not subject to
amortisation.
Notes
Measurement of Impairment Loss on Goodwill

The recoverable amount of
the CGU (higher of fair values
less costs to sell and value in
use, which is based on the
net present value of future
cash flows) is compared with
the carrying amount of the
CGU.
The impairment loss is
allocated by first reducing
any goodwill of the CGU and
then reducing the carrying
value of other assets of the
CGU on a pro rata basis,
subject to certain constraints.
Similar to Indian GAAP. The

impairment test is a one-step
process. If the recoverable
amount is below the carrying
amount, an impairment loss
is recognised. Recoverable
amount is the higher of value
in use and fair value less
costs to sell. Value in use is
future discounted cash flows
from an asset or
cash-generating unit.
An entity may first assess only

qualitative factors to determine
whether it is necessary to
perform the two-step goodwill
impairment test. If an entity
determines that it is more likely
than not that the fair value of a
reporting unit is less than its
carrying amount, the following
process is followed:
The first step compares the fair
value of the reporting unit with
the carrying amount.
Goodwill is impaired if the
reporting units fair value is less
that its carrying amount. If
goodwill is impaired, then the
second step is performed to
determine the amount of
impairment measured as the
difference between goodwills
implied fair value and its
carrying amount.
Measurement of Impairment Loss for Other Non-financial Assets

Impairment loss is
recognised if the assets or
CGUs carrying amount
exceeds its recoverable
amount of the CGU (higher of
fair values less costs to sell
and value in use, which is
based on the net present
value of future cash flows).
Impairment loss is recognised if

the carrying amount of the asset
exceeds its fair value.
For intangible assets that are
amortized and other long-lived
assets, an entity first compares
if the carrying amount exceeds
the sum of the undiscounted
cash flows expected from the
use and eventual disposition to
assess if there is an impairment.
For indefinite-lived intangible
assets, an entity may first
perform a qualitative
assessment to determine
whether it is necessary to
perform the quantitative
impairment test.
Reversal of Impairment Loss

Reversal of impairment loss
is recognised in profit and
loss. An impairment loss
recognised for goodwill
should not be reversed in a
Reversal of impairment is
permitted except for those
relating to goodwill.
Reversal of impairment loss is

not permitted.
20
Notes

subsequent period unless
certain conditions are
satisfied.
Measurement of reversal of
impairment loss:
Entity should increase the
value of the asset to its
current recoverable amount.
However, current recoverable
amount should not exceed
the carrying amount of the
asset that would have existed
if no impairment loss had
been recognised.
1.3.10 Inventories
Primary guidance: ASC 330

measured at the lower of cost
and market. Market means
current replacement cost.
However, Market shall not
exceed net realisable value and
shall not be less than net
realisable value reduced by an
allowance for an approximately
normal profit margin. Net
realisable value is similar to
Indian GAAP and IFRS.
The cost of inventories

comprises of all costs of
purchase, costs of
conversion and other costs
incurred in bringing the
inventories to their present
location and condition.

IFRS.
Inventories purchased on
deferred settlement terms are
not explicitly dealt with in
AS 2. Cost of inventories
include purchase price for
deferred payment term
unless interest element is
specifically identified in the
arrangement.
Difference between the

purchase price for normal
credit terms and the amount
paid, is recognised as
interest expense over the
period of the financing.
Similar to IFRS.

IFRS except that cost of
Measurement of inventories
Measured at the lower of cost
and net realisable value.
Net realisable value is the
estimated selling price less
the estimated costs of
completion and sale.
Cost of Inventories
Cost Formulas
FIFO and weighted average
cost are acceptable
Accounting Norms
21
inventories can also be
determined using LIFO.
accounting method for

determining the cost of
inventories. Specific
identification may be used in
certain situations. The LIFO
method is not permitted.
The same cost formula is
applied for all inventories
having similar nature and use
to the entity.
Notes
Unlike IFRS and Indian GAAP,

the same cost formula need not
be applied to all inventories
having a similar nature and use
to the entity.
Reversal of write down of inventory

guidance. However,
reversals may be permitted
as AS 5 requires this to be
disclosed as a separate line
item in the statement of profit
and loss.
Reversal of write-down of
inventory is permitted. The
amount of reversal is limited
to the original write down.

reversal of a write-down of
inventory is not permitted.

IAS 40, SIC 15, SIC 27,
IFRIC 4

IFRS, except that lease
accounting guidance applies
only to property, plant and
equipment.
Liabilities
1.3.11 Leases
Scope
A lease is an arrangement
whereby the lessor conveys
to the lessee in return for a
payment or series of
payments the right to use an
asset for an agreed period of
time. Lease agreement to
use land is not accounted as
lease transaction.
on whether an arrangement
contains a lease. Payments
under arrangements which
are not in the form of leases
are generally recognised in
accordance with the nature of
expense incurred.
Lease arrangement to use

lands are accounted as lease
transaction.
Arrangements that do not
take the legal form of a lease
but fulfillment of which is
dependent on the use of
specific assets and which
convey the right to use the
assets may have to be
accounted for as leases.
Similar to IFRS.
Similar to IFRS.
Lease Classification
A lease is classified as either
an operating or a finance
lease at the inception of the
lease.

IFRS. Finance lease is referred
as capital lease. In respect of
lessors, capital leases are
categorised as direct financing
leases and sale-type leases,
22

which differ in certain respects
from IFRS and Indian GAAP.
Notes
The classification of a lease

depends on whether the lease
meets certain criteria. Lease of
land is generally classified as
operating lease unless the title
transfers to the lessee.
Land and buildings elements

are classified and accounted
for separately unless the land
element is not material.
Land and building elements are

classified and accounted for as
a single unit unless land
represents more than 25
percent of the total fair value of
the leased property.
Lease rentals: Lease rentals

shall be expensed by the
lessee and lease revenue
shall be recognised by the
lessor on a straight-line basis
over lease term unless
another systematic basis is
representative of the time
pattern of the users benefits.

IFRS.

on lease incentives.
Lease incentives (such as

rent-free period) are
recognised by both the lessor
and the lessee as a reduction
in rental income and
expense, respectively, over
the lease term
Similar to IFRS.

IFRS
The lease classification

depends on whether
substantially all of the risks
and rewards incidental to
ownership have been
transferred from the lessor to
the lessee.
Separation of Lease Elements
on separation of leases of
land and buildings.
Accounting Treatment
Operating leases:
Finance leases:
The lessor recognises a
finance lease receivable and
the lessee recognises the
leased asset and a liability for
future lease payments.
1.3.12 Provisions, Contingent Liabilities and Contingent Assets


IFRIC 1

ASC 420, ASC 450

except that constructive
obligations are also
recognised.
Similar to IFRS.
Recognition
A provision is recognised for
a present obligation arising
from past event, if the liability
is considered probable and
Accounting Norms
23
can be reliably estimated.

Probable means more likely
than not.
Notes
Constructive obligations are

not recognized.
Measurement
The amount recognised as a
provision should be the best
estimate of the expenditure
required to settle the present
obligation at the balance

sheet date.
The amount of a provision is

not discounted to its present
value.
Where the effect of the time

value of money is material,
the provision shall be
discounted at a pre-tax
discount rate that reflects
current market assessments
of the time value of money
and the risks specific to the
liability.

IFRS. However, when the
reasonable estimate of the loss
is a range and some amount
within the range appears at the
time to be a better estimate than
any other amount within the
range, that amount is accrued. If
no amount within the range is a
better estimate than any other
amount, the minimum amount in
the range is accrued.
Accruals for loss contingencies
provisions are not discounted
unless the timing of the related
cash flows is fixed or reliably
determinable.
Reimbursement Right
A reimbursement right is
recognised as a separate
asset only when its recovery
is virtually certain. The
amount recognised for the
reimbursement should not
exceed the amount of the
related provision.

recovery should be probable
and need not be virtually
certain.
Disclosure is required for loss

contingencies that are not
recognised if it is reasonably
possible that a loss may have
been incurred.
Contingent Liability
A contingent liability is not
recognised. However, it is
disclosed, unless the
possibility of an outflow of
resources is remote. In
extremely rare cases,
exemption from disclosure of
information that may be
prejudicial to an entity is
permitted.

there is no such exemption.
Contingent Asset
A contingent asset is:
recognised when the
realisation is virtually
Similar to Indian GAAP,

except that the disclosure is
made in the financial
Contingent assets are not

recognised until they are
realised.
24
Notes

certain; and
statements.
disclosed in the Directors

report when the
realisation is probable.
Restructuring Costs
Recognised if the recognition
criteria for a provision is met.

a liability for a cost associated
with an exit or disposal activity
is recognised when the
definition of a liability is met.
Unless specific codification

topic/subtopic requires,
obligations for onerous
contracts are not recognised
Deferred taxes are

recognised for the estimated
future tax effects of timing
differences and unused tax
losses carried forward.
Unused tax credits carried
forward is considered a
prepaid tax asset provided
the definition of asset is met.
Deferred taxes are

recognised for the estimated
future tax effects of
temporary differences,
unused tax losses and
unused tax credits carried
forward.
Although US GAAP also follows

an asset and liability approach
for calculating deferred taxes,
there are some differences in
the application of the approach
from IFRS.
Timing differences are the

differences between taxable
income and accounting
income for a period that
originate in one period and
are capable of reversal in one
or more subsequent periods.
Temporary differences are

differences between the tax
base of an asset or liability
and its carrying amount in the
statement of financial
position.
Definition of temporary
differences is similar to IFRS.
Onerous Contracts
An onerous contract is
defined as a contract where
the unavoidable costs to
meet the obligations exceed
the expected economic
benefits.
If an entity has an onerous
contract, the present
obligation shall be
recognised and measured as
a provision.
1.3.13 Taxation
Primary guidance: AS22
Introduction
Current TaxRecognition and Measurement

Tax expense comprises of
current tax and deferred tax
which should be included in
the determination of the net
profit or loss for the period.
Current tax should be

IFRS.
Accounting Norms
25
measured at the amount

expected to be paid to
(recovered from) the taxation
authorities in respect of
taxable profit (loss), using the
applicable tax rates and tax
laws.
Notes
Deferred TaxRecognition and Measurement

Deferred tax assets and
liabilities should be measured
using the tax rate and tax
laws that have been enacted
or substantively enacted at
the balance sheet date. In
practice, deferred tax is
measured based on the
expected manner of
settlement of liability or
recovery of an asset.

except that IAS IAS 12
specifically requires deferred
tax to be measured based on
the expected manner of
settlement of liability or
recovery of an asset.

deferred tax assets and
liabilities should be measured
using tax rates and tax laws that
have been enacted at the
reporting date. Further, deferred
tax is measured on the
assumption that the underlying
asset or liability will be settled or
recovered in a manner
consistent with its current use in
the business.
Deferred tax assets should

be recognized and carried
forward when it is reasonably
certain that future taxable
profit will be available for
reversal of the deferred tax
assets. However, where an
entity has unabsorbed
depreciation or carry forward
of losses under tax laws,
deferred tax assets should be
recognised only when there
is virtual certainty supported
by convincing evidence that
sufficient future taxable
income will be available
against which such deferred
tax asset can be realised.
Deferred tax assets is

recognised to the extent it is
probable that taxable profit
will be available against
which deductible temporary
differences and unused tax
losses and unused tax credits
carried forward can be
utilised.

deferred tax assets are
recognised in full and reduced
by a valuation allowance if it is
more likely than not that some
portion or all of the deferred tax
assets will not be realised.
Deferred Tax on Unused Tax Credits

Unused tax credits carried
forward are considered as
prepaid tax assets provided
the definition of asset is
satisfied on a continuing
basis.
Deferred tax assets and
liabilities should not be
discounted to their present
value.
Unlike Indian GAAP, unused

tax credits carried forward
are considered as deferred
tax assets.
Similar to IFRS

IFRS.
Indian GAAP IFRS US GAAP
26
Notes

Exceptions from Accounting for Deferred Taxes
Deferred taxes are not
recognised for permanent
differences.

recognised for the following
items:

recognised if it arises from the
initial recognition of goodwill.
the initial recognition of

goodwill
However, unlike IFRS, US

GAAP does not have a similar
exception in respect of initial
recognition of an asset or
liability in a transaction that is
not a business combination and
at the time of the transaction
neither accounting profit nor
taxable profit (tax loss) is
affected.
the initial recognition of an

asset or liability in a
transaction that is not a
business combination and at
the time of the transaction
neither accounting profit nor
taxable profit (tax loss) is
affected.
Deferred Tax on Investments in Subsidiaries, Branches, Associates and Interest in Joint

Ventures
No deferred tax is
recognised.
Deferred tax should not be

recognised for temporary
differences in respect of
investment in subsidiaries,
branches, associates and
interest in joint ventures if
certain conditions are
satisfied.
Similar to IFRS. However, these

conditions are different from
IFRS. Further, unlike IFRS,
deferred tax is always
recognised in respect of
branches and associates.
Deferred Tax on Unrealised Intragroup Profits

Deferred tax on unrealised
intra group profits is not
recognised. deferred tax
expense is an aggregation
from separate financial
statements of each group
entity and no adjustment is
made on consolidation.
Unlike Indian GAAP, deferred

taxes on elimination of
intragroup profits and losses
are calculated with reference
to the tax rate of the buyer at
the end of the reporting
period.

current tax on unrealised inter
company profits and losses
(calculated with reference to the
tax rate of the seller) is deferred
and subsequently, recognised
as current tax in the year of sale
to an external party.
Similar to Indian GAAP, the

recognitionand measurement
provisions of IAS 37 are
relevant because an
uncertain tax position may
give rise to a liability of
uncertain timing and amount.

US GAAP uses a two-step
process to recognise and
measure the financial statement
effects of a tax position. An
entity initially recognises the
financial statement effects of a
tax position when it is more
likely than not (likelihood of >50
percent), based on the technical
merits, that the position will be
sustained on examination. A tax
position that meets the more
likely than not threshold is then
initially and subsequently
measured as the largest
Uncertain Tax Positions

The recognition and
measurement provisions of
AS 29 are relevant because
an uncertain tax position may
give rise to a liability of
uncertain timing and amount.
Accounting Norms
27
amount that is greater than 50
percent likely of being realised
on settlement with a taxing
authority.
Notes
Business Combinations
provided under Indian GAAP
on accounting for a change in
the acquirers deferred tax
asset as a result of a
business combination. In
practice, such a change is
accounted in profit or loss.

except that IFRS specifically
requires such a change to be
accounted in profit or loss.
Similar to IFRS.
Deferred taxes are recorded

for the difference between
the amount of the tax
deduction (or future tax
deduction) and cumulative
remuneration expense
related to share-based
payment awards.
Deferred tax assets are based

on the amount of compensation
cost recorded.
Share-based Payment
Unlike IFRS, the deferred tax

adjustment for current share
price is recorded on settlement.
Deferred tax assets are

adjusted each period to the
amount of tax deduction that
the entity would receive if the
award was tax deductible as
of the reporting date based
on the current market price of
the shares.
Presentation and Disclosure
An entity should offset assets
and liabilities representing
current tax if it has a legally
enforceable right to set off
the recognized amounts and
intends to settle the asset
and the liability on a net
basis.

IFRS except that intentions to
net settle is not required.
There is no requirement for

disclosing the relationship
between the tax expense and
accounting profit.
All entities should disclose an

explanation of the
relationship between tax
expense and accounting
profit using a numerical
reconciliation.
Public entities-Similar to IFRS.

Nonpublic entities should
disclose the nature of significant
reconciling items but may omit a
numerical reconciliation.
28
Notes
Income and Expenditure

1.3.14 Revenue General
Indian GAAP
Primary guidance: AS 9;
Guidance Note on
accounting for Dot-com
companies
IFRS
US GAAP

IFRIC 13, IFRIC 15, IFRIC
18, SIC 31

ASC 845, Industry topics, SEC
SAB Topic 13
Revenue is the gross inflow

of economic benefits during
the period arising in the
course of the ordinary
activities of an entity when
those inflows result in
increases in equity, other
than increases relating to
contributions from equity
participants.
Revenue is defined as inflows

or other enhancements of
assets of an entity or
settlements of its liabilities (or a
combination of both) from
delivering or producing goods,
rendering services, or other
activities that constitute the
entitys ongoing major or central
operations.
Unlike Indian GAAP, specific

guidance exists.
Similar to IFRS except that

guidance under US GAAP is
more comprehensive.
Revenue is recognised only

when it is probable that any
future economic benefit will
flow to the entity and such a
benefit can be measured
reliably.
Revenue is generally
recognised when it is realised or
realisable and earned. US
GAAP includes specific revenue
recognition criteria for different
types of revenue generating
transactions. For many
transactions, criteria differ from
Indian GAAP and IFRS.
Revenue is recognised at the

fair value of the consideration
received or receivable. Fair
value is determined by
discounting all future receipts
using an imputed rate of
interest. The difference
between the fair value and the
consideration is recognised as
interest income using the
effective interest method.
Similar to IFRS.
Definition
Revenue is the gross inflow
of cash, receivables or other
consideration arising in the
course of the ordinary
activities from the sale of
goods, from the rendering of
services and from the use by
others of entity resources
yielding interest, royalties
and dividends.
Principal versus Agent
on whether an entity is acting
as a principal or an agent.
Recognition
Recognition criteria depend
on the category of revenue
transaction. In general
criteria includes no significant
uncertainty exists regarding
the amount of the
consideration that will be
derived from the sale of
good/rendering of service.
Measurement
Revenue is recognised at the
consideration received or
receivable
Specific Industry and Other Guidance

Revenue recognition is
mainly based on general

US GAAP has comprehensive
Accounting Norms
29
guidance specific to industry
and type of revenue
arrangement. For e.g., there
exists comprehensive guidance
on software revenue
recognition.
principles that are applied to

different types of
transactions.
Notes
Multiple Element Arrangements

guidance.
To present the substance of a

transaction appropriately, it
may be necessary to apply
the recognition criteria to the
separately identifiable
component of a single
transaction. However, There
is no specific guidance for
making this assessment.
Unlike IFRS, US GAAP

provides detailed guidance on
multiple-element revenue
arrangements and establishes
detailed criteria for determining
whether each element may be
separately considered for
recognition.
IFRIC 13 indicates that

customer loyalty programs
are deemed multiple-element
Similar to Indian GAAP, there is

no specific guidance that
addresses customer loyalty
programs. The facts and
circumstances of the program
are considered to determine the
appropriate accounting. Although
customer loyalty programs are
not in the scope of ASC 605-25,
some companies apply that
guidance by analogy and
allocate revenue to the award
credits. Others may follow an
incremental cost approach in
which the cost associated with
the award credit is accrued.
Customer Loyalty Program

on accounting for customer
loyalty programs.
revenue transactions and that

the fair value of the
consideration received
should be allocated between
the components of the
arrangement.
Rendering Services
Completed service contract
method or proportionate
completion method is
permitted.
Revenue is recognised using

percentage of completion
method.
Revenue from service is

generally recognised using the
proportional performance or
straight-line method rather than
the completed service contract
method or proportionate
completion method (cost 5241,
completion method is not
permitted).
Interest income is recognised

using the effective interest
method.
Similar to IFRS.
Interest Income
Interest is recognised on a
time proportion basis taking
into account the amount
outstanding and the rate
applicable.
30
Notes
1.3.15 Revenue Long-term Contracts/Construction Contracts

Guidance Note on
Accounting for Real Estate
Developers

IFRIC 15
Primary guidance: ASC

605-35
Construction Contracts (Other than Real Estate Sales)

Revenue is recognised
based on the percentageof-completion method.
However, when the
percentage-of-completion
method is deemed
inappropriate (e.g., when the
outcome of the contract
cannot be estimated reliably),
revenue is recognised to the
extent that costs have been
incurred, provided that the
costs are recoverable. The
completed- contract method
is not permitted.
Revenue is recognised based

on the percentageof-completion method, provided
the entity has an ability to make
dependable estimates relating
to the extent of progress toward
completion, contract revenues
and contract costs. If otherwise,
the completed contract method
is used. Similar to Indian GAAP
and IFRS, probable losses are
recognised as an expense
immediately.
Contract revenue and contract
costs are recognised by
reference to the stage of
completion of work.
Probable losses are

recognised as an expense
immediately.
Contract revenue and
contract costs are recognised
by reference to the stage of
completion of work.

the revenue to be recognised
can also be determined by
reference to the gross margin
earned. Gross profit earned on
a contract is computed by
multiplying the total estimated
gross profit on the contract by
the percentage of completion.
Construction contracts are

segmented or combined, as
the case may be, when
certain criteria are met.

IFRS.
There is specific guidance.

Application of this guidance
may result in revenue being
recognised on a percentageof-completion basis, a
continuous delivery basis, or
at a single point in time.
However, the guidance
differs from the guidance
under Indian GAAP.
There is detailed guidance on

accounting for real estate sales.
results in revenue being
recognised under full accrual
method, the installment method,
the cost recovery method, the
percentage of completion
method, or the deposit method.
Real Estate Sales

There is specific guidance.
may result in revenue being
recognised on a percentageof-completion basis, a
continuous delivery basis, or
at a single point in time.
Accounting Norms
31
1.3.16 Employee Benefits

Notes
IFRIC 14

ASC 715
Post-employment Defined BenefitsActuarial Gains and Losses

Projected unit credit method
is used to perform actuarial
valuations. All actuarial gains
and loss are recognised
immediately in profit or loss.
Similar to Indian GAAP,

except re-measurements are
recognized immediately in
other comprehensive income.
These are subsequently not
reclassified to income
statement

the actuarial method used
depends on the type of plan.
Immediate recognition in other
comprehensive income is not
permitted, however an entity
may adopt policy of immediate
recognition in income
statement; corridor method is
also permitted.
Post-employment Defined BenefitsRecognition of Prior Service Costs

Prior service costs are
recognized immediately if
they are related to vested
benefits; otherwise, they are
recognized over the vesting
period.
An entity recognises prior

service cost as an expense at
the earlier of the following
dates:
When the plan amendment or
curtailment occurs;
When the entity recognises
related restructuring costs or
termination benefits.
Prior service costs are

recognised initially in other
comprehensive income, and
both vested and unvested
amounts amortised over the
average remaining service
period.
However, if all or almost all of
the plan participants are
inactive, prior service cost are
amortised over the remaining
life expectancy of those
participants.
Measurement Frequency
Detailed actuarial valuation to
determine present value of
the benefit obligation is
carried out at least once in
every three years, and fair
value of plan assets are
determined at each balance
sheet date.
No explicit requirement on how

frequently the defined benefit
obligation and the plan assets
are measured. However, they
should be measured regularly
enough that the amount
recognised is not materially
different from the amount that
would be determined on the
reporting date.
Measurement should be
performed at least once
annually, or more often when
certain events occur.
Market yield on high quality

corporate bonds as at the
balance sheet date is used.
In countries where there is no
deep market in such bonds,
the market yield on
government bonds is used.
Rates of return on high-quality

fixed-income investments
currently available and
expected to be available during
the period to maturity of the
pension benefits is used.
Discount Rate
Market yield on government
bonds as at the balance
sheet date is used as
discount rates.
Circumstances in which there is

no deep market in high-quality
corporate bonds are not
specifically addressed.
32
Notes

Curtailments
Gains and losses on the
curtailment of a defined
benefit plan are recognised
when the curtailment occurs.
Curtailment gains and losses

are recognized when an
entity is demonstrably
committed and a curtailment
has been announced.
A curtailment loss is recognised

when it is probable that a
curtailment will occur and the
effects are reasonably
estimable. A curtailment gain is
recognised when the relevant
employees are terminated or
the plan suspension or
amendment is adopted, which
could occur after the entity is
demonstrably committed and a
curtailment is announced.
Recognised when an
employer is demonstrably
committed to pay.
Termination benefits are

recognised on the basis of the
type of benefits.
Termination Benefits
Recognised if the transaction
meets the definition of a
Provision.
For special termination benefits,

a liability and a loss is
recognised when the employee
accepts the offer and the
amount of benefits can be
reasonably estimated. For
contractual termination benefits,
a liability and a loss is
recognised when it is probable
that the specified event that
triggers the termination will
occur and the amount of
benefits can be reasonably
estimated.
Compensated Absences
The plan is segregated
between short term and other
long term employee benefits.
The expected cost of
accumulating short term
compensated absences is
recognised on an accrual
basis. Liability for long-term
compensated absences is
measured on actuarial basis.

compensated absences are
recognised on an accrual basis.
1.3.17 Share-based Payments

Primary guidance:
Guidance Note by the ICAI
and SEBI Guidelines
Primary guidance: IFRS 2

ASC 505-50
Share-based Payments to Employees

Option to measure based on
the grant date fair value or
Measured based on the

grant-date fair value of the
Similar to IFRS. However,

unlike IFRS, intrinsic value
Accounting Norms
intrinsic value of the equity
instruments issued.
33
equity instruments issued.
Intrinsic value approach is
permitted only when the fair
value of the equity
instruments cannot be
estimated reliably.
approach can be followed by

non-public companies for
share-based awards classified
as liabilities.

grant date is the date: (i) at
which an employer and
employee reach a mutual
understanding of the key terms
and conditions of a share-based
payment award and (ii) that an
employee begins to benefit
from, or be adversely affected
by, subsequent changes in the
price of the employers equity
shares.
Notes
Grant Date
Grant date is the date on
which the entity and the
employee have a shared
understanding of the terms
and conditions of the
arrangement.
Share Based Payments to Non-employees

guidance.
Generally, measured based

on the fair value of the goods
or services received.
Unlike IFRS, equity-settled

share based payment
transactions with nonemployees are accounted for
based on the fair value of the
consideration received or the
fair value of the equity-based
instruments issued, whichever
is more reliably measurable.
Unlike Indian GAAP, awards

with graded vesting is
measured as, in substance,
multiple awards.
Graded Vesting
Entity may choose to
measure on a straight-line
basis as a single award or an
accelerated basis as though
each separately vesting
portion of the award is a
separate award.
1.4 The Roadmap for implementation of Ind AS

On 16th February 2015, the Ministry of Corporate Affairs (MCA) notified the
Companies (Indian Accounting Standards) Rule, 2015 (the Rules) (pending publication in
the Gazette of India). The Rules specify the Indian Accounting Standards (Ind AS)
applicable to certain class of companies and set out the dates of applicability.
The key requirements of the Rules with regard to the class of companies that will be
required to follow Ind AS and the date of adoption by such companies are as under:
Voluntary Adoption
Companies may voluntarily adopt Ind AS for financial statements for accounting
periods beginning on or after 1 April 2015 with the comparatives for the periods ending
34
Notes
31 March 2015 or thereafter. Once a company opts to follow the Ind AS, it will be required
to follow the same for all the subsequent financial statements.
Mandatory Adoption
For the accounting periods beginning on or
after 1 April, 2106
For the accounting periods beginning on or

after 1 April, 2107
The following companies will have to adopt Ind

AS for financial statements from the above
mentioned date
The following companies will have to adopt Ind

AS for financial statements from the above
mentioned date
(i) Companies whose equity and/or debt

securities are listed or are in the process
of listing on any stock exchange in India
or outside India (listed companies) and
having net worth of ` 500 crore or more
(i) Listed companies having net worth of

less than ` 500 crore.
(ii) Unlisted companies having net worth of

` 500 crores or more
(iii) Holding subsidiary, joint venture or
associate companies of the listed and
unlisted companies covered above
Comparative for these financial statements will
be periods ending 31 March 2016 or thereafter.
(ii) Unlisted companies having net worth of

` 250 crore or more but less than ` 500
crore
(iii) Holding subsidiary ,joint venture or
associate companies of the listed and
unlisted companies covered above
Comparative for these financial statements will

be periods ending 31 March 2016 or thereafter.
The road map will not be applicable to:
Companies whose securities are listed or in the process of listing on SME

exchanges.
Companies not covered by the road map in the Mandatory adoption
categories above.
Insurance companies banking companies and non-banking finance
companies.
These companies should continue to apply existing Accounting standards

prescribed in the Annexure to the Companies (Accounting Standards) Rules, 2006
unless they opt for voluntary adoption. Insurance companies, banking companies and
non-banking finance companies cannot voluntarily adopt the Ind AS.
1.5 Summary
The unit has covered the following:
(i) Introduction to various accounting standards operating in India
Financial statements summarize the end-result business activities of an
enterprise during an accounting period in monetary term. In order that the
methods and principles adopted by various reporting enterprises are coherent,
not misleading and to the extent possible are uniform and comparable
standards are evolved. Accounting Standard is an authoritative
pronouncement of code of practice of the regulatory accountancy body to be
observed and applied in the preparation and presentation of financial
statements.
World over, professional bodies of accountants have the authority and the
obligation to prescribe Accounting Standards. International Accounting
Standards (IASs) are pronounced by the International Accounting Standards
Committee (IASC). The IASC was set up in 1973, with headquarters in London
Accounting Norms
35
(UK). In India, the Institute of Chartered Accountants of India (ICAI) had

established in 1977 the Accounting Standards Board (ASB).
Notes
List of Accounting Standards in India

Accounting Standards (AS) Title of the Accounting Standards
AS 1
Disclosure of Accounting Policies
AS 2 (Revised)
Valuation of Inventories
AS 3 (Revised)
Cash Flow Statements
AS 4 (Revised)
Contingencies and Events Occurring after the Balance Sheet Date
AS 5 (Revised)
Net Profit or Loss for the Period, Prior Period Items and Changes in
Accounting Policies
AS 6 (Revised)
Depreciation Accounting
AS 7 (Revised)
Accounting for Construction Contracts
AS 9
Revenue Recognition
AS 10
Accounting for Fixed Assets
AS 11 (Revised 2003)
The Effects of Changes in Foreign Exchange Rates
AS 12
Accounting for Government Grants
AS 13
Accounting for Investments
AS 14
Accounting for Amalgamations
AS 15
Accounting for Retirement Benefits in the Financial Statements of

Employers
AS 16
Borrowing Costs
AS 17
Segment Reporting
AS 18
Related Patty Disclosures
AS 19
Leases
AS 20
Earnings Per Share
AS 21
Consolidated Financial Statements
AS 22
Accounting for Taxes on Income
AS 23
Accounting for Investment in Associates in Consolidated Financial

Statements
AS 24
Discontinuing Operations
AS 25
Interim Financial Reporting
AS 26
Intangible Assets
AS- 27
Financial Reporting of Interest in Joint Ventures
AS 28
Impairment of Assets
AS 29
Provisions, Contingent Liabilities and Contingent Assets
(ii) Comparison of Indian AS with International Accounting standards and US

GAAP with reference to the following:
Overall financial statement presentationPresentation of Financial Statements,
Statement of cash flows; Non-current assets held for sale and discontinued
operations,
Accounting Policies with reference toChanges in accounting policy,
estimates and correction of errors; Assets, Borrowing costs, Investment
36
Notes
property, Intangible assets, Impairment (other than financial assets),

Inventories, Leases, Provisions, contingent liabilities and contingent assets,
Taxation;
Income and ExpenditureRevenue General,. Revenuelong-term contracts/
construction contracts, Employee benefits, Share-based payments
(iii) The Road map for implementation of Indian ASvoluntary and mandatory

I. State Whether the Following Statements are True or False
1. IFRS are the Financial Reporting Standards issued by IASB.
2. The objective of IFRS is to ensure that financial statements report high quality
information.
3. IFRS enhances uniformity in the accounting principles.
4. Due to IFRS, cost of raising funds in the foreign market will be higher.
5. Investors will rely on financial statements prepared as per IFRS.
6. ICAI has decided to have convergence of AS with IFRS in July 2011.
7. A core group is constituted by MCA.
8. The first phase of implementation of IFRS was for those companies having net
worth over 1,000 crores.
II. Multiple Choice Questions
1. IFRS are issued by __________.
(a) IASB
(b) ICAI
(c) FASB
(d) IASC
2. The ICAI has decided to adopt IFRS w.e.f. __________.
(a) 1-4-2015
(b) 1-4-2016
(c) 1-4-2014
(d) 1-1-2016
3. IFRS are the __________.
(a) Sets of financial reporting standards
(b) Rules of accounting
(c) Sets of auditing standards
(d) None of the above
4. The objective of IFRS is to __________.
(a) ensure preparation of financial statements
(b) ensure that the financial statements contain high quality information.
(c) ensure uniformity in financial statements at national level
(d) none of the above
5. IFRS will facilitate __________.
(a) better access and reduction in cost of capital raised from global market.
(b) easy borrowing from Indian capital market.
(c) improvement in comparability of financial information.
(d) (a) + (c)
Accounting Norms
37
6. IFRS are applicable to All the entries having net worth in excess of
__________.
(a) ` 500 crores
(b) ` 1000 crores
(c) ` 100 crores
(d) ` 10,000 crores
7. Convergence of Indian Accounting Standards with IFRS implies that
__________.
(a) Indian Accounting Standards will be known as IFRS
(b) IFRS will adopt Indian Accounting Standards
(c) Indian Accounting Standards I will be known as IFRS 1.
(d) Indian Accounting Standards will achieve harmony in relation to IFRS
Notes

1. Can you draw comparison between Ind.AS, IFRS and US GAAP with reference
to __________.
(a) Selection of accounting policies
(b) components of financial statements.
2. With regard to Cash Flows prepare comparative analysis between Ind AS,
IFRS and US GAAP with reference to __________.
(a) Definition of cash and cash equivalents,
(b) Classification of cash flows
(c) methods of presenting operating cash flows.
3. With regard to changes in accounting policy, estimates and correction of errors,
prepare comparative analysis between Ind AS, IFRS and US GAAP.
4. Can you draw comparison between Ind AS, IFRS and US GAAP with reference
to Property, Plant and Equipment?
5. With regard to Borrowing costs and its impact of cost of asset, prepare
comparative analysis between Ind AS, IFRS and US GAAP.
6. With regard to Intangible assets (excluding goodwill), prepare comparative
analysis between Ind. AS, IFRS and US GAAP.
7. With regard to Inventories prepare comparative analysis between Ind AS, IFRS
and US GAAP with reference to:
(a) cost formula
(b) measurement of inventories
(c) reversal of write down inventory
1.8 Key Terms
IAS: International Accounting Standards,

IASB: International Accounting Standards Board,
ICAI: Institute of Chartered Accountants of India,
IFRS: International Financial Reporting Standards,
Indian GAAP: Accounting principles generally accepted in India,
US GAAP: Accounting principles generally accepted in the US,
38
Notes

I. True or False
1.
2.
3.
4.
5.
6.
7.
8.
True
True
True
False
True
False
True
False

1.
2.
3.
4.
5.
6.
7.
(a) IASB
(b) 1-4-2016
(d) (a) + (c)
(a) ` 500 crores
(d) Indian Accounting Standards will achieve harmony in relation to IFRS
1.10 Case Study

1. PQR Ltd. shows its inventory at cost in the financial statements. In the current
year, the realizable value of a portion of inventory has gone down below the
cost of goods. Comment.
2. RST Ltd. shows its inventory at the lower of cost or net realizable value. For
this purpose, the cost is ascertained by applying the LIFO method and the net
realizable value is taken as equal to the current market price of purchasing of
these inventories. Comment.
3. M Ltd. values its finished goods at prime cost (FIFO) or net realizable value,
whichever is less. Comment.
4. ABC Ltd. purchased on credit, an asset costing ` 5,00,000 during the year
2004. It charges depreciation @ 15% WDV on this types of asset. During the
year, it has paid ` 2,20,000 to the supplier, including the interest for the
delayed payment. ` 3,00,000 together with interest will be payable next year.
The amount of depreciation provided for the year is ` 33,000, i.e., 15% of
` 2,20,000. Comment.

1. Indian Accounting Standards and GAAP by Dolphy D Souza, Snow White
Publications.
2. Accounting Standards by Rustagi R.P., Golgotia Publications, Website:
www.icai.org
Accounting for Merger and Acquisitions
39
Notes
Unit 2:
Structure:
2.1
2.2
2.3
2.4
2.5
2.6
2.7
2.8
2.9
2.10
2.11
2.12
2.13
2.14
2.15
2.16
2.17
Introduction
Definitions
Types of Amalgamations and its Accounting
Accounting for Amalgamation in the Books of Transferee Company (i) The
Pooling of Interests Method and (ii) The Purchase Method
Accounting for Amalgamation in the Books of Transferor Company
Treatment of Reserves:
2.6.1 Statutory Reserves
2.6.2 Amalgamation after the Balance Sheet Date
Disclosure
Limited Revisions to AS 14 of Accounting Standard 14 Accounting for
Amalgamation
Companies Act, 1956 and AS 14
AS 14 and International Accounting Standards
Summary
Check Your Progress
Key Terms
Case Study
Further Readings
Objectives
Quite often, two or more companies separately incorporated under the Companies
Act, 1956 are merged together and resulting in winding up of one or more
companies. In this process, there may arise goodwill or capital reserve (being the
difference between the purchase price paid and the net assets acquired) in the
books of the accounting company.
AS 14 aims to provide for accounting treatment of mergers and also the treatment
of goodwill/capital reserve arising there from. The Standard does not deal with
acquisitions where an investor acquires whole or part of capital of some other
company and does not result in dissolution of the acquired entity.
2.1 Introduction
The direct relationship between good accounting practices and better economic
outcomes is widely recognized. There are numerous instances in India and around the
world of bad accounting practices leading to corporate failures. With so much activity
happening on the acquisition front by Indian companies in cross-border markets, it is an
40
Notes
opportune time to evaluate whether within the framework of accounting standards the
structuring of the M&A transaction can be done.
2.2 Definitions
The following terms are used in this Standard:
(i) Amalgamation means an amalgamation pursuant to the provisions of the
Companies Act 1956.
(ii) Transferor company means the company which is amalgamated into another
company.
(iii) Transferee company means the company into which a transferor company is
amalgamated.
(iv) Reserve means the portion of earnings, receipts or other surplus of an
enterprise (whether capital or revenue) appropriated by the management for a
general or specific purpose other than a provision for depreciation or diminution
in the value of assets of for a known liability.
(v) Amalgamation in the nature of merger is an amalgamation which satisfies all
the following conditions:
All the assets and liabilities of the transferor company become, after
amalgamation, the assets and liabilities of the transferee company.
Shareholders holding not less than 90% of the face value of the equity
shares of the transferor company become equity shareholders of the
transferee company by virtue of the amalgamation
The consideration for the amalgamation receivable by those equity
shareholders of the transferor company who agree to become equity
shareholders of the transferee company, is discharged by the transferee
company wholly by the issue of equity shares in the transferee company,
except that cash may be paid in respect of fractional shares.
The business of the transferor company is intended to be carried on, after
the amalgamation, by the transferee company.
No adjustment is intended to be made to the book value of the assets and
liabilities of the transferor company when they are incorporated in the
financial statements of the transferee company except to ensure
uniformity of accounting policies.
(vi) Amalgamation in the nature of purchase is an amalgamation which does not
satisfy any one or more of the conditions specified above.
(vii) Consideration for the amalgamation means the aggregate of the shares and
other securities issued and the payment made in the form of cash or other
assets by the transferee company to the shareholders of the transferor
company.
(viii) Fair value is the amount for which an asset could be exchanged between a
knowledgeable, willing buyer and a knowledgeable, willing seller at an arms
length transaction.
2.3 Types of Amalgamations and its Accounting

As per AS 14, there are two types of amalgamations:
(i) Amalgamation in the nature of merger; and
(ii) Amalgamation in the nature of purchase
41
2.4 Accounting for Amalgamation in the Books of Transferee

Company
Notes
There are two methods of accounting for amalgamation:

(i) The pooling of Interests Method: Under the pooling of interests method, the
assets, liabilities and reserves of the transferor company are recorded by the
transferee company at their existing carrying amounts in the financial
statements of the transferred company. This method is applicable in the books
of transferee company in case of amalgamation in the nature of merger
(ii) The Purchase Method: Under the purchase method, the transferee company
records the amalgamation by incorporating the assets and liabilities taken over,
at their fair values at the date of amalgamation.
The difference between the purchase consideration and the fair value of identifiable
assets and liabilities is recorded as Goodwill or Capital Reserve. The asset and liabilities
not taken over by transferee company are disposed off by transferor company. This
method is applicable in the books of transferee company in case of amalgamation in the
nature of purchase.
2.5 Accounting for Amalgamation in the Books of Transferor

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

In case of amalgamation in the nature of merger, the identity of the reserves of
transferor company is preserved and they appear in the financial statements of the
transferee company in the same form in which they appeared in the financial statements
of the transferor company. The General Reserve, the Capital Reserve and the
Revaluation Reserve of the transferor company becomes the General Reserve, the
Capital Reserve and the Revaluation Reserve of the transferee company. The difference
between the consideration payable (in term of share capital of the transferee company or
cash or otherwise) and amount of the share capital of the transferor company should be
adjusted in the reserves of the transferee company.
In case of amalgamation in the nature of purchase, the identity of the reserves,
other than the statutory reserves is not preserved. The amount of the consideration is
deducted from the value of the net assets of the transferor company acquired by the
transferee company. If the result of the computation is negative, the difference is credited
to Capital Reserve.The goodwill/capital reserve, so created, appears in the balance
sheet of the transferee company.
2.6.1 Statutory Reserves
Statutory reserves are those reserves, which are required and created as per the
provisions of some law, and generally, there is a restriction on the utilization of this
reserve. If a Statutory Reserve is appearing in the balance sheet of the transferor
42
Notes
company, then it should appear in the balance sheet of Transferee Company also, after
amalgamation. This can be ensured as follows:
(a) In case of amalgamation in the nature of merger: As already stated, in case
of merger, all the reserves of the transferor company are shown in the balance
sheet of the transferee company, the Statutory Reserves will appear together
with other reserves in the balance sheet of transferee company. So, no
separate treatment is required for Statutory Reserves in case of amalgamation
in the nature of merger.
(b) In case of amalgamation in the nature of purchase: In case of purchase, the
transferee company is required to record the Statutory Reserves of transferor
company and for this purpose, a separate entry is required as follows:
Amalgamation Adjustment A/c
Dr.
To Statutory Reserves A/c

The Amalgamation Adjustment A/c will appear under the heading
Miscellaneous Expenditures, and Statutory Reserves would appear under the
heading Reserves and Surplus in the balance sheet of transferee company
after amalgamation.
Later on, when the identity of the Statutory Reserves is not to be maintained or
required, both these accounts should be contra-cancelled by the following
entry:
Statutory Reserves A/c
Dr.
To Amalgamation Adjustment A/c

2.6.2 Amalgamation after the Balance Sheet Date
When an amalgamation is effected after the balance sheet date but before the
issuance of the financial statements of either party to the amalgamation, disclosure
should be made in accordance with AS 4, contingencies and events occurring after the
Balance Sheet date, but the amalgamation should not be incorporated in the financial
statements.
2.7 Disclosure
The following disclosures should be made in the first financial statements after the
amalgamation:
(a)
(b)
(c)
(d)
names and general nature of business of amalgamating companies;

effective date of amalgamation for accounting purposes
the method of accounting used to reflect the amalgamation
the amount of any difference between the consideration paid and the net
assets acquired, and the treatment thereof; and
(e) description and number of shares issued and ratio for exchange of shares
2.8 Limited Revisions to AS 14 of Accounting Standard 14

Accounting for Amalgamation
The Council of the Institute of Chartered Accountants of India has decided to make
the following limited revisions to Accounting Standard (AS) 14, Accounting for
Amalgamations.
It has been decided to substitute paragraph 42 of AS 14 by the following paragraph
(modifications made are shown as underlined):
43
42. Where the scheme of amalgamation sanctioned under a statute prescribes the
treatment to be given to the reserves of the transferor company after amalgamation, the
same should be followed. Where the scheme of amalgamation sanctioned under a
statute prescribes a different treatment to be given to the reserves of the transferor
company after amalgamation as compared to the requirements of this Statement that
would have been followed had no treatment been prescribed by the scheme, the
following disclosures should be made in the first financial statements following the
amalgamation
Notes
(a) A description of the accounting treatment given to the reserves and the
reasons for following the treatment different from that prescribed in this
Statement.
(b) Deviations in the accounting treatment given to the reserves as prescribed by
the scheme of amalgamation sanctioned under the statute as compared to the
requirements of this Statement that would have been followed had no
treatment been prescribed by the scheme.
(c) The financial effect, if any, arising due to such deviation.
The limited revisions come into effect in respect of accounting periods commencing
on or after 1-4-2004.
2.9 Companies Act, 1956 and AS 14

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

AS 14 is based on IAS 22 and US GAAP, still there are many differences between
them.
Under AS 14, in case of purchase method, the transferee company can record the
assets acquired either at the carrying amounts in the books of transferor company or at
the fair value. However, in case of IAS 22 and US GAAP, only fair values have been
provided.
In case of amalgamation in the nature of purchase, the transferee company may
intend to effect changes in the activities of the transferor company. AS 14 necessitates
that in such a case, the transferee company should create specific provision for the
expected costs of say, employee termination, plant relocation, etc. However, IAS 22 and
US GAAP provide for detailed provisions for recognition of such liability.
Regarding goodwill, which arises in case of purchase method, there are varying
provisions. AS 14 says that it should be written off over a period of 5 years unless
somewhat longer periods can be justified. IAS 22 provides for a maximum period of 20
years, while US GAAP says that goodwill need not be written of unless impaired.
AS 14 provides for two types of amalgamation i.e. in the nature of merger and in the
nature of purchase. However under IAS 22 and US GAAP, the pooling of interest method
has been made redundant.
44
Notes
AS 14 does not provide for treatment of merger related expenses. However IAS 22
and US GAAP state that the merger expense should be charged to the Profit and Loss
A/c of the merged entity (i.e., the transferee company).
2.11 Summary
Accounting Standard 14 deals with Accounting for Amalgamation. It gives
accounting to be made in the books of the transferee company. This standard is not
applicable when one company acquires or purchases the shares of another company.
The acquired company is not dissolved and its separate entity continues to exist.
Accounting for mergers can be handled by:
(i) Pooling of interest method: Under the pooling of interests method, the assets,
liabilities and reserves of the transferor company are recorded by the
statements of the transferred company, and
(ii) Purchase method: The transferee company records the amalgamation by
incorporating the assets and liabilities taken over, at their fair values at the date
of amalgamation.
The method of calculating consideration are lump sum method, net asset method,
net payment method and intrinsic method.
AS 14 is silent on the accounting for amalgamation in the books of transferor
company. It has given accounting treatment only for the transferee company. Therefore,
accounting for amalgamation in the books of transferor company should be recorded as
per normal principles and practices of accounting, whether it is amalgamation in the
nature or merger or in the nature of purchase

1. Under pooling of interest method, the reserves of the transferor company
should be recorded at their existing carrying amounts in the same form as at
the date of amalgamation.
2. The consideration for the amalgamation should include any non-cash element
at fair value.
3. The scheme of amalgamation may provide for an adjustment to the
consideration contingent on one or more future events.
4. When the purchasing company decides to compensate, the selling company
on the basis of agreed value of assets and liabilities, the method for calculating
purchase consideration is called Net Payments Method.
5. When one existing company takes over the business of another company or
companies, it is known as absorption.
1. Under the net payments method, purchase consideration is arrived at by
adding up the payments made to _________ in the vendor company.
(a) debt holders
(b) shareholders
(c) liabilities
(d) assets
45
2. When there are one or more liquidations and no formation, it is known as

________.
(a) amalgamation
(b) merger
(c) takeover
(d) acquisition
3. When an existing company takes over the business of existing company/
companies, it is known as ________.
(a) amalgamation in the nature of merger
(b) amalgamation in the nature of purchase
(c) takeover
(d) acquisition
4. Items in the nature of accumulated profits or losses in the books of the vendor
company should be transferred to _________.
(a) transferor company
(b) transferee company
(c) both transferee company and transferor company
(c) in neither s books
5. If preference shareholders or debenture holders are to receive more or less in
liquidation, such amount should be adjusted through _________.
(a) Amalgamation adjustment
(b) Miscellaneous expenditure
(c) Capital Reserve
(d) Realization Account
Notes

1. What is Amalgamation of Companies? And What are the types of
Amalgamation as per AS 14?
2. What is Merger and what is purchase of business?
3. What do you mean by Transferor Company and Transferee Company?
4. How is Purchase Consideration calculated as per (i) Net Asset method and
(ii) Net Payment Method?
5. What do you mean by Accumulated Profits? Mention any five items of
Accumulated Profits.
6. Which funds are strictly liabilities and which funds are accumulated profits?
7. How are realization expenses treated in Amalgamation of Companies and how
is the claim of Equity Shareholders settled?
8. Mention disclosures required under AS 14.
2.14 Key Terms

Amalgamation: Means an amalgamation pursuant to the provisions of the
Companies Act,1956.
Transferor company: The company which is amalgamated into another
company.
46
Notes
Transferee company: Means the company into which a transferor company is

amalgamated.
Amalgamation in the nature of merger is an amalgamation which satisfies all
All the assets and liabilities of the transferor company become, after
amalgamation, the assets and liabilities of the transferee company.
Shareholders holding not less than 90% of the face value of the equity
shares of the transferor company become equity shareholders of the
transferee company by virtue of the amalgamation.
The consideration for the amalgamation receivable by those equity
shareholders of the transferor company who agree to become equity
shareholders of the transferee company, is discharged by the transferee
company wholly by the issue of equity shares in the transferee company,
except that cash may be paid in respect of fractional shares.
The business of the transferor company is intended to be carried on, after
the amalgamation, by the transferee company.
No adjustment is intended to be made to the book value of the assets and
liabilities of the transferor company when they are incorporated in the
financial statements of the transferee company except to ensure
uniformity of accounting policies.
The Pooling of Interests Method: Under the pooling of interests method, the
assets, liabilities and reserves of the transferor company are recorded by the
statements of the transferred company. This method is applicable in the books
of transferee company in case of amalgamation in the nature of merger.
The Purchase Method: Under the purchase method, the transferee company
records the amalgamation by incorporating the assets and liabilities taken over,
at their fair values at the date of amalgamation.

I. True or False
1.
2.
3.
4.
5.
True
False
False
True
False

1.
2.
3.
4.
5.
(b) Shareholders
(b) Merger
(a) amalgamation in the nature of merger
(b) Transferee company
(a) amalgamation adjustment
47
2.16 Case Study
Notes
1. The following are the Balance Sheets as on 31/12/2014 of X Co. Ltd. and Y Co. Ltd.:
Liabilities
X Ltd.
Y Ltd.
Assets
X Ltd.
Y Ltd.
Equity share capital

(` 100 per share)
10,00,000
6,00,000
Land and Buildings

Plant and Machinery
3,00,000
11,00,000
5,00,000
10% Debentures of
` 10 each
2,00,000
Stock
1,60,000
80,000
Reserve Fund
3,40,000
Debtors
1,40,000
90,000
40,000
30,000
Cash
30,000
10,000
1,00,000
80,000
17,30,000
6,80,000
Div Equalization Fund

Employees Provident
Fund
Trade Creditors
Profit and Loss Account
20,000
17,30,000
6,80,000
The two companies agree to amalgamate and for a new company called Z Ltd.
which takes over assets and liabilities of both the companies. The authorized capital of
Z Ltd. is ` 100,00,000 consisting of 10,00,000 equity shares of ` 10 each.
The assets of X Ltd. are taken over at a reduced valuation of 10% with the exception
of Land and Buildings which are accepted at book value.
Both companies are to receive 5% of the net valuation of their respective business
as goodwill. The entire purchase price is to be paid by Z Ltd. in its fully paid shares. In
return for debentures in X Ltd. debentures of the same amount and denomination are to
be issued by Z Ltd.
Calculate purchase consideration for both the companies. Give journal entries to
close the books of X Ltd. and Y Ltd. and show the opening balance sheet of Z Ltd.
Hints: Calculation of purchase consideration
Particulars
X Ltd.
Assets are per Balance sheet

Less: 10% reduction for X Ltd. excluding land and buildings and cash
17,30,000
1,40,000
Y Ltd.
6,80,000
15,90,000
Less: Liabilities taken over
10% Debentures 2,00,000
Employees PF
Sundry creditors
Add: Goodwill 5% of net valuation
Purchase consideration
30,000
1,00,000
3,30,000
80,0000
12,60,000
6,00,000
63,000
30,000
13,23,000
6,30,000

1. Mergers, Restructuring and Corporate Control by J. Fred Weston, K. Wang,
S. Chung and Susan E. Hoag, Prentice-Hall of India Private Ltd.
2. M&A and Corporate Restructuring by Patrick A. Gaughan, Wiley Finance
Series.
3. AS 14 from icai.org website
48
Notes
Unit 3:
Valuation of Goodwill and Shares
Structure:
3.1
3.2
3.3
3.4
3.5
3.6
3.7
3.8
3.9
3.10
3.11
3.12
3.13
3.14
3.15
Introduction to Goodwill
Factors Affecting Value of Goodwill
Need for Valuation of Goodwill
Method of Valuing Goodwill
Introduction to Valuation of Shares
Major Reasons for Valuation of an Enterprise
Analysis and Estimate of Value
Valuation Methods
3.8.1 Market Approaches
3.8.2 Asset Based Approaches
3.8.3 Income Approaches
3.8.4 Market Based
3.8.5 Earnings Based Valuation
3.8.6 Comparative Ratios
Summary
Check Your Progress
Key Terms
Case Study
Further Readings
Objectives
Definition of goodwill and the methods of valuing goodwill
The significance of business valuation
The different approaches to business valuation
3.1 Introduction to Goodwill

Good will is the present value of the firms excess earnings.
The word excess gives indication as to its valuation which is equal to earnings
attributable to rate of return on tangible assets and intangible assets (other than goodwill)
over and above the normal rate of return of return earned by representative firms in the
same industry. Excess earnings also reflect various advantages which a firm may enjoy
in comparison with its competitors such as general public patronage and encouragement
due to its local position, common celebrity, reputation for skill, affluence, punctuality,
accidental circumstances and necessities or even from partialities or prejudices.
49
Lord Eldon says Goodwill is nothing more than the probability that the old
customers will resort to the old place.
Notes
According to Lord Macnaghten, It is a thing easy to describe, very difficult to define.

It is the benefit and advantage of the good name, reputation and connection of a
business. It is the attractive force which brings in customers. It is one thing which
distinguishes and old established business from a new business at its first start.
3.2 Factors Affecting Value of Goodwill

There are several factors which contribute to the goodwill of the business and the
important ones are listed below:
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
(13)
(14)
(15)
(16)
(17)
(18)
Quality of the management team.

Market share s for the product.
Productivity levels of the workers.
Research and development efforts.
Effective advertising to establish brand popularity
Good industrial relations.
Training and development programmes for workers, supervisors, and
executives at various levels.
Locational factors and proximity to markets.
Effective tax planning.
Favorable attitude of government to the industry in general and the particular
business in special.
Popularity of products in terms of quality and effective after sales service.
Customers favorable attitude and customer satisfaction.
Corporate image among the general public
Assured supplies and relation with suppliers.
The longevity of the enterprise.
The position of the business in relation to its competitors
The profit position over years.
Technical collaborators with established companies
3.3 Need for Valuation of Goodwill

The need for valuation of goodwill depends on the form of business organization. In
the case of sole trader, it is usually valued at the time of selling the business, so as to
determine the amount payable by the buyer towards goodwill. In the case of partnership,
there are several circumstances when goodwill has to be valued. They are:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
when a new partner is admitted

when a partner retires or dies.
When there is a change in the ratio of profit-sharing and
When there is dissolution either by sale to a company or amalgamation with
another firm In the case of limited companies
When two or more companies amalgamate.
When one company takes over another
When a company wants to acquire controlling interest in another company, and
When government takes over the business.
50
Notes
3.4. Method of Valuing Goodwill

Each business has its own particular characteristics and its special set of
circumstances and these factors make it difficult to lay down a general formula, which
covers all cases. Three points require emphasis, viz.:
1. The most important consideration is that the method of computing goodwill
should if possible; take into account the earning capacity of the business. A
person buying a business, for example, is concerned with the question as to
whether it will maintain its profits in future.
2. Unless the goodwill can be transferred for valuable consideration no value can
be said to attach to it. Thus, the personal knowledge and skill (such as that
possessed by a barrister) cannot be sold and should the goodwill of the
practice of such a person be made up wholly of such factor, then no
commercial value attaches to it.
3. A prospective purchaser will be vitally concerned with the question of possible
future taxation liability. The purchaser of goodwill expects to recoup what he
has paid for it out of the future profits.
The following are the main bases and methods adopted in valuing goodwill:
1. Arbitrary Assessment: Under this method, a valuation is made by one of the
parties (vendor or purchaser) to which the other agrees, or an independent
party may be called in to give his opinion.
2. Capitalization of Expected Future Net Profits: The necessary steps to be
taken in computing goodwill by this method are as follows:
(a) Ascertain the average net profits, which it is expected, will be earned in
the future.
(b) Capitalize the net profit at the rate, which is considered a suitable return
on capital invested in a business of the type under consideration.
(c) Find the value of the net tangible assets used in the business (i.e., assets
less external liabilities)
(d) Deduct the net tangible assets as per (c) from the capitalized profit earned
in (b) and the difference in goodwill.
Past profits generally provide the basis for ascertaining the average net profit, which
is expected to be earned in future. A reduction is made for remuneration of proprietors
and in the case of a limited company income tax payable on such profits. If it is known
that certain expenses will not recur or that some increased expenses are likely to be
incurred, then due allowance should be made for these. The main difficulty of this method
is the determination of appropriate return on capital in such type of business.
Illustrative Example I:
A company desirous of selling its business to another company has earned an
average profits in the past of ` 150,000 p.a. Such average profit fairly represents the
profit likely to be earned in the future, except that:
1. Directors fees ` 10,000, charged against such profits will not recur in future.
2. Rent @ ` 20,000 p.a. that had been paid by the vendor company will not be a
charge in the future.
The value of the net tangible assets of the vendor company at the proposed date of
sale was ` 1900,000 and it was considered that a reasonable return on capital invested
for the type of company is 8%.
51
The profits of the vendor company would in no way be affected by the sale of its
business to the purchasing company and goodwill existed and was to be paid for on the
basis that the vendor company was a continuing enterprise. Calculate the value of the
goodwill:
Notes
Solution:
` 150,000
Average net profits

`
Add: Non-recurring charges for:

Directors fees
10,000
Rent
20,000
30,000
Estimated future maintainable profits

Future profits capitalized at 8%
180,000 100
8
180,000
= ` 2250,000
Less: Net Tangible Assets
1900,000
Goodwill
350,000
Illustrative Example 2:
From the following information, value the goodwill of XY Co. Pvt. Ltd. carrying on
business as retail traders:
`
Bank O/D
11,670
Plant & Equip at cost less dep.
20,000
Spares
18,100
Land & buildings at cost
22,000
Prov. for tax
3,900
Paid up capital
33,670
Goodwill at cost
50,000
5,000 47,000
Sundry debtors less provn.

for doubtful debts
P & L Approp. A/c
11,330
61,330
18,000
Stock on hand 30,000
95,000
95,000
Profits earned before tax, have been as follows (Tax @ 30%)

Year I
` 8,200
Year 2
` 8,800
Year 3
` 10,300
Year 4
` 11,600
Year 5
` 13,000
Reasonable return on capital invested for such type of business is 12.5%

Solution:
Total profits for 5 years (year1 to 5)
Less: Income tax @ 30%
` 51,900
15,570
36,330
Average profits
Capitalized at 12.5% =
Total Assets:
7,266
7266 100
12.5
` 58,128
` 95,000
52
Notes
Less: Goodwill (computed separately) 5000

External liabilities
33670
` 38,670
Net Tangible Assets
` 56,330
Now Capitalized Profits
` 58,128
Less: Net Tangible Assets
` 56,330
Goodwill
1,798
3. Purchase of Past Profits: This method is widely practiced. It is calculated as

follows:
1. The profits for an agreed number of years preceding the valuation are
averaged, so as to arrive at the average annual profit earned during the period.
2. The goodwill is then estimated on so many years purchase of such average
profit. The number of years selected is presumed to bear relation to the number
of years benefit to be derived from the past association.
The profit referred may be either net profit or gross profit according to what is
agreed upon by the parties.
X, Y and Z are partners sharing profits and losses in the ratio of 2 : 2 : 1. It was
provided in the partnership agreement that on the death or retirement of a partner,
Goodwill to be calculated on the basis of four years purchase of the average net profits
for the preceding seven years. Z retires on 30th June. Calculate the amount of Goodwill
due to Z. Net profits for the seven years are:
Year 1
` 16,000
Year 2
` 20,000
Year 3
` 36,000
Year 4
` 32,000
Year 5
` 16,000
Year 6
` 40,000
Year 7
` 36,000
Solution:
Total profits for preceding 7 years
= ` 1,96,000
Average Profits
= 1,96,000 7 = ` 28,000
4 years purchase of average profits
= 28,000 4 = ` 1,12,000
Zs share of goodwill
=1,12,000 5= ` 22,400
4. Valuation based on Turnover: This method is similar to previous one except

that instead of profit it is based on turnover. The purchaser in other words, pays
for goodwill on one or more years purchase of Gross takings. This method is
particularly suitable for certain professional practices.
5. Purchase of Super Profits: In this method, the attention is focused upon
super profits, which are those profits remaining after deducting from the
estimated annual future profits:
The B Co. Ltd. is to be absorbed by the D Co. Ltd. and in order to decide upon the
purchase consideration, it is necessary to value the Goodwill attached to the business of
53
G Co. Ltd. The two companies agree that Goodwill to be computed shall be three years
purchase of the average annual super profits, the profits being averaged over five years
and subject to whatever adjustments you, as the accountant making the valuation,
consider necessary.
Notes
The profits of the G Co. Ltd. for the last 5 years (before charging corporate tax at say
25%) are as follows:
` 20,000, ` 24,800, ` 17600, ` 28,000, ` 21,600
The above profits does not consider services rendered by the directors of G Co. and
who will be retained in future for ` 4,000.
The average capital invested in net tangible assets over the period is ` 104,800 and
it is considered that the normal return to be expected from the particular type of business
carried on by G Co. Ltd.
Calculate the Goodwill of G Co. Ltd. based on the above.
Solution:
Total profits for 5 years
Average profits
1,12,000 5
Less: Directors fees
` 1,12,000
22,400
4,000
` 18,400
` 4,600
Less: Corporate Tax at 25%

1,38,00
Less: Return on capital invested (10% on ` 104,800)
10,480
` 3,320
Goodwill = 3 years purchase of super profits 3,320 3 = ` 9,960

6. The Annuity Method: This method of calculating Goodwill is similar to the
previous one except that the super profits when arrived at is not multiplied by a figure
representing a certain number of years purchase of such super profits. Instead it is
considered that if the super profits is to continue over an estimated period, then goodwill
is to be calculated by finding the present worth of an annuity (paying the super profit per
year) over the estimated period, discounted at the appropriated rate of interest.
In other words, we have to ascertain the amount of cash it is necessary to pay out
now in order
(i) to obtain the right to receive the amount of super profits annually for the
estimated number of future years and
(ii) to allow for the fact that the money would earn its appropriate rate of interest if
invested. It can be calculated by the formula
Q=
1 - (1 r/100)-n
R/100
where Q = the present value of an annuity of ` 1 for a year at r %

r = the rate percent p.a. ;
n = the no. of years
Super Profit
= ` 20,000
No. of years over which super profit is to be paid
=3
Rate percent per annum
= 10%
Calculate the value of Goodwill by the Annuity Method.

54
Notes
Solution:
The present value of an annuity ` 1 under these conditions:
=
1 - (1 10/100) -3
=
=
10/100
1 - (1.10) -3
0.1
1 18(1.10)3
1 1/1.331
0.1
0.1
0.331
0331
= 2.4868
1.331
0.1331
0.1
Goodwill (being present value of an annuity of ` 20,000) = 20,000 2.4868 = ` 49736

Alternatively: One can compensate from the present value table cumulative
against 10% rate of interest and year 3, the cumulative PV factor is 2.4868.
3.5. Introduction to Valuation of Shares

Valuation of shares one of the most complex of the accounting problems, involves
the use of financial and accounting data, but much depends on the valuers judgment,
experience and knowledge. Any valuation based purely on quantitative data is also not
realistic. Thus, share valuation is an intricate exercise involving accounting as well as
non-accounting data, objective and subjective consideration and balancing of the
interests of the parties involved in it Valuation is closely linked to the purpose of valuation
3.6. Major Reasons for Valuation of an Enterprise

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
Amalgamation or merger with another enterprise.

Closure and sale of assets due to liquidation or other reasons.
Assessment of fund raising capacity and required rating by lenders.
Issue of shares.
Partial or full privatization.
The enterprises own internal exercise for the knowledge of owners and top
executives.
Group restructuring exercise leading to mergers and demergers inside the
group.
Strategic alliances and joint ventures with domestic and international partners.
Sale (or exchange) of a few assets, brands and other claims.
Governmental requirements for taxation, securitization. etc.
Rehabilitation of a sick or dying enterprise. Significant change is to be made in
the value-chain, knowing the independent strength of various value-drivers
contributing to the value-chain of the enterprise.
Converting key employees into entrepreneurial employees and then into equal
partners in the enterprise.
Valuation of goodwill for its presentation in the Balance Sheet or for charging
royalty to dealers, representatives, group-members. etc.
Partial valuation of certain divisions and product lines, for partial restructuring.
55
3.7 Analysis and Estimate of Value
Notes
Valuation Process
Decide on business valuation method to be used
Analyze the company information in conjunction with the industry and
comparable company data
Normalization of Financial Statements
The most common normalization adjustments fall into the following four categories:
(i) Comparability Adjustments: The valuation may adjust the subject companys
financial statements to facilitate a comparison between the subject company
and other business in the same industry or geographical location These
adjustments are intended to eliminate differences between the way that
published industry data is presented and the way that the subject companys
data is presented in its financial statements.
(ii) Non-operating adjustments: It is reasonable to assume that if a business
were sold in a hypothetical sales transaction (which is the underlying premise
of the fair market value standard), the seller could retain any assets which were
not related to the production of earnings or price those non-operating assets
separately .For this reason non-operating assets (such as excess cash) are
usually eliminated from the balance sheet.
(iii) Non-recurring adjustments: The subject companys financial statement s
may be affected by events that are not expected to recur, such as the purchase
or sale of assets, a law suit or an unusually large revenue or expense. These
non-recurring items are adjusted so that the financial statements will better
reflect the managements expectations of future performance.
(iv) Discriminatory adjustments: The owners of private companies may be paid
at variance from the market level of compensating that similar executives in the
industry might command. In order to determine fair market value, the owners
compensation, benefits, perquisites and distributions must be adjusted to
industry standards. Similarly, the rent paid by the subject business for the use
of property owned by the companys owners individually may be scrutinized.
3.8 Valuation Methods

Three different approaches are commonly used in business valuation
(i) the market approach
(ii) the asset-based approach and the income approach.
The market approaches determine value by comparing the subject company to
other companies in the same industry, of the same size, and/or within the same region.
The asset-based approaches determine value by adding the sum of the parts of
the business. The income approach determine value by calculating the net present
value of the benefit stream generated by the business.
In determining which of these approaches to use, the valuation professional must
exercise discretion. Each technique has advantages and drawbacks which must be
considered when applying those techniques to a particular subject company. Most
treaties and court decisions encourage the valuator to consider more than one technique,
which must be reconciled with each other to arrive at a value conclusion. A measure of
common sense and a good grasp of mathematics is helpful.
56
Notes
3.8.1 Market Approaches

It is similar in many respects to the comparable sales method that is commonly
used in real estate appraisal. The market price of the stocks of publicly traded companies
engaged in the same or a similar line of business, whose sales are actively traded in a
free and open market, can be a valid indicator of value when the transactions in which
stocks are traded are sufficiently similar to permit meaningful comparison The difficulty
lies in identifying public companies that are sufficiently comparable to the subject
company for this purpose.
Guidelines Public Company Method
Guideline Public Company method entails a comparison of the subject company to
publicly traded companies The comparison is generally based on publish data regarding
the public companies stock price and earnings, sales, or revenues, which is expressed
as a fraction known as a multiple. If the guideline public companies are sufficiently
similar to each other and the subject company to permit a meaningful comparison then
their multiples should be nearly equal. In another variation of this method, the valuator
may determine market multiples by reviewing published data regarding actual
transactions involving either minority or controlling interests in either publicly traded or
closely held companies. In judging whether a reasonable basis for comparison exists, the
valuator must consider: (1) the similarity of qualitative and quantitative investment and
investor characteristics; (2) the extent to which reliable data is known about the
transactions in which interests in the guideline companies were bought and sold: and
(3) whether or not the price paid for the guidelines was in an arm-length transaction, or a
forced or distressed sale.
Discounts and Premiums
There are three common levels of value: controlling interest, marketable minority,
and non-marketable minority The intermediate level, marketable minority interest, is
lesser than the controlling interest level and higher than the non-marketable minority
interest level. The marketable minority interest level represents the perceived value of
equity interests that are freely traded without any restrictions. These interests are
generally traded in stock exchanges where there is a ready market for equity securities.
These values represent a minority interest in the subject companies-small block of
shares that represent less than 50% of the companys stock and usually less than 50%.
Controlling interest level is the value that an investor would be willing to pay to acquire
more than 50% of a companys stock, thereby gaining the attendant prerogatives of
control. Some of the prerogatives of control include electing directors, hiring and firing the
companys management and determining their compensations; declaring dividends and
distribution, determining the companys strategy and line of business, and acquiring,
selling or liquidating the business. This level of value generally contains a control
premium over the intermediate level of value, which typically ranges from 25% to 50%.
An additional premium may be paid by strategic investors who are motivated by
synergetic motives. Non-marketable minority level is the lowest level on the chart,
representing the level at which non-controlling equity interests in private companies are
generally valued or traded. This level of value is discounted because no ready market
exists in which to purchase or sell interests. Private companies are less liquid than
publicly traded companies, and transactions in private companies take longer and are
more uncertain. between the intermediate and lowest levels of chart, there are restricted
shares of publicly-traded companies. Publicly traded stocks have grown more liquid in
the pat decade due to rapid electronic trading, reduced commissions, and government
deregulation.
57
Discount for Lack of Control

Minority interest discount (MID) are the inverse of control premiums to which the
following mathematical relationship can be applied: MID=1 [1/(1 + CP)]. The most
common source of data regarding control premiums is the Control Premium Study,
published annually by Mergerstat since 1972. Mergerstat defines the control premium
as the percentage difference between the acquisition price and the share price of the
freely traded public shares five days prior to the announcement of the M&A transaction.
Notes
Discount for Lack of Marketability

Marketability is defined as the ability to convert the business interest into cash
quickly with minimum transaction and administrative costs, and with a high degree of
certainty as to the amount of net proceeds. There is usually a cost and a time lag
associated with locating interested and capable buyers of interests in privately held
companies, because there is no established market of readily-available buyers and
sellers. All possible factors being equal, an interest in a publicly traded company is worth
more because it is readily marketable Conversely, an interest in a private-held company
is worth less because no established market exists. The concept has been established
that investors prefer an asset which is easy to sell, that is liquid. It is the valuation
professional task to quantify the lack of marketability of an interest in a privately-held
company. Several empirical studies have been published that attempt to quantify the
discount for lack of Marketability. These studies indicate an average discount of 35% to
50%.
Restricted Stock Studies
Restricted stocks are equity securities of public companies that are similar in all
respects to the freely traded stocks of those companies except that they carry a
restriction that prevents them from being traded on the open market for a certain period
of time, which is usually one year. Restricted stock can be traded in private transactions
and usually do so at a discount. Studies have revealed that average discount varies
between 26% and 45% and this has full support from valuation professionals and the
courts.
Option Pricing
US publicly traded companies are able to sell stock to offshore investors (SEC
Regulations, enacted in 1990) without registering the share with the securities and
exchange commission. The offshore buyers may resell these shares in the US, still
without having to register the shares after holding them for just 40 days Typically these
shares have been reported with discounts of 20% to 30% below the publicly traded share
price.
Pre-IPO Studies
Another approach to measure the marketability discount is to compare the prices of
stock offered in initial public offerings (IPOs) to transactions in the same companys
stocks prior to the IPO. Companies that are going public are required to disclose all
transactions in their stocks for a period of three years prior to the IPO. The pre-IPO
studies are alternative to the restricted stocks in quantifying the marketability discount
Applying the Studies
The study confirm what the marketplace knows intuitively. Investors cover liquidity
and loather obstacles that impair liquidity. Prudent investors buy illiquid investments only
when there is sufficient discount in the price to increase the rate of return to a level which
58
Notes
brings risk-reward back into balance. The referenced studies establish a reasonable
range of valuation discounts from the mid-30% to the low 50%. The more recent studies
appeared to yield a more conservative range of discounts than older studies, which may
have suffered from smaller sample sizes.
3.8.2. Asset Based Approaches
The value of asset based analysis of a business is equal to the sum of its part.
Pursuant to accounting convention, most assets are reported on the books of the subject
company at their acquisition value, net of depreciation where applicable. These values
may be adjusted to fair market value wherever possible. The value of a companys
intangible assets, such as goodwill, is generally impossible to determine apart from the
companys overall enterprise value. For this reason, the asset based approach is not the
most probative method of determining the value of going business concerns. In these
cases, the asset based approach yields a result that is probably lesser than the fair
market value of the business. In considering an asset based approach, the valuation
professional must consider whether the shareholder whose interest is being valued
would have any authority to access the value of the assets directly. Shareholders own
shares in a corporation, but not its assets, which are owned by the corporation. A
controlling shareholder may have the authority to direct the corporation to sell all or part
of the assets it owns and to distribute the proceeds to the shareholder(s). The
non-controlling shareholders, however, lacks this authority and cannot assess the value
of the asset. As a result, the value of a corporations assets is rarely the most relevant
standard of value to a shareholder who cannot avail itself of that value. Adjusted net book
value may be the most relevant standard of value where liquidation is imminent or
ongoing; where a company earnings or cash flow are nominal, negative or worth less
than its assets; where net book value is standard in the industry in which the company
operates. None of these situations applies to the company which is the subject of this
valuation report. However, the adjusted net book value may be used as a sanity check
when compared to other methods of valuation such as the income and market
approaches.
Different Methods of Asset Based Valuation
Valuation in relation to book value, which is the difference between the net
assets and the outstanding liabilities of the firm. The book value of a firm is
based on the balance sheet value of the owners equity. It is determined
dividing net worth by the no. of equity shares outstanding. The book value is
based on historical costs of the assets of the firm and do not bear a relationship
either to the value of the firm or to its ability to generate earnings. Book value
may represent a fair and equitable basis of value in determination of purchase
price of the target company. For negotiated mergers, book value could be
taken into consideration.
Valuation as a function of liquidation, or breakup, value. Breakup value can be
defined as the difference between the market value of the firm's assets and the
cost to retire all outstanding liabilities. The difference between book value and
liquidation value is that the book value of assets, taken from the firm's balance
sheet, are carried at historical cost. Liquidation value involves the current, or
market, value of the firm's assets.
Open Market Value: Open market value refers to a price of the assets of the
company which could be fetched or realized by negotiating sale provided there
is a willing seller, property is freely exposed to market, sale could be
59
materialized within a reasonable period and throughout this period orders will
remain static and without interruption from any extraordinary purchaser giving
higher bid. The assets of the company which are not subject to regular sale
could be assessed on depreciated or replacement cost. Each asset of the
company is normally valued on the basis of liquidation as a resale item rather
than on going-concern basis. This takes care of undervalued assets to be
properly assessed. Besides, intangible assets like goodwill will also be
assessed as per normal practices of the business firms and recognized
conventions.
Notes
Replacement Cost: Some valuations, particularly for individual business units

or divisions, are based on replacement cost. This is the estimated cost of
duplicating or purchasing the assets of the division at current market prices.
Obviously, some premium is usually applied to account for the value of having
existing and established business in place.
Reproduction Cost: Reproduction cost method is based on assessing the
current cost of duplicating the properties or constructing similar enterprise in
design and material. It does not take into account the intangible assets for
negotiations to settle the bargain price of assets; but it is a good method of
valuation for preliminary negotiations.
Substitution Cost: Substitution cost is the estimate of the cost of the
construction of the undertaking or enterprise in the same utility and capacity.It
need not necessarily be similar in design to one being substituted. This method
is good for valuation when plant, machinery and other assets are important
considerations in acquisition bargaining. This method is also good for
negotiated bargaining.
Investment Value: Investment value signifies the cost incurred to establish an
enterprise. These cost include the original investment plus the interest accrued
thereon. This determines the sale price of the target company which the
acquirer may be asked to pay for the negotiated merger where it could be
taken into consideration for valuation.
Asset Backing Method: The Asset Backing Method (sometimes termed the
Balance Sheet Method) is concerned with the asset backing per share and may be based,
either:
(a) on the view that the company is a continuing concern or
(b) on the fact that the company is being liquidated
Company as continuing concern: Two approaches are available, viz.:
(i) to value the shares on the net tangible asset basis (excluding goodwill). By this
method, the total of net tangible assets (assets less liabilities) is divided by the number of
issued shares to give the asset backing for each issued share. For instance if the
assets total ` 50,000 and the liabilities ` 10,000, the net assets ` 40,000 divided by the
number of shares of 20,000 will give the asset value of each share ` 2. That means if all
assets are disposed off and all liabilities are paid there will be available for each
shareholder ` 2/- for each share held.
In valuing shares under this method, the following need to be done:
1. The figures representing the assets are sound, that intangible assets (unless
represented by such items as trade marks, patterns etc). having a definite
value and preliminary expenses are eliminated and all liabilities are taken into
60
Notes
account, not forgetting of course, accrued item (including taxation) and

provisions.
2. Specific provisions for depreciation and doubtful debts normally deducted from
the asset concerned to arrive at correct valuation
3. Items that represent shareholders funds such as reserves are not included in
the amount deducted from assets.
4. Different considerations to be given in cases where there is more than one
class of shares issued, e.g., ordinary and preference shares and regard must
be had to the respective rights of the shareholders. The preference
shareholders may be entitled to return of their capital in priority to the ordinary
shareholders or on the other hand the preferential right may extend only to
dividends. So that they share pro rata with the ordinary shareholders in the
return of capital.
In our above example, if we assume that capital of the company is composed of
10,000 preference shares (preferential as to capital) and 10,000 ordinary shares it would
be said that preference shares had an asset backing of ` 4 each. The ordinary shares will
likewise be affected and would have an asset backing of ` 3. This is arrived at by
deducting the preference shares from the net assets (` 40,000 less ` 10,000) and
dividing the result by the total number of ordinary shares (10,000)
2. Asset Backing (including goodwill): In many cases, goodwill needs to be
valued even if there is some figure in the balance sheet or not. It is generally considered
that the value of fixed assets of the company depends on their ability to earn profits, i.e.,
on the goodwill attaching to them. In such cases, Goodwill should be included with the
other tangible assets for valuation purposes. Sometimes, goodwill attaches to the
business of a company even though the company is being liquidated as for example, in
the case of an amalgamation where one company is liquidated and its balance sheet sold
to another company.
3.8.3. Income Approaches
The income approaches determine fair market value by multiplying the benefit
steam generated by the subject company times a discount or capitalization rate. The
discount or capitalization rate converts the stream of benefits into present value. There
are several different income approaches, including capitalization of earnings or cash
flows, discounted future cash flows (DCF), and the excess earnings method (which is a
hybrid of asset and income approaches). Most of the income approaches consider the
subject companys historical data; only the DCF method requires data for multiple future
periods. The discount or capitalization rate must be matched to the type of benefit stream
to which it is applied. The result of the value creation under this method is generally the
fair market value of a controlling, marketable interest in the subject company, since the
entire benefit stream of the subject company is most often valued, and the capitalization
and discount rates are derived from statistics concerning public companies.
Discount or Capitalization rates: A discount or capitalization rate is used to
determine the present value of the expected returns of a business. The discount rate and
capitalization rate are closely related to each other but distinguishable. Generally
speaking, the discount rate or capitalization rate may be defined as the yield necessary
to attract investors to a particular investment, given the risks associated with that
investment. The discount rate is applied only to discounted cash flow (DCF) valuations,
which are based on projected business data over multiple periods of time. In DCF
valuations, a series of projected cash flows is divided by the discount rate to derive the
present value of the discounted cash flows. The sum of the discounted cash flows is
61
added to a terminal value, which represents the present value of business cash flows into
perpetuity. The sum of the discounted cash flows and the terminal value is the value of
the business. On the other hand, a capitalization rate is applied in methods of business
valuation that are based on historical business data for a single period of time.. The after
tax cash flow capitalization rate is equal to the discount rate minus the long term
sustainable sustainable growth rate. The future tax cash flow of the business is divided
by the capitalization rate to derive the present value. Capitalization rates may be modified
so that they may be applied to after tax net income or pretax cash flows or income. There
are several different methods of determining the appropriate discount rates. The discount
rate is composed of two elements: (1) the risk-free rate which is the return that an
investor would expect from a secure, practically risk-free investment, such as
government bond plus (2) a risk premium that compensates an investor for the relative
risk associated with a particular investment in excess of the risk free rate. Again, the
selected discount or capitalization rate must be consistent with stream of benefits to
which it is to be applied.
Notes
Build Up Method: The Built-up method is a widely recognized method of

determining the after-tax net cash flow discount rate, which in turn yields the
capitalization rate. The method is called a built-up method because it is the sum of risks
associated with various classes of assets. It is based on the principle that investors would
require a greater return on classes of assets that are more risky. The first element is risk
free rate which is the rate of return for long-term government bonds. Investors who buy
large cap equity stocks, which are inherently more risky than long-term government
bonds, require a greater return so the next element of Build-up method is the equity risk
premium. In determining a companys value, the long horizon equity risk premium is used
because the Companys life is assumed to be infinite. Similarly investors who invest in
small cap stocks, which are riskier than blue-chip stocks, require a greater return, called
the size premium. By adding the first three elements of a Build-up discount rate, we can
determine the rate of return that investors would require on their investments in small
public company stocks. These three elements of the Build-up discount rate are known
collectively as the systematic risks. In addition, the discount rate include unsystematic
risks which include two categories industry risk premium and specific company risk.
Information on industry specific risks can be obtained. No specific published data is
available to quantify specific company risks. Instead, specific company risks are
determined by the valuation professional based upon the specific characteristics of the
business and the professionals reasonable discretion applied to appropriate criteria. The
capitalization rate for small, privately-held companies is significantly higher than the
return that an investor might expect to receive from other common types of investments,
such as money market accounts, mutual funds, or even real estate. Those investments
involve lower levels of risk than an investment in a closely held company. Depository
accounts are insured up to certain limits; mutual funds are composed of publicly-traded
stocks for which risk can be substantially minimized through portfolio diversification; and
real estate almost invariably appreciates in value for long time horizons. Closely held
companies, on the other hand frequently fail for variety of reasons too numerous to name.
The risk of investing in a private company can be reduced through diversification and
most businesses do not own the type of hard assets that can ensure capital appreciation
over time. This is why investors demand a much higher return on their investment in
closely-held businesses; such investments are inherently much more risky.
Capital Asset Pricing Model (CAPM): The Capital Asset Pricing model is another
method of determining the appropriate discount rate in business valuations. Like the
Build-up method, the CAPM method derives the discount rate by adding a risk premium
to the risk-free rate. In this case, the risk is derived by multiplying the equity risk premium
62
Notes
times Beta, which is a measure of stock price volatility. Beta is published by various
sources for particular industries and companies. Beta is associated with systematic risk
of an investment. One of the criticisms of CAPM method is that Beta is derived from the
volatility of prices of publicly traded companies which is likely to differ from private
companies in their capital structures, diversification of products and markets, access to
credit markets, size, management depth, and may other respects. Where private
companies can be shown to be sufficiently similar to public companies, however, the
CAPM model may be appropriate.
Weighted Average Cost of Capital (WACC): WACC is the third approach to
determine a discount rate. The WACC method determines the subject companys actual
cost of capital by calculating the weighted average of the companys cost of debt and
cost of equity. One of the problems with this method is that the valuer may elect to
calculate WACC according to the subject companys existing capital structure, the
average industry capital structure, or the optimal capital structure.
Once the capitalization or discount rate is determined, it must be applied to an
appropriate benefit streams: pretax cash flow, after-tax cash flow, pretax net income,
after tax net income, excess earnings, projected cash flows, etc.
3.8.4. Market Based
Market capitalization for listed companies. Market value does not exactly
depict the real worth of the company because it does not take into
consideration various intangible factors like abilities of management, prospects
of industry in which the company operates and strategic values possessed by
the company on account of patents, technical collaborations, locational
benefits, institutional finance, etc. To arrive at a fair value, it may be ensured
that temporary factors causing volatility or fluctuations are eliminated by
averaging the quotations over a period of time. Market value alone is not
considered as a good measure of valuation unless there is broad market for the
companys securities. But it is relied upon along with the valuation arrived at on
the basis of net assets or earnings. In hostile takeovers, the acquirer pays only
market value.
Market multiples of comparable companies for unlisted company. Here
the procedure is to calculate a representative P/E ratio of a group of quoted
companies after suitable adjustments. Generally for small companies which
are not quoted and are closely held or private companiesa discount is
applied for valuation to the prevalent P/E ratio of comparable listed company.
This discount increases the earnings yield but reduces the capitalization rate
and consequently the valuation to the size of discount will vary depending upon
the quantum of voting rights being acquired. Higher the voting rights, lower is
the discount rate to be applied and the discount rate as such will differ between
0% to 50%. In case there are restrictions on transfer of shares in the Articles of
Association of the company, the discount rate applied in such cases is higher.
Generally, as per practices in vogue in European nations, P/E ratio of a quoted
company is reduced to half for private unquoted company.
3.8.5 Earnings Based Valuation
Historical earnings valuation: Valuation based on earnings is a popular
method of valuation, the pre-determined rate of return expected by investor on
investment is used which is equal to simple rate of return on capital employed.
63
From the earnings last declared by the company, items such as tax, preference
dividends are deducted and net earnings are taken for calculation. But this
valuation invites criticism, as it is based on past performance. Whereas for fair
valuation, reliable forecasts of future earnings is necessary Another viewpoint
is that instead of using the accounting rate of return for valuation, the price
earning (P/E) ratio could be used .
Notes
Future maintainable earnings valuation: This method of valuing shares is

also known as Profit valuation or Earning Capacity Method or Yield Basis. The
method of valuation takes into account the companys earning capacity and the
normal rate of interest or dividend that is current on outside investments. The
concept is that an investor is primarily concerned with the possible return on
the capital he invests. The class of the company whether it is well established
or speculative, as well as the type of share (preference, ordinary) is important
factors.
The following are the steps for a yield based valuation
1. Ascertain the future maintainable profits
2. Ascertain the normal rate of return
3. Determine the capitalization factor or the multiplier, which is 100 divided by the
normal rate of return. If the normal rate of return is 12.5%, multiplier will be 100
12.5 = 8
4. Ascertaining the capitalized value of maintainable profits by multiplying the
future maintainable profits with capitalization factor.
5. The yield value of the shares will be ascertained by dividing the capitalized
value of maintainable profits by the number of equity shares.
Example: H holds 5000 shares in Hindustan Ltd. The nominal and paid up capital of
which is ` 300,000 in ` 10 shares divided into 10,000 5% Preference Shares of ` 10 each
and 20,000 ordinary shares of ` 10 each. It is ascertained that:
(a) The normal annual net profit of such company is ` 50,000 and
(b) The normal return by way of dividend on the paid up value of share capital for
the type of business carried out by company is 8%
You are required to value Hs holding.
Solution:
` 50,000
Net Profit for the Company

Less: Dividend to be paid to preference shareholders
@ 5% on ` 10,000
5,000
` 45,000
Profit available to equity shareholders

This profit of ` 45,000 to be capitalized @ 8% =
The value of each ordinary shares therefore =
45,000 100
8
= ` 5,62,500
5,62,500
= ` 28.125 per share
20,000
Value of 5,000 shares held by H = 28.125 5000 = ` 1,40,625

In the above case, it has been assumed that the preference shares do not
participate further in the profits and therefore as the profits earned by them is normal,
they are valued at par.
64
Notes
If the preference shares are participating preference shares how the valuation are to
be done for preference shares and equity shares are given in the following example:
Example: Assume the following details relating to the capital of a certain company.
10,000, 5% Participating Preference shares of ` 10 each
20,000 ordinary shares of ` 10 each
The preference shares are entitled to participate in the share of the profits to the
extent of a further 4% after payment of a dividend of 10% to the ordinary shareholders.
Any further excess is available to ordinary shareholders.
The normal average profits less tax of the company are ` 40,000 p.a. The normal
return applicable to the particular type of company is 8% on the nominal value of the
ordinary shares and 8% on preference shares, which are participating.
You are required to find the value of each of the classes of shares.
Solution:
Profits available to Preference shareholders
5% on ` 100,000
5000
4% on ` 100,000
4000
Profits available to ordinary shareholders

10% on ` 200,000
20,000
Plus balance of profits
11,000
9000
31000
40000
Value of Preference shares:

Profits of ` 9000 capitalized at 8%
112500
Value of preference shares = 112,500 10000 = ` 11.25 per share

Value of Ordinary Shares
` 387500
Value of Ordinary Shares = 387, 500 20,000 = ` 19.374
Let us now discuss certain concepts used in this regard:
Maintainable future profits: There are three steps involved in estimating the future
maintainable profits. They are:
(1) Computing past average earnings after tax. The period selected must not
be remote. Since the earnings of such period may not have any bearing on the
future. In arriving at the past average the following adjustments should be
made:
(a) Any exceptional events of non-recurring nature on the profits of the
company should be eliminated.
(b) Only profits of routine operations should be considered. Profits and losses
on non-trading assets should be eliminated.
(c) Managerial Remuneration should be fair and reasonable, undercharging
or overcharging should be adjusted
(d) Inadequate provision for tax, bad debts, gratuity, depreciation, etc. should
be adjusted. Improper valuation of stocks should be avoided.
(e) Tax provision should be made based on latest tax provision and
adjustments for future should be accordingly made.
65
(2) Projections for future profits: If business is contemplating any expansion,

diversification, discontinuance of any segment, change in the policy, the past
average profits must be adjusted suitably. Sometimes, there may be change in
Government policy towards the particular industry or general change such as
the current deregulation and opening up of the economy, which may have
significant impact on business. Such impact must be considered to adjust
these profits for the future.
(3) Adjustment of preferred rights: Since we are computing share valuation for
equity shareholders, full provision must be made for interest on debt holders
and loan, and maximum dividends payable to preference shareholders as per
terms of issue.
Notes
Normal rate of return: Share valuation on yield basis hinges on the normal rate of
return chosen. The normal rate of return should be equal to risk free return plus premium
to cover the risk involved in the particular business. Risk free rate refers to the interest
earnings on investments, which are completely, risk free such as Treasury Bills. However,
it is not an easy task to measure the risk associated with a particular business and
determine the additional earnings expected to compensate such risk. Normally the
principle is higher the risk, higher would be the premium expected. In the case of equity
shares, the risk differs according to industry and in each industry according to the specific
unit; companies, which are managed well, will carry a lower risk because of stability.
Earnings Before Interest Taxes Depreciation and Amortization (EBITDA)
valuation (Capitalization of Cash flow): The adjusted cash earnings may be
capitalized in arriving at a value for the firm.This method may be suitable for a
service business.
Example
Adjusted Cash Earnings
X Capitalization Factor (25%)
Capitalization of cash Flow
Less Liabilities Assumed
Capitalization of Cash Flow Earnings
` 100,000
4
400,000
50,000
350,000
The Free Cash Flow (FCF) Basis for Valuation

The following steps are necessary:
(a) Earnings are the basis for estimating cash flows.
Year wise cash inflow = Year wise accounting profit of the company or
business units after tax + Depreciation/Amortization + All other non-cash
expenses Non-cash revenue
(b) Further cash flows are to be estimated for the next 3 to 5 years based on long
term strategic plans.
(c) Determine free cash flow Free cash flow is the cash flow available to all
investors in the company both shareholders and bond holders after
considering taxes, capital expenditure and working capital investment.
(d) At the end of 3 or 5 years, the terminal value (just like the project or the asset)
of the business unit (or the company) is to be estimated.
66
Notes
There are four approaches for calculating terminal value:

Approach I: Terminal value is a growing perpetuity
Free cash flow (1 growth rate)
For Terminal value =
Cost of capital rate growth rate
Approach 2: Terminal value is a stable perpetuity
Free cash flow
Terminal value =
Discount rate (Cot of capital)
Approach 3:
Approach 4:
Terminal value as a Multiple of Book value. The terminal value can be

estimated by multiplying the forecasted book value of capital by an
approximate market to book ratio. Normally, the current market/book
value ratio is taken as proxy for future.
Terminal value as a Multiple of earnings the terminal value under
this method is established by multiplying the forecasted terminal year
profits by an approximate price minus the earning multiple. As usual,
the current price/earnings multiple can be used as proxy for future.
Illustration:
The cash flows of a division of a company are given below:
(` Crores)
Year 1
Year 2
Year 3
Year 4
Year 5
Net operating profit after tax (1)
65
70.20
75.40
80.6
87.10
Depreciation expenses (2)
20
22
24
26
28
Capital expenditure (3)
30
32
35
37
40
Working capital (4)
20
22
23
25
27
Free cash flow (5) = (1) + (2) (3) (4)
35
38.20
41.40
44.60
48.10
Year 5
Cash flows are expected to grow at 5% after 5th year.

Cost of capital is 15% and assets employed ` 325 crores.
Evaluate the performance of Division A.
Solution:
Free cash flow terminal value
Year 1
Year 2
Year 3
Year 4
35
38.20
41.40
44.60
48.10
505.05
Discount factor @ 15%
0.870
0.756
0.658
0.572
0.497
Discounted cash flow
30.45
28.88
27.24
25.51
274.91
Total of Discounted Cash Inflow
386.99
Less: Capital employed
325.00
NPV
61.99
IRR of the Division (approx)
20%
(i.e., the discount factor or the cost of interest the unit can bear)
Note: Terminal value =
48.10 1.05
50.505
=
= ` 505.05 crores
0.15 0.05
0.15 0.05
67
3.8.6 Comparative Ratios
Notes
The following are two examples of the many comparative metrics on which acquiring
companies may base their offers:
Price-Earnings Ratio (P/E Ratio): With the use of this ratio, an acquiring
company makes an offer that is a multiple of the earnings of the target
company. Looking at the P/E for all the stocks within the same industry group
will give the acquiring company good guidance for what the target's P/E
multiple should be. Earnings per share (EPS) are obtained by dividing the
earnings with the number of equity shares. Comparison is made between
average earnings per share and earnings per share of the specific company to
obtain the value of the share. This may be expressed in a formula.
Value of share on EPS basis =
EPS of the company Paid up value of equity share
Average EPS
In the illustration given earlier, the EPS of ordinary shares works out to be
` 31,000 20,000 = ` 1.55 per share
Normal EPS for equity shares = 8% i.e.
Hence value of shares =
8
10
` 10 = ` 0.8 per share
1.55
10 = ` 19.375 per share
0.8
Dividend basis of Yield Value: Yield value can be determined by taking

dividend as the basis. Yield value of a share = Expected rate of dividend/
Normal rate of Dividend x paid up value per share.
Yield value can be calculated by taking dividend as the basis. For example,
10% is the normal dividend in an industry and 20% is the dividend paid by a
particular company, the value of the shares will be twice its paid up amount.
Conversely, if the particular company pays a dividend of 5%, the value of its
share will be only 50% of the paid up amount. This can be expressed by way of
formula :
Expected rate of dividend paid up value per share
Yield value of a share =
Normal rate of dividend
This method and the earlier method will give the same result if all the earnings
are distributed as dividend. In other words, the company is adopting a dividend
payout ratio of 100% (i.e., whatever profit is earned after tax it is paid by way of
dividend).
Enterprise-Value-to-Sales Ratio (EV/Sales): With this ratio, the acquiring
company makes an offer as a multiple of the revenues, again, while being
aware of the price-to-sales ratio of other companies in the industry. This
approach may be used when earnings are questionable.
Here are some Indian examples of the amount paid for acquisition. Udayan
Boses (Chairman, Lazard Credit Capital) thumb rule for buying a consumer
product company is to offer 1 to 1.5 times the turnover. Coca Colas offer to
Parle was equal to the Indian companys turnover. The Khaitans paid 1.7 times
the turnover ` 290 crorefor Union Caebide (UCIL), and Heinz paid ` 210
crore for Glaxos food business, 2.1 times the turnover.
68
Notes
Discounted Cash Flow (DCF): A key valuation tool in M&A, discounted cash
flow analysis determines a company's current value according to its estimated
future cash flows. Forecasted free cash flows (net income + depreciation/
amortization capital expenditures change in working capital) are discounted
to a present value using the company's weighted average costs of
capital (WACC). Admittedly, DCF is tricky to get right, but few tools can rival
this valuation method. First, the present value of the equity of the target firm
must be established. Next, the present value of the expected synergies from
the merger, in the form of cost savings or increased after-tax earnings, should
be evaluated. Finally, summing the present value of the existing equity with the
present value of the future synergies results in a present valuation of the target
firm.
An expected earnings multiple: First, the expected earnings in the first year
of operations for the combined or merged firm should be estimated. Next, an
appropriate price-earnings multiple must be determined. This figure will likely
come from industry standards or from competitors in similar business lines.
Now, the PE ratio can be multiplied by the expected combined earnings per
share to estimate an expected price per share of the merged firm's common
stock. Multiplying the expected share price by the number of shares
outstanding gives a valuation of the expected firm value. Actual acquisition
price can then be negotiated based on this expected firm valuation.
Marakon Approach based on market to book-value approach: According to
the Marakon model, the market-to-book values ration is a function of the return
on equity, the growth rate of dividends (as well as earnings), and the cost of
equity
M r-g
B k-g
Where,
M = market value of equity

B = book value of equity
r = return on equity
g = growth rate of dividends
k = cost of equity
From the above equation, it is evident that (M/B) > 1 only when r > k. Put
differently, value is created only when there is a positive spread between the
return on equity and the cost of equity. Further, when r > k, the higher the g the
higher the M/B ratio. This means that when the spread is positive, a higher
growth rate contributes more to value creation.
EVA and Valuation: Conceptually, the value of a firm or a division thereof is
equal to the current economic book value of assets plus the present value of
the future EVA stream expected from it: EVA valuation = Economic book value
of assets + Present value of EVA stream associated with it.
Example: Global Ltd. is interested in acquiring the foods division of Regional
Company. The forecast of the free cash flow for the proposed purchase, as
developed by G Ltd. is shown below. It is based on the following assumptions:
(i) The growth rate in assets, revenues and profit after tax will be 20% for the
first 3 years, 12% for the next 2 years and 8% thereafter.
69
(ii) The ratio of net profit after tax to net assets would be 0.12. The
opportunity cost of capital for the proposed acquisition is 11%.
Notes
Free Cash Flow

Year
Asset value
50.00
60.00
72.00
86.40
96.77
108.38
Net operating profit after tax

Net investment
6.00
7.20
8.64
10.37
11.61
13.00
Free cash flow
10.00
12.00
14.40
10.37
11.61
8.67
Growth rate (%)
(4.00)
( 4.80)
(5.76)
4.33
20
20
20
12
12
0.901
0.812
0.731
0.659
0.593
0.535
(3.604)
(3.898)
( 4.216)
2.316
Discount factor at 11%

Discounted Free cash flow
Discounted terminal value at the
end of six years = 4.33 1.08/
(0.11 0.08) = 155.88 0.535
83.08
Hence, the total of present value of free cash flow = 73.678

Let us now value the foods division of Regional Company using EVA approach.
EVA Projection
Year
Beginning capital
50.00
60.00
72.00
86.40
96.77
108.38
Net operating profit after tax
6.00
7.20
8.64
10.37
11.61
13.00
Cost of capital (%)
11
11
11
11
11
11
Capital charge
5.50
6.60
7.92
9.50
10.64
11.92
EVA
0.50
0.60
0.72
0.87
0.97
1.08
20
20
12
12
0.451
0.487
0.563
.0.573
0.575
0.578
Growth rate (%)

Discounted EVA @ 11%
Terminal value 1.08 1.08/(0.11 0.08)
38.88
Discounted terminal value
20.801
The present value of EVA stream = 24.028

Given the beginning capital of 50, the EVA valuation is 50 + 24.028 = 74.028 This is
same as DCF the minor difference is due to rounding off.
Problems
1.
Assume the following details relating to the capital of a certain company.
10,000, 5% Participating Preference shares of ` 10 each 20,000 ordinary shares of

` 10 each.
The preference shares are entitled to participate in the share of the profits to the
extent of a further 4% after payment of a dividend of 10% to the ordinary shareholders.
Any further excess is available to ordinary shareholders.
The normal average profits less tax of the company are ` 40,000 p.a. The normal
return applicable to the particular type of company is 8% on the nominal value of the
ordinary shares and 8% on preference shares, which are participating.
You are required to find the value of each of the classes of shares.
70
Notes
Solution:
Profits available to Preference shareholders
5% on ` 100,000
5000
4% on ` 100,000
4000
9000
Profits available to ordinary shareholders

10% on ` 200,000
20,000
Plus balance of profits
11,000
31000
40000
Value of Preference shares:

112500
Value of preference shares = 112,500 10000 = ` 11.25 per share

Value of Ordinary Shares
` 387500
Value of Ordinary Shares = 387,500 20,000 = ` 19.374
2. The P Ltd has paid the following dividends per shareYear
Dividend per share
Year
Dividend per share
` 2.00
` 2.40
2.10
2.58
2.24
2.80
Assuming a 16% required, and ` 3 per share dividend in year 7, Compute the value
of the share.
Solution
The dividend of ` 2.00 has grown to ` 2.80 in 5 years, i.e., total growth of 2.80/2.00 =
1.40. Hence, average growth of (1.40)-5 =6.96%, i.e., 7%
Hence, price of the share in 7th year =
3.00
16% - 7%
3
= ` 33.33
0.09
3. FTL creates leading-edge technologies for fast growing market Its reported
earnings and dividends per share were ` 11.50 and ` 2.40 respectively in 2009. For the
nest 5 years, the projected earnings growth is 30.1%. It is expected to decline linearly to
8% after 5 years. The dividend payout ratio is likely to remain stable during 2009-14. It
would rise linearly after that and reach 21% in 2019-20. The shares of FTl are expected
to have a beta of 1.18 in the next 5 years but is expected to decline linearly over the
following 5 years to reach 1 by the time the FTL reaches its steady level of growth (8%) in
2019. The risk free rate is currently 8% and may be assumed to remain constant in the
foreseeable future. The market risk premium may be assumed to be 4%. Compute the
value of FTL share, using dividend discount valuation model.
Solution:
Present dividend payout ratio = 2.40/11.50 = .2087 rounded to 0.209 to remain
stable during 2009-14
Return on equity % as of today = 8% + 1.18 4 = 12.72% and remain same during
2009 to 2014
Return on equity as on 2019 = 8% + 1 4 = 12%, hence from 12.72% in 2014 it will
decline to 12% steadily, i.e., 0.72/5 = 0.144 per year
71
Earnings growth rate from 2014 for the next 5 years to decline linearly to 8.0%, i.e.,
(30.1 8)/5 = 4.42% per annum
Year
09
10
11
12
13
14
Earnings
30.1
30.1
30.1
30.1
30.1
15
16
17
18
25.68 21.26 16.84 12.42
19
20
8.0
8.0
Notes
Total
growth
Earnings
11.50 14.96 19.46 25.32 32.94 42.86 53.87 65.32 76.32 85.80 92.67 100.08
Payout
0.209 0.209 0.209 0.209 0.209 0.209 0.209
.209
.209
0.209
0.21
0.21
ratio
Dividend
2.40
3.12
4.06
5.28
6.87
8.95
11.25 13.64 15.94 17.92 19.46
21.02
Beta
1.18
1.18
1.18
1.18
1.18
1.18
1.14
1.00
Return
1.11
1.07
1.04
1.00
on 12.72 12.72 12.72 12.72 12.72 12.72 12.58 12.43 12.29 12.14
12.0
equity
Compound 12.72 12.72 12.72 12.72 12.72 12.72 12.70 12.66 12.61 12.56 12.50
ed return
PV at
1.0
0.89
0.79
0.70
0.62
0.56
0.49
0.43
0.39
0.34
0.31
2.77
3.21
4.25
4.26
5.01
5.52
5.87
6.22
6.09
6.03
comp rate
PV of
49.23
dividend
Share price at the end of 2019 = 21.02/(12% 8%) = 525.5 discount factor 0.31 = 162.91
Share value at the end 2009 = 212.14
4. H Ltd. is growing at an above average rate. It foresees a growth rate of 20% per
annum in free cash flows to equity holders in the next 4 years. It is likely to fall to 12 % in
the next 2 years. After that, the growth rate is expected to stabilize at 5% per annum. The
amount of free cash flow (FCFE) per equity share at the beginning of the current year is
` 10. Find out the maximum price at which an investor, follower of free cash flow
approach will be prepared to buy the companys shares as on date, assuming an equity
capitalization of 14%.
Solution:
Maximum price of equity shares will be sum of (i) PV of FCFE during 1-6 years and (ii)
PV of expected market price at the end of year 6, based on a constant growth rate of 5%.
Present value of FCFE (years 1-6)
FCFE per share `
Year
PV factor (0.14)
Total PV `
10 (1 + 0.20)
12
0.877
10.52
12 (1 + 0.20)
14.40
0.769
11.07
14.40 (1 + 0.20)
17.28
0.675
11.66
17.28 (1 + 0.20)
20.74
0.592
12.28
20.74 (1 + 0.12)
23.23
0.519
12.06
23.23 (1 + 0.12)
26.02
0.456
11.86
Total PV of FCFE
Market price of share at year-end 6 =
69.45
FCFE7
26.02(1.05 )
27.321
=
=
= ` 303.57
Ke g
14% - 5%
9%
PV of ` 303.57= ` 303.57 .456 = ` 138.43

Maximum price of share = 69.45 + 138.43 = ` 207.88
72
Notes
3.9 Summary
In this unit, various methods of valuing goodwill and a business enterprise have
been covered
Valuation of Goodwill: The following are the various methods used
1. Arbitrary Assessment: A valuation is made by one of the parties (vendor or
purchaser) to which the other agrees, or an independent party may be called in
to give his opinion.
2. Capitalization of Expected Future Net Profits: The necessary steps to be
taken in computing goodwill by this method are as follows:
(a) Ascertain the average net profits, which it is expected, will be earned in
the future.
(b) Capitalize the net profit at the rate, which is considered a suitable return
on capital invested in a business of the type under consideration.
(c) Find the value of the net tangible assets used in the business (i.e., assets
less external liabilities)
(d) Deduct the net tangible assets as per (c) from the capitalized profit earned
in (b) and the difference in goodwill.
3. Purchase of Past Profits: This method is widely practiced. It is calculated as
follows:
(a) The profits for an agreed number of years preceding the valuation are
averaged, so as to arrive at the average annual profit earned during the
period.
(b) The goodwill is then estimated on so many years purchase of such
average profit. The number of years selected is presumed to bear relation
to the number of years benefit to be derived from the past association.
(c) The profit referred may be either net profit or gross profit according to
what is agreed upon by the parties.
4. Valuation based on turnover: This method is similar to previous one except
that instead of profit it is based on turnover. The purchaser in other words, pays
for goodwill on one or more years purchase of Gross takings. This method is
particularly suitable for certain professional practices.
5. Purchase of Super Profits: In this method, the attention is focused upon
super profits, which are those profits remaining after deducting from the
estimated annual future profits:
6. The Annuity Method: This method of calculating Goodwill is similar to the
previous one except that the super profits when arrived at is not multiplied by a
figure representing a certain number of years purchase of such super profits.
Instead it is considered that if the super profits is to continue over an estimated
period, then goodwill is to be calculated by finding the present worth of an
annuity (paying the super profit per year) over the estimated period, discounted
at the appropriated rate of interest.
In other words, we have to ascertain the amount of cash it is necessary to pay out
now in order to obtain the right to receive the amount of super profits annually for the
estimated number of future years and to allow for the fact that the money would earn its
appropriate rate of interest if invested.
Major reasons for valuation of an enterprise are:
1. Amalgamation or merger with another enterprise.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
73
Closure and sale of assets due to liquidation or other reasons.

Assessment of fund raising capacity and required rating by lenders.
Issue of shares.
Partial or full privatization
The enterprises own internal exercise for the knowledge of owners and top
executives
Group restructuring exercise leading to mergers and demergers inside the
group.
Strategic alliances and joint ventures with domestic and international partners.
Sale (or exchange) of a few assets, brands and other claims.
Governmental requirements for taxation, securitization etc.
Rehabilitation of a sick or dying enterprise. Significant change is to be made in
the value-chain, knowing the independent strength of various value-drivers
contributing to the value-chain of the enterprise.
Converting key employees into entrepreneurial employees and then into equal
partners in the enterprise.
Valuation of goodwill for its presentation in the Balance Sheet or for charging
royalty to dealers, representatives, group-members, etc.
Partial valuation of certain divisions and product lines, for partial restructuring
Notes
Valuation Methods for Enterprise

(i) The market approaches determine value by comparing the subject company to
other companies in the same industry, of the same size, and/or within the same
region.
(a) Market multiples of comparable companies for unlisted company
Comparative Ratios: The following the many comparative metrics on which
acquiring companies may base their offers:
(ii)
Price-Earnings Ratio (P/E Ratio)

Enterprise-Value-to-Sales Ratio (EV/Sales)
Discounted Cash Flow (DCF)
An expected earnings multiple
Marakon Approach based on market to book-value approach
EVA and Valuation
The asset-based approaches determine value by adding the sum of the parts
of the business. These are as follows:
Valuation in relation to book value (which is the difference between the
net assets and the outstanding liabilities of the firm)
Valuation as a function of liquidation, or breakup, value. Breakup value
can be defined as the difference between the market value of the firm's
assets and the cost to retire all outstanding liabilities.
Open Market Value: Open market value refers to a price of the assets of
the company which could be fetched or realized by negotiating sale
provided there is a willing seller, property is freely exposed to market, sale
could be materialized within a reasonable period and throughout this
period orders will remain static and without interruption from any
extraordinary purchaser giving higher bid.
Replacement Cost: Some valuations, particularly for individual business
units or divisions, are based on replacement cost.
74
Notes
Reproduction Cost: Reproduction cost method is based on assessing

the current cost of duplicating the properties or constructing similar
enterprise in design and material.
Substitution Cost: Substitution cost is the estimate of the cost of the
construction of the undertaking or enterprise in the same utility and
capacity.
Investment Value: Investment value signifies the cost incurred to
establish an enterprise. These cost include the original investment plus
the interest accrued thereon.
Asset Backing Method:
The Asset Backing Method (sometimes termed the Balance Sheet Method) is
concerned with the asset backing per share and may be based, either:
(a) on the view that the company is a continuing concern or
(a) on the fact that the company is being liquidated.
(iii) The income approach determine value by calculating the net present value of
the benefit stream generated by the business through one of the rates
computed as
(a) Discount or Capitalization rates
(b) Build Up Method
(c) Capital Asset Pricing Model (CAPM)
(d) Weighted Average Cost of Capital (WACC)
Different methods used under income approach are as:
Earnings Before Interest Taxes Depreciation and Amortization (EBITDA)
valuation (Capitalization of Cash flow)
The Free Cash Flow(FCF) basis for Valuation

1. Super profit is the increase in current years profit over the average profits of
the preceding three years.
2. Normal rate of return is the rate of return which the investors in general expect
on their investments in a particular industry having regard to the risk-free rate
of interest and the business and financial risks associated with the investment.
3. In the calculation of goodwill, past profits will have to be adjusted ,in order to
determine the future expected profits.
4. Fair value of a share is the weighted average of intrinsic value and yield value.
5. Normal rate of return and PE ratio are one and the same.
6. For calculating the market value of shares, one should take into account the
rate of earning and not the rate of dividend, if the shares are acquired for
control purpose.
1. A business is having adjusted net profits of` ` 100,000 and capital employed of
` 600,000. If goodwill is taken at 3 years purchase of super profits and the
expected rate of return is 10%, the value of goodwill will be __________.
75
(a) ` 3,00,000
(b) ` 500,000
(c) ` 1,20,000
(d) ` 180,000
2. A company is having 40,000 equity shares of ` 15 paid. If the dividend per
share is Re. 1 and the expected rate of return is 12%, the market value of
share will be __________.
(a) ` 12
(b) ` 8.33
(c) ` 10
(d) ` 12.5
3. For calculating market value using PE ratio, it is necessary to know
__________.
(a) Earnings per share
(b) Rate of dividend
(c) Average profits
(d) Super profits
4. The relationship between normal rate of return and PE ratio is __________.
(a) Inverse
(b) Direct
(c) Irregular
(d) None of these
Notes

1. Define goodwill. Distinguish between purchased goodwill and inherent goodwill.
Describe briefly the contributing factors of goodwill.
2. Discuss with examples various methods for valuation of goodwill.
3. What are the reasons for valuation of a business?
4. What valuation base does one adopt while valuing a business as a going
concern?
5. Explain briefly the relative advantages and disadvantages of valuation of
business following:
(i) Capitalisation of future maintainable profit method
(ii) Present value of future earnings and
(iii) Present value of future cash flows method.
6. Why does valuation of a business differ if it does in isolation as compared to
that when in combination of another business? What is meant by control?
7. What are the four equivalent ways of calculating EVA?
8. What are the three components of EVA calculation?
9. Discuss the adjustments for calculating EVA?
10. In the most recent financial year, the firm reported depreciation of ` 20 crores
and earnings before interest and taxes (operating income) of ` 100 crores on
revenue of ` 1000 crores, the tax rate is 40%. The capital invested in the firm
was ` 400 crores. The firm expects to maintain the return on capital in
perpetuity. The firm expects to reinvest 60% of its after tax operating income
76
Notes
back into the business entity every year for the next 5 years. The cost of capital
is 10% in perpetuity and the expected growth rate after year 5 will be 4%.
11. From the under mentioned facts determine the cost of equity of Company X
(i) Current market price of a share = ` 150
(ii) Cost of floatation per share on new shares ` 3
(iii) Dividend paid on the outstanding shares over the past five years:
Year
1
2
3
4
5
6
Dividend per share

` 10.50
11.02
11.58
12.16
12.76
13.40
(iv) Assume a fixed dividend pay out ratio

(v) Expected dividend on the new shares at the end of the current year is `
14.10 per share
12. FTL creates leading-edge technologies for fast growing market Its reported
earnings and dividends per share were ` 11.50 and ` 2.40 respectively in 2009.
For the nest 5 years, the projected earnings growth is 30.1%. It is expected to
decline linearly to 8% after 5 years. The dividend pay-out ratio is likely to remain
stable during 2009-14. It would rise linearly after that and reach 21% in 2019-20.
The shares of FTl are expected to have a beta of 1.18 in the next
5 years but is expected to decline linearly over the following 5 years to reach 1 by
the time the FTL reaches its steady level of growth (8%) in 2019. The risk free
rate is currently 8% and may be assumed to remain constant in the foreseeable
future. The market risk premium may be assumed to be 4%. Compute the value
of FTL share, using dividend discount valuation model.
3.12 Key Terms

Goodwill: It is the benefit and advantage of the good name, reputation and
connection of a business. It is the attractive force which brings in customers. It
is one thing which distinguishes an old established business from a new
business at its first start.
Value of shares: Valuation of shares involves the use of financial and
accounting data, but much depends on the valuers judgement, experience and
knowledge. The share valuation is an intricate exercise involving accounting as
well as non-accounting data, objective and subjective consideration and
balancing of the interests of the parties involved in it. Valuation is closely linked
to the purpose of valuation
Net asset backing: The value of asset based analysis of a business is equal
to the sum of its part. Pursuant to accounting convention, most assets are
reported on the books of the subject company at their acquisition value, net of
depreciation where applicable. These values may be adjusted to fair market
value wherever possible.
Income approach: The income approaches determine fair market value by
multiplying the benefit steam generated by the subject company times a
discount or capitalization rate. The discount or capitalization rate converts the
stream of benefits into present value. There are several different income
approaches, including capitalization of earnings or cash flows, discounted
77
future cash flows (DCF), and the excess earnings method (which is a hybrid of
asset and income approaches).
Yield method: Yield value can be determined by taking dividend as the basis.
Yield value of a share = Expected rate of dividend/Normal rate of dividend
Paid-up value per share.
Notes
3.13 Check your Progress: Answers

I. True or False
1.
2.
3.
4.
5.
6.
False
True
True
False
False
True

1. (c) ` 1,20,000;
2. (d) ` 12.5
3. (a) earnings per share
4. (a) Inverse,
3.14 Case Study

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

1. Mergers, Restructuring and Corporate Control by J. Fred Weston, K. Wang,
S. Chung and Susan E. Hoag, Prentice-Hall of India Private Ltd.
2. M&A and Corporate Restructuring by Patrick A. Gaughan, Wiley Finance
Series.
78
Notes
Unit 4:
Basic Concepts of Income Tax
Structure:
4.1 Introduction to Income Tax
4.1.1 Introduction
4.1.2 Direct and Indirect Tax
4.1.3 History of the Income Tax Act
4.1.4 Overall View of the Legal System
4.1.5 Charging Section Section 4 of the Act
4.1.6 Rates of Tax
4.1.7 Important Terms Used in the Income Tax Act
4.1.8 Coverage under Gross Total Income
4.1.9 Rounding off of Total Income (Sec. 288A)
4.1.10 Computation of Tax Liability on Total Income
4.1.11 Method of Accounting and Accounting Standards for Computing Income
(Section 145 of the Act)
4.2 Residential Status
4.2.1 Definition of Total Income [Section 2(45)]
4.2.2 Meaning of Total Income in the Context of Residential Status [Sec. 5(1)]
4.2.3 Residential Status
4.2.4 Scope of Total Income and Incidence of Tax
4.2.5 Income Deemed to be Received in India [Sec. 7]
4.2.6 Section 8: Inclusion of Dividend as Defined u/s 2(22) in the Total
Income of a Person
4.2.7 Section 9: Income Deemed to Accrue or Arise in India
4.2.8 Other Points
4.3 Exempted Incomes of Companies
4.3.1 Income of Foreign Companies Providing Technical Services in Projects
Connected with the Security of India [Section 10(6C)]
4.3.2 Section 10AA: Special Provisions in Respect of Newly Established
Units in Special Economic Zones
4.3.3 Income from Property Held for Charitable Purposes
4.4 Profit and Gains from Business or Profession
4.4.1 Introduction and Incomes Chargeable under this Head as per the
Provisions of Section 28
4.4.2 Computation of Income under the Head [Section 29]
4.4.3 Deductions under Sections 30 to 37(i)
4.4.4 Expenses Not Deductible
4.4.5 Miscellaneous Provisions
4.5 Income under the Head Capital Gains
4.5.1 Introduction
4.5.2 Basis of Charge [Sections 45 and 46]
4.6
4.7
4.8
4.9
4.10
4.11
4.12
4.13
4.14
4.15
79
4.5.3 Transactions not Regarded as Transfer [Sections 46 and 47]

4.5.4 Withdrawal of Exemption in Certain Cases [Section 47A]
4.5.5 Computation of Capital Gains [Sections 48 to 51]
4.5.6 Cost of Improvement [Section 55(1)(b)]
4.5.7 Cost Inflation Index
Exemptions from Capital Gains
4.6.1 Capital Gains Exempt from Tax [Sections 54, 54B, 54D, 54EC, 54F,
54G, 54H, 54GA]
4.6.2 Tax on Short-term Capital Gains in Certain Cases [Section 111A]
4.6.3 Tax on Long-term Capital Gains [Section 112]
Hints for Tax Planning
Problems
Summary
Check Your Progress
Key Terms
Case Study
Further Readings
Notes
Objectives
To gain knowledge about the basic provisions of the Income Tax Law which have a
bearing upon liability under that tax
To determine the residential status of the assessee and its bearing on the income
to be included for computation of the total income
To gain knowledge about incomes which do not form part of total income. These
incomes being tax-free offer a great scope for tax planning to the assessees
wherever suitable circumstances exist
to aware of the provisions of Income Tax regarding computation of income under

the head Profits and Gains from Business/Profession
To gain knowledge about computation of income under the head Capital Gains
4.1 Introduction to Income Tax

4.1.1 Introduction
As the first step towards understanding income tax law in India, it would be
appropriate to begin with acquiring knowledge about the structure of the tax regime in the
country. Taxes are the basic source of revenue for the government. Revenue so raised is
utilised for meeting the expenses of the government as well as to carry out
developmental works.
4.1.2 Direct and Indirect Tax
There are basically two types of taxes, Direct and Indirect taxes. Direct taxes are
collected by the government directly from the taxpayer through levies such as income tax,
wealth tax and interest tax. Whereas, indirect taxes are collected indirectly as a part of
80
Notes
the prices of goods and services on which these are levied. In India these comprise
excise duty, sales tax, customs duty and value added tax. While direct taxes form 30%
of the governments revenue, indirect taxes contribute a large chunk of the left over 70%.
Gift tax and estate duty were part of the direct tax revenue. As an ongoing process of
simplification and rationalisation of the direct tax structure in India, the government
repealed the Gift Tax Act in 1998 and the Estate Duty Act in the late eighties.
4.1.3 History of the Income Tax Act
1857
1886
1918
1922
1947
1961
The Great Liberation Movement. British rule called this movement as the
Great Revolt. In order to recover the expenses/loss of this great revolt, the
British Government, introduced Law of Taxation on Income.
After few experiments in implementation, the Income Tax Act, 1886
became a permanent guest to this country.
Again, due to financial difficulties of the First World War, a rigorous 53
section act Income Tax Act, 1918 replaced the previous one.
The two acts, levying income tax and super tax, were replaced by a
consolidated Act the Indian Income Tax Act, 1922.
Soon after independence, the ruling party felt the ever-increasing need for
money. By that time, too many amendments and changes were made in the
1922 Act and there was a need to replace the said Act. The Direct Taxes
Administration Enquiry Committee was constituted in the year 1958,
under the Chairmanship of Shri Mahabir Tyagi.
Ultimately, the Income Tax Bill, 1961 successfully presented and the
Income Tax Act, 1961 received the accent of the President on September
13, 1961 and came into force from 1st April 1962 replacing the 1922 Act.
4.1.4 Overall View of the Legal System

(a) The Income Tax Act, 1961 and the Annual Finance Acts: The Indian
Constitution has empowered only the Central Government to levy and collect
Income Tax. The Income Tax Act was enacted in 1961. The act came into
force from the April 1, 1962 and extends to the whole of India. The expression
whole of India also includes the territorial waters up to 12 nautical miles from
the nearest point of the appropriate base line. It consists of over 400 sections
and 12 schedules. The Income Tax Act determines which persons are liable to
pay tax and in respect of which income. The various sections lay down the law
of income tax and the schedules elucidate certain procedures and give certain
lists, which are referred to, in the sections. However, the act does not prescribe
the rates of Income Tax. These rates are prescribed every year by the Finance
Act (popularly known as The Budget). This is done mainly to:
keep the rates of tax under annual review by the government and thereby,
provide flexibility to the government in terms of the amounts to be
collected by the way of income tax revenue.
leave the main framework of the income tax relatively untouched, i.e., to
make adjustment through the annual finance act, so that the law on
income could adjust with the times.
(b) Income Tax Rules, 1962 (amended up-to-date): Every act normally gives
power to an authority, responsible for implementation of the Act, to make rules
for carrying out purposes of the Act. Section 295 of the Income Tax Act has
given power to the Central Board of Direct Taxes to make such rules, subject to
the control of Central Government, for the whole or any part of India. These
81
rules are made applicable by notification in the Gazette of India. These rules
were first made in 1962 and are known as the Income Tax Rules, 1962. Since
then many new rules have been framed or existing rules have been amended
from time to time and the same have been incorporated in the aforesaid rules.
(c) Circulars and Clarifications by the Central Board of Taxes: At the time of
drafting of the act, many situations and circumstances remain unseen. Many
times the legislature wants the administrators of the Act to make provisions to
suit their requirements. The legislature has left many things to be decided by
the department and mention of these is made in the relevant sections of the
Income Tax Act, 1961. The administration of all the Direct Taxes is looked after
by the Board known as the Central Board of Direct Taxes (CBDT). The CBDT
in exercise of the powers conferred on it under Section 119 has been issuing
certain circulars and clarifications from time to time, which have to be followed
and applied by the Income Tax Authorities. However, these circulars are not
binding on the assessee or Commissioner (Appeal) or the ITAT or on the
courts.
(d) Decisions: Decisions of the tax tribunals and courts on disputes pertaining to
aspects of the income tax law form case laws. Case laws result in the formation
of precedents in law, i.e., in case a similar dispute arising in future, the decision
of the court on that point may be used to decide the current dispute. The
decisions of the Supreme Court, however, are binding on all the lower courts
and tax authorities in India. High Court decisions are binding only in those
specific states which are within the jurisdiction of that particular High Court.
However, decision of one High Court has the persuasive power over other High
Courts when deciding similar issues.
Notes
4.1.5 Charging Section Section 4 of the Act

Income tax is charged under the above components of legal scheme for charge of
that tax. The basis for the levy of income tax is spelt out in Section 4 of the Income tax
Act, 1961. It provides that:
1. Income Tax shall be charged at the rate prescribed for the year by the Annual
Finance Act.
2. The charge is on every person including the assessable entities specified in
Section 2 (31).
3. The income taxed is that of the previous year and not of the year of
assessment (subject to exceptions provided by Sections 172, 174, 174A, 175
and 176).
4. The levy of tax shall be made on the total income of the assessable entity
computed in accordance with and subject to the various provisions for the levy
of additional Income Tax contained in the Act.
5. It also provides that, in respect of the income chargeable under the above
proviso, the Income Tax shall be deducted at source or paid in advance, where
it is so deductible or payable under any provision of the Act.
This section provides the foundation for the levy of tax on all incomes. Income Tax is
an annual tax on income levied by the Central Government. This tax is charged in
respect of the income of the financial year (known as the previous year) in the next
financial year (known as the assessment year) at the rates fixed for such an assessment
year in the Finance Act passed each year by the Parliament.
82
Notes
4.1.6 Rates of Tax

Income tax is to be charged at the rates fixed for the year by the Annual Finance Act.
The Finance Act consists of three schedules at the end of it. The last schedule consists
of four parts.
Part I Consists of the rates of tax applicable to the income of various types of
assesses for the current assessment year, for e.g., the Finance Act, 2012 has
given rates for the assessment year 2013-14 and the Finance Act, 2013 has
given rates for the assessment year 2014-15.
Part II Consists of the rates of deduction of tax at source from the income earned in
the current financial year, for e.g., Finance Act, 2012 has given rates at which
tax is to be deducted at source in the Financial Year 2012-13. Similarly, the
Finance Act, 2013 shall give the rates of TDS on the income earned during the
Financial Year 2013-14.
Part III Consists of the rates for deduction of tax from salary and also for computing
advance tax, for e.g., Finance Act, 2012 has given rates for the computation for
the assessment year 2013-14. Similarly, the Finance Act, 2013 shall give the
rates of advance tax for the assessment year 2014-2015.
Part IV It gives rules for computation of Net Agricultural Income.
When Finance Act 2013 is passed by the Parliament, Part III of the First
schedule of Finance Act 2012 will become Part I of Finance Act 2013. Rates of
income tax are normally fixed as percentage of total income.
4.1.7 Important Terms used in the Income Tax Act
The Income Tax Act is a self-contained Act. Sections 2 and 3 define the
terms/expressions used in Income Tax Act. The word means, includes and means and
includes are used in the definitions and the significance of these terms need to be
understood.
When a definition uses the word means the definition is self-explanatory, restrictive
and in a sense exhaustive. It implies that the term or expression so defined means only
as to what it is defined as and nothing else. For example, the terms Agricultural Income,
Assessment year, Capital Asset, are exhaustively defined.
When the legislature wants to widen the scope of the term or expression and where
an exhaustive definition cannot be given, it uses the word includes in the definition.
Hence, the inclusive definition provides an illustrative meaning and not an exhaustive
meaning. In practical application, the definition could include what is not specifically
stated or mentioned in the definition as long as the stipulated criteria are satisfied. To
illustrate, reference is drawn to the definition of the terms inclines, person, transfer.
When the legislature intends to define a term or expression to mean something and
also intends to specify certain items to be included, both the words means as well as
includes are used. Such a definition is not only exhaustive but also illustrative. For
example, the terms assessee, Indian company, recognised Provident Fund.
Income
Though the term income is not defined in an exhaustive manner under the act,
generally speaking, it includes receipts in the shape of money or moneys worth which
arise with certain regularity or expected regularity from a definite source. The expression
income, according to the dictionary, means a thing that comes in. Income may also be
defined as the gain derived from land, capital or labour or any two or more of them.
Income in this act connotes a periodical monetary return coming in with some sort of
83
regularity or expected regularity, from definite sources CIT vs. Shaw Wallace and Co. 6
ITC 178 (PC)/Padmaraje R. Kadambande vs. CIT [1992] 195 ITR 877 (SC). The word
income is not limited by the words profits and gains. Anything which can properly be
described as income, is taxable under the act unless expressly exempted
Maharajkumar Gopal Saran Narain Singh vs. CIT [1935] 3 ITR 237 (PC).
Notes
Though the dictionary meaning of the term income is a thing that comes in, every
receipt of a person is not considered as income and therefore, not taxed under the act.
Income, for the purposes of taxation, has an element of gain or profit as distinguished
from the corpus or principal. An analogy can be drawn of a house and the rent received
on letting of that house or a machine and the profit obtained on sale of production
generated out of that machine. A house owned by a person becomes a source of income,
whereas rent received on letting that house constitutes income from that house.
Accordingly, receipt from the sale of the house which is a source of income, does not
constitute income by itself, but rent received from that house becomes income of the
owner of that house. In the same way, receipt from the sale of a machine is not income
but from the sale of the produce brought out from the machine is income. Receipt in the
former case is called as capital receipt and the receipt in the later case is called as
revenue receipt. In these cases, however, if a person deals in purchase and sale of
house properties or machines, these assets do not remain a source and the profit derived
from these activities of purchase and sale becomes income. The source need not
necessarily be tangible as the return for human exertion is also income.
Section 2(24) gives a statutory meaning of the term Income. The section does not
define the term income, but merely describes the various receipts that can be known as
income. At present the following items of receipts are included in Income u/s 2(24).
1. Profits and Gains
2. Dividends
3. Voluntary contributions received by a trust/institution created wholly or partly
for charitable or religious purposes or by an association or institution covered
by Section 10 (21) or (23) or (23-C) (iv) or (v).or by a fund or trust or institution
referred to in sub clause(iv) or sub clause(v) or by any university or other
educational institution referred to in sub-clause (iiiad) or sub clause (vi) or by
any hospital or other institution referred to in sub-clause (iiiae) or sub-clause
(via) of clause (23C) of section 10 or by an electoral trust
4. The value of any perquisite or profit in lieu of salary taxable and Section 17.
5. Any special allowance or benefit other than the perquisite included above,
specifically granted to the assessee to meet expenses wholly, necessarily and
exclusively for the performance of the duties of an office or employees of a
private firm.
6. Any allowance granted to the assessee to meet his personal expenses at the
place where the duties of his employment of profit are ordinarily performed by
him or at a place where he ordinarily resides or to compensate him for the
increased cost of living.
7. The value of any benefit or perquisite whether convertible into money or not,
obtained from a company either by a director or by a person who has a
substantial interest in the company or by a relative of the director or such
person and any sum paid by any such company in respect of any obligation
which, but for such payment would have been payable by the director or other
person aforesaid.
8. The value of any benefit or perquisite, whether convertible into money or not,
which is obtained by any representative assessee mentioned in clauses (iii)
84
Notes
9.
10.
11.
12.
13.
14.
15.
16.
17.
and (iv) of Section 160(1) or by any beneficiary or any amount paid by the
representative assessee for the benefit of the beneficiary which the beneficiary
would have ordinarily been required to pay.
Value of any benefit or perquisite, whether convertible into money or not arising
from a business or exercise of profession.
Any sum chargeable to income tax under Section 41 and Section 59.
Any sum chargeable to income tax under (ii), (iii), (iii-a), (iii-b), (iii-c), (iv) and (v)
of Section 28.
Any sum chargeable to tax u/s 28(v) [interest, salary, bonus, commission or
remuneration to a partner of a firm].
Any capital gains chargeable under Section 45.
The profits and gains of any insurance carried on by a Mutual Insurance
Company or by a cooperative society.
The profits and gains of any business (including providing credit facilities)
carried on by a cooperative society with its members.
The profit and gains of any business of banking (including providing credit
facilities ) carried on by a co-operative society with its members
Any winnings from lotteries, cross-word puzzles, races including horse races,
card games and other games of any sort or from gambling or betting of any
form or nature what so ever.
For the purpose of this sub-clause:

1. Lottery shall include winnings from prizes awarded to any person by draw of
lots or by chance or in any other manner whatsoever under any scheme or
arrangement by whatever name called;
2. Card game and other game of any sort shall include any game show, an
entertainment programme on television or electronic mode, in which people
compete to win prizes or any other similar game.
3. Any sum received by the assessee from his employers as contributions to any
provident fund or superannuation fund or employees state insurance fund or
any other fund for the welfare of such employees.
4. Any sum received under a lump sum insurance policy including sum allocated
by way of bonus in such a policy.
5. Any sum received/receivable as specified in Sec. 28 (v-a) [i.e., sum received in
cash or kind under an agreement for not carrying out any activity in relation to
business or not to share any know-how patent etc.].
6. Any sum referred to in Section 56(2)
7.
any consideration received for issue of shares as exceeds the fair market
value of the shares referred to in clause (viib) of sub section(2) of section 56.
The definition of income of an individual or HUF will now include any sum received
from any person in cash or cheque or by any other mode or credit, otherwise than as
consideration for goods or services. However, this would not include the following:
Amounts received by an individual from a relative out of natural love and
affection. The term relative has been specifically defined for this purpose.
Amounts received by an individual or HUF under a will or by way of an
inheritance.
Amounts received by an employee/dependent of a deceased employee from
an employer by way of bonus, gratuity or pension or insurance or any other
sum solely in recognition of services rendered.
85
Amounts received in contemplation of death of an individual or karta or

member of HUF.
Any income exempt under Section 10 or otherwise or which is excluded from
the total income.
Amounts received on transactions not regarded as transfer for the purpose of
capital gains.
A general exemption of ` 50,000 per year in the aggregate will be available in
respect of the receipts/credits mentioned above. In addition, gifts received on
marriage will be exempt.
The income of the nature described above will be taxable under the head
income from other sources.
Based on the above, gifts received on any occasion other than marriage,
unless specifically excluded, will be treated as income.
Notes
Some Interesting Facets of Income under the Income Tax Act

1. Form of Income: The income received by the assessee need not be in the
shape of cash only. It may also be some other property or right which has
monetary value. [CIT vs. Central India Industries Ltd. (1971) 82 ITR 555 (SC)].
Wherever income is received in kind, like perquisites, then their value has to be
found as per the rules prescribed and this value shall be taken to be the
income.
2. Tainted/Illegal Income: Income is income, though tainted. For the purpose of
income tax, there is no difference between legal and tainted income. Even
illegal income is taxed just like any legal income.
3. Application of Income vs. Diversion:
Where an assessee applies an
income to discharge an obligation after the income reaches the hands of the
assessee, it would be an application of income and this would result in taxation
of such income before it reaches the hands of the assessee, it cannot be
treated as an income of the assessee.
4. Disputed Income: Any dispute regarding the title of the income cannot hold up
the assessment of the income in the hands of the recipient. The recipient is,
therefore, chargeable to tax though there may be rival claims to the source of
income.
5. Basis of Income: Income can be taxed on receipt basis or on accrual basis.
In case of income from business or income from other sources, the taxability
would depend upon the method of accounting adopted by the assessee; while
in other cases, it would generally be taxed on receipt or accrual basis,
whichever happens earlier. However, a contingent income, i.e., an income
which may or may not arise cannot be taxed unless and until such contingency
actually occurs and the income arises to the assessee.
6. Lump sum receipts: If a receipt has an income, then whether it is received in
lump sum or in instalment, would not affect is taxability. For example, if a
person receives arrears of salary in a lump sum amount, it would still be his
income.
Capital and Revenue Receipts
The Income Tax Act charges tax on income and not on capital and hence, it is very
essential to distinguish between capital and revenue receipts. The Income Tax Act does
not define the term capital receipts and revenue receipts. Therefore, whether a certain
receipt is capital or revenue would be a mixed question of law and fact. It is to be
86
Notes
determined on the basis of the particular facts and circumstances of each case.
Following are some of the important rules which guide in making a distinction between
them.
1. A receipt referable to fixed capital would be a capital receipt, whereas a
receipt referable to circulating capital would be a revenue receipt.
Circulating capital is the capital which is turned over and in the process of
being turned over yields profit or loss, for e.g., fixed capital is also involved in
this process but remains unaffected by the process. A capital asset in the
hands of one person may be a trading asset in hands of another. Thus, while
determining the nature of receipt one has to consider the nature of trade in
which the asset is employed.
2. A receipt in substitution of a source of income is a capital receipt,
whereas a receipt in substitution of an income is a revenue receipt.
Compensation for loss of employment is a capital receipt; whereas
compensation for temporary disablement is a revenue receipt. Compensation
received from the government in respect of stock in trade destroyed or
damaged by enemy action constitutes revenue receipts. On the contrary,
compensation paid for the acquisition of land or property which constituted
capital asset in the hands of a lessee would be a capital receipt.
3. An amount received as a compensation for the surrender of certain rights
under an agreement is a capital receipt. For e.g., if a director/partner
receives an amount from the company in consideration of giving up his right to
carry on competitive business similar to that of company/firm it will be a capital
receipt. An amount received as a compensation for loss of future profits is a
revenue receipt.
4. Receipt to be of a revenue nature need not necessarily be repetitive or
recurring. Thus, a bulk purchase followed by bulk sale or a series of sales
would constitute an adventure in the nature of trade and consequently, the
income arising there from would be taxable.
5. Nature of receipt in the hands of the recipient: In the case of CIT v. Kamal
Behari Lal Singha (SC), the Supreme Court held that it was a well settled
principle that to find out whether a receipt is a capital or a revenue receipt, one
had to see what its nature is in the hands of the receiver and not in the hands of
payer. The easiest example to understand is the case of a builder. If he sells a
particular property or a flat, he would be receiving the money on revenue
account, as it constitutes his stock in trade, whereas it does not matter that the
person making the payment would consider the payment on capital account.
6. Annuity: In case of annuities, which are, payable in specified sums at periodic
intervals of time the receipt would be of a revenue nature. The fact that annuity
is contingent or variable in amount does not in any way affect its character as
income. An annuity received from an employer is taxable as income from
salaries, whereas all other annuities are chargeable under the head income
from other sources irrespective of the fact whether or not they are payable:
(1) under a deed of family arrangement (ii) under a deed of separation to a wife
or (iii) under a degree for alimony or (iv) to the estate of a deceased partner by
the remaining partners for the use of the firms name and goodwill.
Annual payments (i.e., annual instalments) as distinguished from annuities in
the nature of capital. Thus, the amount of instalment received by the assessee
would be of capital nature and hence, not liable to tax. In order to ascertain,
87
whether a certain payment is an annuity or annual instalments regard must be

had to the true nature and character of a transaction, for e.g.;
(a) if the sale of the property/business is for a price which is to be paid in
instalments, the instalments would be capital receipts.
(b) if the property is sold for an annuity payable regularly, the property
disappears and the annuity assumes the character of definite income and
hence, chargeable to tax.
7. Lump sum receipts: In order to determine whether a receipt is capital or
revenue in nature, the fact that it is a lump sum payment, large payment or
periodic payment is not relevant. A lump sum paid in commutation of salaries,
pensions, royalties or other periodic payments would be income, taxable under
the respective heads. Similarly, royalties received for the use of patents,
whether paid in lump sum or in instalments of fixed or varying amounts would
be taxable as income. However, if the payment received were in lieu of the total
or partial assignment of the patent under which, the owner ceases to own the
patent as a capital asset it would constitute a capital receipt.
Notes
Receipts Bereft of the Revenue Element

Income Tax is a tax on income. All receipts are not income. Particular receipts
cannot be taxed because they cannot be proved to be a taxable income at all. Knowledge
of such receipts is essential to understand the meaning of term Income.
1. Surplus arising to mutual concerns (concept of mutuality): One cannot
make a profit from dealing with oneself. Income should be received from
outside. If a person revalues his goods/assets and shows a higher value in
books, he cannot be considered as having sold the goods and made a profit
thereon. Similarly, in the case of mutual concerns (clubs, associations and
societies) if the subscription from the members exceeds its expenditure on its
members, the excess cannot be treated as taxable income.
2. Pin Money: Pin money received by wife for her dress/personal expenses and
small savings made by a woman out of the money received from her husband
for meeting household expenses is not treated as her income [Rani Amruit
Kanvir v. CIT SC].
Person [Sec. 2(31)]
The term person includes:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
An individual
A Hindu Undivided Family
A company
A firm
An association of persons or body of individuals whether incorporated or not
A local authority and
Every artificial juridical person not falling within any of the preceding
categories.
The aforesaid definition is inclusive and not exhaustive. Therefore, any person not
falling in the above seven categories may still fall in the term person and accordingly,
may be liable to Income Tax.
(i) Individual: The expression individual as an unit of assessment refers only to
a natural person, i.e., a human being, deities and statutory corporations are
88
Notes
(ii)
(iii)
(iv)
(v)
(vi)
assessable as juridical person. An individual also includes a minor and a

person of unsound mind.
Hindu undivided family: Family connotes a group of people related by blood
or marriage. According to the Shorter Oxford English Dictionary, 3rd Edition,
the word family means the group consisting of parents and their children,
whether living together or not; in a wider sense, all those who are nearly
connected by blood or affinity; a persons children regarded collectively; those
descended or claiming descent from a common ancestor; a house, kindred,
lineage; a race; a people or group of people. The word family always signifies
a group. Plurality of persons is an essential attribute of a family. A single
person, male or female, does not constitute a family. He or she would remain,
what is inherent in the very nature of things, an individual, till per chance he or
she finds a mate. The expression Hindu joint family in the Income Tax Act is
used in the sense in which a Hindu joint family is understood under the various
schools of the Hindu law. The word Hindu preceding the words undivided
family signifies that the undivided family should be of those to whom the Hindu
law applies.
Company: Under Sec. 2(17), the expression company is defined to mean the
following :
(a) an Indian company or
(b) any corporate body incorporated under the laws of a foreign country or
(c) any institution, association or a body which is assessed or was
assessable as a company for any assessment year, commencing on April
1, 1970 or
(d) any institution, association or a body, whether incorporated or not and
whether, Indian or non-Indian which is declared by the general or special
order of the Central Board of Direct Taxes to be a company.
Firm: Firm is a collective noun, a compendious expression to designate an
entity, not a person. Under the Income Tax Act, firm, partner and
partnership have been given the same meaning as assigned to them in the
Indian Partnership Act. But the expression partner has been extended to
include any person who, being a minor, has been admitted to the benefits of a
partnership. Only the members who have entered into a partnership are to be
regarded as partners and collectively a firm and the name under which their
business is carried on, is called the firms name.
Association of Persons (AOP): The word associate means, according to the
Oxford Dictionary, to join in the common purpose or to join in an action.
Therefore, an association of persons must be one in which two or more
persons join in a common purpose or common action and as the word occurs
in Section 3 of the 1922 Act, which imposes a tax on income, profits or gains,
the association must be such that the one object of which is to produce income,
profits or gains. An association of persons can be formed only when two or
more individuals voluntarily combine together for a certain purpose. Even a
minor can join an association of persons if his lawful guardian gives his
consent. An association of persons does not mean any and every combination
of persons. It is only when they associate themselves in an income-producing
activity that they become an association of persons.
Body of Individuals: The expression body of individuals includes a
combination of individuals who have a unity of interest but who are not
actuated by a common design and one or more of whose members produce or
89
help to produce income for the benefit of all. The absence of a common design
is what principally distinguishes a body of individuals from an association of
persons. Another distinguishing feature is that the one refers to persons and
the other to individuals.
Distinction between an Association of Persons and a Body of Individuals:
1. An association of persons may consist of non-individuals but a body of
individuals has to consist of individuals only. If two or more persons (like
firms, company, HUF, individual etc.) join together, it is called an
association of persons. For example, where X, ABC Ltd. and PG & Co. (a
firm), join together for a particular venture that they may be referred to as
an association of persons. If X, Y and Z join together for a particular
venture, but do not constitute a firm, then they may be referred to as a
body of individuals.
2. An association of persons implies a voluntary getting together for a
common design or combined will to engage in an income producing
activities, whereas, a body of individuals may or may not have such a
common design as well.
(vii) A Local Authority: A local authority means:
(i) A Panchayat as referred to in Article 243(a) of the Constitution.
(ii) A Municipality as referred to in Article 243 P of the Constitution.
(iii) A Municipal Committee and District Board legally entitled or entrusted by
the government with the management of municipal or local funds.
(iv) A Cantonment Board as defined in Sec. 3 of the Cantonment Act, 1924.
(viii) An Artificial Person: Artificial persons are entities which are not natural
persons but are separate entities in the eyes of the law. Though they may not
be sued directly in a court of law, but they can be sued through the persons
managing them, for e.g., gods, idols and deities are artificial persons. However,
under the Income Tax Act, they have been provided exemption from the
payment of tax under separate provisions of the act, if certain conditions
mentioned therein are satisfied.
Similarly, all other artificial persons will also fall under this category if they do
not fall under any of the preceding categories of persons. For e.g., the
University of Pune is an artificial person, as it does not fall in any of the six
categories mentioned above.
Notes
Assessee [Sec. 2(7)]

An assessee is a person by whom any tax or any other sum of money (for example,
interest, penalty, fine etc.) is payable under the Income Tax Act and includes:
(a) A person in whose respected proceedings for determining income or for
assessment of fringe benefits or of the income of any other person in respect of
which he is assessable or of the loss sustained by him or by such other person
or of the amount of refund due to him or to such other person have been
commenced by the Income Tax Department. Thus, a person may become an
assessee even if no amount is payable by him under the Income Tax Act.
(b) A deemed assessee, i.e., a person who is himself not an assessee but is
treated as an assessee for the purposes of the Income Tax Act. For example,
the trustee of a trust is deemed as an assessee in respect of the trust. The
income earned is the income of the trust but is assessed in the hands of the
trustee as his income.
90
Notes
(c) An assessee in default, i.e., a person on whom certain obligations have been
imposed under the Income Tax Act but who has failed to carry out those
obligations. For example, any person who employs another person to deduct
income tax at source from the taxable salary of the employee and pay the tax
deducted at source to the government within the prescribed time as income tax
paid on behalf of the employee. In case the employer fails to carry out these
obligations, he becomes an assessee in default.
Assessment Year (AY) [Sec. 2(9)]
Assessment Year (AY) means the financial year (1st April to 31st March of the next
year) in which the income is taxed or assessed. Income of the previous year is taxed in
the assessment year (next year) at the rates prescribed by the relevant finance act, for
e.g., income earned during the previous year 2012-13 is taxable in the assessment year
2013-14 at the rates prevailing by the relevant Finance Act.
Previous Year [Sec. 2(34) and Section 3]
Previous Year (PY) means the financial year immediately proceeding the
assessment year. In case of a business or profession which is newly started, the
previous year commences from the date of commencement of the new business or
profession up to the next 31st day of March.
Relationship between the Previous Year and Assessment Year is such that the
income, which is earned in the previous year, is charged to income tax in the assessment
year at the rates applicable for that assessment year. Thus, if an income of ` 1,00,000 is
earned in PY 2014-15 (which commences on 1.4.14 and ends on 31.3.15), this income is
charged to income tax in the AY 2015-16 at the rates applicable for that AY.
Uniform previous yea: From the assessment year 1989-90 onwards, all assesses
are required to follow financial year (i.e., April 1 to March 31) as the previous year. This
uniform previous year has to be followed for all sources of income. This has been
illustrated in the following example.
Illustration: For the assessment year 2015-16, the income earned by X Ltd. during
the previous year 2014-15 (i.e., April 1, 2014 to March 31, 2015) is chargeable to tax. It is
not necessary that X Ltd. maintains a book of account on the basis of financial year, it
can maintain in any other basis but for the purpose of income tax, income of the previous
year 2014-15 (i.e., April 1, 2014 to March 31, 2015) is taxable for the Assessment year
2015-16 Suppose X Ltd. maintains books of account in the calendar year basis (1st
January to 31st December), the taxable income will be computed as follows.
Accounting year
Income as per books of

account
Quarter wise break-up of income

January to March
April to December
2013
` 120,000
` 36,000
` 84,000
2014
` 140,000
` 52,000
` 88,000
2015
` 180,000
` 42,000
` 1,38,000
Taxable Income
Assessment Year
Previous Year
Income
2014-15
2013-14
84,000 + 52,000 = ` 1,36,000
2015-16
2014-15
88,000 + 42,000 = ` 1,30,000
91
Illustration of a newly started business or source of income:
Notes
X joins an Indian company on Dec. 21, 2012. Prior to this, he is not in employment
nor has any other source of income. What are the previous years for the assessment
year 2013-14 and 2014-15 ?
Solution:
Previous year for the assessment years 2013-14 and 2014-15 will be as follows
Assessment Year
Previous Year
2013-14
Dec. 21, 2012 to March 31, 2013
2014-15
April 1, 2013 to March 31, 2014
A financial year plays a double role It is a previous year as well as an assessment

year.
Illustration:
Financial Year
Previous Year
Assessment Year
2013-14 (April 1, 2013 to

March 31, 2014)
2013-14 is previous year for

the income received or
accrued during April 1, 2013
to March 31, 2014.
2014-15 is the assessment year

for the income received or
accrued in the immediately
preceding previous year (1st
April 1, 2013 to March 31, 2014).
2014-15 (April 1, 2014 to

March 31, 2015)
2014-15 is the previous year

accrued during April 1, 2014
to March 31, 2015.
2015-16 is the assessment year

accrued in the immediately
preceding previous year (April 1,
2014 to March 31, 2015).
4.1.8 Coverage under Gross Total Income

Gross Total Income
As per Section 14, income of a person is computed under the following five heads:
1.
2.
3.
4.
5.
Salaries
Income from house property
Profits and gains of a business or profession
Capital gains
Income from other sources.
The aggregate income under these heads is termed as the gross total income. In
other words, gross total income means total income computed in accordance with the
provisions of the Act before making any deduction under Chapter VI A. (Section 80C to
80U).
Further Section 14A provides that no deduction shall be made in respect of
expenditure incurred by the assessee in relation to the income that does not form part of
the total income under the Act.
Income
The total income of an assessee is a gross total income as reduced by the amount
permissible as deduction under Sections 80C to 80U.
92
Notes
How to Compute Total Income?

The steps in which the total income for any assessment year is determined are as follows:
1. Determine the residential status of the assessee to find out which income is to
be included in the computation of his total income (residential status and need
for determining residential status are given in the next chapter).
2. Classify the income under each of the following five heads. Compute the
income under each head after allowing deductions prescribed for each head of
income as given below :
(a) Income from salaries
Income by way of allowances
_________
Taxable value of perquisites
_________
Gross salary
_________
Less: Deductions u/s 16
_________
Entertainment allowances
Professional tax
Net taxable income from salary
_________
(b) Income from House Property
Net annual value of house property
_________
Less: Deduction under section 24
_________
_________
(c) Profits and gains of business and profession
Net profit as per P & L A/c
_________
Less/Add: Adjustments required
to be made to the profit as per provisions of Income Tax Act ________
Net profit and gains of business and profession
________
(d) Capital gains
Capital gains as computed
Less: Exemptions u/s 54/54B/54D etc.
Income from capital gain
(e) Income from other sources:
Gross income
________
Less: Deductions
________
Net income from other sources
________
Total [(a) + (b) + (c) + (d) + (e)]
Less : Adjustment on account of set off and carry
forward of losses
Gross total income
Less : Deductions available under Chapter VIA
Sections 80C to 80U)
________
Total Income or net income [Rounded off]

Computation of Tax Liability
Tax on net income
Add: Surcharge
Tax and surcharge
________
________
________
93
4.1.9 Rounding off of Total Income (Sec. 288A)
Notes
The total income as computed above shall be rounded off to the nearest multiple of
ten rupees (part of the rupee consisting of paise to be ignored). Thereafter, if the last
figure is 5 or more, it should be grossed up to the next higher multiple of 10 and if it is
lower than 5 it should be grossed up to the next lower multiple of 10.
4.1.10 Computation of Tax Liability on Total Income
On the total income, tax is to be calculated according to the rates prescribed under
the relevant Finance Act.
A rebate u/s 88E, if any, in respect of securities transaction tax to an assessee
dealing in securities shall be allowed from the tax so computed.
The amount arrived at, after allowing the rebate shall be increased by a surcharge if
applicable and education cess (at present 3%) and the amount so arrived at is the tax
liability of the person for that year.
Rounding off of tax (Sec. 288B) The amount of tax (incl. TDS, Advance Tax,
penalty, fine or others) should be rounded off to the nearest multiple of ten rupees.
4.1.11 Method of Accounting and Accounting Standards for Computing Income
(Section 145 of the Act)
1 Income chargeable under the head Profits and gains of business or profession
or Income from other sources shall be computed only in accordance with
either the cash or the mercantile system of accounting, regularly employed by
an assessee.
2. The Central Government has been empowered to prescribe by notification in
the official gazette the accounting standards which an assessee have to follow
in computing his income under the head Profits and gains of business or
profession or Income from other sources. The government would consult
expert bodies, like The Institute of Chartered Accountants of India, while laying
down such standards.
The government has notified the Accounting Standard I, relating to disclosure of
accounting policies and the Accounting Standard II relating to disclosure of prior period
and extra ordinary items and charges in accounting policies.
Method of accounting irrelevance in case of income chargeable under the heads
Salaries, Income from House Property and Capital gains. Since for calculating taxable
income under these heads one has to follow the statutory provisions of the Income Tax
Act, which expressly provide whether revenue (or expenditure) is taxable (or deductible)
on accrual basis or cash basis.
Method of Accounting in Certain Cases (Section 145A of the Act)
Notwithstanding any thing to the contrary contained in section145,the valuation of
purchase and sale of goods and inventory for the purpose of determining the income
chargeable under the head Profit and gains of business or profession shall be:
(a) in accordance with the method of accounting regularly employed by the
assessee, and
(b) further adjusted to include the amount of any tax, duty, cess (by whatever
name called) actually paid or incurred by the assessee to bring the goods to
the place of its location and condition as on the date of valuation
94
Notes
Explanation: For the purpose of this section, any tax, duty, cess (by whatever name
called)under any law for the time in force, shall include all such payment notwithstanding
any right arising as a consequence to such payment.
Residential Status and Chargeability
4.2 Residential Status

Residential status of an assessee is important in determining the scope of the
income on which income tax has to be paid in India. Broadly, an assessee may be a
resident or non-resident in India in a given previous year. An individual or HUF assessee
who is a resident in India may be further classified into: (1) resident and ordinarily
resident and (2) resident but not ordinarily resident.
Under the Income Tax Act, the incidence of tax is highest on a resident and
ordinarily resident and lowest on a non-resident. Therefore, it is in the interest of an
assessee that he claims non-resident status if he satisfies the conditions for becoming a
non-resident.
4.2.1 Definition of Total Income [Section 2(45)]
Total income means the total amount of income referred to in Section 5, computed
in the manner laid down in the Income Tax Act. As already mentioned in the last chapter,
total income is computed under five heads of income. Income computed under each
head is thereafter aggregated and the aggregate amount is known as Gross Total
Income. From Gross Total Income, certain deductions are allowed under section 80C to
80U and the balance income after deductions is known as Total Income. Section 5 of the
act provides the meaning of total income in relation to resident status of the assessee
since, the incidence of tax depends upon its residential status.
4.2.2 Meaning of Total Income in the context of Residential Status [Sec. 5(1)]
According to Section 5(1), incidence of tax in case of a resident and ordinary
resident the total income of a resident assessee would consist of all income from
whatever source derived which
1. is received or deemed to be received in India in the relevant previous year by
or on behalf of such person; or
2. accrues and arises or is deemed to accrue or arise in India during the relevant
previous year; or
3. Income which accrues or arises outside India even if it is not received or
brought into India during the relevant previous year.
Provision to Section 5(1): Incidence of tax in case of a resident but not
ordinarily resident: The computation of income of a person who is resident but not
ordinarily resident would be the same as in case of resident stated above, except that the
income accruing or arising to him outside India shall not be so included unless it is
derived from a business controlled wholly or partly from India or from a profession set up
in India.
Section 5(2): Incidence of tax in case of a non-resident: A non-residents total
income of any previous year includes all income from whatever source derived which:
1. is received or is deemed to be received in India during the previous year (place
or date of accrual being immaterial);or
2. Income which accrues or arises or is deemed to accrue or arise in India (place
or date of receipt being material).
95
Table 4.1: Taxability of Income based on Residential Status
Notes
Sr. No.
Status
Income liable to Tax
Resident and ordinarily resident
Global or world income
Resident but not ordinarily

resident
(a) All incomes realised within India (i.e., received/

deemed to be received and accrued/deemed
to accrue in India).
(b) Income from a business or profession outside
India, if this business is controlled in or
profession set up in India.
Non-resident
All
income
realised
within
India
received/deemed
to
be
received
accrued/deemed to be accrued in India).
(i.e.,
and
Important Points related to Taxable Income:

1 Income accruing or arising outside India shall not be deemed to be received in
India, by reason only of the fact that it is taken into account in a balance sheet
prepared in India [Expl. 1 to Section 5].
2. It is to be noted that income which has been included in the total income of a
person on the basis that it has accrued or arisen or is deemed to have accrued
or arisen to him shall not again be so included on the basis that it is received or
deemed to be received by him in India [Expl. 2 to Section 5] merely because it
has been remitted to India during the previous year.
3. Income should pertain to the previous year. The income to be taxed in a
particular assessment year is the income which is earned or which arises
during the relevant previous year. Therefore, if an income which was earned
during an earlier year but which could not be taxed in India due to any reason
may be because of the fact that the assessee was a non-resident in that year,
will not become taxable.
4. Any income is to be included in the total income only if it is taxable as per the
provisions of the income tax act and shall be computed as per the provisions of
the act. Exempt income shall not form part of the total income.
5. In the case of a resident, if the income earned outside India is charged to tax in
that country then the application of Sections 90 and 91 in respect of double
taxation relief has to be looked into. If a double taxation avoidance agreement
has been entered into between Government of India and the government of
that country (in which he has earned income) then the agreement will be
looked into for deciding the taxability of such incomes arising or accruing
outside India.
If an agreement with a foreign country does not exist, then in respect of the
income earned outside India, the tax paid on such income in the foreign
country (ascertaining the average rate of tax and applying such rate on the said
income) or the Indian rate of tax, whichever is lower, is deductible from the total
tax payable by the assessee on his total income including such foreign income.
6. The terms (a) income deemed to be received, (b) dividend income when
received, (c) income deemed to accrue or arise in India have been
explained/classified in Section 7, 8 and 9 respectively.
96
Notes
Residential Status and Scope of Taxable Income Relatable to that Status:

Having established the source of income of a person and the related head of
Income, the next step is to define the residential status and determine the scope of
taxable income relatable to that status.
4.2.3 Residential Status
Resident Status of an Individual
Under Section 6(1) an individual is said to be resident in India in any previous year if
he satisfies any one of the following two basic conditions:
(a) He is in India for a period or periods amounting in all to 182 days or more in the
previous year;
(b) He is in India for a period or periods of atleast 60 days during the relevant
previous year and atleast 365 days during the four years preceding that
previous year.
The aforesaid rule of residence is subject to the following exceptions :
1. Where an individual, who is a citizen of India, leaves India in any year for the
purpose of employment (or where an individual, who is a citizen of India, leaves
India as a member of the crew of an Indian ship), he is not to be treated as
resident in India in that year unless he has been in India for a period or periods
in that year for atleast 182 days (note that the period of 60 days in condition b.
is substituted).
2. Where an Indian citizen or a person of Indian origin, who has settled abroad,
comes on a visit to India in the previous year, he is not to be treated as resident
in India in that year unless he has been in India in that year for atleast 182 days
(note that the period of 60 days in condition b. is substituted).
In other words, such individuals do not become residents of India, if they are less
than 182 days in India. For such individuals, the conditions mentioned in clause (b)
above do not apply. Therefore, such individuals may stay in India up to 181 days in a
given previous year without becoming residents of India for that previous year. An
individual who does not satisfy any condition, neither condition (a) nor condition (b) is
non-resident for that previous year.
A resident individual may either be an ordinary resident or not ordinarily resident in
India for a given previous year. In order to determine whether a resident individual is
ordinarily resident (ROR) or not ordinarily resident (RNOR), the tests laid down under
section 6(6) have to be applied. A resident individual is treated as not ordinarily resident
in India in a given previous year, if he satisfies the following additional conditions:
(a) He has been non-resident in India in atleast 9 out of 10 previous years
immediately preceding the relevant previous year.
(b) He has been in India for a period or periods amounting in all to 729 days or less
in 7 previous years preceding the relevant previous year.
An individual who is resident in India but does not satisfy either or both the additional
conditions is RNOR for that previous year.
97
Flow Chart Showing the Residential Status of an Individual
Notes
Individual
Does he satisfy any one of the

conditions of Sec. 6(6)
No
Non Resident
Yes
Resident
Does he satisfy both of

The conditions of Sec. 6(6)
No
Resident but not

Ordinarily resident
Yes
Resident and Ordinarily
Resident
Important Points
1. It is not essential that the stay should be at the same place. Similarly, place or
purpose of the stay is not material.
2. Where a person is in India for a part of the day, the calculation of physical
presence in India in respect of such broken period should be made on an
hourly basis. A total of 24 hours of stay spread over a number of days is to be
counted as a stay of one day.
3. The stay in a ship or boat moored in the territorial waters in India would be
treated as his presence in India.
Illustration:
Residential status of an individual can be illustrated with the help of the following
examples:
(a) Mr. A, resident of Mumbai left India for the first time for USA for higher studies
on June 7, 2012 and returned on March 25, 2013. For the previous year
2012-13 (Assessment Year 2013-14), A was in India for 73 days (from April 1,
2012 to June 6, 2012 and March 26, 2013 to March 31, 2013). A has satisfied
the condition of being at least 60 days in India in P.Y. 2012-13 and of being at
least 365 days in the preceding four previous years (i.e., P.Y. 2008-09,
2009-10, 2010-11 and 2011-12). Therefore, he is resident in India for previous
year 2012-13. Since he has gone outside India for the first time, he satisfies the
additional two conditions also for becoming ROR. Accordingly, he is ROR in
India for P.Y. 2012-13.
(b) Mr. X, a citizen of India goes abroad for employment on August 15, 2012 and
comes back on June 10, 2013. For the previous year 2012-13, X was in India
for 136 days (From April 1, 2012 to August 14, 2012). Since X was not in India
for atleast 182 days in P.Y. 2012-13, he is non-resident in India for P.Y.
2012-13. The second condition of 60 days in the relevant P.Y. And 365 days in
98
Notes
the preceding four previous years is not applicable to him since he is an Indian
citizen who has gone abroad for employment.
The following points are very important in determining the residential status of an
assessee:
(i) The residential status may change from year to year depending on whether the
condition for residency is satisfied in that year or not.
(ii) The residential status under the Income Tax Act, 1961 has no connection with
the provisions for residency under the Foreign Exchange Regulation Act or any
other law in India. A person may be resident under FERA and yet be
non-resident under the Income Tax Act and vice versa.
(iii) Residential status must not be confused with the nationality or citizenship of
the assessee. These are entirely different concepts.
Residential Status of a Hindu Undivided Family, Partnership Firms or Association
of Persons
A Hindu Undivided Family, partnership firm or an association of persons are said to
be resident in India in any previous year in every case except where, during the year, the
control and management of its affairs is situated wholly outside India. In other words, it
will be non-resident in India if no part of the control and management of its affairs is
situated in India.
When is HUF said to be a resident but not ordinarily so in India ? [Section 6(6) (b)] :
A HUF, which is resident in India is said to be resident but not ordinarily resident in
India during the relevant previous year, if the manager (Karta) of the HUF does not
satisfy any one or both, of the conditions mentioned in clause (a) and (b) above or in
other words, the Karta satisfies any of the following two conditions:
(1) He has been non-resident in India in 9 out of 10 previous years immediately
preceding the relevant previous year,
(2) He has been in India for a period of 729 days or less in 7 previous years
immediately preceding the relevant previous year.
Excepting individual and HUF, all other persons are classified as resident or
non-resident. They are not to be further classified as ordinarily resident or as not
ordinarily resident.
Residential Status of a Company
A company is said to be resident in India in any previous year if :
(i) It is an Indian company, or
(ii) During the relevant previous year, the control and management of its affairs is
situated wholly in India.
Residential Status of Every Other Person
Every other person is resident in India if the control and management of his affairs is
wholly or partly situated within India during the relevant previous year. On the other hand,
every other person is non-resident in India if the control and management of its affairs is
wholly situated outside India.
(a) As already mentioned, the coverage of income tax is highest in the case of
ROR and lowest in case of NR. While the residential status of an assessee will
determine the scope of his income liable to income tax, the status as a type of
99
person (i.e., individual, HUF, firm, company, AOP etc.) will determine the rate
of income tax applicable to the assessee.
(b) The following table indicates the tax incidence on income in different situations
depending on the residential status of the assessee.
Notes
Table 4.2 : Income Tax in Different Situations

Place of Income
Taxability under Income Tax in respect of

Resident and
ordinarily
resident
Resident but not

ordinarily resident
Non-resident
(NR)
(RONR)
(ROR)
Income received or deemed to be
received in India whether earned
in India or elsewhere.
Yes
Yes
Yes
Income accruing or arising in India

whether received in India or
elsewhere.
Yes
Yes
Yes
Income deemed to accrue or arise

in India whether received in India
or elsewhere.
Yes
Yes
Yes
Income received/accrued outside

India from a business controlled
from India.
Yes
Yes
No
Income which accrues or arises

outside India and received from
outside India from any other
source.
Yes
No
No
Income which accrues or arises

outside India and received outside
India during the years preceding
the previous year and remitted to
India during previous year.
No
No
No
Connotation of the receipt of income: Income received in India is taxable in all

cases irrespective of the residential status of an assessee. The following points are worth
mentioning:
Receipt vs. Remittance:
The receipt of income refers to the first occasion when the recipient gets the money
under his control. Once an amount is received as income, any remittance or transmission
of the amount to another place does not result the receipt at the other place.
Illustration: An assessee receives $ 10,000 in USA on May 16, 2013. Out of that
amount, he remits ` 50,000 to India on May 18, 2013. In this case, income is received
outside India on May 16, 2013.
Conclusion: An assessee after receiving income outside India cannot say that
money has again been received in India because of remittance. The position remains the
same if the income is received outside India by an agent of the assessee (may be a bank
or some other person) who later on remits the same to India. Income after the first receipt
merely involves movement as a remittance of money. The same income cannot be
received by the same person twice, once outside India and again within India.
100
Notes
Cash vs. Kind: It is not necessary that the income should be received in cash.
It may be received in cash or in kind. For instance, value of free residential
house provided to an employee is taxable, as salary in the hands of the
employee through the income is not received in cash.
Receipt vs. Accrual: Receipt is not the sale test of chargeability to tax. If an
income is not taxable on a receipt basis, it may be taxable on accrual basis.
Actual Receipt vs. Deemed Receipt: It is not necessary that the income
should be actually received in India in order to attract tax liability.
4.2.5 Income deemed to be received in India [Sec. 7]
This term refers to the income which is not actually received in the hands of the
assessee but is nevertheless his income and is to be treated as if it has been actually
received by him. The following incomes are deemed to have been received in India:
(a) Income tax deducted at source from the income received by the assessee.
(b) Annual accretions to the balance of an employee an assessee with a
recognised Provident Fund to the extent such accretions are taxable. Any
contribution by the employer in excess of 12% of the employees salary to the
PF and interest credited on the balance to the credit of the employee at a rate
exceeding a rate fixed by the Central government (at present is 9.5%).
(c) The transferred balance in a Recognised Provident Fund.
(d) Deemed Profit u/s 41 and 59.
(e) The contribution made by the Central Government to the account of the
employee under a pension scheme referred to in Sec. 80CCD.
(f) Undisclosed income/unexplained investments u/s 68, 69, 69a, 69B, 69C, 69D.
Connotation of accrual income How is it understood?
Income accrued in India is chargeable to tax in all cases, irrespective of the
residential status of an assessee. The words accrue and arise are used in contradiction
to the word receive. Income is said to be received when it reaches the assessee; when
the right to receive the income becomes vested in the assessee, it is said to accrue or
arise CIT v. Ashokbhai Chiman Bhai [1965] 56 ITR 42.
4.2.6 Section 8: Inclusion of Dividend as Defined u/s 2(22) in the Total Income of a
Person
Any interim dividend shall also be deemed to be income of the previous year, if such
dividend is unconditionally made available by the company during that previous year.
4.2.7 Section 9: Income Deemed to Accrue or Arise in India
Certain incomes are deemed to accrue or arise in India under Section 9 even
though they may actually accrue or arise outside India. This section applies to all the
assesses irrespective of their residential status, nationality, domicile, place of business,
relationship with persons in India. Thus, the scope of this section is to shift the place of
accrual of the income.
Implications of this section are of utmost importance to all non-resident tax payers
and persons who are not ordinarily residents in India, who in the absence of this provision
would exempt from tax in respect of their foreign income. The categories of income which
are deemed to accrue or arise in India are covered in the paragraphs that follow.
101
Section 9(1)(i):
Income from Business Connection: The Income Tax Act does not define the term
business connection. A business connection involves a relation between a business
carried on by a non-resident that yields profits and gains and some activity in India which
contributes directly or indirectly to the earning of those profits and gains. It implies an
intimate relation between trading activity carried on outside India and trading activity
within India and such relation is contributing to the earning of profit by non-residents. To
illustrate the term business connection, following are some instances:
Notes
1. Maintaining a branch office, factory, agency receivership or management for

the purchase and sale of goods or transacting any other business.
2. Appointing an agent in India for the systematic and regular purchase of raw
materials or other commodities or for sale of the non-residents goods for
business purposes or for securing orders in India.
3. Erecting a factory in India where the raw products purchased locally is worked
into a form suitable for export abroad.
4. Forming a local subsidiary company to sell the products of the non-resident
parent company.
5. Having financial association between a resident and non-resident company.
6. Granting a continuing license to a resident to exploit for profit an asset
belonging to a non-resident even if the transaction might be disguised as out
and out sale.
In B.P. Ray v. ITO, the Supreme Court held that the expression business
connection u/s 9(1)(i) would refer to Professional Connection also.
Exception to Section 9(1)(i):
In the case of a non-resident, no income shall be deemed to accrue/arise in India in
the following situations:
1. Where the business connection is confined only to the purchase of goods in
India for the purpose of exports. (This exception is made to encourage
exports).
2. Where the business connection is confined only to collection of news and
views in India for transmission out of India.
3. Where the business connection is confined to the shooting of any
cinematography firm in India. (This exception is also available to a firm and
company which does not have any partner/shareholder who is a citizen of India
or who is resident in India).
4. Where all operations of a business are not carried out in India, the extent of
income of the business relating to operations not carried out in India.
Section 9(1)(i):
Income from Property, Asset and Source of Income: The term property includes
both movable and immovable property and the term asset includes all intangible rights,
i.e., interests, dividend, patents, copyrights, royalty, rent etc. Income arising in a foreign
country from or through the property, assets and sources of income shall be deemed to
accrue or arise in India.
102
Notes
Section 9(1)(i):
Income from the transfer of any capital assets situated in India: Any capital
gain, within the meaning of Section 45, earned by a non-resident by transfer of any
capital asset situated in India is deemed to accrue or arise in India.
Section 9(1)(ii):
Income under the head salaries if it is earned in India: Income under the head
salaries if it is earned in India is deemed to accrue or arise in India if it is earned in India.
Salary or Pension is said to be earned in India if services are rendered in India and the
rest period or leave period which is preceded or succeeded by services rendered in India
and form part of the service contract of employment.
Exception: [Section 9(2)]: Pensions payable outside India by the government to
government officials and judges, who permanently reside outside India, shall not be
deemed to accrue or arise in India.
Section 9(1)(iii):
Salary paid by the government outside India to an Indian citizen for the services
rendered outside India would be deemed to accrue or arise in India. It is important to note
that this provision is not applicable to a salary paid by the government to the citizen of
other countries.
Section 9(1) (iv):
Dividend paid by an Indian company outside India is deemed to accrue or arise in
India.
Section 9(1)(v):
Income by way of interest is deemed to accrue or arise in India if it is payable by:
1. The Government, whether Central or State.
2. A person who is resident in India. (However, if interest relates to a debt used
for a business or profession carried outside India or for the purpose of earning
any income from any source outside India, the interest so paid shall not be
deemed to accrue in India), or
3. A person who is non-resident, only if interest rates to debt used for a business/
profession carried on by such person in India.
Section 9(1)(vi):
Income by way of royalty is deemed to accrue or arise in India if it is payable by:
1. The Government whether Central or State
2. A person who is resident in India except where the royalty is payable in respect
of its right/property utilised for the business or profession carried outside India
or for the purpose of earning any income outside India or
3. A non-resident, if royalty is in respect of any right/property utilised for the
business/ profession carried in India or any other source of his income in India.
Exceptions to the above provisions are mentioned below:
1. Royalty received shall not be deemed to accrue/arise in India if following
conditions are fulfilled:
(a) Royalty is received in lump sum,
(b) Royalty is received by a non-resident from a resident,
103
(c)
Royalty is received for transfer of any/all right(s) of computer software

along with computer hardware under any scheme approved under the
Policy on Computer Software Export, Software Development and Training,
1986 of the Government of India.
2. If Royalty is payable under an approved agreement made before April 1, 1976.
Lump sum payment outside India in respect of any data, documentation,
drawing or specification to a patent etc. shall not be income deemed to accrue
or rise in India, if such income is payable pursuance of an agreement made
before April 1, 1976 and the agreement is approved by the Central
Government. In this connection, Explanation 1 specifies the following
conditions where under even an agreement made on or after April 1, 1976 shall
deemed to have been made before that date :
(i) In the case of taxpayer other than a foreign company, if the agreement is
made in accordance with proposals approved by the Central Government
before that date.
(ii) In the case of a foreign company, if the condition referred to in (i) above is
satisfied and the foreign company exercises an option by furnishing a
declaration in writing to the Income Tax Officer that the agreement may be
regarded as having been made before the April 1, 1976. The option in this
behalf will have to be exercised before the expiry of the time allowed
under Section 139(1).
Notes
Section 9(1)(vii):
Income by way of fees for Technical Services: This is deemed to accrue or arise
in India and it is payable by:
1. A Government or
2. A resident person except where the fees are payable in respect of services
utilised in a business or profession carried outside India or for the purpose of
earning income outside India or
3. A non-resident, if fees are in respect of services utilised in a business or
profession carried on in India or any other source of his income in India.
Exception: Explanation with effect from 1/6/1976 occurring after subsection (2)
namely
For the removal of doubts, it is hereby declared that for the purposes of this section,
income of a non-resident shall be deemed to accrue or arise in India under clause (v) or
clause (vi) or clause (vii) of subsection (1) and shall be included in the total income of the
non-resident, whether or not
(i) the non-resident has a residence or place of business or business connection
in India; or
(ii) the non-resident has rendered services in India.
4.2.8 Other Points
Income accruing, organising outside India will not be deemed to be received in India,
merely because it has been included in the balance sheet in India. Once income included
on accrual basis cannot be included against a receipt basis on the same or subsequent
years.
104
Notes
Exception to the Rule that Income of P.Y. is assessed to Tax in A.Y. :

Exceptions to the general rule that tax is chargeable only on the income of the
previous year the Assessment Years are contained in sections 172, 174, 175, 176. The
object of these exceptions is to see that interest of revenue is not jeopardized. In all these
four exceptions, there will be assessments the normal assessment and the summary
assessment. The exceptions are explained below.
Section 172: Shipping Business of a Non-resident: This section taxes the
income of ships belonging to non-residents which occasionally call at Indian ports and for
which there is no account in India from whom tax can be recovered. The rate of tax is
1
7 % of the net income of the accruing in India for that particular voyage. The tax is
2
enforced by providing that the ships shall be permitted to sail only on payment of tax at
that rate on the amount paid or payable to the owner on account of carriage of goods
since its arrival at an Indian port.
Section 174: Person leaving India: When any individual who has no intention to
return is about to immigrate from India, the Assessing Officer may initiate summary
proceedings for assessing such a person and compute his total income for the period
commencing from the end of the previous year up to the probable date of his departure.
He can also levy and collect the tax before he leaves India in addition to normal
assessment for the previous year.
Section 174A: Assessment of an Association of Persons or a Body of
Individuals or Artificial Juridical Person formed for a Particular Event or Purpose:
Where it appears to the Assessing Officer that any association of persons or a body of
individuals or an artificial juridical person formed or established or incorporated for a
particular event or purpose is likely to be dissolved in the assessment year in which such
association of persons or body of individuals or artificial juridical person, for the period
from the expiry of the previous year for that assessment year up to the date of its
dissolution, shall be chargeable to tax in that assessment year.
Section 175: Persons Likely to Transfer Property to Avoid Tax: When the
Assessing Officer feels that a person is likely to sell or transfer or otherwise part with any
of his assets in order to avoid paying any tax liability, the officer may start emergency
proceedings to compute his total income from the end of the previous year up to the date
of commencement of the proceedings. He can also determine the tax thereon and
recover the same even before the previous year ends.
Section 176: Discontinued Business: This last exception provides for a situation
where a business or profession is discontinued in any financial year. In such cases, the
income for the period commencing from the end of the previous year up to the date of
discontinuance will be calculated and the tax levied during the course of the year of
discontinuance itself. The question may arise as to how the tax authorities know when a
particular business is being discontinued. The same section also imposes on the
assessees an obligation to notify the Assessing Officer that a particular business is being
discontinued.
In all these four exceptional situations, there will be two assessments; the normal
assessment and the summary assessment. In both these assessments, the rate of tax
applied would be that applicable for the relevant Assessment Year. The exceptions are
only to see that the interests of the revenue are not jeopardized in the circumstances
envisaged in these sections just because the normal provision is to tax the income of the
previous year in the Assessment Year.
105
Problems on Incidence of Tax:
Notes
1. For the assessment year 2013-14 (previous year 2012-13), X is employed in India
and receives ` 24,000 as salary (net of standard deduction). His income from other
sources includes:
Dividend received in London on June 3, 2012: ` 31,000 from a foreign company;
share of profit received in London on Dec. 15, 2012 from a business situated in Sri Lanka
but controlled from India; ` 60,000 remittance from London on Jan. 15, 2013 out of part
untaxed profit of 2009-10 earned and received there ` 30,000 and interest earned and
received in India in May 11, 2013 ` 76,000.
Find out his Gross Total Income, if he is (a) resident and ordinarily resident (b) resident
but not ordinarily resident and (c) non-resident for the Assessment Year 2013-2014.
Solution:
If X is resident and ordinarily resident :
Gross total income will be ` 115,000 (i.e., ` 24,000 + 31,000 + 60,000)
If X is resident and not ordinarily resident :
Gross total income will be ` 84,000 (i.e., 24,000 + 60,000)
If X is a non-resident
His gross total income will be ` 24,000.
Important Points:
1. Remittance from London of ` 30,000 is not taxable in the previous year
2012-13 because it does not amount to the receipt of income.
2. Although interest of ` 76,000 earned and received in India is taxable but not
included in total income of the Assessment Year 2013-14 as it is not earned
and received in the previous year 2012-13. It will be included in the total
income of X for the Assessment Year 2014-15 (previous year 2013-14).
2. X furnishes the following particulars of his income earned during the previous
year relevant to the assessment year 2013-14.
No.
Particulars
Amount
(`)
Interest on German Development Bonds (2/5th received in India)
60,000.00
Income from agriculture in Bangladesh received there but later on ` 50,000 is

remitted to India (agricultural activity is controlled from Bangladesh)
1,81,000.00
Income from property in Canada received outside India (` 76,000 is used

in Canada for meeting educational exp. of Xs daughter in USA and
` 10,000 is later on remitted to India)
86,000.00
Income earned from business in Kampala (Uganda) which is controlled

from Delhi (` 15,000 is received in India)
65,000.00
Dividend paid by a foreign company but received in India on 10.4.2012
46,500.00
Past untaxed profit of 2003-04 brought to India in 2012-13
Profits from business in Chennai and managed from outside India
Profit on sale of a building in India but received in Sri Lanka
Pension from a former employer in India received in Rangoon (net of

standard deduction)
36,000.00
10
Gift in foreign currency from a relative received in India on 20-1-2013
80,000.00
10,43,000.00
27,000.00
14,50,000.00
106
2. Find out the gross total income of X if he is:
Notes
(i) Resident and ordinarily resident in India

(ii) Resident but not ordinarily resident in India
(iii) Non-resident for the AY 2013-14.
Solution:
Interest
on
German
Resident and
Resident but
ordinarily
Not ordinarily
Non-resident
resident
resident
Remark
Development
Bonds
2/5th taxable on receipt basis
24,000.00
24,000.00
24,000.00
See Note 1
3/5th taxable on accrual basis
36,000.00
See Note 2
1,81,000.00
See Note 3
86,000.00
See Note 2
Taxable on receipt basis
15,000.00
15,000.00
15,000.00
See Note 1
Balance non-taxable in case of
50,000.00
50,000.00
See Note 4
46,500.00
46,500.00
46,500.00
See Note 1
See Note 5
27,000.00
27,000.00
27,000.00
See Note 6
14,80,000.00
14,80,000.00
14,80,000.00
See Note 7
36,000.00
36,000.00
36,000.00
See Note 8
80,0000.00
80,000.00
80,000.00
See Note 9
Income
from
agriculture
in
Bangladesh income accrued and

received in India
Income
received
from
property
outside
in
Canada
income
India
accruing and arising outside India

Income accruing or arising outside
India
non-resident
Dividend paid by a foreign company
Income received in India

Past untaxed profit brought to India
Not an income of the previous year

2012-13 relevant for the AY 2013-14,
hence not taxable
Profits from a business in Chennai and
managed from outside India
Income accrued in India

Profit on sale of a building in India but
received in Sri Lanka
Income deemed to accrue or arise in

India
Pension
from
an
Indian
former
employer received in Rangoon
Income deemed to accrue or arise in

India
Gift from a relative it is taken as an
income
107
Important Points:
1. It is Indian income. It is always taxable.
2. It is received as well as accrued outside India. It is not business income or
income from profession. It is taxable only in the case of resident and ordinarily
resident.
3. It is received outside India (remittance of ` 50,000 to India is not receipt of
income in India). It is therefore taxable in India only in the case of a resident
and ordinarily resident taxpayer.
4. It is accrued outside India. It is received outside. It is foreign income. It is not
taxable in the case of a non-resident. Since it is business income and business
is controlled from India, it is taxable in the hands of a resident but not ordinarily
resident taxpayer.
5. It is an income of the previous year 2003-04 and cannot be taxed at the time of
remittance 2012-13.
6. As the income is accrued in India, it is an Indian income and taxable in all
cases.
7. As the building is situated in India, income is deemed to accrue in India.
Consequently it is an Indian income and chargeable to tax in all cases.
8. Service was rendered in India. Pension income is deemed to accrue in India. It
is Indian income and chargeable to tax in all cases.
9. If the aggregate amount of gifts received by an individual/HUF from all persons
(not being relatives) during a financial year exceeds ` 50,000 it is taxable as
income.
Notes
3. A has the following income during financial year 2012-13. Compute his taxable
income if he is (i) ROR (ii) RNOR (iii) NR for that year.
(a) Interest from Bank Deposit in UK (1/3 received in India) ` 6,000.
(b) Rent from property in UK received in India ` 12,000.
(c) Pension from a former Indian employer received in UK ` 50,000.
(d) Income earned from a business set up in UK and controlled from UK
` 25,000.
(e) Income earned from a business set up in UK and controlled from India
` 50,000.
Solution:
Particulars of income
Interest from bank deposit in UK
Particulars of income
Resident and
ordinarily resident
6000
Resident and
ordinarily resident
Resident and not

ordinarily resident
2000
Resident and not
ordinarily resident
Non-resident
2000
Non-resident
Rent from property in UK
12000
Pension from Indian Employer
50000
50000
50000
Income from business in UK and

controlled from UK
25000
Income from business in UK but

controlled from India
50000
50000
143000
102000
52000
Total Income
108
Notes
Scope and Orbit of Business Connection in the Case of a Non-resident:

In the case of income deemed to accrue or arise in India, the scope and ambit of
business connection of a non-resident can be explained with the help of following
illustrative instances.
(a) Maintaining a branch office in India for the purchase or sale of goods or
transacting other business.
(b) Appointing an agent in India for the systematic and regular purchase of raw
materials or other commodities or for sale of the non-residents goods or for
other business purposes.
(c) Erecting a factory in India, where the raw produce purchased locally is worked
(d) Forming a local subsidiary company to sell the products of the non-resident
parent company.
(e) Having financial association between a resident and a non-resident company.
Following clarifications regarding applicability of provisions of Section 9 are
made in respect of certain specified situations:
Non-resident exporters selling goods from abroad to an Indian importer: No
liability will arise on accrual basis to the non-resident on the profits made by him where
the transactions of sale between the two parties are on a principal-to-principal basis. If
the non-resident makes over the shipping documents to a bank in his own country which
discounts the documents and sends them for collection to the bankers in India, who
present the sight or issuance draft to the resident importer and deliver the documents to
him against payment or acceptance by the latter, the non-resident will not be liable to tax
on the profit arising out of the sales on receipt basis.
Non-resident company selling goods from abroad to its Indian subsidiary: In
such a case, if the transactions are actually on a principal-to-principal basis and are at an
arms length and the subsidiary company functions and carries business on its own,
instead of functioning as an agent of the parent company, the mere fact that the Indian
company is a subsidiary of the non-resident company will not be considered a valid
ground for invoking Section 9 for assessing the non-resident. Where a non-resident
parent company sells goods to its Indian subsidiary, the income from the transaction will
not be deemed to accrue or arise in India under Section 9, provided that (a) the contracts
to sell are made outside India, (b) the sales are made on a principal-to-principal basis
and at arms length, and (c) the subsidiary does not act as an agent of the parent
company.
Sale of plant and machinery to an Indian importer on instalment basis:
Where the transaction of sale and purchase is on a principal-to-principal basis and the
exporter and the importer have no other business connection, the fact that the exporter
allows the importer to pay for the plant and machinery instalments will not, by itself,
render the exporter liable to tax on the ground that the income is deemed to arise to him
in India.
Foreign Agents of Indian Exporters: Where a foreign agent of an Indian
exporter operates in his own country and his commission is usually remitted directly to
him and is, therefore, not received by him or on his behalf in India. Such an agent is not
liable to income tax in India on the commission.
Non-resident person purchasing goods in India: A non-resident will not be
liable to tax in India on any income attributable to operations confined to the purchase of
goods in India for export, even though the non-resident has an office or an agency in
India for this purpose.
109
Sales by a non-resident to Indian customers either directly or through

agents: Where a non-resident allows an Indian customer the facilities of extended credit
for payment, there would be no assessment merely for this reason provided that: (i) the
contracts to sell were made outside India; and (ii) the sales were made on a
principal-to-principal basis. Where a non-resident has an agent in India and makes sales
directly to Indian customers, Section 9 of the Act will not be invoked, even if the resident
pays his agent an overriding commission on all sales to India, provided that (i) the agent
neither performs nor undertakes to perform any service directly or indirectly in respect of
these direct sales; (ii) the contracts to sell are made outside India; and (iii) the sales are
made on a principal-to-principal basis. Where a non-residents sales to Indian customers
are secured through the services of an agent in India, the assessment in India of the
income arising out of the transaction will be limited to the amount of profit which is
attributable to the agents services, provided that (i) the non-resident principals business
activities in India are wholly channelled through his agent, (ii) the contracts to sell are
made outside India, and (iii) the sales are made on a principal-to-principal basis. Where a
non-resident principals business activities in India are not wholly channelled through his
agent in India, the assessment in India will be on the sum total of the amount of profit
attributable to his agents activities in India and the amount of profit attributable to his own
activities in India, less the expenses incurred in making the sales.
Notes
Extent of the profit assessable under Section 9: If a non-resident has a

business connection in India, it is only that portion of the profit which can reasonably be
attributed to the operations of the business carried out in India, which is liable to Income
Tax Circular No. 23 [F. No. 7A/38/69-IT(A-II)], dated 23.07.1969.
Agency engaged in activity of purchase of goods for export: The mere
existence of an agency established by a non-resident in India will not be sufficient to
make the non-resident liable to tax, if the sole function of the agency is to purchase
goods for export Circular No. 163 [F. No. 488/23/73-FTD], dated 29.5.1975.
Foreign company engaged in re-insurance with Indian companies:
Regarding taxability of a foreign company on its profits of re-insurance with companies in
India no uniform principle could be laid down which will be applicable in all cases. The
ITO will have to be examined each case in the light of its facts and decide, where tax
liability is attracted and what portion of the income from the re-insurance should be
assessed Circular No. 35(XXXIII 7) of 1956 [F. No. 51(5)-IT 54], dated 3.9.1956.
Pensions received in India from abroad: Pensions received in India from
abroad by pensioners residing in this country, for past services rendered in the foreign
countries, will be income accruing to the pensioners abroad and will not, therefore be
liable to tax in India on the basis of accrual. These pensions will also not be liable to tax in
India on receipt basis, if they are drawn and received abroad in the first instance and
thereafter remitted or brought to India. While the pension earned and received abroad will
not be chargeable to tax in India if the residential status of the pensioner is either
non-resident or resident but not ordinarily resident, it will be so chargeable if the
residential status is resident and ordinarily resident Circular No. 4 [F. No. 73A/2/69-IT
(A-II)], dated 20.02.1969.
Shares allotted to non-residents in consideration for machinery and plant:
Where shares in Indian companies are allotted to non-residents in consideration for
machinery and plant, the income embedded in the payments would be received in India
as the shares in the Indian companies are located in India and would accordingly attract
liability to income tax as income received in India Circular No. 382 [F. No.
484/12/78-FTD], dated 4.5.1984.
110
Notes
4.3 Exempted Incomes of Companies

4.3.1 Income of Foreign Companies Providing Technical Services in Projects
Connected with the Security of India [Section 10(6c)]
Any income arising to a notified foreign company by way of fees for technical
services rendered in pursuance of an agreement entered into with the government for
providing service in or outside India in projects connected with the security of India, shall
be exempt from tax.
4.3.2 Section 10AA: Special Provisions in Respect of Newly Established Units in
Special Economic Zones
Subject to the provisions of this section, a deduction of such profits and gains
derived by an assessee being an entrepreneur from the export of articles or things or
providing any service, as the case may be, from his unit shall be allowed from the total
income of the assessee.
Notes:
1. The deduction under this section is available for the unit and not the assessee.
2. Meaning of Entrepreneur: Entrepreneur means a person who has been
granted a letter of approval by the development commission under section 15(9)
[Section 2(j) of the Special Economic Zone Act, 2005].
Essential conditions to claim deduction: The deduction shall apply to an undertaking
which fulfills the following condition:
1. It has begun or begins to manufacture or produce articles during the previous
year, relevant to the assessment year commencing on or after 1-4-2006 in any
Special Economic Zone.
2. It should not be formed by the splitting up or reconstruction of a business
already in existence.
3. It should not be formed by the transfer of machinery or plant, previously used
for any purpose, to a new business.
4. The exemption shall not be admissible unless the assessee furnishes in the
prescribed form [Form No. 56F] along with the return of income, the report of
the chartered accountant certifying that the deduction has been correctly
claimed as per provisions of this section.
Notes:
1. Manufacture means to make produce, fabricate, assemble, process or bring into
existence, by hand or by machine, a new product having a distinctive name, character or
use and shall include processes such as refrigeration, cutting, polishing, blending, repair,
remaking, re-engineering and includes agriculture, aquaculture, animal husbandry,
floriculture, horticulture, pisciculture, poultry, sericulture, aviculture and mining [Section
2(f) of the Special Economic Zone [Section 2(za) of the Special Economic Zones Act,
2005].
Period for Which Deduction is Available
The deduction under this section shall be allowed as under for a total period of
15 relevant assessment years.
111
For the first 5 consecutive assessment years

beginning with the assessment year relevant
to the previous year in which the unit begins
to manufacture such articles or things or
provide services.
100% of the profits and gains derived from

the export of such articles or things or from
services.
Next 5 consecutive assessment years.
50% of such profits or gains.
Next 5 consecutive assessment years.
So much of the amount not exceeding 50%

of the profits as is debited to profit and loss
account of the previous year in respect of
which the deduction is to be allowed and
credited to Special Economic Zone.
Reinvestment Reserve Account to be
created and utilised for the purpose of the
business of the assessee in the manner laid
down in subsection (2) below.
Notes
Conditions to be Satisfied for Claiming Deduction for Further 5 Years (After 10 Years)
[Section 10AA(2)]
1. The amount credited to the Special Economic Zone Reinvestment Reserve
Account is to be utilised
(i) For the purpose of acquiring machinery or plant which is first put to use
before the expiry of a period of 3 years following the previous year in
which the reserve is created; and
(ii) Until the acquisition of this machinery or plant as aforesaid, for the
purposes of the business of the undertaking other than for distribution by
way of dividends or profits or for remittance outside India as profits or for
creation of any asset outside India.
2. The particulars as may be prescribed in this behalf, should be furnished in
Form 56FF, by the assess in respect of machinery or plant along with the
return of income for the assessment year relevant to the previous year in which
such plant or machinery was first put to use.
Consequences of Misutilisation/Non-utilisation of Reserve [Section 10AA(3)]
Where any amount credited to the Special Economic Zone Re-investment Reserve
Account:
(a) has been utilised for any purpose other than the purchase of machinery or
plant as mentioned above, the amount so utilised shall be deemed to be the
profits of the year in which it was so utilised and shall be charged to tax; or
(b) has not been utilised before the expiry of the aforesaid period of 3 years, the
amount no so utilised shall be deemed to be the profits of the year immediately
following the period of said 3 years and charged to tax.
How to compute profit and gains from exports of such undertakings [Section
10AA(7)]: If the aforesaid conditions are satisfied, the deduction u/s 10AA may be
computed as under:
Profits from business of the undertaking being the unit
Export turn over of the undertaking of such articles / thigs or services
Total turnover of the busines carried by the assessee
112
Notes
For this purpose, export turnover means the consideration in respect of export by
the undertaking of articles or things or services received in, or brought into India by the
assessee but does not include freight, telecommunication charges, or insurance
attributable to the delivery of the article or things outside India, or expenses, if any,
incurred in foreign exchange in rendering of services (including computer software)
outside India.
The profits and gains derived from on-site development of computer software
(including services for development of software) outside India shall be deemed to be the
profits and gains derived from the export of computer software outside India.
Ban on Enjoyment of Other Tax Benefits
The following allowances or expenditure shall be deemed to have been allowed and
absorbed during the course of the relevant assessment years ending before 1-4-2006:
(i) Depreciation allowance under section 32
(ii) Expenditure on scientific research under section 35; and
(iii) Expenditure relating to family planning under section 36(1)(ix)
The aforesaid expenditure/allowance even if unabsorbed during the assessment
years ending before 1-4-2006, shall be deemed to have been fully claimed and allowed.
However, unabsorbed depreciation, unabsorbed expenditure on scientific research and
capital expenditure on family planning pertaining to assessment year 2006-07 or any
subsequent assessment years shall be allowed to be carried forward and set off.
No portion of the losses pertaining to business under section 72(1) or capital gains
under section 74(1) or section 74(3) with respect to any assessment year ending before
1-4-2006 forming part of the tax holiday period, to the extent pertaining to the undertaking,
being the unit shall be claimed in any assessment year subsequent to the last of the
assessment year forming part of the tax holiday. However, losses referred to in Section
72(1) or Section 74(1) and (3) in so far as such losses relate to the business of the
undertaking being the unit, pertaining to the assessment year 2006-07 or any
subsequent assessment year shall be allowed to be carried forward and set off.
WDV after Tax Holiday Period
It shall be presumed that during the tax holiday period under section 10AA, the
assessee had claimed and had been allowed depreciation allowance, and hence the
written down value of the depreciable assets shall be computed accordingly, after the
conclusion of the tax holiday period.
4.3.3 Income from Property Held for Charitable Purposes
The following sections of the Income Tax Act deal with the subject of exception of
income from property held for charitable or religious purposes:
Section 11: Exemption of income from property held in trust or other legal obligation
for religious or charitable purposes.
Section 12: Exemption of income derived by such a trust from voluntary
contributions made with a specific direction that they shall form of the corpus of the trust
or institution.
Section 12 A: Prescribes the conditions for registration of a trust.
Section 12 AA: Prescribes the procedure for registration.
Section 13: Enumerates the circumstances under which exemption available under
Sections 11 and 12 will be denied.
113
Table 4.3 : Exempt Income in Case of a Charitable or Religious Trust

No.
Nature of income
Notes
To what extent
Conditions
Relevant
Remarks, if
exempt from
applicable
provisions
any
Section 11(i)(a)
Accumulation
allowed
A
Income derived from
To the extent such
Accumulation allowed
property held under trust
income is applied in
up to 15% of such
treated as
wholly for charitable or
India for such
income
applied for
religious purposes
purposes
such
purposes
Accumulation in
Section 11(2)
- do -
- do -
excess of 15% allowed

subject to certain
conditions being
satisfied
B
Income derived from
To the extent such
(i) Do
Section
income is applied in
(ii) Trust should have
11(1)(b)
which is applied in part only
India for such
been created before
for charitable or religious
purposes
1.4.62
purposes
C
Income derived from

Created on or after 1.4.52
To the extent such
The purpose of the
Section
Accumulation
for charitable purposes
income is applied to
trust is to promote
11(1)(c)(1)
not exempt
outside India (Religious
such purposes
international welfare in
trusts not covered)
outside India
which India is
interested. Further
general or special
order of Board for
exemption is
necessary. No
accumulation allowed
Ii
Created before 1.4.1952 for
To the extent such
No condition
Section
Accumulation
charitable or religious
income is applied
applicable but general
11(1)(c)(ii)
not exempt.
purpose to be used for such
outside India for such
or special order of the
purposes outside India
purposes
Board for exemption is

necessary
Income in the form of
100% exempt with
There should be
voluntary contribution
no condition of
specific direction that
forming part of corpus
application or
such contribution to
accumulation
form part of corpus of
Section 11(i)(a)
the trust or institution

E
Capital gain arising from
(i) The whole of the
(i) If the net
Section
transfer of a capital asset,
capital gain
consideration is
11(IA)(a)
held under trust wholly for
utilised for purchasing
new capital asset
purposes
(ii) To the extent of
If a part of the net
capital gain as is
consideration is
equal to the amount
utilised for requiring
if any, by which the
capital asset
114

amount so utilised
Notes
exceeds the cost of

the transferred asset
F
Capital gain arising from
(i) the whole of the
(i)
transfer of a capital asset
appropriate fraction
consideration is
held under trust, partly used
of such capital gain
utilised for providing
for charitable or religious
(to the extent such
new capital asset
purpose
asset was used for
If the net
Section
11(IA)(b)
purpose)
(ii) So much of the
(ii)
appropriate function
net consideration is
of the capital gain as
utilised for acquiring.
If a part of the
is equal to the
amount if any by
which the
appropriate fraction
of the amount used
for acquiring new
asset exceeds the
extent of cost of
transferred asset
4.4 Profit and Gains from Business or Profession

4.4.1 Introduction and Incomes Chargeable under this Head as per the Provisions
of Section 28
1. Income from business or profession is taxed under this head of income.
2. Business includes any trade, commerce, manufacturing unit or any adventure
or concern in the nature of trade, commerce or manufacture Section 2(13). The
word business normally connotes some real, substantial and systematic or
organised course of activity or conduct with a set purpose. In taxing statutes, it
is used in the sense of an occupation or profession, which occupies the time,
attention and labour of a person, normally with the object of making profit. To
regard an activity as business, there must be a course of dealings, either
actually continued or contemplated to be continued with a profit motive and not
for sport or pleasure. A single transaction also can constitute a business,
depending upon the circumstances of the case. Whether a person carries on
business in a particular commodity normally depends upon the volume,
frequency, continuity and regularity of transactions of purchase and sale in a
class of goods and the transaction must ordinarily be entered into with a profit
motive. Business is an activity capable of producing a profit which can be taxed.
The expression business in ordinary parlance means any trading activity
accompanied by regularity of transactions intended for the purpose of making
profit. Generally speaking, business is an activity of a commercial nature and
means practically anything which is an occupation as distinguished from a
pleasure. If the transaction is a trading transaction or an adventure in the
nature of trade, it will amount to business, no matter whether it results in loss or
profit. It also includes adventure in the nature of trade.
115
3. Under this head, any income from the exercise of any profession is also taxed.
A profession as a specialised nature of business normally refers to those
activities which particularly involve greater degree of personal skill, such as
occupations in the field of law, medicine or engineering, accountancy,
management etc., which require considerable training and specialised study of
the subject for exercising that occupation. According to Section 2(36),
profession includes vocation.
4. Income from an illegal business such as smuggling is also taxable under the
Income Tax Act, i.e., taxability of income has no connection to whether the
income is legal or illegal. In CIT v. Piara Singh, the Supreme Court has held
where income from an illegal business is assessed to tax as such, the loss
arising directly in the course of business is deductible as business expenditure.
5. More particularly following are the incomes, which are chargeable under this
head, as per provisions of Section 28.
(a) Profits or gains from any business or profession carried on by the
assessee at any time during the previous year.
(b) Income derived from sale of an import license or any export incentive
received, such as cash compensatory support or drawback of duty or any
other export incentive.
Compensation or other payment due to or received by any person holding
an agency in India for any part of the activities relating to the business of
any person at or in connection with the termination or modifications of
terms and conditions compensation or other payment due to be received
by any person from or in connection with the resting of the Government or
in any corporation owned or controlled by the Government under any law
of the management of the presents or any business, any sum, whether
received or receivable in cash or in kind for not carrying out any activity in
relation to any business or not showing any know-how, patent, copyright,
trademark, license, franchise or any other business or commercial rights
etc., likely to assist in the manufacture or processing of goods or provision
for services. Exception if received on account of transfer of right to
manufacture etc. will be chargeable under the head of capital gains.
(c) Income derived by any trade association or professional association or
any other similar association from specific services rendered to its
members. For example, income earned by the Chambers of Industries
from conference organised by them.
(d) Export incentives which include profit on sale of import licenses, duty
drawbacks of customs and central excise duties, cash assistance, any
profit on the transfer of the Duty Entitlement Pass Book Scheme and profit
on the transfer of the Duty Free Replenishment Certificate.
(e) Any income from speculative transactions like buying and selling of shares
without giving or taking actual physical delivery.
(f) The value of any benefit or perquisite, whether convertible into money or
not, arising from the business or from the profession such as gifts
received in the course of business.
(g) Any interest, salary, bonus, commission or remuneration received by a
partner of a partnership firm from the partnership firm.
(h) Any sum received under Keyman Life Insurance Policy including bonus on
such policy, if such sum is not to be taxed as salary income.
Notes
116
Notes
(i)
Any amount received by a person who is in charge of the management of

an affair of an Indian Company or any other company for agreeing to the
termination or modification or relinquishment of his management powers
or authority.
(j) Any sum, whether received or receivable, in cash or kind on account of
any capital asset (other than land or goodwill or financial instrument)
being demolished, destroyed, discarded or transferred, if the whole of the
expenditure on such capital asset has been allowed as a deduction under
section 35AD.
(k) Any sum, whether received or receivable, in cash or kind under an
agreement for not carrying out activity in relation to any business or not
sharing any know-how, patent, copyright, trade mark, license, franchise or
any other business or commercial right of similar nature or information or
technique likely to assist in the manufacture or processing of goods or
provision of services.
(l) Profits and gains of managing agency; and
(m) Income form speculative transaction.
6. Apart from the above-mentioned incomes, any income which is in the nature of
business income or professional income will be chargeable to tax under this
head. Interest income is either assessed as Business Income or as Income
from other sources depending upon the activities carried on by the assessee.
If the investment yielding interest were part of the business of the assessee,
the same would be assessable as Business Income, but where the earning of
the interest income is incidental to and not the direct outcome of the business
carried on by the assessee, the same is assessable as Income from other
sources. Business implies some real, substantial and systematic or organised
course of activity with a profit motive. Interest generated from such an activity is
considered as Business Income. Otherwise, it would be interest from other
sources.
7. For charging the income under the head Profits and Gains of Business, the
following conditions should be satisfied:
(a) There should be a business or profession.
(b) The business or profession should be carried on by the assessee.
(c)The business or profession should have been carried on by the
assessee at any time during the previous year.
(d) The charge is in respect of the profits and gains of the previous year
of the business or profession.
(e) The charge extends to any business or profession carried on.
Exceptions to the Business to be Carried on During the Previous Year
Certain receipts are taxable as Income from business though no business is
carried on by the assessee in the year of receipt
(i) Recovery against any loss, expenditure or trading liability earlier allowed as a
deduction [Section 41(1)].
(ii) Balancing charge in case of electricity companies [Section 41(2)].
(iii) Sale of capital asset used for scientific research [Section 41(3)].
(iv) Recovery against bad debts. [Section 41(4)]
(v) Annual amount withdrawn from Special Reserve [Section 41(4A)].
117
(vi) Receipt of discontinued business under cash system of accounting [Section

176(3A)(4)].
(vii) Sum received for restrictive covenant [Section 28(va)].
Notes
4.4.2 Computation of Income under the head [Section 29]

Section 29 lays down that the income referred to in Section 28 shall be computed in
accordance with the provisions contained in Section 30 to Section 43D. It may be added
that the provisions of Sections 44 to 44D are also to be taken into account in this context
as they make certain special provisions regarding the computation of profits and
deductions of expenditure in certain cases.
It is important to note that specific allowances and deductions stated in these
sections are not exhaustive. Besides these deductions, other deductions are also
available on the general commercial framework while computing Profits and Gains of
Business/Profession. Following general commercial principles, losses of a capital nature
which are incidental to the trade and arise expectedly in the regular course of business
would be deductible, even though there may not be a specific provision in the act for such
deductions. Examples of such losses are embezzlement of cash, theft of cash, robbery,
destruction of assets, loss of stock in transit by fire or ravages of white ants or by enemy
action during war etc.
Further profits chargeable under the head Profits and Gains of Business/
Profession should be computed in accordance with the method of accounting regularly
employed by the assessee accrual basis or receipt basis or a mixture of the two.
1. The profit of a trade or business is the surplus by which the receipts from the
trade or business exceed the expenditure necessary for the purpose of earning
those receipts. The tax is upon income, profits or gains; it is not a tax on the
gross receipts. From the charging provisions of the act, it is discernible that the
words income or profits and gains should be understood as including losses
also, so that, in one sense profits and gains represent plus income, whereas
losses represent minus income. In other words, loss is negative profit. Both
positive and negative profits are of a revenue character. Both must enter into
computation, wherever it becomes material, in the same mode of the taxable
2. The general rule of determining taxable business or professional income is that,
from the gross income or gross receipts or gross sales, expenses incurred for
earning that income will be allowed as a deduction. The balance of profit
remaining after claiming all the allowable expenses as a deduction will be the
taxable income from the business.
3. Expenses will be allowed as a deduction from gross receipts only if they have
been incurred in the relevant previous year. Expenses incurred before setting
of the business will not be allowed except where specifically provided by law.
4. Typical steps for computation of income under this head can be listed as
below :
(a) Find out Profit as per the P & L A/c.
(b) Deduct those expenses, which are not claimed but are allowable as
deductions under Sections 30 to 37.
(c) Add those expenses that have been debited to the Profit & Loss A/c but
are not allowable as deduction u/s 40, 40A and 43B.
(d) Deduct those incomes which have been credited to the Profit & Loss A/c
but which are not chargeable to income tax.
118
Notes
(e) Add those incomes which have not been credited to the Profit & Loss A/c
but which are taxable as business income under Section 28 described
above.
5. As stated above, Sections 30 to Section 37 deal with the various expenses
which will be allowed as a deduction in getting the amount of taxable business
or professional income. These are explained in the paragraphs as follows.
Method of Accounting [Section 145]
The profits from business and profession and income under the head Income from
other sources are to be computed in accordance with the method of accounting regularly
employed by the assessee. There are three methods of accounting, i.e., (i) mercantile
system; (ii) cash system and (iii) mixed or hybrid system. However, as per Section 145 of
the Income Tax Act, only one of the two methods of accounting can be followed:
(a) Mercantile system
(b) Cash system.
If the assessee is carrying on more than one business, he can follow the cash
system of accounting for one business and mercantile system of accounting for another
business. Similarly, if he has more than one source of income under the head from other
sources, he can follow cash system of accounting for one source and mercantile system
of accounting for other sources.
Further, the profits from business and profession will have to be computed in
accordance with the accounting standards which may be prescribed by the Central
Government from time to time. The Central Government has since notified the following
two accounting standards to be followed by all assesses who are following mercantile
system of accounting, w.e.f. 1-4-1996:
(A) Accounting Standard 1 relating to the disclosure of accounting policies.
(B) Accounting Standard 2 relating to the disclosure of prior period and
extraordinary items and changes in accounting policies.
4.4.3 Deductions under Sections 30 to 37 (i)
Rent, Rates, Taxes, Repairs and Insurance for Building [Section 30]
If the assessee is the owner of the premises and uses the premises for his business
purpose, no notional rent would be allowed under this section. He can claim only the
following expenses under this section:
Local rates, municipal taxes, land revenue etc. However these are allowable
subject to provisions of Section 43B, i.e., if these expenses are claimed on due
basis, the payment of the same must be made on or before the due date of
furnishing the return of income.
Insurance premium covering the risk of the damage or destruction of premises.
Current repairs to the building [not including expenditure in the nature of capital
expenditure].
If assessee is a tenant, he can claim rent paid under this section. Besides this, he
can claim all expenses which he has undertaken to bear, for e.g. the cost of repairs [not
including expenditure in the nature of capital expenditure], local rates, municipal taxes,
land revenue, insurance, etc.
Important Points:
1. Where assessee is a firm and business premises belonging to a partner of the
firm, the rent payable to the partner would be an allowable deduction. On the
2.
3.
4.
5.
6.
119
other hand, the income from such a building would be computed under the
head Income from House Property in the hands of the partner.
If the assessee has taken the building on rent for business purpose and sub-let
a part of it, in such a case the deduction allowable u/s 30 would be a sum equal
to the difference between the rent paid by the assessee and the rent collected
from the sub-tenant.
If assessee occupies the premises otherwise than as tenant or owner, i.e., as a
lessee, licencee, mortgagee with possession then he is entitled to a deduction
under this section in respect of current repairs of the premises.
Where the premises are used partly for the business and partly for other
purposes, only a proportionate part of the expenses attributable to the part of
the premises used for the purposes of business will be allowed as a deduction
(Section 38).
Where assessee pays Salami in acquiring a lease of the business premises, it
will not be admissible as a charge because, it is a capital expenditure. Similarly,
if the expenditure on repairs is of a capital nature, no allowances can be made.
Where the assessee has paid rent for residential accommodation for temporary
stay of employees while on duty, the rent so paid and amount spent on repairs
(if any) is deductible u/s 30.
Notes
Repairs and Insurance of Machinery, Plant and Furniture [Section 31]

An assessee can claim the following deductions under this section:
(a) Insurance Premium paid (or payable by the assessee under mercantile
system) deduction for insurance of machinery, plant or furniture is allowable u/s 31
subject to the following conditions:
(i) The assets must be used by the assessee for the purpose of his
business/profession during the accounting year.
(ii) Insurance must be against the risk of damage or destruction of the machinery,
plant or furniture.
Premium may take the form of contribution to a trade association which may
undertake to indemnify and insure its members against loss; such premium or
contribution would be deduction as an allowance under this section even if a part of it is
returnable to the insured in certain events.
(b) Repairs to Plant and Machinery are allowable subject to the following
conditions:
(i) Plant, machinery, furniture must have been used by the assessee for the
purpose of his own business or profession. This deduction is available even if
the assessee is not the owner. What is essential is that the assets must have
been used by the assessee in his own business during the previous year
though not continuously, i.e., even if an asset is used for a part of the
accounting year, the assessee is entitled to the deduction of the full amount of
expenses on repairs and insurance charges and not merely an amount
proportionate to the period of this use.
(ii) Under this section only current repairs are deductible. Current repairs refer to
the expenditure incurred with a view to preserve and maintain an existing asset
and not with a view to bringing a new asset into existence or obtaining any new
or fresh advantage. The term repairs under this section does not mean petty
repairs. It includes renewal or renovation of an asset but not replacement or
reconstruction. Following points are noteworthy in this connection:
120
Notes
This section is applicable to current repairs but not arrears of repairs for earlier
years [though arrears of repairs are deductible u/s 37(1)].
This section is not applicable to cost of replacing or reconstruction.
Depreciation [Section 32]
Depreciation is the diminution in the value of an asset due to normal wear and tear
and due to efflux of time or obsolescence.
Deduction under this section is allowable subject to the following conditions:
1. The following are the three kinds of depreciation allowances that are
allowed under the Income Tax Act:
(i) Normal depreciation for block of assets [Section 32(1)(ii)];
(ii) Additional/extra depreciation in case of any eligible new machinery or
plant (other than ship or aircraft) which has been acquired and installed
after 31-3-2005 by an assessee engaged in the business of manufacture
or production of any article or things [Section 32(1)(iia)];
(iii) Normal asset-wise depreciation for an undertaking engaged in generation
or generation and distribution of power [Section 32(1)(i)].
2. The depreciation is allowed on specified assets as given below:
(a) Buildings, machinery, plant and furniture being tangible assets; and
(b) Know-how patents, copyrights, trademarks, licenses, franchises or any
other business or commercial rights of similar nature being intangible
assets acquired after 1-4-1998.
Depreciation is not allowed in the following cases:
(a) In respect of any machinery or plant if the actual cost thereof is allowed as a
deduction in one or more years under an agreement entered into by the Central
Government under Section 42 (this section relates to deduction in case of
business for prospecting for mineral oil).
(b) No depreciation on an imported car acquired after 28-2-1975 but before
1-4-2001 unless used for a specified purpose.
Building refers only to the superstructure but not the land on which it has been
erected. Obviously, depreciation cannot be claimed on the cost of the land. Building
includes roads, bridges, culverts, wells and tube-wells.
Plant as defined by Section 43(3) included ships, vehicles, scientific apparatus,
surgical equipments, books (including technical know-how reports) used for the purpose
of business or profession but does not include tea bushes or livestock or buildings or
furniture and fittings.
On the basis of cases decided by the courts, the following are also included under
the term Plant:
(a) In the case of a hotel, pipe and sanitary fittings [CIT v. Taj Mahal Hotel (SC)].
(b) In the case of an electric supply company; mains, service lines and switch
gears.
(c) In the case of manufacture of oxygen, gas-cylinder for storing gas.
(d) Technical know-how (Scientific Engineering House (P) Ltd. v. CIT).
(e) Drawings, designs, plans, processing data, books [Scientific Engineering
House (P) Ltd. v. C.I.T. (SC)].
(f) Drawings and patterns acquired from a foreign collaborator [CIT v. Elecon
Engineering Co. Ltd. (SC)]
121
(g) Safe deposit vaults in banks [CIT v. Union Bank of India].

(h) Air-conditioning equipments, air-conditioners and plants installed in the office
premises.
(i) Fencing around a refinery.
(j) Any installation facilitating production is a plant. Internal telephone system
constitutes a plant. However, plant does not include a harbour bed, human
body or stock-in-trade.
Notes
Books: Each book by itself constitutes a plant. Where a book runs into more than
one volume all the volumes taken together constituted a book. Periodicals are also
treated as books, but in their case if they are arranged in parts of a volume and each
volume is given a specific number, each volume is treated as a separate book, for e.g.,
I.T.R. which is published weekly is divided into parts of a volume in a year. Here, the
issues of one year will be treated as six books or six plants (as per CBDT Instructions).
3. Assessee must be the owner of the assets: In case of the buildings, the
assessee must own the super structure and not necessarily land. It is important
to note that, depreciation would also be allowable to the owner in respect of
assets which are actually worked/utilised by another person, for e.g., lessee or
licensee; therefore, if the assessee has let out on hire his building, machinery,
plant or furniture and letting out of such asset is his business, he can claim
depreciation u/s 32. In other cases, where the letting out of such asset does not
constitute the business of the assessee, the deduction on account of
depreciation can be claimed u/s 57(ii).
Exception to the general rule that the assessee must be the owner:
(a)
If the assessee carries the business in a rented or leasehold premises and

if he incurs any capital expenditure for the purpose of the business or
profession, on construction of any structure or renovation or improvement
to the building then he can claim depreciation on such capital expenditure
as if the structure/work is a building owned by him [Explanation I to Section
32(i)(i)].
(b) Depreciation is allowed on the machinery acquired on hire purchase
agreement as if the assessee is the owner of such an asset.
4. Assets must be used for business/profession carried on by the assessee
during the relevant previous year: If the asset is partly used for the business or
profession and partly used for some personal purpose, cost of the asset
attributable to the business use, shall be taken as a base for computation of
depreciation.
5. Depreciation on actual cost or written down value: In the case of any block
of asset, the depreciation is allowable at a prescribed percentage of written
down value of the block as defined in Section 43(6) as on the last day of the
previous year. Due to the block concept, the actual cost of the asset brought
into use during the year will be added to the existing block, if any. However, in
case of power generating undertakings, it may be claimed at a certain
percentage of the actual cost.
6. 50% depreciation only: If the asset is acquired during the year and used for
the period of less than 180 days, depreciation shall be allowed to the extent of
50%.
7. No depreciation is allowed on land.
8. No deduction under this section is allowable if:
1. The assessee is not the owner.
122
2.
3.
4.
Notes
5.
6.
The assessee is not the user.

The asset is sold during the year.
The asset is an imported car which is purchased after 28/2/75 but before
1/4/2001. However, if such an imported motorcar is used in a business of
running it on hire for tourists, the depreciation is allowable. Also if the
imported motorcar is used outside India in the business carried on by the
assessee in another country, depreciation will be allowed on the same.
The asset is used for scientific research.
The asset is used for exploration of mineral oil u/s 42.
Concept of Block of Assets:

Block of assets means a group of assets falling within a class of assets comprising
of
(a) Tangible assets being buildings, machinery, plant or furniture;
(b) Intangible assets being know-how, patents, copyrights, trademarks, licenses;
in respect of which the same percentage of depreciation is prescribed.
Class of Assets:
Assets eligible for depreciation have been classified into five classes, i.e.:
(a)
(b)
(c)
(d)
(e)
Building;
Furniture;
Plant and machinery;
Ships;
Intangible assets of the type discussed above.
Each class of assets other than intangible assets may have different blocks or
groups on which separate rates of depreciation are prescribed and for each such rate, a
separate block will be formed.
In the case of intangible assets there will be one block as only one rate, i.e., 25%
has been prescribed for all such intangible assets.
Table 4.4: Blocks Formed on the Basis of the Class of Assets and
their Rates of Depreciation
Buildings
Block 1
Block 2
Block 3
Buildings which are used for residential purposes except hotels and boarding
houses.
Buildings other than those used mainly for residential purposes and not
covered by Blocks 1 and 3.
(i) Purely temporary erections such as wooden structure.
(ii) Buildings acquired on or after September 1, 2002 for installing machinery
and plant forming part of water supply project or water treatment system
and which is put to use for the purpose of business of providing
infrastructure facilities under Section 80-1A(4)(i).
5%
10%
100%
Furniture and Fittings

Block 4
Furniture and fittings including electrical fitting.
10%
Machinery and Plant

Block 5
Plant and machineryAny plant or machinery [not covered by block 6,

7,8,9,10,11 or 12], motor cars (other than those used in a business of running
them on hire) acquired or put to use on or after April1, 1990.
15%
123
Block 6
Plant and machinery-ocean-going ships, vessels ordinarily operating on

inland waters and including speed boats.
Block7
Plant and machinery

(i)
Motor buses, motor Lorries and motor taxis used in a business of
running them on hire
(ii) Moulds used in rubber and plastic goods factories
(iii) Machinery and plant, used in semi-conductor industry
(iv) Life saving medical equipment
Block 8
Block 9
Block 10
Block 11
Block 12
Plant and machinery

(i) Aeroplanes Aero Engines
(ii) Specified life saving medical equipment
(iii) New Commercial vehicles acquired after 30-9-1998 but before
1-4-1999 and put to use before 1-4-1999
(iv) Plant and machinery which satisfy conditions of rule 5(2)
Plant and machinery
(i)
New Commercial vehicles acquired during 2001-02 and put to use
before 31-3-2002 for the purpose of business or profession.
(ii) Machinery/plant used in weaving, processing and garment sector of
textile industry which is purchased under Technology Upgradation Fund
Scheme during April 1, 2001 and March 31, 2004 and put to use up to
March 31, 2004; and
(iii) New
Commercial
vehicles
acquired
after
1-1-2009
and
September 30, 2009 1-4-1999 and put to use before October 1, 2009 for
the purpose of business or profession.
Plant and machinery
(i) Computers including computer software.
(ii) Books (other than books, (a) being annual publications or (b) books
owned by assessees carrying on business in running lending libraries).
(iii) New Commercial vehicles acquired in replacement of condemned
vehicle of 15 years of age which is put to use before April 1, 1999
(if acquired during October 1, 1998 and March 31, 1999) or before
April1, 2000 (if acquired during 1999-2000) and used for the purpose of
business or profession.
(iv) Gas-cylinders; plant used in field operations by mineral oil concerns;
direct fire glass melting furnaces.
Plant and machinery
Rollers used in flour mills, rolling mill rolls used in iron and steel industry,
rollers used in sugar works.
Plant and machinery
(i)
Machinery and plant acquired and installed on or after 1-9-2002 in a
water supply project or a water treatment system and which is put to
use for the purpose of business of providing infrastructure facility under
section 80-1A(4)(i).
(ii) Wooden parts used in artificial silk manufacturing machinery.
(iii) Cinematograph films-bulbs of studio lights.
(iv) Match factories (wooden match frames).
(v) Tubs, winding ropes, haulage ropes and sand stowing pipes and safety
lamps used in mines and quarries.
(vi) Salt works Saltpans, reservoirs and condensers, etc. made of earthy,
sandy or clayey material or any other similar material.
Notes
30%
40%
50%
60%
80%
100%
124

(vii) Books owned by the assessees carrying on a profession, being annual
publications.
(viii) Books owned by the assessees carrying on business in running lending
libraries.
(ix) Air pollution control equipment, water pollution control equipment, solid
waste control equipments, solid waste recycling and resource recovery
systems.
Notes
Block 13
Block 14
Intangible assets (acquired after March 31,1998) Know-how, patents,

copyrights, trademarks, licenses, franchises or any other business or
commercial rights of a similar nature.
(i)
(ii)
(iii)
Ocean going ships including dredgers, tugs, barges, survey launches

and other ships used mainly for dredging purposes and wishing vessels
with wooden hull
Vessels ordinarily operating on inland waters,not covered by sub-item
(c) below
Vessels ordinarily operating on inland waters being speed boats
25%
20%
Meaning of certain terms relevant for the computation of depreciation:

1. Block of Assets: The term block of assets has been defined under Section
2(11) to mean a group of assets falling within a class of assets, being buildings,
machinery, plant or furniture in respect of which the same percentage of
depreciation is prescribed. Thus, under each of the five types of assets (viz.,
buildings, furniture and fittings, plant and machinery, ships and intangible
assets) several blocks of assets shall be formed on the basis of percentage of
depreciation.
2. Written Down Value for charging depreciation Section 43(6): Written down
value of a block of assets for the purpose of charging depreciation of the
current year means:
(i) In the case of assets acquired before the previous year, the actual cost to the
assessee of all the assets falling within the block minus all the depreciation
actually allowed to him;
(ii) In the case of assets acquired in the previous year, the actual cost to the
assessee.
However, if any asset of the block is sold during the year, the written down
value of a block of assets shall be computed in the following steps:
Step 1 - Aggregate of WDV of the block of assets at the beginning of the year.
Step 2 - Actual cost of any asset falling within the block acquired during the year.
Step 3 - From Step 1 + Step 2, deduct the money received/receivable in respect of
that asset (falling within a block of assets) which is sold, discarded, demolished or
destroyed during the year.
The resulting amount is the WDV of the block of assets at the end of the year.
WDV in case of Slump Sale:
Step 1 Find out the depreciated value of the block on the first day of the previous year.
Step 2 To this add, the actual cost of the asset acquired during the previous year.
Step 3 From the resultant figure, deduct money received/receivable (together with
scrap value) in respect of that asset (falling within the block of assets) which is
sold, discarded, demolished or destroyed during the previous year.
125
Step 4 In the case of a slump sale deduct the actual cost of the asset falling within that
block as reduced:
(i) By the amount of depreciation actually allowed to him in respect of any
previous year relevant to the A.Y.s, and
(ii) By the amount of depreciation that would have been allowable to the assessee
for the AY onwards as if that asset was the only asset in the relevant block of
assets.
So, however, that the amount of such decrease does not exceed the written
down value (i.e., the amount computed as per Step I + Step II - Step III).
Step 5 The resultant figure, i.e., Step1 + Step II Step III Step IV shall be the WDV
for the purpose of charging the current year depreciation of the block left with
the assessee after the slump sale.
Illustration: Compute the WDV from the following information for the A.Y. 2011-12.
Plant A, B and C 15% WDV as on 1.4.2010
` 10, 40,000
Plant H 15% Purchased on 11.5.2010
` 18,000
Plant B (Sold on Dec. 20, 2010) for
` 25,10,900
Notes
Solution:
Plant and Machinery (rate of depreciation 15%)
Opening WDV as on 1.4.2010
Add: Plant H
Total
Less: Sale proceeds of Plant B (although sale proceeds
of plant B is more than ` 10,58,000, amount to be
deducted is restricted to ` 10,58,000)
WDV as on 31.3.2011
10,40,000
`18,000
10,58,000
` 10,58,000
NIL
Notional Written Down Value:

(i) Succession in business or profession: When in the case of succession, the
assessment is to be made on the successor, depreciation is to be calculated
taking the WDV of the block of assets as if there had been no change in the
ownership at all.
(ii) Transfer between the holding and the subsidiary company: Where any
block of assets is transferred by a holding company to its wholly owned
subsidiary company or vice versa (transferee company being an Indian
Company), then the actual cost of the block of assets in the case of transferee
company shall be WDV of the block of assets of the transferor company for
the immediately preceding previous year as reduced by the depreciation
actually allowed in relation to the said previous year.
(iii) Transfer in a scheme of amalgamation: In such a case, the actual cost of the
block of assets in the case of an amalgamated company shall be the WDV of
the block of assets as in the case of the amalgamating company for the
immediately preceding previous year as reduced by the amount of depreciation
actually allowed in relation to the said previous year.
(iv) WDV when assets are transferred in demerger: In such a case, the WDV of
the block of assets of the demerged company for the immediately preceding
year shall be reduced by the WDV of assets transferred to the resulting
company in order to get WDV in the hands of the demerged company.
126
Notes
(v) WDV in the hands of the resulting company: In such a case, the WDV of the
one block of assets in case of the resulting company shall be the WDV of the
transferred assets appearing in the books of account of the demerged
company immediately before the de-merger.
(vi) WDV in case of corporatisation of a recognised stock exchange in India
(applicable from 2002-03): Where in the previous year any asset forming part
of a block of assets is transferred by a recognised stock exchange in India to a
company under a scheme for corporatisation, the WDV of the block of assets in
the case of such a company shall be the WDV of the transferred assets
immediately before such a transfer.
(3) Actual Cost [Section 43(1)]: Actual cost means the actual cost of the assets to
the assessee, reduced by the portion of the cost of the asset, if any, as has been met
directly or indirectly by any other person or authority.
The actual cost of the assets would include all the expenses incurred in the
acquisition of the asset, like expenses on freight for bringing the asset, travelling
expenses of the staff engaged in purchasing the asset, installation expenses of the asset
etc.; the provisions regarding the treatment of interest, travelling expenses, etc. for the
purchase/construction of the asset have been discussed separately.
If any part of the cost of the asset is met by any other person or authority then the
cost is to be reduced to that extent, for e.g., X purchases a generator set for ` 2,00,000
and receives a subsidy of 25% from the State Government. The cost of the asset to X
would be taken at ` 1,50,000.
Notional Actual Cost [Explanations to Section 43 (1)]: In the following cases, the
actual cost for purposes of depreciation shall be a notional cost to the assessee.
(i) Assets used for scientific research [Explanation 1]: When an asset is used
in the business after it ceases to be used for scientific research, the actual cost
of the asset to the assessee will be the actual cost as reduced by the amount of
any deduction allowed u/s 35, on account of expenditure on scientific research,
i.e., it will be nil because the entire cost is written off u/s 35.
(ii) Assets acquired by way of gift or inheritance [Explanation 2]: Where an
asset is acquired by the assessee by way of gift or inheritance, the actual cost
of the asset to the assessee shall be the actual cost to the previous owner as
reduced by:
(a) The amount of depreciation actually allowed on the asset in respect of any
previous year relevant to the assessment year commencing before April 1,
1988, i.e., depreciation actually allowed up to assessment year 1987-88;
and
(b) The amount of depreciation that would have been allowable to the
assessee for any assessment year commencing on or after April 1, 1988
as if the asset was the only asset in the relevant block of assets.
(iii) Assets transferred to reduce the tax liability [Explanation 3]: Where, before
the date of acquisition by the assessee, the assets were at any time used by any other
person for the purposes of business or profession and the Assessing Officer is satisfied
that the main purpose of the transfer of such assets, directly or indirectly to the assessee,
was the reduction of a tax liability (by claiming excess depreciation with reference to an
enhanced cost), the actual cost to the assessee shall be such an amount as is
determined by the assessing officer, with the previous approval of the Joint
Commissioner.
127
Example: An asset which has been used by R for several years was transferred to
G, his brother for ` 3,00,000 although the market value at the time of the transfer was
` 1,20,000. In this case, the Assessing Officer is entitled to estimate the actual cost of the
asset at ` 1,20,000 if he is satisfied the main purpose of the transfer was the reduction of
tax liability of G. However, in this case, he has to take prior approval of the Joint
Commissioner. However, R will have to pay Capital Gain Tax on such a transfer and
consideration price for this transfer shall remain at ` 3,00,000.
Notes
(iv) Assets which are reacquired by the assessee [Explanation 4]: Where an
asset which had once belonged to the assessee and had been used by him for the
purpose of his business or profession and thereafter, ceased to be his property by reason
of transfer or otherwise, is reacquired by him, the actual cost to the assessee shall be:
(a) The actual cost to him when he first acquired the asset as reduced by:
(i)
(ii)
The amount of depreciation actually allowed to him in respect of any

previous year relevant to the assessment year commencing before April 1,
1988, and
The amount of depreciation that would have been allowable to the
assessee for any assessment year commencing on or after the first day of
April 1988, as if the asset was the only asset in the relevant block of
assets (in other words, WDV at the time when the asset is sold,
considering it to be the only asset in the block).
OR
(b) The actual price for which the asset is reacquired by him, whichever is less.
(v) Sale and lease back transactions [Explanation 4A]: Where before the date
of acquisition by the assessee (hereinafter referred to as the first mentioned person), the
assets were at any time used by any other person for the purpose of his business or
profession and depreciation allowance has been claimed in respect of such assets, in the
case of the second mentioned person and such person acquired on lease, hire or
otherwise assets from the first mentioned person, then notwithstanding anything
contained in Explanation 3, the actual cost of the transferred assets, in the case of first
mentioned person (who is the legal owner), shall be the same as the written down value
of the said assets at the time of transfer thereof by the second mentioned person w.e.f.
01.10.1996.
Example: R has been using an asset for his business and its written down value as
on 1.4.2013 was ` 2,00,000. He sold this asset to G for ` 4,00,000 and G leased back
this asset to R, i.e., R reacquires that asset from G by way of lease, hire or otherwise. In
this case, the cost of this asset to G (who is the legal owner) for the purpose of charging
depreciation shall be ` 2,00,000, i.e., the written down value of this asset at the time of
transfer by R to G and not ` 4,00,000 for which he acquired the asset.
1.
If Explanation 4A is applicable then Explanation 3 shall not be applicable. However,

where Explanation 4A is not applicable, Explanation 3 shall be applicable, for e.g., if
the asset acquired by G from R is not leased back to R, Explanation 4A shall not be
applicable but Explanation 3 shall be applicable, i.e., in this case, the actual cost shall
be an amount as determined by the Assessing Officer.
2.
It is clarified that if there are one or more intermediate sale between the point of first
sale and its reacquisition by the assessee by way of lease/hire or otherwise, then the
actual cost shall be WDV at the time of first sale. Even if the asset forms part of a
block of assets, the individual written down value has to be worked out separately to
give effect to this provision.
128
Notes
(vi) Building brought into use for business purposes subsequent to its
acquisition [Explanation 5]: Where a building previously owned by the assessee is
brought into use for the purpose of the business or profession, the actual cost to the
assessee shall be the actual cost of the building to the assessee, as reduced by an
amount equal to the depreciation calculated at the rate in force on that date which would
have been allowable had the building been used for the purpose of the business since
the date of its acquisition.
Illustration: R purchased a building for ` 500,000 on1.12.2011 which was used by
him as a dwelling place w.e.f. 5-2-2014 he uses his building as an office of his profession,
the actual cost to R for the purpose of charging depreciation in the previous year
2013-2014 shall be computed as under:
Actual cost of building on 1.12.2011
Depreciation for previous year2011-12@5% of 5,00,000
WDV as on 1.4.2012
Less: Depreciation for previous year 2012-13 @ 10%
` 5,00,000
25,000
4,75,000
47,500
4,27,500
Actual cost to R for the purpose of charging depreciation ` 4,27,500.

(vii) Assets transferred by a holding company to its subsidiary company
[Explanation 6]: Where an asset is transferred by a holding company to its 100%
subsidiary company or vice versa, then, if the transferee company is an Indian company,
the actual cost of the transferred capital asset to the transferee company shall be the
same as it would have been if the transferor company had continued to hold the capital
asset for the purpose of its business.
Illustration: R Ltd., a holding company, transfers two assets to its 100% subsidiary
company G Ltd. for ` 3, 00,000 although the written down value to the holding company
at the beginning of the year was ` 1,40,000. In this case, the actual cost to G Ltd. shall be
` 1,40,000 (being the written down value to the holding company). If the assets are
transferred for ` 1,00,000, the actual cost to G Ltd. shall remain as ` 1,40,000.
(viii) Assets transferred under a scheme of amalgamation [Explanation 7]:
Where, in a scheme of amalgamation, any capital asset is transferred by the
amalgamating company to the amalgamated company and the amalgamated company is
an Indian company, the actual cost of the transferred capital asset to the amalgamated
company shall be taken to be the same as it would have been if the amalgamating
company had continued to hold the capital asset for the purposes of its business.
(ix) Actual cost in case of demerger [Explanation 7A] has been inserted to
provide that, in case of demerger, the actual cost of the transferred capital asset to the
resulting company shall be taken to be the same as it would have been if the demerged
company has continued to hold the capital asset for the purpose of its own business.
(x) Interest [Explanation 8]: Any amount paid or payable as interest in connection
with the acquisition of an asset and relatable to a period after the asset is first put to use
will not form part of the actual cost of the asset.
(xi) Actual cost of Cenvatable goods [Explanation 9]: Where an asset is or has
been acquired on or after 1.3.1994 by an assessee, the actual cost of the asset shall be
reduced by the amount of duty of excise or additional customs duty (also known as
countervailing duty) leviable under Section 3 of the Customs Tariff Act, 1975 in respect of
which a claim of credit has been made and allowed under the Central Excise Rules, 1944.
In other words, if the assessee has taken Modvat Credit (Cenvat Credit now) of Central
Excise or countervailing duty of Customs paid on such purchase of the asset under the
129
Central Excise Rules, the actual cost of the asset shall be reduced by the amount of such
a Cenvat Credit.
Notes
Example: If an assessee has purchased a machine whose sale price (without

excise duty) was ` 1,00,000 and was charged 10.3% central excise duty and 2% CST.
The actual cost of the asset in this case was, 1,00,000 + 10,300 + 2206 (2% CST on
` 1,10,300) = 1,12,506 but if he takes Cenvat credit of excise of ` 10,300 on capital
goods purchased by him, then the actual cost for the purpose of depreciation shall be
` 1,12,506-10,300 (Cenvat credit taken) = ` 1,02,206.
(xii) Actual cost of Subsidised assets [Explanation 10]: Where a portion of the
cost of an asset acquired by the assessee has been met directly or indirectly by the
Central or State Government or any authority established under any law or by any other
person, in the form of subsidy or grant or reimbursement, then in a case where the
subsidy is directly relatable to the asset, such subsidy shall not be included in the actual
cost of the asset. In a case where such subsidy or grant or reimbursement is of such a
nature that it cannot be directly relatable to any particular asset, the amount so received
shall be apportioned in a manner that such asset bears to all the assets in respect of or
with reference to which the subsidy or grant or reimbursement is so received and such
subsidy shall not be included in the actual cost of the asset.
(xiii) Asset acquired by non-resident outside India [Explanation 11]: The actual
cost of the asset which was acquired by a non-resident outside India and is brought by
him to India and used for the purpose of his business and profession shall be the actual
cost to the assessee minus the depreciation that would have been allowed, had the asset
been used in India from the date of acquisition.
(xiv) Transfer in the case of Corporatisation of a Recognised Stock Exchange
[Explanation 12]: Where any capital asset is acquired by the assessee under a scheme
of corporatisation of recognised stock exchange in India the actual cost of the asset shall
be deemed to be the amount which would have been regarded as actual cost had there
been no such corporatisation.
(4) Additional Depreciation on new machinery or plant [Section 32(iia)]: With a
view to give boost to the manufacturing sector, an additional depreciation shall be
allowed to an industrial undertaking subject to the provisions given below. Such
additional depreciation shall be in addition to the normal depreciation which is being
allowed to all assesses.
(A) Who can claim additional depreciation: An assessee engaged in the
business of manufacture or production of any article or thing can claim additional
depreciation.
(B) Asset which qualifies for additional depreciation: Any plant and machinery,
other than ships and aircrafts, which has been acquired or installed after March 31, 2005
by an assessee is qualified for additional depreciation.
(C) Assets which are expressly not eligible for additional depreciation:
(i) Plant and Machinery, which before its installation by the assessee was used
either within or outside India by any other person.
(ii) Plant and Machinery which is installed in any office premises or residential
accommodation, including guesthouse.
(iii) Office appliances or road transport vehicles.
(iv) Plant and Machinery, whole of the actual cost of which is allowed as a
deduction (whether by way of depreciation or otherwise), in computing the
income chargeable under the head Profits and Gains of Business/Profession
of any one previous year.
130
Notes
(D) Rate of Additional Depreciation:

(i) If the asset is put to use for less than 180 days
in the year in which it is acquired
(ii) In any other case
10% of actual cost

20% of actual cost
(E) Year in which additional depreciation is available: In case of a new industrial

undertaking, additional depreciation is available during the previous year in which it
begins to manufacture or produce any article on or after 31.3.2005.
(F) Certificate from a Chartered Accountant: Additional depreciation will not be
available unless the assessee furnished details of machinery and plant and increase in
installed capacity in a prescribed form along with the return of income and a report of a
Chartered Accountant certifying that the deduction has been correctly claimed.
Unabsorbed Depreciation [Section 32(2)]:
Step 1: Depreciation allowance of the previous year is first deductible from income
under the head Profits and Gains of Business/Profession.
Step 2: If the depreciation allowance is not fully deductible under the head Profit
and Gain of Business/Profession because of the absence or inadequacy of profits, it is
deductible from the income chargeable under another head of income for the same A.Y.
Step 3: If the depreciation allowance is still unabsorbed it can be carried forward to
the subsequent Assessment Year by the same assessee (no time limit is fixed for carry
forward).
Note: In the subsequent years, unabsorbed depreciation can be set off against any
income whether chargeable under the head Profits and Gains of Business/Profession.
Under any other head in the following priority minus the current depreciation, B/f of
business loss, unabsorbed depreciation. (2) Continuity of business is not relevant for set
off and carry forward.
Depreciation on Straight-line basis in the case of Power Units: An undertaking
engaged in generation or generation and distribution of power can claim depreciation (in
respect of assets acquired after March 31, 1997) according to nay one of the following
methods
Straight-line basis: Depreciation can be claimed according to straight line basis in
the case of tangible assets at the percentage specified in Appendix IA to the Income-tax
Rules on the actual cost of the individual asset. The aggregate depreciation cannot
exceed the actual cost.
Written down basis: Alternatively such undertaking can claim depreciation at its
option according to written down value method like any other assessee. The option for
this purpose shall be exercised before the due date of furnishing return of income. Once
the option is exercised, it shall be final and shall apply to all the subsequent years.
Terminal Depreciation (i.e., Loss on transfer) or Balancing charge (in the case
of gain) in the case of power units: When a depreciable asset (on which depreciation
is claimed on Straight line basis) of a power generating unit is sold, discarded,
demolished or destroyed in a previous year, then terminal depreciation (in case of loss) is
deductible on balancing charge (in case of gain) is taxable.
Terminal depreciation is calculated as follows
Step one: Find out the written down value of the depreciable asset on the first day
of the previous year in which such asset is sold, discarded, demolished or destroyed.
Step two: Find out the actual money (received or receivable in cash or by cheque or
draft) and it does not include nay other thing or benefit which can be converted in terms
of money
131
If the amount calculated under Step two is less than the amount of Step one, then
the deficiency is deductible as terminal depreciation. The following points should be
noted
Notes
1. When the asset is sold, discarded, etc. in the previous year in which it is first
put to use, any loss arising there from is not allowed as terminal depreciation
but it is treated as capital loss.
2. Terminal depreciation allowance cannot be claimed if the asset is not used for
the purpose of business or profession of the assessee at least for sometime
during the previous year in which the sale takes place.
3. Terminal depreciation is allowed only if it is actually written off in the books of
the assessee.
Balancing charge under section 41(2) and capital gain under section 50A. If the
amount calculated under Step two is more than the amount of Step 1, the tax treatment
of such surplus is as follows:
1. So much of the surplus which is equal to the amount of depreciation already
claimed, is taxable as balancing charge under section 41(2) as business
income.
2. The remaining surplus (if any) is taxable according to the provisions of section
45 under the head Capital Gains.
Other points: The following points should be noted
1. Where an asset is sold, discarded etc. in the previous year in which it is first put
to use, any profit arising there from will not be chargeable to tax as balancing
charge but will be treated as capital gains and chargeable to tax under section
45 under the head Capital Gains.
2. Balancing charge is taxable under section 41(2) in the previous year in which
sale price, insurance, salvage or compensation money becoming due (whether
the business is in existence in that year or not). In case of compulsory
acquisition, it is taxable in the year of receipt of additional compensation.
Tea Development Account, Coffee
Development Account [Section 33 AB]
Development
Account
and
Rubber
An assessee carrying on business of growing and manufacturing tea or coffee in

India is entitled for deduction to the extent of least of the following:
(a) amount deposited in special A/c with NABARD maintained by the assessee
with that bank in accordance with and for the purpose specified in a scheme
approved in this behalf by the Tea Board or the Coffee Board or the Rubber
Board within a period of 6 months from the end of the previous year or before
due date of furnishing return of income, whichever is earlier.
(b) 40% of profits of such business as computed before making deduction u/s
33AB and before adjusting brought forward business loss u/s 72.
How to compute profits from such business?: If separate accounts are not
maintained in respect of business of growing and manufacturing tea or coffee or rubber in
India, it shall be profits from such business before claiming deduction under this section.
In case separate accounts are not maintained it will be calculated as under:
Profits of the business
Total turnover of business of growing and manufacturing tea coffee/rubber
Total turnover of the assessee' s business
132
Notes
1. For claiming deduction u/s 33AB, assessee must get accounts audited by a
Chartered Accountant and furnish the report of such audit in prescribed form
along with his return of income.
2. The amount standing to the credit of special account with NABARD is to be
utilized as per the specified scheme of Tea Board.
In no case, it shall be utilized for the purpose of the following:
(a) Any machinery/Plant installed in any office premises/residential
accommodation including guest house.
(b) Any office appliances (other than computer).
(c) Any machinery or plant entitled for 100% write off by way of depreciation
or otherwise.
(d) Any new machinery or plant installed for production of any low priority
item specified in the Eleventh Schedule.
3. Deduction allowed under this provision will be withdrawn if the asset acquired
in accordance with the scheme, is sold or otherwise transferred within 8 years
from the end of the previous year in which it was acquired. However, it shall not
be withdrawn in the following cases:
Transfer to Government, Local Authority or Statutory Corporation or
Government Co.
In case of Sale of business by partnership firm to a company, if Company
has taken over all assets and liabilities of the firm and all the shareholders
of the company were partners of the firm before such sale.
4. Assessee is however, allowed to withdraw any amount standing to his credit in
special account with NABARD in the following circumstances:
(a) Closure of business
(b) Dissolution of firm
(c) Death of an assessee
(d) Partition of a HUF
(e) Dissolution of a Company
Where the withdrawal is made in the circumstances stated above in (a) and (b), the
amount withdrawn such business shall be taxable as business profit of that Previous year,
as if the business had not been closed or the firm had not been dissolved.
Site Restoration Fund [Section 33ABA]
This section has been inserted to allow deduction to an assessee who is carrying on
business consisting of the prospecting for or extraction or production of petroleum or
natural gases or both in India.
Essential conditions:
1. This deduction will be allowed to any assessee who is carrying on business
consisting of prospecting for or extraction or production of petroleum or natural
gas or both in India and in relation to which the Central Government has
entered into an agreement with such assessee for such business.
2. The assessee has before the end of the previous year
(a) Deposited with the State Bank of India any amount(s) in a special account
maintained by the assessee with that bank, in accordance with and for the
purposes specified in, a scheme approved in this behalf by the Ministry of
Petroleum and Natural Gas of the Government of India; or
133
(b) Deposited any amount in the Site restoration Account opened by the
assessee in accordance with, and for the purpose specified in a scheme
framed by the aforesaid Ministry. This scheme is known as Deposit
Scheme.
3.
The assessee must get its accounts audited by a Chartered Accountant and
furnish the report in the prescribed form (Form No. 3AD) along with the return of
income. In a case where the assessee is required by or any other law to get its
accounts audited, it shall be sufficient compliance if such assessee gets the
account of such business audited under such law and furnishes the report of
the audit as required under such other law and a further report in the form
prescribed.
Profits from business in this case is to be calculated in the same manner as is
mentioned in section 33AB.
Notes
Quantum of deduction: Quantum of deduction shall be

(a) The amount deposited in the scheme referred to above; or
(b) 20% of the profit of such business computed under the head profits and gains
of business or profession, whichever is less.
The profits are to be computed before making any deduction under this section, i.e.,
Section 33ABA and before making adjustment for brought forward losses under Section
72.
Restriction on utilization of the amount deposited: The amount standing to the
credit of the assessee, in the Special Account of State Bank of India or the Site
Restoration Account, is to be utilized for the business of the assessee in accordance with
the scheme specified. However, no deduction shall be allowed in respect of any amount
utilized for the purchase of
(a) Any machinery or plant to be installed in any office premises or residential
accommodation, including any accommodation in the nature of a guest house;
(b) Any office appliances (not being computers);
(c) Any machinery or plant, the whole of the actual cost of which is allowed as a
deduction (whether by way of depreciation or otherwise) in computing the
income chargeable under the head Profits and gains of business or
profession of any one previous year;
(d) Any new machinery or plant to be installed in an industrial undertaking for
purposes of business of construction, manufacture or production of any article
or thing specified in the list in the Eleventh Schedule.
Consequence if new asset is transferred within 8 years: Same as in Section
33AB.
Withdrawal of deposits: Any amount deposited in the special account maintained
with State Bank of India or the Site Restoration Account shall not be allowed to be
withdrawn, except for the purposes specified in the scheme, or as the case may be, in
the deposit scheme.
Where any amount standing to the credit of the assessee in the special account
or in the Site Restoration Account is utilized by the assessee for the purpose of any
expenditure in connection with such business not in accordance with the scheme or
the deposit scheme, such expenditure shall not be allowed in computing the income
chargeable under the head Profit and gains of business or profession, i.e., Double
Deduction is not possible.
134
Notes
Expenditure on Scientific Research [Section 35]

The expression scientific research means, activities for the extension of knowledge
in the fields of natural or applied science including agriculture, animal husbandry or
fishery.
Besides scientific research, donation for research in social sciences like human
behaviour and marketing research work are also covered under this section.
Scientific research may be carried on:
(a) by the assessee, relating to his business; or
(b) by making payment to outside agencies engaged in scientific research work.
(A) Where the assessee carries Scientific Research relating to his business:
1. Before the commencement of business: If the assessee incurs any
expenditure within three years immediately preceding the commencement of
his business, on:
Payment of salary to research personnel engaged in scientific research,
and
Material inputs for such scientific research.
Such expenditure will be allowed as deduction in the year in which the
business is commenced. The deduction will be limited to the amount certified
by the prescribed authority. Similarly, Capital Expenditure (except, Acquisition
of Land after 29/4/84) incurred during three years immediately preceding the
date of commencement of the business shall be deemed to be the expenses of
the previous year of the commencement of the business and allowed in that
year.
2. After commencement of the business: Any revenue as well as capital
expenditure, except for Acquisition of Land after 29.4.84, on scientific research
relating to his business is deductible in full.
Important Points:
1. Carry forward of unabsorbed capital expenditure: Capital expenditure on
scientific research, which cannot be absorbed on account of insufficiency of
profits in any accounting year, can be carried forward for an indefinite period
and can be set off against income under the head Profits and Gains of
Business/Profession and under any other head.
2. Use of the asset for some other purposes: If the capital asset used for
scientific research purposes is used in the business for some other purposes,
no further depreciation can be allowed u/s 32.
3. Sale of asset: If any asset used for scientific research purpose, is sold, then
the price realised for the same shall be taxable u/s 41(3).
4. Amalgamation: Where amalgamating company transfers to the amalgamated
company, (being an Indian company), any asset representing capital
expenditure on scientific research, provisions of Section 35, would apply to the
amalgamated company as if the amalgamating company had not transferred
the asset.
Payment to outside agencies: Payment may be made for
1. Scientific research [Section 35(1)(ii) and (iia): Any payment made to outside
agencies for scientific research whether related to the business of the
assessee or not, is allowed as weighted deduction @ 175 the amount so paid
in the previous year in which payment is made. The deduction is allowable if
the payment is made to any of the following agencies:
135
(a) scientific research association which has the object of undertaking

scientific research;
(b) a university, college or other institutions to be used for scientific research.
2. Research in social science or statistical research [Section 35(1)(iii)] :
Payment made by the assessee to a university, college or other institution to be
used for research in social sciences or statistical research shall also be eligible
for deduction @ 125% of the amount so paid whether such research is related
to the business of the assessee or not.
The deduction mentioned in clause (1) and (2) above shall be allowed only if
the association, university, college or other institution mentioned in clause (a)
or (b) above
(A) Is for the time being approved, in accordance with the guidelines, in the
manner and subject to such conditions as may be prescribed.
(B) Such association, university, college or other institution is specified as such by
notification in the Official Gazette, by the Central Government.
Notes
Weighted deduction on contribution to National Laboratory [Section 35(2AA)]:

(i) The payment is made to National Laboratory, or, University; or Indian Institute
of Technology; or, specified person as approved by the prescribed authority.
(ii) The above payment is made under a specific direction that it should be used by
the aforesaid person for undertaking scientific research programme approved
by the prescribed authority.
If the aforesaid conditions are satisfied, the tax payer is eligible for weighted
deduction which is equal to 200%.
Weighted deduction on in-house research and development to a company
assessee in certain cases [Section 35(2AB)]:
Weighted deduction of 200% will also be allowed to a company which
(a) is engaged in any business of manufacture or production of any article or thing
not being an article or thing specified in the list of the Eleventh Schedule of the
Act, and
(b) has incurred expenditure (except on land and building) on in-house scientific
research and development facility approved by the prescribed authority.
No company shall be entitled to this deduction unless it enters into an agreement
with the prescribed authority for cooperation in such research and development facility
and for the audit of the accounts maintained for that facility.
Notes:
(i) If expenditure is allowed under this section, it will not be allowed under any
other provision of the Act.
(ii) The expenditure incurred on the acquisition of building(excluding cost of land)
shall be allowed @ 100% under section 35(1)(iv) read with Section 35(2).
(iii) The expenditure incurred on scientific research by the above company after
31-3-21012 shall not be eligible for weighted deduction extended to 31-3-2017
by the Finance Act, 2012.
(iv) The deduction u/s 35(2AB) shall not be allowed to a company who has the
main object the scientific research and development.
Contribution to a Company to be Used by Such Company for Scientific
Research [Section 35(1)(iia)]
Section 35(1)(iia) is applicable from the AY 2009-10 if the following conditions are
satisfied
136
Notes
1. The taxpayer is any person (may be an individual, HUF, firm, company or any
other person.
2. The tax payer has paid any sum to a company to be used by the payee for
scientific research.
3. The scientific research may or may not be related to the business of the
taxpayer.
4. The payee-company is registered in India and has as its main object the
scientific research and development
5. The payee-company is for the time being approved by the prescribed authority
and fulfills such conditions as may be prescribed.
Amount of deduction: If the above conditions are satisfied, then the tax payer can
claim a weighted deduction of 125 per cent of the amount paid by him to the payee
company.
Expenditure on Acquisition of Patent Rights and Copyrights [Section 35A]: No
deduction is available u/s 35A.
Expenditure for Obtaining License to Operate Telecommunication Service [Section
35ABB]
Where any capital expenditure is incurred by the assessee for acquiring any right to
operate telecommunication services either before the commencement of the business to
operate a telecommunication service or thereafter, any time during any previous year
and for which payment has actually been made to obtain a license, a deduction will be
allowed in equal instalments over the period for which the license remains in force,
subject to the following:
(a) If the fee is paid for acquiring any right to operate telecommunication services
before the commencement of such business, the deduction shall be allowed for
the previous years beginning with the previous year in which such business
commenced.
(b) If the fee is paid for acquiring such rights after the commencement of such
business the deduction shall be allowed for the previous years beginning with
the previous year in which the license fee is actually paid.
Sale of License:
(a) Where the entire license is transferred
(i) If the sale proceeds and the deductions already allowed are less than the
cost of acquisition, such deficiency shall be allowed as deduction in the
year in which the license is transferred.
(ii) If the sale proceeds and the deductions already allowed exceed the cost
of acquisition of the license, then the amount of such excess or the
aggregate of the deductions already allowed in the past, whichever is less,
shall be taxable as business income of the year in which the license is
transferred.
(b) Where a part of the license is transferred.
(i) Where a part of the license is transferred for a sum less then the written
down value of the total license, the balance amount not yet written off
shall be allowed as deduction in the balance number of equal
installments.
(ii) If part of the license is transferred for a sum exceeding the written down
value of the license, the sale proceeds minus the written down value of
the full license shall be the profit from such sale. Out of such profit, an
137
amount equal to the amount already written off in the earlier years shall
be deemed to be the business income.
It may be mentioned that the license constitutes a capital asset and as such there will
be capital gain/loss on sale of the entire part of the license.
Notes
Notes:
1. In the case of amalgamation and demerger, the amalgamated company or the
resulting company, as the case may be, shall be allowed to writ off the balance
amount of license which was not written off by the amalgamating company or
de-merged company as the case may be.
2. Where a deduction for any previous year under section 35ABB(1) is claimed
and allowed in respect of any expenditure referred to in that sub section, no
deduction shall be allowed on account of depreciation under section 32(1) for
the same previous year or any subsequent previous year.
Expenses on Eligible Projects or Schemes [Section 35 AC]
Under this section, deduction will be allowed in computing profits of business or
profession chargeable to tax, in respect of the expenditure incurred for an eligible project
or scheme for promoting social and economic welfare or uplift of the public as may be
specified by the Central Government on the recommendations of the National
Committee.
The deduction will be allowed in cases where the qualifying expenditure is either
incurred by way of payment to the public sector company, a local authority or to and
approved association or institution for carrying out any eligible project or scheme.
Companies will however, be allowed the deduction also in cases where the expenditure
is incurred by them directly on an eligible project or scheme.
The claim for deduction should be supported by an audit certificate obtained from a
public sector company, local authority or approved association or institution or from a
Chartered Accountant in cases where the claim is in respect of expenditure directly
incurred by a company on an eligible project or scheme.
Deduction in respect of Expenditure on Specified Business [Section 35AD]
The income tax act provides for profit linked exemption/deduction under various
sections. Some of the exemptions are provided in the following sections:
1. Section 10AA
2. Section 80-1A, 80-1AB, 80-1B, 80-1C,80-1D and 80-1E
However, from assessment year 2010-11, it has made a departure and now onwards
incentive linked tax incentive(instead of profit linked exemption/deduction, shall be
allowed to assessee carrying on certain specified business. In this regard, Section 35AD
has been inserted for specified business.
1. To whom deduction shall be allowed: Deduction u/s 35AD shall be allowed
to the assessee which is carrying on the following specified business:
(i) setting up and operating a cold chain facility on or after 1.4.2009.
(ii) setting up and operating a warehousing facility for storage of agricultural
produce on or after 1.4.2009.
(iii) laying and operating a cross-country natural gas or crude or petroleum oil
pipeline network for distribution, including storage facilities being an
integral part of such network on or after 1.4.2007.
138
Notes
(iv) the business of building and operating new hotel of two star or above
category, as classified by the Central Government, any where in India and,
which starts operating after 1-4-2010.
(v) building and operating anywhere in India, a hospital with at least 100 beds
for patients on or after 1-4-2010.
(vi) developing and building a housing project under a scheme for slum
redevelopment or rehabilitation framed by the central Government or a
State Government as the case may be, and notified by the Board in this
behalf in accordance with the guidelines as may be prescribed on or after
1-4-2010.
The Finance Act 2011 has also included the following business within the
purview of specified business, if they start functioning on or after
1-4-2011.
(vii) on or after 1st April, 2011, where the specified business in the nature of
developing and building a housing project under a scheme for affordable
housing framed by the central Government or a State Government as the
case may be, and notified by the Board in this behalf in accordance with
the guidelines as may be prescribed.
(viii) production of fertilizer in India
(ix) on or after 1st April, 2012, setting up and operating inland container depot
or a container freight station notified or approved under the Customs Act,
1962.
(x) bee-keeping and production of honey and bees wax on or after 1-4-2012.
(xi) in the nature of setting up and operating a warehousing facility for storage
of sugar on or after 1-4-2012.
2. Nature and amount of deduction: 100% deduction shall be allowed on
account of any expenditure of capital nature incurred wholly and exclusively for
the purpose of any specified business, shall be allowed as deduction during the
previous year in which he commences operations of his specified business, if
(a) the expenditure is incurred prior to the commencement of its operation;
and
(b) the amount is capitalized in the books of account of the assessee on the
date of commencement of its operations.
Weighted deduction for certain specified business commencing operations
on or after 1-4-2012 [Section 35AD(IA)]
The following specified business commencing operations on or after 1.4.2012 shall
be allowed a weighted deduction of 150% of the capital expenditure incurred under
Section 35AD(IA) of the Income Tax Act, namely:
(i) Setting and operating a cold chain facility
(ii) setting up and operating a warehousing facility for storage of agricultural
produce
(iii) building and operating anywhere in India, a hospital with at least 100 beds for
patients
(iv) developing and building a housing project under a scheme for affordable
housing framed by the Central Government or a State Government as the case
may be, and notified by the Board in this behalf in accordance with the
guidelines as may be prescribed,and
(v) production of fertilizer in India
139
Conditions to be satisfied:
(i) It is not formed by the splitting up or the reconstruction of a business already in
existence.
(ii) It is not formed by the transfer to new business of machinery or plant previously
used for any purpose.
(iii) Where the business is of laying and operating a cross country natural gas or
crude or petroleum oil pipeline network, etc., it satisfies the following conditions
also:
(a) it is owned by a company formed and registered in India under the
Companies Act, 1956 or by a consortium of such companies or by an
authority or board or a corporation established or constituted under any
Central or State Act.
(b) it has been approved by the Petroleum and Natural Gas Regulatory
Board established under sub-section (1) of Section 3 of the Petroleum
and Natural Gas Regulatory Board Act, 2006 and notified by the central
Government in the Official Gazette in this behalf;
(c) it has made not less than one-third [amended to such proportion of its
total pipeline capacity as specified by regulations made by the Petroleum
and Natural Gas Regulatory Board established under sub-section (1) of
Section 3 of the Petroleum and Natural Gas Regulatory Board Act, 2006
[Finance Bill 2010, to take effect retrospectively from 1.4.2010] of its total
pipeline capacity available for use on common carrier basis by any person
other than the assessee or an associated person; and
(d) it fulfills any other conditions as may be prescribed.
Notes
Notes:
(1) The assessee shall not be allowed any deduction in respect of the specified
business under the provisions of Chapter VIA under the heading C
Deductions in respect of certain incomes in relation to such specified business
for the same or any other assessment year.
(2) An associated person in relation to the assessee means a person
(i) Who participates directly or indirectly or through one or more
intermediaries in the management or control or capital of the assessee.
(ii) Who holds directly or indirectly, shares carrying not less than twenty-six
per cent of the voting power in the capital of the assessee.
(iii) Who appoints more than half of the board of directors or members of the
governing board or one or more executive directors or executive
members of the governing board of the assessee.
(iv) Who guarantees not less than 10% of the total borrowings of the
assessee.
(3) Sum received or receivable on sale or destruction of an asset for which
deduction under section 35D has been claimed in nay earlier year.
If the asset whose cost has been allowed as deduction u/s 35AD is later on
sold, demolished or discarded then,
(a) the sale price of such asset to the extent of its original cost shall be
taxable under Section 28 as profit or gains of business and profession.
(b) The amount received s compensation from the insurance company on
destruction of such asset shall be taxable u/s 28 as profit or gains of
business and profession.
140
Notes
Payment to Institutions for Carrying Out Rural Development Programmes [Section

35CCA]
Any assessee who wants to avail of this section will get a deduction only if he makes
a payment to the National Fund for Rural Development and National Urban Poverty
Eradication Fund which are the only funds which have been notified so far by the Central
Government u/s 35CCA(1).
Expenditure on agricultural project [Section 35CCC]: Where an assessee incurs
any expenditure on agricultural extension project notified by the board in this behalf in
accordance with the guidelines as may be prescribed then, there shall be allowed a
deduction equal to one-and-one-half times of such expenditure.
Where a deduction under this section is claimed and allowed for any assessment
year in respect of any expenditure referred here deduction shall not be allowed in respect
of such expenditure under any other provisions of this Act.
Expenditure on skill development project [Section 35CCD]: Where a company
incurs any expenditure (not being in the nature of cost of any land or building) on any skill
development project notified by the Board in this behalf in accordance with the guidelines
as may be prescribed then, there shall be allowed a deduction equal to one and one-half
times of such expenditure.
Amortisation of Preliminary Expenses [Section 35 D]
Where an Indian Company or a resident non-corporate assessee in India incurs any
expenditure of the nature specified either:
before the commencement of the business or
after the commencement of the business, in connection with extension of his
industrial undertaking or setting up a new industrial unit, a deduction u/s 35 D is
available.
Quantum of Deduction: Amount equal to 1/5 of the eligible expenditure is
deductible over a period of five years beginning with the previous year in which the
extension of the industrial undertaking is completed or a new industrial unit commences
production or operation.
Eligible Expenditure:
(a) Expenditure in connection with:
(i) Preparation of a feasibility report;
(ii) Preparation of a project report;
(iii) Conducting a market survey or any other survey necessary for the
business of the assessee;
(iv) Engineering services relating to the business of the assessee.
(b) Legal charges for drafting any agreement between the assessee and any other
person for any purpose relating to the setting up or conduct of the business of
the assessee.
(c) Where the assessee is a company, also expenditure:
(i) By way of legal charges for drafting the Memorandum and Articles of the
Association of the Company;
(ii) On printing of the Memorandum and Articles of the Association;
141
(iii) By way of fees for registering the company under the provisions of
Companies Act, 1956;
(iv) In connection with the issue, for public subscription, of shares in or
debentures of the company, being underwriting commission, brokerage
and charges for drafting, printing and advertisement of the prospectus.
Expenses incurred in connection with refund of the amount over
subscribed, are entitled to deduction u/s 35D [CIT vs. Shree Synthetics
Ltd. (1986)].
(d) Such other items of expenditure as may be prescribed.
Notes
Limit on eligible expenditure:

In case of non corporate resident assessee 5% of project cost,
In case of Indian Company 5% of or project cost or 5% of capital employed
(at the option of the assessee).
Important Points:
1. Cost of the project is the cost of a fixed asset to an assessee as on the last day
of the previous year in which the business commences/extension is
completed/the new industrial unit commences production or operation.
2. Capital employed is the aggregate of the issued share capital, debentures,
long-term borrowing as on the last day of previous year in which the business
commences/extension is completed/the new unit commences production or
operation.
3. In case of extension/new unit cost of the project/capital employed is considered
in connection with the extension or setting up of a new unit only.
4. In case of transfer of the undertaking, the transferee company (except in case
of amalgamation and demerger) looses the benefit of any deduction for the
years after such transfer.
Amortisation of expenditure in the case of amalgamation/demerger [Section
35 DD]: Where an assessee, being an Indian Company incurs expenditure (on or after
01.04.1999) wholly and exclusively for the purpose of amalgamation or demerger; the
assessee shall be allowed a deduction equal to one-fifth (1/5th) of such expenditure for
5 successive previous years beginning with the previous year in which amalgamation or
demerger takes place,w.e.f. A.Y. 2000-01.
Amortisation of expenditure under voluntary retirement scheme [Section
35DDA]: Where an assessee incurs any expenditure in any previous year by way of
payment of any sum to an employee at the time of his voluntary retirement under any
scheme of voluntary retirement 1/5th of the amount so paid shall be deducted in
computing the profits and gains of the business for that previous year and the balance in
equal instalments for each of the four immediately succeeding previous years.
Deduction for Expenditure on Prospecting for Minerals [Section 35E]
This section has been inserted with a view to encouraging investment in high risk
areas, especially in exploiting amortisation of expenditure incurred wholly and exclusively
on any operations relating to prospecting for certain specified minerals or groups of
minerals or on developing mines etc. Following points are to be noted:
1. Deduction is available only to an Indian resident or an Indian company but not
to any foreign citizen or foreign company.
2. 1/10th of the amount of expenditure would be allowed as a deduction for the
10 years beginning with the years in which commercial production starts.
142
Notes
3. Expenses, to be amortised, will be expenses incurred under the specified

heads during the five years period ending with the year of commercial
production.
4. If, in any year, income arising out of commercial exploitation of wasting asset is
NIL or insufficient to absorb, the allowance under this section the unabsorbed
allowance is to be carried forward to the next year(s). However, this process of
carry forward cannot be continued beyond 10 years as reckoned from the year
of commercial production.
5. Deduction in case of amalgamation/demerger Where in a scheme of
amalgamation, the Indian company is transferred to another Indian company
before the expiry of the said period of 10 years, the provisions of this section
shall, as far as may be, apply to the amalgamated company as they would
have applied to the amalgamating company if the amalgamation had not taken
place. Similarly where the undertaking of an Indian company which is entitled
to deduction under this section, before the expiry of the period of 10 years to
another company in a scheme of demerger, no deduction shall be admissible
in this case to the demerged company for the previous year in which the
demerger takes place and the provision of this section, as far as may be, apply
to the resulting company, if the demerger had not taken place.
Other Deductions under Section 36: There are various other expenses, which are
allowed as deduction u/s 36 for obtaining the taxable profits. They are briefly described
below:
1. Insurance premium paid for risk or damage or destruction of stock or stores or
other inventories or assets used for the business or profession will be
deductible [Section 36(1)(i)].
2. Insurance of life of cattle Insurance premium paid by a federal milk
cooperative society on the life of any cattle owned by any member of a primary
milk cooperative society affiliated to it will be allowed as a deduction [Section
36(1)(ia)].
3. Employees Health Insurance Premium paid by cheque by an
employer-assessee to effect or keep in force insurance of the health of his
employees under an approved scheme will be avowed as a deduction in
computing his business income [Section 36(1)(ib)].
4. Bonus and Commission paid to an employee for services rendered by him, will
be allowed as a deduction, subject to a primary condition that the amount has
not been distributed by way of profits or dividends and such bonus or
commission has been paid in the relevant previous year or on or before the due
date of filing of the return of income of the assessee [Section 36(1)(ii)].
5. Interest on money borrowed Interest paid in respect of money borrowed for
the purposes of business or profession is deductible u/s 36(1)(iii), provided the
following conditions are satisfied. Pro rata discount on zero coupon bonds also
gets allowed under this category subject to certain conditions:
(a) Money must have been borrowed by the assessee.
(b) It must be borrowed for the purpose of business or profession.
(c) Interest is paid or is payable on such a borrowing.
6. Discount on issue of Zero Coupon Bonds to be allowed as deduction on pro
rata basis [(Section 36(1)(iiia)] The pro-rata amount of discount on a zero
coupon bond having regard to the period of life of such a bond calculated in the
manner prescribed below.
7.
7a.
8.
9.
10.
11.
143
Discount means the difference between the amount received or receivable by

the infrastructure capital company or infrastructure capital fund or public sector
company issuing the bond and the amount payable by such a company or fund
or public sector company on maturity or redemption of such a bond. Period of
the life of the bond means the period commencing from the date of issue of the
bond and ending on the date of maturity or redemption of such a bond.
Infrastructure capital company and infrastructure capital fund shall have the
same meanings respectively assigned to them as provided in Explanation I to
Clause 23G of Section 10.
The employers contribution to a recognised provident fund or approved
superannuation fund is allowed as deduction, subject to the limit laid down for
such payments and provided these payments have been made on or before
the due date of making such payments by the employer [Section 36 (1)(iv)].
Employers contribution towards a pension scheme referred to in section
80CCD [Section 36(1)(iva)].
The employers contribution to an approved gratuity fund will be allowed as a
deduction, provided these payments have been made on or before the due
date of making such payments by the employer [Section 36(1)(v)].
The employees contribution to approved or statutory staff welfare schemes will
be allowed as a deduction from the income of the employer provided such
amounts have been paid on or before the due date of making such payments
[Section 36(1)(va)].
Animals written off In the case of animals used for the purpose of business/
profession otherwise than a stock-in-trade, if such animals have died or have
become permanently useless for the purpose of such business or profession,
the difference between their actual cost and the amount realised on sale of
those animals or their carcasses will be allowed as a deduction [Section
36(1)(vi)].
Bad Debts [Section 36 (1)(vii)] Bad debts, which are written off as
irrecoverable, can be deducted subject to the following conditions:
(a) The debt or loan should be in respect of a business, which was carried on
during the relevant previous year.
(b) The debt must have been taken into account in computing the income of
the assessee of the previous year in which such a debt is written off or of
an earlier previous year. [In the case of a banking company, such a debt
should represent money lent in the ordinary course of the business of
banking or money lending.]
Notes
Recovery of bad debt in the subsequent year shall be added to the taxable income
of the previous year in which recovery is made u/s 41(4).
12. Provision for bad and doubtful debts by commercial banks (other than a
cooperative bank) [Section 36(1)(viia)].
(a) A scheduled or non-scheduled bank may provide for the provision for bad
and doubtful debts up to 7.5% of their total income (before making any
deductions under Chapter VIA) plus an additional 10% of the aggregate
average advances made by the rural branches of these banks.
(b) Foreign banks may make such provision up to 5% of the total income
(before making deduction under Chapter VIA).
(c) Public financial institutions may make such provision up to 5% of the total
income (before making deductions under Chapter VIA).
144
Notes
Important Points:
1. A scheduled bank means the SBI, a subsidiary bank of SBI, a corresponding
new bank constituted u/s 3 of the Banking Companies (Acquisition and
Transfer of Undertaking) Act, 1970/1980 of a bank included in the second
schedule to RBI, 1934, but doesnt include a cooperative bank.
2. Foreign bank refers to the bank incorporated in a foreign country.
3. A scheduled bank or non-scheduled bank at its option is allowed a further
deduction in excess of the limits specified, for an amount not exceeding the
income derived from the redemption of securities in accordance with a scheme
framed by the Central Government. No deduction, as aforesaid, shall be
allowed unless such income has been disclosed in the return of income under
the head Profits and Gains of Business/Profession).
13. Transfer to a special reserve [Section 36(1)(viii), w.e.f. A.Y. 2008-09]: A
public financial corporation engaged in long-term finance for industrial or
agricultural developments or infrastructure development in India and a public
company formed and registered in India with the main object of providing
long-term finance for industrial or agricultural developments or infrastructure
development in India and a public company formed and registered in India with
the main object of providing long-term finance for the construction or purchase
of residential housing in India are entitled for deduction of the amount
transferred by them to a special reserve account subject to a maximum of 20%
of profit from such business (computed before making any deductions under
Chapter VIA). However, where the aggregate amounts carried to such
reserves from time to time exceeds twice the paid-up share capital and
reserves, no allowance is further allowed.
14. Family Planning Expenditure [Section 36(1)(ix)]: Any expenditure bona-fide
incurred by the company for the purpose of promoting family planning among
the employees is allowed as a deduction. If such expenditure is of a revenue
nature, the entire amount will be allowed as a deduction if it is of a capital
nature (such as, purchase of equipment or construction of a clinic or
dispensary). 1/5th of the expenditure will be allowed as a deduction in each of
the five years from the year in which such expenditure has been incurred in
equal instalments.
15. Revenue expenditure incurred by a corporation or body corporate for the
objects and purposes authorised [Section 36(1)(xii)].
Any expenditure (not being in the nature of capital expenditure) incurred by a
corporation or a body corporate by whatever name called, shall be allowed as
deduction in computing its income under Section 28 of the act, if the following
conditions are satisfied:
(a) It is constituted or established by a Central, State or Provincial Act.
(b) Such corporation or body corporate, having regard to the objects and
purposes of the act referred to in sub-clause (a) is notified by the Central
Government in the Official Gazette for the purposes of this clause; and
(c) The expenditure is incurred for the objects and purposes authorised by
the act under which it is constituted or established.
16. Contributions made by a financial institution to a notified credit
guarantee fund trust for small industries [Section 36(1)(xiv)]: Any sum
paid by a public institution by way of a contribution to such credit guarantee
fund trust for small industries as the Central Government may, by notification in
the Official Gazette, specified in this behalf, shall be allowed as deduction.
145
General Deductions under Section 37

1. General deductions are allowed for expenses which are not covered by any
other section will be allowed as a deduction under Section 37 provided the
following conditions are satisfied:
(a) Expenditure should not be covered specifically by any of the provisions of
Section 30 to 36.
(b) Such expense should be in respect of a business carried out by the
assessee and the profits of which are to be computed and assessed and
should be incurred after the business set up.
(c) It should not be in the nature of personal expenses of the assessee.
(d) Such expenses should not be in the nature of capital expenditure.
(e) Such expenses should have been incurred only and exclusively for the
purpose of such business.
(f) Such expenses should not be incurred for any purpose which is an
offence as prohibited by law.
2. Under this section, therefore, expenses by the way of cost of raw materials,
tools, spares, etc. cost of labour, salary and various expenses incurred by the
assessee will be allowed as a deduction.
3. Few items of business expenditure covered under Section 37 are as follows:
4. Salary/wages for training period: The salaries and wages paid to the
employees for the period of the training in the courses organised by the Central
Board of Workers Education should be allowed as admissible deduction while
computing the income of the employers Letter: F.No.27 (30)-IT/59, dated
6-7-1959.
5. Membership fees: The expenditure by the way of membership fee of the
Indian Institute of Foreign Trade can be said to be wholly and exclusively
incurred for the purpose of business of the members. Therefore, such
expenditure may be allowed as admissible deduction under Section 37(a) in
the hands of the payers in computing their total income from business Letter:
F. No.9/54/64-IT (A-1), dated 2-9-1964 and Letter: F. No.9/56/66-IT (A-I), dated
17-1-1967.
6. The expenditure by way of membership fee of the Indian Institute of Packaging
can be said to be wholly and exclusively incurred for the purpose of business of
the members. Therefore, such expenditure may be allowed as admissible
deduction, under Section 37(1), in the hands of the prayers in computing their
total income from business Letter: F No. 9/23/67-IT (a-1) dated 26.08.1965.
7. Laga contribution Where laga contribution is made at the customary
rate prevalent in the market, such contribution should be allowed in full
in the assessment of the member-contributors Circular: No. 5-P (XIV-1)
dated 28.09.1963].
8. Share listing expenses: Expenses incurred by a company on getting its
shares listed in a stock exchange should be considered as laid out wholly and
exclusively for the purposes of the business and therefore, admissible as
business expenditure under Section 37(1) [Letter F. No. 10/67-65-IT (A-1)
dated 26.08.1965.
9. Professional Tax: Professional tax paid by a person carrying on business or
trade can be allowed to him as a deduction under Section 37(1) Circular No.
16(F. No. 9/38/69-IT (A-II)], dated 18.09.1969.
Notes
146
Notes
10. Payments under profit sharing scheme: Where the payments made under a
profit sharing scheme are bonafide and not merely a device to reduce tax
liability and the sums have actually been paid to the employees, the amounts
may be treated to have been expended wholly and exclusively for the purposes
of the employers business Circular No. 64(XI-2) [F. No. 27(10)-IT-51], dated
27.10.1951.
11. Rebate/bonus to members by Consumer Cooperative stores:
Rebate/bonus (which is in the nature of deferred discount) passed on by the
consumer cooperative stores to their members on the value of the purchases
made by them during a year should be allowed as a deduction in computing the
business income of such a society Circular No. 117 [F. No. 201/5/73-IT (A-II)],
dated 22.08.1973.
12. Remuneration paid by a company to the Registrar: Reasonable
remuneration paid by a company to its Registrar for performing duties in
connection with the companys legal obligations to be discharged under the
company law should be regarded as revenue expenditure, provided the
company is not itself maintaining a separate organisation for the performance
of such duties Letter [F. No. 10/25/63-IT (A-I)], dated 18.06.1964.
13. Expenses allowable to Indian authors/writers: In cases of Indian authors/
writers where the amount receivable from royalties/writings is less than
` 25,000 and where detailed accounts regarding expenses incurred are not
maintained, claims of expenses to the extent of 25% of such amount or
` 5,000, whichever is less, may be allowed in the year of publication of a book
or other publication, including articles. The expenses to the extent mentioned
above will be allowable without calling for any evidence in support of the claim.
This circular will not, however, be available in cases of such authors/writers
who are included in the terms of film artistes being storywriters, screenplay
writers and dialogue writers if they are engaged in their professional capacity in
the production of cinematograph film Letter [F. No. 204/42/77-IT (A-II)], dated
28.09.1977.
14. Royalty/dead rent: Royalty and dead rent paid under the Mineral Concession
Rules, 1960 will have to be allowed as revenue deduction Circular No. 1D
(IV-53), dated 20.01.1966.
15. Expenses on sales tax assessments/appeals: The expenses incurred in
original proceedings for assessment to sales tax as also in appeals arising
from such proceedings should be allowed as a deduction in income tax
assessments Circular No. 2 [C. No. 27(8)-IT/46], dated 8.3.1946.
16. Maintenance expenses on tea garden: All expenditure on the maintenance
of a tea garden, including expenditure on the maintenance of an area that has
not reached maturity, is an item of revenue expenditure and as such is
allowable as deduction for the purposes of computing the income of a tea
estate, under the Income Tax Act Source: Income Tax Circulars published by
Directorate of Inspection (RS and P), 1968 Edition, p. 192.
17. Telephone/conveyance expenses of newspaper agencies: Expenditure on
qua telephones and conveyance laid out wholly and exclusively by small
newspaper agencies for the purposes of the business can be allowed as
deduction, but any expenditure in the nature of personal expenses of such
assessees is not admissible as deduction.
18. In determining the non-business part of such expenditure, the Assessing
Officers need not go into meticulous details regarding each item and the
19.
20.
21.
22.
23.
24.
25.
26.
147
officers should adopt a reasonable approach in this respect having regard to

the circumstances of the newspaper business Letter F. No. 35/5/65-IT (A-I),
dated 1.7.1965.
Initial installation of fluorescent lights: The initial expenditure on the first
installation of fluorescent lights, including the expenditure on wiring and fittings,
should be treated as capital expenditure as it creates an asset and all
subsequent expenditure for replacement of the tubes should be treated as of a
revenue nature, allowable in lot Circular No. 69(XIX-3) [F. No. 27(31)-IT/51],
dated 27.11.1951.
Expenditure on visits to foreign countries: The question of admissibility of
expenditure on visits to foreign countries should not be approached from the
point of view as to whether such visits result immediately in the earning of
profits. All that the law requires is that the expenditure should not be in the
nature of capital expenditure or personal expenditure of the assessee and
should be wholly and exclusively laid out for the purposes of the business
Circular No. 4 [C. No. 27(3)-IT/50], dated 19.06.1950.
Maintenance expenses of Industrial Home Guard Units: Revenue
expenses incurred by the industrial undertakings in connection with the
maintenance of the Industrial Home Guard Units may be treated as deductible
expenses under Section 37(1) Letter F. No. 10/80/64-IT (A-1), dated
26.02.1965.
Interest payable on unpaid purchase price of plant and machinery:
Expenditure on interest payable on the unpaid purchase price of plant or
machinery should be allowed as revenue deduction under Section 37(1)
Letter F. No. 10/92/64-IT (A-I), dated 13.09.1965.
Labour welfare expenditure: Any expenditure on labour welfare work, not of
a capital nature actually incurred during the previous year should be
allowed in entirety as deduction in income tax assessments, irrespective of the
actual amount of profits for that year available for meeting the expenditure
Circular No. 3 [R. Disc No. 27(50)-IT/46], dated 26.3.1946.
Legal expenses for renewal of lease: Legal expenses incurred in connection
with the renewal of lease should be allowed as an admissible deduction for the
purposes of income tax, provided that the renewal of the lease is for a period of
less than fifty years. Expenditure incurred on the compulsory removal of
business premise, i.e., in cases where the removal has taken place under the
directions of government should, as in the case of air raid precautions
expenditure, be allowed as a deduction for purposes of income tax Circular
No. 22 [R. Disc. No. 27(53)- IT/43], dated 23.06.1943.
Managerial subsidy to the employees cooperative stores: Out of the
financial assistance to be given by the employers in connection with setting up
of consumers cooperative stores for industrial workers, the managerial subsidy
to meet the establishment cost, such as salaries and rent charges on a
tapering basis for three years, may be treated as being of the nature of
expenditure for the welfare of the industrial workers of the employer concerned
and can be permitted to be deducted in computing the taxable income of the
employer Letter F. No. 10/16/63-IT (A-1), dated 14.05.1963.
Contribution to a subsidised industrial housing scheme: The contributions
to a fund set up under a subsidised industrial housing scheme cannot be
regarded as admissible deduction under Section 37(1) of the Act Letter F. No.
10/8/63-IT (A-1) dated 14.10.1963.
Notes
148
Notes
27. Contribution by members to a cycle export pool: The contributions made

by members to the cycle export pool vide rule 5(c) of the scheme, will be
admissible as a deduction under Section 37(1) of the Act in their assessments.
The subsidies received from the pool by the members will be treated as taxable
income in their hands Letter F. No. (24)-IT/59, dated 19.5.1959.
28. Guarantee commission paid to banks: Commission payable to banks for
furnishing guarantees regarding deferred payments for the import of plant and
machinery is in the nature of a capital expenditure and cannot be allowed as
deduction in computing the total income under the Income Tax Act. The Board
has, however, no objection to permit such expenditure to be added to the cost
of the plant and machinery and to allow depreciation thereon at the usual
prescribed rates Letter F. No. 7/33/62-IT (A-I), dated 28.8.1963.
29. Commitment charges on the unused portion of a loan: Commitment
charge payable by a party on the unused portion of the loan which has not
been drawn, has to be taken as an expenditure laid out wholly and exclusively
for the purposes of the business and therefore, permissible as a revenue
deduction under Section 37(1) Circular No. 2-P (XI-6) [F. No. 10/67/65-IT
(A-I)], dated 23.08.1965.
30. Expenses on Diwali and Mahurat: As the expenses incurred on the occasion
of Diwali and Mahurat are in the nature of business expenditure, it has been
decided not to lay down any monetary limits for the purpose of their
allowance Letter F. No. 13A/20/68-IT (A-II), dated 03.10.1968.
31. Incidental expenses on raising loans on short-term basis: Incidental
expenses incurred for raising other short-term loans from financial institutions
by way of temporary accommodation or ordinary trading facilities can be
allowed as deduction in computing the income from business subject to the
following conditions:
(a) The short-term loan is of a duration of not more than two years, and
(b) The total amount of incidental expenses does not normally exceed 1% of
the amount of the loan raised Letter: F. No. 32/6/62-IT (A-1) dated
16.1.1963.
32. Education cess: Education cess is allowable as a deduction. Source: Extracts
from the minutes of the 16th meeting of CDTAC held on 2.2.1972.
33. Amount paid under OYT Scheme for Telephone: It is open to the subscriber
either to claim the entire amount paid under the OYT scheme in the year in
which the payment is made or proportionately in the years for which an
advance payment of the rent is made. Where the installation of telephone is in
the previous year subsequent to the previous year in which the deposit is made,
the deduction for the payment should be allowed in the year of payment
irrespective of the fact whether the telephone has been installed or not
Instruction: No. 943 [F. No. 204/15/76-IT (A-II)], dated 2.4.1976.
34. Amount paid under Tatkal Telephone Deposit Scheme: Amount paid by
an assessee for obtaining a new telephone connection under the Tatkal
Telephone Deposit Scheme can be allowed as revenue expenditure in the
year of payment. The refund of said amount, if any, will be taxed under Section
41(1) Circular No. 671, dated 27.10.1993.
35. Deposit paid for a telex connection: Since the deposit of ` 10,000 for a telex
connection does not earn any interest when the telex machine is installed, at
that stage, this amount may be treated as a revenue expenditure allowable as
a deduction, if the assessee makes such a claim. However, when the amount
36.
37.
38.
39.
40.
41.
149
is returned by the postal authorities when the telex connection is finally closed,
the refund of ` 10,000 shall be treated as an income of the assessee of the
year in which the amount is refunded Circular No. 420 ([F. No. 204/10/83-IT
(A-II)] dated 4.6.1985.
Expenses abroad on market promotion and similar export promotional
activities: With regard to the expenses incurred by members of a delegation
going abroad for exploring new markets for Indian products and similar export
promotional activities, all reasonable expenditure incurred by the members of
the delegations should be allowed in the assessment of the members
concerned Circular No. 2(40)/6-EAC, dated 16/17.1.1967, issued by the
Ministry of Commerce.
Training of apprentices: In view of the statutory obligation cast on the
employers under the provisions of the Apprentices Act, 1961, recurring
expenses incurred on imparting of the basic training to the apprentices under
the said act will be allowable as a deduction under Section 37(1).
As regards expenses for imparting of practical training under Practical
Training Stipends Scheme and Programme of Apprenticeship Training
(PAT), these expenses will not be covered within the meaning of Section 37(1),
as no statutory obligation is cast on the employer under these two training
schemes Circular No. 192 [F. No. 204/39/75-IT (A-II)]; dated 10.3.1976.
Additional price and year in which deductible: Additional price payable to
the cultivators is to be allowed as a deduction in the year in which the additional
liability arose and not in the year to which it relates as it was ascertained only
on the date of the order of the price fixation authority Instruction: No. 745
F. No. 228/28/74-IT (A-II), dated 30.8.1974. [Source: 153rd Report (1974-75)
of the Public Accounts Committee, p. 66].
Interest on delayed payment to SSI ancillary units: For the Assessment
Year 1993-94 and later years, the interest on delayed payments to Small Scale
Ancillary Industrial Undertakings Act, 1993 shall be applicable and the
Assessing Officers are entitled to disallow the interest inadmissible under the
said act in the assessment of buyers Circular No. 651, dated 11.6.1963.
VRS ex gratia payments: Ex gratia amount paid by an assessee/employer for
gaining enduring benefit or advantage under the Voluntary Retirement Scheme
is a capital expenditure Press release, dated 23.1.2001.
Notes
Examples of Expenditure not allowed as Deduction u/s 37(1)

1. Expenditure incurred by way of stamp paper, underwriting commission,
registration fees, lawyers fees etc. in connection with the issue of debentures
is of a capital nature and cannot in law be allowed as deduction.
2. Incidental expenses incurred for raising short-term loans from financial
institutions by way of temporary accommodation or ordinary trading facilities
can be allowed as deduction in computing the income from business subject to
(a) the short-term loan is of a duration of not more than two years and
(b) the total amount of incidental expenses does not normally exceed 1% of
the amount of the loan raised.
3. Commission payable to banks for furnishing guarantees regarding deferred
payments for import of plant and machinery is in the nature of a capital
expenditure and cannot be allowed as deduction in computing the total income
under the Income Tax Act. The Board has, however, no objection to permit
150
Notes
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
such expenditure to be added to the cost of the plant and machinery and to
allow depreciation thereon at the usual prescribed rates Letter F. No.
7/33/62-IT (A-I), dated 22.08.1963.
Fees paid to the Registrar of Companies for bringing about change in the
Memorandum and Article is a capital expenditure.
The legal expenses incurred in connection with the amalgamation of the
assessee company with another company is capital expenditure.
Expenditure incurred by the assessee for getting vacant possession of land
owned by it is not revenue expenditure.
Bank guarantee commission for payment of taxes is capital expenditure.
Payment for obtaining tenancy rights is in the nature of premium, though the
called contribution is capital expenditure.
Penalty paid for violation or infringement of any law is not allowable.
Expenditure incurred by a company in connection with shifting of his registered
office is not allowable.
Expenditure incurred in dismantling of building in order to construct a hotel is
not allowed, as these are capital in nature.
Pension paid to the widow of the chairman of the board of directors, who was
not an employee of the company nor was there any agreement for such
payment between the company and the chairman is not deductible.
Assessee made payment to ward off competition of business to a rival. Held it
was capital expenditure.
Interest paid for non-payment, less payment, delayed payment, deferment of
advance tax cannot be allowed as business expenditure nor is it in the nature
of payment of other taxes like purchase tax expenditure.
Sales tax is a tax on the sale or purchase of goods and not on profits, hence, a
deductible expense. But taxes such as income tax, surcharge etc. are not
expenditure laid for the purposes but are paid after the profits are earned,
hence, not deductible expenses.
Deduction for the Building Partly Used for Business and Partly Used as Dwelling
House [Section 38]
Where the premises are used partly for the business and partly for other purposes,
only a proportionate part of the expenses attributable to the part of the premises used for
the purposes of business will be allowed as deduction.
4.4.4 Expenses Not Deductible
Section 40: Disallows certain amounts specifically
business/professional income, in the following manner :
while
computing
Section 40(a): Disallowance in case of all assessees.

Section 40(b): Disallowance in case of Partnership firm.
Section 40(ba): Disallowance in case of AOP or BOI Provisions of above sections
are briefly explained as follows.
151
Table 4.5: Disallowance in the case of AOP or BOI Provisions

Section No. and
Type of
Assessee
All assesses
Section 40(a)
Notes
Disallowance under Section 40
1.
Wealth tax.
2.
Income tax.
3.
Payments outside India : Interest, royalty, fees for technical services or

other sum chargeable outside India, on which tax has not been
deducted at source or after deduction it has not been paid to the
government shall not be allowed.
4.
Payment in India to a Non-resident (not being a company) or to a

foreign company; interest, royalty, fees for technical services on which
tax has not been deducted or after deduction it has not been paid to
the government.
5.
Any interest, commission or brokerage, fees for professional services

or fees for technical services payable to a resident or any amount
payable to a contractor/sub-contractor will not be allowed as a
deduction if the income tax has not been deducted and paid.
6.
Salary payable outside India or to a Non-resident in India without

deducting tax at source or after deducting it has not been paid to the
Government.
7.
Payment to Provident Fund or other fund established for the benefit of

the employees of the assessee, unless the assessee has made proper
arrangement to deduct tax at source on the payments made from the
fund which are chargeable to tax under the head salaries.
Explanation: Any tax on business assets (other than wealth tax) is
deductible. Hence, tax paid on tea garden lands under UP. Large Land
Holdings Tax Act 1937, is deductible (Dehradun Tea Co. Ltd. v. CIT
SC).
8.
Tax on perquisites paid by the employer on behalf of the employee

(which is exempt u/s 10(10CC) in the hands of the employee is not
allowed as a deduction from business income in the hands of the
employer (assessee) via Section 40(a)(v).
9.
Any sum paid on account of securities transaction tax under Chapter

VII of Finance Act 2004.
10. Any sum paid on account of fringe benefit tax under Chapter XII.
Section 40 (b)
in case of
partnership firm
Deductions on account of interest and remuneration to the partners can be

claimed under section 36 or 37 as the case may be but it will be subject to
the conditions prescribed as under:
1.
Payment of salary, bonus, commission, or remuneration by whatever

name called, to a non-working partner shall not be allowed as
deduction.
2.
Payment of remuneration to working partners and interest to any

partner will be allowed as deduction only when it is authorized by and
is in accordance with partnership deed.
3.
Payment of remuneration/interest, although authorized by the

partnership deed but which relates to a period prior to the date of such
partnership deed, shall not be allowed.
4.
Interest payable to a partner, although authorized by the partnership

deed shall be allowed as a deduction subject to a maximum of 12%
152

simple interest p.a. or as provided by the partnership deed, which ever
is lower.
Notes
5.
The remuneration to all working partners shall not exceed the following
limits (w.e.f.AY 2010-11) :
(a) In case of a firm carrying on business or profession: On the first
` 3,00,000 of the book profit (or loss) ` 1, 50,000 or @ 90% of the
book profit, whichever is more
(b) On the balance of book profit ---> @ 60%
Explanation:
Such disallowance is not applicable where an individual is a partner in
the capacity of:
Representative and payment is done in individual capacity. OR
Individual and payment is done in representative capacity
AOP/BOI 40 (ba)
Interest payment by AOP/BOI to a member as well as salary/bonus/

commission, or remuneration paid by AOP/BOI will not be allowed as a
deduction:
Explanation:
1.
If the AOP/BOI pays certain amount of interest to its members and the
member has also paid certain amount of interest to it, only so much of
the interest paid in excess of amount received from the member shall
be disallowed in computation of income of AOP/BOI.
2.
Where the individual is a member of AOP/BOI in a representative

capacity, interest paid by AOP/BOI to such an individual,
otherwise
than as a member in representative capacity will not be disallowed.
3.
Where an individual is a member of AOP/BOI, otherwise than as a

member in representative capacity, interest paid by AOP/BOI to such
individual will not be disallowed.
Expenses of payments not deductible where such payments are made to relatives
[Section 40A(2)]
Where an assessee incurs any expenditure, in respect of which payment has been
made or is to be made to certain specified persons and the Assessing Officer is of the
opinion that such expenditure is excessive or unreasonable having regard to the fair
market value of the goods, services or facilities for which the payment is made or the
legitimate needs of the business or profession of the assessee or the benefits derived or
accruing to him therefore, so much of the expenditure, as is so considered by him to be
excessive or unreasonable, shall not be allowed as a deduction. Therefore, for an
amount to be disallowed under this section, two conditions have to be fulfilled:
(a) The payment is made to a specified person.
(b) The payment for the expenditure is considered excessive or unreasonable
having regard to fair market value of the goods, services or facilities.
Specified persons: The specified persons are, in case of an assessee who is an
individual where payment is made:
(i) any relative (i.e., spouse, any brother, sister, lineal ascendant or descendant)
of such individual;
(ii) any person (individual, company, firm AOP, HUF, etc.) having a substantial
interest in the business of the individual (i.e., being entitled to not less than
20% of the profit of the business of the individual);
153
(iii) any person of which a director, partner or member has a substantial interest in
the business of the individual any relative of any such person given under (ii)
or (iii) above.
Notes
Company: Where the payment is made to:

(i) any director of the company or his relative;
(ii) any person (individual firm, company, AOP, HUF etc.) having a substantial
interest (i.e., owning at least 20% voting rights on holding of equity shares) in
the company;
the company;
any relative of person given as (ii) and (iii).
Firm: Where the payment is made to :
(i) any partner of the firm or his relative;
(ii) any partner of which a director, partner or member has a substantial interest in
the business of the firm;
the business of the firm;
any relative of such person; gives in (ii) or (iii) above.
AOP or HUF: Where the payment is made to:
(i) any member of the AOP or HUF, as the case may be; or his relative;
(ii) any person having substantial interest in the business of the AOP or HUF as
the case may be;
(iii) any person of which a directors, partner or member has a substantial interest in
the business of the AOP or HUF, as the case may be;
any relative of person: given in (ii) or (iii) above.
Judicial Decisions:
1. Unless it is determined that the expenditure was excessive or unreasonable,
this section would not apply to case [Upper India Publishing House (P) Ltd., v.
CIT (1979) 117 ITR 569 (SC)].
2. The words goods, services and facilities, referred to in this section mean those
which have some market value and are commercial in character.
Disallowance out of cash expenditure exceeding ` 20, 000 [Section 40A(3)]:
Where the assessee incurs any expenditure, in respect of which payment is made, in a
sum exceeding ` 20,000 otherwise than by a crossed cheque drawn on a bank or a
crossed bank draft, 100% of such expenditure shall not be allowed as a deduction.
However, there are certain exceptions provided in Rule 6DD, under which expenditure,
even exceeding ` 20, 000 shall be allowed as deduction, even though the payment is not
made by a crossed cheque/draft. These exceptions are:
(a) Payments made to banks, including cooperative banks or land mortgage banks,
Life Insurance Corporation and financial institutions like IDBI, UTI, State
Industrial Development Corporations and State Financial Corporations,
Primary Agricultural Credit Societies.
(b) Payments made to the Government where such payment is required to be
made in legal tender, for e.g., payment of sales-tax, customs duty, excises duty
etc.
(c) Payments made by way of Letter of Credit, telegraphic transfer, transfer from
one bank account to another or through a Bill of Exchange payable to a bank
154
Notes
(d) Where the payment is made by way of adjustment against the amount of any
liability incurred by the payee for any goods supplied or services rendered by
the assessee to such payee.
(e) Payment for purchases of : (i) agricultural or forest produce, (ii) the produce of
animal husbandry (including hides and skins), dairy or poultry farming, (iii) fish
cultivator, grower or producer of such articles.
(f) Payments made for purchases of products manufactured without the aid of
power in a cottage industry, if the payment is made to the producer of such
products.
(g) Where the payment is made in a village or town, which is not served by any
bank, to any person who ordinarily resides or is carrying on any business,
profession or vacation in any village or town.
(h) Payment by way of gratuity, retrenchment compensation or similar terminal
benefits made to an employee or his legal heirs, if the income under the head
salary of the employee does not exceed ` 50,000.
(i) Payment made by way of salary to its employees after deducting the Income
Tax from the salary, when such an employee is temporarily posted for a
continuous period of fifteen days or more in a place other than his normal place
of duty or on a ship and the employee does not maintain any account in any
bank at such place.
(j) Where the payment is required to be made on a date on which the banks were
closed, either on account of a holiday or strike.
(k) Payment made by any person to his agent who is required to make payments
in cash for goods or services on behalf of such a person.
(l) where the payment is made by an authorized dealer or a money changer
against purchase of foreign currency or travelers cheques in the normal course
of business.
Scope of Disallowance and Cash Payments under Section 40(A)(3)
Section 40(A)(3) applies to all categories of expenditure involving payments for
goods or services, which is deductible in computing the taxable income. It does not apply
to loan transactions or to payments made by commission agents (arhatiyas) for goods
received by them for sale on commission or consignment basis. It does apply to
payments made for goods purchased on credit. Hundi transactions entered into in
connection with the advancing of loans or the repaying of loans are outside the scope of
Section 40(A)(3). Payments made to the grower or producer of agricultural products are
excluded from the operation of Section 40(A)(3) even where these have been subjected
to some processing by him. Payments, made in towns having banking facilities for
purchase of goods from a villager whose village does not have banking facilities, are not
excluded from the requirement in Section 40(A)(3) [Press Note: Dated 2.5.1969, issued
by the Ministry of Finance].
The word expenditure in Section 40(A)(3) covers expenditure of all categories
including that on purchase of goods and merchandise as also payment for services. The
payments made in advancing loans and returning the principal amounts of borrowed
moneys are not covered by these provisions of Section 40(A)(3) [Letter: F. No.
1(22)/69-TPL (Pt.), dated 18.4.1969].
Return of paid cheques by a bank to its constituents: Banks may now return the paid
cheques to their constituents after obtaining a formal undertaking from them to the effect
that they shall retain the returned paid cheques for a period of eight years and produce
155
them before the ITO whenever called upon to do so [Circular No. 33 F. No. 9/50/69-IT
(A-II), dated 29.12.1969].
Notes
Payments made during suspension of clearing operations: Any payment for

business expenditure made during the period when the cheque clearing operations are
suspended or other similar circumstances exist, will not be covered by the provisions of
Section 40(A)(3) [Circular No. 250 F. No. 206/1/79-IT (A-II), dated 11.01.1979].
The suspension of cheque clearing and banking operations consequential to the
strike of bank employees will constitute exceptional or unavoidable circumstances.
Accordingly, payments for business expenditure made during this period and until the
clearance of cheques is resumed, will be exempted from the operation of Section
40(A)(3)* [Letter F. No. 142(14)/70-TPL, dated 28.9.1970].
Illustrative situations of exceptional circumstances: All the circumstances in
which the conditions laid down in rule 6 DD (j)* would be applicable cannot be spelt out.
However, some of them, which would seem to meet the requirements of the said rule,
are :
(a) The purchaser is new to the seller; or
(b) The transactions are made at place where either the purchaser or the seller
does not have a bank account; or
(c) The transactions and payments are made on a bank holiday or the seller is
refusing to accept the payment by way of crossed cheque/draft and the
purchasers business interest would suffer due to non availability of goods
otherwise than from this particular seller; or
(d) The seller, acting as a commission agent, is required to pay cash in turn to
persons from whom he has purchased the goods; or specific discount is given
by the seller for payment to be made by way of cash [Circular No. 220 [F. No.
206/17/76-IT (A-II)] dated 31.05.1977].
Important Points:
1. The provisions of Section 40(A)(3) are attracted only when a payment
exceeding ` 20,000 at a time is made in cash. It is possible that a person may
make different payments at different times during the day to the same person
and the aggregate of the payments during the day to the same party may
exceed ` 20,000. In this case, if each payment is below ` 20,000 no
disallowance can be made.
2. The provisions of the section do not cover payments for acquiring capital
assets not for resale.
Provision for Gratuity [Section 40A(7)]:
Gratuity actually paid during the year is allowed as a deduction. Provision made for
the payment of gratuity to the employees on retirement or on termination of services will
not be allowed as a deduction in computing taxable profits of the business or profession.
However, any provision made by the assessee for the purpose of payment of a sum by
way of any contribution towards an approved gratuity fund or for the purpose of payment
of any gratuity that has become payable during the previous year, shall not be
disallowed.
Contribution to Non-statutory Fund [Section 40(A)(9)]:
No deduction shall be allowed in respect of any sum paid by the assessee as an
employer towards the setting up of any fund or as contribution to any funds or trust
except where such sum is paid to a recognised provident fund or an approved
superannuation fund or approved gratuity fund.
156

Table 4.6: Certain Deductions to be made only on Actual Payments [Section 43B]
Notes
Expenses
When payment should be made to

get the deduction
During the previous year or on or
before due date for furnishing return of
income under Section 139(1).
1.
Any sum payable by way of tax, duty or fee under

any law
2.
Any sum payable by the assessee as an employer

by way of contribution to any provident fund or
superannuation fund or gratuity fund or any other
fund for the welfare of employees
3.
Any sum payable as bonus or commission to

employees
4.
Interest on loans or advances or borrowings from

scheduled banks and public financial institutions
or State Financial Investment Corporation or State
Financial Corporation like ICICI, IDBI, GIC, UTI,
SFC, with the terms and conditions governing
such loan or borrowing
5.
Any sum payable by the assessee as interest on

any loan or advance from a scheduled bank in
accordance with the terms and conditions of the
agreement governing such loan
6.
Contribution to provident fund, superannuation

fund or any other fund for the welfare of the
employee
As given above
Any sum payable by an employer in lieu of leave at

the credit of his employee
As given above
Special Provisions in case of Income of a Public Financial Institution, Public

Companies etc. [Section 43D]:
1. In the case of a public financial institution or a scheduled bank or a State
Financial Corporation or a State Industrial Investment corporation, the income
by way of interest in relation to such categories of bad or doubtful debts as may
be prescribed having regard to guidelines issued by the RBI.
2. In the case of a public company, the income by way of interest in relation to
such categories of bad or doubtful debts, as may be prescribed, having regard
to guidelines issued by the National Housing Bank in relation to such debts,
shall be chargeable to tax in the previous year in which it is credited to the
respective profit and loss account or as the case may be, the year in which it is
actually received by the institution or bank or corporation or company,
whichever is earlier.
4.4.5 Miscellaneous Provisions
Profit Chargeable to Tax [Section 41]
Recovery of any loss or expenditure [Section 41(1)] : Where any allowance or
deduction has been made in the assessment of any year in respect of loss, expenditure
or trading liability and subsequently, during any previous year, any amount received by
the assessee whether in cash or in any other manner in respect of such loss or
expenditure or some benefit for such trading liability by way of remission or cessation
157
thereof, the amount obtained by him or benefit accruing to him is chargeable to tax as
business income.
Notes
Important Points:
1. Recovery of loss or expenditure is taxable, irrespective of the fact that whether
the business or profession is in existence in that year or not.
2. Where the assessee to whom the trading liability may have been allowed has
succeeded in his business, then the successor in business will be chargeable
to tax on any amount received in relation to which deduction or allowance has
been made. Successor in business means:
(a) In case of amalgamation, the amalgamated company;
(b) Where a firm is succeeded by another firm, the other firm;
(c) Where a person is succeeded by any other person, the other person;
(d) Where there has been a demerger, the resulting company.
Balancing Charge [Section 41(2)]: Where any building, machinery, plant or
furniture:
(a) which is owned by the assessee;
(b) in respect of which depreciation is claimed under Section 32(1)(i);
(c) which was or has been used for the purpose of business;
is sold, discarded, demolished or destroyed and the money is payable in respect of
such building, machinery, plant or furniture, as the case may be together with the amount
of scrap value, if any, exceeds the written down value, so much of the excess as does not
exceed the difference between the actual cost and the written down value shall be
chargeable to Income Tax as the income of the business of the previous year in which
the money is payable for the building, machinery, plant or furniture became due.
If the business is no longer in existence the provisions of Section 41(2) shall apply as
if the business is in existence in that previous year.
Sale of Asset used for Scientific Research [Section 41(3)]: If a capital asset
used for scientific research is sold without having been used for other purposes and the
sale proceeds together with the deduction, allowed u/s 35 exceeds the amount of capital
expenditure incurred on it, such surplus or the amount of deduction allowed u/s 35,
whichever is less, is chargeable to tax as business income of the previous year in which
the sale took place. If the deduction allowed is less than the aforesaid surplus, the excess
of surplus over the deduction allowed is chargeable to tax as capital gain.
Bad Debts Recovered [Section 41(4)] : Where the deduction has been allowed in
respect of a bad debt or part of debt under Section 36(1)(vii) then if the amount
subsequently recovered on such debt (or part) is greater than the difference between the
debt (or part of the debt) and the amount of deduction so allowed, the excess shall be
deemed to be profits and gains of business or profession and chargeable to tax as the
income of the previous year in which the debt is recovered. For this purpose, it is
immaterial whether the business of the assessee is in existence during the P.Y. in which
recovery is made.
Withdrawal of special reserve created by financial institutions [Section 41(4A)]:
Where a deduction has been allowed under Section 36(1)(viii) at the time of creation of
Reserve, withdrawal of the same will amount to income.
Set off Losses against Deemed Profits [Section 41(5)]: Deemed profits from
Business/Profession u/s 41 can be used to set off business/profession losses, if the
following conditions are fulfilled :
1. Business/profession is ceased to exist.
158
Notes
2. Loss must pertain to the year in which the business/profession ceased to exist.
3. It is not possible to set off such loss against any other income of that year.
4. Loss is not from speculation business.
Recovery after discontinuance of business [Section 176(3A)]: Where any
business is discontinued in any year and any sum is recovered thereafter, it will be
deemed to be income of the recipient and charged to tax in the year of receipt, provided
that it had been chargeable to tax had it been received before the discontinuance of the
business.
Special deduction in case of business of exploiting mineral oil including of
petroleum and natural gas [Section 42] : Special allowance in this regard would be
in relation to:
1. expenditure incurred by way of exploration expenses prior to beginning of
commercial production;
2. expenditure incurred in respect of drilling or exploration activities after the
beginning of commercial production;
3. expenditure incurred in relation to the depletion of mineral oil.
Special provision consequential to changes in the rate of exchange of
currency [Section 43A]: Where an assessee has acquired any asset in any the
previous year from a country outside India, for the purpose of his business or profession
and in consequence of a charge in the rate of exchange during any previous year after
the acquisition of such asset, there is an increase or reduction in the liability of the
assessee as expressed in Indian currency (as compared to the liability existing at the
time of acquisition of the asset) at the time of making payment:
(a) towards the whole or part of the cost of the asset or
(b) towards repayment of the whole or a part of the moneys borrowed by him from
any person, directly or indirectly in any foreign currency specifically for the
purpose of acquiring the asset along with interest, if any.
The amount by which the liability as aforesaid is so increased or reduced during
such previous year and which is taken into account at the time of making the payment,
irrespective of the method of accounting adopted by the assessee, shall be added to r as
the case may be, deducted for :
1. The actual cost of the asset as defined in Section 43(1).
2. The amount of capital expenditure referred to in Section 35(1)(iv) (Scientific
Research).
3. Expenditure in the nature of capital expenditure on acquisition of Patent Rights
or copyrights as provided in Section 35A.
4. The cost of acquisition of a capital asset (not being a capital asset referred to in
section 50 computation of capital gains in case of depreciable asset) for the
purpose of mode of computation of capital gains as mentioned in Section 48.
5. The amount of expenditure of a capital nature referred to in Section 36(1)(ix),
i.e., promoting family planning amongst its employees and the amount arrived
at after such addition or deduction shall be taken to be the actual cost of the
asset or the amount of capital expenditure as the case may be, the cost of
acquisition of the capital asset.
Profits and Gains of Insurance Business [Section 44]: The profits and gains of
any business of insurance carried on by an insurance company or by a mutual insurance
company or by a cooperative society shall be computed in accordance with the rules
contained in the First Schedule and not in accordance with the provisions of this Act.
159
In case of insurance business of a non-resident, the taxable income shall be

computed in the following manner:
Notes
Global income Premium income in India/Total premium income of the company =

Total income in India
Maintenance of Accounts by certain persons carrying on profession or
business [Section 44AA and Rule 6f]:
A. Person carrying on a specified profession: Every person, carrying on
specified profession, is compulsorily required to maintain prescribed books of accounts
and documents if his gross receipts in the profession exceed ` 1,50,000 in all the three
years immediately preceding the previous year or where the profession has been newly
set up in the previous year, if his gross receipts for that year are likely to exceed the said
amount.
Specified profession: Specified profession include persons carrying on the
following professions :
(a) a person carrying on legal, medical, engineering or architectural profession or
the profession of accountancy or technical consultancy or interior decoration or
any other profession as is notified by the Board in the Official Gazette.
(b) authorised representatives, film artists and company secretaries have been
notified for this purpose.
Authorised representative means a person, who represents any other person, on
payment of any fee or remuneration, before any Tribunal or Authority constituted or
appointed by or under any law for the time being in force, but does not include an
employee of the person so represented or a person carrying on legal profession or a
person carrying on the profession of accountancy.
Film artist, for the aforesaid purpose, means any person engaged in his professional
capacity in the production of a cinematograph film, whether produced by him or by any
other person as an actor, a cameraman, a director, a music director, an art director, a
dance director, an editor, a singer, a lyricist, a story writer, a screen play writer, a
dialogue writer and a dress designer.
The prescribed books and documents under Rule 6F are as follows:
(a) A cashbook,
(b) A journal, if the accounts are maintained according to the mercantile system of
accounting,
(c) A ledger,
(d) Carbon copies of machine numbered bills, exceeding ` 25, issued by the
person,
(e) Original bills wherever issued to the person and receipts are not issued and the
expenditure incurred does not exceed fifty rupees payment vouchers prepared
and signed by the person.
A person carrying on the medical profession shall, in addition to the above books of
accounts and documents, keep and maintain the following also:
(a) a daily case register in Form 3C;
(b) an inventory under broad heads as on the first and the last day of the previous
year, of the stock of drugs, medicines and other consumable accessories used
for the purpose of his profession.
Persons carrying on specified profession, but whose receipts from the profession
do not exceed the aforesaid amount, are also required to maintain books of accounts,
160
Notes
but in their case, no books have been prescribed. They should maintain such books of
accounts and other documents and other documents as may enable the Assessing
Officer to compute their taxable income under the Income Tax Act.
B. Person carrying on a non-specified profession or carrying on business:
Every other person carrying on a business or non-specified profession, whose total
income from business or profession exceeds ` 1,20,000 or his total sales or gross
receipts from such business or profession exceed ` 10,00,000 in any of the three years
immediately preceding the relevant previous year is required to maintain books of
accounts. However, in the case of a newly set up business, the assessee will be required
to maintain accounts compulsorily if, during the relevant accounting year, either his total
income is likely to exceed ` 1,20,000 or the total sales or gross receipts are likely to
exceed ` 10,00,000.
Person falling under the above category is required to maintain such books of
accounts and other documents as may enable the assessing officer to compute their
taxable income under the Income Tax Act. No specified accounts books have been
prescribed for this category of persons.
C. Assessees covered under Sections 44AD, 44AE, 44AF, 44BB or 44BBB: An
assessee who is carrying on a business and is covered under Sections 44AD (civil
constructions), 44AE (goods carriages) and 44AF (retail trade) claims that his income
from the said business is lower than the deemed profits or gains computed under the
above relevant sections, he shall be required to keep and maintain such books of
accounts and other documents as may enable the Assessing Officer to compute his total
income in accordance with the provisions of Income Tax Act. Further in these cases, the
assessee will be required to get his accounts audited even if his turnover does not
exceed ` 1 crore.
(i) Assessee is carrying on a business or non-specified profession;
(ii) The income or total sales or a gross receipt is less than the specified amount;
(iii) If he is covered under Sections 44 AD, 44AE, 44AF he should not declare
income lower than that which is prescribed under these relevant sections.
Compulsory Audit of Accounts [Section 44AB]:
1. Every person carrying on business shall, if his total sales, turnover or gross
receipts in business exceed ` 100,00,000 in any previous year, get his
accounts of such previous year audited by a Chartered Accountant before the
specified date and furnish by that date the report of such audit in the prescribed
form, duly signed and verified, by such accountant.
Specified date is November 30 of the relevant Assessment Year in the case of
assessee who has undertaken international transaction as per section 92B or
specified domestic transaction as per newly inserted section 92BA and 30th
September of the relevant assessment year in case of any other assessee.
2. In the case of person carrying on a profession, the provisions for compulsory
audit are applicable if his gross receipts in profession exceed ` 25,00,000 in
any previous year.
3. Similarly in case of a person who is carrying on the business and covered
under Sections 44AD and claims that his income from the said business is
lower than 8% of the turnover and his income exceeds the maximum amount
which is not chargeable to income tax in any previous year; he shall get his
accounts of the previous year audited by a chartered Accountant on or before
the specified date.
161
Report of Audit of Accounts (Rule 6G):

(a) In the case of a person who carries on business or profession and who is
required by or under any other law to get his accounts audited, be in Form
No. 3CA;
(b) In the case of a person who carries on business or profession, but not
being a person referred to in clause (a), be in Form No. 3CB.
2. The particulars which are required to be furnished under section 44AB shall be
in Form No. 3CD.
Notes
Special Provisions for computing profits and gains of business on presumptive

basis [Section 44AD]
The broad features of the scheme are as under:
(a) The scheme shall be applicable to an individual, a HUF or partnership firm who
is a resident but not to a Limited Liability partnership firm. The scheme shall
also not be applicable to an assessee who is availing deductions u/s 10AA or
deduction under any provisions of chapter VIA.
(b) This scheme shall not be applicable if the aforesaid gross receipts paid or
payable exceeds an amount of ` 100,00,000.
Gross Receipts are the amount paid/payable to the assessee by the clients
for the contract and will not include the value of the material supplied by the
client.
(c) Presumptive taxation is not applicable to a person carrying on profession as
referred to in section 44AA(1); a person carrying income in the nature of
commission or brokerage income; or, a person carrying on any agency
business.
(d) a sum equal to 8% of the total turnover or gross receipts of the assessee in the
previous year on account of such business or as the case may be, a sum
higher than the aforesaid sum claimed to have been earned by the eligible
assessee shall be deemed to be the profits and gains of such business.
(e) Any deduction allowable under the provisions of Sections 30 to 38, shall, for
the purpose of above income, be deemed to have been already given full effect
to and no further deduction under those Sections shall be allowed. However,
where the eligible assessee is a firm, the salary and interest paid/payable to
partners shall be allowed as deduction from the income computed under this
Section. Such deduction shall, however, be subject to the conditions and limits
specified u/s 40(b).
(e) The written down value of any asset used for the purpose of the business shall
be deemed to have been calculated as if the assessee had claimed and had
been actually allowed the deduction in respect of the depreciation for each of
the relevant assessment years.
(f) an assessee opting for the above scheme shall be exempted from payment of
advance tax related to such business under the current provisions of the
Income tax Act.
(g) an assessee opting for the above scheme shall be exempted from
maintenance of books of accounts related to such business as required u/s
44AA of the Income Tax Act
(h) An assessee with turnover below ` 1 crore, who shows an income below the
presumptive rate prescribed under these provisions, will, in case his total
income exceeds the taxable limit, be required to maintain books of accounts as
162
Notes
per section 44AA(2) and also get then audited and furnish report of each such
audit as required under section 44AB
Special Provisions for computing Profits and Gains of Business of Plying,
Hiring or Leasing Goods Carriages [Section 44AE]:
Notwithstanding any to the contrary contained in sections 28 to 43C, the scheme u/s
44AE also provides for a system for estimating the income of an assessee engaged in
the business of plying, hiring, or leasing of goods carriages. The broad features of the
scheme are:
(a) The scheme is applicable to an assessee who owns not more than 10 goods
carriages at any time during the previous year and who is engaged in the
business of plying, hiring or leasing of such goods carriages;
(b) The profits and gains of each goods carriage owned by the above assessee in
the previous year shall be estimated as under:
(i) For heavy goods vehicle ` 5,000 or actual amount earned whichever is
higher for every month or part of a month during which the heavy vehicle
is owned by the assessee in the previous year.
(ii) For goods carriage other than heavy goods vehicle - ` 4,500 or actual
amount for every month or a part of a month in during which the goods
carriage is owned by the assessee in the previous year. The assessee
may declare a higher income than that specified above.
(c) Any deduction allowable under the provisions of Sections 30 to 38 shall, for the
purpose of the above income, be deemed to have been already given full effect
to and no further deduction under those Sections shall be allowed.
Remuneration and interest paid/payable to partners, shall be allowed as
deduction from the income computed under this Section. Such deduction shall,
however, be subject to the conditions and limits specified u/s 40 (b).
(d) The Written Down Value of any asset used for the purpose of the business
shall be deemed to have been calculated as if the assessee had claimed and
had been actually allowed the deduction in respect of the depreciation for each
of the relevant assessment years.
(e) The provisions of Sections 44AA and 44AB shall not apply in so far as they
relate to this business. And in computing the monetary limits under those
Sections for other business, the gross receipts or, as the case may be, the
income from the said business shall be excluded.
(f) The assessee may choose not to opt for the scheme and may declare an
income lower than the specified amount. In this case, w.e.f. assessment year
1998-99 the assessee shall have to maintain books of accounts and get his
accounts audited by a Chartered Accountant.
Special Notes
1. The expression goods carriage and heavy goods vehicle shall have the
meanings respectively assigned to them in Section 2 of the Motor Vehicles Act,
1988. According to Section 2(14) of the Motor Vehicles Act, 1988 the
expression goods carriage means:
(a) any motor vehicle constructed or adapted for use solely for the carriage of
goods, or
(b) any motor vehicle not so constructed or adapted when used for the
carriage of goods and according to Section 2(16) of the Act, the
expression heavy goods vehicle means
(i) any goods carriage the gross vehicle weight of which, or
2.
3.
4.
5.
6.
163
(ii) a tractor the unladen weight of which, or

(iii) a road roller the unladen weight of which, exceeds 12,000 kilograms.
An assessee, who is in possession of a goods carriage, whether taken on hire
purchase or on instalments.
And for which the whole or part of the amount payable is still due, shall be
deemed to be the owner of such goods carriage.
The income estimated as per Section 44AE, shall be his income from the
business of plying, hiring, or leasing goods carriages. This income will be
aggregated with the other income of the assessee and deductions u/s 80C to
80U, if any, will be available to the assessee, subject to fulfillment of conditions
mentioned therein.
Income from vehicles is to be computed for every month or part of the month
during which these were owned by the assessee even though these are not
actually used for business.
Provision of section 44AE are not applicable in case the assessee owns more
than 10 goods carriage or where he decides lower profits and gains than the
profits and gains specified in section 44AE.
Notes
Special Provisions for Computing Profits and Gains of Retail Business upto
A.Y. 2010-11 only [Section 44AF]:
A special scheme has been introduced for estimating the profits and gains of
assessees engaged in retail trade and the broad features of the scheme are as under:
(a) In the case of an assessee engaged in retail trade in any goods or
merchandise, a sum equal to 5% of the total turnover in the previous year on
account of such business shall be deemed to be profits and gains of such
business chargeable under the head profits and gains of business or
profession. The assessee can however voluntarily declare a higher income in
his return. The scheme shall not be applicable if the total turnover of such retail
trade exceeds ` 40 lakhs in the previous year.
(b) Any deduction allowable under the provisions of sections 30 to 38 shall for the
purpose of above income be deemed to have been already given full effect to
and no further deduction under these sections shall be allowed. However,
remuneration to working partner and interest paid or payable to partner shall be
allowed as deduction from the income computed under this section. Such
deduction shall however be subject to conditions and limits specified under
section 40(b).
(c) The written down value of any asset used for the purpose of the business shall
been actually the deduction in respect of depreciation for each of the relevant
assessment years.
(d) The provisions of sections 44AA and 44 AB shall not apply in so far as they
relate to this business and in computing the monetary limits under these
sections, the total turnover or as the case may be, the income from said
business shall be excluded.
(e) The assessee may choose not to opt for this scheme and may declare an
income lower than the specified amount. In this case, the assessee shall have
to keep and maintain books of accounts as per Section 44AB.
With effect from assessment year 2011-12, section 44AF will be deleted and a
new section 44AD shall substitute the existing provision sec. 44AD as the act has
164
Notes
expanded the scope of presumptive taxation to all business. The salient features of
the presumptive taxation scheme are as under:
(a) The scheme shall be applicable to individuals, HUFs and the partnership firms
excluding Limited liability partnership firms. It shall also not be applicable to an
assessee who is availing deductions under sections 10A, 10AA, 10B, 10BA or
deductions under any provisions of Chapter VIA under the heading
C-deductions in respect of certain incomes in the relevant assessment year.
(b) The scheme is applicable for any business (excluding a business already
covered under section 44AE) which has maximum gross turnover/gross
receipts of ` 40 lakhs.
(c) A sum equal to 8% of the total turnover or gross receipts of the assessee in the
(d) Any deduction allowable under the provisions of sections 30 to 38 shall for the
section 40(b).
assessment years.
(f) An assessee opting for the above scheme shall be exempted from payment of
Income Tax Act.
(g) An assessee opting for the above scheme shall be exempted from
maintenance of books of accounts related to such business as required under
section 44AA of the income tax Act.
(h) An assessee with turnover below ` 40 lakh who shows an income below the
per section 44AA(2) and also get them audited and furnish a report of each
such audit u/s 44AB.
(i) The existing section 44AF will be made inoperative for the Assessment Year
beginning on or after 1-4-2011.
Special provisions in the case of shipping business [Section 44B]
In the case of an assessee, who is a non-resident and is engaged in the business of
operation of ships, a sum equal to 7.5 percent of the aggregate of the following:
(a) The amounts paid or payable whether in or out of India to the assessee on
account of carriage of passengers, livestock, mail or goods shipped at any port
in India, and,
(b) Any amount received or deemed to be received in India on account of carriage
of passengers, livestock, mail or goods shipped at any port outside India, shall
be deemed to be the profits of such business. The carriage amount will also
include amount paid or payable by way of demurrage charge or any other
amount of similar nature.
165
Special provision for deduction in the case of business for prospecting etc.
for mineral oil [Section 42 and 44BB].
Notes
Section 42: Special deduction in case of business of exploiting mineral oil

including of petroleum and natural gas: Special allowance in this regard would be in
relation to:
1. Expenditure incurred by way of exploration expenses prior to beginning of
commercial production.
2. Expenditure incurred in respect of drilling or exploration activities after the
beginning of commercial production.
3. Expenditure incurred in relation to the depletion of mineral oil.
The provision of Section 44BB are given below:
Condition:
(i) The assessee is non-resident.
(ii) The assessee is engaged in the business of providing services and facilities in
connection with or supplying plant and machinery on hire, used or to be used in
the exploration for and exploitation of mineral oils.
Consequences if the above conditions are satisfied:
(i) The provisions of sections 28 to 41, 43 and 43A are not applicable.
(ii) Income is calculated at the rate of 10% of the amounts given below.
(iii) The amount in respect of which the provisions apply are the amounts paid or
payable to the tax payer or to any person on this behalf whether in or out of
India, on account of the provision of aforesaid services or facilities or supplying
plant and machinery for the aforesaid purposes. The amount also includes the
amounts received or deemed to be received in India on account of such
services or facilities or supply of plant and machinery.
Special provisions for computing profits and gains of business of operations
of aircraft in the case of non-residents [Section 44BBA]: Notwithstanding anything to
the contrary contained in Sections 28 to 43A, the income of a non-resident engaged in
the business of operation of an aircraft shall be completed at flat rate of 5% of:
(a) the amount paid or payable whether in India or out of India to the assessee or
to any person on his behalf on account of carriage of passengers, livestock,
mail or goods from any place in India and
(b) The amount received or deemed to be received in India, on account of carriage
of such items from a place outside India.
Special provisions for computing profits and gains of foreign companies
engaged in the business of civil construction etc. in certain turnkey power projects
[Section 44BBB]: Notwithstanding anything to the contrary contained in Section 28 to
44AA in the case of an assessee, being a foreign company, engaged in the business of
civil construction or the business of erection of plant or machinery or testing or
commissioning thereof, in connection with a turnkey power project approved by the
Central Government in this behalf and financed under international aid programme, a
sum equal to 10% of the amount paid or payable (whether in or out of India) to the said
assessee or to any person on his behalf on account of such civil construction, erection,
testing or commissioning shall be deemed to be profits and gains of such business
chargeable to tax under the head Profits and Gains of Business/Profession.
Method of Accounting:
1. Mercantile system of accounting is compulsory for business, whereas cash
system is permitted for professionals. Accrual principle is followed in mercantile
166
Notes
system which refers to the assumption that revenues and costs are accrued,
that is, recognised as they are earned or incurred (and not as money is
received or paid) and recorded in the financial statements of the periods to
which they relate.
2. The following accounting standards are notified, to be followed by all the
assessees following mercantile system of accounting, namely:
3. Accounting Standard I relating to disclosure of accounting policies:
I. All significant accounting policies adopted in the preparation and
presentation of financial statements shall be disclosed.
II. The disclosure of the significant accounting policies shall form part of the
financial statements and the significant accounting policies shall normally
be disclosed in one place.
III. Any change in an accounting policy which has a material effect in the
previous year or in the years subsequent to the previous years shall be
disclosed. The impact of and the adjustments resulting, from, such
change, if material, shall be shown in the financial statements of the
period in which such change is made to reflect the effect of such change.
Where the effect of such a change is not ascertainable, wholly or in part,
the fact shall be indicated. If a change is made in the accounting policies
which has no material effect on the financial statements for the previous
year but which is reasonably expected to have a material effect in any
year subsequent to previous year, the fact of such change shall be
appropriately disclosed in the previous year in which the change is
adopted.
IV. Accounting policies adopted by an assessee should be such so as to
represent a true and fair view of the state of affairs of the business,
profession or vocation in the financial statements prepared and presented
on the basis of such accounting policies. For this purpose, the major
considerations governing the selection and application of accounting
policies are following namely:
(a) Prudence: Provisions should be made for all known liabilities and
losses even though the amount cannot be determined with certainty
and represents only a best estimate in the light of available
information.
(b) Substance over form: The accounting treatment and presentation
in financial statements of transactions and events should be
governed by their substance and not merely by the legal form.
(c) Materiality: Financial statements should disclose all material items,
the knowledge of which might influence the decisions of the user of
the financial statements.
4. If the fundamental accounting assumptions relating to Going Concern,
Consistency and Accrual are followed in financial statements, specific
disclosure in respect of such assumptions is not required. If a fundamental
accounting assumption is not followed, such fact shall be disclosed.
Consistency refers to the assumption that accounting policies are consistent
from one period to another. Financial Statements means any statement to
provide information about the financial position, performance and changes in
the financial position of an assessee and includes balance sheet, profit and
loss account and other statements and explanatory notes forming part thereof.
Going Concern refers to the assumption that the assessee has neither the
167
intention nor the necessity of liquidation or of curtailing materially the scale of

the business, profession or vocation and intends to continue his business,
profession or vocation for the foreseeable future.
5. Accounting Standard II relating to disclosure of prior period and extraordinary
items and changes in accounting policies.
Prior period items shall be separately disclosed in the profit and loss account
as part of taxable income. The nature and amount of each such item shall be
separately disclosed in a manner so that their relative significance and effect
on the operating results of the previous year can be perceived.
A change in an accounting policy shall be made only if the adoption of a
different accounting policy is required by statute or if it is considered that the
change would result in a more appropriate preparation or presentation of the
financial statements by an assessee.
Any change in an accounting policy, which has a material effect, shall be
disclosed. The impact of and the adjustments resulting from such change, if
material shall be shown in the financial statements of the period in which such
change is made to reflect the effect of such change. Where the effect of such
change is not ascertainable, wholly or in part, the fact shall be indicated. If a
change is made in the accounting policies which has no material effect on the
financial statements for the previous year but which is reasonably expected to
have a material effect in years subsequent to the previous years, the fact of
such change shall be appropriately disclosed in the previous year in which the
change is adopted.
A change in an accounting estimate that has a material effect in previous year
shall be disclosed and quantified. Any change in an accounting estimate which
is reasonably expected to have a material effect in years subsequent to
previous year shall also be disclosed.
Notes
Deduction of Head Office Expenditure in the case of Non-residents [Section

44C]: Notwithstanding anything to the contrary contained in Sections 28 to 43A, in the
case of an assessee, being a non-resident no allowance shall be made in computing the
income changeable under the head Profits and Gains of Business/Profession, in respect
of so much of the expenditure in the nature of head office expenditure as is in excess of
the amount computed as hereunder normally:
(a) an amount equal to five percent of the adjusted total income or
(b) the amount of expenditure in the nature of head office expenditure incurred by
the assessee as is attributable to the business or profession of the assessee in
India, whichever is the least.
Provided that, in a case where the adjusted total income of the assessee is a loss,
the amount under clause (a) shall be computed at the rate of five percent of the average
adjusted total income of the assessee during the last three years so that loss of that
particular year need not be accounted for computing average adjusted total income. H.O.
expenses means executive and general administration expenditure incurred by the
assessee outside India including rent, rates, taxes, repairs or insurance of any premises
outside India used for the purpose of business. Salary, wages, annuity, pension, fees,
bonus, commission, gratuity, perquisites or profits in lieu of or in addition to salary of any
office outside India, travelling by an employee or other persons employed in or managing
the affairs of any office situated outside India, and such other matters connected with
executive and general administration as may be prescribed.
168
Notes
Special Provisions in the Case of Royalty Income of Foreign Companies

[Section 44D]
The provisions are given below:
Agreement made before April 1, 1976: Where such income is received under an
agreement before April 1, 1976, the deduction in respect of expenses incurred for
earning such income is subject to a ceiling limit of 20% of the gross amount of such
income, as reduced by the amount, if any, of so much of the royalty income as consists of
lump sum consideration for the transfer outside India of, or the imparting of information
outside India in respect of, any data, documentation, drawing or specification relating to
any patent, invention, model, design, secret formula or process or trade mark or similar
property.
Agreement made after April 1, 1976 not being covered by Section 44D
Royalties and technical service fees received under an agreement made after
31-3-1976 but before 1-6-1997 not being covered by Section 44DA are chargeable to tax
@ 30% (+ SC + EC); under an agreement made after 31-5-1997 but before 1-6-2005 @
20%; and in pursuance of an agreement made after 31-5-2005 @ 10%; by virtue of
section 115A in the following four cases
(a) Where such agreement is with the Government of India; or
(b) Where such agreement is with an Indian concern, the agreement is approved
by the Central Government ; or
(c) Where such agreement relates to a matter included in the industrial policy, for
the time being in force, of the Government of India, the agreement is in
accordance with that policy; or
(d) Where such royalty is in consideration for the transfer of all or any rights
(including the granting of a license) in respect of copyright in any book on a
subject referred to in proviso to subsection (IA) of Section 115A to the Indian
concern or in respect of computer software referred to the second proviso to
Section 115A(IA) to a person resident in India
Special provision for computing income by way of royalties etc. in the case of
non-residents in pursuance of an agreement entered into after 31-3-2003 Section
44DA:
The income by way of royalty or fees for technical services received from
government or an Indian concern in pursuance of an agreement made by a non resident
(not being a company) or a foreign company with govt. of the Indian concern after 31st
day of March 2003, where such non-resident (not being a company) or a foreign
company carries on business in India through a permanent establishment situated
therein, or perform professional services from a fixed place of profession situated therein
and the right property or contract in respect of which the royalties or fees for technical
services are paid is effectively connected with such permanent establishment or fixed
place of profession, as the case may be, shall be computed under the head Profits and
gains of business or profession in accordance with the provisions of this Act.
Provided that no deduction shall be allowed:
1. In respect of any expenditure or allowance which is not wholly and exclusively
incurred for the business of such permanent establishment or fixed place of
professions in India or
2. In respect of amounts, if any, paid (otherwise than towards reimbursement of
actual expenses), by the permanent establishments to its head office or to any
of its other offices.
169
It may be noted that every non-resident (not being a company) or a foreign company
shall keep and maintain books of accounts and other documents in accordance with the
provisions contained in Section 44AA and get his accounts audited by an accountant as
defined in Section 288(2) and furnish along with the return of income, the report of such
audit in the prescribed form duly signed and verified.
Notes
Note: In order to remove the doubts and clarify the distinct scheme of taxation of
income by way of technical services, it is proposed (by Finance Bill 2010) to amend the
proviso to Section 44BB so as to exclude the applicability of section 44BB to the income
which is covered under section 44DA. Similarly section 44DA is also proposed to be
amended to provide that provisions of section 44BB shall not apply to the income
covered under section 44DA.
Problems on Computation of Income from Business/Profession
Problem 1: Dr J.L. Gupta is a renowned medical practitioner who maintains books
on cash basis. The following is the balance sheet of the receipts and payments a/c for the
financial year 2013-14 in `.
Particulars
Balance brought forward
`
44,000
Consultation fees
2012-13
5,000
2013-14
1,35,000
Visiting fees
Loan from bank
30,000
1,25,000
Sale of medicines
60,000
Gifts from patients
5,000
Royalties for articles published in

various journals
Particulars
Rent of clinic
2013-14
24,800
2014-15
1.200
2,000
Water & Electricity Bills

Purchase of professional books
40,000
Household expenses
47,800
Collection charges for dividend

income
Motor car purchased
6,000
100
1,30,000
Surgical equipment purchased
24,800
Income-tax
7,000
Interest on Government
Banking cash transaction tax
3,000
Securities
Salary to staff
15,000
Life insurance premium
15,000
Dividend
10,000
7,000
Gift to son
4,27,000
5,000
Interest on loan
11,000
Car expenses
15,000
Purchase of medicines
40,000
Balance c/d
45,300
4,27,000
Compute his income from profession for the A.Y. 2014-15 after taking into account
the following information:
1. Books worth ` 25, 000 were purchased on 15-5-2013, which were annual
publication and the balance on 5-2-2014 which were books other than annual
publications.
2. Car was purchased on 1-1-2014 and the surgical equipment on 4-9-2013.
3. It is estimated that 1/3 of the use of car is for his personal use.
4. Gifts and presents include ` 2,000 from patients in appreciation of his medical
service and ` 3,000 received as birthday gifts.
170
Notes
5. Opening and closing stock of medicines amounted to ` 10,000 and ` 6,000

respectively.
Solution:
`
Particulars
Gross receipts
Consultation fees
2012-13
2013-14
Visiting fees
Sale of medicines
Gifts from patients
5,000
1,35,000
30,000
60,000
2,000
2,32,000
Less: Expenses:
Rent of the clinic
2013-14
24,800
2014-15
1,200
Water & Electricity Bills
2,000
Depreciation books
On 25000-100%
25,000
On 15,000-30%
4,500
Depreciation on car [15% (1/2 130,000 2/3)]
6,500
Depreciation on surgical equipment [15% on 24,800]
3,720
Banking cash transaction tax
3,000
Salary to staff
15,000
Interest on loan
11,000
Car expenses [2/3 15,000]
10,000
Medicines consumed [40,000 + 10,000 6,000]
44,000
1,50,720
81,280
Income from profession

Royalty for articles is taxable under the head Income from other sources
Books which are annual publications are eligible for depreciation @ 100% whereas
books other than annual publication are eligible for Depreciation @ 60%. Since the books
which are not annual publication were purchased on 5-2-2014, depreciation should be
charged @ 50% of 60%, i.e., 30%.
Problem 2: R is engaged in the business of civil construction. The profit and loss
account of the company for the year ending 31-3-2013 is as under:
Particulars
Opening stock of building materials
Salary to workers and employees
Purchase of building materials
`
40,000
4,10,000
24,00,000
Interest on loan
3,20,000
Office Admin. Expenses
2,60,000
Travelling expenses
1,40,000
Municipal taxes on godown

Insurance premium for godown
12,000
8,000
Particulars
Receipts from the business of civil

construction contracts
37,60,000
Rent of godown
Surplus from insurance
compensation received for loss of
plant and machines by fire
80,000
2,00,000
Interest on company deposits
25,000
Dividend from companies
50,000

Directors remuneration
171
2,53,000
Depreciation on plant and machinery
Closing stock of building materials
25,000
65,000
Notes
Provision for tax

Current tax
1,00,000
Deferred tax
43,000
Net profit
89,000
41,40,000
41,40,000
Some additional information is given below:

1. Municipal tax of godown includes ` 3,000 not paid by the company.
2. The book value of the plant and machinery, which was insured against fire was
` 4,20,000. The WDV of plant and machinery block under Section 43(6) as on
31-3-2012 was ` 1, 85,000.
3. The entire building material was purchased from a firm in which the MD of this
company is a partner. The fair market value of materials purchased is
` 20,00,000.
4. Interest on loan includes ` 15,000 being interest on loan taken for investment in
shares of various companies.
5. Office admin. Expenses include ` 90,000 paid as a donation to charitable
organisation recognised under Section 80G.
6. The prescribed rate of depreciation under the I-T Rules for Plant and
Machinery is 15%.
7. The company has decided to follow the presumptive tax provision in respect of
its business income.
Compute the total income of X Ltd. for the A.Y.2013-14. Your answer should include
explanations of your treatment of various items. Ignore the provision of minimum
alternate tax under Section 115JB.
Solution:
Computation of income from house property
Rent from godown
80,000
Less municipal tax on godown actually paid during P.Y. 2012-13
9,000
71,000
Deduction u/s 24
Statutory deduction @ 30%
21,300
49,700
Computation of business income

Income from business of civil construction (8% of 37,60,000)
3,00,800
Computation of capital gains

Sales consideration 4,20,000 + surplus 2,00,000
6,20,000
Less: WDV of plant and machines block as on 1-4-2012

(assuming such WDV is after deducting depreciation for
previous year 2011-12)
1,85,000
Short-term capital gains
4.35,000
172
Notes
Computation of income from other sources

Interest on company deposits
25,000
Dividend from companies
Exempt
Income from other sources
25,000
Gross total Income

Less: Deduction u/s 80G ` 90,000 but 50% of the adjusted
8,10,500
Gross total income, i.e., 50% of 81,050
40,525
Total income
7,69,975
Rounded to the nearest ten

Problem 3: A submits to you following profit and loss A/c for the year ending
31-3-2013. The date of furnishing the return of income in his case is 30-9-2013.
+3
`
Particulars
1,50,000
Salary
Bonus 25%
37,500
Repairs of house property
15,000
Municipal taxes of house property
20,000
Repairs of machine
30,000
Expenditure on scientific research
20,000
Depreciation @25% on machine

purchased for scientific research for
6 months
12,500
Donation to National Lab for Scientific

Research
10,000
Patents and copyrights (1/10)
14,000
Amortisation of Preliminary Exp. (2/5)
5,000
Bad debts
5,000
Provision for bad and doubtful debts
10,000
Expenses
on
family
amongst employees
12,000
planning
Donation to approved institution for

family planning
8,000
Premia for insurance on health of

employees
20,000
Interest on borrowed capital
50,000
Contribution to RPF @ 14% of

employees salary
Contribution to ESI
18,000
6,000
Entertainment expenses
20,000
Advertisement expenses
50,000
Travelling expenses
60,000
Expenses on guest house:

(a) Repair of guest house
(b) Salary to employees
(c) Other expenses
Loss due to theft of stocks
Particulars
5,000
12,000
8,000
10,000
9,08,000
Gross profit
Rent of 50% house property
given on rent
24,000
Bad debt recovered,

allowed as deduction
10,000
earlier
Excise duty recovered, earlier

not allowed as deduction
Receipts from
guest house
guests
5,000
using
12,000
Gift from father
10,000
Profit on machine sold
15,000

Life insurance premium of A
173
5,000
Loss of stock due to fire
15,000
Sales tax
60,000
Sales tax penalty
10,000
Interest for late payment of sales tax
6,000
Diwali expenses
10,000
Lump sum for technical know-how

acquired on 1-1-2011
30,000
Income-tax paid
30,000
Wealth-tax due
20,000
Depr. on machine sold @ 20% for

9 months
15,000
Depr. on machine purch. @ 20% for

9 months
24,000
Depr. on machine purch. @ 20% for

3 months
6,000
Depr. on machine @ 20% for full year

Net Profit
Notes
25,000
1,20,000
9,84,000
9,84,000
Additional information:
1. Salary includes ` 10,000 paid to employees as entertainment allowance.
2. Bonus was due on 31-3-2013 which was paid as under:
25-7-2013
` 30,000
30-11-2013 ` 7,500
3. Municipal taxes were due on 31-3-2013. ` 15000 were paid on 29-7-2013. The
balance is still outstanding. The due date as per municipal laws was 15-4-2013.
50% of the house property is used for own business and the balance 50% has
been let out to others for business.
4. ` 5,000 paid towards insurance on health of employees was paid in cash.
5. Interest includes the following
(a) Interest on money borrowed for purchase of machine during the year put to
use immediately ` 20,000. The loan was taken from a financial institution.
The interest was due on 31-3-2013 but was paid on 31-12-2013
(b) Interest on money borrowed for purchase of house property ` 30, 000.
6. ` 1000 as contribution to ESI by employer, already included in P & L A/c was
due on 31-3-2013 but was paid on 20-11-2013.
7. ` 2000 was recovered as contribution by workers on account of PF for the
month of March 2010. It was supposed to be deposited by 15-4-2010 but was
deposited on 30-4-2010.
8. Entertainment includes:
(a) ` 13,000 spent on providing food and beverages to employees at place of
work;
(b) ` 6000 spent on providing food and beverages to customers at office.
9. Advertisement expenses include ` 40,000 being cost of 20 brief cases given to
customers. It also includes ` 5,000 for advertisement given to a political party.
10. Travelling expenses were paid to employees @ ` 2,000 per day.
174
11. Sales tax includes a sum of ` 20,000 due on 31-3-2013. The same was paid on
31-5-2013. The due date under the sales tax law was 15-5-2013. Further, it
also includes ` 25,000 deposited in cash with the State Bank of India.
12. Diwali expenses include ` 2000 gifts given to wife of A on her visit to office on
Diwali day.
13. Wealth-tax was due on 31-3-2013 but the same was paid on 30-6-2013.
14. Rate of depreciation for machinery as per income tax is 15%.
15. Patents were acquired on 5-6-2012 for ` 1, 40,000.
16. Preliminary expenses were incurred in the previous year 2009-10.
Notes
Solution:
Computation of Gross Total Income of A for the assessment year 2013-14
(`)
1,20,000
Net profit as per P & L A/c

Less: Income credited to P & L A/c but either taxable under other heads
or not taxable
(a) Rent from house property
(b) Excise duty recovered
24,000
5,000
10,000
(c) Gifts from father

(d) Profit on machine sold to be considered under-depreciation
15,000
54,000
66,000
Add: Expenses inadmissible

1.
Bonus as paid after due date of return
2.
Municipal tax 50% on let out portion
3.
Balance 50% municipal taxes of business, but not paid till the due
date of return of income (` 10,000 ` 7,500 paid till due date of
return)
4.
50% repair of house property, balance allowed under house

property
5.
Depreciation on machine for scientific research to be considered

separately.
6.
Patents and copyrights
7.
Preliminary exp in excess of 1/5th
8.
Provision for bad and doubtful debts
9.
Expenditure on family planning (allowed only to company

assesses)
10. Donation to approved institution for family planning (deduction
7,500
10,000
2,500
7,500
12,500
14,000
2,500
10,000
12,000
allowable from GTI)

11. Premia for insurance of health of employees (allowed only if paid
by cheque)
8,000
12. Interest on financial institution (paid after due date of return)
5,000
13. Interest on purchase of house property 50% (allowed under house

property)
20,000
14. Contribution to ESI(deposited after due date of furnishing the

return of income deduction will be allowed in next year as paid on
2011-2013.
15,000
15. Advertisement to political party

175
16. LIP of A
1,000
17. Sales-tax penalty
5,000
18. Out of Diwali expenses Gift to wife
5,000
19. Lump sum payment for technical know-how
Notes
10,000
20. Wealth tax
2,000
21. Income tax
30,000
22. Depreciation on machine for separate consideration
20,000
(` 15,000 + 24,000 + 6000 + 25,000)
30,000
70,000
2,99,500
3,65,500
Less: Amount allowable:

(1)
100% cost of machine for scientific research
1,00,000
(2)
Extra 25% deduction for donation to national Lab
(3)
Depreciation on machine as per Income Tax Act (as per note),
51,750
(4)
Depreciation on intangible assets (as per note).
38,750
2,500
1,93,000
1,72,500
Add Contributions by employees to PF not deposited by due date by the

employer Profits and gains of business or profession
2,000
1,74,500

24,000
Gross Annual Value

Less: Municipal taxes (not allowed as outstanding even though paid
by due date of return)
Net Annual value
NIL
24,000
Less: Deductions u/s 24(1)

Statutory deduction @ 30%
Interest @ 50%
7,200
15,000
22,200
1,800
Gross Total Income
1,76,300
Working Notes:
1. Entertainment expenditure will now be allowed in full.
2. Calculation of depreciation
(a) WDV of 15% block of machine at the beginning of the year will be:
WDV of machine sold (15,000 100/20 12/9)
1,00,000
WDV of machine on which depreciation is charged for full year 1,25,000
WDV at the beginning of the year
2,25,000
(b) Asset purchased during the year
Used for 180 days or more
Cost of asset purchased on which 9 months depreciation is
Charged (24,000 100/20 12/9)
1,60,000
Used for less than 180 days
Cost of asset purchased on which 3 months depreciation is
Charged (6,000 100/20 12/3)
(c) Sale price of machine sold during the year
1,00,000
176
Less: Depreciation charged
Notes
Profit on sale
(d) Depreciation will be charge as under:
WDV of the block at the beginning of the year
Additions 1,60,000 + 1,20,000
Less: Sold during the year
Depreciation at 15% 50% on 1,20,000
Depreciation at 15% on2,85,000
15,000
85,000
15,000
1,00,000
2,25,000
2,80,000
1,00,000
4,05,000
9,000
42,750
51,750
3. Guesthouse expenses will now be allowed in full.

4. Municipal taxes of house property used for business will be allowed on due
basis if the payment of the same is made on or before due date of furnishing
the return of income. However, the municipal taxes due on account of house
property, will not be allowed as deduction on due basis if the payment is made
on or before the due date of furnishing the return of income.
5. Cost of assets purchased for scientific research is allowed in full. It does not
form part of depreciable assets.
6. Donation to approved institute for family planning will be allowed as deduction
from GTI u/s 80G.
7. Depreciation on intangible assets
WDV as on 1-4-2012
Patents
Technical know-how
Nil
1,40,000
30,000
1,70,000
Less: Sold during the year

WDV as on 31-3-2013
Less: Depreciation (` 140,000 @ 25%)
` 30,000 @ 12.5% used for less than 180 days
NIL
1,70,000
35,000
3,750
38,750
WDV as on 1-4-2013
1,31,250
4.5 Income under the Head Capital Gains

4.5.1 Introduction
Under this head of income, profits arising from sale of capital assets and how to
compute tax an assessee has to pay in this regard and how can get tax exemption is
discussed
4.5.2 Basis of Charge [Sections 45 and 46]
Transfer of Capital Asset [Section 45(1)]: Any profits and gains arising from the
transfer of a capital asset effected in the previous year shall be deemed to be chargeable
to Income Tax under the head Capital Gains and shall be deemed to be the income of
the previous year in which the transfer took place excluding the exemptions provided.
177
Position after Insertion of Section 45(1A): Capital gain in case of amount

received from an insurer on account of damage or destruction of any capital asset:
According to this Section, where any person receives at any time during any previous
year any money or other assets under an insurance from an insurer on account of
damage to or destruction of any capital asset, as a result of:
Notes
(i) Flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature;

or
(ii) Riot or civil disturbance; or
(iii) Accidental fire or explosion; or
(iv) Action by an enemy or action taken in combating an enemy (whether with or
without a declaration of war, then, any profits or gains arising from the receipt
of such money or other assets shall be chargeable to Income Tax under the
head capital gains and shall be deemed to be the income of such a person of
the previous year in which such money or other asset was received and for the
purposes of Section 48, value of any money or the fair market value of other
assets on the date of such receipt shall be deemed to be the full value of the
consideration received or accruing as a result of the transfer of such a capital
asset. It shall be deemed to be the income of such a person for the previous
year in which such money or other asset is received.
Conversion of a Capital Asset into Stock in Trade [Section 45(2)]: A person who
is the owner of a capital asset may convert the same or treat it as stock in trade of the
business carried on by him. Such conversion is transfer under Section 2(47) and profits
or gains arising from such conversion shall be chargeable to tax as his income of the
previous year in which such stock-in-trade is sold or otherwise transferred by him.
For the purpose of computing the capital gains in such cases, the fair market value
of the capital asset on the date on which it was converted into stock in trade shall be
deemed to be full value of the consideration received or accruing as a result of the
transfer of the capital asset.
Total profit on the sale of stock in trade is treated in the following manner:
Total Profit = (SP Cost of Capital Asset)
Capital gains u/s 45(2)
(Fair market value Cost of capital as on conversion)
Asset SP = Selling Price
Business Income u/s 28

SP Fair market value as
on Conversion
Transfer by a Partner [Section 45(3)]: Where a partner or a member of an

association of persons or body of individuals, transfers any asset by way of capital,
contribution and otherwise to the firm partner/member shall be chargeable to tax as his
income of the previous year in which such a transfer takes place. The amount recorded in
the books of firm/association, as the value of the asset shall be deemed to be the full
value of consideration received or accrued.
Transfer by a Firm [Section 45(4)]: Where a firm or AOP or BOI transfers a capital
asset on its dissolution or otherwise to a partner/member, the gains arising to the
firm/association shall be chargeable to tax as its income of the previous year in which
such transfer takes place. The fair market value of the asset on the date of such a
transfer shall be deemed to be the full value of consideration received or accrued.
Compulsory Acquisition of an Asset and Enhanced Compensation [Section
45(5)]: Sometimes, when a building or other capital asset belonging to a person is taken
over by the Central Government by way of compulsory acquisition, capital gains may
178
Notes
arise. Such capital gains are chargeable as the income of the previous year in which
such compensation was received.
Enhanced compensation: Many times, persons whose capital assets have been
taken over by the Central Government go to the court of law for enhancement of the
compensation. Enhanced compensation received, if any, is chargeable capital gains in
the year in which the same is received. In this context, the following points are to be
noted :
1. The cost of acquisition/improvement shall be taken to be NIL.
2. Where an assessee expires or for any other reason, the enhanced
compensation is received by any other person, the other person is liable to pay
tax on such capital gains.
3. Litigation expenses for getting the compensation enhanced are deductible.
4. Where the compensation is subsequently reduced by the court, such assessed
capital gain shall be recomputed.
Transfer of Securities by the Depository [Section 45(2A)]: Where any person
has had, at any time during previous year any beneficial interest in any securities, then,
any profits or gains arising from transfer made by the depository or participant of such
beneficial interest in respect of the securities shall be chargeable to Income Tax as the
income of the beneficial owner of the previous year in which such transfer took place and
shall not be regarded as income of the depository who is deemed to be the registered
owner of securities by virtue of sub-section (1) of Section 10 of the Depositories Act,
1996 and for the purposes of:
(i) Section 48 (Computation of Capital Gains) and
(ii) Proviso to Clause 42(A) of the Depositories Act, 1996;
the cost of acquisition and the period of holding of any securities shall be
determined on the basis of the first-in-first-out method.
In this connection, CBDT vide Circular No. 768, dated 24.6.1998 has clarified that :
(a) The FIFO method will be applied only in respect of the dematerialised holdings
because in the case of sale of dematerialised securities, the securities held in
physical form cannot be considered to have been sold as they continue to
remain in the possession of the investor and are identified separately.
(b) In the depository system, the investor can open and hold multiple accounts. In
such a case, where an investor has more than one security account, the FIFO
method will be applied account wise. This is because in case where a particular
account of an investor is debited for sale of securities, the securities laying in
his other account cannot be construed to have been sold as they continue to
remain in that account.
If in an existing account of dematerialised stock, old physical stock is dematerialised
and entered at a later date, under the FIFO method, the basis for determining the
movement out of the account is the date of entry into that account.
Depository means a company registered under the Companies Act and which has
been granted a Certificate of Registration under Section 12(1A) of the Securities and
Exchange Board of India Act. Security means such security as may be specified by the
SEBI.
Capital Gains on Distribution of Assets by Companies in Liquidation [Section
46(1)]: Where the assets of a company are distributed to its shareholders on its
liquidation, such distribution shall not be regarded as a transfer for the purpose of Section
45. There are no capital gains on such distribution. However, if the liquidator sells the
179
assets of the company resulting in a capital gain and distributes the funds so collected,
the company will be liable to pay tax on such gains [Sri Kannan Rice Mill Ltd. v. CIT].
Notes
Capital Gains in the hands of the Shareholders in Case of Liquidation of

Companies [Section 46(2)]: If a shareholder receives money or other assets from the
company on its liquidation, he is liable to tax under the head Capital Gains in respect of
the market value of the assets received on the date of distribution to the accumulated
profits of the company which are to be treated as dividend income of the shareholder u/s
2(22) (c) and be taxed in his hands as dividend. The balance, if any, is to be taken as the
full value of consideration for the purpose of ascertainment of capital gains.
Capital Gains on the Purchase by a Company of its own Shares or other
Specified Securities [Section 46(A)]: According to this section, where a shareholder or
a holder of other specified securities receives any consideration from any company for
the purchase of its own shares or other specified securities held by such a shareholder of
other specified securities, then, subject to the provisions of Section 48, the difference
between the cost of acquisition and the value of consideration received by the
shareholder or the holder of other specified securities, as the case may be, shall be
deemed to be the capital gains arising to such a shareholder or the holder of other
specified securities, as the case may be, in the year in which such shares or other
specified securities were purchased by the company.
For the purposes of this section, Specified Securities shall have the meaning
assigned to it an explanation to Section 77A of the Companies Act, 1956. According to
the explanation to Section 77A of the Companies Act, 1956, the Specified Securities
include an employees stock option or other securities as may be notified by the Central
Government from time to time.
In the Charging Sections 45 and 46, the following expressions are important:
I. Year of Chargeability
II. Capital Asset
III. Transfer.
I. Year of Chargeability: Capital gains are chargeable to tax on accrual basis. The
actual realisation of the capital gains is immaterial for the purpose of taxation. Thus,
when an assessee transfers a capital asset and thereby, some capital gain arises, such
gains are to be included in the income of the previous year in which the asset is
transferred whether such gains are realised in a later year or not realised at all.
Exceptions:
1. In case of compulsory acquisition, transfer is deemed to have taken place in
the previous year in which the compensation or part thereof is received.
2. In case of conversion of a capital asset in to stock in trade, capital gain accrues
in the year of conversion, but taxable in the year in which the stock is sold out.
3. Damage or destruction of any capital asset by fire or other calamities.
II. Capital Assets [Section 2(14)]: A Capital Asset means property of any kind
held by an assessee whether or not connected with his business or profession. The
definition of capital asset is very wide. It includes every kind of asset, movable or
immovable, tangible or intangible. Therefore, goodwill, leasehold rights, the right to a
share in the profits of partnership firm, the right to receive shares from a fresh issue by a
company, trees standing on agricultural land, State Development Loan Bonds in the
hands of a Financial Corporation are Capital Assets.
Capital asset as defined u/s 2(14), subject to the following five exceptions:
180
Notes
1. Any stock in trade, consumable stores or raw material held for the purpose of
business.
2. Personal effects, that is to say, movable property (including wearing apparel
and furniture, but excluding jewellery) held for personal use by the assessee or
any member of his family dependent on him.
3. Agricultural Land in India which does not fall within the jurisdiction of the
municipality or cantonment board having a population of 10,000 or more or
within the 8 kilometres from the local limits of such a municipality or
cantonment board.
4. 6 1/2% Gold Bonds, 7% Gold Bonds or National Defence Gold Bonds, 1980
issued by the Central Government.
5. Special Bearer Bonds, 1991 issued by the Central Government.
6. Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999.
Explanation: Personal effects include only those articles, which are intimately and
commonly used by the assessee or his dependent family member. Thus, a car, any other
vehicle, refrigerator, television or other electrical appliances are personal effects.
Jewellery has been specifically excluded from personal effects. Jewellery
includes:
(a) Ornaments made of gold, silver, platinum or any other precious metals,
whether or not containing any precious or semi-precious stone and whether or
not worked or sewn into any wearing apparel.
(b) Precious or semi-precious stones, whether or not set in any furniture, utensil or
other article or worked or sewn into any wearing apparel.
Types of Capital Assets: For the purpose of taxation, the capital assets have been,
divided into:
(a) Short-term capital assets
(b) Long-term capital assets
(a) Short-term Capital Assets: According to Section 2(42A), a short-term capital
asset means a capital asset held by an assessee for not more than thirty-six months
immediately preceding the date of its transfer. Capital Gains arising from the transfer of
short-term capital assets are called short-term capital gains, provided that :
(i) In case of company shares (equity or preference) or any other security listed in
a recognised stock exchange.
(ii) Units of UTI and Mutual Funds or a zero coupon bond.
The provision of this clause will have effect as if for words thirty-six months the
words twelve months had been substituted.
(b) Long-term Capital Assets: Any capital asset other than a short-term capital
asset is termed as a long-term capital asset. Gains arising from the transfer of a
long-term capital asset are called long-term capital gains. The long-term capital gains
qualify for Concessional Tax Treatment under the Income Tax Act.
Determination of the Period for which the Asset is held by the Assessee:
Generally, the asset is held by the assessee from the date of acquisition to the date of
transfer. But in certain cases, the period for which the asset is held is determined as
under:
(a) In the case of shares held in a company in liquidation, the period subsequent to
the date on which the company goes into liquidation is excluded.
181
(b) In the case of a capital asset which becomes the property of the assessee in
the circumstances mentioned in Section 49(1) (discussed later), the period for
which the asset was held by the previous owner is included.
(c) In the case of shares in an Indian company which becomes the property of the
assessee in consideration of transfer of shares in a scheme of amalgamation
[Clause vii of Section 47], the period for which the shares in the amalgamating
company were held by the assessee is included.
(d) In the case of a capital asset being a share or shares in an Indian company,
which becomes the property of the assessee in consideration of a transfer
referred to in Clause vii of Section 47, there shall be included the period for
which the share or shares in the amalgamating company were held by the
assessee.
(e) In the case of right issue of shares or other securities subscribed to by the
assessee on the basis of his rights to subscribe, the counting of the period is
from the date of allotment.
(f) In case of remuneration of a rights issue, for the person who has acquired the
rights, the period shall be reckoned from the date of the offer of such rights by
the company or institution.
Notes
III. Transfer [Section 2(47)]: The liability to tax on capital gains arises only if there
is a transfer of the capital asset(s). The term transfer in relation to a capital asset,
includes:
1. Sale, exchange or relinquishment of the capital asset; or
2. The extinguishment of any rights therein. [For e.g., where shares are forfeited
by the company, it is extinguishment of the right in the shares. The capital loss
on forfeiture of shares is deductible.]
3. The compulsory acquisition thereof under any law; or
4. Conversion of asset into stock-in-trade.
5. Any transaction which has the effect of allowing the possession of any
immovable property in part performance of a contract of the nature referred to
in Section 53A of the Transfer of Property Act, 1882; or
6. Any transaction [by way of becoming a member of shareholder in cooperative
arrangements] which has the effect of transferring or enabling the enjoyment of
any immovable property.
7. The maturity or redemption of a zero coupon bond.
4.5.3 Transactions Not Regarded as Transfer [Sections 46 and 47]
The meaning of transfer is given in Section 2(47), whereas transactions not
regarded as transfers are covered u/s 46 and 47. In the following transactions although
there is a transfer, but it is not considered to be transfer for purpose of capital gains.
1. Where the assets of a company are distributed to its shareholders on
liquidation of a company, such distribution shall not be regarded as transfer in
the hands of the company [Section 46(1)].
2. Any distribution of capital assets on the total or partial partition of Hindu
Undivided Family [Section 47(i)].
3. Any transfer of a capital asset under a gift or will or an irrevocable trust [Section
47(iii)]. Proviso to Section 47(iii) provides that transfer under a gift or
irrevocable trust of a capital asset being shares, debentures or warrants
allotted by a company directly or indirectly to its employees under the ESOP
shall be regarded as transfer and be chargeable as capital gain.
182
Notes
4. Any transfer of a capital asset by a company to its 100% subsidiary company,

provided the subsidiary company is an Indian company [Section 47(iv)].
5. Any transfer of a capital asset by a 100% subsidiary company to its holding
company, if the holding company is an Indian company [Section 47(v)].
In other words, under items (4) and (5), there must be a transfer of an asset by a
holding company to a subsidiary company or vice versa provided the following conditions
are satisfied :
(a) the subsidiary company is a wholly owned subsidiary company and
(b) the transferee company is an Indian company.
6. Any transfer in a scheme of amalgamation of a capital asset by the
amalgamating company to the amalgamated company, if the amalgamated
company is an Indian company [Section 47(vi)].
7. Any transfer in a scheme of amalgamation of shares held in an Indian company
by the amalgamating foreign company to the amalgamated foreign company,
if:
(a) at least 25% of the shareholders of the amalgamating foreign company
continue to remain shareholders of the amalgamated foreign company,
and
(b) such a transfer does not attract capital gains tax in the country, in which
the amalgamating company is incorporated [Section 47(via)].
8. Any transfer in a demerger, of a capital asset by the demerged company to the
resulting company, if the resulting company is an Indian company [Section
47(vib)], then
(a) The shareholders holding not less than 75% in value of the shares of the
demerged foreign company continue to remain the shareholders of the
resulting foreign company, irrespective of the number of such
shareholders.
(b) Such transfer does not attract tax on capital gains in the country, in which
the de-merged foreign company is incorporated;
Provided that the provisions of Section 391 to 394 of the Companies Act, 1956 shall
not apply in case of de-mergers referred to in this clause [Section 47(vic)].
9. Any transfer in a business reorganisation, of a capital asset by the predecessor
co-operative bank to the successor co-operative bank. [Section 47(vica)].
10. Any transfer by a shareholder ,in a business reorganisation of a capital asset
being a share or shares held by him in the predecessor co-operative bank if
the transfer is made in consideration of the allotment to him of any share or
shares in the successor co-operative bank [Section 47(vicb)].
11. Any transfer or issue of shares by the resulting company, in a scheme of
de-merger to the shareholders of the demerged company if the transfer or
issue is made in consideration of demerger of the undertaking [Section
47(vid)].
12. Any transfer by a shareholder, in a scheme of amalgamation of shares held by
him in the amalgamating company, if:
(a) The transfer is made in consideration of the allotment to him or any share
or shares in the amalgamated company;
(b) The amalgamated company is an Indian company [Section 47(vii)];
13.
14.
15.
16.
17.
18.
19.
183
(c) The consideration received by the shareholder should only be shares. If

the consideration includes anything in addition to shares, then it will be
treated as a transfer and there will be a capital gain.
Any transfer of bonds or Global Depository Receipts referred to in Section
115AC(1), i.e., purchased in foreign currency, made outside India by a
non-resident to another non-resident [Section 47(viia)].
Any transfer of urban agricultural land in India before 1.3.1970 [Section
47(viii)].
Any transfer of a capital asset, being any work of art, archaeological, scientific
or art collection, book, manuscript, drawing, painting, photograph or print, to
the Government or a University or the National Museum, National Art Gallery,
National Archives or any such other public museum or institution, as may be
notified by the Central Government in the Official Gazette to be of national
importance or to be of renown throughout any State or States [Section 47(ix)].
Any transfer by way of conversion of bonds or debentures, debenture stock or
deposit certificates in any form, of a company into shares or debentures of that
company [Section 47(x)].
Transfer by way of conversion of bonds into shares or debentures of any
company [Section 47(xa)].
Any transfer made on or before 31.12.1998 by a person (not being a company)
of a capital asset being membership of a recognised stock exchange in India to
a company in exchange of shares allotted by that company to the transferor.
However, it will be subject to provisions of Section 47A [Section 47(xi)].
Any transfer of a capital asset being land of a sick industrial company made
under a scheme prepared and sanctioned under Section 18 of the Sick
Industrial Companies (Special Provisions) Act, 1985 where such sick industrial
company is being managed by its workers cooperative [Section 47(xii)].
Where a firm is succeeded by a company in the business carried on by it, as a
result of which, the firm sells or otherwise transfers any capital asset or
intangible asset to the company provided the following conditions are satisfied:
(a) All the assets and liabilities of the firm relating to the business
immediately before the succession, become the assets and liabilities of
the company.
(b) All the partners of the firm immediately before the succession become the
shareholders of the company in the same proportion in which their capital
accounts stood in the books of the firm on the date of the succession.
(c) The partners of the firm do not receive any consideration or benefit,
directly or indirectly, in any form or manner, other than by way of allotment
of shares in the company; and
(d) The aggregate of the shareholding in the company of the partners of the
firm is not less than fifty percent of the total voting power in the company
and their shareholding continues to be such for a period of five years from
the date of succession [Section 47(xiii)].
Transfer of capital asset being a membership right held by a member of a
recognised stock exchange in India [Section 47(xiiia)].
Transfer of a capital asset by a private company/unlisted public company
to a limited liability partnership or any transfer of shares held in the
company by a shareholder in the case of conversion by the company into
a LLP [Section 47(xiiib)].
Notes
184
Notes
20.
21.
22.
23.
(e) the demutualisation or corporatisation of a recognised stock exchange in

India is carried out in accordance with a scheme of corporatisation which
is approved by SEBI
Where a sole proprietary concern is succeeded by a company in the business
carried on by it, as a result of which, the sole proprietary concern sells or
otherwise transfers any capital asset or intangible asset to the company
provided the following conditions are satisfied:
(a) all the assets and liabilities of the sole proprietary concern relating to the
business immediately before the succession become the assets and
liabilities of the company;
(b) the shareholding of the sole proprietor in the company is not less than fifty
percent of the total voting power in the company and his shareholding
continues to remain as such for a period of five years from the date of
succession; and
(c) the sole proprietor does not receive any consideration or benefit, directly
or indirectly, in any form or manner, other than by the way of allotment of
shares in the company [Section 47(xiv)].
Any transfer in a scheme for lending of any securities under an agreement or
arrangement which the assessee has entered into with the borrower of such
securities and which is subject to the guidelines issued by the Securities and
Exchange Board of India, established under Section 3 of the Securities and
Exchange Board of India Act, 1992 in the regard [Section 47(xv)].
Note: Securities Lending Scheme, 1997, lending of shares under this scheme
will not be transfer.
Any transfer in a scheme of amalgamation of a banking company with a
banking institution sanctioned and brought into force by the Central
Government under Section 45(7) of the Banking Regulation Act, 1949, of a
capital asset by the banking company to the banking institution.
A banking company and a banking institution shall have the same meaning
assigned under Section 5(c) and Section 45(15) of the Banking Regulation.
Any transfer of a capital asset in a transaction of reverse mortgage under a
scheme made and notified by the Central Government [Section 47(xvi)].
4.5.4 Withdrawal of Exemption in Certain Cases [Section 47A]

As per Section 47 discussed earlier, the following three transactions are not
regarded as transfer for capital gain purposes only when certain conditions are satisfied:
1. Transfer of a capital asset by a holding company to its wholly owned subsidiary
company or vice versa [Section 47(iv) and (v)].
2. Transfer by a person other than a company having the membership of a
recognised stock exchange to a company in exchange of shares allotted
[Section 47(ix)].
3. Transfer where a firm/proprietary concern is succeeded by a company [Section
47(xiii) and (xiv)].
If the conditions mentioned, under the respective sections in the above three cases
are not complied with, the exemption allowed shall be withdrawn as per Section 47A. The
withdrawal of exemption in each of the above case shall be as under:
Transfer by a Holding Company to its wholly owned Subsidiary Company or
vice versa [Section 47A(1)]: As per Section 47(iv) and (v), any transfer of a capital
asset by a company to its 100% Indian subsidiary company or by a subsidiary company
185
to its Indian holding company is not treated as a transfer and therefore, the profit or gain
arising from such a transfer is not charged as capital gains. However, Section 47A
provides that the exemption granted shall be withdrawn in the following circumstances:
Notes
(i) where at any time before the expiry of a period of 8 years from the date of
transfer of the capital asset by a holding company to its wholly owned
subsidiary company or vice versa, such a capital asset is converted by the
transferee company into or is treated by it as, stock-in-trade of its business; or
(ii) The parent company, i.e., the holding company or its nominees, ceases to hold
the whole of the share capital of the subsidiary company before the expiry of a
period of 8 years from the date of transfer of the capital asset.
Treatment in the case of a Transferor Company: In the above two circumstances,
the profits or gains arising from the transfer of such a capital asset, which was exempt,
shall be deemed to be the income of the transferor company and be chargeable under
the head capital gains of the previous year in which transfer of such a asset to the
transferee company had taken place.
Treatment in the case of Transferee Company is as follows:
(a) Where the capital asset is converted into stock-in-trade by the transferee
company within a period of eight years from the date of its transfer, such a
conversion shall be treated as transfer of the previous year in which such an
asset is converted into stock-in-trade. But the capital gain will arise in the
previous year in which such a converted asset is sold.
For the purpose of computation of capital gain as per Section 49(3), the cost of
acquisition of such a asset to the transferee company will be the cost for which
such asset was acquired by it, i.e., the price at which it was given to it by the
transferor company [Section 49(3)]. And if it happens to be long- term capital
gain, the indexation of the cost of acquisition will be done till the year of
conversion of such an asset into stock-in-trade. The consideration price will be
the market value of that asset on the date of conversion.
(b) Where the company ceases to be a wholly owned subsidiary company within
eight years of the date of the transfer of the capital asset. At this point of time,
there will be no income chargeable in the hands of the transferee company at it
has not transferred any asset. But, when this asset is sold or transferred, the
cost of acquisition of this asset will be taken as the cost for which such asset
was acquired by it.
4.5.5 Computation of Capital Gains [Sections 48 to 51]
Section 48: The income under the head Capital Gains shall be computed by
deducting the following from the full value of the consideration received or accrued as a
result of the transfer of the capital asset:
1. expenditure incurred wholly and exclusively in connection with such a transfer;
2. the cost of acquisition of the asset and the cost of any improvement thereto.
However, Provision 1 to Section 48 gives special concession to non-residents and
Provision 2 gives special concession to residents in respect of long-term capital gains.
Concession to a Non-resident [Provision 1 to Section 48]: In order to give
protection to non-residents who invest foreign exchange to acquire capital assets,
section 48 contains a provision. Accordingly, in the case of non-residents, capital gains
arising from the transfer of shares/debentures of an Indian Company are to be computed
as follows :
186
Notes
The cost of acquisition, the expenditure incurred wholly and exclusively in

connection with the transfer and full value of the consideration are to be converted into
the same foreign currency with which such shares were acquired. The aforesaid manner
of computation of capital gains shall be applied for every purchase and sale of shares or
debentures in an Indian company.
Concession to a Resident [Provision 2 to Section 48]: Where long-term gains
arise in the hands of residents, capital gains shall be computed by deducting: (i) indexed
cost of acquisition, (ii) indexed cost of improvement and (iii) transfer expenses from full
value of the consideration received or accrued as a result of the transfer of the capital
asset.
Provision 3 to Section 48: The long-term gains arising from the transfer of a
long-term capital asset being bond or debenture other than capital indexed bonds issued
by the Government, the cost of acquisition and improvement will not be indexed.
Provision 4 to Section 48: Where shares, debentures or warrants referred to in
Proviso to Section 47(iii), ESOP, are transferred under a gift or an irrevocable trust, the
market value on the date of such a transfer shall be deemed to be the full value of
consideration received or accruing as a result of transfer for the purpose of Section 48 in
the hands of the transferor.
Proviso 5 to Section 48: No deduction shall be allowed in computing the income
chargeable under the head Capital Gains in respect of any sum paid on account of
securities transaction tax under Chapter VII of the Finance Act, 2004.
Computation of Capital gains:
Computation of Short-term Capital Gains
Computation of Long-term Capital Gains
From the full value of consideration, deduct:
From the full value of consideration, deduct:
1. Expenditure incurred wholly and

exclusively.
1. Expenditure incurred wholly and

exclusively connection with the transfer.
2. Cost of acquisition.
2. Indexed cost of acquisition of asset.
3. Cost of any improvement of asset.
3. Indexed cost of any improvement of an

asset.
Meaning of terms used in the context of computation of capital gains is given below:
(A)
(B)
(C)
(D)
(E)
(F)
(G)
Full Value of Consideration

Expenses incurred wholly, exclusively in connection with Transfer
Cost of Acquisition
Cost of Improvement
Cost Inflation Index
Indexed cost of Acquisition
Indexed cost of Improvement.
Full Value of Consideration

The expression full value means the whole price without any deduction
whatsoever and it cannot refer to adequacy or inadequacy of price. The consideration for
the transfer of capital asset is what the transferor receives in lieu of the asset he parts
with, namely money or moneys worth. It is not necessarily always the market value of the
asset on the date of transfer. However, at many places, reference is made to Free Market
Value (FMV). Determination of FMV is required for the following purposes:
(i) Section 45(2) relating to the conversion of capital assets into stock-in-trade for
determining its consideration price on the date of conversion.
187
(ii) Section 45(4) relating to distribution of a capital asset by the firm to its partners
on dissolution, for determining sale consideration.
(iii) Section 46(2), relating to distribution of an asset by the company to its
shareholders at the time of its liquidation.
(iv) Section 55 for determining the market value of an asset as on 1.4.1981.
Notes
Full value of consideration in case of Real Estate Transactions [Section 50C]:

The salient features of Section 50C are as follows:
1. Section 50 C is applicable only in the case of transfer of land or building or both.
On transfer of any other asset, Section 50C is not applicable.
2. Where, the consideration declared to be received or accruing as a result of the
transfer of land and building or both, is less than the value adopted or
assessed by any authority of a State Government for the purpose of payment
of stamp duty in respect of such transfer, the value, so adopted or assessed,
shall be deemed to be the full value of consideration and capital gains shall be
computed accordingly under Section 48.
3. Where the assessee claims before any Assessing Officer that, the value
adopted or assessed for stamp duty exceeds the fair market value of the
property as on the date of transfer and the value so adopted or assessed for
stamp duty authority has not been disputed in any appeal or revision or no
reference has been made before any other authority, court or High Court, the
Assessing Officer may refer the valuation of the capital asset to a Valuation
Officer.
4. Where any such reference is made, the provisions of Sections (2), (3), (4), (50)
and (6) of Section 16A, sub-section (1)(i) and sub-sections (6) and (7) of
Section 23A, sub-section (5) of Section 24, Section 34AA, Section 35 and 37 of
the Wealth Tax Act, 1957 shall with the necessary modifications, apply in
relation to such reference as they apply in to a reference made by the
Assessing Officer under Section 16A(1) of that Act. The Valuation Officer shall
be the Valuation Officer as defined in Section 2r of the Wealth Tax Act, 1957.
5. If the market value determined by the Valuation Officer is less than the value
adopted for stamp duty purposes, the Assessing Officer may take such fair
market value to be the full value of consideration. However, if the fair market
value determined by the Valuation Officer is more than the value adopted or
assessed for stamp duty purposes. The Assessing Officer shall not adopt such
fair market value and will take the full value of consideration to be the value
adopted or assessed for stamp duty purposes.
6. If the value adopted or assessed for stamp duty purposes is revised in any
appeal, revision or reference to the assessment made shall be amended to
recompute the capital gains by taking the revised value as the full value of
consideration.
Valuation of Capital Assets which can be referred to Valuation Officer: With a
view to ascertaining the fair market value, the A.O. may refer the valuation of the capital
asset to a valuation officer in the following cases:
1. Where the value of the asset, as claimed by the assessee, is in accordance
with the estimate made by a registered value and the Assessing Officer is of
opinion that the value so claimed is less than its market value.
2. Where the A.O. is of the opinion that the fair market value of the asset exceeds
the value of the asset by more than ` 25,000 or 15% of the value claimed by
assessee, whichever is less.
188
Notes
3. Where the A.O. is of the opinion that, having regard to the nature of asset and
relevant circumstances, it is necessary to do so.
Expenses incurred wholly and exclusively in connection with such Transfer
Refer to expenses necessary for effecting transfer, for e.g., brokerage, commission
paid for securing a purchaser, cost of stamp, travelling expenses incurred in connection
with transfer, litigation expenditure for claiming enhancement of compensation, etc.
Cost of Acquisition
The cost of acquisition of an asset would normally be taken to be the price at which
the asset was acquired by the assessee. Such a price may include the price paid to the
vendor, buying expenses, transportation charges and cost of installation of the asset.
Litigation expenses incurred for having the shares registered in his name (as the
company refused to register the same) is part of the cost of acquisition and that incurred
for gaining better voting rights is cost of improvement [Bengal Assam Investors Ltd. v.
CIT].
However, under different circumstances, the cost of acquisition of a capital asset is
determined in the following manner:
1. Cost to the Previous Owner [Section 49(1)];
(a) on any distribution of an asset on the total or partial partition of a HUF;
(b) under a gift or will;
(c) by succession, inheritance or devolution;
(d) on any distribution of assets on the liquidation of the company;
(e) under a transfer to revocable or an irrevocable trust;
(f) under any transfer by a holding company to its 100% subsidiary or
vice-versa;
(g) on any transfer in a scheme of amalgamation of two Indian companies
subject to certain conditions u/s 47(vi);
(h) on any transfer in a scheme of amalgamation of two foreign companies
subject to certain conditions u/s 47(via);
(i) an any transfer of a capital asset by the banking company to the banking
institution in a scheme of amalgamation of a banking company with a
banking institution u/s 47(viaa);
(j) Transfer in a demerger of a capital asset by the demerged company to
resulting company u/s 47(vib);
(k) Transfer of shares held in an Indian company by a demerged foreign
company to the resulting foreign company u/s 47(vic);
(l) on transfer in a business reorganisation of a capital asset by the
predecessor cooperative bank to the successor co-operative bank u/s
47(vica);
(m) by conversion by an individual of his separate property into a HUF
property;
Then the cost of acquisition of the asset shall be deemed to be cost for which the
previous owner of the property acquired it. To this cost, the cost of improvement to the
asset incurred by the previous owner or the assessee must be added.
Important Points:
(i) Where the cost for which the previous owner acquired the property cannot be
the ascertained cost of acquisition to the previous owner means the fair market
(ii)
2.
3.
4.
5.
189
value on the date on which the capital asset became the property of the
previous owner.
Previous owner means the last previous owner of the capital asset who
acquired it through a mode of acquisition other than referred to in clauses (a) to
(g) above. In other words, a previous owner means the previous owner who
actually paid for the asset.
Cost of acquisition of shares in an Amalgamated Company [Section
49(2)]: Where a share or shares in an amalgamated company, which is an
Indian company, became the property of the assessee in consideration of a
transfer of his share or shares held in the amalgamating company, the cost of
acquisition of the asset (share) shall be deemed to be the cost of acquisition to
him of the share or shares in the amalgamating company.
Cost of acquisition of Shares or Debentures [Section 49(2A)]: Cost of
acquisition of shares or debentures of a company acquired in consideration of
conversion of debenture, debenture stock or deposit certificates shall be
deemed to be the cost of original debentures, debenture stock or deposit
certificates converted.
Cost of acquisition of Specified Securities [Section 49(2B)]: Where the
capital gains arise from the transfer of specified securities referred to in Section
17(2(iii)(a) which includes employees stock option and seat equity shares; also,
the cost of acquisition of such specified security shall be the fair market value
on the date of exercise of option.
Effect of omission of Section 49(2B): In view of omission of Section 49(2B),
cost of acquisition of specified securities (ESOP) to the employee shall be the
cost of acquisition and not fair market value on the date of exercising of option,
in case the employee sells/transfers such securities.
Cost of acquisition of the shares in the Resulting Company [Section
49(2C)]: It shall be the amount which bears to the cost of acquisition of shares
held by the assessee in the demerged company, the same proportion as the
net book value of the assets transferred in a demerger bears to the net worth of
the demerged company immediately before such a demerger.
In other words:
Cost of acquisition
of the shares in the
resulting company
Notes
Net book value of

the assets transferred
Cost of acquisition
in a demerged
of shares in held by the assessee
Net worth of the
in the demerged company
demerged company
immediately before
demerger
6. Cost of acquisition of the original share of the Demerged Company

[Section 49(2D)]: It shall be deemed to have been reduced by the amount as
so arrived at under sub-section (2C) above Net Worth for this section shall
mean the aggregate of the paid-up share capital and general reserves as
appearing in the books of accounts of the demerged company immediately
before demerger.
7. Cost of acquisition of Self-generated Assets: Self-generated assets which
are specifically mentioned in the Income Tax Act are subject to Capital Gains.
Such assets are :
(a) Goodwill of the business
190
Notes
(b)
(c)
(d)
(e)
8.
9.
10.
11.
12.
13.
14.
15.
Tenancy rights
Route permits
Loom hours
Right to manufacture/produce on article.
Cost of such self-generated assets shall be considered as NIL and accordingly,
Capital Gains are to be computed. However, other self-generated assets like
goodwill of a profession, patents and trademarks are not subject to Capital
Gains.
Cost of acquisition of an asset acquired before April 1, 1981 [Section 55
(2)(b)(i)]: Where the capital asset other than an asset on which depreciation
has been allowed (CIT vs. Commonwealth Trust Ltd.) became the property of
the assessee before April 1, 1981, the cost of acquisition of the asset may, at
the option of the assessee, be taken to be any one of the following :
(a) the cost of acquisition of the assessee; or
(b) the fair market value of the asset on April 1, 1981.
Cost of acquisition of an asset acquired on distribution of capital assets
of a company on its liquidation [Section 55(2)(b)(iii)]: Where the capital
asset became the property of the assessee on the distribution of the capital
assets of a company on its liquidation and the assessee has been assessed to
Income Tax under the head Capital Gains in respect of that asset under
Section 46, the cost of acquisition to him shall be the fair market value of the
asset on the date of distribution.
Cost of acquisition on consolidation or conversion of shares [Section
55(2)(b)(v)]: Where the capital asset, being a share or a stock of a company
became the property of the assessee on the consolidation and division of
shares into shares of larger amount than its existing shares or on the
conversion or reconversion of any shares, into stock or vice versa or on the
subdivision of any shares into shares of smaller amount or on the conversion of
one kind of shares into another kind, the cost of acquisition shall be taken to be
the cost of the assessee of the original shares or stock held by him.
Cost of acquisition of Bonus Shares shall be taken as NIL and the net sale
proceeds will be treated as capital gains. The period of holding of such a bonus
issue will be reckoned from the date of allotment of such bonus issue.
Cost of Right shall be taken as NIL: Sale price realised in respect of such
right renounced will be taken as capital gain. The period of holding in the hands
of the renounce will be computed from the date of offer made by the
company/institution to the date of renouncement. Generally, it will be a
short-term capital gain.
Cost of Right Shares in the hands of the renounce will be the aggregate of the
amount of purchase price paid to the renouncer to acquire the right entitlement
and the amount paid by him to the company/institution for subscribing to such
right shares.
Cost of Right Shares: The cost of the right shares shall be the price paid for
them.
Cost of acquisition of gold on redemption of National Defence Gold
Bonds: The cost of acquisition of such gold is the market value of the gold on
the date of redemption of such bonds. Whether the gain on sale of gold
received on redemption of the Gold Bonds, 1980 would be short-term or
16.
1.
2.
3.
4.
17.
18.
191
long-term capital gain depends upon the date of redemption of the bonds
(27.10.1980) and the date of sale of the gold.
Cost of Acquisition in the case of slump sale [Section 50 B]: Section 50B
has been inserted with effect from the assessment year 2000-01. Provisions of
Section 50B, applicable for the computation of capital gains in the case of
slump sale are given below :
Any profits or gains arising from the slump sale affected in the previous year
shall be chargeable as long-term capital gains and shall be deemed to be
income of the previous year in which the transfer took place.
Where, however any capital asset being one or more undertakings owned and
held by the assessee for not more than 36 months is transferred under the
slump sale, then the capital gain shall be deemed to be a short-term capital
gain.
In the case of slump sale of the capital asset being one or more undertaking,
the net worth of the undertaking shall be taken as the cost of acquisition and
cost of improvement. Net worth for this purpose is the aggregate value of the
total assets of the undertaking of division as reduced by the value of liabilities
of such an undertaking of division or division as appearing in the books of
account. Any change in the value of assets on account of the revaluation of
asset of such undertaking or division shall be the written down value of block of
asset determined in accordance with the provisions contained in sub-item (C)
of Section 43(6)(c)(i) in the case of depreciable assets and the book value for
all other assets.
The benefit of indexation will not be available.
Every assessee, in the case of slump sale, shall furnish along with the return of
income, a report of a Chartered Accountant in form No. 3 CEA indicating the
computation of the net worth of the undertaking or division as the case may be
has been correctly arrived at.
Cost of acquisition of share allotted to a shareholder of a Recognised
Stock Exchange: Cost of acquisition in relation to a capital asset, being equity
shares allotted to a shareholder of a Recognised Stock Exchange in India
under a scheme for corporation approved by SEBI shall be cost of acquisition
of his original membership of the exchange (applicable from A.Y. 200203).
Computation of Capital Gains in case of Depreciable Assets [Section 50]:
Where the capital asset is an asset forming part of a block of assets in respect
of which depreciation has been allowed, the provisions of Section 48 and 49
shall be subject to the following modifications:
(i) Where the full value of consideration received or accruing for the transfer
of the asset plus the full value of such consideration for the transfer of any
other capital asset falling with the block of assets during the previous year
exceeds the aggregate of the following amounts namely:
1. Expenditure incurred wholly and exclusively in connection with such
transfer;
2. WDV of the block of assets at the beginning of the previous year;
3. The actual cost of any asset falling within the block of assets
acquired during the previous year, such excess shall be deemed to
be the capital gains arising from the transfer of short-term capital
assets.
(ii) Where all assets in a block are transferred during the previous year, the
block itself will cease to exist. In such a situation, if the aggregate of
Notes
192
Notes
above 3 items exceeds the full value of consideration received/accruing

for the transfer of asset(s), the loss shall be deemed to be short-term
capital loss.
Adjustment of Advance Money received against Cost of Acquisition
[Section 51]: It is possible for an assessee to receive some advance in regard
to the transfer of a capital asset. Due to the breakdown of the negotiation, the
assessee may have retained the advance. Section 51 provides that while
calculating capital gains, the above advance retained by the assessee must be
used to reduce the cost of acquisition.
19. Cost of acquisition in case of reduction of capital: Where the shareholder
receives cash or the market value of the asset, such asset received will be
gross consideration and from such consideration deemed dividend u/s 2(22)(d)
to the extent of accumulated profits shall be reduced to compute net
consideration which will be relevant for capital gain.
Example: Suppose the assessee has paid ` 250 per share for 2000 shares
with face value of ` 10 each and on reduction, face value of the share has been
reduced by ` 6, reduction in cost will be computed according to the following
formula:
Cost Reduction in Face Value/Face value before reduction = 250 6/10 =
` 150 per share. For 200 shares, his cost is ` 3,00,000 which is eligible for
indexation and the same will be deducted from net consideration price to
calculate his capital gain.
20. Special provision for full value of consideration for computation of
capital gains in real estate transaction [Section 50C]: Where the
consideration declared to be received or accruing as a result of the transfer of
land or building or both, is less than the value adopted or assessed or
assessable by any authority of a State government (i.e. stamp valuation
authority) for the purpose of payment of stamp study in respect of such
transfer, the value so adopted or assessed or assessable shall be deemed to
be the full value of the consideration, and capital gains shall be computed on
the basis of such consideration under Section 48 of the Income Tax Act.
4.5.6 Cost of Improvement [Section 55(1)(b)]
It includes all the expenditure of a capital nature incurred in making any additions or
alterations to the capital asset by the assessee after it became his property. Where a
capital asset has become the property of the assessee by any of the modes specified in
Section 49(i), the expenditure incurred for the purpose by the previous owner.
It is important to note that where the capital asset became the property of the
assessee (or previous owner) prior to 1.4.1981 and FMV of asset on 1.4.81 shall be
taken as the Cost of Improvement. Any such expenditure incurred prior to 1.4.81 shall
be ignored.
4.5.7 Cost Inflation Index
This is the index as the Central Government may notify in this behalf. The
government has notified the following cost of inflation index vide notification dated
August 5, 1992 as amended till 2004:
Sr. No.
Financial Year
Cost Inflation Index
1981-82
100
1982-83
109
193
1983-84
116
1984-85
125
1985-86
133
1986-87
140
1987-88
150
1988-89
161
1989-90
172
10
1990-91
182
11
1991-92
199
12
1992-93
223
13
1993-94
244
14
1994-95
259
15
1995-96
281
16
1996-97
305
17
1997-98
331
18
1998-99
351
19
1999-2000
389
20
2000-2001
406
21
2001-2002
426
22
2002-2003
447
23
2003-2004
463
24
2004-2005
480
25
2005-2006
497
26
2006-2007
519
27
2007-2008
551
28
2008-2009
582
29
2009-2010
632
30
2010-11
711
31
2011-12
785
32
2012-13
852
33
2013-14
939
Notes
Computation of indexed Cost of Acquisition :

Cost of acquisition
Cost of inflation index of the year of transfer/sale

Cost of inflation index of the year of acquisition
Notes :
1. If the asset is acquired by the assessee before 1-4-1981, he may opt for the
market value as on 1-4-1981 to the cost of acquisition. In this case indexation
will be cost of acquisition or Fair market value as on 1-4-1981 whichever is
more.
194
Notes
2. Asset acquired from the previous owner in any mode given u/s 49(1) in this
case, the cost of acquisition is taken as the cost to previous owner and it is this
cost which will be indexed. For the purpose of indexation the year in which the
asset was first held by the assessee (not the previous owner) is to be
considered.
Indexation of cost not allowed:
1. Transfer of bonds and debentures of a company or government other than
capital indexed bonds issued by the Government.
2. Transfer of shares or debentures acquired by a non-resident to foreign
currency in an Indian company.
3. Transfer of undertaking or division in a slump sale.
4. Transfer of units of Unit Trust of India or Mutual Fund covered u/s 10(23D).
5. Transfer of Global Depository Receipt or Bonds of an Indian company or
shares or bonds of public sector company sold by the government and
purchases in foreign currency by a non-resident.
6. Transfer of GDR purchased in foreign currency by an individual resident in
India and employee of an Indian Company.
7. Transfer of securities by foreign institutional investors.
8. Transfer of foreign exchange asset by a non-resident India.
(G) Indexed Cost of Improvement :
Cost of improvement
in curred after 1.4.81
cost inflation index for the
year in which the asset is sold
Indexed Cost of Improvement =
Cost of inflation index of the year of acquisition
4.6 Exemptions from Capital Gains

1. Long-term Capital Gain on Eligible Equity Shares Exempt if the Shares
are Acquired within a Certain Period [Section 10(36)]: Any income arising from the
transfer of a long-term capital asset being an eligible equity share in a company shall be
exempt provided these are acquired on or after 1-3-2003 but before 1-3-2004 and held
for a period of 12 months or more.
Eligible equity share means an equity share in a company being a constituent of
BSE-500 Index of the stock market (and equity share allotted through a public issue on or
after 1-3-2003), Mumbai as on 1-3-2003 and the transactions of purchase or sale of such
equity shares are entered into on a recognised stock exchange in India.
2. Capital Gain on Compulsory Acquisition of Urban Agricultural Land
[Section 10(37)]: In the case of an assessee, being an individual or a Hindu Undivided
Family, any income chargeable under the head capital gains arising from the transfer of
agricultural land, is exempt from income tax where :
(i) Such land is situated in any area referred to in item (a) or item (b) of sub-clause
(iii) of clause (14) of section 2;
(ii) Such land, during the period of two years immediately preceding the date of
transfer, was being used for agricultural purposes by such Hindu undivided
family or individual or a parent of his;
195
(iii) Such transfer is by way of compulsory acquisition under any law or a transfer,
the consideration for which is determined or approved by the central
government or the Reserve Bank of India;
(iv) Such income has arisen from the compensation or consideration for such
transfer received by such an assessee on or after the first day of April 2004.
Notes
Explanation: For the purposes of this clause, the expression compensation or

consideration includes the compensation or consideration enhanced or further enhanced
by any court, tribunal or other authority.
3. Long-term Capital Gain on Transfer of Securities covered under
Securities Transactions Tax STT [Section 10(38)]: Any income arising from the
transfer of a long-term capital asset, being an equity share in a company or a unit of an
equity oriented fund where the transaction of sale of such equity share or unit is
entered into on or after 1.10.04 and such transaction chargeable to securities transaction
tax under that chapter, is exempt from income tax.
Explanation: For the purposes of this clause, equity oriented fund means a fund,
(i) where the investible funds are invested by way of equity shares in domestic companies to
the extent of more than fifty per cent of the total proceeds of such fund; and (ii) which has
been set up under a scheme of a Mutual Fund specified under clause (23D).
Provided that the percentage of equity shareholdings of the fund shall be computed
with reference to the annual average of the monthly averages of the opening and closing
figures.
4.6.1 Capital Gains Exempt from Tax [Sections 54, 54B, 54D, 54EC, 54F, 54G, 54H
and 54GA]
Capital Gains Arising from the transfer of Residential House Property [Section
54]: Capital Gains arising from the transfer of a Residential House Property are exempt
from tax provided the following conditions are satisfied:
1. The house property is a residential house whose income is taxable under the
head Income from House Property.
2. The house property is owned by an individual or HUF.
3. The house property is a long-term capital asset.
4. The assessee has purchased a residential house within a period of one year
before the transfer or within two years after the date of transfer.
OR, he has constructed a residential house property within a period of three years
after the date of transfer.
Important Points:
1. Construction of the house should be completed within 3 years from the date of
transfer. The date of commencement of construction is irrelevant.
2. Case of allotment of flat under the self-financing scheme of DDA is treated as
construction of house for this purpose.
Amount of Exemption: (i) If the amount of the capital gains is less than the cost of
the new house property, the entire amount of capital gains is exempt from tax. (ii) On the
other hand, if the amount of capital gains is greater than cost of new house property, the
difference between the new house and the amount of capital gains is chargeable to tax
as capital gains.
Withdrawal of Exemption: The new house (purchased or constructed) should not
be transferred within a period of three years of its purchase or construction. If it is
transferred within three years, the cost of the new house will be reduced by the amount of
196
Notes
capital gains invested in its purchase/construction and claimed exempt. The capital gains
arising on the transfer of the new house shall be chargeable to tax as the short-term
capital gains of the previous years in which the new house is transferred.
Deposit in Capital Gains Account Scheme, 1988: The amount of capital gain
which is not appropriated by the assessee towards the purchase or construction of a new
asset before the date of furnishing the return of income under Section 139 shall be
deposited by him before furnishing such return in an account in any such bank in
accordance with the New Capital Gains Account Scheme, 1988 and such return shall be
accompanied by proof of such a deposit. The amount already utilised by the assessee for
the purchase or construction of the new asset together with the amount so deposited
shall be deemed to be the cost of new asset.
If the amount so deposited is not utilised wholly or partly for the purchase or
construction of the new asset, the amount not so utilised shall be charged as capital gain
under Section 45 in the previous year in which the period of three years from the date of
the transfer of the original asset expires. The assessee shall be entitled to withdraw such
an amount in accordance with the scheme.
It may be noted that amendments have been made on similar lines in Sections 54B,
54D, 54F and 54G also facilitating investment by way of deposit in the Capital Gains
Account Scheme, 1988, pending utilisation of the capital gains (under Section 54B and
54D) and the net consideration (under Section 54F) for the purpose of acquiring the
specified assets. This new scheme would obviate the need for rectification of
assessment of the earlier years.
Section 54B: Capital Gains on Transfer of Agricultural Land: Any capital gains
arising on the transfer of agricultural land situated in an urban is exempt subject to the
following conditions:
1. The agricultural land is owned by an individual. If the agricultural land is
transferred by a HUF, the family is not entitled to exemption u/s 54B [CIT v.
G.K. Devrajulu].
2. The agricultural land must have been used by the assessee or his parents for
agricultural purpose during the two years immediately preceding the date of its
transfer.
3. The assessee has purchased within a period of two years from the date of
transfer (and not before sale) any other land for being used for agricultural
purposes.
Amount of Exemption: The capital gains arising from the transfer of such an
agricultural land is exempt to the extent of the cost of the new agricultural land purchased
within the period mentioned above. It means, if the whole capital gain is reinvested it is
fully exempt from tax.
Withdrawal of Exemption: The new asset (agricultural land) should not be
transferred within a period of three years of its purchase. If it is transferred within three
years, the cost of the new agricultural land will be reduced by the amount of capital gains
invested in its purchase and claimed exempt. The capital gains, if any, arising on the
transfer of a new asset, shall be chargeable to tax as short-term capital gains of the
previous year in which the new asset is transferred.
The benefit of the Capital Gains Account Scheme, 1988 is available u/s 54B also.
Capital Gains on Compulsory Acquisition of Lands and Buildings [Section
54D]: Any capital gain arising on the transfer of land or building or any right in land or
building is exempt, subject to the following conditions:
1. The assessee is engaged in an industrial undertaking.
197
2. The land or building or any right therein should form part of the industrial
undertaking.
3. Such asset should have been compulsorily acquired under any law.
4. The assessee has used the land or building or any right therein for the
purposes of the business of industrial undertaking in the two years immediately
preceding the date on which the transfer took place.
5. The assessee has, within a period of three years after such transfer, purchased
any other land or building or any right in any other land or building or
constructed any other building for the purposes of shifting or re-establishing the
industrial undertaking or setting up another industrial undertaking.
6. The capital gain arising from the transfer of such a land or building is exempt to
the extent of the cost of the new land or building purchased or constructed
within the period mentioned in (5) where the amount of the capital gain
exceeds the cost of acquisition or construction, only excess shall be
chargeable to tax.
Notes
The benefit of the Capital Gains Account Scheme, 1988 is available u/s 54B also.
Exemption of Long-term Capital Gain in case of investment of Capital Gains in
certain Bonds [Section 54EC]: With effect from 1.4.2000 (Assessment Year 2000-01
and onwards), where the capital gain arises from the transfer of a long-term capital asset,
it will be exempt if the assessee has invested the capital gain in the long-term specified
asset subject to the fulfillment of all the conditions given hereunder:
1. The capital gain arises from the transfer of a long-term capital asset (hereafter
referred to as an original asset).
2. The assessee has, within a period of 6 months after the date of transfer or sale
of the original asset, invested whole or any part of capital gains, in a long-term
specified asset. A long-term specified asset is defined to mean any bond
redeemable after three years and issued, on or after 1.4.2000, by the National
Bank for Agricultural and Rural Development or by the National Highways
Authority of India.
3. The cost of the long-term specified asset is not less than the capital gain in
respect of the original asset. If the cost of the long-term specified asset is less
than the capital gain, then, the capital gain, proportionate to a part of the capital
gain invested will be exempt. However, the investment made on or after
1-4-2007 in the long-term specified asset by the assessee during any financial
year cannot exceed ` 50 lakhs.
After availing the exemption, the assessee has to retain the long-term specified
asset for a minimum period of three years from the date of its acquisition.
If the long-term specified asset is transferred or converted (otherwise than by
transfer) into money or the assessee takes a loan or advance on the security of such a
long-term specified asset, at any time within a period of three years from the date of its
acquisition, the amount of exempted capital gain on transfer of the original asset will be
deemed to be long-term capital gain.
(a) of the previous year in which long-term specified asset is transferred/converted
into money, or
(b) of the previous year in which the loan or advance is taken against security of
such a long-term specified asset. It may be noted that irrespective of the
quantum of loan or advance taken, the entire exempted amount of capital gain
will be brought to tax.
198
Notes
Capital Gain on the transfer of a Long-term Capital Asset [Section 54F]

[Exempted if the net consideration is invested in a residential house]: Exemption is
granted if the following conditions are fulfilled:
1. The assessee is either an individual or a HUF.
2. The assessee has transferred a long-term capital asset other than a residential
house.
3. The assessee purchases within a year before or within a period of 3 years after
the date of transfer, a residential house.
4. The assessee does not own more than one residential house except as
mentioned in 3 above.
Amount of Exemption:
1. If the cost of the new house is more than the net consideration in respect of the
capital asset transferred, the entire capital gain arising from the transfer will be
exempt from tax.
2. If the cost of the new house is less than the net consideration in respect of the
asset transferred, the exemption from long-term capital gains will be granted
proportionately on the basis of investment of the net consideration, either for
purchase or construction of the residential house (cost of new house X capital
gains/net consideration). The net consideration in respect of the transfer of a
capital asset is the full value of the consideration received or accruing as a
result of the transfer of a capital asset after deduction of any expenditure
incurred wholly and exclusively, in connection with the transfer.
Withdrawal of Exemption:
(a) If the individual sells or transfers the new house within 3 years of its purchase
or construction; or
(b) If the individual purchases, within a period of two years of the transfer of the
original asset or constructs, within a period of three years of such an asset, a
residential house other than the new house [annual value of such house shall
be taxable under the head Income from House Property].
In the aforesaid two cases, the amount of capital gains arising from the transfer of
the original asset, which was not charged to tax, will be deemed to be the income by the
way of long-term capital gains of the year in which a new house is transferred or another
residential house (other than the new house) is purchased or constructed, as the case
may be.
Benefit of Capital Gains Account Scheme, 1988 is available u/s 54F also.
Capital Gains on the Shifting of Industrial Undertakings from Urban Area
[Section 54G]: Capital gains on the shifting of an industrial undertaking from urban area
to non-urban area are exempt if the following conditions are satisfied:
1. The assessee transfers a long-term or short-term capital asset in the nature of
plant, machinery, building or land or any right in building or land. It means
exemption is not available on the capital gains on transfer of other assets, for
e.g., furniture.
2. Such an asset should have been used for the purpose of the business of
industrial undertaking situated in an urban area.
3. The asset should have been transferred in connection with the shifting of the
undertaking to a non-urban area.
4. The amount of capital gains should be utilised within a period of one year
before or three years after the date of transfer for the following purposes:
199
(a) purchase of new machinery or plant, acquire land or building or

construction of building for the purposes of his business in the area to
which the undertaking is shifted; or
(b) incurs expenses on shifting the original asset and transferring the
establishment of the undertaking to such area; or
(c) incurs expenses on such other purposes as may be specified in a scheme
framed by the Central Government; the capital gain shall be exempted to
the extent such gain has been utilised for the aforesaid purposes.
Notes
Withdrawal of Exemption: Where the new asset is transferred within three years of
its being purchased, acquired, constructed or transferred, the cost of the new asset shall
be taken as NIL. Where the capital gains were more than the cost of the new asset, the
unutilised capital gains shall be put to tax u/s 54. Where the cost of the new asset is more
than the capital gains, the cost of the new asset shall be other cost as reduced by the
amount of capital gains.
Benefit of the Capital Gains Account Scheme, 1988 is available u/s 54G also.
Extension of time limit for acquiring a new asset: Where the transfer of the
original asset is by the way of compulsory acquisition under any law and the amount of
compensation awarded for such acquisition is not received by the assessee on the date
of such transfer, the period of acquiring the new asset under Sections 54, 54B, 54D,
54BC and 54F by the assessee or the period for depositing or investing the amount of
capital gain shall be extended in relation to such an amount of compensation as is not
received on the date of transfer. The extended period shall be reckoned from the date of
transfer. The extended period shall be reckoned from the date of receipt of the amount of
compensation.
Exemption of Capital Gains on the transfer of assets in cases of shifting of an
industrial undertaking from an urban area to any Special Economic Zone [Section
54GA]: The benefits under this section are similar to Section 54G. Exemption of capital
gains on the transfer of assets in cases of shifting of an industrial undertaking from an
urban area to any special Economic Zone. Such Special Economic Zone may be situated
in urban area or any other area.
The assessee has within a period of one year before or 3 years after the date on
which the transfer took place:
(a) Purchased machinery or plant for the purposes of business of the industrial
undertaking the Special Economic Zone to which the said undertaking is
shifted.
(b) Acquired building or land or constructed building for the purposes of his
business in the Special Economic Zone;
(c) Shifted the original asset and transferred the establishment to Special
Economic Zone; and
(d) Incurred expenses on such other purpose as may be specified in a scheme
framed by the Central Government for the purposes of this section.
Amount of Exemption If the above conditions are satisfied, then the amount of
exemption is equal to
(a) the amount of capital gain generated on transfer of capital assets in the case of
shifting of an undertaking as stated above; or
(b) the cost and expenses incurred in relation to all or any of the purposes
mentioned in (a) to (d) supra (such cost and expenses being hereinafter
referred to as the new asset), whichever is lower.
200
Notes
Consequences if the new asset is transferred within 3 years If the new asset
is transferred within a period of 3 years from the date of its purchase/construction/
acquisition, the amount of exemption given earlier under section 54GA would be taken
back.
Scheme of Deposit in respect of exemption under section 54GA These
provisions have been framed on similar lines as given in Sections 54, 54B, etc.
4.6.2 Tax on short-term Capital Gains in certain cases [Section 111A]
Where the total income of an assessee includes any income chargeable under the
head Capital Gains, arising from the transfer of a short-term capital asset, being an
equity share in a company or a unit of equity oriented fund and
the transaction of sale of such equity share or unit is entered into on or after
1-10-2004;
such transaction is chargeable to securities transaction tax;
such equity shares are transferred through a recognised stock exchange or
such units are transferred through a recognised stock exchange or sold to
mutual fund.
The tax payable by the assessee on the total income shall be aggregate of
the amount of income tax calculated on such short term capital gains at the
rate of 15%; and (ii) the amount of income-tax payable on the balance amount
of total income as if such balance amount were the total income of the
assessee.
However, in the case of an individual or a HUF being a resident, where the total
income as reduced by such short-term capital gains is below the maximum amount which
is not chargeable to income tax, then such short-term capital gains shall be reduced by
the amount by which the total income as so reduced falls short of the maximum amount
which is not chargeable to income-tax and the tax on the balance of such short-term
capital gains shall be computed at the rate of 15%.
No deduction under Chapter VI: Further, where the gross total income of an
assessee includes any short-term capital gains referred to above, the deduction under
Chapter VIA shall be allowed from the gross total income as reduced by such capital
gains
4.6.3 Tax on Long-term Capital Gains [Section 112]
The basic reason for making a distinction between short-term capital gain and
long-term capital gain is that a short-term capital gain (other than short-term capital gain
in case of listed equity shares and units of equity oriented mutual fund mentioned above
under section 111A), is to be taxed at the normal rates of tax like any other income,
whereas, long-term capital gain and short-term capital gain under section 111A above
are to be taxed at a concessional rate. Further, although, short-term capital gain and
long-term capital gain are part of the total income, but for purpose of computation of tax
on long-term capital gain, such long-term capital gain, like short-term capital gain under
section 111A mentioned above, is kept separate from the gross total income due to
following reasons:
(i) Deductions permissible under Chapter VIA are not allowed from long-term
capital gains.
(ii) Rate of long-term capital gain will be at concessional rate.
(iii) Hence the following steps should be followed for calculation of tax on total
income, where long-term capital gains are included in the total income.
201
1. Compute the gross total income without including long-term capital gain.
2. Allow deductions permissible u/s 80C to 80U from such gross total
income.
3. Calculate the income tax at the normal rate of tax on income arrived at in
Step 2.
4. Compute the tax at the flat prescribed rates on long-term capital gains.
5. The aggregate of the tax computed in step3 and step4 shall be the tax on
net income.
6. Add surcharge, if applicable plus education cess plus SHEC on tax so
computed at the rate applicable.
Notes
Further, where the total income of the resident individual or resident HUF, as
reduced by long-term capital gain is below the maximum amount which is not chargeable
to tax, then such long-term capital gains shall be reduced by the amount by which such
total income (exclusive of long-term capital gains) falls short of the exemption limit and
tax on balance shall be computed at the rate of 20%. For example ,the income of X for
the previous year 2013-14 without long-term capital gains is ` 1,45,000 and the long term
capital gains are ` 70,000.In this case total income excluding long-term capital gain is
` 1,45,000 whereas the maximum exemption on which no tax is payable is ` 2,00,000
[` 2,00,000 in case of resident woman, ` 2,50,000 in case of resident woman who is of
the age 60 years or above and ` 5,00,000 in case of resident individual of the age of 80
years or more] for assessment year 2014-15. Therefore ` 55,000 will be reduced from
the long term capital gain of ` 70,000 to claim the full exemption of ` 2,00,000.The tax at
the rate of 20% shall be payable on balance long-term capital agin
However, in case of long-term capital gain
115AB,115AC,115AD and 115E, the rate of tax is 10%.
covered
by
sections
Concessions/Special Rates of Income Tax on Long-term Capital Gains

Class of Assessee
Rate of tax
1.
Resident individual and HUF
20%
2.
Domestic companies
20%
3.
Other residents like firms, AOPs
20%
Rate of tax on long-term capital gain

(a) in case of non-resident (not being a company or a foreign company:
(i) from the transfer of capital asset being unlisted securities @ 10% without
giving effect of first and second proviso(indexation)
(ii) from the transfer of capital asset other than (i) above 20%
(b) in the case of a resident from transfer of any capital asset 20%
Tax on long-term capital gains from listed securities, units etc.
Long-term capital gain from the sale of equity shares or units of equity oriented fund
is exempted u/s10(38) if shares are sold through recognized stock exchange or units of
equity oriented funds are either sold through recognized stock exchange or sold to
mutual fund and security tax has been paid.
However, in other cases ,the tax payable by the assessee on long-term capital gain
from securities listed on any recognised stock exchange in India or units of UTI or Mutual
Funds covered under Section 10(23D) and Zero Coupon bonds shall be minimum of the
following two amounts :
1. Tax @ 20% on long-term capital gains computed after indexation of cost of
such shares, securities or units. Or
202
Notes
2. Tax @ 10% on long-term capital gains computed without indexation of its cost.
Meaning of listed securities: Listed securities means the securities as
defined in Section 2(h) of the Securities Contracts (Regulation) Act, 1956 and
listed in any recognised stock exchange in India.
As per section 2(h) securities, include: (i) shares, scrips, stocks, bonds, debentures,
debenture stock or other marketable securities of a like nature in or of any incorporated
company or other body corporate, (ii) Government securities, (iia) such other instruments
as may be declared by the Central Government to be securities and (iii) rights or interest
in securities.
Benefit of lower tax rate of 10% is available in case of bonus shares although its
cost is nil and indexation is not possible.
Benefit of 10% rate in case of long-term capital gain also applicable to non-resident
who has bought shares in foreign currency.
Rates of Tax on Long-term Capital Gain from the Transfer of Capital asset
Being Unlisted Securities [Sub-clause (iii) to Clause (c) of Section 112(1) [w.e.f. A.Y.
2013-14]
The amount of income-tax on long-term capital gains arising from transfer of a
capital asset, being unlisted securities shall be calculated at the rate of 10% on the
capital gains in respect of such asset as computed without giving effect to the first and
second proviso to section 48
4.7 Hints for Tax Planning

For the purpose of tax planning, the following propositions should be borne in mind
each depending in the context in which they have been made.
1. Since long-term capital gains lower tax burden, taxpayers should so plan as to
transfer their capital assets normally only 36 months after acquisition.
2. The assessee should take advantage of exemption under section 54 by
investing the capital gain arising from sale of residential house property in the
purchase of another house (even out of India)within the specified period.
3. In order to claim advantage of exemption under sections 54B and 54D it should
be ensured that the investment in new asset is made only after effecting
transfer of capital assets.
4. In order to take advantage of exemption under sections 54, 54B, 54D, 54EC,
54F, 54G and 54GA the tax payer should ensure that the newly acquired asset
is not transferred within 3 years from the date of acquisition. Alternatively it will
be advisable that instead of selling or converting assets acquired under
sections 54, 54B, 54D, 54F, 54G and 54GA into money, the tax payer should
obtain loan against the security of such asset(even by pledge) to meet the
exigency
5. In the two cases discussed below, surplus arising on sale or transfer of capital
assets is chargeable to tax as short term capital gains by virtue of Section 50.
These cases are: (a) when written down value of a block of assets is reduced
to nil, though all the assets falling in the block are not transferred, (b) when a
block of assets ceases to exist.
Further tax on short term capital gain can be avoided if
(a) another capital asset ,falling in that block of assets, is acquired at any
time during the previous year; or
(b) benefit of section 54G is availed
203
4.8 Problems
Notes
Problems in the Computation of Income under the head Capital Gains:

1. A resident of India purchased 1,000 listed equity shares of ` 10 each at ` 115 per
share from a broker on 5-4-1997. He paid ` 2,000 as brokerage. On 2-3-2002 he was
given bonus shares by the company on the basis of one share for every 2 shares held.
On 24-2-2013, he was given a right to acquire 1,000 right shares @ ` 60 per share. He
acquired 50% of the right shares offered and sold the balance 50% of the right for a sum
of ` 60,000 on 3-4-2013. The right shares were allotted to him on 20-4-2013.
All the shares held by him were sold on 24-3-2014 @ ` 350 per share.
(a) Compute the capital gains and tax for the A.Y. 2014-15 assuming his income
from other sources is ` 62,000.
(b) What shall be your answer, if these shares had been sold through as
recognised stock exchange?
Solution:
Assessment Year 2014-15 Capital Gains on the original shares, i.e., 1000 shares
Full value of consideration (1000 350)
3,50,000
Less: Indexed cost of acquisition (1,17,000 939/ 331)
3,31,912
Long-term capital gain after indexation
18,088
Long-term capital gain without indexation (3,50,000 1,17,000)
2,33,000
Capital gains on bonus shares:

Less: Indexed cost of acquisition
1,75,000
Nil
Long-term capital gain after indexation

Long-term capital gain without indexation (1,75,000 Nil)
1,75,000
175,000
Capital gains on right shares:

1,75,000
Less: Cost of acquisition (500 60)
30,000
Short-term capital gain
1,45,000
Capital gains on sale of right:

Full value of consideration
60,000
Less: Cost of acquisition
Nil
60,000
Tax on long-term capital gain on shares:
1.
2.
@20% (after indexation)
@10% (without indexation)
3618
35,000
23,300
17,500
Original shares
Bonus shares
Take in each case which ever is minimum

Thus, it will be ` 3,618 + 17,500
Tax on other income 62,000 + 1,45,000 + 60,000 = 267,000
21,118
6,700
204
Notes
Tax
27,818
Less: Rebate u/s 87A
2,000
25,818
Add: Education cess and SHEC @ 3%
775
26,593
Tax rounded off
26,590
(B) Since shares are sold through a Recognised Stock Exchange, long-term capital
gains on original shares amounting to ` 18,088 and on bonus shares amounting to
` 1,75,000 shall be exempt.
Short-term capital gain on right shares shall be taxable @ 15% but short-term
capital gain on the sale of right shall be taxable at the normal rate and included in other
income. Thus, tax will be calculated as under:
Tax on short-term capital gain on the sale of right shares (15% of ` 67,000)
10,050
Tax on other income
62,000 + 60,000 + 78,000 (shifted from STCG on sale of right shares)
Total Tax
Less rebate u/s 87A
Nil
10,050
2000
Add: Education cess and SHEC (@ 3%)
242
Total Tax payable
8292
Tax rounded off
8290
2. R owns two buildings, the depreciated value of the block on 1-4-2010 being 22.50
lakhs. On of the said buildings which had been purchased on 30-4-1997 for ` 18 lakhs
compulsorily acquired by the government on 15-5-2010 for which a sum of ` 50 lakhs is
paid as a compensation on 20-3-2011. The said building was being used by the company
as a tenant for about 4 years prior to the date of acquisition of the same by the company.
The company purchases a new building on 10-4-2011 for ` 14 lakh, for the purpose of
setting up another industrial undertaking.
Compute the amount of capital gains for the Assessment Year 2011-12. What would
be the capital gains if the new building was purchased on 8-5-2010?
Solution:
Computation of Capital Gains for the Assessment Year 2011-12
Particulars
Sale consideration
50,00,000
Less: Cost of acquisition being the depreciated value of the block on 1-4-2010
22,50,000
Short-term capital gains
27,50,000
Less : Exemption under Section 54D

As the tax payer has purchased a new building for setting up another industrial
undertaking within 2 years from 20-3-2011, the exemption is available u/s 54D,
the exemption being ` 14 lakhs
14,00,000
Short-term Capital Gains chargeable to tax for A.Y. 2011-12
13,50,000
If the new building is purchased on 8-5-2010, i.e., before the date of acquisition by
the Government, the capital gains shall be determined as follows :
Sale consideration
50,00,000
205
Less : Depreciated Value of the block on 1-4-2010 plus cost of asset acquired
during the previous year 2010-11
(` 22,50,000 + cost of building purchased during 2010-11 ` 14 lakhs)
Notes
36,50,000
13,50,000
Exemption under Section 54D

Short-term Capital Gain
Nil
13,50,000
3. A acquired a plot of land on 15-6-1994 for ` 10,00,000, which was sold on

5-1-2011 for ` 44,00,000. The expenses of transfer were ` 1,00,000. A made the
following investments on 4-2-2011 from the proceeds of the above plot.
(a) Bonds of Rural Electrification Corporation Ltd. redeemable after a period of
3 years ` 12,00,000.
(b) Deposits under Capital Gain Scheme for purchase of a residential house as he
does not own any house ` 8,00,000.
Compute the Capital Gain chargeable to tax for the A.Y. 2011-12.
Assessment Year 2011-12
`
`
44,00,000
Total consideration
Less :
(i)
Expenses on transfer
1,00,000
(ii)
Indexed cost of acquisition (10,00,000 711/259)
27,45,174
28,45.174
15,54,826
Long-term capital gain

Less :
Exemption u/s 54EC

Exemption u/s 54F (15,54,826 ( 8,00,000/43,00,000)
12,00,000
2,89,270
14,89,270
65,556
Taxable Long-term Capital Gain
4.
X Ltd. owns the following assets on April 1, 2010.

Rate of depreciation
Depr. Value on 31.03.2010
Plant A
25%
4,05,000
Plant B
25%
1,95,000
Plant C
25%
7,05,700
On June 2010, it acquires Plant D for ` 20,000 (rate of depreciation 25%). The
company sells the following assets 2010-11 :
Sale consideration
Expenses on transfer
Plant A
2,12,000
12,000
Plant B
6,17,500
Plant C
4,30,000
Plant D
95,000
200
Determine the amount of depreciation and capital gains for A.Y. 2011-12. Is it
possible to avoid tax on capital gains?
206
Notes
Solution:
Depreciation :
First Block: Plant (rate of depreciation 25%)
Depreciated value of Plant A + B + C
Add: Cost of plant D acquired during the year
13,05,700
20,000
13,25,700
Less : Sale consideration of Plants A, B, C and D

i.e., 2,12,000 + 6,17,500 + 4,30,000 + 95,000, i.e., 13,54,500
Subject to a maximum of
13,25,700
WDV
NIL
Depreciation @ 25% on WDV
NIL
Capital Gains
Sale consideration of plant A, B, C and D
13,54,500
Less: Cost of Acquisition

Depreciated value as on 1.4.2010
13,25,700
Balance
28,800
Less : Expenses on Transfer
12,200
16,600
Important Points :
1. Tax on short-term capital gains can be avoided if the company purchases
another plant (eligible for depreciation @ 25%) during the Previous Year
2010-11 of ` 16,600 or more.
2. If the plants A, B, C and D are transferred for less than ` 13,25,700, the
deficiency would be treated as short-term capital loss.
4.9 Summary
The purpose of this part is to enable the students to comprehend basic
expressions used in taxation. Therefore, all the basic terms are explained and
suitable illustrations are provided to define their meaning and scope. These
terms are : income, rates of tax, person, assessee, assessment year, previous
year, gross total income, total income, computation of tax liability on total
income
Tax incidence on an assessee depends on his residential status. All taxable
entities are divided in the following categories for the purpose of determining
residential status: an individual, a Hindu undivided family, a firm or an
association of persons, a joint stock company and every other person.
An assessee is either resident in India or non-resident in India. However, a
resident individual or Hindu undivided family can be resident and ordinarily
resident or resident but not ordinarily resident. Residential status of an
assessee is to be determined in respect of each previous year.
Indian income is always taxable in India in respect of the residential status of
the taxpayer. Foreign income is taxable in the hands of a resident or resident
and ordinarily resident (in the case of an individual and a Hindu undivided
family) in India. Foreign income is not taxable in the hands of a non-resident in
207
India. In the hands of a resident not ordinarily resident taxpayer, foreign income
is taxable only if it is business income and business is controlled from India or
professional income from a profession which is set up in India. In any other
case, foreign income is not taxable in the hands of resident but not ordinarily
resident taxpayers.
This part deals with: (a) Income of foreign companies providing technical
services in projects connected with the security of India [Section 10 (6C)].
(b) Section 10AA: Special provisions in respect of newly established units in
Special Economic Zones and (c) Income from property held for charitable
purposes [Section 10AA].
This portion deals with the Profits and Gains from Business/Profession as
provided in the tax statute. The expression in the ordinary parlance means an
activity of a commercial nature capable of producing profit. The chapter
summarises the income that are to be included under the head Profits and
Gains of Business/Profession as distinguished from income from other
sources. It also provides for computation of income, deductions that can be
claimed as deductible, income that are not chargeable to tax and expenses
though charged to profit and loss in arriving at the net income but expressly not
allowed as per Income Tax Statute. Depreciation allowable as per the Income
Tax Statute are to be separately computed as the assessee has been allowed
flexibility to provide depreciation in the books as per broad framework provided
in Companies Act. It also deals with maintenance of accounts by certain
persons carrying on business or profession and audit therein. It also covers
method of accounting to be followed including compulsory adopting of
Accounting Policy.
In this part, we have discussed basis of charge for capital gains; Transaction
not regarded transfer withdrawal of exemption in certain cases; Computation of
capital gains; Capital gains exempt from tax; Tax on long term capital gains.
Notes
4.10 Check Your progress

I. Fill in the Blanks
1. Expenditure incurred by a company after its incorporation and after his
business has been set up, on development of website for conducting its
business partly through website could be considered as _________
expenditure.
2. interest on borrowed funds utilized for acquisition of an asset as part of
extension of business could be capitalized till the asset ___________.
3. Subsidy received by a company operating a sugar mill which could be utilized
only for repayment of term loans taken by it for setting up new units and
extension of existing units would be treated as __________.
II. State Whether the Following Statements are True or False
1. The definition of transfer u/s 2(47) is applicable only in the case of a capital
asset.
2. Compulsory Acquisition of a property by the Government is transfer.
3. Redemption of share capital is transfer.
4. Reduction of share capital is not transfer.
208
5. A taxpayer converts his capital asset into stock in trade. There is no transfer
since the person who holds the asset before and after this transaction is the
same.
6. X sells a residential house property. He has received the full consideration and
the possession has been transferred to the buyer as per agreement to sell. But
since the sale deed is not registered in favour of the buyer, there is no transfer.
7. If the property constitutes to exist after relinquishment, there is transfer, but if
a property disappears at the time of relinquishment there is no transfer.
Notes
III.
Multiple Choice Questions

1. the benefits of amortization of preliminary expenses under section 35D has
been extended to __________.
(a) Manufacturing companies,
(b) Post commencement preliminary expenses of service sector units,
(c) Non-resident companies, or
(d) Non-resident individuals.
2. No disallowance under section 40(a)(ia) shall be made in case of a deductor in
respect of expenditure incurred in the month of March if the TDS on such
expenditure has been paid before __________.
(a) 31st December,
(b) 30th September,
(c) due date for filling the return, or
(d) 30 days from the date of deduction
3. Depreciation on new plant acquired and kept as standby in anticipation of an
order for supply of goods is __________.
(a) An allowable expenditure on an asset kept as standby,
(b) Not allowable as asset acquired but put to use,
(c) partly allowable, or
(d) None of the above

1. Explain the meaning of previous year. What would be the previous year for a
new business started during the financial year? Explain with examples.
2. Income tax is assessed on the income of the previous year in the next
assessment year. State the exceptions to this rule.
3. What are the essential features of the term Income?
4. Discuss capital receipts vis--vis revenue receipts.
5. Tax rates are not given under the Income Tax Act 1961, but by the Annual
Finance Act. Discuss.
6. A financial year has a double role to play. It is a previous year as well as an
assessment year. Do you agree?
7. Determine the status of the following under the Income Tax Act, 1961:
(i) Delhi University
(ii) L & T Ltd.
(iii) Pune Municipal Corporation
(iv) Taxman Publication (P) Ltd.
209
(v)
(vi)
(vii)
(viii)
(ix)
Laxmi Cooperative Bank Ltd.

ABC Group Housing Co-operative Society
X, Y & Co., firm of X and Y
A joint family of X, Mrs. X and their sons A and B
X and Y are legal heirs of Z (Z died in 2004 and X and Y will carry on his
business without entering into partnership).
8. Indicate whether the following statements are true or false:
(i) X is a partner of a firm. He is assessable as an individual.
(ii) Y is the managing director of A Ltd. Y is assessable as an individual.
(iii) Delhi Municipal Corporation is assessable as artificial juridical person.
(iv) Co-owners (with specific shares in a house property) transfer the property
capital gain generated on the transaction is taxable in the hands of
co-owners as body of individuals.
9. Discuss whether the following are true or false:
(i) On rendering some service to a manufacturing garment unit, X is paid
remuneration in kind (i.e., a silk tie) since he has not received anything in
cash it is not an income.
(ii) On sale of goods illegally imported from a foreign country, X generates a
surplus of ` 25,000. As the income is derived from an illegal activity, it is
not chargeable to tax.
(iii) Out of `15, 000 received by Mrs. X from her husband for household
expenses, she saves approximately ` 1000 per month which is deposited
by her in a bank account. ` 1000 per month is the income of Mrs. X.
(iv) Sale proceeds of a house property is capital receipt, which is however
chargeable to tax.
(v) Salary paid to B by his employer X Ltd. out of capital reserve is not
income in the hands of B.
(vi) A birthday gift received by Z from his uncle is not taxable as income of Z.
(vii) Income under the head Income from house property is computed on the
basis of method of accounting adopted by the assessee.
10. Which period will be treated as previous year for income tax purposes for the
assessment year 2013-14 in the following cases?
Notes
(a) Sumit starts a new business on 1.11.2012 and prepares final accounts on
30.06.2013.
(b) Meenal joined service in a company on 1.1.2012 at ` 20,000/- per month.
His next increment in salary will be in 1.1.2013. Prior to this, he was
unemployed.
(c) Ashish keeps his accounts on the basis of financial year.
(d) Abhay Verma is a registered doctor and keeps his income and
expenditure account on calendar year basis.
(e) Jyoti Gupta bought a house on 1.8.2012 and let it out at ` 8000 per
month.
11. X who is a famous singer came to India from America for the first time on
26.01.2013. He gave many performances in India from which he received
` 1,00,000. When he was about to return to US, the Income Tax Officer gave
him a notice and asked him to pay Income Tax immediately. He said in his
reply, My previous year ends on 31.03.2013 and my tax liability will be in the
Assessment year 2013-14. What is your opinion in this regard ?
210
Notes
12. R who has been permanently in India migrated to US on 18.11.2012. Explain

how he will be taxed with regard to income earned between 1.4.2012 and
18.11.2012.
13. X Ltd., an Indian company, is engaged in the business of trading goods since
1960 (income of trading business for previous years 2011-12 and 2012-13 is
` 139,000 and ` 786,000, respectively). On January 6, 2013 it starts a
processing unit at Pune [income of the period ending on March 31, 2013
` 14,600]. Compute the income of X Ltd. chargeable to tax for the assessment
year 2012-13 and 2013-14.
14. A single letter of enquiry was issued by the Income Tax Dept. to Mr. S of Pune.
In this letter, there was no specific mention of any provision of the Income Tax
Act. Can Mr. S be treated as an assessee under the Income Tax Act?
Residential Status and Chargeability
1. The incidence of income tax depends upon the residential status of an
assessee. Discuss.
2. Discuss the scope of total income of a person who is a resident in India.
3. Explain under what circumstances an assessee will be considered
non-resident for income tax purposes and on what income he will be liable to
be assessed.
4. How would you decide the question of residence of an individual and a Hindu
undivided family?
5. Write short note on the following:
(a) Income received in India
(b) Income deemed to accrue or arise in India
(c) Control and management of a business.
6. How would you determine the residential status of a company? Can a company
be Not Ordinarily Resident in India?
7. X, a foreign national (not being a person of Indian origin) comes to India for the
first time on April 15, 2008. During the financial year 2008-09, 2009-10,
2010-11, 2011-12 and 2012-13 he is in India for 130 days, 80 days, 13 days,
210 days and 75 days respectively. Determine the residential status of X for the
assessment year 2013-14.
8. A, an Indian citizen, who is appointed as a senior taxation officer by the
Government of Nigeria leaves India for the first time September 26, 2010 for
joining his duties in Nigeria. During the previous year 2011-12, he comes to
India for 176 days. Determine the residential status of A for the assessment
year 2011-12 and 2012-13.
9. Y an Indian citizen leaves India for the first time on September 20, 2010 for
taking employment outside India. He comes to India for a visit of 146 days on
April 10, 2011. He comes back on May 16, 2012. Find out the residential status
of Y for the Assessment year 2013-14.
10. A Ltd. is an Indian company. It carries on business in New Delhi and London.
The entire control and management of A Ltd. is situated outside India. 80% of
the total income of the company is from the business in London. What is the
residential status of A Ltd. ?
11. From the following information about R, compute his taxable income for the
Assessment Year 2013-14 assuming Mr. R is: (i) resident but not ordinarily
resident and (ii) Non-resident.
211
(a) Remuneration for consultancy service in Japan of ` 1,00,000 but received

in India.
(b) Income from business in UAE received in Scotland ` 11,500. The
business is however controlled from India.
(c) Pension for services rendered in India but received in China ` 40,000.
(d) Fee for technical services payable by G, a resident in India, the payment
relates to a business carried out in India ` 100,000.
12. From the following particulars compute the taxable income of R when his
residential status is (i) resident, (ii) resident but not ordinarily resident and
(iii) non-resident.
(i) Interest for debentures in an Indian company received in London ` 5000.
(ii) Interest on a company deposit in India but received in Germany ` 22,000.
(iii) Interest on UK Development Bonds, 50% of interest received in India
` 40,000.
(iv) Profit on sale of shares in a Indian company received in London ` 24,000.
(v) Dividend from British Co. received in London ` 10,000.
(vi) Profit on sale of plant at Germany, 50% of the profits are received in India
is ` 60,000.
(vii) Income earned from business in Germany which is controlled from Delhi,
` 40,000 is received in India ` 70,000.
(viii) Profits from a business in Delhi, but managed entirely from London
` 45,000.
(ix) Rent from property in London deposited in Indian Bank at London brought
to India ` 50,000.
(x) Interest received in London on money but to resident in India in London
but the same money was used in India ` 46,000.
(xi) Fees for technical services rendered in India but received in London
` 25,000.
(xii) Royalty received in London for a right given to non-resident in India to be
used for business in India ` 34,000.
13. In the year 2012-2013 (previous year) a sailor has remained on ship for a
private company owning ocean going ships as follows:
1. Outside the territorial waters of India for 183 days.
2. Inside the territorial waters of India for 183 days.
Notes
Is he considered to be a resident or not for the A.Y. 2013-14 (Previous year

2012-13)? Comment.
Exempted Income of Companies
1. State the provisions relating to Income of foreign companies providing technical
services in projects connected with the security of India [Section 10 (6C)]
2. State the provisions relating to exemption relating to Special provisions in
respect of newly established units in Special Economic Zones Section 10AA.
3. State the provisions relating to exemption relating to Income from property held
for charitable purposes (Sections 11,12,13).
Profit and Gains from Business or Profession
1. Discuss the provisions of Section 28(iv) regarding tax incidence in respect of
benefits or perquisites arising from a business or exercise of a profession.
212
Notes
2. What tests would you apply to determine whether a transaction is an adventure

in the nature of trade?
3. A non-resident is engaged in shipping business. The company also operates
its shop in India. Explain how the income from the companys business
operation in India is computed.
4. What are the tax consequences in the following situations:
(i) A firm of three partners is dissolved. It held stocks valued at ` 4,80,000 on
the date of dissolution, the basis of valuation being cost for settlement of
accounts between the partner on dissolution, they have adopted
` 4,80,000 as the value of stocks.
(ii) The Director of a company was accompanied by his wife on a foreign tour
undertaken by him for business purposes. It was claimed that her
presence fulfilled a social purpose and facilitated transaction of business.
(iii) Expenditure incurred in connection with increase of the authorised capital
of a company and issue of bonus shares by it is capital in nature.
5. Discuss the following:
(i) Compensation is normally a capital receipt but there are certain receipts
by way of compensation which are taxable as income from business.
(ii) State the situation under which WDV of a block of assets will be reduced
to Nil.
(iii) Describe the provisions of Income Tax Act that deal with the computation
of business income on a presumptive basis in certain cases, in the cases
of resident assessees.
(iv) The provisions that relate to amortisation of expenses for obtaining a
license to operate telecommunication services.
(v) The concession available under the Income Tax Act to profits derived
from infrastructure business.
6. (i) What are the receipts to be excluded for computing actual loss of an asset
under Income Tax Act?
(ii) Discuss Block of Assets concept under the Income Tax Act.
(iii) While computing income from business or profession certain deduction
will be allowed only on actual payments. Discuss.
7. (i) State the cases when payment exceeding ` 20,000 made otherwise than
by a crossed cheque or by a crossed demand bank draft will not be
disallowed ?
(ii) Income from business or profession is chargeable to tax, only if it is
carried on during the previous year by an assessee. Give five examples of
cases where the income is taxable even if the business or profession is
not in existence during any previous year.
8. (i) Compare and contrast the provisions of tax audit as contained in Section
44AB of the Income Tax Act, with the provisions of the audit u/s 142(2A) of
the Act.
(ii) Anand, is a person carrying on profession as Film Artist. His gross
receipts from profession are as under:
Financial year 2011-2012
` 1,25,000.00
` 1,60,000.00
` 1,80,000.00
213
Is he required to maintain any books of accounts, u/s 44A of the Income Tax Act? If
so, what are these books?
Notes
9.
(i) State the conditions to be satisfied for claiming deductions u/s 37(1) of the Act.
(ii) What is meant by Speculation Business? What are the transactions not
deemed to be speculative transactions?
(iii) Enumerate the classes of receipts deemed to be profits and gains of business
or profession under Section 41.
10. (i) From the following figures, you are required to ascertain the depreciation
admissible and other liabilities if any, in respect of the previous year relevant to
the A.Y. 2013-14.
Plant and Machinery
Building
2,50,000.00
10,00,000.00
Additions during the year
3,00,000.00
NIL
Sales during the year
6,00,000.00
2,00,000.00
(ii) Calculate the deduction admissible u/s 37(2) in respect of entertainment

expenditure for A.Y. 2013-2014, from the following data :
Expenditure incurred on food provided to employees
` 25,000.00
Entertainment allowance paid to Directors
` 10,000.00
Other items of entertainment
` 50,000.00
(iii) From he following find out the admissible deduction u/s 37(3) and the rules
there under in respect of expenditure incurred on advertisement in a souvenir:
Expenditure on advertisement in a souvenir
` 50,000
Issued by a political party
Expenditure on presentation articles:
Value per article less than ` 1,000
` 20,000
Value per article exceeding ` 1,000
` 10,000
Expenditure incurred in cash
` 12,000
11. (a) Atmaram and Co. borrowed ` 20,000 in Hundi by an account payee cheque on
1.1.2014. The amount was repaid in cash on 1.10.2014 along with interest of
` 3,000. What is the effect of the transaction in the assessment of Atmaram
and Co. ?
(b) A manufacturer of goods which are liable to excise duty maintains a separate
account for excise duty collected and paid by him. The balance remaining in
this account is carried to the balance sheet. The levy of Central Excise was
disputed by the assessee and being successful, he received a refund of excise
duty to the tune of ` 10 lakhs which was credited to the Central Excise
Collection Account. The Assessing Officer taking the view that the provisions of
Section 41(1) are attracted brought the sum of ` 10 lakhs to tax. The assessee
disputes this levy on the ground that he had not claimed the payment of Central
Excise as a deduction in arriving at his income and therefore the provisions of
Section 41(1) are not attracted. Discuss the comparative merits of the two view
prints.
12. Jardenes Ltd. is an existing Indian company, which sets up a new industrial
unit. It incurs the following expenditure in connection with the new unit:
Preparation of project report
` 4,00,000
Market survey
` 5,00,000
214
Legal and other charges for issue of additional
Notes
Capital required for the new unit
` 2,00,000
Total
` 11,00,000
The following further data is given :

Cost of project
` 30,00,000
Capital employed in the new unit
` 40,00,000
What is the deduction admissible to the company u/s 35D?

13. From the following data, calculate the depreciation admissible to an individual
carrying on business for the A.Y. 2013-14.
(1) Factory Building WDV (10% Depr.)
` 5,00,000
(2) Plant and machinery WDV (25% Depr.)
` 8,00,000
Additions 30.6.2012 (15% Depr.)
` 1,00,000
31.12.2012 (15% Depr.)
` 1,00,000
Sales 01.12.2012 (25% Depr.)
` 6,00,000
(3) Computer
(60% Depr.)
Addition 1.1.2013
` 60,000
(4) Furniture and Fixtures WDV (15% Depr.)
` 1,00,000
(5) Motor Car WDV (20% Depr.)
` 60,000
14. Discuss the tax implications of the following transactions in the case of a doctor
running a nursing home :
(i) Amount paid to a scientific research association approved by the Central
Government and run by a drug manufacturing company ` 20,000.
(ii) Amount received from the employees as contribution towards PF for the
month of March 2010, paid to PF commissioner on 25.04.2010 ` 25,000.
(iii) Payment made in cash towards purchases of medicines ` 50,000.
(iv) Repayment of loan taken from bank for doing a post graduate course in
medicine
Instalment ` 50,000
Interest ` 10,000
15. The following is the Profit and Loss Account for the year ended 31.3.2013.
Compute his taxable income from business for that year:
Particulars
Particulars
Opening Stock
15,000
Sales
80,000
Purchases
40,000
Closing Stock
20,000
Wages
20,000
Gift from father
10,000
17,000
Rent
6,000
Sale of car
Repairs of car
3,000
Income tax refund
Wealth tax paid
2,000
Medical expenses
3,000
General expenses
10,000
Depreciation of car
4,000
Advance income tax paid
1,000
Profit for the year
26,000
1,30,000
3,000
1,30,000
215
Following further information is given :

1. R carries on his business from rented premises half of which is used as his
residence.
2. R bought a car during the year for ` 20,000. He charged 20% on the value of
the car. The car was sold during the year for ` 17,000. The use of the car was
3/4th for the business and 1/4th for personal purposes.
3. Medical expenses were incurred during sickness of R for his treatment.
4. Wages include ` 2500 on account of Rs driver.
16. Shri Batra is the owner of a small manufacturing unit. He gives you the
following details from his books of accounts for the year 2012-13:
1. Computed net profit, after charging the following items : ` 27,500
2. Provisions and reserves debited to Profit and Loss Account
(i) Provision for doubtful debts ` 15,000
(ii) Depreciation reserve ` 20,000
3. Household expenses ` 30,000
4. Donations to Prime Minister National Relief Fund ` 10,000; Other
Charitable Donations ` 20,000
5. Cheques issued for purchases ` 60,000
6. OY Telephone Deposit ` 5,000
7. Advertisement expenses ` 5,000 spent on Neon Sign given to a customer.
Advertisement gifts to 50 customers at a cost of ` 100 each.
8. Audit fee charged ` 20,000, expenses on income tax assessment ` 15,000
9. Patent purchased for ` 70,000 during the previous year
10. Market survey expenses ` 8,000, feasibility report expenses ` 12,000 on a new
project of ` 10,00,000 started this year.
11. Incomes credited to Profit and Loss Account were:
(i) Bank interest on FD ` 5,000
(ii) Interest on Post Office Savings Bank A/c ` 3,000
(iii) Interest on UTI Units ` 2,000
12. Opening stock is valued at cost plus 10% basis, whereas closing stock was
valued at cost minus 10% basis. Opening stock valued was ` 66,000; closing
stock valued was ` 72,000. Compute the Net Business Income for the A.Y.
2013-14.
17. Find out the gross total income of Sri Syam Lal on the basis of the following
particulars:
Notes
Profit and Loss A/c for the year ended 31.03.2013

`
Interest
1,800
Gross Profit b/d
1,22,700
Repairs & renewal
2,200
Interest on debentures of an
institution (Gross)
10,000
Insurance
4,200
Rent from house property
36,000
Depreciation
5,600
___________
10,200
Law charges
5,100
Labour welfare expenses
3,800
216
Notes

Subscriptions
Net Profit
5,800
1,30,000
1,68,700
1,68,700
Further information provided:

(a) (i) Interest include ` 200 on loan taken for purchasing debentures of a company
and ` 300 on loan taken for reconstruction of house property let out.
(ii) The expenses relating to house property let out are 40% of the repairs and
renewals expenses.
(iii) Depreciation includes ` 1,200 on house property let out.
(iv) Compensation was paid to an employee whose dismissal was in business
interest.
(v) Insurance includes 30% for fire insurance of the house property let out, 30% for
workers accident insurance and balance for life insurance.
(vi) Law charges includes ` 2,000 relation to a petition filed against breach of
contract and the balance regarding sales tax appeal.
(vii) Subscriptions include ` 2,000 given for election purposes to political parties.
(b) The amounts not debited to profit and loss A/c are as follows:
(i) Expenses incurred on the occasion of Dipawali - ` 500.
(ii) Theft of cash from iron safe - ` 1,500.
(iii) Expenses for new telephone connection in the business - ` 2,000.
Capital Gains
1. What is included and excluded from Capital Assets as defined by Section 2(14)
for the A.Y. 2013-14?
2. What is the transfer of a capital asset as per Section 2(47) of the Act?
3. Discuss the provisions of the Income Tax Act, 1961 regarding:
(i) Conversion of capital assets to stock in trade
(ii) Computation of capital gains in case of depreciable assets.
4. Write short notes on the following:
(i) Capital gains in the case of compulsory acquisition of a capital asset
(ii) Reference to valuation officer (u/s 55A of Income Tax Act)
(iii) Computation of capital gains in the case of slump sale u/s 50B of the
Income Tax Act, 1961.
5. State the provisions relating to the computation of capital gains in the hands of
shareholders of a company on a distribution of assets upon liquidation.
6. What are the transactions not regarded as transfer as per Section 47 under the
Income Tax, 1961?
7. Arjun was holding 3000 shares in White Light Ltd. purchased by him on August
8, 2006 at ` 60 per share. He gifted these shares to his girlfriend Chitrangada
on 10.02.2013. Arjun married Chitrangada on 1.3.2013. Chitrangada was
allotted bonus shares by the company at the rate of one share for every three
shares held on 10.09.2013. Chitrangada sold all the shares including the bonus
shares on 31.03.2014 at ` 150 per share.
State in whose hands capital gains on sale of shares is taxable. Also compute
the capital gains.
217
[Hint : Shares have been transferred before marriage, capital gains are taxable
in the hands of Chitrangada]
8. Amin is the holder of 1000 debentures of Amin Ltd. having a face value of
` 1,000 each. The company has offered an option to the debenture holders
either to redeem the debentures at ` 1,200 each or to convent the debentures
in equity shares of equivalent value. The market value of the shares on the
date of exercising the option is ` 1,200 per share (face value of ` 1,000). What
will be the tax consequences of the two options in the hands of the debenture
holder Amin ?
9.
Notes
Discuss giving reasons whether the following are correct :

(a)
(b)
(c)
(d)
10.
11.
12.
13.
A firm can claim exemption u/s 54, 54B, 54F

An individual can claim exemption u/s 54 to 54G
A company can claim exemption u/s 54D, 54EC, 54ED and 54G
A long-term capital asset is qualified for exemption u/s 54 to 54G but a
short-term capital asset is qualified for exemption only under Sections
54B, 54D and 54G.
(e) Multiple exemptions are possible but aggregate exemption under
Sections 54 to 54G cannot exceed the amount of capital gains.
(f) An individual who owns two residential houses cannot claim exemption
under Section 54F on transfer of gold
(g) An individual who owns a residential house and a plot of land in a
residential area can claim exemption under Section 54F if he sells gold
and constructs a residential house on the plot already owned by him.
Mr. P holds 500 shares of ABC Ltd., which were allotted to him on 22.11.1990
@ ` 30 per share. On 22nd July 2010, ABC Ltd., made right issue to the
existing shareholders at the rate of one share for every five shares held @
` 20/- per share. Mr. P instead of exercising his right to obtain right shares has
exercised his right of renouncement by renouncing the said right entitlement in
favour of Mr. Q @ ` 13 per right share entitlement on 4.8.2010. Determine the
nature and amount of capital gain, if any, taxable in hands of P. What will be
the cost of acquisition of the shares purchased to Mr. Q?
In April 2000, S subscribed to the first equity issue of shares of a Public Ltd. Co.
(face value of each share ` 100) to the extent of ` 25,000. In 2,000, the
company converted the face value of the shares from 100 to ` 10 each. Half of
the holdings of the shares held by S were sold by him in October 2010 for
` 50,000 S had to pay a brokerage of 2% on sale. What is the nature of gains
realized and compute the same?
Kishore Industries owned six machines that were in use in the business in
March 2009. Depreciation on these machines was available as plant. The
WDV of these machines at the end of previous year relevant to assessment
year 2011-12 was ` 6,50,000 (depreciation 15%).
A new plant was bought for ` 6, 50,000 on 30.11.2010. Three of the old
machines were sold on 10.06.2010 for ` 9,00,000. Compute:
(i) The claim to depreciation for A.Y. 2011-12.
(ii) Capital gains liable to tax for the same A.Y.
Mr. Sunder furnishes the following particulars for the previous year ending
31.3.2010, and requests you to compute the taxable capital gain
(i) He had a residential house, inherited from father in 1974, the fair market
value of which as on 1.4.1981 is ` 5 lakhs.
218
Notes
(ii) In the year 1997-98, further constructions and improvements costed

` 6 lakhs.
(iii) On 10.05.2010, the house was sold for ` 50 lakhs. Expenditure in
connection with transfer ` 50,000.
(iv) On 20.12.2010, he purchased a residential house for ` 15 lakhs.
Cost of inflation Index
1981-82
1997-98
2010-11
100
331
711
14. Arjun furnishes the following particulars and requests your advice as to the
liability to capital gains for the A.Y. 2011-12:
(i) Jewellery purchased by him on 10.3.2002 for ` 1,05,000 was sold by him
for a consideration of ` 2,85,000 on 2.11.2010.
(ii) He incurred expenses (a) at the time of purchase ` 2,000 (b) At the time
of sale (for brokerage) ` 4,000.
(iii) He invested ` 70,000 in bonds with the National Highway Authority of
India out of sale consideration are these facts:
(a) Compute the capital gains chargeable to tax;
(b) Whether Arjun would be entitled to exemption?
4.12 Key Terms

Income: Section 2(24) of the Income Tax Act,1961 gives a statutory meaning
of the term Income. The section does not define the term income, but merely
describes the various receipts that can be known as income. At present the
following items of receipts are included in Income u/s 2(24).
1. Profits and Gains
2. Dividends
3. Voluntary contributions received by a trust / institution created wholly or
partly for charitable or religious purposes or by an association or
institution .
4. The value of any perquisite or profit in lieu of salary taxable.
5. Any special allowance or benefit other than the perquisite included above,
specifically granted to the assessee to meet expenses wholly, necessarily
and exclusively for the performance of the duties of an office or
employees of a private firm.
6. Any allowance granted to the assessee to meet his personal expenses at
the place where the duties of his employment of profit are ordinarily
performed by him or at a place where he ordinarily resides or to
compensate him for the increased cost of living.
7. The value of any benefit or perquisite whether convertible into money or
not, obtained from a company either by a director or by a person who has
a substantial interest in the company or by a relative of the director or
such person and any sum paid by any such company in respect of any
obligation which, but for such payment would have been payable by the
director or other person aforesaid.
8. The value of any benefit or perquisite, whether convertible into money or
not, which is obtained by any representative assessee or by any
219
beneficiary or any amount paid by the representative assessee for the

benefit of the beneficiary which the beneficiary would have ordinarily been
required to pay.
9. Value of any benefit or perquisite, whether convertible into money or not
arising from a business or exercise of profession.
10. Any sum chargeable to income tax under Section 41 and Section 59.
11. Any sum chargeable to income tax under (ii), (iii), (iii-a), (iii-b), (iii-c), (iv)
and (v) of Section 28.
12. Any sum chargeable to tax u/s 28(v) [interest, salary, bonus, commission
or remuneration to a partner of a firm].
13. Any capital gains chargeable under Section 45.
14. The profits and gains of any insurance carried on by a Mutual Insurance
Company or by a cooperative society.
15. The profits and gains of any business (including providing credit facilities)
carried on by a cooperative society with its members.
16. The profit and gains of any business of banking (including providing credit
facilities) carried on by a co-operative society with its members.
17. Any winnings from lotteries, crossword puzzles, races including horse
races, card games and other games of any sort or from gambling or
betting of any form or nature whatsoever.
Rates of tax: Income tax is to be charged at the rates fixed for the year by the
Annual Finance Act.
Person: The term person includes:
(i) An individual
(ii) A Hindu Undivided Family
(iii) A company
(iv) A firm
(v) An association of persons or body of individuals whether incorporated or
not
(vi) A local authority and
(vii) Every artificial juridical person not falling within any of the preceding
categories.
The aforesaid definition is inclusive and not exhaustive. Therefore, any person
not falling in the above seven categories may still fall in the term person and
accordingly, may be liable to Income Tax.
Assessee: An assessee is a person by whom any tax or any other sum of
money (for example, interest, penalty, fine, etc.) is payable under the Income
Tax Act and includes:
(a) A person in whose respect proceedings for determining income or for
assessment of fringe benefits or of the income of any other person in
respect of which he is assessable or of the loss sustained by him or by
such other person or of the amount of refund due to him or to such other
person have been commenced by the Income Tax Department. Thus, a
person may become an assessee even if no amount is payable by him
under the Income Tax Act.
(b) A deemed assessee, i.e., a person who is himself not an assessee but is
treated as an assessee for the purposes of the Income Tax Act. For
example, the trustee of a trust is deemed as an assessee in respect of the
Notes
220
Notes
trust. The income earned is the income of the trust but is assessed in the
hands of the trustee as his income.
(c) An assessee in default, i.e., a person on whom certain obligations have
been imposed under the Income Tax Act but who has failed to carry out
those obligations. For example, any person who employs another person
to deduct income tax at source from the taxable salary of the employee
and pay the tax deducted at source to the government within the
prescribed time as income tax paid on behalf of the employee. In case the
employer fails to carry out these obligations, he becomes an assessee in
default.
Assessment year: Assessment Year (AY) means the financial year (1st April
to 31st March of the next year) in which the income is taxed or assessed.
Income of the previous year is taxed in the assessment year (next year) at the
rates prescribed by the relevant finance act, for e.g., income earned during the
previous year 2012-13 is taxable in the assessment year 2013-14 at the rates
prevailing by the relevant Finance Act.
Previous year: Previous Year (PY) means the financial year immediately
proceeding the assessment year. In case of a business or profession which is
newly started, the previous year commences from the date of commencement
of the new business or profession up to the next 31st day of March.
Gross total income: As per Section 14, income of a person is computed under
the following five heads:
1. Salaries
2. Income from house property
3. Profits and gains of a business or profession
4. Capital gains
5. Income from other sources.
The aggregate income under these heads is termed as the gross total income.
In other words, gross total income means total income computed in
accordance with the provisions of the Act before making any deduction under
Chapter VIA (Section 80C to 80U).
Further, Section 14A provides that no deduction shall be made in respect of
expenditure incurred by the assessee in relation to the income that does not
form part of the total income under the Act.
Total income: The total income of an assessee is a gross total income as
reduced by the amount permissible as deduction under Sections 80C to 80U.
Computation of tax liability: On the total income, tax is to be calculated
according to the rates prescribed under the relevant Finance Act.
4.13 Check your Progress: Answers

1. Revenue
2. Put to use,
3. Capital receipt
221
II. True or False

1.
2.
3.
4.
5.
6.
7.
III.
Notes
True
True
True
True
False
False
False
Multiple Choice Questions

1. (b) Post commencement preliminary expenses of service sector units,
2. (c) due date for filling the return, or
3. (a) An allowable expenditure on an asset kept as standby,
4.14 Case Study

1.
Atul, a cost accountant has been in service of a company in India for the last
10 years. The last pay drawn by him is consolidated amount of ` 38,000 per month.
He had never been out of India previously. He receives an offer from a company in
Papua New Guinea operating there, for appointment in that country as Chief
accountant on a salary of ` 70,000 per month. The offer was received sometime in
July, 2012 with option of join service before end of October 2012. Advise Atul from
tax point of view as to :
(a) Choice of date of his joining service abroad.
(b) The manner in which salary should be received by him and the necessary
remittance to India made for requirement of his family out of his salary
income.
(c) The maximum period for which he can stay in India, if he comes on leave
during the next year and still remain non-resident.
Solution
(a) Explanation to Section 6(1) provides that an Indian citizen who leave India
during the relevant previous year for the purpose of employment, becomes
resident in India only if he is in India for at least 182 days during the relevant
previous year. Hence, Atul should plan to leave India on or before 28-9-2012 to
join the company in Papua New Guinea.
(b) As per Section 5, salary of a non-resident is not taxable in India if the salary is
accrued and received outside India. Hence, Atul should receive the salary
abroad and thereafter he should remit the required amount to his family in India.
Subsequent remittance will not bring the salary received abroad to tax in India.
(c) As per Explanation to Section 6(1) of the Income Tax Act, if a citizen of India or
a person of Indian origin working abroad comes on a visit to India in any
previous year, then he shall be considered as resident in India in that previous
year if he stays in India for 182 days or more in that previous year.
2.
R, an Indian citizen, joined Oxford School of Economics as a professor on a monthly

salary of US $10,000 on 1-10-2009 on a 6 year contract. He had never been out of
India in the past. His wife and two children live in rented house, which is maintained
by him in Delhi. He wants to proceed in India on leave for a period of 10 months to
222
Notes
get his own house constructed in Delhi. But at the same time he wants to be treated
as a non-resident during his stay here so that his salary earned in the UK may
remain totally exempt from tax in India. He does not propose to make any other visit
to India during the period of his contract of service in the UK. Suggest the dates as to
how he should plan his 10 months visit to India.
Solution
An Indian citizen or a person of Indian origin who is outside India and who
comes to visit India during a previous year becomes resident in India if his stay
in India exceeds 181 days. Thus, R should plan his stay in India in such a
manner so that in any single previous year he is not in India for more than 181
days. In other words, he should split his stay in two previous years. He can
come to India for a period of 10 months at any time between 3-10-2012 to
28-9-2013.

1. Ahuja, Girish Dr. and Gupta Ravi Dr., Direct Taxes Law and Practice including
Tax Planning, Bharat Law House Pvt. Ltd..
2. Singhania Vinod K. Dr. and Singhania Kapil Dr., Direct Taxes Law and Practice
with Special Reference to Tax Planning ,Taxman.
3. Singhania Vinod K. Dr. and Singhania Kapil Dr., Direct Taxes Planning and
Management , Taxman.
223
Notes
Unit 5:
Structure:
5.1 Assessment of Companies
5.1.1 Introduction
5.1.2 Assessment of Companies
5.1.3 Residence of a Company [Section 6(3)]
5.1.5 Computation of Total Income
5.1.6 Assessment Procedure
5.1.7 Problems
5.2 Provisions Relating to Minimum Alternate Tax (MAT)
5.2.1 Introduction to MAT
5.2.2 Provisions of MAT for Payment of Tax by Certain Companies [Section
115JB(1)]
5.2.3 Illustrative Problems
5.2.4 Special Provision Relating to Tax on Distributed Profits of Domestic
Companies
5.2.5 Special Provisions Relating to Tax on Distributed Amount to Unit Holders
[Sections 115R to 115T]
5.3 Set-off and Carry Forward of Losses
5.3.1 Introduction to Set-off and Carry Forward of Losses
5.3.2 Set-off of Loss from One Source Against Income from Another Source
under the Same Head of Income [Section 70]
5.3.3 Inter-head Adjustment [Section 71]
5.3.4 Carry Forward and Set-off of Losses
5.3.5 Carry Forward and Set-off of Loss from House Property [Section 71B]
5.3.6 Carry Forward and Set-off of Business Losses [Section 72]
5.3.7 Carry Forward and Set-off of Speculation Loss (Section 73)
5.3.8 Set off and Carry Forward and Set-off of Loss of a Specified Business
Referred to in Section 35AD [Section 73A]
5.3.9 Carry Forward of Losses under the head Capital Gains [Section 74]:
5.3.10 Carry Forward of Loss from the Activity of Owning and Maintaining
Race Horses [Section 74A]
5.3.11 Brought Forward Losses Must be Set Off in the Immediately
Succeeding Year/Years
5.3.12 Problems on Set-off and Carry Forward of Losses
5.4 Tax Planning with Reference to New Projects/Expansion/Rehabilitation Plans
5.4.1 Introduction: Tax Planning with Reference to New Projects Expansion/
Rehabilitation Plans
5.4.2 Section 10AA: Special Provisions in Respect of Newly Established
Units in Special Economic Zones
5.4.3 Deduction in Respect of Profits and Gains from Industrial Undertakings or
Enterprises Engaged in Infrastructure Development etc. [Section 80IA]
224
Notes
5.4.4 Deduction in Respect of Profits and Gains from Enterprises Engaged in

Development of the Special Economic Zones [Section 80-IAB]
5.4.5 Deduction in Respect of Profits and Gains from Certain Industrial
Undertakings Other than Infrastructure Development Undertakings
[Section 80IB]
5.4.6 Deduction in Respect of Profits and Gains from the Business of Hotels
and Convention Centres in Specified Areas [Section 80ID]
5.4.7 Deduction in Respect of Certain Undertakings in North-Eastern States
[Section 80IE]
5.4.8 Deduction in Respect of Certain Incomes of Off-shore Banking Units
and International Financial Service Centres by the Specific Economic
Zone Act, 2005 [Section 80LA]
5.4.9 Venture Capital Companies [Section 10(23FB)]
5.4.10 Tea Development Account, Coffee Development Account and Rubber
Development Account [Section 33AB]
5.4.11 Site Restoration Fund [Section 33ABA]
5.4.12 Telecommunication Services [Section 35ABB]
5.4.13 Expenditure on Eligible Projects or Schemes [Section 35AC]
5.4.14 Deduction in Respect of Expenditure on Specified Business [Section
35AD] [w.e.f. A.Y. 2010-11]
5.4.15 Section 35 CCA: Payment to Institutions for Carrying out Rural
Development Programmes
5.4.16 Deductions for Expenditure on Prospecting etc. for Certain Minerals
[Section 35E]
5.4.17 Special Reserve Created by a Financial Corporation under Section
36(1)(viii)
5.4.18 Special Provision for Deduction in the Case of Business for Prospecting
etc. for Mineral Oil [Section 42 and 44BB]
5.4.19 Special Provision for Computing Profits and Gains of Civil Construction
[Section 44AD]
5.4.20 Special Provisions for Computing Profits and Gains of Business of
Plying, Hiring or Leasing Goods Carriages [Section 44AE]
5.4.21 Special Provisions for Computing Profits and Gains of Retail Business
upto A.Y.2010-11 Only [Section 44AF]
5.4.22 Special Provisions in the Case of Shipping Business [Section 44B]
Operations of Aircraft in the Case of Non-residents [Section 44BBA]
5.4.24 Special Provisions for Computing Profits and Gains of Foreign
Companies Engaged in the Business of Civil Construction etc. in
Certain Turnkey Power Projects [Section 44BBB]
5.4.25 Special Provisions in the Case of Royalty Income of Foreign
Companies [Section 44D]
5.4.26 In Respect of the Profits from the Business of Processing of
Biodegradable Waste [Section 80JJA]
5.4.27 In Respect of the Employment of New Workmen [Section 80JJAA]
5.4.28 Tax Incentives for Shipping Business Tonnage Tax [Sections 115V to
115VZC]
5.4.29 Problems
5.5 Tax Planning in Respect of Amalgamation, Merger or Demerger of Companies
5.5.1 Introduction
5.5.2 Meaning of Terms as per Tax Law Amalgamation
5.6
5.7
5.8
5.9
5.10
5.11
5.12
5.13
225
5.5.3 Income Tax Implications in Case of Amalgamation or Demerger

5.5.4 Tax Concessions Relating to Transfer of Capital Asset in Case of
Amalgamation/Merger/Demerger
5.5.5 Carry Forward and Set-off of the Accumulated Losses and Unabsorbed
Depreciation Allowance in Amalgamation or Demerger, etc. (Section
72A)
5.5.6 Provisions Relating to Carry Forward and Set-off of Accumulated Loss
and Unabsorbed Depreciation Allowance in Scheme of Amalgamation
of Banking Company in Certain Cases [Section 72AB]
5.6.1 Introduction
5.6.2 Source Rule and Residence Rule
5.6.3 Effects of Double Taxation on Trade and Services and its Remedy
5.6.4 Definition of Double Taxation
5.6.5 Necessity of Double Taxation Agreement
5.6.6 Avoiding and Alleviating the Adverse Burden of International Double Taxation
5.6.7 Salient Features of DTAA
5.6.8 Relief under DTAA
5.6.9 Models of DTAA Model
5.6.10 Analysis of Tax Treaty
Summary
Check Your Progress
Key Terms
Case Study
Further Readings
Notes
Objectives
To understand the salient points regarding the assessment of companies and

computation of total income
To learn provision of minimum Alternate Tax in certain companies and declaration and
payment of dividend
To understand provision relating to set-off and carry forward of losses to subsequent

year
To know Tax Planning with reference to new projects/expansion/rehabilitation plans
To understand tax provisions relating to amalgamation, merger or demerger of

companies so that relevant concessions can be availed through proper tax planning
To know the concept of avoidance of double taxation
5.1 Assessment of Companies

5.1.1 Introduction
A company has been defined as, a juristic person having an independent and
separate legal entity from its shareholders. Income of the company is computed and
226
Notes
assessed separately in the hands of the company. The company is liable to pay tax at a
flat rate like a firm. If any amount is distributed or paid by the company as dividend to the
shareholders, the company shall be liable to pay tax on such dividends distributed or paid
including a surcharge, as applicable. However, the shareholder shall not be liable to pay
Income Tax on such dividends.
5.1.2 Assessment of Companies
Definitions:
1. Company: As per Section 2(17), a company means:
(i) any Indian company, or
(ii) any body, corporate/incorporated by/under the laws of a country outside
India, or
(iii) any institution, association or body which was assessed as a company for
any assessment year under the Income Tax Act, 1922 or was assessed
under this act as a company for any assessment year commencing on or
before 1.4.1970, or
(iv) any institution, association or body, whether incorporated or not and
whether Indian or non-Indian, which is declared by a general or special
order of the CBDT to be a company.
2. A company in which the public is substantially interested: Section 2(18) of
the Income Tax Act has defined a company in which the public is substantially
interested to include:
(i) A company owned by the Government or the Reserve Bank of India.
(ii) A company having Government participation, i.e., a company in which not
less than 40% of the shares are held by the Government or the RBI or a
corporation owned by the RBI.
(iii) Companies registered under Section 25 of the Indian Companies Act,
1956: Companies registered under Section 25 of the Companies Act,
1956 are companies which are promoted with the special object, such as
to promote commerce, art, science, charity or religion or any such useful
object and these companies do not have a profit motive. However, if at
any time these companies declare dividend, they would loose the status
of a company in which the public is substantially interested.
(iv) A company declared by the CBDT: It is a company without share capital
and which, having regard to its object, nature and composition of its
membership or other relevant consideration is declared by the board to be
a company in which the public is substantially interested.
(v) Mutual Benefit Finance Company, where the principal business of the
company is acceptance of deposits from its members and which has been
declared by the Central Government to be a Nidhi or a Mutual Benefit
Society.
(vi) A company having co-operative society participation: It is a company in
which at least 50% or more equity shares have been held by one or more
of the cooperative societies.
(vii) A Public Limited company: A company is deemed to be a public limited
company if it is not a private company as defined by the Companies Act,
1956 and is fulfilling either of the following two conditions:
(a) Its equity shares were listed on a stock exchange, as on the last day
of the relevant previous year; or
227
(b) Its equity shares carrying at least 50% of the voting power (in the
case of an industrial company the limit is 40%) were beneficially held
throughout the relevant previous year by the Government, a
statutory corporation, a company in which the public is substantially
interested or a wholly owned subsidiary of such a company.
Notes
An industrial company means a company whose business consists mainly of the construction of
ships or the manufacturing or processing of goods or in mining or in the generation or distribution
of electricity or any other form of power.
3. Widely held company: It is a company in which the public is substantially

interested.
4. Closely held company: It is a company in which the public is not substantially
interested.
5. Indian company [Section 2(26)]: An Indian Company means a company
formed and registered under the Companies Act, 1956 and includes:
(i) a company formed and registered under any law relating to the
companies formerly in force in any part of India (other than the State of
Jammu and Kashmir and the Union Territories):
(ia) a corporation established by or under a Central, State or Provincial Act;
(ib) any institution, association or body which is declared by the Board to be a
company;
(ii) in the case of the state of Jammu and Kashmir, a company formed and
registered under any law for the time being in force in that state;
(iii) in the case of any of the Union Territories of Dadra and Nagar Haveli, Goa,
Daman and Diu and Pondicherry, a company formed and registered
under any law for the time being in force in that Union Territory.
Provided that the registered or as the case may be, the principal office of the
company, corporation, institution, association or body, in all cases is in India.
6. Domestic Company [Section 2(22A)]: A domestic company means an Indian
company or any other company which in respect of its income, liable to tax
under the Income Tax Act, has made the prescribed arrangements for the
declaration and payment within India, of the dividends (including dividends on
preference shares) payable out of such an income.
7. Foreign Company [Section 2 (23A)]: Foreign Company means a company
which is not a domestic company.
8. Investment Company: Investment Company means a company whose gross
total income consists mainly of income which is chargeable under the heads
Income from House Property, Capital Gains and Income from Other Sources.
5.1.3 Residence of a Company [Section 6(3)]
A company is said to be a resident in India during the relevant previous year if: (a) it
is an Indian company, or (b) if it is not an Indian company then, the control and the
management of its affairs is situated wholly in India.
The company is said to be non-resident in India, if it is not an Indian company and
some part of the control and management of its affairs is situated outside India.
The following table indicates the tax incidence on income in different situations
depending on the residential status of the corporate assessee.
228

Table 5.1: Income Tax in Different Situations
Notes
Place of Income
Resident
Non-resident (NR)
Income received or deemed to be received in

India whether earned in India or elsewhere.
Yes
Yes
Income accruing or arising in India whether

received in India or elsewhere.
Yes
Yes
Income deemed to accrue or arise in India

whether received in India or elsewhere.
Yes
Yes
Income received/accrued outside India from a

business controlled from India.
Yes
No
Income which accrues or arises outside India

and received from outside India from any other
source.
Yes
No
Income which accrues or arises outside India

and received outside India during the years
preceding the previous year and remitted to
India during previous year.
No
No
Further, the term business connection needs to be emphasized.

Section 9(1)(i)
Income from Business Connection: The Income Tax Act does not define the term
business connection. A business connection involves a relation between a business
carried on by a non-resident that yields profits and gains and some activity in India which
contributes directly or indirectly to the earning of those profits and gains. It implies an
intimate relation between trading activity carried on outside India and trading activity
within India and such relation is contributing to the earning of profit by non-residents. To
illustrate the term business connection, following are some instances:
1. Maintaining a branch office, factory, agency receivership or management for
the purchase and sale of goods or transacting any other business.
2. Appointing an agent in India for the systematic and regular purchase of raw
materials or other commodities or for sale of the non-residents goods for
business purposes or for securing orders in India.
3. Erecting a factory in India where the raw products purchased locally is worked
4. Forming a local subsidiary company to sell the products of the non-resident
parent company.
5. Having financial association between a resident and non-resident company.
6. Granting a continuing license to a resident to exploit for profit an asset
belonging to a non-resident even if the transaction might be disguised as out
and out sale.
In B.P. Ray v. ITO, the Supreme Court held that the expression business
connection u/s 9(1)(i) would refer to Professional Connection also.
Exception to Section 9(1)(i)
In the case of a non-resident, no income shall be deemed to accrue/arise in India in
the following situations:
229
1. Where the business connection is confined only to the purchase of goods in

India for the purpose of exports. (This exception is made to encourage
exports).
2. Where the business connection is confined only to collection of news and
views in India for transmission out of India.
3. Where the business connection is confined to the shooting of any
cinematography firm in India. (This exception is also available to a firm and
company which does not have any partner/shareholder who is a citizen of India
or who is resident in India).
4. Where all operations of a business are not carried out in India, the extent of
income of the business relating to operations not carried out in India.
Notes
5.1.5 Computation of Total Income

The total income of a company is also computed in the manner in which income of
any other assessee is computed.
The first and the foremost step in this direction is to ascertain Gross Total Income.
Gross Total Income: As per Section 14, income of a person is computed under the
following five heads:
1.
2.
3.
5.
6.
Salaries
Profits and gains of business or profession
Capital gains
Income from other sources.
The aggregate income under these heads is termed as gross total income. In other
words, gross total income means total income computed in accordance with the
provisions of the Act before making any deduction under Chapter VIA (Section 80C to
80U).
Further, Section 14A provides that no deduction shall be made in respect of
expenditure incurred by the assessee in relation to income which does not form part of
the total income under the Act.
How to Compute Total Income?: The steps in which the total income for any
assessment year is determined as follows:
1. Determine the residential status of the assessee to find out which income is to
be included in the computation of his total income.
2. Classify the income under each of the following five heads. Compute the
income under each head after allowing deductions prescribed for each head of
income:
(a) Income from Salaries
Salary/Bonus/Commission, etc.
________
Taxable Allowance
________
Value of Taxable Perquisites
________
Gross Salary
_________
Less: Deductions u/s 16
_________
Net taxable income from salary
_________
(b) Income from House Property

Net annual value of house property
________
Less: Deduction under section 24
________
230
Notes

_________
(c) Profits and gains of business and profession

Net profit as per P&L A/c
________
Less/Add: Adjustments required to be made to the profit as

per provisions of Income Tax Act
________
Net profit and gains of business and Profession
_________
(d) Capital gains

Capital gains as computed
Less exemptions u/s 54/54B/54D etc.
_________
Income from capital gain
_________
(e) Income from other sources:

Gross income
________
Less: Deductions
________
Net income from other sources
_________
Gross Total Income [(a) + (b) + (c) + (d) + (e)]

Less: Deductions available under Chapter VIA Sections 80C to
80U)
_________
Total Income
Income computed under four heads (salary head is not applicable), is

aggregated. While aggregating the income, Sections 60 and 61 shall be applicable.
Further, effect to set-off of losses and adjustment for brought forward losses will also be
done. From the gross total income so computed, the following deductions of Chapter VIA
should be allowed:
80G
80GGA
80GGB
80IA
80IAB
80IB
80IC
80ID
80IE
80JJA
80JJAA
80LA
Donations to certain funds/charitable institutions, etc.

Certain donations for scientific research or rural development
Contribution to political parties
Profits and gains of new industrial undertakings or enterprises engaged in
infrastructural development, etc.
Deductions in respect of profits and gains by an undertakings or enterprises
engaged in development of Special Economic Zone.
Profits gains from certain industrial undertakings other than infrastructure
development undertakings.
Deductions in respect of certain undertakings or enterprises in certain special
category states [w.e.f. A.Y. 2004-05].
Deduction in respect of profits and gains from business of hotels and
convention centres in specified area [w.e.f. A.Y. 2008-09].
Deduction in respect of certain undertakings in North Eastern States [w.e.f. A.Y.
2008-09].
Deduction in respect of profits and gains from business of collecting and
processing of bio-degradable waste.
Deduction in respect of employment of new workmen.
Deductions in respect of certain incomes of Offshore Banking Units and
International Financial.
231
5.1.6 Assessment Procedure
Notes
The principal officer of the company is required to file the return of total income of
the company on or before 31st October of the assessment year. A company is assessed
like any other assessee. However, its liability differs in two respects:
1. No exemption limit: A company does not enjoy any exemption limit.
2. Flat Rate of Tax: A company pays income tax at a flat rate instead of slab rate.
Rates of Income Tax
The rates of tax which applicable to companies for the assessment year 2013-14
and 2014-15 are as under:
1. Short-term capital gains on equity shares in a company or units of an equity
oriented fund where the transaction is chargeable to securities transaction tax
15%
2. Tax on long-term capital gains 10% in case of listed securities and 20% in case
of capital asset
3. Tax on winnings from lotteries, crossword puzzles, races including Horse races
etc. 30%
4. Tax on any other income
(a) Domestic company
30%
(b) Foreign company 40%
(i) for all income other than given under (ii) below:
(ii) Royalty received after 31/3/1961 but before 1/4/1976 or fees for
technical services received by a foreign company or non-resident
non-corporate assessee from an Indian concern or Government after
29/2/1964 but before 1/4/1976,. In pursuance of an agreement
approved by the Central Government . 50%
Surcharge for AY 2013-14 and 2014-15 if total income exceeds ` 1 crore
for domestic company 5.00%
for foreign company 2%
However, w.e.f. 2014-15, if the total income of the company exceeds ` 10 crore,
surcharge in case of domestic company shall be be 10% (instead of 5%) and 5% (instead
of 2%) in case of foreign company.
5.1.7 Problems
Problem 1: AB Ltd. is a manufacturing company in which public are substantially
interested. For the previous year ending 31.3.2014, it earned a net profit of ` 2,50,000
after providing for depreciation of ` 1 lakh as admissible under the Income Tax Act.
Compute the total income of the company for the assessment year 2014-15 on the basis
of the following information:
(i) The company paid remuneration of ` 1,02,000 to its three whole-time directors
though articles of association do not provide for such payment.
(ii) The miscellaneous expenses include a sum of ` 15,000 paid towards penalty
for non-fulfilment of delivery conditions of a contract of sale for reasons beyond
control.
(iii) The company received fees of ` 75,000 from an Indian company for supply of
know how in the installation of machinery in pursuance of contract approved by
CBDT. This is credited to P&L Account.
232
(iv) The travelling expenses included:

(a) ` 15,000 in respect of technical director to West Germany to study export
market for chemicals;
(b) ` 15,000 in respect of visit of Managing Director to America for purchase
of machinery for the proposed new unit.
(v) The other income credited to P&L Account includes dividend received from an
Indian company ` 30,000 (gross).
(vi) Donations include:
(a) ` 10,000 to an approved scientific research association.
(b) ` 26,750 to an approved charitable trust.
(vii) The interest includes:
(a) ` 5,000 paid on the installments granted for sales tax payment.
(a) ` 5,000 paid to non-resident outside India without deducting tax at source.
(viii) Salary includes bonus paid amounting to ` 90,000. However, bonus was
payable on 31.3.2014 which was paid on 15.09.2014.
Notes
Solution: Total income of the assessee company is computed as follows:

`
(A) Income from business

Net profit as shown:
Less: Dividend received from an Indian company to be considered
separately
2,50,000
30,000
2,20,000
Additions/Adjustments:
(i)
Amount spent on the foreign tour of the Director for purchase of

machinery is disallowed being expenditure of capital nature
15,000
(ii)
Donations to a charitable trust for separate consideration
40,000
(iii)
Interest paid to non-resident outside India without deducting tax

at source is not allowable as deduction in view of the provisions
of Section 40(a)(i)
5,000
Less:
(iv) Additional deduction for donation to approved scientific
research association
2,80,000
Income from business
2,67,500
12,500
(B) Income from other sources:

Dividends from Indian company
Gross Total Income
Less: Deductions under Chapter VIA u/s 80G [50% of ` 26,750]
Exempt
2,67,500
13,375
Taxable Income ` 254,125 rounded to ` 2,54,130
1. Penalty of ` 15,000 paid for not fulfillment of conditions of a contract of sale is

allowable because it is not for breach of any law but for breach of contractual
obligation.
2. Donations to approved scientific research association are eligible for deduction
u/s 35(1)(ii) @ 125% of the donation.
3. Interest on installments of sales tax is allowable as a deduction.
4. Bonus to employees is allowable as it has been paid on 15.9.2014, i.e., before
30.09.2014.
233
Problem 2: R Ltd. is a company incorporated in India. The balance sheet of the company
on 31-3-2014, discloses the following position:
Liabilities
Assets
Preference share capital
2,00,000
Fixed assets
5,00,000
Equity share capital issued for cash
4,00,000
Bonus shares issued in 2006
2,00,000
Investments in shares at cost

(market value ` 7 lakhs)
2,00,000
General Reserve
2,00,000
Other assets
7,00,000
Profit and Loss A/c balance on

31-3-13
1,40,000
Add Profit for year ended 31-3-2014

Provision for taxation
Current liabilities
Notes
60,000
130,000
70,000
14,00,000
14,00,000
The company distributes the entire investment in shares in species to its

shareholders pro rata in August, 2013. Is G, a holder of 10%t of equity share capital,
liable to tax on this receipt ? If so, what is the amount liable to tax?
Solution: Section 2(22)(a) provides that any distribution by a company to the extent of
accumulated profits whether capitalized or not is deemed as a dividend if such
distribution entails the release by the company to its shareholders of all or any part of the
assets of the company.
The accumulated profits can be computed as follows:
Capitalised profits (Bonus shares issued in 2006)
2,00,000
General Reserve
2,00,000
Profit and Loss Account (including profits of current year)
2,00,000
Total
6,00,000
Thus dividend under Section 2(22)(a) shall be ` 6,00,000 and the company shall pay
tax 15% plus surcharge of 0% plus EC plus SHEC = 15.45%, G the holder need not pay
any tax.
5.2 Provisions Relating to Minimum Alternate Tax (MAT)

5.2.1 Introduction to MAT
Where in the case of a company through proper tax planning, the income tax
payable on the total income as computed under the Income Tax Act in respect of the
previous year, is less than certain percentage of its book profit, the companies are
required to pay some minimum income tax which is termed as MAT (Minimum Alternate
Tax).
5.2.2 Provisions of MAT for Payment of Tax by Certain Companies [Section
115JB(1)]
Tax payable for any assessment year cannot be less than 18% of book profit:
Where in the case of a company, the income tax payable on the total income as
computed under the Income Tax Act in respect of the previous year, is less than 18% of
its book profit, such book profit shall be deemed to be the total income of the assessee
and the tax payable by the assessee on such total income (book profit) shall be the
amount of the income tax at the rate of 18%.
234
Notes
Example:
Suppose the book profits a company for the assessment year 2011-12 are
` 10,00,000 whereas its total income as per provision of income tax is ` 3,00,000. Then
the tax shall be payable as under:
1. Tax on total income as computed from Income Tax Act (30% of ` 3, 00,000) =
90,000
2. Tax @ 1 % on book profit of ` 10, 00,000 = 180,000
In the above case, tax payable on total income, i.e., ` 90,000 is less than 18% of the
book profits, i.e., ` 180,000. Hence, in this case, deemed total income shall be
` 10,00,000 and the tax payable shall be ` 1,80,000 plus Education cess and SHEC @
3% 5400 = ` 185,400.
Allowing tax credit in respect of tax paid on deemed income under MAT
provision against tax liability in subsequent years [Section 115JAA]
Section 115JAA provides that where any amount of tax is paid under section
115JB(1) by a company for any assessment year beginning on or after 1-4-2006, credit in
respect of the taxes so paid for such assessment year shall be allowed on the difference
of the tax paid under section 115JB and the amount of tax payable by the company on its
total income computed in accordance with other provisions of the Act.
The amount of tax credit so determined shall be allowed to be carried forward and
set off in a year when the tax becomes payable on total income computed under the
regular provisions. However, no such carry forward shall be allowed beyond the tenth
assessment year immediately succeeding the assessment year in which the tax credit
becomes allowable. The set off in respect of the brought forward tax credit shall be
allowed for any assessment year to the extent of the difference between the tax on the
total income and the tax which would have been payable under section 115JB for that
assessment year. No credit will be allowed in respect of MAT paid in any assessment
year prior to 2006-07.
However, no interest shall be allowed on the amount of tax credit available under
section 115JAA.
Other provisions of section 115JB Profit and Loss of the company to be prepared
as per provisions of the Companies Act [Section 115JB(2)].
Every company shall for the purpose of this section, prepare its profit and loss
account for the relevant previous year in accordance with the provisions of Parts II and III
of Schedule VI to the Companies Act 1956.
Profits and loss account prepared for Section 115JB(2) and annual accounts
including profit and loss account prepared and placed before AGM should have same
accounting policies, standards, etc. [Proviso 1 and 2 to Section 115JB(2)].
While preparing the annual accounts including profit and loss account:
(i) the accounting policies of the company;
(ii) the accounting standards followed by the company for preparing such
accounts including profit and loss account
(iii) the method and rates adopted for calculating the depreciation by the company,
shall be the same as have been adopted for the purpose of preparing such
accounts including profit and loss account as laid before the company at its
annual general meeting in accordance with the provisions of Section 210 of the
Companies Act, 1956.
Further, where the company has adopted or adopts the financial year under the
Companies Act, 1956, which is different from the previous year under the Income Tax Act,
235
the above three (i.e., accounting policies, accounting standards and method of
calculating depreciation) shall correspond to the accounting policies, accounting
standards and the method and rates for calculating the depreciation which have been
adopted for preparing such accounts including profit and loss account for such financial
year or part of such financial year falling with the relevant previous year.
Notes
When an Assessing Officer has power to later the net profit: In the following
cases, the Assessing Officer shall have power to rework or rewrite the profit and loss
account:
(1) Where the profit and loss account submitted is not as per Part II and Part III of
the Schedule VI of the Companies Act.
(2) Where the accounting policies or accounting standards or rate of depreciation
adopted are different from those adopted for the profit and loss prepared for the
annual general meeting.
Assessing Officer has no power to scrutinize profit and loss account: Where
the profit and loss account has been prepared in accordance with Part II and Part III of
the Schedule VI of the Companies Act and which has been and certified by the statutory
auditors and relevant authorities, the Assessing officer has no power to scrutinize net
profit in profit and loss account except to the extent provided in Explanation to 115J.
How to compute book profits? [Explanation to 115JB (1) and (2)]
Step 1: The net profit as shown in the profit and loss account (prepared as per Part
II and III of Schedule VI) for the relevant previous year, shall be increased by the
following, if debited to the Profit and Loss Account:
(a) The amount of income tax paid or payable, and the provision therefore; or
(b) The amounts carried to any reserves by whatever name called
(c) The amount or amounts set aside to provisions made for meeting liabilities,
other than ascertained liabilities; or
(d) The amount by way of provision for losses of subsidiary companies; or
(e) The amount or amounts of dividends paid or proposed; or
(f) The amount or amounts of expenditure relatable to any income to which
Section 10, (other than the provisions contained in clause (38) relating to
long-term capital gain on transfer of shares through a stock exchange, 11 or 12
applies (i.e., incomes which are exempt from tax).
(g) The amount of depreciation.
(h) The amount of deferred tax and provisions therefore (inserted by the Finance
Act, 2008, w.e.f. assessment year 2001-02).
(i) The amount or amounts set aside as provision for diminution in the value of
any asset (inserted by the Finance Act, 2009, w.e.f. assessment year
2001-02).
Notes:
1. The starting figure is the net profit after tax as per profit and loss account.
2. As per clause (a) above only income tax has to be added back. Hence, any tax,
penalty or interest paid or payable under Wealth tax, gift tax, or any penalty or
interest paid or payable under income tax, if debited to profit and loss account
should not be added back to such net profits. Dividend tax paid or payable as
per Section 115-O should be added back. Further, no adjustment is to be done
in respect of income tax refund.
236
Notes
3. Where any amount has been transferred to reserve as per the provisions of
Sec. 36(1)(viii), Sec. 80-IA(6), Sec. 80-IAB(6) or Sec. 10(A)(1A) or Sec. 10AA
the same is also to be added back.
4. Any tax or duty which is not allowed as deduction as per provisions of Section
43B though debited to profit and loss account shall also not to be added back.
5. Any provision made to meet unascertained liabilities like provisions of gratuity
provisions for future losses, etc. should be added back to such net profit.
However, if the provisions for gratuity have been made on the basis of actual
valuation, it becomes an ascertained liability and hence should not be added
back.
6. Every kind of reserve is to be added to net profit to determine book profit.
7. Dividend whether on equity or preference share paid or proposed should both
be added.
8. Security Transaction Tax and Banking Cash Transaction Tax are not to be
added back as these are not income tax.
9. Any expense other than mentioned in clause (5) above should not be added
back even if such expense is not allowable under the Income Tax Act.
10. Deferred tax liability as per Accounting Standards is an unascertained liability,
hence to be added back.
11. Loss of subsidiary company, if debited to the profit and loss account, should be
added back.
12. The provisions of Section 115JB shall not apply to the income accrued or
arising on or after 1-4-2005 from any business carried on, or services rendered,
by an entrepreneur or a Developer, in a Unit or Special Economic Zone as the
case may be [Section 115JB(6)].
Step 2: The profit as per the Profit and Loss Account shall be reduced by the
following:
1. The amount withdrawn from any reserves or provisions, if any, such amount is
credited to the profit and loss account:
A clarificatory amendment has been made by the Finance Act, 2002, i.e.,
assessment year 2001-02 to Section 115JB to provide that the amount withdrawn from
the reserve or provision, created not out of profits before 1.4.1997, if credited to the profit
and loss account, shall not be deducted while computing book profit.
Similarly, the amount withdrawn from the reserve created on or after 1.4.1997 and
credited to the profit and loss account shall not be deducted while computing book profit
unless the book profit in the year of creation of such reserve was increased by such
reserve at that time.
(ii) The amount of income to which any of the provisions section 10 (other than the
income referred to in Section 10(38), 11, 12 or 80-IAB applies, if any such amount is
credited to the profit and loss account; or
2. The amount of depreciation debited to the profit and loss account (excluding
the depreciation on account of revaluation of assets); or
(iv) The amount withdrawn from revaluation reserve and credited to profit and loss
account, to the extent it does not exceed the amount of depreciation on account of
revaluation of assets referred to in clause (iii) above; or
3. The amount of loss brought forward or unabsorbed depreciation, whichever is
less as per books of account. The loss shall, however, not include depreciation.
237
Further the provision of this clause shall not apply if the amount of brought
forward loss or unabsorbed depreciation is Nil; or
Notes
(vi) The amount of profits of sick industrial company for the assessment year
commencing from the assessment year relevant to the previous year in which the said
company has become a sick industrial company under sub-section (1) of Section 17 of
the Sick Industrial Companies (Special Provisions) Act, 1985 and ending with the
assessment year during which the entire net worth of such company becomes equal to or
exceeds the accumulated losses.
For the purposes of this clause, net worth shall have the meaning assigned to it in
clause (ga) of sub-section (1) of section 3 of the Sick Industrial Companies (Special
Provisions) Act, 1985. According to Section 3(1)(ga) of the Sick Industrial Companies
(Special Protection) Act, 1985, net worth means the sum total of the paid-up capital and
free reserves.
Free reserve means all reserve credited out of the profits and share premium
account but does not include reserves credited out of revaluation of assets, write back of
depreciation provisions and amalgamations.
(vii) The amount of profit derived from the activities of a tonnage tax company [Sec.
115VO].
The amount computed after increasing or decreasing the above in Step 1 and Step 2,
respectively is known as book-profit.
How much brought forward loss/unabsorbed depreciation are deductible from
book profits?
As per clause (v) above, the amount of loss brought forward or unabsorbed
depreciation as per books of accounts whichever is less is to be deducted from the book
profits. It has been however clarified that loss however shall not include depreciation. In
this case, brought forward loss and unabsorbed depreciation as per income tax shall
have no relevance.
It has been clarified that where the value of the amount of either loss brought
forward or unabsorbed depreciation is nil, no amount on account of such loss brought
forward or unabsorbed depreciation would be reduced from the book profit.
Furnishing of Report of an Accountant [Section 115JB(4) and Rule 40B]: Every
company to which this section applies, shall furnish a report in Form No. 29B from a
chartered accountant certifying that the book profit has been computed in accordance
with the provisions of this section along with the return of income filed under section
139(1) or along with the return of income furnished in response to a notice under section
142(1)(i).
It may however, be noted that the company shall have to file such report even if it
furnishes the return of income under section 139(4) instead of section 139(1) or in
response to which notice [Section 142(1)(i)].
Unabsorbed Depreciation or Losses which can be Carried Forward [Section
115JB(3)]: Although, the assessee is liable to pay tax @ 10% (plus surcharge if
applicable) of the book profits if its total income computed as per Income Tax Act is less
but it is entitled to determine unabsorbed depreciation u/s 32(2), business loss u/s 72(1),
speculation loss u/s 73 and capital loss u/s 74 and loss u/s 74A and shall be allowed to
carry forward the same to the subsequent years for claiming set off as per the normal
provisions of Income Tax Act.
Are the Provisions of Section 115JB applicable to Foreign Companies?
In connection of old Section 115J, the Authority for Advance Rulings held that such
provisions are applicable to foreign companies also and the foreign companies shall
238
Notes
calculate its Indian Profits separately for the purpose of minimum alternate tax [P No.14
of 1997 In (1998) 234 ITR 828(AAR)]. However, where a non-residents income is
assessed on the basis of presumptive income under section 44B, 44BB, 44BBA, etc. or
at a flat under Section 115A on royalty and technical fee, the book profit becomes
immaterial for regular assessment and the presumptive income tax will prevail [Timken
India Ltd. In re(2005) 273 ITR 67(AAR)].
Other Provisions of the Act shall continue to apply to such Companies
[Section 115JB(5)]:
Save as otherwise provided in section 115JB, all other provisions of the Income Tax
Act shall apply to such companies. Hence, all other provisions relating to Advance tax,
interest chargeable in certain cases shall apply to such companies also.
5.2.3 Illustrative Problems
Problem 1: R Ltd., a closely held Indian company is engaged in the manufacture of
insecticides and fertilizers. Its profits and loss account for the year ended 31-3-2013 is as
under:
Particulars
` in lacs
Particulars
To Salaries and wages
7.50
By Sales
To Depreciation
5.00
By Amount withdrawn from

General Reserve
To Postage and Telegram
0.40
To Traveling expenses
0.50
To Excise duty due
1.00
To Audit fees
0.25
To Directors remuneration
8.00
To Deferred tax liability
1.35
To Provision for future losses
0.60
To Wealth Tax
0.10
To Income tax
4.00
Tp Proposed dividend
0.80
To Loss of subsidiary company

To Net Profit
` in lacs
48.00
3.00
0.50
21.00
51.00
51.00
Additional information
1. The excise duty due on 31.3.2013 was paid on 2-12-2013.
2. Customs duty ` 1,20,000 which was due on 31-3-2011 was paid during the
financial year 2012-13.
3. Depreciation as per income tax ` 11.43 lakhs.
4. The company wants to set off the following losses/allowances:
For Tax purposes
Brought forward loss of A.Y. 2012-13
Unabsorbed depreciation
For accounting purposes
` 12,00,000
` 10,00,000
3,00,000
3,00,000
239
Compute the total income of the assessee and the tax liability for the Assessment
year 2013-14.
Notes
Determine tax payable under section 115JB.

Solution: Book Profit under section 115JB:
Particulars
Net profit as per profit and loss account
`
21,00,000
Add: Amount disallowed

Income tax
4,00,000
Wealth tax
10,000
Outstanding Excise duty
1,00,000
Provision for future losses
60,000
Proposed dividend
80,000
50,000
Loss of subsidiary company

Deferred tax liability
1,35,000
Depreciation for separate consideration
5,00,000
13,35,000
34,35,000
Less:
Depreciation as per income tax
11,43,000
Amount withdrawn form General Reserve
3,00,000
Customs duty of 2010-11 paid
1,20,000
15,63,000
18,72,000
15,00,000
Less: B/f business loss and unabsorbed depr. fully set off
3,72,000
Less deduction under Chapter VIA
Nil
Total income
3,72,000
Book profit u/s 115JB:

Particulars
Net profit as per profit and loss account
`
21,00,000
Add:
Income Tax
4,00,000
Provision for future losses
60,000
50,000
Proposed dividend
80,000
Deferred tax liability
1,35,000
Depreciation
5,00,000
12,25,000
33,25,000
Less:
Depreciation (same amount)
5,00,000
Amount withdrawn from general Reserve
3,00,000
3,00,000
Book profit
11,00,000
22,25,000
Computation of tax liability

Total income
3,72,000
Tax on total income @ 30.9%
114,950
Tax on Book Profit 22,25,000 @ 19.055 (18.5+ surcharge Nil + EC

240
Notes

+ SHEC @ 3%)
4,23,974
Therefore, tax payable for the AY 2013-14
4,23,970
Problem 2: From the following information, compute the total income of R Ltd. and tax
liability for the AY 2013-14.
` Lakhs
Particulars
Expenses relating to goods of
special Economic Zone
Expenses relating to other business
9.00
IT paid
7.00
1.00
Interest on income tax
0.20
General Reserve
4.00
Prov for contingent liability
1.00
Proposed dividend
2.00
` Lakhs
Particulars
Sale of goods of unit in Special
Economic Zone
15.00
Sale of other business
10.60
Interest from Bank deposits
0.20
1.60
Balance c/d
25.80
25.80
Further information:
1. B/f loss as per books ` 2.00 lakhs
2. B/f depreciation as per books ` 1.60 lakhs
3. B/f unabsorbed depreciation as per books ` 4.60 lakhs
Solution:
I Computation of total income
Particulars
Profit as per P&L Account
1.60 lacs
Add: Expenses disallowed

Relating to goods of special Economic Zone [Sec. 10AA]
9.00
IT paid
1.00
0.20
General Reserve
4.00
Prov for contingent liability
1.00
Proposed dividend
2.00
17.20
18.80
Less:
Sale of goods of unit in Special Economic Zone
Interest from Bank deposits
15.00
0.20
15.20
Statement of total income
3.60
Business income
3.60
Less B/f unabsorbed depreciation ` 4.60 lakhs but allowed to

the extent of Business income
3.60
Income
Nil
Income from other sources Bank interest
0.20
0.20
Total income
NIL
241
Notes
1. B/f unabsorbed depreciation c/f to next year ` 460,00 360,000 20,000 =
` 80,000.
2. The assessee shall be allowed deduction of entire profit of ` 600,000 under Section
10AA while computing total income as per normal provisions of Income Tax Act.
Notes
II Computation of Deemed Income u/s 115JB

Income as per P&L account
` 1.60 lacs
Add: Disallowable items:

IT paid
1.00
0.20
General Reserve
4.00
Provision for contingent liability
1.00
Proposed dividend
2.00
8.20
9.80
Less: B/f loss as per books of account or B/F depreciation

as per books, whichever is less
1.60
Book Profit
8.20
Income tax liability @ 19.055 (18.55 plus EC and SHEC @ 3% ` 156,251 or tax
computed on total income which is nil. Hence tax liability shall be higher of the two, i.e.,
` 1,56,251.
It may be noted that w.e.f. A.Y. 2012-13 undertakings eligible for deduction u/s
10AA are covered under MAT provisions.
5.2.4 Special Provision Relating to Tax on Distributed Profits of Domestic Companies
(a) Tax on distributed profits of domestic companies [Section 115-0]: Domestic
Company shall, in addition to the income tax chargeable in respect of its total income, be
liable to pay additional income tax on any amount declared, distributed or paid by such
company by way of dividend (whether interim or otherwise), whether out of current or
accumulated profits. Such additional income tax shall be payable @ 15% plus surcharge
@ 10% plus education cess @ 2% plus SHEC @ 1% of the amount so declared,
distributed or paid.
Dividend received from subsidiary company to be reduced from the above
dividend to be distributed [Section 115-O(IA)]
Notes:
(a) The expression dividend used above shall have the same meaning as is given
in Section 2(22) which shall include Section 2(22)(a), (b), (c), and (d) but shall
not include deemed dividends under section 2(22)(e).
(b) The above additional tax shall be payable by such company on its total income.
No tax on distributed profits by an undertaking or enterprise engaged in developing,
operating and maintaining a Special Economic Zone [Section 115-O(6)].
(b) Time limit for deposit of additional income tax: Such additional tax will have
to be paid by the principal officer of the domestic company and the company within
14 days from the date of declaration of dividend, or distribution or payment of any
dividend.
242
Notes
(c) Tax on distributed profits not allowed as deduction: The company or the
shareholder shall not be allowed any deduction in respect of the amount which has been
charged to tax or the tax thereon under any provisions of the income-tax Act.
(d) Interest payable for non-payment of tax by domestic companies [Section
115P]: In case of default simple interest @ 1% shall be liable for every month or part
thereof beginning on the date immediately after the last date on which tax was payable
and ending with the date on which the tax is actually paid.
(e) When companies deemed to be in default [Section 115Q]: If the principal
officer of a domestic company and the company does not pay tax on distributed profits in
accordance with the provisions of Section 115-O, then he or it shall be deemed to be an
assessee in default in respect of the amount of tax payable by him or it and all the
provisions of the Income Tax Act for the collection and recovery of income tax shall
apply.
(f) Penalty under Section 271C: If any persons fails to pay the whole or any part of
the tax as required u/s 115-O(2), then such person shall be liable to pay, by way of
penalty a sum equal to the amount of tax which such person failed to pay as aforesaid.
5.2.5 Special Provisions Relating to Tax on Distributed Amount to Unit Holders
[Sections 115R to 115T]
(a) Tax on income distributed to unit holders by the specified company or a
Mutual Fund [Section 115R(2)]
(I) Where the income is distributed by money market mutual fund or a liquid fund,
additional income tax @ 25% + 10% SC+ 2% EC + 1% SHEC will be liable to
be paid.
(II) Where the income is distributed by a fund other than a money market mutual
fund and such income is distributed to
(i) individual or HUF additional income-tax @ 12.5% + 10% SC + 2% EC +
1% SHEC will be liable to be paid.
(ii) any person other than individual or HUF- additional income tax @ 20% +
10% SC + 2% EC + 1% SHEC will be liable to be paid.
(b) Time limit for deposit of additional income tax [Section 115R(3)] within
14 days from the date of distribution or payment of such income whichever is earlier
(c) Income charged to tax not allowed as deduction [Section115R(4)] to the
specified company or to a Mutual Fund in respect of which income has been charged to
tax.
(d) Interest payable for non-payment of tax [Section 115S]: In case of default
simple interest @ 1% shall be liable for every month or part thereof beginning on the date
immediately after the last date on which tax was payable and ending with the date on
which the tax is actually paid.
(e) When specified company or Mutual Fund shall be deemed to be the
assessee in default [Section 115T]: If any person responsible for making payment of
the income distributed by the specified company or a mutual fund and the specified
company or the Mutual Fund shall be deemed to be an assessee in default in respect of
the amount of tax payable by him or it and all the provisions of the Income Tax Act for the
collection and recovery of income tax shall apply.
(f) Provisions of Section 115R shall not apply in respect of any income distributed
(i) by the Administrator of the specified undertaking to the unit holders; or (ii) to a unit
holder of an equity oriented fund (whether open ended or close ended) in respect of any
distribution made from such fund.
243
(g) Exemption of income in the hands of unit holder [Section 10(35)]: The
following income shall be exempt in the hands of unit holders
Notes
(a) income received in respect of units of a Mutual fund specified under clause
23D; or
(b) income received in respect of units from the Administrator of the specified
undertaking; or
(c) income received in respect of units from the specified company.
5.3 Set-off and Carry Forward of Losses

5.3.1 Introduction to Set-off and Carry Forward of Losses
Income tax is a composite tax on the total income of a person earned during a
period of one previous year. There might be cases where an assessee has different
sources of income under the same head of income. Similarly, he may have income under
different heads of income. It might happen that the net result from a particular
source/head may be a loss. This loss can be set off against other source/head in a
particular manner. For example, where a person carries on two business and one
business gives him a loss and other profit, then the income under the head profits and
gains of business or profession will be the net income, i.e., after adjustment of the loss.
Similarly, if there is a loss under one head of income, it should normally be adjusted
against the income from another head of income while computing Gross Total Income.
The provisions for set off or carry forward and set off losses are contained in
Sections 70 to 80 of Income Tax Act.
5.3.2 Set-off of Loss from One Source Against Income from Another Source under
the Same Head of Income [Section 70]
During any assessment, if the net result in respect of any source under any head of
income is a loss, the assessee is entitled to have the amount of such a loss set-off
against his income from any other source under the same head of income. This rule is
however subject to the following exceptions:
4. Loss in a speculation business can be set-off only against the profit in a
speculation business.
(ii) Loss incurred in a business of owning and maintaining race horses cannot be
set-off against income from other sources, except income from such business.
Through speculation, losses and losses from the activity of owning and maintaining
racehorses cannot be set-off against other incomes, the vice versa is not applicable. It
implies that, losses from a non-speculation business can be set-off against income from
a speculation business.
5. Winnings in lottery, horse races, crossword puzzles etc. are not available for
adjustment of losses under any head.
(iv) Long-term Capital Loss can be set-off against Long-term Capital Gain only.
6. Loss from a source which is exempt and loss from a source, income from
which exempt cannot be set-off against income from a taxable source [CIT v.
Thyagarajan]. However, short-term capital loss can be set-off from any capital
gain (long-term and short-term).
(vi) Capital Losses: Short term capital losses can be set off from any capital gain
(long-term or short-term) but long-term capital loss can now be set off only
against long-term capital gain.
244
Notes
(vii) Loss arising from the purchase and sale of securities not to be allowed in
certain cases [Section 94(7)]: Where
(a) any person buys or acquires any securities or unit within a period of three
months prior to the record date; and
(b) such person sells or transfers such securities within a period of three
months after such date or transfers such units within a period of 9 months
after such record date; and
(c) the dividend or income on such securities or unit received or receivable by
such person is exempted, then, the loss, if any, arising to him on account
of such purchase and sale of securities or unit, to the extent such loss
does not exceed the amount of dividend or income received or receivable
on such securities or unit, shall be ignored for the purposes of computing
his income chargeable to tax.
(viii) Bonus stripping [Section 94(8)]: Where
(a) a person buys or acquires any units within a period of three months prior
to the record date; and
(b) such person is allotted or is entitled to additional units on the basis of such
units without making any payment; and
(c) he sells, all or any of such units while continuing to hold all or any of the
additional units within a period of 9 months after such date. Then, the loss,
if any, arising to him on account of such purchase and sale of units, shall
be ignored for the purposes of computing his income chargeable to tax.
(ix) Loss from specified business-any loss computed in respect of any specified
business referred to in Section 35AD shall not be set off except against profits
and gains, if any, of any other specified business (applicable from the A.Y.
2010-11 onwards).
5.3.3 Inter-head Adjustment [Section 71]
When the net result of the computation made from any Assessment Year in respect
of any head of income is loss, the same can be set-off against the income from other
heads. However, following are the exceptions:
1. loss in a speculation business;
2. loss incurred in a business of owning and maintaining race horses,
3. winning in lottery, horse races, crossword puzzles, etc. are not available for the
adjustment of losses under any head;
4. loss under the head Capital Gains;
5. business loss cannot be set-off against salary income.
6. Loss in a specified business under section 35AD Loss computed in respect of
any specified business referred to in section 35AD cannot be set off except
against any other income.
Loss under the head Capital Gains: A long-term capital loss can be set-off
against a long-term capital gain in the same Assessment Year. However, a short-term
capital loss can be set-off against a short-term capital gain or a long-term capital gain (if
there is no short-term capital gain) in the same Assessment Year. But where the net
result of computation under the head Capital Gains is a loss, whether short-term or
long-term, such loss is not allowed to be set-off against income under any other head
even in the same Assessment Year.
245
5.3.4 Carry Forward and Set-off of Losses
Notes
If the losses could not be set-off under the same head or under different heads in
the same Assessment Year, such losses are allowed to be carried forward to be claimed
as set-off from the income of the subsequent Assessment Years. All losses are not
allowed to be carried forward. The following losses are only allowed to be carried forward
and set-off in the subsequent Assessment Years:
(a)
(b)
(c)
(d)
(e)
House Property Loss [Sec. 71B];

Business Loss [Sec. 72];
Speculation Loss [Sec. 73];
Capital Loss [Sec. 74];
Loss on account of owning and maintaining race horses [Sec. 74A].
Compulsory Filing of Loss Returns (Section 80): Although the above losses are
allowed to be carried forward, but the carry forward is allowed only when the assessee
has submitted a return of loss on or before the due date of filing of the returns prescribed
under Section 139(1) and such a loss has been assessed.
Losses cannot be carried forward, if no return of the loss is furnished or it is
furnished after the due date prescribed under Section 139(1).
1. Although submission of the return of loss, on or before the due date mentioned
under Section 139(1) is compulsory for carry forward of losses mentioned in
Clause (b) to (e) above, but this provision is not applicable for carry forward of
unabsorbed depreciation which is covered under Section 32(2).
2. There are two conditions, which are to satisfy before loss is allowed to be
carried forward. Firstly, the return of loss must be submitted on or before the
date and secondly, such loss has been determined by the Assessing Officer.
5.3.5 Carry Forward and Set-off of Loss from House Property [Section 71B]
Loss from house property, if could not be set-off in the same Assessment Year from
other heads of income, will be allowed to be carried forward for eight Assessment Years
to claim it as a set-off in the subsequent years under the head Income from House
Property. Therefore, if the loss of house property of the previous year 2008-09 which
could not be set-off because of the absence or inadequacy of the income of previous
year 2008-09, it may be carried forward for eight Assessment Years succeeding the
Assessment Year 2009-2010 to be set-off from income under the head House Property.
5.3.6 Carry Forward and Set-off of Business Losses [Section 72]
Where the loss under the head Profits and Gains of Business/Profession other than
loss from speculation business, could not be set-off in the same Assessment Year
because either the assessee had not income under any other head or the income was
less than the loss, such loss which could not be set-off in the same against the profits and
gains of business or profession subject to the following conditions:
7. Business losses can be adjusted only against business income: The loss
can be carried forward to the subsequent Assessment Year and set-off only
against business income of the subsequent year.
It may be observed that in the Assessment Year, loss from a business can be
adjusted against income from any other head of income. However, when the loss is to be
carried forward to the subsequent year, it can be adjusted only against the business
income. Business income may be from the same business in which the loss was incurred
or may be from any other business.
246
Notes
Certain income, though taxable under other heads, constitutes business

income for set-off of brought forward business loss: The carried forward business
loss is to be adjusted against income from any business activity. Such an income may
generally be taxed under the head, Profits and Gains of Business/Profession. However,
in some cases, income from a business activity may be taxed under other heads also.
For example, if an assessee, carrying on the business of letting out of house properties
received rent from such house properties, it would be an income from business activity
though the rent would be taxable under the head Income from House Property.
Therefore, a business loss of an earlier year can be set-off against the rental income of
house property, although the rental income falls under the head Income from House
Property.
Dividend may be treated as business income: Though the dividend income is
assessable under the head Other Sources, it may be well treated as business income
for the purposes of set-off of past business losses against such income, if the relevant
shares were held as stock in trade and not as investment.
(II) Business in respect of which a loss is incurred need not be continued: The
business or profession, for which the loss was incurred, need not be continued to be
carried on by him in the previous year in which such loss is sought to be set-off.
(III) Losses can be set-off only by the assessee who has incurred loss [Section
78(2)]: The brought forward business losses can be set-off only by the same assessee.
The assessee, who has suffered the loss and in whose hands the loss has been
assessed, is the person who can carry forward the loss and set-off the same against his
business income of the subsequent year. The following are exceptions:
(a) Where a business carried on by one person, is acquired by another person
through inheritance. For example, X is carrying on a business and there are
losses to the extent of ` 5,00,000 which can be carried forward and set-off
against the income of the subsequent years. X dies and his son S inherits his
business. The losses inherited by X can be set-off by his son against the
income from a business activity carried by S. However such loss can be carried
forward by the son for the balance number of years for which the father could
have carried forward the losses.
(b) Business losses of an amalgamating company can be set-off against the
income of the amalgamated company if the amalgamation is within the
meaning of Section 72A/72AA of the Income Tax Act.
(c) Where there has been of business, whereby a proprietary concern or a firm is
succeeded by a company and certain conditions are fulfilled, the accumulated
business loss and the unabsorbed depreciation of the predecessor
firm/proprietary concern shall be deemed to be the loss or allowance for
depreciation of the successor company for the previous year in which the
business was effected and carry forward provisions shall be applicable to the
successor company.
(d) De-merger: Loss of the demerged company can be carried forward by the
resulting company subject to of certain conditions which the Central
Government may for this purpose notify, to ensure that the demerger is for
genuine business purposes. Similarly, certain losses of the demerged
cooperative bank can be carried forward by the resulting cooperative bank in
certain cases.
(IV) Period of Carry Forward: Each years loss is a separate loss and no loss shall
be carried forward for more than eight assessment years immediately succeeding the
Assessment Year for which the loss was first computed. Therefore, a loss of previous
247
year 2008-09, i.e., Assessment Year 2009-10 can be carried forward till Assessment
Year 20162017. However, loss of a specified business under Section 35AD can be
carried forward without any limit. Besides the above, the following can also be carried
forward for unlimited period:
Notes
1. unabsorbed depreciation;
2. unabsorbed scientific research expenditure;
3. unabsorbed expenditure on family planning.
(V) Order of Set-off: Unabsorbed depreciation, unabsorbed capital expenditure on
scientific research and family planning are not a part of business losses and they can
also be carried forward. However, as per Section 72(2), the business loss should be
set-off before setting-off unabsorbed depreciation etc. Such carried forward loss will be
set-off against a business head only after the current years depreciation; current capital
expenditure on scientific research and capital expenditure on family planning have been
claimed. Therefore, the order of set-off will be as under:
8. current year depreciation [Section 32(1)];
(ii) current year capital expenditure on scientific research and capital
expenditure on family planning to the extent allowed;
9. carried forward business or profession losses [Section 72(1)];
(iv) unabsorbed depreciation [Section 32(2)];
10. unabsorbed capital expenditure on scientific research [Section 35(4)];
(vi) unabsorbed expenditure on family planning [Section 36(1) (ix)].
Rehabilitation of business discontinued due to natural calamities etc. [Proviso
to Section 72(1)]
According to this proviso, if there is any loss of a business which is discontinued in
the circumstances specified in Section 33B and it is re-established, reconstructed or
revived by the assessee at any time before the expiry of a period of three years from the
end of the previous year in which it was discontinued, then the loss of the previous year
in which such business is discontinued including the brought forward loss:
(a) shall be allowed to be set-off against the profits and gains, if any, of that
business or any other business carried on by him and assessable for that
assessment year, and
(b) if the loss cannot be wholly set-off, the amount of balance loss be carried to the
following Assessment Year and so on for seven Assessment Years
immediately succeeding, provided such re-established business is continued to
be carried by the assessee.
5.3.7 Carry Forward and Set-off of Speculation Loss (Section 73)
If a speculation loss could not be set-off from the income of another speculation
business in the same Assessment Year, it is allowed to be carried forward to be claimed
as a set-off in the subsequent year, but only against the income of any speculation
business. Such loss is also allowed to be carried forward for four Assessment Years
immediately succeeding the Assessment Year for which the loss was first computed. It
may be observed that it is not necessary that the same speculation business must
continue in the Assessment Year in which the loss is set-off. As already discussed, filing
of return before the due date is necessary to carry forward such a loss.
1. Where a loss arises from illegal speculative business, it cannot be carried
forward to the subsequent years for set-off against the profits of another
speculative business [CIT vs. Kurji Jinabhai Kotecha (1977) 107 ITR 101 (SC)].
248
Notes
2. The loss in speculation may also include the loss on account of bad debts,
irrecoverable profits and interest on borrowings.
3. In respect of unabsorbed depreciation or unabsorbed capital expenditure on
scientific research, the effect shall be first given to the provisions of Section 73,
i.e., carried forward of speculation loss shall be first set-off.
4. Loss from derivative trading shall be treated as loss from non-speculative
business, if transaction of derivatives is done through NSE or BSE.
Companies carrying on business of buying and selling of shares [Explanation
to Section 73]
Where any part of the business of the company (whether private or public) consists
of the purchase and sale of shares of other companies, such company shall be deemed
to be carrying on a speculation business to the extent to which the business consists of
the purchase and sale of such shares. This explanation shall not apply to the following
companies:
(a) Investment companies i.e., a company whose gross total income consists
mainly of income chargeable under the heads income from House
Property, Capital Gains and Income from Other Sources.
(b) A company whose principal business is of banking or granting of loans
/advances.
Notes:
1. The explanation applies only to a company, it does not apply to individual, HUF,
Firm, AOP etc.
2. Explanation does not cover debentures, units of Unit Trust of India or units of
Mutual funds.
5.3.8 Set-off and Carry Forward and Set-off of Loss of a Specified Business
Referred to in Section 35AD [Section 73A]
The loss of a specified business referred to in Section 36AD of any assessment year
is allowed to be set off only against profit and gains, if any, of any other specified
business. But if such loss of specified business has not been wholly set off, so much of
as is not so set off or the whole loss where the assessee has no income from any other
specified business, shall, subject to the other provisions of this chapter, be carried
forward to the following assessment year, and
11. it shall be set off against the profits and gains, if any, of any specified business
carried on by him assessable for the assessment year; and
(ii) if the loss cannot be set off the amount of loss not set off shall be carried
forward to the following assessment year and so on.
In other words loss of a specified business can be carried forward indefinitely till it is
set off.
5.3.9 Carry Forward of Losses under the Head Capital Gains [Section 74]
Where in respect of any assessment year, the net result of the computation under
the head Capital Gains is a loss to the assessee, whether short-term or long-term, such
a loss shall be carried forward to the following assessment years and set-off against the
income under the head Capital Gains of the subsequent years. Such capital losses can
also be carried forward to a maximum of eight Assessment Years, immediately
succeeding the Assessment Year for which the loss was first computed.
249
5.3.10 Carry Forward of Loss from the Activity of Owning and Maintaining Race
Horses [Section 74A]
Notes
Any loss from the activity of owning and maintaining racehorses is included in this
section. Such a set-off is, however, permitted only if the activity of owning and
maintaining racehorses is carried on by the assessee in the previous year relevant to the
Assessment Year in which the loss is sought to be adjusted.
The loss can be carried forward for a maximum of four Assessment Years,
immediately succeeding the Assessment Year for which the loss was first computed.
Filing of returns before the due date prescribed u/s 139(1) is necessary to carry forward
the loss. The brought forward losses must be set-off in the intermediate succeeding
year/years.
5.3.11 Brought Forward Losses Must be Set off in the Immediately Succeeding
Year/Years
The losses which are eligible to be carried forward must be set-off against the
income/profit of the immediately succeeding year and if there is any balance still to be
set-off it should be set-off in the immediately next succeeding year or years within the
time allowed.
Where the losses incurred are not set-off against the income/profit of the
immediately succeeding year/years, as the case may be, they cannot be set-off at a later
date [Tyresoles (India) v. CIT (1963) 49 ITR 525 (Mad.)].
5.3.12 Problems on Set-off and Carry Forward of Losses
Problem 1. X an individual submits the following information for the A.Y. 2014-15:
Particulars
Salary Income computed
Profit
Loss
142,000
Income from House Property

House A
115,000
House B
117,000
House C
121,000
Profits and Gains of Business/Profession

Business A
108,000
Business B
Business C (Speculative)
118,000
111,000
Business D (Speculative)
123,000
Capital Gains
Short term capital gains
106,000
Short term capital loss

Long-term capital gains on sale of building
128,000
12,500
Income from other sources

Income from card games
108,000
Loss from card games
107,010
Loss on maintenance of race horses
106,000
Interest on securities
104,000
Determine the net income of X for the A.Y. 2014-15

250
Notes
Solution:
Step 1: Same head adjustment
Income from salary
`
1,42,000

House A
1,15,000
House B
()1,17,000
House C
() 1,21,000
() 1,23,000

Non-speculative 1,08,000 1,18,000 =
() 10,000
Speculative:
Business C
(+) 1, 11,000
Business D
() 1,23,000
To be carried forward to next year
() 12,000
Capital gains:
Short-term gains
Short-term loss
1,06,000
() 1,28,000
() 22,000
Long-term
It will be carried forward to next year
Income from other sources:
Income from card games
12,500
() 9,500
`
(+) 1,08,000
(Loss from card game cannot be deducted by virtue of Section 58)

Interest on securities
(+) 1,04,000
212,000
() 1,06,000
Loss on maintenance of racehorses can be set-off only against income from the
business of owning and maintaining race horses. In the absence of such income, it
cannot be set-off. However, it can be carried forward to next year for claiming set-off
against income from such business.
Step 2: Inter-head Adjustment:
Salary
1,42,000
Income for other sources
2,12,000
() 1,23,000
Profits and Gains of Business

Non-speculative
Net income
() 10,000
2,21,000
Loss which cannot be set-off against other income but which can be carried forward:
Speculative Business
() 12,000
Capital Gains
Income from Other Sources
() 9,500
251
() 1,06,000
Notes
() 1,27,500
Loss which cannot be set-off against other income cannot be carried forward.
Loss of maintenance of race horses
() 1,07,010
Problem 2. From the following details, compute the gross total income of A for the
Assessment Year 2013-2014.
`
Taxable income from salary
80,000
Income from house property:

House A let out
House B self-occupied
Short-term Capital Gain
Loss from Long-term Assets
Interest on Securities
() 95,000
() 9,000
12,000
() 25,000
10,000
Solution:
`
Taxable income from salary
80,000
Income from house property () 95,000 9,000 () 1,04,000

Income from capital gains short-term
12,000
Income from other sources interest on securities
10,000
Gross total income
NIL
Important Points:
1. Loss under the head Income from House Property amounting to ` 2,000 which
could not be set-off against income under other heads of income can be carried
forward to the subsequent A.Y. to be set-off under the head, Income from
House Property.
2. Loss from long-term capital assets cannot be set-off against short-term capital
gain or income under other heads of income. Such a loss can be carried
forward to the subsequent A.Y.
5.4 Tax Planning with Reference to New Projects/Expansion/

5.4.1 Introduction: Tax Planning with Reference to New Projects/Expansion/
Many factors affect the location and nature of a new business. The impact of tax
incentives within the broad framework of law needs to be considered for determining the
viability of the project. These are given in the subsequent paragraphs.
5.4.2 Section 10AA: Special Provisions in Respect of Newly Established Units in
Special Economic Zones
Subject to the provisions of this section, a deduction of such profits and gains
derived by an assessee being an entrepreneur from the export of articles or things or
252
Notes
providing any service, as the case may be, from his unit shall be allowed from the total
Notes:
Meaning of Entrepreneur: Entrepreneur means a person who has been granted a
letter of approval by the development commission under section 15(9) [Section2(j) of the
Special Economic Zone Act, 2005].
Essential conditions to claim deduction: the deduction shall apply to an undertaking
which fulfills the following condition:
1. It has begun or begins to manufacture or produce articles during the previous
year, relevant to the assessment year commencing on or after 1-4-2006 in any
Special Economic Zone.
2. It should not be formed by the splitting op or reconstruction of a business
already in existence.
3. It should not be formed by the transfer of machinery or plant, previously used
for any purpose, to a new business.
4. The exemption shall not be admissible unless the assessee furnishes in the
prescribed form [Form No. 56F] along with the return of income, the report of
the chartered accountant certifying that the deduction has been correctly
claimed as per provisions of this section.
Notes:
1. Manufacture means to make produce, fabricate, assemble, process or bring
into existence, by hand or by machine, a new product having a distinctive name,
character or use and shall include processes such as refrigeration, cutting,
polishing, blending, repair, remaking, re-engineering and includes agriculture,
aquaculture, animal husbandry, floriculture, horticulture, pisciculture, poultry,
sericulture, aviculture and mining [section2(f) of the Special Economic Zone
[Section 2(za) of the Special Economic Zones Act, 2005].
Period for which deduction is available:
The deduction under this section shall be allowed as under for a total period of
15 relevant assessment years.
1.
For the first 5 consecutive assessment years

beginning with the assessment year relevant to the
previous year in which the unit begins to
manufacture such articles or things or provide
services
100% of the profits and gains derived

from the export of such articles or
things or from services
2.
Next 5 consecutive assessment years
50% of such profits or gains
3.
Next 5 consecutive assessment years
So much of the amount not exceeding

50% of the profits as is debited to profit
and loss account of the previous year
in respect of which the deduction is to
be allowed and credited to Special
Economic
Zone.
Reinvestment
Reserve Account to be created and
utilized for the purpose of the business
of the assessee in the manner laid
down in sub-section (2) below
Conditions to be satisfied for claiming deduction for further 5 years (after

10 years) [Section 10AA(2)]
253
(1) The amount credited to the Special Economic Zone Reinvestment Reserve
Account is to be utilized
(i) For the purpose of acquiring machinery or plant which is first put to use
before the expiry of a period of 3 years following the previous year in
which the reserve is created; and
(ii) Until the acquisition of this machinery or plant as aforesaid, for the
purposes of the business of the undertaking other than for distribution by
way of dividends or profits or for remittance outside India as profits or for
creation of any asset outside India.
(2) The particulars as may be prescribed in this behalf, should be furnished in
Form 56FF, by the assess in respect of machinery or plant along with the
return of income for the assessment year relevant to the previous year in which
such plant or machinery was first put to use.
Notes
Consequences of mis-utilization/non-utilization of reserve [Section 10AA(3)]:

Where any amount credited to the Special Economic Zone Re-investment Reserve
Account:
(a) has been utilized for any purpose other than the purchase of machinery or
plant as mentioned above, the amount so utilized shall be deemed to be the
profits of the year in which it was so utilized and shall be charged to tax; or
(b) has not been utilized before the expiry of the aforesaid period of 3 years, the
amount no so utilized shall be deemed to be the profits of the year immediately
following the period of said 3 years and charged to tax.
How to compute profit and gains from exports of such undertakings [Section
10AA(7)]: If the aforesaid conditions are satisfied, the deduction u/s 10AA may be
computed as under:
Profits from business of the undertaking being the unit x
Export Turnover of the undertaking of such articles/things or services
Total turnover of the business carried on by the assessee
For this purpose, export turnover means the consideration in respect of export by
the undertaking of articles or things or services received in, or brought into India by the
assessee but does not include freight, telecommunication charges, or insurance
attributable to the delivery of the article or things outside India, or expenses, if any,
incurred in foreign exchange in rendering of services (including computer software)
outside India.
The profits and gains derived from on-site development of computer software
(including services for development of software) outside India shall be deemed to be the
profits and gains derived from the export of computer software outside India.
Ban on enjoyment of other tax benefits: The following allowances or expenditure
shall be deemed to have been allowed and absorbed during the course of the relevant
assessment years ending before 1-4-2006:
12. Depreciation allowance under Section 32(ii) expenditure on scientific research
under section 35; and
13. Expenditure relating to family planning under section 36(1)(ix)
The aforesaid expenditure/allowance even if unabsorbed during the assessment
years ending before 1-4-2006, shall be deemed to have been fully claimed and allowed.
However, unabsorbed depreciation, unabsorbed expenditure on scientific research and
capital expenditure on family planning pertaining to assessment year 2006-07 or any
subsequent assessment years shall be allowed to be carried forward and set-off.
254
Notes
No portion of the losses pertaining to business under section 72(1) or capital gains
under section 74(1) or Section 74(3) with respect to any assessment year ending before
1-4-2006 forming part of the tax holiday period, to the extent pertaining to the undertaking,
being the unit shall be claimed in any assessment year subsequent to the last of the
assessment year forming part of the tax holiday. However losses referred to in Section
72(1)or section 74(1) and (3) in so far as such losses relate to the business of the
undertaking being the unit, pertaining to the assessment year 2006-07 or any
subsequent assessment year shall be allowed to be carried forward and set-off.
WDV after tax holiday period: It shall be presumed that during the tax holiday
period under section 10AA, the assessee had claimed and had been allowed
depreciation allowance, and hence the written down value of the depreciable assets shall
be computed accordingly, after the conclusion of the tax holiday period.
5.4.3 Deduction in Respect of Profits and Gains from Industrial Undertakings or
Enterprises Engaged in Infrastructure Development etc. [Section 80IA]
Deduction under section 80IA is available only to the following business carried on
by an industrial undertaking:
1. Provision of infrastructure facility [which includes road, highways, water
supply project, irrigation project, sanitation and sewerage system, water
treatment system, solid waste management system, ports, airports and inland
waterways]
Conditions:
Any enterprise for availing deductions with reference to profits of the business
relating to infrastructure facility, shall fulfill the following conditions:
(i) The enterprise should be owned by a company registered in India or a
consortium of such companies or by an authority or aboard or a corporation or
any other body established or constituted under any Central or State Act.
(ii) The enterprise should enter into an agreement with Central Government or A
State Government or a Local Authority or any other statutory body for
developing or operating and maintaining or developing, operating and
maintaining of a new infrastructure facility.
(iii) The enterprise has started its operation and maintenance on or after 1st April
1995. For the purpose of this section, Infrastructure Facility means
(a) A road including toll road, a bridge or a rail system;
(b) A highway project including housing or other activities being an integral
part of the highway project;
(c) A water supply project, water treatment system, irrigation project,
sanitation and sewerage system or solid waste management system;
(d) A port, airport, inland waterway, inland port or navigational channel in the
sea.
2. Telecommunication services
Eligible business:
Any undertaking providing telecommunication services, whether basic or cellular
including radio paging, domestic satellite service network or trunking, broad band
network and internet services.
Conditions:
The operations of the undertaking should have been started on or after 1st April
1995 but on or before 31st March, 2005.
255
3. Developing, maintaining etc. an industrial park.
Notes
Essential Conditions:
(i) The undertaking should develop, develop and operate or maintain and operate
an industrial park or special economic zone notified by the central Government
in accordance with a scheme framed for such purpose.
(ii) The industrial park should begin to operate, develop etc. at any time on or after
1-4-1997 but before 1-4-2011.
4. Power generation, transmission and distribution
Eligible business:
(i) An undertaking set up in any part of India for the generation or generation and
distribution of power.
(ii) An undertaking which starts transmission or distribution of power by laying a
network of new transmission or distribution lines.
(iii) An undertaking which undertakes substantial renovation and of existing
network of transmission or distribution lines.
Conditions:
(i) In respect of an undertaking set up in any part of India for the generation or
generation or distribution of power the operation of the undertaking should
have been started on or after 1st April,1993 but on or before 31st March, 2013.
(ii) In respect of an undertaking which starts transmission or distribution of power
by laying a network of new transmission or distribution lines the operation of
the undertaking should have been started on or after 1st April, 1999 but on or
before 31st March, 2013.
(iii) In respect of an undertaking which undertakes substantial renovation and
modernization of existing network of transmission or distribution lines of
operations of the undertaking should have been started on or after 1st April,
2004 but on or before 31st March, 2013. Substantial renovation and shall
mean an increase of plant and machinery by at least 50% of the book value of
such plant and machinery as on 1-4-2004.
5. Essential conditions for undertaking set up for reconstruction or revival of a
power generating plant
1. Such undertaking must be owned by an Indian company.
2. Such Indian company is formed before 30-11-2005 with majority equity
participation by public sector companies for purposes of enforcing the security
interest of the lenders to the company owing the power generating plant.
3. Such Indian company is notified before 30-11-2005 by the central government
for the purpose of this clause.
4. Such undertaking begins to generate or transmit or distribute power before
31-3-2011.
Common Points Applicable to all the Above Activities:
(I) It should be an Indian company.
(II) It should be a new Industrial undertaking: The industrial undertaking is not
formed by splitting up, or the reconstruction of a business already in existence.
Exception: This condition will not apply where the business is re-established,
reconstructed or revived by the same assessee after its discontinuance as a direct result
of:
(i) Flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature or,
256
Notes
(ii) Riot or civic disturbance or

(iii) Accidental fire or explosion or
(iv) Action by any enemy or action taken in an enemy (with or without declaration of
war)
Where transfer is pursuant to splitting up or reconstruction of the State Electricity
Board.
(III) It should not be formed by transfer of Machinery or plant previously used for
any purpose.
Exceptions:
1. If the value of the old plant and machinery does not exceed 20% of the total
value of machinery or plant used in the business, this condition is deemed to
have been satisfied.
2. Any machinery or plant which was used outside India by any other person
other than the assessee shall not be regarded as machinery or plant previously
used for any purpose if following conditions are satisfied:
(i) Such machinery or plant was not, at any time previous to the date of the
installation by the assessee, used in India.
(ii) Such machinery or plant is imported into India from any country outside
India.
(iii) No deduction on account of depreciation in respect of such machinery or
plant has been allowed or is allowable under the Act in computing the
total income of any person for any period prior to the date of the
installation of the machinery or plant by the assessee.
(IV) Audit Report: Assessee other than a company or a Co-operative Society
should get its account audited by a chartered Accountant and the audit report is
furnished along with the return of income.
(V) Computation of Profit: For the purpose of determining the quantum of
deduction under section 80IA for the assessment year immediately succeeding
the initial assessment year or any subsequent assessment year, the profits and
gains from the eligible business shall be computed as if such eligible business
were the only source of income of the assessee during the previous year
relevant to the initial assessment year and to every subsequent assessment
year up to and including the assessment year for which the determination is to
be made. Section 80IA(5).
(VI) The assessing officer is empowered in certain cases to recompute profit.
(VII) Consequences of Merger/Amalgamation: In case of merger/amalgamation
between two Indian Companies, the deduction will be available to the
amalgamated company or resulting company from the year of merger/
amalgamation.
(VIII) Double deduction not possible: When deduction under section 80IA is
claimed and allowed then the same profits will not be eligible for deduction
under section 80C to 80U.
(IX) Profits of housing or other activities which are an integral part of the
Highway project: Notwithstanding any thing discussed above, where housing
or other activities are an integral part of the highway project and the profits of
which are computed on such basis and manner as may be prescribed, such
profit shall not be liable to tax where the profit has been transferred to a special
reserve account and the same is actually for the highway project excluding and
other activities before the expiry of three years following the year in which such
257
amount was transferred to the reserve account, and the amount remaining
shall be chargeable to tax as income of the year in which such transfer to
reserve account took place.
(X) Where an infrastructure facility is transferred on or after the 1-4-1999 by an
enterprise which developed such infrastructure facility to another enterprise for
the purpose of operating and maintaining the infrastructure facility on its behalf
in accordance with the agreement with the Central Government, State
Government, Local Authority or Statutory body, the provisions shall apply to the
transferee enterprise as if it were the enterprise to which this clause applies
and the deduction from profits and gains would be available to such transferee
enterprise for the unexpired period, during which the transferor enterprise
would have been entitled to the deduction if the transfer had not taken place.
(XI) Where an Industrial Park develops an industrial park on or after 1-4-1999 till
1-4-2001 and transfers the operation and maintenance of such industrial park,
to another undertaking, the deduction shall be allowed to such transferee
undertaking.
Notes
Quantum and Period of Deduction in Case of All Above Undertaking/Enterprises

Undertaking/Enterprises
Period and Quantum of Deduction
(1) For all the above

undertaking/enterprises
100% of profits and gains derived from such business for

10 consecutive assessment years out of 15 years * beginning with
the year in which undertaking or the enterprise develops and
begins to operate any infrastructure facility or starts providing
communication services or develops an industrial park or
develops a special economic zone or generates power or
commences transmission or distribution of power or undertakes
substantial renovation and modernization of the existing
transmission or distribution lines.
Provided that where the assessee develops or operates and
maintains or develops, operates and maintains any infrastructure
facility relating to a road including toll road, a bridge or rail
system ; a highway project including housing or other activities
being an integral part of the highway project; a water supply
project, water treatment system, irrigation project, sanitation and
sewerage system or solid waste management system; the
provision of this clause shall have effect as if for the words fifteen
years, the words twenty years had to be substituted.
5.4.4 Deduction in Respect of Profits and Gains from Enterprises Engaged in

Development of the Special Economic Zones [Section 80-IAB]
The deduction under this section is available where the gross total income of an
assessee, being a developer, includes any profit and gains derived by an undertaking or
an enterprise from any business of developing a Special Economic Zone, notified on or
after 1-4-2005 under the Special Economic Zones Act, 2005.
Quantum of deduction: The deduction shall be allowed of an amount equal to
100% of the profits and gains derived from such business for 10 consecutive assessment
years.
The deduction may, at the option of the assessee be claimed by him for any
10 consecutive assessment years, out of 15 years beginning from the year in which a
Special Economic Zone has been notified by the Central Government.
258
Notes
Consequences of transfer of the undertaking: Where an undertaking, being a

Developer who develops a Special Economic Zone on or after 1-4-2005 and transfers the
operation and maintenance of such Special Economic Zone to another Developer, the
deduction shall be allowed to such transferee Developer for the remaining period in the
10 consecutive assessment years as if the operation and maintenance were not so
transferred to the transferee Developer.
Profits of eligible business How to compute? For the purpose of determining
the quantum of deduction for the assessment year immediately succeeding the initial
assessment year or any subsequent assessment year, the profits and gains from the
eligible business shall be computed as if such eligible business were the only source of
income of the assessee during the previous year relevant to the initial assessment year
and to every subsequent assessment year up to and including the assessment year for
which the determination is to be made.
Conditions to be applicable to the undertaking for claiming deduction:
These provisions relate to the following in respect of eligible business
1.
2.
3.
4.
5.
Audit of accounts.
Inter unit transfer of goods or services.
Restriction of double deduction.
Restriction of excessive profits.
Power of Central Government to notify undertakings to which Section 80-IAB
shall not apply.
6. Deduction allowed to the amalgamating company for the unexpired period in
case of amalgamation.
7. Deduction not to be allowed in cases where return is not filed within specified
time limit.
5.4.5 Deduction in Respect of Profits and Gains from Certain Industrial
Undertakings Other than Infrastructure Development Undertakings [Section
80IB]
Deduction under section 80IB is available to an assessee whose Gross total Income
includes and profits and gains derived from the business of:
(1) an Industrial undertaking set up in the State of Jammu and Kashmir. Provision
(except the quantum of deduction) relating to other industrial undertakings
have not been discussed as these new industrial undertakings are now not
allowed deduction.
(2) Scientific and industrial, research and development
(3) Commercial production and refining of mineral oil
(4) Developing and building housing projects
(5) Processing, preservation and packaging of fruits and vegetables
(6) Integrated business of handling, storage and transportation of food grain units.
(7) Operating and maintaining a hospital in a rural area
(8) Operating and maintaining a hospital located anywhere in India other than
excluded area.
14. Essential conditions for Industrial undertaking:
1. It should be a new undertaking.
2. It should not be a formed by transfer of machinery or plant previously used for
any purpose.
259
2. It should not manufacture or produce articles specified in the Eleventh

Schedule in any part of India or it operates one or more cold storage plant or
plants or operates cold chain facility, in any part of India. However, a
small-scale industrial undertaking or an industrial undertaking located in an
industrially backward State specified in the Eighth schedule shall be eligible for
the deduction, even if it manufactures or produces any article/thing which is
specified in the Eleventh Schedule.
4. In case where the industrial undertaking manufactures or produces articles or
things, the undertaking employs 10 or more workers in a manufacturing
process carried on with the aid of power or employs 20 or more workers in a
manufacturing process carried on without the aid of power.
5. The industrial undertaking set up in the State of Jammu and Kashmir begins to
manufacture or produce articles or things during the period 1-4-1993 to
31-3-2012.
6. The industrial undertaking in a backward state begins to manufacture or
produce articles or things or to operate its cold storage plant or plants during
the period beginning on 1-4-1993 to 31-3-2004.
Notes
Quantum of deduction
Assessee
Period of Deduction
(commencing from initial
assessment year)
% of profits
eligible for
deduction
First 5 years
100
1. Industrial undertaking
(i) Set up in Jammu & Kashmir
(ii) in district of category A*
(iii) operating a cold chain facility
15. Owned by a company
(b)Owned by a co-operative society
(c) Owned by any other assessee
Next 5 years
30
First 5 years
100
Next 7 years
25
First 5 years
100
Next 5 years
25
2. Industrial undertaking in an industrially

backward district category B*
(a) Owned by a company
(b)Owned by a cooperative society
First 3 years
100
Next 5 years
30
First 3 years
100
Next 9 years
25
First 3 years
100
Next 5 years
25
* Backward districts of category A and Category B have been notified vide

Notification No.10441, dated 7-10-1997.
Initial Assessment year: It means the assessment year relevant to the previous
year in which the industrial undertaking begins to manufacture or produce
articles or things or to operate its cold storage plant(s) or the cold chain facility.
(B) Ten year tax holiday for approved companies carrying on scientific research and
development having its main object of scientific and industrial research and development
260
Notes
The deduction is available to a company assessee if such company was approved

by the prescribed authority at any time after 31-3-2000 but before 1-4-2007 and certain
other conditions are satisfied.
The company is eligible for deduction of 100% of the profits and gains of such
business for a period of 10 consecutive assessment years, beginning from the initial
assessment year.
(C) Industrial undertaking producing or refining Mineral Oils:
1. It should be a new undertaking.
2. It should not be formed by transfer of machinery or plant previously used for
any purpose.
3. It should commence commercial production as follows:
Commercial
production of
mineral oil
Refining of
mineral oil
1. Undertaking
located in
North-Eastern Region
Before April 1,
1997
2. Undertaking
located
anywhere
in India
After March 31,

1997
After September
30, 1998 but
before April, 2009
Commencing refining of
mineral oil by an
undertaking which is
wholly owned by a notified
public sector company or
any other notified
company in which a public
sector company holds
49% of voting right
On or after April1, 2009

but before April1, 2012
It should employ 10/20 workers.

Quantum of deduction:
100% of the profit is deductible for first 7 years commencing with the year in which the
undertaking commences commercial production of mineral oil or refining of mineral oil.
(D) Undertaking engaged in Developing and building housing projects:
1. Allowed to all assessee
2. Project should be approved by a local authority before March 31, 2008
3. Size of plot of land is minimum of one acre. (This condition is not applicable if
the project is in accordance with scheme framed by Central Government or
State government and notified by CBDT).
4. The built up area of each residential unit should be subject to the following
maximum limit:
Place where residential unit is situated
The maximum built up area of each

residential unit should be as given below
1. Within the cities of Delhi and Mumbai
1000 sq. ft.
2. Within 25 kms from the local limits

of Delhi and Mumbai
1000 sq. ft.
3. At any other place
1500 sq. ft.
261
5. The built up area of the shops and other commercial establishments included
in the housing project does not exceed five per cent of the aggregate built up
area of the housing project of two thousand square feet, whichever is less;
6 Not more than one residential unit in the housing project is allotted to any
person not being an individual; and
7. In a case where the residential unit in the housing project is allotted to a person
being an individual, no other residential unit in such housing project is allotted
to any of the following persons, namely:
(i) the individual or the spouse or the minor children of such individual,
(ii) the Hindu Undivided family in which such individual is the karta;
(iii) any person representing such individual, the spouse or the minor children
of such individual or the HUF in which such individual is the karta
8. The undertaking commences development and construction of the housing
project after September 30, 1998 and completes the same by the following
dates:
(a) in case where a housing project has been approved by the local authority
before 1-4-2004, it should complete on or before 31-3-2008.
(b) in a case where a housing project has been, or, is approved by the local
authority on or after 1-4-2004 but not later than 31-3-2005, it should
complete within 4 years from the end of the financial year in which the
housing project is approved by the local authority.
(c) in a case where a housing project has been, or, is approved by the local
authority on or after 1-4-2005 within 5 years from the end of the financial
year in which the housing project is approved by the local authority.
Notes
Quantum of Deduction:
100% of the profit derived in any previous year relevant to any assessment year
from such housing project is deductible.
Other points discussed under section 80-IA are also applicable:
(i)
(ii)
(iii)
(iv)
(v)
Audit Report
Double Deduction is not available
Computation of profit
Re-computation of profit by the Assessing Officer
Consequences of merger/amalgamation.
(E) Undertaking engaged in the business of processing, preservations and

packaging of fruits or vegetables or integrated handling, storage and
transportation of food grains [Section 80 IB(11A)]:
Deduction is available in the case of an undertaking deriving profit from the
integrated business of handling, storage and transportation of food grains, if the
undertaking begins to operate such business after March 31, 2001.
Provided that the deduction shall not apply in respect of an undertaking engaged in
the business of processing, preservation and packaging of meat or meat products or
poultry or marine or dairy products if it begins to operate such business before 1-4-2009.
Amount of deduction: The amount of deduction available under section 80-IB is as
follows:
Enterprises
Owned by a company
Period of deduction commencing

from the initial assessment year
% of profit deductible
First 5 years
100
262
Notes

Owned by any other person
Next 5 years
30
First 5 years
Next 5 years
100
25
Other points: One should also keep in view the following points:
(i) Audit Report
(ii) Double Deduction is not available
(iii) Computation of profit
(iv) Re-computation of profit by the Assessing Officer
(v) Consequences of merger/amalgamation.
(F) Tax holiday to undertakings operating and maintaining a hospital in a rural
area [Section 80IB(11B)]: The deduction will be available commencing from the year in
which the hospital begins to provide medical services. The deduction will be available
only if:
The hospital is constructed and starts functioning between 1 October 2004,
and 31st March 2008.
The hospital has at least 100 beds;
The hospital is constructed in accordance with the regulations of the local
authority; and
The undertaking submits an audit report in the prescribed form along with its
return of income.
The hospital shall be deemed to have been constructed on the date on which a
completion certificate in respect of such construction is issued by the
concerned local authority.
Quantum and period of Deduction: 100% of the profits and gains of such
business for a period of 5 consecutive assessment years, beginning with the initial
assessment year.
(G) Undertaking operating and maintaining hospitals located any where in
India other than excluded area [Section 80IB(11C)]
Essential conditions
(i) Location: The hospital is located anywhere in India, other than excluded area.
The excluded area shall mean an area comprising the urban agglomeration of
Greater Mumbai, Delhi, Kolkata, Chennai, Hyderabad, Bangalore and
Ahmedabad, the districts of Faridabad, Gurgaon, Ghaziabad, Gautam Budh
Nagar and Gandhinagar and the city of Secunderabad. The area comprising an
urban agglomeration shall be the area included in such urban agglomeration
on the basis of 2001 census.
(ii) Construction: The hospital is constructed at any time during 1-4-2008 and
31-3-2013.
(iii) Commencement: The hospital should start functioning at any time during
1-4-2008 and 31-3-2013.
(iv) Number of beds: At least 100 beds.
(v) Municipal bye-laws: The construction is in accordance with the regulation or
bye-laws of the local authority.
Amount of deduction
100 per cent of the profits and gains derived from the business of hospital shall be
deductible for a period of 5 assessment years beginning with the initial assessment year
in which the business of hospital starts functioning.
263
Other Points: One should also keep in view the following points:
(i)
(ii)
(iii)
(iv)
(v)
Audit Report
Double Deduction is not available
Computation of profit
Re-computation of profit by the Assessing Officer
Consequences of merger/amalgamation
Notes
5.4.6 Deduction in Respect of Profits and Gains from the Business of Hotels and
Convention Centres in Specified Areas [Section 80ID]
Deduction under this section is available to an assessee whose gross total income
includes any profit or gain derived from
(a) The business of hotel located in the National Capital Territory of Delhi and the
districts of Faridabad, Gurgaon, Gautam Budh Nagar and Ghaziabad, if such
hotel is constructed and has started or starts functioning at any time during the
period beginning on 1-4-2007 and ending on 31st July, 2010, or
(b) The business of building, owning and operating a convention centre, located in
the National Capital Territory of Delhi and the districts of Faridabad, Gurgaon,
Gautam Budh Nagar and Ghaziabad, if such convention centre is constructed
at any time during the period beginning on 1-4-2007 and ending on 31-7-2010.
(c) The business of hotel located in the specified district having a World heritage
Site, if such hotel is constructed and has started or starts functioning at any
time during the period beginning on 1-4-2008 and ending on 31-3-2013.
The above business is hereinafter referred to as eligible business.
Conditions to be satisfied for claiming deduction:
1. The eligible business is not formed by the splitting up or the reconstruction of a
business already in existence.
2. The eligible business is not formed by the transfer to a new business of a
building previously used as a hotel or a convention centre, as the case may be.
3. The eligible business is not formed by the transfer to a new business of any
machinery or plant previously used for any purpose.
However, plant and machinery already used for any purpose, can be
transferred to the new industrial undertaking, provided value of such plant and
machinery does not exceed 20% of the total value of plant and machinery of
the new industrial undertaking.
4. The assessee furnishes along with the return of income, the report of an audit
in such form and containing such particulars as may be prescribed, and duly
signed and verified by an accountant.
100% of the profit and gains derived from such business for 5 consecutive
assessment years beginning from the initial assessment year.
Initial assessment year
(i) in the case of hotel, means assessment year relevant to the previous year in
which the business of the hotel starts functioning.
(ii) in the case of a convention centre, means assessment year relevant to the
previous year in which the convention centre starts operating on a commercial
basis.
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Notes
Following points discussed under section 80-IA are also applicable:

(i)
(ii)
(iii)
(iv)
(v)
Double deduction not available.

Computation of Profit.
Inter-unit transfer of goods.
Restriction on excessive profits.
Power of central Government to notify undertaking to which section 80-IC will
not apply.
5.4.7 Deduction in respect of certain undertakings in North-Eastern States [Section

80IE]
Deduction under this section is allowed to an assessee whose gross total income
includes any profits and gains derived by an undertaking which fulfils the following
conditions:
(1) It has during the period beginning on 1-4-2007 and ending before 1-4-2017
begun or begins in any of the North-Eastern States:
(a) to manufacture or produce any eligible article or thing;
(b) to undertake substantial expansion to manufacture or produce any
eligible article or thing;
(c) to carry on any eligible business.
(2) It is not formed by splitting up, or the reconstruction, of a business already in
existence
(3) It is not formed by the transfer to a new business of any machinery or plant
previously used for any purpose.
However, plant and machinery already used for any purpose, can be transferred to
the new industrial undertaking, provided value of such plant and machinery does not
exceed 20% of the total value of plant and machinery of the new industrial undertaking;
Eligible business means the business of
hotel (not below two star category)
(ii) adventure and leisure sports including ropeways
providing medical and health services in the nature of nursing home with a minimum
capacity of twenty-five beds;
(iv) running an old age home;
operating vocational training institute for hotel management, catering and food craft,
entrepreneurship development, nursing and para-medical, civil aviation related training,
fashion designing and industrial training;
(vi) running information technology related training centre;
manufacturing of information technology hardware; and
(viii) bio-technology
Substantial expansion means increase in the investment in the plant and machinery
by at least 25% of the book value of plant and machinery (before taking depreciation in
any year) as on the first day of the previous year in which the substantial expansion is
undertaken.
North Eastern States means the States of Arunachal Pradesh, Assam, Manipur,
Meghalaya, Mizoram, Nagaland, Sikkim and Tripura.
265
100% of the profits and gains derived from such business for 10 consecutive
assessment years commencing with the initial assessment year.
Notes
Initial assessment year means assessment year relevant to the previous year in
which the undertaking begins to manufacture or produce articles or things, or completes
substantial expansion.
Following points discussed under section 80-IA are also applicable:
Double deduction not available.
(ii) Computation of profit of eligible business.
Inter-unit transfer of goods.
(iv) Audit of accounts.
Restriction on excessive profits.
(vi) Power of central Government to notify undertaking to which section 80-IC will
not apply.
Deduction allowed to the amalgamated company for the unexpired period in case of
amalgamation.
5.4.8 Deduction in Respect of Certain Incomes of Offshore Banking Units and
International Financial Service Centres by the Specific Economic Zone Act,
2005 [Section 80LA]
To whom the deduction will be allowed: the deduction will be allowed to an
assessee:
(i) Being a scheduled bank (not being a bank incorporated by or under the laws of
a country outside India);
(ii) Owning an Offshore Banking Unit in a Special Economic Zone;
(iii) A unit of international Financial Services centre
Income in respect of which deduction will be allowed: the deduction will be
allowed on account of the following income included in the gross total income of such
banks: Any income:
(i) From an Offshore Banking unit in a Special Economic Zone;
(ii) From the business, referred to in Section 6(1) of the Banking Regulation Act,
1949, with an undertaking which develops, develops and operates and
maintains a Special Economic Zone
(iii) From any unit of the International Services Centre from its business for which it
has been approved for setting up in such a centre in a Special Economic Zone.
(i) 100% of such income for five consecutive assessment years beginning with the
assessment year relevant to the previous year in which the permission, under
section 23(1)(a) of the Banking Regulation Act, 1949, or permission or
registration under the SEBI Act,1992 or any other relevant law was obtained;
(ii) 50% of such income for the next five consecutive assessment years.
Conditions to be satisfied: No deduction under this section shall be allowed
unless the assessee furnishes along with the return of income:
(i) In the prescribed form, the report of a Chartered Accountant, certifying that the
deduction has been correctly claimed in accordance with the provisions of this
section; and
266
Notes
(ii) A copy of the permission obtained u/s 23(1)(a) of the Banking Regulation Act,
1949.
Offshore Banking Unit means a branch of a bank in India located in the special
economic zone and has obtained the permission u/s 23(1)(a) of the Banking Regulation
Act, 1949.
International Financial Services Centre means an International Financial Services
Centre which has been approved by the Central Government under sub section (1) of
section 18 of the special Economic Zones Act, 2005.
5.4.9 Venture Capital Companies [Section 10(23 FB)
Any income of a VCF or a VCC set up to raise funds for investment in a VCU is
exempt subject to certain conditions.
Venture capital company (VCC) means a company which has been granted a
certificate of registration by SEBI and which fulfils the conditions laid down by SEBI with
the approval of the Central Government.
Venture capital fund (VCF) means a fund operating under a trust deed registered
under the Registration Act, 1988, which has been granted a certificate of registration by
SEBI and which fulfils the conditions laid down by SEBI with the approval of the Central
Government.
Venture capital undertaking (VCU) means a domestic company whose shares are
not listed in a recognized stock exchange in India and which is engaged in the business
for providing services, production or manufacture of an article or thing but does not
include activities or sectors which are specified by SEBI with approval of the Central
Government.
5.4.10 Tea Development Account, Coffee Development Account and Rubber
Development Account [Section 33AB]
An assessee carrying on business of growing and manufacturing tea or coffee in
India is entitled for deduction to the extent of least of the following:
(a) amount deposited in special account with NABARD maintained by the
assessee with that bank in accordance with and for the purpose specified in a
scheme approved in this behalf by the Tea board or the Coffee Board or the
Rubber Board., within a period of 6 months from the end of the previous year or
before due date of furnishing return of income, whichever is earlier.
(b) 40% of profits of such business as computed before making deduction u/s 33
AB and before adjusting brought forward business loss u/s 72.
How to compute profits from such business?: If separate accounts are not
maintained in respect of business of growing and manufacturing tea or coffee or rubber in
India, it shall be profits from such business before claiming deduction under this section.
In case separate accounts are not maintained it will be calculated as under:
Profits of the business
Total turnover of business of growing and manufactur ing tea/coffee /rubber

Total turnover of the assessee' s business
1. For claiming deduction u/s 33 AB, assessee must get accounts audited by a
Chartered Accountant and furnish the report of such audit in prescribed form
along with his return of income.
2. The amount standing to the credit of special account with NABARD is to be
utilized as per the specified scheme of Tea Board.
In no case, it shall be utilized for the purpose of the following:
267
(a) Any machinery/plant installed in any office premises/residential

accommodation including guest house.
(b) Any office appliances (Other than Computer)
(c) Any machinery or plant entitled for 100% write off by way of depreciation
or otherwise
(d) Any new machinery or plant installed for production of any low priority
item specified in the Eleventh Schedule.
3. Deduction allowed under this provision will be withdrawn if the asset acquired
in accordance with the scheme, is sold or otherwise transferred within 8 years
from the end of the previous year in which it was acquired. However, it shall not
be withdrawn in the following cases:
transfer to Government, Local Authority or Statutory Corporation or
Government Co.
In case of Sale of business by partnership firm to a company, if Company
has taken over all assets and liabilities of the firm and all the shareholders
of the company were partners of the firm before such sale.
4. Assessee is however, allowed to withdraw any amount standing to his credit in
special account with NABARD in the following circumstances:
(a) Closure of business
(b) Dissolution of firm
(c) Death of an assessee
(d) Partition of a HUF
(e) Dissolution of a Company
Notes
Where the withdrawal is made in the circumstances stated above in (a) and (b), the
amount withdrawn such business shall be taxable as business profit of that Previous year,
as if the business had not been closed or the firm had not been dissolved.
5.4.11 Site Restoration Fund [Section 33ABA]
This section has been inserted to allow deduction to an assessee who is carrying on
business consisting of the prospecting for or extraction or production of petroleum or
natural gases or both in India.
Essential conditions:
1. This deduction will be allowed to any assessee who is carrying on business
consisting of prospecting for or extraction or production of petroleum or natural
gas or both in India and in relation to which the Central Government has
entered into an agreement with such assessee for such business.
2. The assessee has before the end of the previous year
(a) Deposited with the State Bank of India any amount(s) in a special account
maintained by the assessee with that bank, in accordance with and for the
purposes specified in, a scheme approved in this behalf by the Ministry of
Petroleum and Natural Gas of the Government of India; or
(b) Deposited any amount in the Site restoration Account opened by the
assessee in accordance with, and for the purpose specified in a scheme
framed by the aforesaid Ministry. This scheme is known as Deposit
Scheme.
3. The assessee must get its accounts audited by a Chartered Accountant and
furnish the report in the prescribed form (Form No. 3AD) along with the return
of income. In a case where the assessee is required by or any other law to get
268
Notes
its accounts audited, it shall be sufficient compliance if such assessee gets the
account of such business audited under such law and furnishes the report of
the audit as required under such other law and a further report in the form
prescribed.
Profits from business in this case is to be calculated in the same manner as is
mentioned in Section 33AB.
Quantum of deduction: Quantum of deduction shall be:
(a) The amount deposited in the scheme referred to above; or
(b) 20% of the profit of such business computed under the head profits and gains
of business or profession, whichever is less.
The profits are to be computed before making any deduction under this section,
i.e., Section 33ABA and before making adjustment for brought forward losses
under section 72.
Restriction on utilization of the amount deposited: The amount standing to the
credit of the assessee, in the Special Account of State Bank of India or the Site
Restoration Account, is to be utilized for the business of the assessee in accordance with
the scheme specified. However, no deduction shall be allowed in respect of any amount
utilized for the purchase of:
(a) Any machinery or plant to be installed in any office premises or residential
accommodation, including any accommodation in the nature of a guest house;
(b) Any office appliances (not being computers);
(c) Any machinery or plant, the whole of the actual cost of which is allowed as a
deduction (whether by way of depreciation or otherwise) in computing the
income chargeable under the head Profits and gains of business or
profession of any one previous year;
(d) Any new machinery or plant to be installed in an industrial undertaking for
purposes of business of construction, manufacture or production of any article
or thing specified in the list in the Eleventh Schedule.
Consequence if new asset is transferred within 8 years: Same as in Sec. 33AB.
Withdrawal of deposits: Any amount deposited in the special account maintained
with State Bank of India or the Site Restoration Account shall not be allowed to be
withdrawn, except for the purposes specified in the scheme, or as the case may be, in
the deposit scheme.
Where any amount standing to the credit of the assessee in the special account or in
the Site Restoration Account is utilized by the assessee for the purpose of any
expenditure in connection with such business not in accordance with the scheme or the
deposit scheme, such expenditure shall not be allowed in computing the income
chargeable under the head Profit and gains of business or profession, i.e., Double
Deduction is not possible.
5.4.12 Telecommunication Services [Section 35ABB]
Where any capital expenditure is incurred by the assessee for acquiring any right to
operate telecommunication services either before the commencement of the business to
operate telecommunication service or thereafter any time during any previous year and
for which payment has actually been made to obtain a license, a deduction will be
allowed in equal installments over the period for which the license remains in force,
subject to the following:
269
(a) If the fee is paid for acquiring any right to operate telecommunication services
before the commencement of such business, the deduction shall be allowed for
the previous years beginning with the previous year in which such business
commenced.
(b) If the fee is paid for acquiring such rights after commencement of such
business the deduction shall be allowed for the previous years beginning with
the previous year in which the license fee is actually paid.
Notes
Sale of License
(b) Where the entire license is transferred
(ii) If the sale proceeds and the deductions already allowed, are less than the
cost of acquisition, such deficiency shall be allowed as deduction in the
year in which the license is transferred.
(iii) If the sale proceeds and the deductions already allowed exceed the cost
of acquisition of the license, then the amount of such excess or the
aggregate of the deductions already allowed in the past, whichever is less,
shall be taxable as business income of the year in which the license is
transferred.
(c) Where a part of the license is transferred
(i) Where a part of the license is transferred for a sum less then the written
down value of the total license, the balance amount not yet written off
shall be allowed as deduction in the balance number of equal
installments.
(ii) If part of the license is transferred for a sum exceeding the written down
value of the license, the sale proceeds minus the written down value of
the full license shall be the profit from such sale. Out of such profit, an
amount equal to the amount already written off in the earlier years shall
be deemed to be the business income.
It may be mentioned that the license constitutes a capital asset and as
such there will be capital gain/loss on sale of entire part of the license.
Notes:
1. In the case of amalgamation and demerger, the amalgamated company or the
resulting company, as the case may be, shall be allowed to writ off the balance
amount of license which was not written off by the amalgamating company or
demerged company as the case may be.
Where a deduction for any previous year under section 35ABB(1) is claimed and
allowed in respect of any expenditure referred to in that sub section, no deduction shall
be allowed on account of depreciation under section 32(1) for the same previous year or
any subsequent previous year.
5.4.13 Expenditure on Eligible Projects or Schemes [Section 35AC]
Under this section, deduction will be allowed in computing profits of business or
profession chargeable to tax, in respect of the expenditure incurred for an eligible project
or scheme for promoting social and economic welfare or uplift of the public as may be
specified by the Central Government on the recommendations of the National
Committee.
The deduction will be allowed in cases where the qualifying expenditure is either
incurred by way of payment to the public sector company, a local authority or to and
approved association or institution for carrying out any eligible project or scheme.
270
Notes
Companies will however, be allowed the deduction also in cases where the expenditure
is incurred by them directly on an eligible project or scheme.
The claim for deduction should be supported by an audit certificate obtained from
the public sector company, local authority, or approved association or institution or from
the Chartered Accountant in cases where the claims is in respect of expenditure directly
incurred by a company on an eligible project or scheme.
5.4.14 Deduction in Respect of Expenditure on Specified Business [Section 35AD]
[w.e.f. A.Y. 2010-11]
The income tax act provides for profit linked exemption/deduction under various
sections. Some of the exemptions are provided in the following sections:
(1) Sections 10A,10AA,10B and 10BA
(2) Sections 80-1A, 80-1AB, 80-1B, 80-1C,80-1D, and 80-1E
However, with from assessment year 2010-11, it has made a departure and now
onwards incentive linked tax incentive(instead of profit linked exemption/deduction, shall
be allowed to assessee carrying on certain specified business. In this regard, Section
35AD has been inserted for specified business.
1. To whom deduction shall be allowed: Deduction u/s 35AD shall be allowed
to the assessee which is carrying on the following specified business:
(i) Setting up and operating a cold chain facility;
(ii) On or after 1-4-2012 in the nature of setting up and operating a
warehousing facility for storage of agricultural produce;
(iii) On or after 1-4-2007 in the nature of laying and operating a cross-country
natural gas or crude or petroleum oil pipeline network for distribution,
including storage facilities being an integral part of such network;
(iv) Finance Bill, 2010 has included the business of building and operating
new hotel of two star or above category, as classified by the Central
Government, any where in India and, which starts operating after
1-4-2010.
(v) On or after 1st April,2011, where the specified business in the nature of
developing and building a housing project under a scheme for affordable
housing framed by the central Government; in a new plant or in a newly
installed capacity in an existing plant for the production of fertilizers.
(vi) On or after 1st April, 2012, where the specified business in the nature of
setting up and operating inland container depot or a container freight
station notified or approved under the Customs act,1962.
(vii) On or after 1st April, 2012, where the specified business in the nature of
bee keeping and production of honey and beeswax; in the nature of
setting up and operating a warehousing facility for storage of sugar;
(viii) On or after 1-4-2009, in all cases not falling under any of the above
clauses.
2. Nature and amount of deduction: 100% deduction shall be allowed on
account of any expenditure of capital nature incurred wholly and exclusively for
the purpose of any specified business, shall be allowed as deduction during the
previous year in which he commences operations of his specified business, if
(a) the expenditure is incurred prior to the commencement of its operation;
and
271
(b) the amount is capitalized in the books of account of the assessee on the
date of commencement of its operations.
2A 150% of the expenditure shall be allowed in respect of specified business as
given below if it has commenced the operation on or after 1st April, 2012
(i) setting up and operating a warehousing facility for storage of agricultural
produce,
(ii) building and operating anywhere in India, a hospital with atleast one
hundred beds for patients,
(iii) developing and building a housing project under a scheme for affordable
housing framed by the Central Government; production of fertilizers in India.
Notes
(i) It is not formed by the splitting up or the reconstruction of a business already in
existence.
(ii) It is not formed by the transfer to new business of machinery or plant previously
used for any purpose.
(iii) Where the business is of laying and operating a cross country natural gas or
crude or petroleum oil pipeline network, etc., it satisfies the following conditions
also:
(a) it is owned by a company formed and registered in India under the
Companies Act, 1956 or by a consortium of such companies or by an
authority or board or a corporation established or constituted under any
Central or State Act.
(b) it has been approved by the Petroleum and Natural Gas Regulatory
Board established under sub-section (1) of Section 3 of the Petroleum
and Natural Gas Regulatory Board Act, 2006 and notified by the central
Government in the Official Gazette in this behalf;
(c) it has made not less than one-third [amended to such proportion of its
total pipeline capacity as specified by regulations made by the Petroleum
and Natural Gas Regulatory Board established under sub-section (1) of
Section 3 of the Petroleum and Natural Gas Regulatory Board Act, 2006
[Finance Bill 2010, to take effect retrospectively from 1.4.2010] of its total
pipeline capacity available for use on common carrier basis by any person
other than the assessee or an associated person; and
(d) it fulfills any other conditions as may be prescribed.
Notes:
(1) The assessee shall not be allowed any deduction in respect of the specified
business under the provisions of Chapter VIA under the heading C
Deductions in respect of certain incomes in relation to such specified business
for the same or any other assessment year.
(2) An associated person in relation to the assessee means a person
(i) Who participates directly or indirectly or through one or more
intermediaries in the management or control or capital of the assessee.
(ii) Who holds directly or indirectly, shares carrying not less than twenty-six
per cent of the voting power in the capital of the assessee.
(iii) Who appoints more than half of the board of directors or members of the
governing board or one or more executive directors or executive
members of the governing board of the assessee.
272
Notes
(iv) Who guarantees not less than 10% of the total borrowings of the
assessee.
5.4.15 Section 35CCA: Payment to Institutions for Carrying Out Rural Development
Programmes
Any assessee who wants to avail of this section will get a deduction only if he makes
a payment to the National Fund for Rural Development and National Urban Poverty
Eradication Fund which are the only funds which have been notified so far by the Central
Government u/s 35CCA(1).
Expenditure on agricultural project [Section 35CCC]
Where an assessee incurs any expenditure on agricultural extension project notified
by the board in this behalf in accordance with the guidelines as may be prescribed then,
there shall be allowed a deduction equal to one-and-one-half times of such expenditure.
Expenditure on skill development project [Section 35CCD]
Where a company incurs any expenditure (not being in the nature of cost of any land
or building) on any skill development project notified by the Board in this behalf in
accordance with the guidelines as may be prescribed then, there shall be allowed a
deduction equal to one-and-one-half times of such expenditure.
of such expenditure under any other provisions of this Act
5.4.16 Deductions for Expenditure on Prospecting, etc. for Certain Minerals
[Section 35E]
This section has been inserted with a view to encouraging investment in high risk
areas especially in exploiting of expenditure incurred wholly and exclusively on any
operations relating to prospecting for certain specified minerals or groups of minerals or
on developing mines, etc. Following points are to be noted:
1. Deduction is available only to an Indian resident or an Indian company but not
to any foreign citizen or foreign company.
2. 1/10 of the amount of expenditure would be allowed as a deduction for the
10 years beginning with the years in which commercial production starts.
3. Expenses to be amortised will be expenses incurred under the specified heads
during the five years period ending with the year of commercial production.
4. If in any year, income arising out of commercial exploitation of wasting asset is
NIL or insufficient to absorb, the allowance under this section the unabsorbed
allowance is to be carried forward to next year(s). However, this process of
carry forward cannot be continued beyond 10 years as reckoned from the year
of commercial production.
5. Deduction in case of amalgamation/demergerWhere in a scheme of
amalgamation, the Indian company is transferred to another Indian company
before the expiry of the said period of 10 years, the provisions of this section
shall, as far as may be, apply to the amalgamated company as they would
have applied to the amalgamating company if the amalgamation had not taken
place. Similarly, where the undertaking of an Indian company which is entitled
to deduction under this section, before the expiry of the period of 10 years to
273
another company in a scheme of de-merger, no deduction shall be admissible

in this case to the demerged company for the previous year in which the
demerger takes place and the provision of this section, as far as may be, apply
to the resulting company, if the demerger had not taken place.
Notes
5.4.17 Special Reserve Created by a Financial Corporation under Section 36(1)(viii)

A public financial corporation engaged in long-term finance for industrial or
agricultural developments or infrastructure development in India and a public company
formed and registered in India with the main object of providing long-term finance for
industrial or agricultural developments or infrastructure development in India and a public
company formed and registered in India with the main object of providing long-term
finance for construction or purchase residential housing in India are entitled for deduction
of the amount transferred by them to a special reserve account subject to a maximum of
20% of profit from such business (computed before making any deductions under
Chapter VIA). However, where the aggregate amounts carried to such reserves from
time to time exceeds twice the paid-up share capital and reserves, no allowance is
further allowed.
5.4.18 Special Provision for Deduction in the Case of Business for Prospecting, etc.
for Mineral Oil [Sections 42 and 44BB]
Section 42: Special deduction in case of business of exploiting mineral oil
including of petroleum and natural gas: Special allowance in this regard would be in
relation to:
1. Expenditure incurred by way of exploration expenses prior to beginning of
commercial production.
2. Expenditure incurred in respect of drilling or exploration activities after the
beginning of commercial production.
3. Expenditure incurred in relation to the depletion of mineral oil.
The provision of Section 44BB are given below:
Condition:
16. the assessee is non-resident.
(ii) The assessee is engaged in the business of providing services and facilities in
connection with or supplying plant and machinery on hire, used or to be used in
the exploration for and exploitation of mineral oils.
Consequences if the above conditions are satisfied:
17. The provisions of Sections 28 to 41, 43 and 43A are not applicable.
(ii) Income is calculated at the rate of 10% of the amounts given below.
18. The amount in respect of which the provisions apply are the amounts paid or
payable to the taxpayer or to nay person on this behalf whether in or out of
India, on account of the provision of aforesaid services or facilities or supplying
plant and machinery for the aforesaid purposes. The amount also includes the
amounts received or deemed to be received in India on account of such
services or facilities or supply of plant and machinery.
274
Notes
5.4.19 Special Provision for Computing Profits and Gains of Civil Construction
[Section 44AD]
A special scheme has been introduced, for estimating the profits and gains of
engaged in the business of civil construction and the broad features of the scheme are as
under:
(a) In the case of an eligible assessee engaged in an eligible business, a sum
equal to eight per cent of the gross receipts paid or payable to the assessee in
the previous year on account of such business shall be deemed to be the
profits and gains of such business chargeable to tax under the head Profits
and gains of business or profession. The assessee can however voluntarily
declare higher income in his return.
(b) Any deduction allowable under the provisions of Sections 30 to 38, shall, for
the purpose of above income, be deemed to have been already given full effect
to and no further deduction under those Sections shall be allowed. Provided
that where the eligible Assessee is a firm salary and interest paid/payable to
partners shall be allowed as deduction from the income computed under this
Section. Such deduction shall, however, be subject to the conditions and limits
specified u/s 40(b).
been actually allowed the deduction in respect of the depreciation for each of
the relevant assessment years.
(e) The assessee may choose not to opt for the scheme and may declare an
income lower than 8% of the gross receipts. In this case, the assessee shall
have to keep and maintain books of accounts and get his accounts audited by
a Chartered Accountant.
Notes:
1. For the purpose of this section, the expression eligible assessee means:
(i) An individual, HUF, or a partnership firm, who is a resident but not a
limited liability partnership firm.
(ii) Who has not claimed deduction under any sections 10A,10AA, 10B,10BA
or deduction under nay provisions of chapter VIA under the heading C
Deductions in respect of certain incomes in the relevant assessment
year.
2. For the purpose of this section, the expression eligible assessee means
(i) any business except the business of plying hiring or leasing goods
carriages referred to in section 44AE; and
(ii) whose total turnover or gross receipts in the previous year does not
exceed an amount of one crore rupee.
5.4.20 Special Provisions for computing Profits and Gains of Business of Plying,
Hiring or Leasing Goods Carriages [Section 44AE]
Notwithstanding any to the contrary contained in Sections 28 to 43C, the scheme
u/s 44AE also provides for a system for estimating the income of an assessee engaged
in the business of plying, hiring, or leasing of goods carriages. The broad features of the
scheme are:
275
(a) The scheme is applicable to an assessee who owns not more than 10 goods
carriages at any time during the previous year and who is engaged in the
business of plying, hiring or leasing of such goods carriages;
(b) The profits and gains of each goods carriage owned by the above assessee in
the previous year shall be estimated as under:
(i) For heavy goods vehicle 5,000 or actual amount earned whichever is
higher, for every month or part of a month during which the heavy vehicle
is owned by the assessee in the previous year.
(ii) For goods carriage other than heavy goods vehicle 4,500 or actual
amount earned whichever is higher, for every month or a part of a month
in during which the goods carriage is owned by the assessee in the
previous year. The assessee may declare a higher income than that
specified above.
(c) Any deduction allowable under the provisions of Sections 30 to 38 shall, for the
purpose of the above income, be deemed to have been already given full effect
to and no further deduction under those Sections shall be allowed.
Remuneration and interest paid/payable to partners, shall be allowed as
deduction from the income computed under this Section. Such deduction shall,
however, be subject to the conditions and limits specified u/s 40(b).
(d) The Written Down Value of any asset used for the purpose of the business
shall be deemed to have been calculated as if the assessee had claimed and
had been actually allowed the deduction in respect of the depreciation for each
of the relevant assessment years.
(e) The provisions of Sections 44AA and 44AB shall not apply in so far as they
relate to this business. And in computing the monetary limits under those
Sections for other business, the gross receipts or, as the case may be, the
income from the said business shall be excluded.
(f) The assessee may choose not to opt for the scheme and may declare an
income lower than the specified amount. In this case, w.e.f. assessment year
1998-99 the assessee shall have to maintain books of accounts and get his
accounts audited by a Chartered Accountant.
Notes
Special Notes
1. The expression goods carriage and heavy goods vehicle shall have the
meanings respectively assigned to them in Section 2 of the Motor Vehicles Act,
1988. According to Section 2(14) of the Motor Vehicles Act, 1988 the
expression goods carriage means:
(a) any motor vehicle constructed or adapted for use solely for the carriage of
goods, or
(b) any motor vehicle not so constructed or adapted when used for the
carriage of goods and according to Section 2(16) of the Act, the
expression heavy goods vehicle means:
(i) any goods carriage the gross vehicle weight of which, or
(ii) a tractor the unladen weight of which, or
(iii) a road roller the unladen weight of which, exceeds 12,000 kilograms.
2. An assessee, who is in possession of a goods carriage, whether taken on hire
purchase or on instalments.
3. And for which the whole or part of the amount payable is still due, shall be
deemed to be the owner of such goods carriage.
276
Notes
4. The income estimated as per Section 44AE, shall be his income from the
business of plying, hiring, or leasing goods carriages. This income will be
aggregated with the other income of the assessee and deductions u/s 80C to
80U, if any, will be available to the assessee, subject to fulfillment of conditions
mentioned therein.
5. Income from vehicles is to be computed for every month or part of the month
during which these were owned by the assessee even though these are not
actually used for business.
6. Provision of Section 44AE are not applicable in case the assessee owns more
than 10 goods carriage or where he decides lower profits and gains than the
profits and gains specified in Section 44AE.
5.4.21 Special Provisions for Computing Profits and Gains of Retail Business upto
A.Y. 2010-11 Only [Section 44AF]
A special scheme has been introduced for estimating the profits and gains of
engaged in retail trade and the broad features of the scheme are as under:
(a) In the case of an assessee engaged in retail trade in any goods or
merchandise, a sum equal to 5% of the total turnover in the previous year on
account of such business shall be deemed to be profits and gains of such
business chargeable under the head profits and gains of business or
profession. The assessee can however voluntarily declare a higher income in
his return. The scheme shall not be applicable if the total turnover of such retail
trade exceeds ` 40 lakhs in the previous year.
(b) Any deduction allowable under the provisions of Sections 30 to 38 shall for the
section 40(b).
assessment years.
(d) The provisions of Sections 44AA and 44AB shall not apply in so far as they
relate to this business and in computing the monetary limits under these
sections, the total turnover or as the case may be, the income from said
business shall be excluded.
(e) The assessee may choose not to opt for this scheme and may declare an
income lower than the specified amount. In this case, the assessee shall have
to keep and maintain books of accounts as per Section 44AB.
With effect from assessment year 2011-12, Section 44AF will be deleted and a new
section 44AD shall substitute the existing provision Section 44AD as the act has
expanded the scope of presumptive taxation to all business. The salient features of the
presumptive taxation scheme are as under:
(a) the scheme shall be applicable to individuals, HUFs and the partnership firms
excluding Limited liability partnership firms. It shall also not be applicable to an
assessee who is availing deductions under sections 10A, 10AA, 10B, 10BA or
deductions under any provisions of Chapter VIA under the heading C
Deductions in respect of certain incomes in the relevant assessment year.
277
(b) the scheme is applicable for any business (excluding a business already
covered under section 44AE) which has maximum gross turnover/gross
receipts of ` 40 lakhs.
(c) a sum equal to 8% of the total turnover or gross receipts of the assessee in the
(d) Any deduction allowable under the provisions of Sections 30 to 38 shall for the
section 40(b).
assessment years.
(f) An assessee opting for the above scheme shall be exempted from payment of
Income Tax Act.
(g) An assessee opting for the above scheme shall be exempted from
maintenance of books of accounts related to such business as required under
section 44AA of the Income Tax Act.
(h) An assessee with turnover below ` 40 lakhs who shows an income below the
per section 44AA(2) and also get them audited and furnish a report of each
such audit u/s 44AB.
(i) The existing section 44AF will be made inoperative for the Assessment Year
beginning on or after 1-4-2011.
Notes
5.4.22 Special Provisions in the Case of Shipping Business [Section 44B]

In the case of an assessee, who is a non-resident and is engaged in the business of
operation of ships, a sum equal to 7.5% of the aggregate of the following:
(a) The amounts paid or payable whether in or out of India to the assessee on
account of carriage of passengers, livestock, mail or goods shipped at any port
in India, and,
(b) Any amount received or deemed to be received in India on account of carriage
of passengers, livestock, mail or goods shipped at any port outside India, shall
be deemed to be the profits of such business. The carriage amount will also
include amount paid or payable by way of demurrage charge or any other
amount of similar nature.
Operations of Aircraft in the Case of Non-residents [Section 44BBA]
Notwithstanding anything to the contrary contained in Sections 28 to 43A, the
income of a non-resident engaged in the business of operation of an aircraft shall be
completed at flat rate of 5% of:
278
Notes
(a) the amount paid or payable whether in India or out of India to the assessee or
to any person on his behalf on account of carriage of passengers, livestock,
mail or goods from any place in India and
(b) The amount received or deemed to be received in India, on account of carriage
of such items from a place outside India.
5.4.24 Special Provisions for Computing Profits and Gains of Foreign Companies
Engaged in the Business of Civil Construction, etc. in Certain Turnkey
Power Projects [Section 44BBB]
Notwithstanding anything to the contrary contained in Sections 28 to 44AA in the
case of an assessee, being a foreign company, engaged in the business of civil
construction or the business of erection of plant or machinery or testing or commissioning
thereof, in connection with a turnkey power project approved by the Central Government
in this behalf and financed under international aid programme, a sum equal to 10% of the
amount paid or payable (whether in or out of India) to the said assessee or to any person
on his behalf on account of such civil construction, erection, testing or commissioning
shall be deemed to be profits and gains of such business chargeable to tax under the
head Profits and Gains of Business/Profession.
5.4.25 Special Provisions in the Case of Royalty Income Of Foreign Companies
[Section 44D]
The provisions are given below:
Agreement made before April 1,1976 Where such income is received under an
agreement before April 1, 1976, the deduction in respect of expenses incurred for
earning such income is subject to a ceiling limit of 20% of the gross amount of such
income, as reduced by the amount, if any, of so much of the royalty income as consists of
lump sum consideration for the transfer outside India of, or the imparting of information
outside India in respect of, any data, documentation, drawing or specification relating to
any patent, invention, model, design, secret formula or process or trade mark or similar
property.
Agreement made after April 1, 1976 not being covered by Section 44D Royalties
and technical service fees received under an agreement made after 31-3-1976 but
before 1-6-1997 not being covered by Section 44DA are chargeable to tax @ 30% (+ SC
+ EC); under an agreement made after 31-5-1997 but before 1-6-2005 @ 20%; and in
pursuance of an agreement made after 31-5-2005 @ 10%; by virtue of Section 115A in
the following four cases
(a) where such agreement is with the Government of India; or
(b) where such agreement is with an Indian concern, the agreement is approved
by the Central Government ; or
(c) where such agreement relates to a matter included in the industrial policy, for
the time being in force, of the Government of India, the agreement is in
accordance with that policy; or
(d) where such royalty is in consideration for the transfer of all or any rights
(including the granting of a license) in respect of copyright in any book on a
subject referred to in proviso to sub-section (IA) of Section 115A to the Indian
concern or in respect of computer software referred to the second proviso to
Section 115A(IA) to a person resident in India.
5.4.26
279
In respect of the Profits from the Business of Processing of

Bio-degradable Waste [Section 80JJA]
Notes
Section 80JJA is applicable where gross total income of an assessee includes any
profits and gains derived from the business of collecting, processing or treating of
biodegradable waste for generating power or producing bio fertilizers, bio-pesticides or
other biological agents or for producing bio-gas or making pellets or briquettes for fuel or
organic manure.
Amount of deduction: The whole of the profits and gains of the above activities
shall be deductible for a period of five consecutive assessment years beginning with the
assessment year relevant to the previous year in which such business commences.
5.4.27 In Respect of the Employment of New Workmen [Section 80JJAA]
Conditions: The following conditions should be satisfied to avail deduction under
section:
1. The tax payer is an Indian company.
2. Income of the tax payer includes any profits and gains derived from any
industrial undertaking engaged in the manufacture or production of article or
thing.
3. If the factory is not hived off or transferred from another existing entity or
acquired by the assessee company as a result of amalgamation with another
company.
4. The assessee furnishes along with the return of income the report of
Accountant giving such particulars in the report as prescribed.
5. The company employs new regular workmen in the previous year.
Amount of Deductions: If all the aforesaid conditions are satisfied, then the
amount of deduction will be as follows:
1. For the first assessment year: 30% of additional wages (i.e., wages paid to new
workmen in excess of 100 workmen employed during the previous year) paid
to new regular workmen employed by the assessee during the previous year
are deductible.
2. For the next two assessment years: The aforesaid deduction will be available
in the next two assessment years.
Other points:
1. Regular workman does not include
(a) A casual workman; or
(b) A workman employed through contract labour; or
(c) Any other workman employed for a period of less than 300 days during
the previous year.
2. The aforesaid deduction is available over and above the expenditure on wages
or salary which is otherwise allowable as business expenditure to the
company.
5.4.28
Tax Incentives for Shipping Business Tonnage Tax [Sections 115V to

115VZC]
To make the Indian shipping industry more competitive, a tonnage scheme of

taxation of shipping profits has been introduced Many maritime nations have introduced
tonnage based taxation. Some of the basic features of the tonnage tax scheme are as
follows
280
Notes
It is a scheme of presumptive taxation whereby the notional income arising

from the operation of a ship is determined based on the tonnage of the ship
The notional income is taxed at the normal corporate tax applicable for the year
Tax is payable even if there is loss in an year
A company may opt for the scheme and once such option is exercised, there is
a lock in period of 10 years. If the company opts out, it is debarred from
re-entry for ten years
Since this is preferential regime of taxation, certain conditions like creation of
reserves, training, etc. are required to be met
A company may be expelled in certain circumstances.
Salient Features- The salient features are as follows
A company owning at least one qualifying ship may join. A qualifying ship is
one with a minimum tonnage of 15 tons and having a valid certificate. The
company has to opt for the scheme by making an application in the prescribed
form to the concerned Joint Commissioner who may pass an appropriate order.
A new company can make an application within three months of the date of its
incorporation or the date on which it became a qualifying company, as the case
may be.
Certain types of ships like fishing vessels, pleasure craft, and river ferries, etc,
are excluded interims of Section 115VD which gives details of as to what ships
will qualify for the scheme.
The business of operating qualifying ships is to be considered a separate
business and separate accounts are to be maintained. Section115VG gives the
manner of computation of the daily tonnage income as follows:
Qualifying ship having net tonnage
Amount of daily tonnage income
Up to 1,000
` 70 for each 100 tons
Exceeding 1,000 but not more than 10,000
` 700 plus ` 53 for each 100 tons exceeding 1,000

tonnes
Exceeding 10,000 but not more than 25,000
` 5470 plus ` 42 for each 100 tons exceeding

10,000 tonnes
Exceeding 25,000
` 11,770 plus ` 29 for each 100 tons exceeding

25,000 tonnes
The tonnage shall be rounded off to the nearest multiple of 100 tons.
The daily tonnage income shall be multiplied by the number of days the ship
operated. The resulting amount would be the annual tonnage from the ships. A company
owning at least one ship may charter subject to certain limits for the purpose of operation.
Relevant shipping income, which replaces the actual income from operations is defined
in Section 115VL. Section 115VJ gives the treatment of common costs.
The company opting for the scheme is not allowed any set-off loss nor is any
depreciation allowed. However, both loss and depreciation are deemed to have
been allowed and notional adjustments are made against the relevant shipping
income. Although depreciation is not allowed, it is necessary to bifurcate the
qualifying ships and non-qualifying ships at the time company joins the scheme.
Section 115VK lays down the method for allocating the written down value
amongst qualifying and non-qualifying ships. Any income from transfer of
qualifying assets in terms of Section 115VN.
The profits from the business of operating qualifying ships will not be taken into
consideration for the purpose of MAT as per Section 115vo.
281
Section 115VP lays down the procedure for the option and the manner of
granting approval. Section 115VQ lays down that once the company opts for
the scheme, the option remains in force for 10 years, except in certain
circumstances. Section 115VS provides for the circumstances in which the
tonnage tax company is prohibited from opting the scheme. Such prohibition is
for a period of 10 years. Sections 115VT, 115VU, 115VS and 115VW lay down
the conditions for the applicability of the scheme. In terms of Section 115VT, a
tonnage tax company has to create a reserve of at least 20% of its book profits
to be for the purpose of acquisition of new ships. As per Section 115VU, a
tonnage tax company has to comply with the minimum training requirement in
accordance with the guidelines to be issued by the DG (Shipping). The
company will be expelled if the training requirements are not met for
5 consecutive years. Section 115VV lays down that every company which has
opted for tonnage tax scheme, not more than 49% of the net tonnage of the
qualifying ships operated by it during any previous year shall be chartered. In
terms of Section 115VW, maintenance of separate books of account and the
audit of same is compulsory for a company opting for the scheme. Section
115VX lays down, the details regarding valid certificate which indicates the net
tonnage of ships. Section 115VY and Section 115VZ provide for the
contingencies of amalgamation and demerger. Section 115VZB enjoins upon a
company not to abuse the preferential tax regime and Section 115VZC
provides for exclusion of a company in case of abuse.
Notes
5.4.29 Problems
Problem 1: X & Co., a partnership firm, consisting of three partners A, B and C is
engaged in the business of civil construction. The firm gets the following by way of
contract receipts:
Contract work for supply of labour
` 30,00,000
Value of materials supplied by Government
8,00,000
Total value of contract

38,00,000
Each partner of the firm is entitled to draw ` 2,500 per month by way of salary as by
the terms of the partnership deed. Interest of ` 1,00,000 is also paid to partner C on the
capital of ` 5,00,000 contributed by him. The profit as per books of account before
deduction of salary to partners and interest to partner C is ` 250,000. Compute the total
income of the firm applying the provisions of Section 44AD.
Solution: Computation of total income of the firm
Income from business of civil construction (8% of ` 30,00,000)
` 2,40,000
Less expenses
Salary and interest paid to partners (` 2500 3 12 = 90,000 +
12% on ` 500,000, i.e., 60,000)
Other expenses
Income from civil construction
Other income
Gross Total Income
Less deduction u/s 80C to 80U
Net Income
1,50,000
Nil
90,000
Nil
90,000
Nil
90,000
Problem 2: X Cine Arts Ltd. of Mumbai is engaged in distribution of cinematography

films. It starts construction of multiplex theatre and convention hall in Navi Mumbai in
282
Notes
April 2008 and completes in December, 2008. The profits for the year ending March 31,
2009 of all the activities are:
` lakhs
Distribution of cinematography films
Convention centre
Multiplex centre
Compute the taxable income for the assessment year 2009-10 with reasons.
Solution:
Assessment Year 2009-10
` Lakhs
Business income
Distribution of cinematography films
Convention centre
Gross total income
Less deduction under Sec. 80-IB (see note)
Taxable income
Note: Deduction under section 80-IB is not available in respect of multiplex theatre
as it is located within the municipal jurisdiction of Mumbai. However in respect of income
from convention centre, deduction @ 50% of ` 2 lakhs is available under section 80-IB as
there is no stipulation regarding location of convention centre under section 80-IB.
5.5 Tax Planning in Respect of Amalgamation, Merger or Demerger

of Companies
5.5.1 Introduction
Modes of M&A in India
M&A
Amalgamations
Merger
Demerger
Acquisitions
Asset Purchase
Slump Sale
Stock Purchase
Itemized Sale
The question may arise Is merger same as Amalgamation?

5.5.2 Meaning of Terms as per Tax Law Amalgamation
Amalgamation is a blending of two or more existing undertakings into one
undertaking, the shareholders of each blending company becoming substantially the
shareholders in the company which is to carry on the blended undertakings. There may
be amalgamation either by transfer of two or more undertakings to a new company, or by
the transfer of one or more undertakings.
283
Merger is not defined under the Income Tax Act, 1961. However, in common
parlance, merger or amalgamation under the Income Tax Act is said to occur when two
or more companies combine into one company. One or more companies may merge with
an existing company or they may merge to form a new company. Sec. 2(1B) of the
Income Tax Act 1961 defines amalgamation as the merger of one or more companies
with another company or the merger of two or more companies (called amalgamating
companies) to form a new company (called amalgamated company) in such a way that
all assets and liabilities of the amalgamating company or companies become assets and
liabilities of the amalgamated company and shareholders holding not less than
three-fourths in value of the shares in the amalgamating company or companies become
shareholders of the amalgamated company.
Notes
The following cases subject to fulfilling the above conditions fall within the definition
of Section 2(1B)
Merger of A Ltd. with X Ltd. (A Ltd. goes out of existence)
Merger of A Ltd. and B Ltd. with X Ltd. (A Ltd. And B Ltd. go out of existence)
Merger of A Ltd. and B Ltd. into a newly incorporated X Ltd. (A Ltd. and B Ltd.
go out of existence)
Merger of A Ltd., B Ltd. and C Ltd. into a newly incorporated X Ltd. (A Ltd.,
B Ltd. and C Ltd. go out of existence)
In the aforesaid cases, A Ltd., B Ltd. and C Ltd. are amalgamating companies while
X Ltd. is the amalgamated company.
Transactions not treated as amalgamation [Section 2(1B)]
Section 2(IB) specifically provides that in the following two cases there is no
amalgamation, for the purpose of income tax though, the element of merger exists:
(a) Where the property of the company which merges is sold to the other company
and the merger is the result of a transaction of sale.
(b) Where the company which merges is wound up in liquidation and the liquidator
distributes its property to another company.
Demerger Sec. 2(19AA): Demerger in relation to companies, means the transfer,
pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act,
1956 by a demerged company of its one or more undertakings to any resulting company
in such a manner that
(i) All the property of the undertaking, being transferred by the demerged
company, immediately before the de merger, becomes the property of the
resulting company by virtue of de merger.
(ii) All the liabilities relatable to the undertaking, being transferred by the
demerged company, immediately before the de merger, become the liabilities
of the resulting company by virtue of de merger.
(iii) The property and liabilities of the undertaking or undertakings being transferred
by the demerged company are transferred at values appearing in the books of
accounts immediately before the de merger.
(iv) The resulting company issues, in consideration of the de merger, its shares to
the shareholders of the de-merged company on a proportionate basis.
(v) The shareholders holding not less than three-fourths in value of shares in the
demerged company other than shares already held therein immediately before
the de merger, or by a nominee for, the resulting company or, its subsidiary)
become shareholders of the resulting company or companies by virtue of the
de merger, otherwise than as a result of the acquisition of the property or
284
Notes
assets of the demerged company or any undertaking thereof by the resulting

company.
(vi) The transfer of the undertaking is on a going concern basis
(vii) The de merger is in accordance with the conditions, if any, notified under
sub-section (5) of Section 72A by the Central Government in this behalf.
Explanation 1 - For the purpose of this clause undertaking shall include any part
of the undertaking, or a unit or division of an undertaking or a business activity taken as a
whole, but does not include individual assets or liabilities or any key combination thereof
not constituting a business activity.
Explanation 2 - Liabilities include (i) the liabilities which arise out of the activities
or operations of the undertaking (ii) the specific loans or borrowings including debentures
raised, incurred or solely for the activities or operations of the undertaking and (iii) in
other cases so much of the amounts of general or multipurpose borrowings, if any, of the
de-merged company as stand in the same proportion which the value of the assets
transferred in a demerger bears to the total value of the assets of such demerged
company immediately before the demerger.
Explanation 3 - Value of the property of the undertaking being transferred
value of the property and the liabilities of the undertaking(s) being transferred by the
demerged company should be at book value appearing in books immediately before
demerger.
Explanation 4 - Benefit of de-merger also available to certain authorities or
Boards: The splitting up or the reconstruction of any authority or a body constituted or
established under a Central, State or Provincial Act, or a local authority or a public sector
company, into separate authorities or bodies or local authorities or companies as the
case may be, shall be deemed to be a demerger if such split up or reconstruction is as
per the condition, if any, specified by the Central Government.
Shares to be issued on a proportionate basis to the shareholders of demerged
company.
Meaning of demerged company Demerged company means the company
whose undertaking is transferred, pursuant to a demerger, to a resulting company [Sec.
2(19AAA)].
Meaning of resulting company: Resulting company means one or more
companies (including a wholly owned subsidiary thereof) to which the undertaking of the
demerged company is transferred in a demerger and the resulting company in
consideration of such transfer of undertaking, issue shares to the shareholders of the
demerged company and includes any authority or body or local authority or public sector
or a company established, constituted or formed as a result of demerger.
5.5.3 Income Tax Implications in Case of Amalgamation or Demerger
Notional Written Down Value in case of a Capital Asset:
1. Transfer in a scheme of amalgamation: In such a case the actual cost of
block of assets in the case of amalgamated company shall be the WDV of
block of assets as in the case of amalgamating company for the immediately
preceding previous year as reduced by the amount of depreciation actually
allowed in relation to the said previous year.
2. WDV when assets are transferred in demerger: In such a case the WDV of
the block of assets of the demerged company for the immediately preceding
year shall be reduced by the WDV of assets transferred to the resulting
company in order to get WDV in the hands of the demerged company.
285
3. WDV in the hands of the resulting company: In such a case the WDV of the
one block of assets in case of the resulting company shall be the WDV of the
transferred assets appearing in the books of accounts of the demerged
company immediately before de merger.
4. Actual Cost (Section 43(1)]: Actual cost means the actual cost of the assets
to the assessee, reduced by the portion of the cost of the asset, if any, as has
been met directly or indirectly by any other person or authority.
Notional Actual Cost: [Explanations to Section 43(1)]: In the following
cases the actual cost for purposes of depreciation shall be a notional cost to
the assessee.
5. Assets transferred under a scheme of amalgamation [Explanation 7]:
Where, in a scheme of amalgamation, any capital asset is transferred by the
amalgamating company to the amalgamated company and the amalgamated
company is an Indian company, the actual cost of the transferred capital asset
to the amalgamated company shall be taken to be the same as it would have
been if the amalgamating company had continued to hold the capital asset for
the purposes of its business.
6. Actual cost in case of demerger: Explanation 7A has been inserted to
provide that in case of de merger, the actual cost of the transferred capital
asset to the resulting company shall be taken to be the same as it would have
been if the demerged company has continued to hold the capital asset for the
purpose of its own business.
7. Where the assets transferred form part of the block of assets of the
demerged company [Explanation 2A and 2B to Section 43(6): where in any
previous year, any asset forming part of the block of assets is transferred by a
demerged company to the resulting company, then notwithstanding anything
contained in Section 43(1), the written down value of the block of assets of the
demerged company for the immediately preceding previous year shall be
reduced by the written down value of the assets transferred to the resulting
company pursuant to the demerger [Explanation 2A].
Where in a previous year, any asset forming part of a block of assets is
transferred by a demerged company to the resulting company, then,
notwithstanding any thing contained in Section 43(1), the written down value of
the block of assets in the case of resulting company shall be written down of
transferred assets of the demerged immediately before the demerger
[Explanation 2B].
Notes
Case 1 R Ltd. was amalgamated with G Ltd. w.e.f. 29-8-2012. The written down value
of the block of assets as on 1-4-2012, the rate of depreciation on each block and the
values at which the block of assets were transferred by R Ltd. are given below:
Block of Assets
Buildings
Plant and Machinery
Furniture
Rate of
Depreciation
10%
15%
10%
WDV in the hands of

R Ltd. as on 1-4-2012
10,00,000
25,00,000
5,00,000
Transfer value of G
Ltd. `
9,00,000
24,00,000
4,50,000
You are required to work out the deductions admissible under section 32 by way of
depreciation to X Co. Ltd. and to Y Co. Ltd. in respect of these assets for the financial
year 2012-13 relevant to the Assessment Year 2013-14. It may be noted that
amalgamation is in terms of Section 2(IB) of the Income Tax Act.
Solution: As per proviso 4 to Section 32(I)(ii) in a scheme of amalgamation, the
deduction shall be worked out in such a manner that the deduction to the predecessor,
286
Notes
i.e., the amalgamating company and successor, i.e., the amalgamated company shall be
apportioned between them in the ratio of the number of days for which the assets were
used by them. Further, the deduction shall not exceed the deduction calculated in the
prescribed rates as if the amalgamation had not taken place. The deduction shall be as
under
1. In case of R Ltd.
`
Building w.d.v. 10,00,000 10% 150/365
41,096
Plant and Machinery w.d.v. 25,00,000 15% 150/365
154,110
Furniture w.d.v. 5,00,000X10% 150/365
20,545
19. In case of G Ltd.

Building Actual cost 10,00,000 10% 215/365
58,904
Plant and Machinery Actual cost 25,00,000 15% 215/365
2,20,890
Furniture Actual cost 5,00,000 10% 215/365
29,452
Case 2 X Ltd. has two undertakings A and B. The following information is available.
(` in thousands)
Assets
Unit A
Unit B
Plants R and S
Plants P and Q
15 per cent
15 per cent
600
600
Add: Actual cost of plants R and S acquired on

June 1, 2008
400
400
Less: Sale proceeds of Plant P transferred on

November 30, 2008
900
900
Written down value on March 31, 2009
400
100
Less: Depreciation for 2008-09
60
15
Depreciated value on April 1, 2009
340
85
Less:depreciation for 2009-10
51
12.75
289
72.25
Total
On April 1, 2010, Unit A is transferred to Y Ltd., on Indian company, in a scheme of

demerger. What will be the written down value and actual cost in the hands of X Ltd. and
Y Ltd.?
Solution:
Written down value in the hands of X Ltd.
Depreciated value of assets on April 1, 2010
Less: Written down value of assets transferred to Y Ltd.
Written down value on April 1, 2010
`
72,250
() 2,89,000
Nil
Note: By virtue of Section 47(vib), income is not taxable under the head Capital gains.
In the hands of Y Ltd., the written down value shall be ` 2,89, 000.
Section 35 DD: Amortization of Expenditure in the case of Amalgamation/Demerger
Where an assessee, being an Indian Company incurs expenditure (on or after
01.04.1999) wholly and exclusively for the purpose of amalgamation or demerger; the
assessee shall be allowed a deduction equal to one-fifth (1/5th) of such expenditure for
287
5 successive previous years beginning with the previous year in which amalgamation or
demerger takes place.
Notes
Scientific Research [Section 35]

Where amalgamating company transfers to the amalgamated company, (being an
Indian Company), any asset representing capital expenditure on scientific research, and
provisions of Section 35 would apply to the amalgamated company as if amalgamating
company had not transferred the asset.
Expenditure for obtaining license to operate telecommunication services [Section
35ABB(6)]
Where in a scheme of amalgamation, the amalgamating company sells or otherwise
transfer its license to the amalgamated company (being an Indian Company), the
provisions of Section 35ABB which were applicable to the amalgamating company shall
become applicable in the same manner to the amalgamated company.
Treatment of preliminary expenses [Section 35D(5)]
Where an amalgamating company merges in a scheme of amalgamation with the
amalgamated company, the amount of preliminary expenses of the amalgamating
company which are not yet written off, shall be allowed as deduction to the amalgamated
company in the same manner it would have been allowed to the amalgamating company.
Treatment of expenditure on prospecting, etc. of certain minerals [Section
35E(7A)]
Where an amalgamating company merges in a scheme of amalgamation with the
amalgamated company, the amount of expenditure on prospecting, etc. of certain
minerals of the amalgamating company, which are not yet written off, shall be allowed as
deduction to the amalgamated company in the same manner it would have been allowed
to the amalgamating company.
Treatment of capital expenditure on family planning [Section 36(1)(ix)]
Where the asset representing the capital expenditure on family planning is
transferred by the amalgamating company to the Indian amalgamated company, in a
scheme of amalgamation, the provisions of Section 36(1)(ix) to the amalgamating
company shall become applicable, in the same manner, to the amalgamated company.
Treatment of bad debts [Section 36(1)(vii)]
Where due to amalgamation, the debts of amalgamated company have been taken
over by the amalgamated company and subsequently such debt or part of the debt
becomes bad, such debt will be allowed as a deduction to the amalgamated company.
Deduction available u/s 80IA or 80-IAB or 80-IB or 80-IC or 80-IE
Where an undertaking which is entitled to deduction under section 80IA/80-IAB/
80-IB/80-IC/80-IE is transferred in the scheme of amalgamation or demerger, before the
expiry of the period if deduction under section 80IA or 80-IAB or 80-IB or 80-IC or 80-IE,
then
(i) no deduction under section 80IA/80-IAB/80-IB/80-IC/80-IE shall be available to
the amalgamating company for the previous year in which amalgamation or the
demerger takes place; and
288
Notes
(ii) the provisions of section 80IA/80-IAB/80-IB/80-IC/80-IE shall apply to the

amalgamated or the resulting company in such manner in which they have
been applied to the amalgamating or the demerged company.
5.5.4 Tax Concessions Relating to Transfer of Capital Asset in Case of
Amalgamation/Merger/Demerger
Transfer of capital asset [Section 45(1)]: Any profits and gains arising from the
transfer of a capital asset effected in the previous year shall be deemed to be chargeable
to income tax under the head Capital Gains, and shall be deemed to be the income of
the previous year in which the transfer took place excluding the exemptions provided.
Transfer is defined in Section 2(47) as, the liability to tax on capital gains arises only if
there is a transfer of capital asset.
Section 47: Transaction not regarded as transfer
Any transfer of a capital asset by a company to its 100% subsidiary company
provided the subsidiary is an Indian company [Section 47(iv)].
Any transfer of a capital asset by a 100% subsidiary company to its holding
company if the holding company is an Indian company [Section 47(v)].
Any transfer in a scheme of amalgamation of a capital asset by the amalgamating
company to the amalgamated company, if the amalgamated company is an Indian
company [Section 47(vi)];
Any transfer by a shareholder, in a scheme of amalgamation, of shares held by him
in the amalgamating company if
(a) The transfer is made in consideration of the allotment to him or any share or
shares in the amalgamated company, and
(b) The amalgamated company is an Indian company [Section 47(vii)];
(c) The consideration received by the shareholder should only be shares. If the
consideration includes anything in addition to shares, then it will be treated as a
transfer and there will be a capital gain.
Merger of F Co. into I Co
Shareholders
Consideration in the
form of shares of I Co
Merger
F Co
I Co
Merger of an Indian company into a foreign company whether possible in

India?
Merger of an Indian company into a foreign company not envisaged by the
Companies Act, 1956.
Recommendations by J.J. Irani Report on Company Law to allow merger of an
Indian company into a foreign company.
289
Short term mergers also proposed.

No tax exemption under Income Tax Act, 1961 in the case of amalgamation of
an Indian company into a foreign company wherein the amalgamated company
is a foreign company.
Such a merger would result in a F Co. having assets or business in India and
therefore may cause a Permanent Establishment of F Co. in India.
Notes
Any transfer in a scheme of amalgamation of shares held in an Indian company by

the amalgamating foreign company to the amalgamated foreign company if:
(a) At least 25% of the shareholders of the amalgamating foreign company
continue to remain shareholders of the amalgamated foreign company, and
(b) Such a transfer does not attract capital gains tax in the country, in which the
amalgamating company is incorporated [Section 47(viA)].
Any transfer in a scheme of amalgamation of a banking company with a banking
institution sanctioned and brought into force by the Central Government under
sub-section (7) of Section 45 of the Banking Regulation Act,1949, of a capital asset by
the banking company to the banking institution [Section 47(viaa)].
Section 47(via) Merger
F Co. 1
Merger
F Co. 2
I Co.
Banking company and banking institution shall have the same meaning assigned
under Sec. 5(c) and sec. 45(15) of the Banking Regulation.
Any transfer in a demerger, of a capital asset by the demerged company to the
resulting company, if the resulting company is an Indian company [Section 47(vib)];
Any transfer in a demerger, if a capital asset, being a share or shares held in an
Indian company, by the demerged foreign company to the resulting foreign company.
(a) The shareholders holding not less than three-fourth in value of the shares of
the demerged foreign company continue to remain the shareholders of the
resulting foreign company, irrespective of the number of such shareholders.
(b) Such transfer does not attract tax on capital gains in the country, in which the
demerged foreign company is incorporated;
Provided that the provisions of section 391 to 394 of the Companies Act, 1956 shall
not apply in case of de mergers referred to in this clause [Section 47(vic)];
Any transfer in a business reorganization, of a capital asset by the predecessor
co-operative bank to the successor co-operative bank [Section 47 (vica)];
Any transfer by a shareholder, in a business re-organization, of a capital asset being
a share or shares held by him in the predecessor co-operative bank if the transfer is
made in consideration of the allotment to him of any shares or shares in the successor
co-operative bank [Section 47(vicb)];
290
Notes
Any transfer or issue of shares by the resulting company, in a scheme of de merger

to the shareholders of the demerged company if the transfer or issue is made in
consideration of de merger of the undertaking [Section 47(vid)];
Any transfer by a shareholder, in a scheme of amalgamation, of shares held by him
in the amalgamating company if:
(a) the transfer is made in consideration of the allotment to him of any share or
shares in the amalgamated company, and
(b) the amalgamated company is an Indian company [Section 47(vii)].
Note: The consideration received by the shareholder should only be shares. If the
consideration includes any thing in addition to shares, say bonds and debentures then it
will be treated as a transfer and there will be a capital gain [CIT v. Gautam Sarabhai Trust
(1988) 173 ITR210(Guj)].
Computation of Capital Gains (Sections 48 to 51)
Section 48: The income under the head Capital Gains shall be computed by
deducting the following from the full value of the consideration received or accrued as a
result of the transfer of the capital asset:
1. Expenditure incurred wholly and exclusively in connection with such transfer.
2. The cost of acquisition of the asset and the cost of any improvement thereto;
Under different circumstances, the cost of acquisition of a capital asset is
determined in the following manner:
3. Cost to the previous owner: [Sec. 49(1)]:
(a) Under any scheme of amalgamation by the amalgamating company
to the amalgamated company;
(b) Cost of acquisition of shares in amalgamated company [Sec. 49(2)]:
Where a share or shares in an amalgamated company which is an Indian
company became the property of the assessee in consideration of a
transfer of his share or shares held in the amalgamating company, the
cost of acquisition of the asset (share) shall be deemed to be the cost of
acquisition to him of the share or shares in the amalgamating company.
(c) Cost of acquisition of the original share of the demerged company
[Section 49(2D)]: It shall be deemed to have been reduced by the
amount as so arrived at under Sub-section (2C) above. Net Worth for
this section shall mean the aggregate of the paid up share capital and
general reserves as appearing in the books of accounts of the demerged
company immediately before de merger.
4. Cost of Acquisition in the case of slump sale [Sec. 50B]:. Provisions of
Section 50B, applicable for computation of capital gains in the case of slump
sale are given below:
1. Any profits or gains arising from the slump sale affected in the previous
year shall be chargeable as long-term capital gains and shall be deemed
to be income of the previous year in which the transfer took place.
Where however, any capital asset being one or more undertakings owned and held
by the assessee for not more than 36 months is transferred under the slump sale, then
capital gain shall be deemed to be short term capital gain.
In the case of slump sale of the capital asset being one or more undertaking, the net
worth of the undertaking shall be taken as cost of acquisition and cost of improvement.
Net worth for this purpose is the aggregate value of total asset of the undertaking of
division as reduced by the value of liabilities of such undertaking of division as reduced
291
by the value of liabilities of such undertaking or division as appearing in the books of

accounts. Any change in the value of assets on account of revaluation of asset of such
undertaking or division shall be the written down value of block of asset determined in
accordance with the provisions contained in sub-item (C) of Section 43(6)(c)(i) in the
case of depreciable assets and the book value for all other assets.
Notes
The benefit of indexation will not be available.

Every assessee, in the case of slump sale, shall furnish along with the return of
income, a report of a chartered accountant in Form No. 3 CEA indicating the computation
of the net worth of the undertaking or division as the case may be has been correctly
arrived at.
Case 3 X Ltd. has unit C which is not functioning satisfactorily. The details of its fixed
assets are:
Asset
Land
Date of acquisition
Book value ( ` lakhs)
Feb. 10, 2007
30
Goodwill (raised in books on March 31, 2008)
10
Machinery
April 5, 2001
40
Plant
April 12, 2007
20
The written down value is ` 25 lakhs in case of machinery and ` 15 lakhs in case of
plant. The liabilities on this unit on March 31, 2009 are ` 35 lakhs. There are two options
(as on March 31, 2009)
(a) Slump sale to Y & Co. for a consideration of ` 85 lakhs.
(b) Individual sale of assets for the following consideration: Land ` 48 lakhs,
Goodwill ` 20 lakhs, Machinery ` 32 lakhs, Plant ` 17 lakhs.
Which option is to be chosen and why? The other units are deriving taxable income
and there are no carry forward of losses or depreciation for the company as a whole, Unit
C was started on January 1, 2001.
Solution:
Option1: Slump sale
Computation of net wealth of Unit C
` Lakh
Land (book value)
30
Goodwill (book value)[not to be considered as it is raised in books by book entry]
Nil
Machinery (WDV given)
25
Plant (WDV given)
15
Total
70
Less: Liabilities
35
Net Worth
35
Computation of capital gain

Sales consideration
85
Less: Net worth
35
Long-term capital gain (Unit C started on January 1, 2001)
50

Tax on ` 50 lakhs @ 20%
10
Add: Surcharge [10% of tax in case net income exceeds ` 1 crore]
Nil
Tax and surcharge
10
292
Notes
Add: Education cess 2% +SHEC 1%
0.3
Tax liability under option 1

Receipt after tax [i.e., sale consideration ` 85 lakhs 10.3 lakhs]: ` 74.7 lakhs
10.3
Option II: Sale of individual assets

Computation of capital gains
Land
Goodwill
Machinery
Plant
Sale consideration
48
20
32
17
Less: Cost of acquisition*/written down value**
30*
25**
15**
Long-term capital gain*/short-term capital gain**
18**
7**
2**
20*

Tax on long-term capital gains 20% on 20
Tax on short-term capital gains 30% on 18 + 7 + 2
Total
Add: Surcharge [10% of tax in case net income exceeds ` 1 crore]
Tax and surcharge
Add: Education cess 2% +SHEC 1%
Tax liability under Option 2
4
8.1
12.1
Nil
12.1
0.363
12.463
Receipt after tax [i.e., sale consideration ` 117 lakhs 12.463 lakhs]: 104.537 lakhs
Decision Option II is better option for X Ltd. as it leads to higher after-tax receipts.
5.5.5 Carry Forward and Set-off of the Accumulated Losses and Unabsorbed
Depreciation Allowance in Amalgamation or Demerger, etc. (Section 72A)
Section 72A allows carry forward of business loss and unabsorbed depreciation in
case of:
(i) Amalgamation [Section 72A(1), (2) and (3)], or
(ii) Demerger [Section 72A(4) and (5)] or
(iii) Re-organisation of business [Section 72A(6)]
Carry Forward and Set-off of Accumulated Loss and Unabsorbed Depreciation in
Case of Amalgamation [Section 72A(1), (2) and (3)]
As per section 72A(1) where there has been an amalgamation of a company, the
accumulated loss and the unabsorbed depreciation of the amalgamating company shall
be deemed to be loss or as the case may be, allowance for depreciation of the
amalgamated company for the previous year in which the amalgamation is effected and
the other provisions of this Act relating to set off and carry forward of loss and allowance
for depreciation shall apply accordingly, if the following conditions are satisfied:
(1) There is an amalgamation of
(a) A company owning an industrial undertaking or ship or a hotel with
another company or
(b) A banking company referred to in section 5(c) of the Banking Regulation
Act, 1949 with a specified bank, or
(c) One or more public sector company or companies engaged in the
business of operation of aircraft with one ore more public sector company
or companies engaged in similar business
(2) The following conditions laid down under section 72A(2) are satisfied:
293
(a) Conditions to be satisfied by the amalgamated company

(i) The amalgamating company has been engaged in the business in
which the accumulated loss has occurred or depreciation remains
unabsorbed, for 3 or more years.
(ii) The amalgamating company has held continuously as on the date of
the amalgamation at least 75% of the book value of fixed assets held
by it two years prior to the date of amalgamation.
(iii) The amalgamated company continuously for a minimum period of
five years from the date of amalgamation at least 75% in the book
value of assets of the amalgamating company acquired in the
scheme of amalgamation. In this case, book value is to be
considered on the date of amalgamation;
(iv) The amalgamated company continues the business of the
amalgamating company for a period of 5 years from the date of
amalgamation.
(v) The amalgamated company fulfils such other conditions as may be
prescribed (See Rule 9C mentioned below) to ensure the revival of
the business of the amalgamating company or to ensure the revival
of the business of the amalgamating company or to ensure that the
amalgamation is for genuine business purposes laid down by section
72A(2(b).
Notes
If the conditions mentioned under (2)(a) and (2)(b) above are satisfied by both the
amalgamating and amalgamated company shall become the business loss and
unabsorbed depreciation of the amalgamated company. Such accumulated loss will be
allowed to be carried forward by the amalgamated company for fresh 8 years and
unabsorbed depreciation can be carried forward indefinitely.
Consequences if the above conditions are not satisfied [Section 72A(3)]:
In a case where the conditions laid down under clause (b) above are not complied
with, the set off of loss or allowance of depreciation made in any previous year in the
hands of the amalgamated company shall be deemed to be the income of the
amalgamated company chargeable to tax for the year in which such conditions are not
complied with. Further, the balance accumulated loss and unabsorbed depreciation not
yet set off shall not be carried forward and set-off.
The carry forward and set-off of loss and unabsorbed depreciation as per the above
provisions shall be allowed only when amalgamation is as per the provisions of Section
2(1B) of the Income Tax, 1961.
Merger of F Co. into I Co.
Shareholders
Consideration in the
form of shares of I Co.
F Co.
I Co.
294
Notes
Conditions for carrying forward or set-off accumulated loss and unabsorbed

depreciation allowable in case of amalgamation [Rule 9C Notified by Notification
No. 11169 dated 15-12-1999]
The conditions referred to in Section 72A(2)(b)(iii) above shall be the following
namely:
(a) The amalgamating company, owning an industrial undertaking of the said
amalgamating company by way of amalgamation, shall achieve the level of
production of at least fifty per cent of the installed capacity of the said
undertaking before the end of four years from the date of amalgamation and
continue to maintain the said minimum level of production till the end of five
years from the date of amalgamation. However, the Central government, on an
application, may relax the condition of achieving the level of production or the
period during which the same is to be achieved or both in suitable cases having
regard to the genuine efforts made by the amalgamated company to attain the
prescribed level of production and circumstances preventing such efforts from
achieving the same.
(b) The amalgamated company shall furnish to the assessing officer a certificate in
Form No. 62 duly verified by an accountant, with reference to the books of
account and other documents showing particulars of production, along with the
return of income for the assessment year relevant to the previous year during
which the prescribed level of production is achieved and for subsequent
assessment years relevant to the previous years falling within five years from
the date of amalgamation.
Carry Forward and Set-off of Accumulated Losses and Unabsorbed Depreciation
in Case of Demerger [Sec. 72(3)]
In a case where the conditions laid down under clause (b) above are not complied
with, the set-off of loss or allowance of depreciation made in any previous year in the
hands of the amalgamated company shall be deemed to be the income of the
amalgamated company chargeable to tax for the year in which such conditions are not
complied with.
The carry forward and set-off of loss and unabsorbed depreciation as per the
above provisions shall be allowed only when amalgamation is as per the
provisions of Section 2(1B) of the Income Tax 1961.
Carry forward and set-off of accumulated losses and unabsorbed depreciation
in case of de merger [Sec. 72(A)(4) and (5)]:
Notwithstanding anything contained in any other provisions of this Act, in the case of
de merger, the accumulated loss and the allowance for absorbed depreciation of the
de-merged company shall:
(a) Where such loss or unabsorbed depreciation is directly relatable to the
undertaking transferred to the resulting company, be allowed to be carried
forward and set off in the hands of the resulting company;
(b) Where such loss or unabsorbed depreciation is not directly relatable to the
undertakings transferred to the resulting company, be apportioned between the
demerged company and the resulting company in the same proportion in which
the assets of the undertakings have been retained by the demerged company
and transferred to the resulting company, land be allowed to be carried forward
and set off in the hands of the demerged company or the resulting company, as
the case may be.
295
The Central Government may, for the purpose of this Act, by notification in the
Official Gazette, specify such conditions, as it considers necessary to ensure that the de
merger is for genuine business purpose.
Notes
The Carry forward and set off of accumulated loss and unabsorbed depreciation as
per the above provisions shall be allowed only when de merger as per the provisions of
Section 2 (19AA) of Income Tax Act.
Carry Forward and Set-off of Accumulated Losses and Unabsorbed Depreciation
in Case of Re-organisation of Business [Section 72A(6)]
Where there has been re-organisation of business, whereby, a firm is succeeded by
a company fulfilling the conditions laid down in clause (xiii) of Section 47 or a proprietary
concern is succeeded by a company fulfilling the conditions laid down in clause (xiv) or
Section 47, the notwithstanding anything contained in any other provisions of this Act, the
accumulated loss and the unabsorbed depreciation of the predecessor firm or the
proprietary concern, as the case may be, shall be deemed to be the loss or allowance for
depreciation of the successor company for the purpose of previous year in which
business re-organisation was effected and other provisions of this Act relating to set off
and carry forward of loss and allowance for depreciation shall apply accordingly.
Consequences if the conditions laid down under section 47(xiii) and (xiv) are
not complied with [Proviso to section 72A(6)]:
If any of the conditions laid down under section 47(xiii) and (xiv) are not complied
with, the set-off of loss or allowance of depreciation made in any previous year in the
hands of the successor company, shall be deemed to be the income of the company
chargeable to tax in the year in which such conditions are not complied.
If under section 47(xiii) and (xiv) are not complied with, the set-off of loss or
allowance of depreciation made in any previous year in the hands of the successor
company, shall be deemed to be the income of the company chargeable to tax in the
year in which such conditions are not complied with:
(vi) Accumulated loss means so much of the loss of the predecessor firm or the
proprietary concern or the amalgamating company or the de-merged company,
as the case may be,
under the head Profits and gains of business or profession (not being a loss
sustained in a speculation business) which such predecessor firm or the proprietary
concern or amalgamating company or demerged company, would have been entitled to
carry forward and set off under the provisions of Section 72 if the re-organisation of
business or amalgamation or de merger had not taken place.
(vii) Unabsorbed depreciation means so much of the allowance for depreciation of
the predecessor firm or the proprietary concern or the amalgamating company
or the demerged company, as the case may be, which remains to be allowed
and which would have been allowed to the predecessor firm or the proprietary
concern or amalgamating company or demerged company, as the case may
be, under the provision of this Act, if the re-organisation of business or
amalgamation or de merger had not taken place.
Case XY Ltd. wants to amalgamate with PQ Ltd. on June 30,2012. You are requested
to find out the tax implication in respect of the following losses/allowances of XY Ltd. In
the assessments of XY Ltd. (i.e., amalgamating company) and PQ Ltd. (i.e.,
amalgamated company)Unabsorbed depreciation allowance of the previous year 2005-06
Brought forward business loss 2005-2006
` 36,000
10,00,000
296
Notes
Unabsorbed scientific research expenditure
11,000
Bad debts
15,000
Capital gains arising on transfer of assets to PQ Ltd.

Brought forward capital loss
2,50,000
40,000
Also discuss whether PQ Ltd. can claim deduction under section 80-IA or 80-IB in
respect of industrial undertaking taken over from XY Ltd.
Solution: The following table highlights the tax implications in respect of various items
given in the problem on the assumption that assets are transferred in a scheme of
amalgamation which satisfies the provisions of Section 2(IB).
Loss/allowances of XY Ltd.
before amalgamation
Tax implications in the hands

of PQ Ltd.
Tax implications in the

hands of XY Ltd.
allowance 2005-06
` 36,000
If amalgamation satisfies the

conditions of Sec. 72A it is
deductible otherwise not
deductible
As XY Ltd. ceased to exist

after amalgamation, it is not
entitled for deduction
Brought forward business

loss 2005-2006
` 10,00,000
If amalgamation satisfies
condition of Sec. 72A, it can be
set-off and carried forward by PQ
Ltd. Otherwise such right is not
available
XY Ltd. cannot carry it

forward as it has ceased to
exist after amalgamation
Unabsorbed scientific
research expenditure `
11,000
Allowed subject to conditions of

Sec. 35
It cannot be carried forward,

as XY Ltd. has ceased to
exist.
Bad debts ` 15,000
Allowed
It is not allowed as
deduction as XY Ltd. ceased
to exist after amalgamation
Capital gains arising on

transfer of assets to PQ
Ltd. ` 2,50,000
It is not taxable in the hands of PQ

Ltd. If however, assets are
acquired in the scheme of
amalgamation are sold by PQ
Ltd., cost of acquisition for the
purpose of computing capital gain
would be cost to XY Ltd. (indirectly
` 250,000 will merge in capital
gain arising at the time of sale of
assets by PQ Ltd.).
It is not taxable, as transfer

of assets in a scheme of
amalgamation to an Indian
company, does not amount
to transfer for the purpose
of charging tax on capital
gains
Brought forward capital

loss ` 40,000
It cannot be set-off and carried

forward by PQ Ltd.
It cannot be carried forward

by XY Ltd. as it ceased to
exist after amalgamation
Note As benefit of deduction under section 80-IA or 80-IB is attached to the

undertaking (and not to the assessee), deduction under these sections would be
available to PQ Ltd. Even if the industrial undertakings are taken over from XY Ltd.
Case Company X which has an accumulated loss of ` 5,00,000 and unabsorbed
depreciation of ` 3,00,000, wants to re-organise its business by amalgamating with a rival
company Y, which is engaged in the same line of production but with a smaller capital,
but has an efficient management set-up and more modern machinery. Company Y is
agreeable to the amalgamation.
297
What are the alternative courses available to the companies for effecting the merger
and how would you advise them as to the best course of action?
Notes
Solution: The alternatives for merger that are available to X and Y are; (i) merger of X
into Y, whereby X goes out of existence;(ii) merger of Y into X, whereby Y goes out of
existence and (iii) merger of X and Y into a new company, whereby a new company, say
Z, is formed and both X and Y go out of existence.
All the three mergers can take place under one of the following situations
(a) If the merger is not an amalgamation within the meaning of Section 2(IB).
(b) If the merger is an amalgamation within the meaning of Section 2 (IB) though it
does not satisfy provisions of Section 72A.
(c) If the merger satisfies the conditions of Sections 2(IB) and 72A.
Under the aforesaid situations, the set-off of accumulated loss of ` 5,00,000 and
unabsorbed depreciation of ` 3,00,000 is possible in the following cases:
Whether set-off of unabsorbed loss/
depreciation allowance is possible?
Situation (a)
Situation (b)
Situation (c)
(i)
Merger of X into Y, whereby X goes out of

existence
No
No
Yes
(ii)
Merger of Y into X, whereby Y goes out of

existence
Yes
Yes
Yes
(iii) Merger of X and Y into a new company,

whereby a new company, say Z is formed
and both X and Y go out of existence
No
No
Yes
Set off losses of a banking company against the profit of a banking institution
under a scheme of amalgamation [Section 72AA]
Where a banking company has been amalgamated with a banking institution under
a scheme sanctioned and brought into force by the central Government under section
45(7) of the Banking Regulation Act,1949 then notwithstanding any thing contained in
Section 2(IB)(i) to (ii) or Section 72A, the accumulated loss and unabsorbed depreciation
of the amalgamating banking company shall be deemed to be the loss or the allowance
or depreciation of the banking institution for the previous year in which the scheme of
amalgamation is brought into force, and all the provisions contained in the Income Tax
Act, 1961, relating to set off and carry forward of loss and unabsorbed depreciation shall
apply accordingly.
5.5.6 Provisions Relating to Carry Forward and Set-off of Accumulated Loss and
Unabsorbed Depreciation Allowance in Scheme of Amalgamation of Banking
Company in Certain Cases [Section 72AB]
Section 72AB allows carry forward of business loss and unabsorbed depreciation in
case of:
(viii) Amalgamation of Co-operative Banks: Where the amalgamation of a co-operative
bank or co-operative banks has taken place during the previous year, the
successor co-operative bank shall be allowed to set off the accumulated loss and
the unabsorbed depreciation, if any, of the predecessor bank as if the
amalgamation had not taken place and all the other provisions of this Act relating
to set off and carry forward of loss and allowance for depreciation shall apply
accordingly provided the following conditions are satisfied
298
Notes
(ii) Demerger of a Co-operative Bank: Where any de-merger of any cooperative

bank has taken place during the previous year, the resulting cooperative bank
shall be allowed to set off the accumulated loss and unabsorbed depreciation,
if any, as under:
(a) Where the whole of amount of such loss or
unabsorbed depreciation is directly relatable to
the undertaking transferred to the resulting
co-operative bank
The whole of such loss

depreciation
or unabsorbed
(b) Where such accumulated loss or unabsorbed

depreciation is not directly relatable to the
undertaking transferred to the resulting
co-operative bank
[Accumulated loss or unabsorbed depreciation

of the demerged cooperative bank before
demerger] X
[Assets of the undertaking transferred to
resulting cooperative bank]/[Assets of the
de-merged co-operative bank before demerger]
(ix) Conditions to be satisfied by the predecessor bank [Section 72AB(2)(a)]

The predecessor bank should:
(x) have been engaged in the business of banking for 3 or more years, and
(ii) have held at least 75% of the book value of fixed assets as on the date of
reorganization, continuously for two years prior to the date of business
organization.
(xi) Conditions to be satisfied by the successor cooperative bank (amalgamated
cooperative bank or resulting co-operative bank) [Section 72AB(2)(b)]
The successor co-operative bank should:
(xii) hold at least 75% in the book value of assets of the predecessor co-operative
bank acquired through business reorganization, continuously for a minimum
period of five years immediately succeeding the date of business of
reorganization;
(ii) continue the business of the predecessor co-operative bank for a minimum
period of 5 years from the date of business reorganization; and.
(xiii) fulfil such other conditions as may be prescribed to ensure the revival of the
business of the predecessor co-operative bank or to ensure that the business
reorganization is for genuine business purposes.
Accumulated loss means so much of the loss of the amalgamating cooperative bank
or the demerged co-operative bank, as the case may be under the head Profits and
gains of business or profession (not being a loss sustained in a speculative business)
which such amalgamating co-operative bank or the demerged co-operative bank, would
have been entitled to carry forward and set off under the provisions of Sec. 72 as if the
business reorganization had not taken place.
Unabsorbed depreciation means so much of the allowance for depreciation of the
amalgamating co-operative bank or the demerged co-operative bank as the case may be,
which remains to be allowed and which would have been allowed to such bank if the
business reorganization had not taken place.
Case D Ltd. (demerged company wants to transfer one of its undertakings to R Ltd.
(resulting company), D Ltd. is the holding company of R Ltd. The two companies are
Indian companies.
299
The following is the balance sheet of D Ltd. as on March 31, 2012 immediately
before merger.
Notes
(` in thousands)
Equity share capital
140,00
Capital reserve
1,00
Share premium
2,99.290
General reserve
15,00
Revaluation reserve
Unit 1
Land (acquired in 1990)
30,00
Plant and machinery
60,00
Stock-in-trade
4,00
Sundry debtors
3,00
Land of Unit 1
4,00
Deferred revenue expenditure
2,00
Building of Unit 2
6,00
Unit 2
Loan(taken to purchase plant and machinery of

unit 1)
22,00.710
Plant and machinery
36,00
Building
14,00
Loan(general)
Stock-in-trade
6,00
Sundry debtors
4,00
3,00
Current liability
Unit 1
7,00
Other assets
Unit 2
1,00
Land and building
8,00
Investment
Bank overdraft(general)
30,00
-Shares in R Ltd.
8,00
-Shares in Tac Chem
2,00
Cash and bank
10,00
Pre-incorporation expense
210,00
1,00
210,00
Other information:
1. Shareholders list of D Ltd. Is as follows A 20%, B 40 per cent, C Ltd. 30% and
UTI 10%.
2. Accumulated loss for tax purpose of D Ltd. up to the assessment year 2012-13
is ` 45 lakhs.
3. D Ltd. wants to transfer Unit1 to R Ltd. on April 1,2012 by satisfying conditions
of section 2(19AA).
4. The market value of assets of Unit1 is as follows Land ` 69 lakhs, and Plant
and machinery ` 49 lakhs.
5. After the demerger, the face value of equity shares of D Ltd. will be reduced to
` 6 per share.
6. Securities transaction tax is not applicable.
Solution: R Ltd. To take over the following assets and liabilities pertaining to D Ltd.
(` in 000)
Land (` 30 lakhs minus ` 4 lakhs)
26,00
Plant and machinery
60,00
Stock
4,00
Debtors
3,00
Total assets (at book value)
93,00
Fewer liabilities
Loan taken to purchase plant and machinery
Current liabilities
Loan (general) see note
22,00.71
7,00
1,41.62
300
Notes
Bank overdraft (general) see note
3,77.67
Consideration
58, 80
The following points need to be considered:

1. Total assets of D Ltd. are ` 210 lakhs, out of which the following shall be
excluded: Deferred revenue expenditure of Unit 1 ` 2 lakhs, pre-incorporation
expenses ` 1 lakh, revaluation reserve Unit 1 ` 4 lakhs and Unit 2 ` 6 lakhs.
The balance is ` 197 lakhs. The book value of assets of Unit 1 is ` 93 lakhs.
Therefore, general loan and bank overdraft shall be allocated to Unit 1 in the
ratio of 93/197 [i.e., ` 3 lakhs 93/197; ` 1,41,624 and ` 8 lakhs 93/197
` 3,77,665].
2. The total consideration is ` 58,80, 000; it will be paid by R Ltd. by issue of
shares. Suppose shares issued at par, then R Ltd. will issue shares to
shareholders of D Ltd. as follows (a person holding 100 shares in D Ltd. will get
42 shares in R Ltd.).
Number of shares
Face value of shares (`)
A (20%)
1,17,600
11,76,000
B (40%)
2,35,200
23,52,000
C Ltd. (30%)
1,76,400
17,64,000
UTI (10%)
58,800
5,88,000
5,88,000
58,80,000
3. Accumulated loss of D Ltd. which will be set off and carried forward by R Ltd.
Under the provision of Section 72A will be ` 21,24,365 (i.e..` 45 lakhs
93/197).
4. Market value of assets of Unit 1 is not taken into consideration for determining
total consideration.
5. Shareholders of D Ltd. Will get share in R Ltd. by virtue of Section 2(22)(v), it
will not be treated as dividend.
6. D Ltd. transfers Unit1 to R Ltd. It is not treated as transfer for the purpose of
capital gains by virtue of Section 47(vib).
7. Shareholders of D Ltd. get shares in R Ltd. in lieu of reduction in share capital.
It is not chargeable under the head Capital gains, as it is not taken as transfer
under Section 47(vid).
8. Suppose land acquired from D Ltd. is transferred by R Ltd. on March 1, 2013
for ` 80 lakhs, then the amount of capital gain shall be determined as under
Capital gain in the case of R Ltd.
Sale proceeds
80,00,000
Less cost of acquisition
26,00,000
Short term capital gain
54,00,000
In this case the period of holding is taken from April 1, 2012 to March 1, 2013.
9. R Ltd. can claim depreciation in respect of plant and machinery acquired from
D Ltd.
10. D Ltd. can claim depreciation in respect of remaining assets.
301
5.6 Concept of Avoidance of Double Taxation
Notes
5.6.1 Introduction
In the current era of cross-border transactions across the world, due to unique
growth in international trade and commerce and increasing interaction among the nations,
residents of one country extend their sphere of business operations to other countries
where income is earned. One of the most significant results of globalization is the
introduction noticeable impact of one countrys domestic tax policies on the economy of
another country. This has led to the need for incessantly assessing the tax regimes of
various countries and bringing about indispensable reforms. Therefore, the consequence
of taxation is one of the important considerations for any trade and investment decision in
any other countries.
5.6.2 Source Rule and Residence Rule
Where a taxpayer is resident in one country but has a source of income situated in
another country, it gives rise to possible double taxation. This arises from two basic rules
that enable the country of residence as well as the country where the source of income
exists to impose tax, namely. The source rule holds that income is to be taxed in the
country in which it originates irrespective of whether the income accrues to a resident or
a nonresident The residence rule stipulates that the power to tax should rest with the
country in which the taxpayer resides. If both rules apply simultaneously to a business
entity and it were to suffer tax at both ends, the cost of operating in an international scale
would become prohibitive and deter the process of globalization. It is from this point of
view that Double taxation avoidance Agreements (DTAA) become very significant.
Double Taxation Avoidance Agreements with India.
5.6.3 Effects of Double Taxation on Trade and Services and its Remedy
International double taxation has adverse effects on the trade and services and on
movement of capital and people. Taxation of the same income by two or more countries
would constitute a prohibitive burden on the taxpayer. The domestic laws of most
countries, including India, mitigate this difficulty by affording unilateral relief in respect of
such doubly taxed Double income (Section 91 of the Income Tax Act). But as this is not a
satisfactory solution in view of the divergence in Taxation the rules for determining
sources of income in various countries, the tax treaties try to remove tax obstacles that
inhibit trade and services Avoidance and movement of capital and persons between the
countries concerned. It helps in improving the general investment climate. Agreements
The double tax treaties (also called Double Taxation Avoidance Agreements or DTAA)
are negotiated under public international or DTAA law and governed by the principles
laid down under the Vienna Convention on the Law of Treaties. It is in the interest of all
countries to ensure that undue tax burden is not cast on persons earning income by
taxing them twice, once in the country of residence and again in the country where the
income is derived. At the same time sufficient precautions are also needed to guard
against tax evasion and to facilitate tax recoveries. Double Taxation Avoidance
Agreements with India
5.6.4 Definition of Double Taxation
The Fiscal Committee of OECD in the Model Double Taxation Convention on
Income and Capital, 1977, defines double taxation as: The imposition of comparable
taxes in two or more states on the same tax payer in respect of the same subject matter
and for identical periods. Double Taxation of the same income would cause severe
302
Notes
consequences on the future of international trade. Countries of the world therefore aim at
eliminating the prevalence of double taxation. Such agreements are known as "Double
Tax Avoidance Agreements" (DTAA) also termed as "Tax Treaties. In India, the Central
Government, acting under Section 90 of the Income Tax Act, has been authorized to
enter into double tax avoidance agreements with other countries.
5.6.5 Necessity of Double Taxation Agreement
The need and purpose of tax treaties has been summarized by the Double OECD in
the Model Tax Convention on Income and on Capital in the following words: It is
desirable to clarify, standardize, and confirm the fiscal situation of taxpayers who are
engaged, industrial, financial, or any other activities in other countries through the
application by all countries of common solutions to identical cases of double taxation.
5.6.6 Avoiding and Alleviating the Adverse Burden of International Double Taxation
By (1) laying down rules for division of revenue between two countries;
(2) exempting certain incomes from tax in either country; (3) reducing the applicable rates
of tax on certain incomes taxable Double in either countries. Tax treaties help a taxpayer
of one country to know with greater certainty the potential limits of his tax liabilities in the
other country. Another benefit from the taxpayers point of view is that, to a substantial
extent, a tax treaty provides against non-discrimination of foreign taxpayers or the
permanent establishments in the source countries vis--vis domestic taxpayers.
DTAAs ensure that countries adopt common definitions for factors that determine
taxing rights and taxable events. Crucial among these is the definition of a permanent
establishment. Most treaties also specify a Mutual Agreement Procedure (MAP) which is
invoked when interpretation of treaty provisions is disputed. To prevent abuse of treaty
concessions, treaties increasingly incorporate restrictions and rules, such as a general
anti-functions of avoidance rule (GAAR), that allow tax authorities to determine if a
DTAAs transaction is only undertaken for tax avoidance or not. Benefit limitation tests
and controlled foreign corporation (CFC) rules also place limits on claims of residence in
countries eligible for treaty concessions. Exchange of tax information on either a routine
basis or in response to a special request is provided for in most treaties to assist
countries counter tax evasion. As of now, there exists 84 Double Taxation Avoidance
Agreements between India and other countries.
5.6.7 Salient Features of DTAA
These treaties are usually between countries with(i) substantial trade or other
economic relations. Most treaties are between pairs of developed countries while, of the
balance, most of them are between developed and developing countries. (2)Provide
reciprocal concessions to mitigate double taxation, (3) Assign taxation rights roughly in
accordance with that existing consensus and Largely though not rigidly follow the
OECD Model Tax Convention or, for developing countries, the UN Tax Convention.
(DTAAs)
Recent treaties contain new clauses following the OECD Model Tax Conventions of
2005 to 2010 which extend areas of cooperation to administrative and information issues
agreements A typical DTA Agreement between India and another country covers only
residents of India and the other contracting country who has entered into the agreement
with India. A person who is between India and not resident either of India or of the other
contracting country cannot claim any benefit under the said DTA agreement. Such
agreement generally provides that the laws of the two contracting states will govern the
303
taxation of income in respective states except when express provision to the contrary is
made in the agreement.
Notes
Section 90 Agreement with foreign countries or specified territories Bilateral

Relief. Since the tax treaties are meant to be beneficial and not intended to put tax
payers of a contracting state to a disadvantage, it is provided in Sec. 90 that a beneficial
provision under the Indian Income Tax Act will not be denied to residents of contracting
state merely because the corresponding provision in tax treaty is less beneficial. Section
90A - Double taxation relief to be extended to agreements (between specified DTAAs
and Associations) adopted by the Central Government.
Section 91 Countries with which no agreement exists Unilateral Agreements
relevant Some Double Taxation Avoidance agreements provide that income by way of
interest, provisions of royalty or fee for technical services is charged to tax on net basis.
This may result in tax deducted at source from sums paid to Non-residents which may be
Income Tax more than the final tax liability. The Assessing Officer has therefore been
empowered under section 195 to determine the appropriate proportion of the amount
from which tax is to be deducted at source under the Income Tax Act, 1961 There are
instances where as per the Income Tax Act, tax is required to be deducted at a rate
prescribed in tax treaty. However this may require foreign companies to apply for refund.
To prevent such difficulties Sec. 2(37A) provides that tax may be deducted at source at
the rate applicable in a particular case as per section 195 on the sums payable to nonresidents or in accordance with the rates specified in DTA Agreements. Double Taxation
Avoidance Agreements with India.
5.6.8 Relief under DTAA
(1) Bilateral relief: Under this method, the Governments of two countries can enter
into an agreement to provide relief against double taxation by mutually working out the
basis on which relief is to be granted. India has entered into 84 agreements for relief
against or avoidance of double taxation. Bilateral relief may be granted in either one of
the following methods: (a) Exemption method, by which a particular income is taxed in
only one of the two countries; and (b) Tax relief methods under which, an income is
taxable in both countries in accordance with the respective tax laws read with the Double
Taxation Avoidance Agreements. However, the country of residence of the taxpayer
allows him credit for the tax charged thereon in the country of source.
(2) Unilateral relief This method provides for relief of some kind by the home
country where no mutual agreement has been entered into between the countries.
Double Taxation Avoidance Agreements with India.
Exemption Method: One method of avoiding double taxation is for the residence
country to altogether exclude foreign income from its tax base. The country of source is
then given exclusive right to tax such incomes. This is known as complete exemption
method and is sometimes followed Methods of in respect of profits attributable to foreign
permanent establishments or income from immovable property. Indian tax treaties with
Denmark, Norway and Sweden embody with respect to certain incomes.
Method 2: Credit Method Taxation: This method reflects the underline concept
that the resident remains liable in the country of residence on its global income, however
as far the quantum of tax liabilities is concerned credit for tax paid in the source country is
given by the residence country against its domestic tax as if the foreign tax were paid to
the country of residence itself.
3. Tax Sparing: One of the aims of the Indian Double Taxation Avoidance
Agreements is to stimulate foreign investment flows in India from foreign developed
countries. One way to achieve this aim is to let the investor to preserve to himself/itself
304
Notes
benefits of tax incentives available in India for such investments. This is done through
Tax Sparing. Here, the tax credit is allowed by the country of its residence, not only in
respect of taxes actually paid by it in India but also in respect of those taxes India forgoes
due to its fiscal incentive provisions under the Indian Income Tax Act. Thus, tax sparing
credit is an extension of the normal and regular tax credit to taxes that are spared by the
source country, i.e., forgiven or reduced due to rebates with the intention of providing
incentives for investments.
5.6.9 Models of DTAA Model
There are two major types of DTAA Models.
1. OECD MODEL: OECD Models are generally adopted by developed nations and
their emphasis is on the residency based taxation.
2. UN MODEL: UN Model emphasis is on the source based taxation and generally
adopted by the developing nations. There are also US model Convention and Indian
Model Convention too.
5.6.10 Analysis of Tax Treaty
An analysis of any tax treaty would have the following components: (1) The date on
which it come into effect. (2) Applicability Applies to a person who is resident of one or
both the countries. Resident is defined under domestic law of different counties
differently. Article 4 expects that it should based upon domicile, physical residence, place
of management or such other criteria but makes it clear that where a person is a resident
in both the countries, it is the location of the permanent home or where vital interests are
located or where there is fixed abode or where he is citizen, in that order, will decide the
residential status. There may be cases, when it has been found that the assessee is
resident in both the countries then tie-breaker rule has to apply to determine the
residential status. Item (a) In the case of individual his personal and economic ties
determine his residential status of Tax Treaty. (b) In the case of others, it is the place of
effective management. General Definitions Article 3 of DTAA generally covers general
definition of Person, Company, contracting state, Enterprise of a contracting state,
Competent Authority, national etc, which all are applicable to the respective DTAA.
Article 4. The Tax which it covers What kind of tax the treaty covers should be known
as there are different form of tax in different countries and the DTAA will provide the relief
on the specified tax as mentioned in the DTAA. Article 5. The definition which will be
applicable in both countries irrespective of domestic law, as for example on such vital
issues as residence, which may be different from the residential statute in local law with
greater stress on nexus between source and income, definition of certain categories like
technical services etc. (6) Permanent Establishment and its parameters (a) PE means
a fixed place from where the business of the enterprise is carried on. (b) PE includes
place of management, branch, office, factory, workshop, mine, quarry, an oil or gas well,
a construction site for long duration, a service location for a long duration and a
dependent agency with power to conclude contracts. (7) The definition of concepts like
immovable property, dividend, business profits, royalty, technical fees, salaries etc. (8)
Different ways of tax-sharing depending upon the residential statute, permanent
Components establishment, fixed base or tax sharing with both countries giving agreed
part of relief. (9) Stipulation as to the method of relief either by way of exempting income
or where it is taxable, taxing it at stipulated rate, which may be lower than the domestic
rate, or by unilaterally giving credit for tax paid in the other country. (10) Exchange of
information with special reference to the concept of associated enterprises primarily to
tackle diversion of income to avail treaty benefit or evasion of tax in one or the other
country. (11) Provision for elimination of double taxation. (12) Provision for non-
305
discrimination etc. (13) Other clauses to suit the requirement of the participating
countries.
Notes
Case Laws: (1) UOI v. Azadi Bachao Andolan (Mauritius) Validity of CBDT Circular
No. 786, providing that Mauritian tax residency certificate was sufficient proof to avail
benefits under Indo-Mauritius DTAA, upheld: Supreme Court (2) Aditya Birla Nuvo
Limited v. ADIT (Italy) Payment made by assessee to an Italian Company (GTA) for
Deputing Certain Technicians to India for Supervising erection of Machinery would not be
chargeable to tax in India because person who rendered services were not present in
India for required number of days as envisaged by article 5(j) of DTAA. (3) Microsoft
Corporation v. ADIT (USA ITAT Delhi in the case of Microsoft Corporation held that
payment made for grant of licence in respect of Copy right by end user is taxable as
royalty as per Sec. 9(1)(vi), domestic tax legislation to override treaty provisions in case
of irreconcilable conflict. (4) Case Laws ADIT v. Chiron Behring Gmbh & Co KG
(Germany) Royalty income earned by a resident of Germany from India has to be
assessed to tax at the rate of 10% as provided in Article 12 of DTAA. (5) Praxair Pacific
Ltd In RE (Mauritius, 42 DTR (AAR) 177) - Shares held by the applicant as investment in
the books of accounts are treated as capital asset. Applicant is not liable to be taxed in
India on the proposed transfer of said shares to its wholly owned subsidiary company in
India in view of section 47 (iv) or under art 13 of India Mauritius treaties.(6) Hindustan
Petroleum Corporation Ltd. vs. ADIT [(2010) 130 TTJ 518 (Mum.)] It is not necessary that
unless a person be taxed in the UAE that person cannot claim the benefits of Indo-UAE
tax treaty in India, what is really relevant to see is whether or not the recipient was
resident of the UAE.
5.7 Summary
This unit covers the following:
(i) A broad view of computation of Total Income and tax liability of companies.
(ii) Provision of minimum Alternate Tax in certain companies and declaration and
Payment of Dividend have been covered.
(iii) The process of setting off losses and carry forward are covered in the following
steps:
Step 1 Inter-source adjustment under the same head of income.
Step 2 Inter-head adjustment under the same assessment year, step 2 is
applied only if a loss cannot be set off under step 1
Step 3 carry forward of a loss, Step 3 is applied only if a loss cannot be set-off
under Step 1 and 2
Includes provisions relating to set-off and carry forward of losses to subsequent
years
(iv) The unit discusses certain business which are granted special tax treatment.
Some of them relate to:
Special Provisions in Respect of Newly Established Undertakings in Free
Trade Zones [Section 10A]; Special Provisions in Respect of Newly
Established Units in Special Economic Zones Section 10AA]; Special
Provisions in Respect of Newly Established Hundred Percent Export
Oriented Units [Section 10B]; Special Provisions in Respect of Export of
Certain Articles or Things Section 10BA]; Deduction in respect of Profits
and Gains from Industrial Undertakings or Enterprises engaged in
Infrastructure Development etc. [Section 80IA]; Deduction in respect of
Profits and Gains from Enterprises engaged in Development of the
306
Notes
Special Economic Zones [section 80-IAB]; Deduction in respect of Profits

and Gains from certain Industrial Undertakings other than Infrastructure
Development Undertakings [section 80IB]; Deduction in respect of Profits
and Gains from the Business of Hotels and Convention Centres in
Specified Areas [Section 80ID]; Deduction in respect of certain
undertakings in North-eastern States [Section 80IE]; Deduction in respect
of certain incomes of Off-shore Banking Units and International Financial
Service Centres by the Specific Economic Zone Act, 2005 [Section 80LA];
Newly established undertakings in Free Trade Zones [Section 10A];
Newly established undertakings in Special Economic Zones [Section
10AA; Newly established 100 Per Cent Export Oriented Units [Section
10B]; Income of a Venture Capital Fund [section 10(23FB)], Tea
Development Account, Coffee Development Account and Rubber
Development Account: Section 33 AB, Site Restoration Fund Section
33ABA, Amortisation of telecom license fee [Sec. 35ABB]; Deduction for
Expenditure on Prospecting for Minerals: Section 35E; Transfer to a
special reserve [Sec. 36(1)(viii)]: Special Provisions for computing profits
and gains of business of civil construction Section 44AD, Special
Provisions for computing Profits and Gains of Business of Plying, Hiring,
or Leasing Goods Carriages Section 44AE, Special Provisions for
Computing Profits and Gains of Retail Business Section 44AF, Profits
from the Business of Processing of Biodegradable Waste How to
determine Section 80JJA: Employment of New Workmen How to
Determine Section 80JJAA:. Deduction in respect of certain incomes of
Offshore Banking Units and International Financial Service Centre by the
Specific Economic Zone Act, 2005 Section 80LA; Tax Incentives for
shipping business Tonnage tax [Secs. 115V to 115VZC]
(v) The part also discussed tax concessions available for business reorganization
such as amalgamation/merger of companies, de merger of company.

Provisions relating to Minimum Alternate Tax (MAT)
1. Section 2(23A) defines foreign company, which is __________ However, all
non-Indian companies are not necessarily __________.
2. A loss incurring company and a profit making company may _________ in
order to reduce the overall incidence of __________ under the Income Tax Act,
1961.
3. For the assessment year 2013-14 the rate of dividend distribution tax including
surcharge and cess for Indian companies is __________.
(a) 12.5%
(b) 14.025%
(c) 16.225%
(d) 28.325%
307
Notes
1. To be eligible to carry forward and set-off of business losses and unabsorbed

depreciation of demerged company, the resulting company should continue the
original business for __________.
(a) A minimum period of 5 years
(b) 7 years
(c) 2 years
(d) No specified period
Tax Planning with Reference to New Projects//Expansion/Rehabilitation Plans
1. A new factory commences business on 5.4.2013 and has employed w.e.f. that
date.
(a) 90 regular workmen
(b) 105 regular workmen
(c) 105 regular workmen on 5.4.2013,10 regular workmen on 10.5.2013 and
20 workmen on 15.10.2013
What shall be the deduction allowable under section 80JJAA
2. As on 31.3.2013, the regular workers employed by a factory were 80. During
the previous year the following workers were employed by the company.
(a) 7 new regular workmen during the year
(b) 9 new regular workmen during the year
(c) 25 new regular workmen during the year
Compute the deduction u/s 80JJAA.
1. X Ltd transferred its fertilizer business to a new company Y Ltd. by way of
demerger with effect from appointed date of 1.4.2013 and satisfying the
conditions of demerger. Further information given:
(a) WDV of the entire block of plant and machinery held by X Ltd. as on
1.4.2013 is ` 100 crores. Out of the above WDV of block of plant and
machinery of fertilizer division is ` 70 crores.
(b) X Ltd as unabsorbed depreciation of ` 50 lakhs as on 31.3.2013.
You are required to calculate depreciation post merger in the hands of X Ltd.
and Y Ltd as at 31.3.2014. State how the unabsorbed depreciation has to be
dealt with the assessment year 2014-15.

XYZ proposes to construct a hospital for its workers. The alternatives open to it are:
1. To purchase building worth ` 40 lakhs, the purchase price being payable in two
annual equal instalments.
2. To purchase the aforesaid building but instead of paying the price in
instalments, an agreement would be entered into with the vendor of the
building to pay him 10% of the net profits of the company for an indefinite
period of time
308
Notes
3. To contribute ` 30 lakhs to the UP Government which will construct a building

on land owned by it and allow the Company to use it as a hospital for its
workers though the ownership of the building will vest with the Government.
Consider each proposal and advise the company to enable the company to
make the bright choice.
4. For the assessment year 2013-14, a company has currently worked out its
book profits as per section 115JB as ` 12,45,600. The total income computed
as per the provisions is ` 2,87,450. It desires to know how much has to be
shown in the final accounts of the company in provision for taxation
5. Subsequent to demise of Mrs X, her son constituted a firm and ran the same
business. Can the firm claim set-off of unabsorbed business loss of late Mrs. X.
1. What are the steps required to compute taxable income of a corporate
assessee?
2. How the residential status of a company is determined? What role it has in
computing taxable income of the company?
3. What will be the treatment of Income tax on the income received from venture
capital companies/venture capital funds?
4. A domestic companys total income was determined at a loss of ` 20 lakhs for
the year ended 31-3-2014. It has distributed the following dividends to its
shareholders in respect of the previous year ended 31-3-2014. The paid-up
capital of the company on that date was ` 50 lakhs.
(1) Bonus shares in the ratio 1 : 10 on 30-6-2013
(2) Final dividend at 10% on 31-10-2013.
Discuss tax implications.
5. A company issued discount coupons to its shareholders which entitled them to
purchase the products of the company at a discount. The assessing officer
feels that this is a disguised dividend. What are the arguments for and against
such a treatment?
Provisions Relating to Minimum Alternate Tax (MAT)
1. What is the treatment of the following debited to profit and loss account while
calculating book profit?
(i) Wealth tax
(ii) Provision for doubtful debts
(iii) Penalty for non-payment of income-tax.
(iv) Dividend tax
(v) Banking cash transaction tax
(vi) Proposed dividend
(vii) Excise duty due, but not paid
(viii) Provision for gratuity
(ix) Depreciation
2. Are the Provisions of Section 115JB applicable to Foreign Companies?
3. Discuss the provisions relate to tax on distributed profits of domestic
companies under section 115O. Is this in addition to normal tax payable by a
company?
309
4. Discuss the provisions relating to tax on income distributed to unit holders. Is

the recipient of income chargeable to tax?
5. R Ltd., a closely held Indian company is engaged in the manufacture of
insecticides and fertilizers (value of the plant and machinery owned by the
company is ` 55 lakhs). Its profits and loss account for the year ended
31-3-2013 is as under:
Notes

`
Particulars
Particulars
Depreciation
4,16,000
By domestic sales
Salaries and wages
1,34,500
Export sale
5,76,100
Other receipts
2,00,000
Entertainment expenses
10,000
Traveling expenses
36,000
Miscellaneous expenses
5,000
Income tax
3,50,000
Wealth tax
8,000
Outstanding customs duty
17,500
Prov. for unascertained liabilities
70,000
Proposed dividend
60,000
30,000
Consultation fees paid to a tax expert
21,000
Salaries and Perquisites to MD

Excise duty of 2010-11
Net profit
22,23,900
1,80,000
75,500
15,86,500
30,00,000
30,00,00
For tax purposes the company wants to claim the following :

Deduction under section 80IB (30% of ` 15, 86,500).
Excise duty pertaining to 2010-11 paid during 2012-13 (amount actually paid
` 75,500).
Depreciation u/s 32 ` 5, 36,000.
The company wants to set off the following losses/allowances
For tax Purposes
Brought forward loss of 2010-11
For accounting purposes
11, 80,000
9, 10,000
2,45,000
Determine tax payable under section 115JB

1. X, an Indian company, furnishes the following particulars of its income for the
previous year 2012-13. Calculate its total income and income-tax liability for
the Assessment Year 2013-14:
Particulars
Income from business
`
5,20,000
Dividend received during the year:

from Indian company
20,000
310
Notes

from foreign company
5,000
Gains from transfer of capital assets

short term capital gains
25,000
long term capital gains
30,000
Agricultural income in India
35,000
Additional information:
(i) income from business includes ` 1,50,000 profit earned from a new small scale
industry set up on October 1,2002 which is eligible for deduction under section
80-IB.
(ii) Business expenses already charged from business income include ` 10,000
revenue expenditure and ` 30,000 capital expenditure on family planning
program for employees.
(iii) Company has debited following donations in the profit and loss account of the
business of company:
Rajiv Gandhi Foundation: ` 50,000, and
Prime Ministers National Relief Fund: ` 25,000
1. (a) What is meant by inter-source adjustment under the Income Tax Act while
computing the total income of an assessee?
(b) Briefly discuss the provision relating to the losses for Speculation
Business.
2. (a) State the provisions relating to carry forward and set-off losses from the
activity of owning and maintaining race horses.
(b) Discuss about set-off and carry forward of losses under the head Capital
Gains.
3. Write short notes on the following:
(i) Set-off and carry forward of unabsorbed depreciation
(ii) Losses under the head Income from House Property
(iii) Set-off of gambling losses.
4. Discuss whether the following are speculative losses :
(i) A sells goods to Y, which are to be imported by X. Due to change in
import policy of the Government, the goods could not be imported and
finally X agrees to pay Y damages of ` 5 lakhs for non-fulfilment of the
contract.
(ii) On April 1, 2012, A agrees to supply 1000 ton of rice to B at the rate of
` 30,000 per ton, which will be delivered on November 4, 2012. At the
time of entering the contract A does not have rice on his stock, nor does
he take any step to procure the same from the market. The bank balance
and overdraft limits of B do not permit payment of ` 3 crore to A at the
time of delivery. The market rate of rice on Nov. 4, 2012 is ` 32,000 per
ton. A pays ` 20 lakhs (i.e., difference in price) to B to settle the contract.
[Ans. (i) No (ii) Yes]
5. Mr. Yeshwant submits the following information for the financial year ending on
March 31, 2013. He desires that you should: (a) compute the Gross Total
Income and (b) ascertain the amount of losses that can be carried forward; on
the basis of the information given below.
(i) He has two houses :
311
(a) House No. I After all statutory deductions net annual value ` 36,000
(b) House No. II Current year loss ` 10,000
(c) Brought forward loss of Assessment Year 2010-11 of the second
house representing unadjusted interest on borrowed capital ` 30,000
(ii) He has three proprietary businesses:
Notes
(a) Textile Business

(i) Discontinued from October 31, 2011 Current Year Loss ` 25,000
(ii) Brought forward business loss of the year 2010 11 ` 80,000
(b) Chemical Business
(i) Discontinued from March 1, 2009 hence, no profit/loss NIL
(ii) Bad debts allowed in earlier year recovered during this year ` 30,000
(iii) Carried forward business loss for the A.Y. 2007-08 ` 20,000
(c) Leather Business
(i)
Profit for the Current Year ` 70,000
III (i) Short-term capital gains
` 20,000
(ii) Long-term capital loss ` 15,000
6. For the A.Y. 2013-14, X a resident individual furnishes the following particulars
of his income :
` 18,000
Loss from being
() 2,000
Business income
` 6,000
Income from speculative business
` 3,000
Short-term Capital Gains
` 15,000
Long-term Capital Gains
` 88,000
Winning from betting
` 13,000
Winning from horse races
` 23,000
Besides, X wants to set-off the following allowances/losses of the earlier years:

Business loss for the A.Y. 2008-2009
Unabsorbed depreciation allowance of A.Y. 2001-02
Short-term capital loss of the A.Y. 2010-11
Long-term capital loss for the A.Y. 2008-2009
` 14,000
` 2,000
` 74,000
` 8,000
Loss for betting of the A.Y. 2011-12
` 26,000
Loss from the business of owning and maintaining

Racehorses of the A.Y. 2009-10
` 38,000
Determine the net income of X for the A.Y. 2013-14.

1.
Discuss the Following
An assessee intending to establish an undertaking for the manufacture and sale of

goods with a distinct export orientation will have both domestic as well as export sales.
He seeks your advice as to how he can 2.R and Company started two separate industrial
undertakings which prima facie are eligible for deduction under section 80-IB. For the
312
Notes
year ending 31-3-2013, the profit of one unit was ` 6 lakh, while the other unit suffered a
loss of ` 2 lakh. The assessing officer has allowed the deduction under section 80-IB on
the net profit of ` 4 lakh Is the action of the assessing Officer justified?
3. A corporate form of organization wants to start a new business in respect of the
following in respect of the previous year 2012-13
(a) to manufacture or produce any article not specified in the Eleventh Schedule
(b) Producing or refining mineral oil in the North-Eastern Region
(c) operating and maintaining a hospital in a Rural area or the City of
Secunderabad
(d) business of hotels and convention centres in Jalgaon or Aurangabad
(e) Business of collecting and processing of bio-degradable waste for producing
bio-gas.
What are the benefits available under the Income Tax Act and what are the
conditions to be complied with.
4. The Gross total income of an Indian company includes profits and gains derived
from any industrial undertaking engaged in the manufacture or production of article or
thing and the company has employed new workmen during the previous year. Is there
any benefit available to the company under tax statute?
5.A new industrial undertaking commences business on 5-4-2012 and has
employed w.e.f. that date:
(a) 90 regular workmen
(b) 105 regular workmen
(c) 105 regular workmen on 5-4-2012, 10 regular workmen on 10-5-2012 and
20 workmen on 15-10-2012
What shall be deduction allowable u/s 80JJAA.
1. Explain the term amalgamation as defined in Section 2 (IB) of the Income Tax
Act
2. Company A is proposed to be merged with company B. The following are the
particulars of the former company:
Unabsorbed business loss
` 2,50,65,000
1,15,10,000
Consider which of the benefit can be availed of by the company under the
following situations(a) if the merger is not amalgamation within the meaning of Section 2(IB)
(b) if the merger is an amalgamation within the meaning of Section 2(IB) but it
does not fulfill conditions of Section 72A; or
(c) if the merger satisfies conditions of section 2(IB) as well as Section 72A
3. Amalgamation is tax neutral for purposes of income tax. Explain with
reference to provisions under income tax in respect of amalgamation.
4. H Ltd. owns the following asset on April 1, 2008
Block of asset
Written down value on

April 1, 2008
Plants (consisting of Plant A, B and C)
25% (15% from the

assessment year 2006-07)
20,50,000
313
On June 30, 2008, it sells plant A for ` 6,00,000. It, however, acquires a plant D for
` 15,00,000 on March 10,2009. On April 16, 2009 plant B, C and D are transferred by it to
S Ltd. (a wholly owned subsidiary of H Ltd.) for ` 3,50,000 or for ` 60,00,000. S Ltd. owns
Plant P whose written down value on April 1, 2009 is ` 2,00,000, besides it purchases
plant Q on May 10, 2009 for ` 1,00,000. In either case, the rate of depreciation is 15%
and new acquisitions are not eligible for additional depreciation. Find out the tax
consequence if S Ltd. is an Indian company or foreign company. Additional depreciation
is not available.
Notes

1. Give definition of double taxation and what do you know about Source rule and
residence rule.
2. What are the effects of double taxation on trade and services and its remedy?
3. What is the necessity of Double Taxation agreement?
4. What are the steps taken for Avoiding and alleviating the adverse burden of
international double taxation?
5. Discuss the salient features of DTAA.
6. What are the reliefs contemplated under DTAA?
7. Discuss the different Models of DTAA.
8. Can you give Analysis of Tax Treaty and its salient features?
5.10 Key Terms

Amalgamation: Sec. 2(1B) of the Income Tax Act 1961 defines amalgamation
as the merger of one or more companies with another company or the merger
of two or more companies (called amalgamating companies) to form a new
company (called amalgamated company) in such a way that all assets and
liabilities of the amalgamating company or companies become assets and
three-fourths in value of the shares in the amalgamating company or
companies become shareholders of the amalgamated company.
Demerger: Sec. 2(19AA): Demerger in relation to companies, means the
transfer, pursuant to a scheme of arrangement under sections 391 to 394 of
the Companies Act, 1956 by a demerged company of its one or more
undertakings to any resulting company
Gross Total Income: As per Section 14, income of a person is computed
under the following five heads:
1. Salaries
2. Income from house property
3. Profits and gains of business or profession
5. Capital gains
5. Income from other sources.
The aggregate income under these heads is termed as gross total income.
Total Income: Total income means Gross total income computed in
accordance with the provisions of the Act after making deductions under
Chapter VIA (Section 80C to 80U).
Domestic Company: A domestic company means an Indian company or any
other company which in respect of its income, liable to tax under the Income
Tax Act, has made the prescribed arrangements for the declaration and
314
Notes
payment within India, of the dividends (including dividends on preference

shares) payable out of such an income.
Foreign Company: Foreign Company means a company which is not a
domestic company.
Investment Company: Investment Company means a company whose gross
total income consists mainly of income which is chargeable under the heads
Income from House Property, Capital Gains and Income from Other
Sources.
Residence of a Company: A company is said to be a resident in India during
the relevant previous year if: (a) it is an Indian company, or (b) if it is not an
Indian company, then the control and the management of its affairs is situated
wholly in India.
Set-off of losses: Income tax is a composite tax on the total income of a
person earned during a period of one previous year. There might be cases
where an assessee has different sources of income under the same head of
income. Similarly, he may have income under different heads of income. It
might happen that the net result from a particular source/head may be a loss.
This loss can be set-off against other source/head in a particular manner. For
example, where a person carries on two business and one business gives him
a loss and other profit, then the income under the head profits and gains of
business or profession will be the net income, i.e., after adjustment of the loss.
Similarly, if there is a loss under one head of income, it should normally be
adjusted against the income from another head of income while computing
Gross Total Income.
Carry forward of losses: If the losses could not be set-off under the same
head or under different heads in the same Assessment Year, such losses are
allowed to be carried forward to be claimed as set-off from the income of the
subsequent Assessment Years.
Minimum Alternate Tax (MAT): Where in the case of a company through
proper tax planning, the income tax payable on the total income as computed
under the Income Tax Act in respect of the previous year, is less than certain
percentage of its book profit, the companies are required to pay some
minimum income tax which is termed as MAT (Minimum Alternate Tax). Tax
payable for any assessment year cannot be less than 18% of book profit.
Computation of book profits: Compute book profits [Explanation to 115JB(1)
and (2)]
Step 1: The net profit as shown in the profit and loss account (prepared as per Part
II and III of Schedule VI) for the relevant previous year, shall be increased by the
following, if debited to the Profit and Loss Account:
(a) The amount of income tax paid or payable, and the provision therefor; or
(b) The amounts carried to any reserves by whatever name called; or
(c) The amount or amounts set aside to provisions made for meeting liabilities,
other than ascertained liabilities; or
(d) The amount by way of provision for losses of subsidiary companies; or
(e) The amount or amounts of dividends paid or proposed; or
(f) The amount or amounts of expenditure relatable to any income to which
Section 10 (other than the provisions contained in clause (38) relating to
long-term capital gain on transfer of shares through a stock exchange, 11 or 12
applies (i.e., incomes which are exempt from tax), or
315
(g) The amount of depreciation, or

(h) The amount of deferred tax and provisions therefore (inserted by the Finance
Act, 2008, w.e.f. assessment year 2001-02).
(i) The amount or amounts set aside as provision for diminution in the value of
any asset (inserted by the Finance Act, 2009, w.e.f. assessment year
2001-02).
Notes
Notes:
1. The starting figure is the net profit after tax as per profit and loss account.
2. As per clause (a) above only income tax has to be added back. Hence, any tax,
penalty or interest paid or payable under wealth tax, gift tax, or any penalty or
interest paid or payable under income tax, if debited to profit and loss account
should not be added back to such net profits. Dividend tax paid or payable as
per section 115-O should be added back. Further, no adjustment is to be done
in respect of income tax refund.
3. Where any amount has been transferred to reserve as per the provisions of
Sec. 36(1)(viii), Sec. 80-IA(6), Sec. 80-IAB(6) or 10(A)(1A) or 10AA, the same
is also to be added back.
4. Any tax or duty which is not allowed as deduction as per provisions of Section
43B though debited to profit and loss account shall also not to be added back.
5. Any provision made to meet unascertained liabilities like provisions of gratuity,
provisions for future losses, etc. should be added back to such net profit.
However, if the provisions for gratuity have been made on the basis of actual
valuation, it becomes an ascertained liability and hence should not be added
back.
6. Every kind of reserve is to be added to net profit to determine book profit.
7. Dividend whether on equity or preference share paid or proposed should both
be added.
8. Security Transaction Tax and Banking Cash Transaction Tax are not to be
added back as these are not income tax.
9. Any expense other than mentioned in clause (5) above should not be added
back even if such expense is not allowable under the Income Tax Act.
10. Deferred tax liability as per Accounting Standards is an unascertained liability,
hence to be added back.
11. Loss of subsidiary company, if debited to the profit and loss account, should be
added back.
12. The provisions of Section 115JB shall not apply to the income accrued or
arising on or after 1-4-2005 from any business carried on, or services rendered,
by an entrepreneur or a Developer, in a Unit or Special Economic Zone as the
case may be [Section 115JB(6)].
Step 2: The profit as per the Profit and Loss Account shall be reduced by the
following:
1. The amount withdrawn from any reserves or provisions, if any, such amount is
credited to the profit and loss account:
A clarificatory amendment has been made by the Finance Act, 2002, i.e.,
assessment year 2001-02 to Section 115JB to provide that the amount
withdrawn from the reserve or provision, created not out of profits before
1.4.1997, if credited to the profit and loss account, shall not be deducted while
computing book profit.
316
Notes
Similarly, the amount withdrawn from the reserve created on or after 1.4.1997
and credited to the profit and loss account shall not be deducted while
computing book profit unless the book profit in the year of creation of such
reserve was increased by such reserve at that time.
(ii) The amount of income to which any of the provisions Section 10 (other
than the income referred to in Section 10(38), 11, 12 or 80-IAB applies, if
any such amount is credited to the profit and loss account; or
2. The amount of depreciation debited to the profit and loss account (excluding
the depreciation on account of revaluation of assets); or
(iv) The amount withdrawn from revaluation reserve and credited to profit and
loss account, to the extent it does not exceed the amount of depreciation
on account of revaluation of assets referred to in clause (iii) above; or
3. The amount of loss brought forward or unabsorbed depreciation, whichever is
less as per books of account. The loss shall, however, not include depreciation.
Further, the provision of this clause shall not apply if the amount of brought
forward loss or unabsorbed depreciation is Nil; or
(vi) The amount of profits of sick industrial company for the assessment year
commencing from the assessment year relevant to the previous year in
which the said company has become a sick industrial company under
sub-section (1) of Section 17 of the Sick Industrial Companies (Special
Provisions) Act, 1985 and ending with the assessment year during which
the entire net worth of such company becomes equal to or exceeds the
accumulated losses.
For the purposes of this clause, net worth shall have the meaning
assigned to it in clause (ga) of sub-section (1) of Section 3 of the Sick
Industrial Companies (Special Provisions) Act, 1985. According to
Section 3(1)(ga) of the Sick Industrial Companies (Special Protection) Act,
1985 net worth means the sum total of the paid-up capital and free
reserves.
Free reserve means all reserve credited out of the profits and share
premium account but does not include reserves credited out of
revaluation of assets, write back of depreciation provisions and
amalgamations.
(vii) The amount of profit derived from the activities of a tonnage tax company
[Sec 115VO].
The amount computed after increasing or decreasing the above in Step 1
and Step 2, respectively is known as book profit.
How much brought forward loss/unabsorbed depreciation are deductible
from book profits?
As per clause (v) above, the amount of loss brought forward or
unabsorbed depreciation as per books of accounts whichever is less is to
be deducted from the book profits. It has been, however, clarified that loss
shall not include depreciation. In this case, brought forward loss and
unabsorbed depreciation as per income tax shall have no relevance.
It has been clarified that where the value of the amount of either loss
brought forward or unabsorbed depreciation is nil, no amount on account
of such loss brought forward or unabsorbed depreciation would be
reduced from the book profit.
Tax on distributed profits of domestic companies: Domestic Company
shall, in addition to the income tax chargeable in respect of its total income, be
317
liable to pay additional income tax on any amount declared, distributed or paid
by such company by way of dividend (whether interim or otherwise), whether
out of current or accumulated profits. Such additional income tax shall be
payable @ 15% plus surcharge @ 10% plus education cess @ 2% plus SHEC
@ 1% of the amount so declared, distributed or paid.
Enterprises engaged in Infrastructure Development, etc.
Deduction under section 80IA is available only to the following business carried
on by an industrial undertaking:
1. Provision of infrastructure facility [which includes road, highways, water
supply project, irrigation project, sanitation and sewerage system, water
treatment system, solid waste management system, ports, airports and
inland waterways]
2. Telecommunication services
3. Developing, maintaining, etc. an industrial park.
4. Power generation, transmission and distribution
100% of profits and gains derived from such business for 10 consecutive
assessment years out of 15 years * beginning with the year in which
undertaking or the enterprise develops and begins to operate any infrastructure
facility or starts providing communication services or develops an industrial
park or develops a special economic zone or generates power or commences
transmission or distribution of power or undertakes substantial renovation and
modernization of the existing transmission or distribution lines.
Provided that where the assessee develops or operates and maintains or
develops, operates and maintains any infrastructure facility relating to a road
including toll road, a bridge or rail system ; a highway project including housing
or other activities being an integral part of the highway project; a water supply
project, water treatment system, irrigation project, sanitation and sewerage
system or solid waste management system; the provision of this clause shall
have effect as if for the words fifteen years, the words twenty years had to
be substituted.
Industrial Undertakings other than Infrastructure Development
Undertakings: Deduction under section 80IB is available to an assessee
whose Gross total Income includes and profits and gains derived from the
business of:
1. An Industrial undertaking set up in the State of Jammu and Kashmir.
Provision (except the quantum of deduction) relating to other industrial
undertakings have not been discussed as these new industrial
undertakings are now not allowed deduction
2. Scientific and industrial, research and development
3. Commercial production and refining of mineral oil
4. Developing and building housing projects
5. Processing, preservation and packaging of fruits and vegetables
6. Integrated business of handling, storage and transportation of food grain
units
7. Operating and maintaining a hospital in a rural area
8. Operating and maintaining a hospital located anywhere in India other than
excluded area.
Notes
318
Notes
Assessee
Period of Deduction
(commencing from initial
assessment year)
% of profits
eligible for
deduction
1.Industrial undertaking
(i) set up in Jammu & Kashmir
(ii) in district of category A*
(iii) operating a cold chain facility
(b) Owned by a co-operative society
2. Industrial undertaking in an
backward district category B*
(b) Owned by a cooperative society
First 5 years
100
Next 5 years
30
First 5 years
100
Next 7 years
25
First 5 years
100
Next 5 years
25
First 3 years
100
industrially
Next 5 years
30
First 3 years
100
Next 9 years
25
First 3 years
100
Next 5 years
25
* Backward districts of category A and Category B have been notified vide Notification No.
10441, dated 7-10-1997.
Offshore Banking Units and International Financial Service Centres;
To whom the deduction will be allowed: The deduction will be allowed to an
assessee:
(i) Being a scheduled bank (not being a bank incorporated by or under the laws of
a country outside India);
(ii) Owning an Offshore Banking Unit in a Special Economic Zone;
(iii) A unit of international Financial Services centre.
Income in respect of which deduction will be allowed: The deduction will be
allowed on account of the following income included in the gross total income of such
banks: Any income:
(i) From an Offshore Banking unit in a Special Economic Zone;
(ii) From the business, referred to in Section 6(1) of the Banking Regulation Act,
1949, with an undertaking which develops, develops and operates and
maintains a Special Economic Zone;
(ii) From any unit of the International Services Centre from its business for which it
has been approved for setting up in such a centre in a Special Economic Zone.
(i) 100% of such income for five consecutive assessment years beginning with the
assessment year relevant to the previous year in which the permission, under
section 23(1)(a) of the Banking Regulation Act, 1949, or permission or
registration under the SEBI Act, 1992 or any other relevant law was obtained;
(ii) 50% of such income for the next five consecutive assessment years.
319
Conditions to be satisfied: No deduction under this section shall be allowed

unless the assessee furnishes along with the return of income:
Notes
(i) In the prescribed form, the report of a Chartered Accountant, certifying that the
deduction has been correctly claimed in accordance with the provisions of this
section; and
(ii) A copy of the permission obtained u/s 23(1)(a) of the Banking Regulation Act,
1949.
Offshore Banking Unit means a branch of a bank in India located in the special
economic zone and has obtained the permission u/s 23(1)(a) of the Banking Regulation
Act, 1949.
International Financial Services Centre means an International Financial Services
Centre which has been approved by the Central Government under sub-section (1) of
Section 18 of the Special Economic Zones Act, 2005.
Amalgamation: Sec. 2(1B) of the Income Tax Act 1961 defines amalgamation
as the merger of one or more companies with another company or the merger
of two or more companies (called amalgamating companies) to form a new
company (called amalgamated company) in such a way that all assets and
liabilities of the amalgamating company or companies become assets and
three-fourths in value of the shares in the amalgamating company or
companies become shareholders of the amalgamated company.
Demerger: Sec. 2(19AA) Demerger in relation to companies, means the
transfer, pursuant to a scheme of arrangement under sections 391 to 394 of
the Companies Act,1956 by a demerged company of its one or more
undertakings to any resulting company.
Double Taxation agreement: The double tax treaties (also called Double
Taxation Avoidance Agreements or DTAA) are negotiated under public
international or DTAA law and governed by the principles laid down under the
Vienna Convention on the Law of Treaties. It is in the interest of all countries to
ensure that undue tax burden is not cast on persons earning income by taxing
them twice, once in the country of residence and again in the country where the
income is derived. At the same time, sufficient precautions are also needed to
guard against tax evasion and to facilitate tax recoveries.
Double Taxation Avoidance Agreements with India: A typical DTA
Agreement between India and another country covers only residents of India
and the other contracting country who has entered into the agreement with
India.
Tax Treaty: These treaties are usually between countries with: (1) substantial
trade or other economic relations. Most treaties are between pairs of
developed countries while, of the balance, most of them are between
developed and developing countries. (2) Provide reciprocal concessions to
mitigate double taxation, (3) Assign taxation rights roughly in accordance with
that existing consensus and largely though not rigidly follow the OECD Model
Tax Convention or, for developing countries, the UN Tax Convention (DTAAs).
320
Notes

Provisions Relating to MAT
1. not a domestic company; non-domestic companies
2. merge; Liability to tax or tax liability.
3. 16.225%
Under Situation
1. company can claim depreciation on ` 40 lakhs;
2. The company can claim deduction on account of 10% of the net profits of the
company for an indefinite period of time. If the ownership of the building is
transferred to the assessee, it can claim normal depreciation.
3. The ownership remains with the Government the assessee can claim
deduction of ` 30 lakhs but cannot claim depreciation.
Provisions Relating to MAT
1. Computation of tax liability under normal provisions 30% plus EC and SHEC
@3% = ` 88,823 rounded to 88,820
Computation u/s 115JB 12,45,600 @ 18.5% plus EC and SHEC at 3% ` 2,37,349
rounded to ` 2,37,350
Therefore tax liability will be ` 237,350
1. (d) No specified period
2. The firm can claim set off unabsorbed business loss of late Mrs X
1.
(a) No deduction as workmen employed are less than 100.
(b) Deduction will be allowed @ 30% of the wages paid during the previous
year to 5 workmen employed after initial 100 regular workmen.
(c) Deduction will be allowed @ 30% of the wages paid during the previous
year to 15 regular workmen employed after the initial 100 regular
workmen. No deduction under this section will be allowable in respect of
20 workers employed w.e.f. 15.10.2013 as they are employed during the
previous year for less than 300 days and hence are not regular workmen
for the previous year 2013-14.
2.
(a) and (b) No deduction as the total strength is less than 100.
(c) Deduction allowable @30% of the wages paid to 5 workers employed
after initial 10.
321
Notes
1. Depreciation on plant and machinery in the hands of X Ltd. and Y Ltd. will be
computed as under:
Particulars
As at 1-4-2013
Less: Depreciation @ 15%
WDV as at 31-3-2014
X Ltd (crores `)
Y Ltd (crores `)
30.00
70.00
4.50
10.50
25.50
59.50
The unabsorbed depreciation directly relatable to the undertaking transferred to the

resulting company is allowed to be carried forward and set off in the hands of the
resulting company. In case it is not directly relatable to the undertaking transferred to the
resulting company it has to be apportioned between the demerged company and the
resulting company in the same proportion in which the assets of the undertakings have
been retained by the demerged company and transferred to the resulting company.
5.12 Case Study

1. The net profit as per Profit and Loss Account of R Ltd., a resident company, for
the year ended 31-3-2014 is ` 190 lakhs arrived at after making the following
adjustments:
(i) Depreciation on assets ` 100 lakhs
(ii) Reserve for currency exchange fluctuations` 50 lakhs
(iii) Provision for tax ` 40 lakhs
(iv) Proposed dividend ` 120 lakhs
Following further information are also provided by the company:
(a) Net profit includes ` 10 lakhs received from a subsidiary company.
(b) Provision for tax includes ` 16 lakhs of tax payable on distribution of profits and
of ` 2 lakhs of interest payable on income tax.
(c) Depreciation includes ` 40 lakhs towards revaluation of assets
(d) Amount of ` 50 lakhs credited to P&L Account was drawn from revaluation
reserve.
(e) Balance of profit and loss account shown in balance sheet in the asset side as
at 31-3-2013 was ` 30 lakhs representing unabsorbed depreciation.
Compute the income of the company for the year ended 31-3-2014 liable to tax
under MAT.

1. Ahuja. Girish Dr. and Gupta Ravi Dr., Direct Taxes Law and Practice including
Tax Planning, Bharat Law House Pvt. Ltd.
2. Singhania Vinod K. Dr. and Singhania Kapil Dr., Direct Taxes Law and Practice
with Special Reference to Tax Planning, Taxman.
3. Singhania Vinod K. Dr. and Singhania Kapil Dr., Direct Taxes Planning and
Management, Taxman.

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Corporate Tax

DIRECTORATE OF DISTANCE &

Introduction to Accounting Standards

Unit 2 : Accounting for Mergers and Acquisitions

Unit 3: Valuation of Goodwill and Shares

Check Your Progress

Unit 4: Basic Concepts of Income Tax

Introduction to Income Tax

Unit 5: Assessment of Companies

Various accounting standards operating in India

Comparison of Indian AS with International Accounting standards and US GAAP

1.1 Introduction to Accounting Standards