Amount received deferred from income recognition on account of the obligations to be discharged

Issue

CLL is an educational institution run by CLL Charities. The institution collected fees from students for two years (consisting of four half-yearly terms) and in the event of students discontinuing, they are eligible for refund of fees for the remaining half-yearly terms. The educational institution consistently follows cash system of accounting. The fee received for the subsequent year was not recognized in the income and expenditure account of the institution for the reason that in the case of any dropout of any student the fee had to be refunded. The Assessing Officer in assessment held that the assessee having admitted that it is following cash system of accounting cannot defer such actual receipt to the subsequent year. Decide the correctness of action.

Opinion

The facts of the case show that the assessee is following cash system of accounting and has collected fees in advance for two years consisting of four half yearly terms. In the event of any student dropping out, the fee relating to the unexpired term or terms has to be refunded and on this condition only the amounts were collected upfront by the institution.

The apex court in CIT v. Shoorji Vallabhdas & Co (1962) 46 ITR 144 (SC) has held that the income tax levy, is on income. The Act takes into account two points of time at which the liability to tax is attracted viz. the accrual of income and its receipt. The substance of the matter is the income which is chargeable to tax regardless of an entry or no entry in the books of account. When the income is received and subsequently given up it remains income though it is given up and similarly an item of income for which an entry though made would not be an income unless it has accrued in favour of the assessee. When the income has not resulted at all there is neither accrual nor receipt of income even though an entry to that effect is passed in the books of account.

Advance amount received will not have the character of income till the obligation embedded with the advance is discharged. Case laws such as Lakshminarayana Films v. CIT (2000) 244 ITR 344 (Mad); CIT v. Shah Construction Co Ltd (1999) 237 ITR 814 (Bom) are relevant in this context.

In K.K.Kullar v. Dy.CIT (2009) 23 DTR (Delhi)(Trib) 231 the assessee an advocate received retainership fee in advance and admitted only a part as income of the year and did not offer the balance as income. The Revenue contended that the assessee following cash system of accounting had not offered the entire receipt as income which is contrary to the method of accounting followed by him. The tribunal held that the amounts not offered as income relate to the services to be rendered subsequently. The amount received in advance, represents the debt pertaining to services to be rendered subsequently. The excess amount had to be returned in the event of non –performance in future. Therefore, the amount received did not become the income of the assessee. The amount received hence could not be subjected to tax.

In Career Launcher (India) Ltd v. Asstt. CIT (2011) 56 DTR (Del) (Trib) 10 similar such issue was decided where a part of the coaching fees received was treated as advance of the next accounting year. The tribunal held that the entire receipts could not be taxed as income of the year and held that even non-refundable advance money could not be subjected to tax. It held that the amount of fee which accrued to the assessee as income during the relevant previous year is only chargeable to tax and not the entire receipt.

Position under DTC: Section 90 to section 103 of the DTC deal with computation of total income of non-profit organizations. Section 92(1) says that non-profit organizations have to account receipts and payments in accordance with cash system of accounting. In spite of following cash system of accounting it is possible that all the receipts could not be treated as income if the obligation to perform is embedded in the receipt and in the event of non-performance, the obligation to repay / refund remains therein. Hence these decisions might be relevant even in DTC regime.

Source: The Tax Referencer, Volume 120, Issue no.3, Dt.18.07.2011
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Deduction in respect of advance payment of duties and taxes

Issue

BP & Co engaged in manufacture of commodities liable for excise duty made advance payment of Rs.15 lakhs before the goods were removed from factory premises. The assessee excluded the value of duty on closing stock but claimed the advance payment as allowable expenditure. The Assessing Officer contested both the claims of the assessee and held that the closing stock must be inclusive of duties and taxes and the actual payment is not eligible for deduction under section 43B. Decide.

Opinion

Section 145A deals with valuation of inventory. It says that the valuation of purchase and sale of goods and inventory shall be in accordance with the method of accounting regularly employed by the assessee and it should be adjusted to include the amount of any tax, duty, cess or fee 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. Section 145A inserted by the Finance (No.2) Act, 1998 has provided for inclusive basis of closing stock valuation as a mandatory measure. Thus the valuation of the assessee by excluding the value of duty on closing stock is not in consonance with the provisions of law. The value of inventory and the applicable amount of duties and taxes are to be aggregated and disclosed in the tax statements.

Section 43B provides for deduction in respect of statutory payments which are allowable on actual payment basis. The amount so paid is eligible for deduction irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him. Hence, even for an assessee following mercantile system of accounting these statutory payments are deductible on actual payment basis regardless of the year in which the liability to pay such sum was incurred as per regular method of accounting employed by him.

In Dy.CIT v. Glaxo Smithkline Consumer Health Care Ltd (2007) 107 ITD 343 (Chd) (SB) similar such issue came up before the tribunal. It was held that the deduction for excise duty is allowable on payment basis even though such payment is made before incurring liability in respect of such amount. It was held that it is not necessary that the liability to pay is incurred first and only on such payment the deduction could be made on actual payment basis.

In CIT v. Modipon Ltd (2011) 334 ITR 106 (Del) the assessee made advance payment of excise duty to the extent of Rs.14.71 lakhs even before the goods were removed from the factory premises. The contention of the Revenue that only on removal of goods that the amount remitted could be claimed as deduction under section 43B was rejected by the court. Contrary view holding that when the payment is in advance and it does not relate to the year it will not be eligible for deduction was the decision in Gopi Krishna Granites India Ltd v. Dy.CIT (2001) 251 ITR 337 (AP).


Hence, it is possible to claim that the advance payment of excise duty is eligible for deduction regardless of the fact that the liability to pay was not incurred prior to such payment.

Position under DTC: Section 35(1)(xxxv) says that tax (not being a tax under this Code), duty, cess, royalty or fee by whatever name called is deductible as operating expenditure if the amount is actually paid. Therefore, the position in DTC is the same as it exists now under the Income-tax Act, 1961. It seems that incurring of liability is not a pre-condition for allowance of the claim in the DTC.

Valuation of inventory on the closing date is not specifically given in DTC however, section 33(1)(iii) dealing with computation of gross earning from business says that “the value of inventory as on the close of the financial year” is to be adopted. The opening stock of inventory, purchase of raw materials, stores, spares and consumables or stock in trade are dealt with in operating expenditure contained in section 35 of the DTC do not also specify that the tax paid thereon are to be included.

Source : The Tax Referencer, Volume 120, Issue No.3 Dt.18.07.2011
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Issue

TCL Private Limited had filed its return of income for the assessment year 2006-07 and the assessment was completed under section 143(3) in March 2008. The assessee had claimed deduction under section 80-IA which was also accepted in the assessment. The Assessing Officer issued a notice under section 148 dated 31st March, 2011, which was served on the assessee on 7th April 2011. The assessee sought the reason prompting reopening of assessment made by the Assessing Officer. The Assessing Officer informed the assessee that wrong claim of deduction under section 80-IA was the reason for reopening the assessment.

The assessee claims that (a) the notice issued was barred by limitation and (b) there was no sufficient cause for reopening the case. Decide.

Opinion

Proviso to section 147 says that where an assessment has been made under section 143(3), no action for reopening the case shall be taken after the expiry of 4 years from the end of the relevant assessment year unless the income chargeable to tax had escaped assessment by reason of the failure on the part of the assessee to disclose fully and truly all material facts necessary for assessment, for that assessment year. In Kanubhai M.Patel (HUF) v. Hiren Bhatt Or His Successors to Office and Others (2011) 334 ITR 25 (Guj) it was held that the expression ‘issue’ in the context of issuance of notices, writs and process would mean, to send out; to place in the hands of proper office for service. The court accordingly held that the expression ‘shall be issued’ used in section 149 must be read in that manner.

For the assessment year 2006-07 the time period of 4 years expired on 31.03.2011. The service of notice on 07.04.2011 is thus is barred by limitation.

Assuming the case is contested on the sufficiency of cause prompting the reassessment, provisions of section 147 have to be applied. In Titanor Components Limited v. CIT (Writ No.71 of 2005 decided on 09.06.2011) the assessment was completed for the assessment year 1997-98 under section 143(3), the Assessing Officer reopened the assessment for the reason that the assessee had wrongly claimed deduction under section 80-IA of the Act which was also allowed by him.

On writ, the court held that the Assessing Officer for invoking reassessment provisions must show that there was failure on the part of the assessee to disclose fully and truly material facts necessary for assessment. It held that section 147 does not provide a fresh opportunity to the Assessing Officer to correct an incorrect assessment unless the mistake in the assessment is due to the failure of the assessee to fully and truly disclose all material facts necessary for assessment. The Assessing Officer had not recorded any such failure and merely had claimed that the assessee had claimed certain deductions which he was not entitled to. The court held that there is a difference between a wrong claim made by the assessee after disclosing all the true and material facts and a wrong claim made by the assessee by withholding the material facts fully and truly.

It may be recalled that in Hindustan Lever Ltd v. R.B.Wadkar, Asstt.CIT (2004) 268 ITR 332 (Bom) it was held where the reasons of the Assessing Officer for reopening the assessment do not show any failure on the part of the assessee to disclose fully and truly all material facts necessary for assessment, he cannot invoke jurisdiction for reassessment. In a case of the same assessee (i.e.) Hindustan Lever Ltd v. R.B.Wadkar, Asstt.CIT (2004) 268 ITR 334 (Bom) the assessee had claimed expenditure towards stamp duty which was allowed in original assessment. Reassessment after four years for disallowing the same was held as invalid for the reason that there was no failure on the part of the assessee to disclose material facts at the time of original assessment.

In view of the above, though the Assessing Officer may invoke reassessment provisions upto 6 years from the end of the relevant assessment year, since there was no failure on the part of the assessee in disclosing fully and truly all material facts the time limit got curtailed to 4 years. As the disclosure of the assessee was full and true, no reassessment could be made for disallowing a wrong claim allowed earlier.

Position under DTC: Section 159 deals with reopening of assessment and the proviso to section 147 of the present dispensation giving some relief to the taxpayers now is not incorporated into the DTC. Therefore, the Assessing Officer in DTC regime need not have to prove that there was failure on the part of the assessee to disclose fully and truly all material facts necessary for initiating a reassessment proceeding. Thus the proposal in DTC is in favour of the Revenue.


Source : The Tax Referencer Vol 120 Dt.18.07.2011

Retrospective amendment and subsequent judgment prompting action under section 154.

Issue:

XYZ & Co filed its return of income for the assessment year 2008-09 on 10.06.2008. The return was processed and subsequently assessment under section 143 (3) was completed in December 2009. During the course of assessment, certain deductions and claims were disallowed by the Assessing Officer. The assessee based on the retrospective amendment made subsequently claimed that the order of the Assessing Officer has defect apparent on record which requires rectification under section 154. Also decide whether a subsequent Supreme Court judgment prompt a rectification under section 154?

Opinion

The claim of the assessee in respect of certain deductions was disallowed by the Assessing Officer based on the law prevailing on the date of assessment. A subsequent amendment of law, may be retrospective, whether would make the order liable for rectification under section 154, is to be decided.

If the issue is debatable the provisions of section 154 cannot be invoked in spite of a subsequent retrospective change of law (CIT v. M.S.Aggarwal (2009) 308 ITR 69 (Del)).

An amendment though retrospective will not unsettle an order if it was made earlier as per the provisions of law prevailing at that time. The apex court in CIT v. Max India Ltd (2007) 295 ITR 282 (SC) has held that when the order was consistent with the law at the time it was passed notwithstanding it was amended retrospectively at a later point of time, will not entitle a revision under section 263. When revision under section 263 is not possible, the question of invoking section 154 is also impossible. This is because section 154 allows only rectification of errors apparent on record and whereas section 263 empowers revision by looking into the correctness of assessment. The time limit for section 263 is less than the time limit prescribed under section 154. Thus when section 263 could not be invoked, it is not possible to conceive a situation where section 154 could be applied.


The apex court in Mepco Industries Ltd v. CIT (2009) 319 ITR 208 (SC) has held that the right to rectify mistake apparent on record under section 154 cannot be made on mere change of opinion. Subsequent judgment of the Supreme Court and rectification based on such judgment would only amount to rectification prompted by a change of opinion. Therefore, rectification based on Supreme Court judgment is not permitted since the order passed by the Assessing Officer originally would have been in consonance with the law as interpreted at that time.

Position under DTC: Section 161 of the DTC deals with rectification of mistake and the time limit is four years from the end of the financial year in which the order sought to be amended was passed. It also says that any mistake apparent on the face of the record is eligible for such rectification. It seems that the present position with regard to rectification of mistake apparent on record will continue without any change in the DTC regime also.

Source: The Tax Referencer, Volume 120 dt.01.08.2011
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Levy of penalty when one business is audited under section 44AB and the rest are not audited.

Issue:

Raj is engaged in the business of trade in textiles and also manufacture of certain industrial items. The units are located at different places and there is no interlacing or intermixing of funds. The assessee has made annual turnover of more than Rs.100 lakhs in both the businesses. While the accounts of textile business were audited under section 44AB of the Act, the account books of the other business was not audited. The Assessing Officer computed 0.5% of the turnover of both the businesses and levied maximum penalty of Rs.1 lakh. Is he justified?



Opinion

Section 44AB mandates that every person must get his books of account audited where the turnover, sales or gross receipt exceeds Rs.60 lakhs in a year. Section 44AD being a presumptive provision will apply where the turnover does not exceed Rs.60 lakhs. If the assessee covered by section 44AD does not offer income at 8% or more of the turnover, sales etc., then also the books of account are to be audited as per section 44AB(d).

Factually, the assessee in this case, has two businesses located at different places and both having turnover exceeding Rs.100 lakhs. The presumptive provision contained in section 44AD hence cannot be applied.

The assessee has obtained his books of account of the textile business audited as per section 44AB and whereas the unit engaged in manufacture of some industrial items was not subjected to audit under section 44AB.

The Assessing Officer has aggregated the turnover of both the businesses and levied 0.5% of the turnover or Rs.1 lakh whichever is less as penalty. In this case, the monetary limit of Rs.1 lakh is the penalty leviable since the turnover of both the businesses had exceeded Rs.100 lakhs.

When the assessee has subjected the books of account liable for audit under section 44AB such business could not be made liable for penalty under section 271B. In Asstt. CIT v. Smt.Bharti Sharma (2011) 44 SOT 230 (Del) the assessee had carried on two businesses of which only one of them was subjected to audit under section 44AB but the Assessing Officer aggregated the turnover of both the businesses and levied penalty. The tribunal held that since the assessee had failed to get the books of account audited in respect of one business, she could be made liable to pay penalty only in respect of such business and not on the total turnover of both the businesses.

The tribunal held that nothing has been provided in law or rules where the assessee having more than one business but gets books of account audited in respect of one business and fails to get the accounts audited in respect of others. Section 271B is also silent about such a situation. The tribunal referred to R.B.Jodha Mal Kuthiala v. CIT (1971) 82 ITR 570 (SC) and held that equitable considerations though not applicable in interpreting tax laws yet it has to be interpreted reasonably and in consonance with justice. The tribunal accordingly held that penalty under section 271B must be confined to the business for which audit was not conducted as per section 44AB and such penalty cannot be levied in respect of business for which such audit under section 44AB was made.

Position under DTC: Section 88(1) prescribes the monetary limit for getting the books of account audited. The limits are Rs.25 lakhs in the case of persons carrying on any profession and Rs.100 lakhs for persons carrying on business. The penalty provision is contained in section 232(1)(a) and the quantum is, not less than Rs.50,000 but which shall not exceed Rs.2 lakhs. This would mean that some discretion is vested with the Assessing Officer for levy of penalty. The procedure for levy of penalty is contained in section 233 of the DTC.

Source: The Tax Referencer, Volume 120 dt.01.08.2011
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Disallowance under section 14A would not arise unless there is income chargeable to tax.

Issue:

ABC (P) Ltd has paid up share capital and reserves and surplus of Rs.500 lakhs. During the year 2009-10 it had borrowed Rs.1000 lakhs from various financial institutions and invested Rs.1200 lakhs in shares of companies. For the financial year 2010-11 it has not received any dividend from the companies but proposes to claim interest on monies borrowed from financial institutions as a deduction. Decide whether the provisions of section 14A would be applicable for disallowing the interest claim of the assessee.

Opinion

Section 14A has the title “Expenditure incurred in relation to income not includible in total income”. It says for computing total income under Chapter IV (consisting of five heads of income) no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income.

The Assessing Officer has to determine the amount of expenditure incurred in relation to such income which does not form part of the total income, in accordance with rule 8D of the Income-tax Rules if he is not satisfied with the correctness of the claim made by the assessee.

Section 14A(3) says that such amount of expenditure to be disallowed shall be determined by the Assessing Officer even where the assessee claims that no expenditure was incurred by him in relation to such income, which does not form part of the total income under the Act.

From the above, the conditions for applying section 14A are (i) no expenditure will be allowed as a deduction where the income does not form part of total income; (ii) the Assessing Officer will determine the amount of expenditure incurred in relation to such income when he is not satisfied with the correctness of the claim of the assessee; and (iii) such disallowance of expenditure will apply even where the assessee claims no expenditure was incurred in respect of such income i.e. exempt income.

In M/s. Siva Industries & Holdings Ltd v. Asstt. CIT (ITA No.2148/Mds/2010 decided on 20.05.2011) the aspect of disallowance of expenditure under section 14A, when could be made, was discussed in detail. The assessee filed its original return disallowing the interest expenditure to the extent of Rs.42 crores. Later, a revised return was filed wherein the disallowance to the extent of Rs.30.90 crores was withdrawn. The Assessing Officer accepted the claim of interest payment to the extent of Rs.8.14 crores and the balance of Rs.33.86 crores was disallowed by him. The assessee explained in detail the various transactions of borrowings and investments and fairly agreed that out of borrowings only Rs.8.68 crores was connected to investment in shares. Some of the borrowings made and for which interest was charged to revenue account did not show any nexus to the investment in shares. The assessee explained that it had not claimed any dividend income as exempt from tax and therefore the provisions of section 14A could not be invoked. It was also contended that only when there was an income which did not form part of total income under the Act during any relevant assessment year, no deduction in respect of expenditure incurred for earning such income which does not form part of total income, was allowable. During the relevant assessment year the assessee did not have any income which did not form part of total income and therefore no disallowance under section 14A could be made.

In CIT v. Winsome Textile Industries Ltd (2009) 319 ITR 204 (P&H) the assessee engaged in manufacture and sale of cotton yarn made investment in shares. The Assessing Officer disallowed interest on the amount of investments on the ground that the dividend income was exempt from tax and the provisions of section 14A are applicable. The court held that since the assessee did not make any claim for exemption, the provisions of section 14A would not be applicable.

The tribunal while deciding M/s.Siva Industries (Supra) also referred to the apex court decision in the case of CIT v. Walfort Share & Stock Brokers (P) Ltd (2010) 326 ITR 1 (SC) and enunciated the following principles which emerged from the decision.

a) the mandate of section 14A is to prevent claims for deduction of expenditure in relation to income which does not form part of the total income of the assessee;

b) section 14A is enacted to ensure that only expenses incurred in respect of earning taxable income are allowed;

c) the principle of apportionment of expenses is widened by section 14A to include even the apportionment of expenditure between taxable and non-taxable income of an indivisible business;

d) the basic principle of taxation is to tax net income. This principle applies even for the purposes of section 14A and expenses towards non-taxable income must be excluded;

e) once a proximate cause for disallowance is established – which is the relationship of the expenditure with income which does not form part of the total income – a disallowance has to be effected.

The tribunal held that for application of section 14A there must be (i) income which is taxable under the Act for the relevant assessment year; and (ii) there should also be an income which does not form part of the total income under the Act during the relevant assessment year. If either one is absent, section 14A(1) has no applicability.

If we assume that section 14A would apply even when the assessee does not have any income which does not form part of total income, then it would lead to conclusion that the expenditure in relation to investment would stand for disallowance. If this would continue and go on accumulating, when the assessee liquidates the investment and derives gain that will also be taxed. These are not contemplated under section 14A.

Thus once there is no claim of income which does not form part of the total income, there cannot be any disallowance in relation to an investment which may or may not give rise to any income which does not form part of total income. Since the investments made have not generated any dividend income, the disallowance of interest expenditure would not arise in this case.

Position under DTC: Section 18(1)(a) of the DTC says that any expenditure attributable to income which is not included in total income shall not be allowed deduction. Incomes which are not to be included in the total income are listed in the Sixth Schedule. It contains any dividend declared, distributed or paid to a company or a non-resident in respect of which dividend distribution tax has been paid under section 109 of the DTC.

Source: The Tax Referencer, Volume 120 dt.01.08.2011
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