Year: 2020

Management Notes

Meaning of Partnership, Firm and Partners

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The Income Tax Act, 1961, in India, the terms “partnership,” “firm,” and “partners” hold specific meanings and implications for tax purposes. Understanding these definitions and the legal framework surrounding them is crucial for compliance and tax planning for entities operating as partnerships.

Definition of Partnership

Under Section 4 of the Indian Partnership Act, 1932, a partnership is defined as “the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.” This definition underscores the essence of a partnership as a voluntary association of two or more persons who agree to carry on a business and share its profits or losses. The Partnership Act does not limit the maximum number of partners; however, the Companies Act, 2013, imposes a limit of 50 partners for a partnership firm to prevent it from becoming an association or company.

Characteristics of a Partnership:

  • Agreement-Based:

The formation of a partnership is based on a contract, either oral or written (Partnership Deed), among the partners.

  • Profit and Loss Sharing:

Partners agree to share the profits and bear the losses of the business in a predetermined ratio.

  • Mutual Agency:

Every partner acts as both an agent and principal. Each partner is an agent of the firm and other partners, binding the entity in the course of the business.

  • Unlimited Liability:

Partners have unlimited liability, meaning their personal assets can be used to settle the firm’s debts if necessary.

Definition of Firm

In the context of the Income Tax Act, the term “firm” specifically refers to a partnership entity that is engaged in a business or profession. The Act recognizes a firm as a separate taxable entity distinct from its partners. The term is synonymous with a partnership firm and carries the same legal implications as outlined under the Partnership Act, with additional requirements for taxation purposes.

Characteristics of a Firm:

  • Separate Legal Entity for Tax Purposes:

Although not a separate legal entity like a corporation, for tax purposes, a firm is treated distinctly from its partners.

  • Taxation:

A firm is taxable at a rate specified for firms under the Income Tax Act. It enjoys certain benefits and deductions specific to its status.

  • Partnership Deed:

The existence of a partnership deed is crucial for the recognition of a firm for tax purposes. It outlines the rights, duties, profit-sharing ratio among partners, and other terms governing the partnership.

Definition of Partners

Partners are individuals who have entered into a partnership with one another. They contribute capital, share profits and losses, and participate in the firm’s management, unless otherwise agreed. Partners are the driving force behind the partnership, making decisions and undertaking actions for the firm’s benefit.

Taxation of Partnership Firms and Partners

The Income Tax Act lays down specific provisions for the taxation of partnership firms and their partners:

  • Taxation of Firms:

A firm is taxed on its income at the rates applicable to firms. It is required to file an annual income tax return. A partnership firm is also eligible for certain deductions and benefits under the Act.

  • Remuneration and Interest to Partners:

The Act allows firms to deduct interest on capital and remuneration (salary, commission) paid to partners, provided these payments are authorized by the partnership deed and within the limits prescribed under the Act.

  • Taxation of Partners:

Individual partners are taxed on their share of the firm’s profits. The share of profit from a firm is exempt in the hands of the partners to avoid double taxation, as the income is already taxed at the firm level. However, interest and remuneration received by partners from the firm are taxable as income from other sources or profits and gains from business or profession, depending on the nature of the receipt.

Basis of Comparison

 Partnership Firm Partners
Definition Agreement Business Entity Individuals
Legal Status Not Separate Separate Individuals
Formation Agreement Registration Joining Agreement
Liability Unlimited Unlimited Unlimited
Management Shared By Partners Personal Involvement
Profit Sharing Agreed Ratio As per Agreement Direct Share
Loss Bearing Shared By Firm Individual Share
Decision Making Collective Partners’ Consent Individual Opinion
Continuity Uncertain Depends on Agreement Affects Continuity
Ownership Shared By Partners Personal Stake

Number of Members

 2-20 (Typically) Not Applicable At least 2
Dissolution Easier Legal Process Affects Partnership
Legal Formalities Fewer More Minimal
Capital Contribution Voluntary As per Agreement Personal Contribution

Books of Accounts

 Maintained Mandatory

Partner’s Responsibility


Compliance and Documentation

Compliance with tax laws for a partnership firm involves the proper documentation of the partnership deed, accurate bookkeeping, timely filing of income tax returns, and adherence to the provisions related to remuneration and interest payments to partners. The partnership deed, in particular, plays a pivotal role in determining the tax obligations and entitlements of both the firm and its partners.

Management Notes

New Scheme of Taxation of Firms

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Rate of Income tax applicable to Partnership Firm / LLP

Flat rate of 30% on the total income after deduction of interest and remuneration to partners/Designated Partners at the specified rates + Surcharge of 12% if Total Income exceeds 1 Crore and will be further increased by education cess secondary and higher education cess @ 3% on Income-tax (wef A.Y. 2019-20 health and education cess @ 4% shall be levied in lieu of education cess secondary and higher education cess @ 3% )

Income Tax Slabs for Partnership Firm / LLP

F.Y. 2017-18 F.Y. 2018-19
Tax Rate 30% 30%
Surcharge If income is greater than Rs.1,00,00,00 12% of income tax amount. Subject to marginal relief. If income is greater than Rs.1,00,00,00 12% of income tax amount. Subject to marginal relief.
Education Cess 2% extra – charged on the amount of income tax + surcharge being paid.

 

 N.A.
Secondary and Higher Education Cess  1% extra – charged on the amount of income tax + surcharge being paid.

 

 N.A.
Health and Education cess N.A. 4% extra – charged on the amount of income tax + surcharge being paid.

Remuneration to Partners/Designated Partners

  • Payment of Remuneration to a non-working partner will not be allowed as a deduction
  • A ‘working partner’ is an individual who is actively engaged in conducting the affairs of the business or profession of the firm.
  • Quantum of allowance is to be determined with reference to ‘book profit’ which is defined to mean an amount computed in accordance with the provisions of sections 28 to 44D of the Income-tax Act, as increased by the amount of remuneration to partners if deducted in determining book profit.

As per section 40(b)(v) any payment of remuneration to any partner who is a working partner, which is authorised by, and is in accordance with, the terms of the partnership deed and relates to any period falling after the date of such partnership deed in so far as the amount of such payment to all the partners during the previous year exceeds the aggregate amount computed as hereunder will be disallowed:

Slab of Remuneration to Partners/Designated Partners

Particulars Salary Allowed
a. On the first 3,00,000 of book profits or in case of a loss Rs. 1,50,000 or at the rate of 90% of the book profit (whichever is higher)

 
b. On the balance of book profits at the rate of 60%

 

Explanation 3 to section 40(b) defines “book-profit” as to mean the net profit, as shown in the profit and loss account for the relevant previous year, computed in the manner laid down in Chapter IV-D as increased by the aggregate amount of the remuneration paid or payable to all the partners of the firm if such amount has been deducted while computing the net profit.

Conditions for allowance of remuneration and interest to partners

  1. Remuneration should be to a working partner.
  2. Payment of remuneration and interest should be authorised by and should be in accordance with the terms of the partnership deed and should relate to any period falling after the date of such partnership deed.
  3. No deduction u/s. 40(b)(v) will be admissible unless the partnership deed either specifies the amount of remuneration payable to each individual working partner or lays down the manner of quantifying such remuneration: Circular No. 739 dt. 25-3-1996.
  4. Conditions for assessment as a firm
  • The partnership should be evidenced by an instrument in writing specifying individual shares of the partners.
  • A certified copy of the instrument signed by all the partners (not being minors) shall accompany the return of the firm for the first assessment as a ‘firm’.
Management Notes

Remuneration Received by partners (Sec 40b)

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The Treatment of remuneration received by partners is a critical aspect of tax planning and compliance for partnerships and Limited Liability Partnerships (LLPs) under the Indian Income Tax Act, 1961. Section 40(b) of the Act plays a pivotal role in defining the deductibility of such remuneration for the purpose of calculating the taxable income of the partnership firm.

The treatment of remuneration received by partners under Section 40(b) of the Income Tax Act, 1961, is a complex but crucial element of tax planning for partnerships and LLPs. It requires a careful balance between optimizing tax liability and adhering to stringent legal requirements. Strategic planning, meticulous documentation, and adherence to prescribed limits and conditions are fundamental to ensuring that remuneration paid to partners is recognized as a deductible expense by the firm, thereby minimizing the overall tax burden. Given the intricacies involved and the potential for significant financial implications, seeking professional advice and conducting regular reviews of remuneration policies in light of evolving tax laws and judicial rulings is highly recommended for firms.

Understanding Remuneration to Partners

Remuneration to partners may include salaries, bonuses, commissions, or any other form of compensation for services rendered to the firm. While such remuneration is an expense from the firm’s perspective and reduces its taxable income, it is concurrently taxable as income in the hands of the receiving partner under the head “Profits and gains of business or profession.”

Legal Framework Under Section 40(b)

Section 40(b) of the Income Tax Act specifies conditions under which remuneration paid to partners can be claimed as a deductible expense by the firm:

  1. Authorization in Partnership Deed:

The payment of remuneration to partners must be authorized by the partnership deed. The deed should clearly stipulate the amount of remuneration or the formula for its calculation.

  1. Quantum of Remuneration:

The Act prescribes limits on the amount of remuneration that can be deducted as an expense by the firm. The allowable deduction is subject to a ceiling based on the firm’s book profits:

  • On the first INR 3,00,000 of book profits or in case of a loss – 90% of book profits or INR 1,50,000, whichever is more.
  • On the balance of the book profits – 60%.
  1. Payment for Services Rendered:

The remuneration must be paid for services rendered by the partner to the firm. It should be directly related to the operations of the firm and not for personal services.

  1. Timing and Payment Method:

The remuneration must be paid within the stipulated time frame and in accordance with the terms specified in the partnership deed. Payments should ideally be made through traceable banking channels to establish a clear record.

Compliance and Documentation

For the remuneration to be recognized as a deductible expense, firms must ensure:

  • Adequate documentation, including maintaining an updated partnership deed that specifies the terms of remuneration.
  • Compliance with the prescribed limits and conditions under Section 40(b).
  • Disclosure of remuneration payments in the firm’s tax returns and financial statements, and proper accounting in the books of the firm.

Strategic Considerations for Structuring Remuneration

  1. Tax Efficiency:

Structuring remuneration within the limits of Section 40(b) can optimize the overall tax liability of the firm and its partners. Consideration should be given to the tax brackets of individual partners and the firm’s profitability.

  1. Compliance:

Ensuring that remuneration agreements are fully compliant with the legal requirements minimizes the risk of disallowances during tax assessments.

  1. Flexibility in Partnership Deed:

The partnership deed should be drafted to allow flexibility in determining remuneration, within the bounds of the law, to adapt to changing business needs and tax laws.

Implications of Non-Compliance

Non-compliance with the conditions laid out in Section 40(b) can lead to the disallowance of remuneration expenses, resulting in a higher taxable income for the firm and potentially higher tax liabilities. Furthermore, discrepancies or inconsistencies in the documentation or payment of remuneration can attract scrutiny from tax authorities, leading to assessments, penalties, or litigation.

Case Studies and Judicial Precedents

Several judicial precedents highlight the importance of adherence to the stipulations of Section 40(b). Courts have consistently ruled that for remuneration to be allowed as a deductible expense, strict compliance with the conditions mentioned in the section is mandatory. Cases where firms failed to properly document the terms of remuneration or exceeded the allowable limits have resulted in disallowances upon review by tax authorities.

Challenges and Best Practices

  • Determining Appropriate Remuneration:

Determining the quantum of remuneration that balances tax efficiency and compliance with legal norms can be challenging. Firms must undertake careful planning and analysis to arrive at an optimal figure.

  • Documentation and Record-Keeping:

Maintaining robust documentation, including a comprehensive partnership deed that meets legal standards, is essential for compliance and audit readiness.

  • Staying Updated:

Tax laws and interpretations can evolve, affecting the treatment of partner remuneration. Regularly reviewing and updating the partnership deed and remuneration strategy in light of current laws and judicial precedents is advisable.

Management Notes

Treatment of Interest, Commission

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Treatment of Interest and Commission in the taxation context requires careful consideration of the provisions of the Income Tax Act, 1961, particularly those related to allowable deductions for firms. Compliance with the conditions set forth in the Act, proper documentation, and strategic tax planning are pivotal in optimizing the tax implications of these transactions. Firms must navigate the complexities of tax regulations judiciously, ensuring that interest and commission payments are structured in a manner that is both tax-efficient and compliant with the law. Given the intricacies involved, professional advice from tax experts and careful planning are indispensable in managing the tax treatment of interest and commission effectively.

Understanding Interest and Commission

Interest refers to the cost paid for borrowing funds. It is an expense for the borrower and income for the lender. In business contexts, interest can be paid on loans, advances, or credit facilities.

Commission represents a service charge or a fee paid for services rendered or for executing specific transactions. It is commonly incurred in sales-driven businesses where salespersons receive a commission as part of their remuneration.

Tax Treatment of Interest and Commission: General Overview

  1. As Income:

Interest and commission received by a firm from its operations, investments, or services are considered income and are taxable under the head “Income from Other Sources” or “Profits and Gains from Business or Profession,” depending on the context of the receipt.

  1. As Expense:

When a firm pays interest or commission, these are generally allowable as business expenses, provided they are incurred wholly and exclusively for the purpose of the business and are not of a capital nature.

Specific Provisions Affecting Firms and Partners

Interest to Partners

Under Section 40(b) of the Income Tax Act, 1961, interest paid to partners is allowed as a deduction to the firm, subject to certain conditions:

  • The interest must be authorized by the partnership deed.
  • The rate of interest does not exceed 12% per annum or such rate prescribed under the Act.
  • The interest is paid on the capital contributed by the partner and not on loans or advances for personal purposes.

Commission to Partners

Similarly, commission paid to partners is deductible subject to the partnership deed authorizing such payment and the payment being in accordance with the terms of the deed. The commission must be for services rendered to the firm, and the amount must be reasonable and justifiable as per the business needs.

Compliance and Documentation

For both interest and commission payments to be recognized as deductible expenses, firms must ensure:

  • Proper documentation, including the partnership deed specifying the terms of such payments.
  • The payments are made via banking channels, ensuring traceability and compliance with tax laws.
  • Adequate disclosure of these transactions in the firm’s tax returns and financial statements.

Implications for Tax Planning

  1. Optimizing Deductions:

By structuring payments of interest and commission within the permissible limits, firms can optimize their taxable income, thereby reducing their overall tax liability.

  1. Strategic Allocation:

Firms might strategically allocate interest and commission to partners in higher tax brackets, thus ensuring a more tax-efficient distribution of income.

  1. Meeting Compliance to Avoid Disallowance:

Ensuring that all conditions under Section 40(b) are met is crucial for the deduction of interest and commission payments to be allowed. Non-compliance can lead to disallowances, increasing the firm’s tax liability.

Case Studies and Judicial Precedents

Numerous judicial rulings and case studies highlight the importance of adherence to the conditions under Section 40(b). For example, cases where firms failed to prove the business necessity of high commission payments to partners resulted in partial disallowances. Similarly, interest payments without proper documentation or exceeding the prescribed limits have been disallowed, underscoring the need for meticulous compliance and documentation.

Challenges in Treatment

  • Determining Reasonableness:

One of the primary challenges in deducting interest and commission expenses is establishing their reasonableness and direct relation to business purposes. This often requires a detailed analysis and justification.

  • Changing Tax Laws:

With frequent amendments to tax laws and rates, staying updated and ensuring compliance with the current provisions is essential for firms.

  • Documentation and Compliance:

Maintaining exhaustive records and ensuring that all transactions are adequately documented and comply with tax regulations can be burdensome for firms but is critical for audit and verification purposes.

Strategic Considerations

  • Holistic Planning:

Interest and commission payments should be part of a firm’s overall tax planning strategy, considering other deductions, allowances, and the firm’s and partners’ overall tax scenarios.

  • Legal and Financial Advice:

Consulting with legal and financial advisors can provide valuable insights into structuring transactions in a tax-efficient manner while ensuring compliance with the law.

Management Notes

Assessment of Companies Meaning

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Every taxpayer must furnish the details of his income to the Income-tax Department. These details are to be furnished by filing up his return of income. Once the return of income is filed up by the taxpayer, the next step is the processing of the return of income by the Income Tax Department. The Income Tax Department examines the return of income for its correctness. The process of examining the return of income by the Income-Tax department is called as “Assessment”. Assessment also includes re-assessment and best judgment assessment under section 144.

Under the Income-tax Law, there are four major assessments given below:

  • Assessment under section 143(1), i.e., Summary assessment without calling the assessee.
  • Assessment under section 143(3), i.e., Scrutiny assessment.
  • Assessment under section 144, i.e., Best judgment assessment.
  • Assessment under section 147, i.e., Income escaping assessment.

Assessment under section 143(1)

This is a preliminary assessment and is referred to as summary assessment without calling the assessee (i.e., taxpayer).

Scope of assessment under section 143(1)

Assessment under section 143(1) is like preliminary checking of the return of income. At this stage no detailed scrutiny of the return of income is carried out. At this stage, the total income or loss is computed after making the following adjustments (if any), namely:

(i) any arithmetical error in the return; or

(ii) an incorrect claim (*), if such incorrect claim is apparent from any information in the return.

(iii) disallowance of loss claimed, if return of the previous year for which set-off of loss is claimed was furnished beyond the due date specified under section 139(1); or

(iv) disallowance of expenditure indicated in the audit report but not taken into account in computing the total income in the return; or

(v) disallowance of deduction claimed u/s 10AA, 80IA to 80-IE, if the return is furnished beyond the due date specified under section 139(1); or

(vi) addition of income appearing in Form 26AS or Form 16A or Form 16 which has not been included in computing the total income in the return. However, no such adjustment shall be made in relation to a return furnished for the assessment year 2018-19 and thereafter.

However, no such adjustment shall be made unless an intimation is given to the assessee of such adjustment either in writing or in electronic mode. Further, the response received from the assessee, if any, shall be considered before making any adjustment, and in case where no response is received within 30 days of the issue of such intimation, such adjustments shall be made.

For the above purpose “an incorrect claim apparent from any information in the return” means a claim on the basis of an entry in the return :-

(i) of an item which is inconsistent with another entry of the same or some other item in such return;

(ii) in respect of which the information is required to be furnished under the Act to substantiate such entry and has not been so furnished; or

(iii) in respect of a deduction, where such deduction exceeds specified statutory limit which may have been expressed as monetary amount or percentage or ratio or fraction;

Procedure of assessment under section 143(1)

  • After correcting arithmetical error or incorrect claim (if any) as discussed above, the tax and interest and fee*, if any, shall be computed based on the adjusted income.
  • Any sum payable by or refund due to the taxpayer shall be intimated to him.
  • An intimation shall be prepared or generated and sent to the taxpayer specifying the sum determined to be payable by, or the amount of refund due to the taxpayer. An intimation shall also be sent to the taxpayer in a case where the loss declared in the return of income by the taxpayer is adjusted but no tax or interest is payable by or no refund is due to him.
  • The acknowledgement of the return of income shall be deemed to be the intimation in a case where no sum is payable by or refundable to the assessee or where no adjustment is made to the returned income.

*As per section 234F (as inserted by Finance Act, 2017 with effect from Assessment Year 2018-19), a fee shall be levied where the return of income is not filed within the due dates prescribed under section 139(1). The amount of fee is as follows:-

(a) Rs. 5,000, if the return is furnished on or before the 31st day of December of the assessment year;

(b) Rs. 10,000 in any other case:

Provided that if the total income of the person does not exceed Rs. 5,00,000, the amount of fee shall not exceed Rs. 1000.

Time-limit

Assessment under section 143(1) can be made within a period of one year from the end of the financial year in which the return of income is filed.

Assessment under section 143(3)

This is a detailed assessment and is referred to as scrutiny assessment. At this stage a detailed scrutiny of the return of income will be carried out is to confirm the correctness and genuineness of various claims, deductions, etc., made by the taxpayer in the return of income.

Scope of assessment under section 143(3)

The objective of scrutiny assessment is to confirm that the taxpayer has not understated the income or has not computed excessive loss or has not underpaid the tax in any manner.

To confirm the above, the Assessing Officer carries out a detailed scrutiny of the return of income and will satisfy himself regarding various claims, deductions, etc., made by the taxpayer in the return of income.

Procedure of assessment under section 143(3)

  • If the Assessing Officer considers it necessary or expedient to ensure that the taxpayer has not understated the income or has not computed excessive loss or has not underpaid the tax in any manner, then he will serve on the taxpayer a notice requiring him to attend his office or to produce or cause to be produced any evidence on which the taxpayer may rely, in support of the return.
  • To carry out assessment under section 143(3), the Assessing Officer shall serve such notice in accordance with provisions of section 143(2).
  • Notice under section 143(2) should be served within a period of six months from the end of the financial year in which the return is filed.
  • The taxpayer or his representative (as the case may be) will appear before the Assessing Officer and will place his arguments, supporting evidences, etc., on various matters/issues as required by the Assessing Officer.
  • After hearing/verifying such evidence and taking into account such particulars as the taxpayer may produce and such other evidence as the Assessing Officer may require on specified points and after taking into account all relevant materials which he has gathered, the Assessing Officer shall, by an order in writing, make an assessment of the total income or loss of the taxpayer and determine the sum payable by him or refund of any amount due to him on the basis of such assessment.

Assessment under section 144

This is an assessment carried out as per the best judgment of the Assessing Officer on the basis of all relevant material he has gathered. This assessment is carried out in cases where the taxpayer fails to comply with the requirements specified in section 144.

Scope of assessment under section 144

As per section 144, the Assessing Officer is under an obligation to make an assessment to the best of his judgment in the following cases:

  • If the taxpayer fails to file the return required within the due date prescribed under section 139(1) or a belated return under section 139(4) or a revised return under section 139(5).
  • If the taxpayer fails to comply with all the terms of a notice issued under section 142(1).

Assessment under section 147

This assessment is carried out if the Assessing Officer has reason to believe that any income chargeable to tax has escaped assessment for any assessment year

Scope of assessment under section 147

  • The objective of carrying out assessment under section 147 is to bring under the tax net any income which has escaped assessment in original assessment.
  • Original assessment here means an assessment under sections 143(1), 143(3), 144 and 147 (as the case may be).
  • In other words, if any income has escaped (*) from being taxed in the original assessment made under section 143(1) or section 143(3) or section 144 or section 147, then the same can be brought under tax net by resorting to assessment under section 147.

* In the following cases, it will be considered as income having escaped assessment:

  • Where no return of income has been furnished by the taxpayer, although his total income or the total income of any other person in respect of which he is assessable during the previous year exceeded the maximum amount which is not chargeable to income-tax.
  • Where a return of income has been furnished by the taxpayer but no assessment has been made and it is noticed by the Assessing Officer that the taxpayer has understated the income or has claimed excessive loss, deduction, allowance or relief in the return.
  • Where the taxpayer has failed to furnish a report in respect of any international transaction which he was required to do under section 92E.
  • Where an assessment has been made, but:
  1. income chargeable to tax has been under assessed; or
  2. income has been assessed at low rate; or
  3. income has been made the subject of excessive relief; or
  1. excessive loss or depreciation allowance or any other allowance has been computed;
  • Where a person is found to have any asset (including financial interest in any entity) located outside India.
  • Where a return of income has not been furnished by the assessee and on the basis of information or document received from the prescribed income-tax authority under section 1 33C(2), it is noticed by the Assessing Officer that the income of the assessee exceeds the maximum amount not chargeable to tax.
  • Where a return of income has been furnished by the assessee and on the basis of information or document received from the prescribed income-tax authority under section 133C(2), it is noticed by the Assessing Officer that the assessee has understated the income or has claimed excessive loss, deduction, allowance or relief in the return.

Procedure of assessment under section 147

  • For making an assessment under section 147, the Assessing Officer has to issue notice under section 148 to the taxpayer and has to give him an opportunity of being heard. The time-limit for issuance of notice under section 148 is discussed in later part.
  • If the Assessing Officer has reason to believe that any income chargeable to tax has escaped assessment for any assessment year, then he may assess or reassess such income and also any other income chargeable to tax which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under this section. He is also empowered to re-compute the loss or the depreciation allowance or any other allowance, as the case may be, for the assessment year concerned.
  • Items which are the subject matters of any appeal, reference or revision cannot be covered by the Assessing Officer under section 147.

Time-limit for completion of assessment under section 147

As per Section 153, the time limit for making assessment under section 147 is:

1) Within 9 months from the end of the financial year in which the notice under section 148 was served (if notice is served before 01-04-2019).

2) 12 months from the end of the financial year in which notice under section 148 is served (if notice is served on or after 01-04-2019).

Note: If reference is made to TPO, the period available for assessment shall be extended by 12 months.

Time-limit for issuance of notice under section 148

Notice under section 148 can be issued within a period of 4 (*) years from the end of the relevant assessment year. If the escaped income is Rs. 1,00,000 or more and certain other conditions are satisfied, then notice can be issued upto 6 years from the end of the relevant assessment year.

 In case the escaped income relates to any asset (including financial interest in any entity) located outside India, notice can be issued upto 16 years from the end of the relevant assessment year.

Management Notes

Computation of Depreciation under section of 32 of Income Tax Act

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Depreciation under the Income Tax Act is a deduction allowed for the reduction in the real value of a tangible or intangible asset used by a taxpayer. The concept of depreciation is used for the purpose of writing off the cost of an asset over its useful life.

Depreciation is a mandatory deduction in the profit and loss statements of an entity and the Act allows deduction either in Straight-Line method or Written Down Value (WDV) method. The calculation for depreciation under the WDV method is widely used except for undertaking engaged in generation or generation and distribution of power. The Act also allows a deduction for additional depreciation in the year of purchase in certain circumstances. To read about additional depreciation visit Additional Depreciation Under the Income Tax Act.

Block of Assets: Concept

Depreciation is calculated on the WDV of a Block of assets. Block of assets is a group of assets falling within a class of assets comprising of:

  • Tangible assets, being building, machinery, plant, or furniture,
  • Intangible assets, being know how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature

The block of assets is classified further depending on the similar use, life of the asset and nature of the asset.

Conditions for Claiming Depreciation

You can avail deduction for depreciation, only if it satisfies the following conditions.

  1. The assets must be owned, wholly or partly, by the assessee.
  2. The assets must be in use for the business or profession of the taxpayer. If the assets are not used exclusively for the business, but for other purposes as well, depreciation allowable would be proportionate to the use of business purpose. The Income Tax Officer also has the right to determine the proportionate part of the depreciation under Section 38 of the Act.
  3. Co-owners can claim depreciation to the extent of the value of the assets owned by each co-owner.
  4. You cannot claim depreciation on the cost of land.
  5. Depreciation is mandatory from A.Y. 2002-03 and shall be allowed or deemed to have been allowed as a deduction irrespective of a claim made by a taxpayer in the profit & loss account.

Written Down Value

As per Section 32(1) of the IT Act depreciation should be computed at the prescribed percentage on the WDV of the asset, which in turn is calculated with reference to the actual cost of the assets. In the context of computing depreciation, it is important to understand the meaning of the term ‘WDV’ & ‘Actual Cost’.

WDV under the Income Tax Act means:

  1. Where the asset is acquired in the previous year, the actual cost of the asset shall be treated as WDV.
  2. Where the asset is acquired in an earlier year, the WDV shall be equal to the actual cost incurred less depreciation actually allowed under the Act.

Depreciation Allowed

  • The allowance for depreciation is calculated under the WDV method except for undertaking engaged in generation or generation and distribution of power. The depreciation rates are given in Appendix 1. In the case of undertakings engaged in generation or generation and distribution of power, such undertaking has an option to claim depreciation on WDV method at the rates provided in New Appendix I – if such option is exercised before the due date of filing the return.

In the case of amalgamation or demerger, the aggregate depreciation allowance shall be apportioned between the amalgamating and the amalgamated company, or the demerged and the resulting company. The aggregate depreciation would be computed as if the amalgamation or demerger had not taken place. It shall be apportioned based on the number of days the assets were used by such companies.

In case of a finance lease transaction, the lessee has to capitalise the assets in its books under AS-19 – the Accounting standard on leases. In such cases, the lessee can exercise the rights of the owner in his own right and hence the allowance for depreciation is available to the lessee.

Sl.No Asset

Class

 Asset Type Rate of Depreciation
1 Building Residential buildings not including boarding houses and hotels 5%
2 Building Boarding houses and hotels 10%
3 Building Purely temporary constructions like wooden structures 100%
4 Furniture Any fittings / furniture including electrical fittings 10%
5 Plant and machinery Motor cars excluding those used in a business of running them on hire 15%
6 Plant and machinery Lorries/taxis/motor buses used in a business of running them on hire 30%
7 Plant and machinery Computers and computer software 60%
8 Plant and machinery Books owned by assessee carrying on a profession being annual publications 100%
9 Plant and machinery Books owned by assessee carrying on profession not being annual publications 60%
10 Plant and machinery Books owned by assessee carrying on business in running lending libraries 100%
11 Intangible assets Franchise, trademark, patents, license, copyright, know-how or other commercial or business rights of similar nature 25%

Depreciation Rates as per the Income Tax Act

Part A Tangible Assets:

Asset Class Sl.No Asset Type Rate of Depreciation
Building 1 Buildings used primarily for residential reasons (excluding boarding houses and hotels) 5%
  2 Buildings apart from those used primarily for residential reasons and not covered by subitems 1 (above) and 3 (below) 100%
  3 Buildings procured on or after September 1, 2002, for installing plant and machinery forming part of water treatment system or water supply project and which is used for the purpose of business of providing infrastructure facilities under clause (i) of subsection (4) of section 80-IA 100%
  4 Purely temporary erections like wooden structures 100%
Furniture and fittings   Furniture and fittings including electrical fittings 10%
Plant and machinery 1 Plant and machinery excluding those covered by sub-items (2), (3) and (8) below 15%
  2 Motor cars, excluding those used in a business of running them on hire, procured or put to use on or after April 1, 1990 15%
  3(i) Aeroplanes, Aero Engines 40%
  3(ii) Motor taxis, motor buses and motor lorries used in a business of running them on hire 30%
  3(iii) Commercial vehicle which is procured by the assessee on or after October 1, 1998, but before April 1, 1999, and is used for any period of time prior to April 1, 1999, for the purpose of profession or business in agreement with the third proviso to clause (ii) of sub-section (1) of section 32 40%
  3(iv) New commercial vehicle procured on or after October 1, 1998, but prior to April 1, 1999, in replacement of condemned vehicle of more than 15 years of age and is used for any period of time prior to April 1, 1999, for the purpose of profession or business in agreement with the third proviso to clause (ii) of sub-section (1) of section 32 60%
  3(v) New commercial vehicle procured on or after April 1, 1999, but before April 1, 2000, in replacement of condemned vehicle of more than 15 years of age and is put to use prior to April 1, 2000, for the purposes of profession or business in agreement with the second proviso to clause (ii) of sub-section (1) of section 32 60%
  3(vi) New commercial vehicle procured on or after April 1, 2001, but before April 1, 2002, and is put to use before April 1, 2002, for the purpose of profession or business 50%
  3(vii) Moulds used in plastic and rubber goods factories 30%
  3(viii) Air pollution control equipment

  • Felt
  • filter system
  • Electrostatic precipitation systems
  • Scrubber
  • Counter current / packed bed / venture / cyclonic scrubbers
  • Dust collector systems
  • Evacuation system and ash handling system
 100%
  3(ix) Water pollution control equipment

  • Aerated detritus chambers (including air compressor)
  • Mechanical screen systems
  • Mechanically skimmed grease and oil removal systems
  • Flash mixing equipment and chemical feed systems
  • Mechanical reactors and mechanical flocculators
  • Mechanically aerated activated sludge / diffused air systems
  • Biofilters
  • Aerated lagoon systems
  • Air floatation systems
  • Methane
  • recovery anaerobic digester systems
  • Steam/air stripping systems
  • Marine outfall systems
  • Urea Hydrolysis systems
  • Activated carbon column
  • Bio
  • Disc or rotating biological contractor
  • Marine outfall systems
  • Ion exchange resin column
  • Centrifuge for dewatering sludge
 30%
  3(x) (a) Solid waste, control equipment Cryolite / mineral / lime / caustic / chrome recovery system (b) Resource recovery and solid waste recycling systems 100%
  3(xi) Plant and machinery used in semiconductor industry covering all integrated circuits (ICs) (not including hybrid integrated circuits) ranging from small scale integration (SSI) to large scale integration / very large scale integration (LSI/VLSI) as also discrete semiconductor devices like diodes, triacs, thyristors, transistors, etc., except those covered by entries (viii), (ix), (x) of this sub-item and sub-item (8) below 30%
  3(xi)a Life Saving medical equipment

  • D.C Defibrillators for pacemakers and internal use
  • Colour Doppler
  • Haemodialysis
  • Cobalt therapy unit
  • Vascular Angiography System including Digital subtraction Angiography
  • Heart lung machine
  • Spect Gamma Camera
  • Magnetic Resonance Imaging System
  • Ventilator used with anaesthesia apparatus
  • Ventilator except those used with anaesthesia
  • Surgical laser
  • Gamma knife
  • Fibreoptic endoscopes including audit resectoscope/paediatric resectoscope, arthoscope, peritoneoscopes, fibreoptic flexible nasal pharyngo, microaryngoscope, video laryngo, fiberoptic flexible laryngo bronchoscope.
  • Bronchoscope, video oescophago gastroscope, video oescopghago bronchoscope, fibreoptic flexible oesophago gastroscope
 40%
  4 Containers made of plastic or glass used as refills 50%
  5 Computers including computer software 60%
  6 Plant and machinery, used in processing, weaving and garment sector of textile industry, which is bought under TUFS on or after April 1, 2001, but prior to April 1, 2004, and is put to use prior to April 1, 2004 50%
  7 Plant and machinery procured and installed on or after September 1, 2002, in a water treatment system or a water supply project and put to use for the purpose of business of providing infrastructure facility under clause (i) of sub-section (4) of section 80-IA 100%
  8 1. Wooden parts used in artificial silk manufacturing machinery 100%
    2. Match factories, wooden match frames  
    3. Cinematograph films, bulbs of studio lights 100%
    4. Salt works, condensers, reservoirs, salt pans, etc., made of clayey, sandy or earthy material or any other similar material 100%
    5. Quarries and mines 100%
    Sand stowing pipes, winding ropes, tubs and haulage ropes  
    Safety lamps  
    6. Flour mills, rollers  
    7. Sugar works, rollers 80%
    8. Steel and iron industry, rolling mill rolls 80%
    9. Energy saving devices 80%
    (A) Furnaces and specialised boilers  
    (i) Fluidized bed boilers / ignifluid 80%
    (ii) Continuous pusher type furnaces and flameless furnaces  
    (iii) High efficiency boilers  
    (iv) Fluidized bed type heat treatment  
    (B) Instrumentation and monitoring system for monitoring energy flows 80%
    (i) Digital heat loss meters  
    (ii) Automatic electrical load monitoring systems  
    (iii) Infrared thermography  
    (iv) Microprocessor based control systems  
    (v) Meters for measuring heat losses, steam flow, furnace oil flow, power factor and electric energy meters  
    (vi) Exhaust gas analysers  
    (vii) Maximum demand indicator and clamp on power meters  
    (viii) Fuel oil pump test bench  
    (C) Waste heat recovery equipment 80%
    (i) Air pre-heaters and recuperators  
    (ii) Feed water heaters and economisers  
    (iii) Thermal energy wheel for low and high temperature heat recovery  
    (iv) Heat pumps  
    (D) Co-generation systems 80%
    (i) Controlled extraction, back pressure pass out, extraction cum condensing turbines for cogeneration along with pressure boilers  
    (ii) Organic rankine cycle power systems  
    (iii) Vapour absorption refrigeration systems  
    (iv) Low inlet pressure small steam turbines  
    (E) Electrical equipment 80%
    (i) Synchronous condenser systems and shunt capacitors  
    (ii) Relays (automatic power cut off devices)  
    (iii) Power factor controller for AC motors  
    (iv) Automatic voltage controller  
    (v) Solid state devices for controlling motor speeds  
    (vi) FACT (Flexible AC Transmission) devices, Thyristor controlled series compensation equipment  
    (vii) Thermally energy-efficient stenters  
    (viii) Series compensation equipment  
    (ix) TOD (Time of Day) energy meters  
    (x) Intelligent electronic devices/remote terminal units, computer software/hardware, bridges/router, other required equipment and associated communication systems for data acquisition systems and supervisory control, distribution management systems and energy management systems for power transmission systems  
    (xi) Special energy meters for ABT (Availability Based Tariff)  
    (F) Burners 80%
    (i) Zero to ten per cent excess air burners  
    (ii) Burners using air with high preheat temperature (above 300 degrees Celsius)  
    (iii) Emulsion burners  
    (G) Other equipment 80%
    (i) Mechanical vapour recompressors  
    (ii) Wet air oxidation equipment for recovery of heat and chemicals  
    (iii) Automatic microprocessor based load demand controllers  
    (iv) Thin film evaporators  
    (v) Fluid couplings and fluid drives  
    (vi) Coal based producer gas plants  
    (vii) Super-charges/turbo charges  
    (viii) Sealed radiation sources for radiation processing plants  
    10. Gas cylinders including regulators and valves 60%
    11. Glass manufacturing concerns, Direct fire glass melting furnaces 60%
    12. Mineral oil concerns 60%
    (i) Plant used in field operations (above ground) distribution, returnable packages  
    (ii) Plant used in field operations (below ground), but not including kerbside pumps including fittings and tanks used in field operations (distribution) by mineral oil concerns  
    13. Renewable energy devices 60%
    (i) Pipe type and concentrating solar collectors  
    (ii) Flat plate solar collectors  
    (iii) Solar cookers  
    (iv) Air/fluid/gas heating systems  
    (v) Solar water heaters and systems  
    (vi) Solar crop drivers and systems  
    (vii) Solar steels and desalination systems  
    (viii) Solar refrigeration, air conditioning systems and cold storages  
    (ix) Solar pumps based on solar-photovoltaic and solar-thermal conversion  
    (x) Solar power generating systems  
    (xi) Solar-photovoltaic panels and modules for water pumping and other applications  
    14. Wind mills and any other specially designed devices that operate on wind mills (installed on or after April 1, 2014) 80%
    15. Any special devices including electric pumps and generators operating on wind energy (installed on or after April 1, 2014) 80%
    16. Books owned by assessees carrying on a profession  
    (i) Books, being annual publications 100%
    (ii) Books, excluding those covered by entry (i) above 60%
    (iii) Books owned by assessees carrying on business in running lending libraries 100%
Ships 4(i) Ocean-going ships including tugs, survey launches, dredgers, barges and other similar ships used primarily for dredging purposes and sighing vessels with wooden hull  
  4(ii) Vessels ordinarily operating on inland waters, not covered by sub-item (iii) below 20%
  4 (iii) Vessels ordinarily operating on inland waters being speed boats 20%

Part B Intangible Assets:
Patents, know-how, trademarks,franchises,copyrights, licenses or any other commercial or business right of similar nature – 25% is the Depreciation Rate.

Management Notes

Computation of Taxable Income of Companies

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Addressing specific problems on the computation of total income for companies involves understanding the framework of the Income Tax Act, 1961, in India. Although providing detailed computations for hypothetical situations without specific data can be challenging.

For a comprehensive illustration, let’s assume a simplified scenario for a domestic company:

Basic Framework for Computation of Total Income for Companies:

Gross Total Income (GTI):

Calculate the gross total income by aggregating the income from various sources under the five heads of income, which are:

  • Income from Salaries (not applicable for companies directly, but salaries paid to employees affect business income)
  • Income from House Property (e.g., rental income)
  • Profits and Gains of Business or Profession
  • Capital Gains (short-term and long-term)
  • Income from Other Sources (interest, dividends, etc.)

Allowable Deductions:

Deduct allowable expenses and depreciation related to business operations, investments, and other deductible expenses under sections 30 to 43D of the Income Tax Act. This includes specific deductions available under sections 80C to 80U (if applicable).

Set-off and Carry Forward of Losses:

Apply provisions for the set-off and carry forward of losses from previous years if applicable and permissible under the Act.

Simplified Example:

Let’s consider a hypothetical company, XYZ Pvt. Ltd., with the following financial details for the fiscal year:

Revenue from operations: ₹50,00,000

Rental income from property: ₹2,00,000

Interest received on fixed deposits: ₹1,00,000

Profit from the sale of a capital asset (held for more than 24 months): ₹5,00,000

Business expenses (including salaries, rent, utilities): ₹30,00,000

Depreciation: ₹4,00,000

Investment in eligible securities under section 80C: ₹1,50,000

Step 1: Calculate Gross Total Income (GTI)

Business Income: ₹50,00,000 (Revenue) – ₹30,00,000 (Expenses) – ₹4,00,000 (Depreciation) = ₹16,00,000

House Property Income: ₹2,00,000

Capital Gains: ₹5,00,000

Other Sources (Interest): ₹1,00,000

GTI = ₹16,00,000 (Business) + ₹2,00,000 (House Property) + ₹5,00,000 (Capital Gains) + ₹1,00,000 (Other Sources) = ₹24,00,000

Step 2: Deduct Allowable Deductions

Deduction under section 80C for investments: ₹1,50,000

Step 3: Compute Total Income

Total Income =

GTI – Deductions = ₹24,00,000 – ₹1,50,000 = ₹22,50,000

Tax Computation

The tax on the total income would then be calculated according to the prevailing corporate tax rates for that financial year, plus cess and surcharge if applicable.

Management Notes

Deductions under section 80G, 80GGB, 80IA, 80IB

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Section 80GG: House Rent Paid

Deduction for House Rent Paid Where HRA is not Received

  1. Section 80GG deduction is available for rent paid when HRA is not received. The taxpayer, spouse or minor child should not own residential accommodation at the place of employment
  2. The taxpayer should not have self-occupied residential property in any other place
  3. The taxpayer must be living on rent and paying rent
  4. The deduction is available to all individuals

Section 80GGB: Company Contribution

Deduction on contributions given by companies to Political Parties

Section 80GGB deduction can an Indian company for the amount contributed by it to any political party or an electoral trust. Deduction is allowed for contribution done by any way other than cash.  

the deductions U/s 80IA which is coming to end for certain categories of enterprises in respect of certain incomes.

(a) Developing Roads etc.:  The eligible enterprise should commence business between 01.04.1995 and 31.03.2017.  100% of profit for any 10 consecutive assessment years in a block of 20 years commencing from the previous year in which the enterprise starts business. Accordingly, for those enterprises who commenced business & started claiming deduction between 01.04.1995 and 01.04.2009, the deduction came to end for them w.e.f. A.Y. 2020-21.

(b) Developing Ports etc.: The eligible enterprise should commence business between 01.04.1995 and 31.03.2017.  100% of profit for any 10 consecutive assessment years in a block of 15 years starting from the previous year in which the enterprise starts business. Accordingly, for those enterprises who commenced business & started claiming between 01.04.1995 and 01.04.2009, the deduction came to end for them w.e.f. A.Y. 2020-21.

(c) Telecommunication Services: The eligible enterprise should commence business between 01.04.1995 and 31.03.2005.  100% of profit for first 5 assessment years and 30% for next five assessment years for any 10 consecutive years in a block of 15 years commencing from the previous year in which the enterprise starts business. Accordingly, for those enterprises who commenced business & started claiming deduction between 01.04.1995 and 01.04.2009, the deduction came to end for them w.e.f. A.Y. 2020-21.  Further, A.Y. 2020-21 is the last year of the block of 15 years after which the deduction will never be available.

(d) Industrial Parks: The industrial park should be notified by the Central Govt. in accordance with the scheme framed between 01.04.1997 and 31.03.2011. 100% of profit for any 10 consecutive assessment years in a block of 15 years starting from the previous year in which the enterprise starts business. Accordingly, for those enterprises who commenced business & started claiming deduction between 01.04.1997 and 01.04.2009, the deduction came to end for them w.e.f. A.Y. 2020-21.

(e) Special Economic Zones: The SEZs should be notified by the Central Govt. in accordance with the scheme framed between 01.04.1997 and 31.03.2005. 100% of profit for any 10 consecutive assessment years in a block of 15 years starting from the previous year in which the enterprise starts business. Accordingly, for those enterprises who commenced business & started claiming deduction between 01.04.1997 and 01.04.2009, the deduction came to end for them w.e.f. A.Y. 2020-21. Further, A.Y. 2020-21 is the last year of the block of 15 years after which the deduction will never be available.

(f) Generation or generation and distribution of Power: The business should commence between 01.04.1993 and 31.03.2017. 100% of profit for any 10 consecutive assessment years in a block of 15 years starting from the previous year in which the enterprise starts business. Accordingly, for those enterprises who commenced business & started claiming deduction between 01.04.1993 and 01.04.2009, the deduction came to end for them w.e.f. A.Y. 2020-21.

(g) Laying a Network: The business should commence between 01.04.1999 and 31.03.2017. 100% of profit for any 10 consecutive assessment years in a block of 15 years starting from the previous year in which the enterprise starts business. Accordingly, for those enterprises who commenced business & started claiming deduction between 01.04.1999 and 01.04.2009, the deduction came to end for them w.e.f. A.Y. 2020-21.

(h) Substantial Renovation and Modernisation: The business should commence between 01.04.2004 and 31.03.2017. 100% of profit for any 10 consecutive assessment years in a block of 15 years starting from the previous year in which the enterprise starts business. Accordingly, for those enterprises who commenced business & started claiming deduction between 01.04.2004 and 01.04.2009, the deduction came to end for them w.e.f. A.Y. 2020-21.

(i) Reconstruction or revival of a power generating plant: The company must be notified before 31.12.2005 by the Central Government. Such undertaking begins to generate or transmit or distribute power before 31.03.2011.  100% of profit for any 10 consecutive assessment years in a block of 15 years starting from the previous year in which the company starts business.  Accordingly, for those companies who commenced business & started claiming deduction between 01.04.2006 and 01.04.2009, the deduction came to end for them w.e.f. A.Y. 2020-21.

Sec – 80-Ib: Deduction In Respect Of Profit And Gains From Industrial Undertakings Other Than Infrastructure Development Undertakings

  1. The deduction in case of an assessee whose gross total income includes any profits and gains from any business of an industrial undertaking, shall be of the following amount:

i. In case of an industrial undertaking located in an industrial Backward State:

  1. For the initial 5 assessment years: 100% of the profit and gains derived from such undertaking and
  2. Thereafter, for the next 5 assessment years: 25% of the profits and gains derived from such industrial undertaking. (30% in case of a company) (25% for 7 assessment years in case of co-operative society)

ii. In case of an industrial undertaking located in an industrial Backward district:

  1. For the initial 5 assessment years: 100% of the profit and gains derived from such undertaking and
  2. Thereafter, for the next 5 assessment years: 25% of the profits and gains derived from such industrial undertaking. (30% in case of a company) (25% for 7 assessment years in case of co-operative society)

Note: The deduction is available to an Industrial Undertaking, which fulfills all the following conditions:

  1. It is not formed by splitting up, or the reconstruction of a business in existence.

Exception: If re-construction takes place in the circumstances and period given in section 33B, then deduction is available.

  1. It is not formed by the transfer to a new business of machinery or plant previously used for any purpose. [Note: The deduction under section 80IB shall be available if the new undertaking is started in an old building or if old furniture and fittings are used]

Exception:

  1. Imported old Plant & Machinery
  2. 20% of total Plant & Machinery can be old.
  3. It begins to manufacture or produce articles or things at any time up to 31-03-2004. For Jammu & Kashmir sunset date is 31-03-2012.
  4. The undertaking employs ten or more workers in a manufacturing process carried on with the aid of power or employs twenty or more workers in a manufacturing process carried on without the aid of power.
  5. The deduction is available to any undertaking which begins commercial production or refining of mineral oil in any part of India. The deduction is 100% of the profits from such business for the 7 consecutive assessment years including the initial assessment year. Initial assessment year means the assessment year relevant to the previous year in which the undertaking commences the commercial production or refining of mineral oil.
  6. The deduction under section 80-IB shall be:
  • 100% of the profits for a period of 7 consecutive Assessment Years
  • Derived from an undertaking which is engaged in commercial production of natural gas in blocks licensed under the New Exploration Licensing Policy (NELP)
  • And which begins commercial production of natural gas
  • The deduction shall commence from the AY relevant to the previous year in which the undertaking commences commercial production of natural gas.

Explanation: For the purpose of claiming deduction under this section, all blocks licensed under a single contract, which has been awarded under the NELP, shall be treated as a single undertaking. (This explanation is relevant for both mineral oil and natural gas)

Business Sunset Date
Refining of Mineral Oil Refining to start by 31st March, 2012 9 (but not later than 31.03.2017)
Production of Mineral Oil No deduction in respect of blocks licensed after 31.03.2011 (but not later than 31.03.2017)
Production of Natural Gas Commercial production to start by 01.04.2009 (but not later than 31.03.2017)
  1. The amount of deduction in the  case of an undertaking developing and building housing projects approved by a local authority shall be 100% of the profits derived in any previous year from such housing project if:
  • such undertaking commences development and construction of the housing project and completes such construction within 5 years, from the end of the financial year in which the housing project is approved by the local authority.
  • the project is on the size of a plot of land which has a minimum area of an acre
  • the residential unit has a maximum built-up area of 1000 square feet where such residential unit is situated within the city of Delhi or Mumbai or within 25 kilometers from the municipal limits of these cities and 1500 square feet at any other place and
  • the built up area of the shops and other commercial establishments included in the housing project does not exceed 3% of the aggregate built-up area of the housing project or five thousand square feet, whichever is higher.
  • Not more than one residential unit in the housing project is allotted to any person not being an individual and
  • in a case  where a 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 HUF in which such individual is the Karta

iii. The person representing such Individual, the spouse or the minor children of such individual or the HUF in which such individual is the Karta.

The deduction is 100% of the profits derived from the housing project in any previous year. It is possible that the residential units are sold say over a period of 6 years, then the deduction shall be profits derived during these 6 years from the housing project.

Note: Deduction can be claimed on a year to year basis where assessee is showing profit from partial completion of project. If later any of the condition is violated, then deduction allowed in earlier years shall be withdrawn.

  1. The amount of deduction in the case of an undertaking deriving profits from the business of operating and maintaining a hospital located anywhere in India, other than the excluded area, shall be 100% of the profits and gains derived from such business for a period of 5 consecutive assessment years, beginning with  the initial assessment year, if:
  2. The hospital has at least 100 beds for patients
  3. The construction of the hospital is in accordance with the regulations or bye-laws of the local authority.

80IC

Tax subsidy for enterprises in Himachal Pradesh, Sikkim, Uttaranchal and North – Eastern states

For the purpose to set up more industries for overall development of some less developed states in India, this section came into the picture. The major objective of providing tax holiday to specified states is to promote and encourage industrial development in those states.

Deduction under this section is available to undertakings established in specified states. Under this section, eligible assessee will get tax deduction on profits under business head for specified period of time.In this blog, we will discuss the list of states covered who are eligible to claim deduction, conditions and amount of deduction etc. This section was inserted from the assessment year 2004-05.

States covered under section 80-IC

S.No. Name of state
1. Sikkim
2. Himachal Pradesh
3. Uttranchal
4. North Estern States ( Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram, Nagaland and Tripura )

Management Notes

Introduction, Meaning and Definition of Company, Types of Companies under Income Tax Act

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The Concept of a company in the context of the Indian Income Tax Act encompasses a wide range of entities engaged in commercial, financial, or industrial activities. The taxation regime for companies is designed to accommodate the diverse structures and operations of these entities, ensuring a fair and efficient method of tax collection. Companies, owing to their significant contribution to the economy, are subject to a distinct set of tax rules and rates, reflective of their operational complexities and revenue generation capacities.

Meaning and Essence

Company is not merely a business entity; it is a juristic person established under the Companies Act, 2013, or previous legislation, recognized for its capacity to earn income, incur liabilities, and be held accountable for tax obligations. The essence of a company, from a tax perspective, lies in its distinct legal identity, separate from its members or shareholders. This separation underpins the taxation principles applicable to companies, ensuring that the entity’s income is taxed independently of the personal income of its constituents.

Definition under the Income Tax Act

Income Tax Act, 1961, provides a broad and inclusive definition of a company to capture the varied forms and structures of entities operating in the economic landscape. Section 2(17) of the Act defines a company as follows:

  • Indian Company:

An Indian company is defined as a company formed and registered under the Companies Act, 2013, or under any previous company law, which has its registered office in India.

  • Foreign Company:

A foreign company refers to a company that is not an Indian company and has control and management situated wholly outside India.

  • Domestic Company:

A domestic company includes any Indian company and any foreign company that is liable to tax under the Income Tax Act on income received within India.

This definition is instrumental in determining the tax obligations and entitlements of companies operating within the Indian jurisdiction. It encompasses both domestic and foreign entities, ensuring that all companies engaged in generating income within India are subject to taxation in accordance with the Act.

Taxation of Companies

The taxation of companies under the Income Tax Act is characterized by specific provisions that address the computation of taxable income, allowable deductions, and the imposition of tax at prescribed rates. Key aspects of company taxation:

  • Tax Rates:

Companies are taxed at rates that are periodically revised and specified in the Finance Acts. These rates may differ based on the nature and income of the company, with distinctions often made between domestic and foreign companies, as well as between small companies and other entities.

  • Minimum Alternate Tax (MAT):

MAT is a provision aimed at bringing companies with large profits but low taxable income, due to exemptions and deductions, into the tax net. It ensures that such companies pay a minimum amount of tax.

  • Dividend Distribution Tax (DDT):

Although the concept of DDT has been abolished since the financial year 2020-21, it was a significant feature in the taxation of companies, where companies distributing dividends were required to pay a tax on such distributions.

  • Compliance and Reporting:

Companies are required to adhere to strict compliance and reporting standards, including the filing of annual returns, tax audits, and transfer pricing documentation, where applicable.

Implications for Tax Planning

The definition and taxation of companies under the Income Tax Act have profound implications for tax planning. Entities must navigate the complex provisions of the Act to optimize their tax liabilities, leveraging allowable deductions, incentives, and benefits. Effective tax planning strategies enable companies to achieve tax efficiency, ensuring compliance while minimizing tax outflows.

Types of Companies under Income Tax Act:

The Income Tax Act, 1961, in India categorizes companies into various types for the purpose of taxation, each subject to specific tax provisions and rates. This classification is crucial for determining the applicable tax obligations and benefits.

  1. Indian Company

An Indian company is defined under section 2(26) of the Income Tax Act as a company that is registered under the Companies Act of India, 2013, or any previous Companies Act. The key characteristic of an Indian company is that it must have been formed and registered in India, making it a resident company for tax purposes. Indian companies are subject to tax on their global income, i.e., income earned both from within India and abroad.

  1. Foreign Company

A foreign company, as per section 2(23A) of the Income Tax Act, refers to a company that is not registered under any Indian law and has its management and control primarily situated outside of India. These companies are taxed only on the income that is received, accrued, or is deemed to be received or accrued in India.

  1. Domestic Company

This category includes Indian companies as well as foreign companies that have made arrangements for the declaration and payment of dividends within India. The term is significant for taxation purposes, as domestic companies are taxed at rates specified for them in the Act. The Act also provides various tax benefits, deductions, and incentives specifically tailored for domestic companies.

  1. Public Company

A public company is defined under the Companies Act, not directly in the Income Tax Act, but its structure affects its tax obligations. It is a company that is not a private company and has a minimum paid-up capital as prescribed by the Companies Act. Public companies can have any number of members, and they can freely transfer their shares. The tax treatment of public companies is aligned with the general provisions applicable to companies under the Income Tax Act.

  1. Private Company

A private company is defined under the Companies Act, with specific characteristics such as restrictions on the transfer of shares, a limit on the number of members (excluding present and past employees), and prohibition on inviting the public to subscribe to any shares or debentures. While the Income Tax Act does not directly define private companies, their structure and earnings influence their tax treatment.

  1. Subsidiary and Holding Companies

These are categorized based on their relationship with other companies. A subsidiary is a company controlled by another company (the holding company). The tax implications for subsidiaries and holding companies are based on their earnings, transactions between them, and their respective structures.

  1. Listed and Unlisted Companies

Companies can also be categorized based on whether their securities are listed on a recognized stock exchange (listed companies) or not (unlisted companies). This classification impacts their tax treatment in terms of deductions, exemptions, and tax rates applicable to their capital gains.

  1. Special Purpose Vehicles (SPVs) and Start–ups

Special categories such as SPVs (created for a specific purpose) and start-ups (newly established companies) may enjoy certain tax benefits or exemptions under the Income Tax Act or through specific government schemes to encourage innovation, investment, and economic growth.

Management Notes

Minimum Alternate Tax (115JB) Objective, Applicability, Challenges

indiafreenotesby indiafreenotes1

The Concept of Minimum Alternate Tax (MAT) under Section 115JB of the Income Tax Act, 1961, is a critical mechanism in the Indian tax framework, designed to ensure that companies paying minimal or no income tax, despite declaring substantial profits in their financial statements, contribute a fair share of tax to the government. MAT addresses the issue of tax avoidance, where companies take advantage of various incentives, exemptions, and deductions to reduce their taxable income.

Background and Objective

Before the introduction of MAT, numerous companies reported high profits in their books but paid negligible income tax by leveraging the deductions and exemptions available under the Income Tax Act. This discrepancy led to the introduction of MAT, ensuring that all profitable companies pay a minimum amount of tax to the government. The primary objective of MAT is to bring these zero tax-paying companies into the tax bracket and to rationalize the tax system by minimizing tax disparities.

Applicability of MAT

MAT is applicable to all companies, including foreign companies with income sources in India. However, it specifically targets companies that report profits in their financial statements but have a low taxable income due to various adjustments and exemptions. Section 115JB stipulates that if the tax payable on the total income of a company, as computed under the Income Tax Act, is less than 15% (rate as of the latest financial year) of its book profit, then the book profit shall be deemed to be the total income, and the company is liable to pay tax at the rate of 15% on such book profit.

Computation of Book Profit

The computation of book profit is a pivotal aspect of MAT. It starts with the net profit as shown in the profit and loss account of the company for the relevant financial year. Certain adjustments are made to this net profit as specified under Section 115JB, which include adding back deducted amounts not permissible under MAT and deducting incomes that are exempt under the Act. The aim is to arrive at a figure that more accurately reflects the company’s profitability for MAT purposes.

MAT Credit

To alleviate the potential hardship that MAT could cause to companies, the concept of MAT credit was introduced. Companies paying MAT in a financial year can avail of MAT credit, which is the difference between the tax paid under MAT and the tax payable under the normal provisions of the Income Tax Act. This MAT credit can be carried forward and set off against future tax liabilities for a period of fifteen years, ensuring that companies are not unduly penalized for fluctuations in their taxable income.

Recent Amendments and Current Scenario

Over the years, MAT has undergone several amendments to address emerging economic scenarios and to fine-tune its applicability. Notable among these amendments was the reduction of the MAT rate from 18.5% to 15% for companies, effective from the financial year 2019-20 onwards, to boost the corporate sector. Additionally, the introduction of the Taxation Laws (Amendment) Act, 2019, provided companies with an option to opt for a lower corporate tax rate of 22% (plus applicable surcharge and cess) under Section 115BAA, subject to the condition that they will not avail of certain specified deductions and exemptions, including the MAT provisions.

Implications for Corporate Tax Planning

The presence of MAT has profound implications for corporate tax planning. Companies must meticulously plan their investments, utilization of deductions, and exemptions to optimize their tax liabilities considering the MAT provisions. The option to switch to the new tax regime under Section 115BAA further complicates this planning, requiring a careful analysis of long-term tax benefits.

Criticism and Challenges

While MAT serves to ensure a minimum level of tax contribution from all profitable companies, it has faced criticism for complicating the tax regime and increasing the compliance burden on companies. Critics argue that MAT negates the benefits of certain exemptions and incentives intended to promote investments in specific sectors or activities. Additionally, the calculation of book profits and MAT credit involves complex adjustments, often leading to disputes between taxpayers and the tax authorities.

Strategic Financial Planning

MAT necessitates a strategic approach to financial and tax planning for companies. Since MAT is based on book profits, companies need to evaluate how various accounting policies and decisions impact their reported profits. Strategic decisions related to depreciation methods, inventory valuation, and recognition of income can influence book profits and, consequently, MAT liability. Companies often work closely with financial and tax advisors to align their business strategies with tax-efficient practices without compromising compliance.

Impact on Cash Flow

The imposition of MAT can significantly impact a company’s cash flow, especially for those heavily investing in research and development or in industries benefiting from tax incentives. Although the MAT credit mechanism provides relief, the initial outflow of tax payments under MAT can strain the cash reserves of companies, affecting their operational and investment capabilities. Effective cash flow management, therefore, becomes crucial for companies subject to MAT.

International Taxation and Foreign Companies

For foreign companies with operations in India, MAT adds an additional layer of complexity to their tax obligations. The applicability of MAT on foreign companies, especially those with significant income from royalties, fees for technical services, or capital gains from the transfer of assets in India, requires careful tax planning and structuring of operations to mitigate tax liabilities. The interplay between MAT and the provisions of Double Taxation Avoidance Agreements (DTAAs) that India has with various countries also necessitates expert guidance.

MAT and Corporate Restructuring

Corporate restructuring activities, including mergers, acquisitions, and demergers, must be planned by considering the implications of MAT. The carry forward and set-off of MAT credit in cases of business reorganizations are subject to specific conditions and limitations, which can influence the structuring and timing of such transactions. Ensuring the availability and utilization of MAT credit post-restructuring is a critical consideration for corporate finance and tax professionals.

Reporting and Compliance

Compliance with MAT provisions requires meticulous documentation and reporting. Companies must reconcile their financial statements prepared according to corporate laws with the tax computation under MAT, detailing the adjustments made to arrive at book profits. This exercise demands robust accounting and financial reporting systems capable of addressing both corporate and tax regulatory requirements efficiently.

Recent Regulatory Developments

The Indian government and tax authorities periodically review the MAT regime to align it with the evolving economic environment and policy objectives. Recent budget announcements and tax amendments reflect a trend towards rationalizing the MAT rates and enhancing the MAT credit system to support business growth and investment. Companies need to stay abreast of these changes to leverage any new benefits and to ensure compliance.

Long-term Strategic Implications

The choice between continuing with existing tax incentives and exemptions versus opting for the lower corporate tax rate without MAT, as offered under the new tax regime, requires a strategic evaluation of long-term tax liabilities and benefits. This decision is pivotal for companies planning for long-term growth, as it affects their effective tax rate, availability of MAT credit, and overall tax strategy.

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