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A query in every quarter

V. K. Subramani looks at Part A of the December 1999 CS (Intermediate) paper on tax laws

ANSWER Question 1, which is compulsory, and any three of the rest from this part.

1(a) State, giving reasons, whether the following are capital or revenue expenditure: i) cost of shifting of plant to another place; ii) annual sum paid for use of goodwill; and

iii) payment of royalty correlated with production. (3 marks)

b) Ashok, an employee of ABC Ltd, receives Rs. 2,05,000 as gratuity under the Payment of Gratuity Act, 1972. He retires on September 10, 1998, after rendering service for 35 years and seven months. The last-drawn salary was Rs. 2,700 per month. Calculate the amount of gratuity chargeable to tax. (3 marks)

c) On April 1, 1998, Everrise Ltd owns plants A, B, C and D (rate of depreciation -- 25 per cent). The depreciated value of the block as on April 1, 1998, is Rs. 4,60,000. On June 14, 1998, plant E, which was initially purchased for Rs. 51,000 fo r conducting scientific research, is transferred from the laboratory to the factory. No other asset is purchased or sold. Find out the written-down value (WDV) as on March 31, 1999. (3 marks)

d) When is `urban land' not treated as an `asset' under the Wealth Tax Act, 1957? (3 marks)

e) What is `block of assets' for the purpose of charging depreciation? (3 marks)

2(a)Compute the income under the head `income from house property' from the particulars shown in Table 1.

b) When is an individual a resident, but not ordinarily resident in India? (5 marks)

3(a) Explain the provisions of amortisation of preliminary expenses under Section 35D of the Income-Tax (I-T) Act, 1961.

b) Elucidate the amended provisions relating to set-off and carry forward of unabsorbed depreciation under the head `profits and gains of business or profession'. (7 marks)

4(a) ``Capital gain arises only on sale of a capital asset''. Comment on this statement. (5 marks)

b) Rustam, the general manager of Ferrous Ltd, retired on December 31, 1998, after 30 years of service. The particulars of his income are as follows:

i) salary -- Rs. 8,000 per month from January 1, 1998; house-rent allowance -- Rs. 3,000 per month from January 1, 1998;

ii) medical expenses reimbursed by employer: Rs. 21,000 for the period from April 1, 1998 to December 31, 1998, which includes Rs. 5,000 paid to a government hospital;

iii) the employer provides him a car of more than 16 HP for official and personal use. The expenses of running and maintenance of car and salary of a driver for official use was borne by the employer;

iv) Rustam contributes 22 per cent (12 per cent regular and 10 per cent additional voluntary contribution) to a recognised provident fund and the company matches his regular contribution of 12 per cent;

v) he has invested Rs. 20,000 in the ULIP scheme of UTI and Rs. 10,000 in the public provident fund. He paid Rs. 8,000 towards life insurance premium on policy for a sum assured of Rs. 60,000;

vi) he lives in a rented house in Delhi and pays Rs. 4,000 per month as rent;

vii) he received Rs. 1,50,000 as gratuity. He is not covered by the Payment of Gratuity Act, 1972; and

viii) he received Rs. 1,60,000 for encashment of leave, being 16 months' leave not availed of.

Compute Rustam's income for the assessment year (AY) 1999-2000. (10 marks)

5) Compute the net wealth of Kameshwar for the AY 1999-2000 from the following Schedule III value:

i) house property let out for commercial purposes for 290 days during the previous year -- Rs. 17,00,000;

ii) gold ornaments for personal uses -- Rs. 18,00,000;

iii) Commercial complex in New Delhi -- Rs. 40,00,000;

iv) furniture made of costly wood -- Rs. 2,00,000;

v) Urban land situated 2 km away from the municipal limits of Delhi -- Rs. 72,50,000;

vi) residential house allotted to a full-time finance manager whose gross annual salary is Rs. 2,40,000 -- Rs. 18,40,000;

vii) house property which is used by Kameshwar for his business purposes -- Rs. 19,26,000;

viii) farm house situated within 13 km from the municipal limits of Mathura -- Rs. 17,60,000;

ix) coparcenary interest in his HUF properties -- Rs. 1,80,000;

x) share of net wealth of a partnership firm in which he is one of the partners -- Rs. 17,65,000; and

xi) jewellery gifted by Kameshwar to his married daughter -- Rs. 1,60,000. (15 marks)

Suggested answers

The paper is on expected lines. Question 4(a) is theory-based, and given the due weightage of marks. Question 4(b) is slightly tricky. It provides nine months' figures for the previous year instead of the 12 months, which students normally consider for c alculation/computation of income. Question 1 tests the students on the basic provisions of the Act. In all, by giving small questions carrying three/five marks, the paper-setters have covered almost the entire syllabus -- a healthy sign indeed.

A look now at the suggested answers.

1(a) i) Shifting a plant to another place is not a regular event and the cost involved would be a capital expenditure of the assessee, as held in Sitalpur Sugar Works Ltd vs CIT (1963 49 ITR 160 SC).

ii) The annual sum paid for use of goodwill is a revenue expenditure (Vithaldas Thakordas & Co vs CIT (1946 14 ITR 822 Bombay).

iii) Payment of royalty correlated with production is a revenue expenditure (Mewar Sugar Mills Ltd vs CIT -- 1973 87 ITR 400).

b) Fifteen days' salary for each year of completed service or part thereof in excess of six months will be taken. In this case, 18 months' salary for 36 years of service (rounded off) will be payable to employee Ashok. The amount will be Rs. 56,076 (2700 x 15 x 36/26 working days in a month).

Sec. 10(10) says that least of the following as exempt from tax: i) monetary ceiling of Rs. 3.50 lakhs; ii) actual amount received as gratuity (Rs. 2.05 lakhs in this case); and iii) 15 days' salary for each year of completed service (that is, Rs. 56,076 ).

The receipt of Rs. 2.05 lakhs will be reduced by Rs. 0.56 lakhs and the balance of Rs. 1.49 lakhs will be liable to tax.

c) Where an asset is used for scientific research and the entire sum has been allowed as a deduction under Sec. 35, then, upon transfer of such asset to the assessee's regular business, it would be included in the block with `nil' value, as the entire co st would have been allowed as an expenditure well before this inclusion. The opening WDV of Rs. 4.60 lakhs will be the value on which depreciation K 25 per cent will be claimed resulting in WDV of the asset in March 1999 K Rs. 3.45 lakhs.

d) Urban land is not an asset under the Wealth Tax Act, 1957 in the following situations: i) on which construction is not permissible under any law which is in force; ii) a building has been constructed on the land with the appropriate authority's appro val; iii) for industrial purpose -- which is exempt from tax for two years -- even if unused; and iv) kept as stock-in-trade will not invite wealth tax levy for a period of 10 years from the date of acquisition.

e) Sec. 2(11) says that block of assets would mean group of assets falling within a class of assets in respect of which the same rate of depreciation is prescribed. Assets with the same rate of depreciation will be grouped and all additions during the ye ar less deletions (arising because of transfer) will be reckoned for computing the depreciation.

2) (a) The computation of income from house property is shown in Table 2.

b) An individual who has remained in India for 182 days or more during the previous year -- but could not be categorised as resident in India in nine out of the 10 years preceding the previous year and who has not remained in India excee ding 730 days in seven previous years preceding the previous year -- will be known as not ordinarily resident.

In a nutshell, if an individual remains out of India for two consecutive years, then for the next 10 years he will be not ordinarily resident.

3) a) The Finance (No. 2) Act, 1998 has inserted a proviso to Sec. 35 D, whereby preliminary expenses incurred after March 31, 1998, will be deductible in five-yearly instalments as against the earlier 10-yearly instalments. Similarly, the quantum of exp enditure will be limited to 5 per cent of the project cost as against 2.5 per cent prescribed prior to the amendment. In the case of a company, the capital employed in the business of the company will be taken instead of the project cost if the assessee opts for it.

The preliminary expenses include those on feasibility and project reports, market survey and engineering service expenses of the assessee. Legal charges for drafting agreements relating to setting up or conduct of the business will also be included.

For companies, legal charges for drafting memorandum and articles of the company, printing of such documents, registration fees and expenses, including underwriting and brokerage charges in connection with the issue of shares and debentures, will be incl uded in preliminary expenses.

b) Depreciation is an incentive given under the Income-Tax (I-T) Act, 1961. There is controversy on whether the claim is optional or compulsory. The controversy apart, the following are the basic principles in regard to set off and carry forward of depre ciation:

i) the depreciation will be chargeable against the profits and gains of the business to which it relates. In case the profits of the business are not sufficient to absorb the entire depreciation, then, to the extent of the profits it will be claimed;

ii) the balance of the depreciation can be set off against profits of any business or profession carried on by the assessee and assessable for that assessment year (AY);

iii) if the business or profession head could not absorb the depreciation in full, then such depreciation shall be set off against the income under any other assessable head;

iv) if the depreciation cannot still be claimed in full, it will be carried forward for set off against any business/profession carried on by the assessee in the subsequent year;

v) this carry forward for set off against any other head of income in the future years is, however, limited to eight assessment years. The only precondition -- that the business to which such depreciation relates must be continued to be carried on b y the assessee -- has been dispensed with in the Finance Bill, 2000.

4) a) Capital gain can arise upon transfer of capital asset and not necessarily only upon sale of such asset. The statement given covers only a situation where capital gain could arise and the universal statement should be ``capital gain will arise upon transfer of capital asset''.

One of the pre-conditions for capital gain is that the asset transferred must be a capital asset covered by Sec. 2(14) and it must be transferred as specified in Sec. 2(47).

Exchange, relinquishment and even compulsory acquisition of capital asset could result in capital gain because the word `transfer' encompasses a wide spectrum of transactions.

b) The statement of Mr. Rustam's total income and the computation of his taxable income are shown in Table 3. The assessee can claim rebate under Sec. 88 in respect ULIP (Rs. 20,000), PPF (Rs. 10,000), LIC (Rs. 6,000) and RPF contribution of Rs. 15,840 ( 22 per cent) on the tax due.5) i) A residential house property when let out for a minimum period of 300 days is exempt from wealth tax levy. In this case, it is let out for 290 days only, hence, the house property let out is chargeable to wealth-tax. How ever, a commercial complex is exempt from wealth-tax levy without any limitation on the let-out time period during the previous year. The question says that the house property is let out for commercial purpose, hence, assuming it as residential property, it is liable for inclusion in the net wealth.

ii) Gold ornaments meant for personal use is subject to wealth-tax levy.

iii) A commercial complex is exempt from wealth tax under Sec. 2(ea)(i)(5).

iv) Furniture is exempt from wealth tax.

v) Urban land within 8 km from the local limits of a municipality is chargeable to wealth tax.

vi) A house property let out to an employee whose annual income is less than Rs. 5 lakhs is not chargeable to wealth tax.

vii) Property used for own business is also not chargeable to wealth tax under Sec. 2(ea)(i)(3).

viii) Farm houses situated within 25 km from the local limits of a municipality are chargeable to wealth tax.

ix) Coparcenary interest in HUF properties is not a wealth chargeable to tax in the hands of the coparcener.

x) Share of net wealth in a partnership firm computed in accordance with part E of schedule III is chargeable to wealth tax.

xi) Jewellery gifted by an assessee to a married daughter cannot be included in the net wealth, as the assessee would have parted with the asset and there is no deeming provision for taxing the same.

The chargeable net wealth would be Rs. 1,42,75,000.