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Lacking in punch -- II

V. K. Subramani examines the December 1999 CS (Final) paper on direct taxes

DISTINGUISH between `revision of an order' and `rectification of an order' under the I-T Act.

b) What is the effect of an administrative circular issued by the Central Board of Direct Taxes (CBDT) giving extra-legal benefits to tax-payers? Is it enforceable against the I-T department when such a circular has not been adhered to in assessment. Dis cuss. (8 marks each)

6(a) Briefly summarise the tax implications of mergers/amalgamations. (6 marks)

b) Explain the areas of tax planning in respect of employees' remuneration. (10 marks)

7) ``An entrepreneur may form a partnership firm or a limited company to share the earnings from the venture in different ways''. Give a comparative analysis of tax implications of the decision from the point of view of: i) firm and its partners; and ii) company and its directors. Explain with the help of a suitable example, by making your own assumptions. (16 marks)

8(a) A company has the following liabilities as on March 31, 1999: Income-tax -- Rs. 5,00,000; Wealth-tax --Rs. 60,000; Loan -- Rs. 2,00,000 (for purchase of a car); Overdraft -- Rs. 1,50,000 (for financing working capital); Loan -- Rs. 20,00 0 (taken to invest in shares of other companies); Outstanding wages -- Rs. 6,000 (pertaining to accounting year 1996-97).

Specify debts deductible while computing net wealth.

b) On March 31, 1999, the value of assets as per the Wealth Tax Act, 1957 is less than the amount of debts deductible. Specify whether negative net wealth can be set-off in the following year.

c) Specify the instances of deemed assets taxable in the case of a company.

d) Discuss the rules regarding valuation of business assets disclosed/not disclosed in the balance-sheet. (4 marks each)

Suggested answers

5) (a) `Revision of order' would mean changes made because of Sec. 263 or 264 or the decision/direction of the appellate authorities. `Rectification of an order' would mean an error in the order itself, or a statutory clarification/amendment having effec t on the assessment already made.

Sec. 154 deals with rectification of mistakes in an order and Sec. 155 deals with other amendments to the order because of various reasons. Students have to elaborate on these issues.

b) Under Sec. 119, the CBDT can issue orders, instructions and directions to income-tax authorities for the proper administration of the Act. Such authorities shall observe such orders, instructions and directions in discharge of their duties. However, t he order of CBDT cannot be to give a direction for a particular case/assessment and also it cannot interfere with the discretion of the CIT (Appeals) in the exercise of his appellate functions.

As held in CWT vs Vasudeo V. Dempo (1992 196 ITR 216 SC), circulars issued by the CBDT are binding on the departmental officers. Further, even if the direction contained in the circular deviates from the provisions of the Act, they are binding on the off icers (Ellerman Lines Ltd vs CIT 82 ITR 913). However, circulars cannot enlarge the provisions of the Act and circulars which are in force in the year of assessment will have to be applied and circulars issued subsequent to the relevant period cannot be applied for earlier years unless specified so.

In effect, circulars are enforceable against the Department when it is not adhered to in the assessment.

6) a)Though the term mergers and amalgamations is common now, it is `de-mergers' and `reorganisations' that are in vogue, because the company which comes into existence can have the combined benefits of the erstwhile entities and enjoy tax incentives wit hout any difficulty.

Where an assessee transfers shares in an Indian company for de-merger, then the shares obtained from the resulting company will replace the earlier holding and there would not be any tax liability. Also, transfer of assets by the companies for the purpos e of de-merger will not be liable to capital gain tax.

From the corporate angle, the deductions -- such as Sec. 35 A, relating to deduction of patent, copyright and deduction under Sec. 35 B towards expenditure on knowhow -- can be amortised by the resulting company as would have been claimed b y the de-merged companies but for the de-merger.

Depreciation allowance also will be available to the old and the new companies based on the number of days the depreciable assets were held by them in the previous year.

Even expenditure relating to de-merger can be amortised in five annual instalments because of the new Sec. 35 DD brought in by Finance Act, 1999. Earlier, instead of straightforward mergers by complying with Sec. 72 A, a concept of reverse merger was fol lowed to circumvent the legal hurdles contained in the Act. Now that the statute recognises de-mergers with all fiscal incentives, the reverse merger concept may not be attractive.

b) In regard to tax planning of employees' remuneration, the following areas can be considered:

a) house-rent allowance should be paid to the employees by a realistic appraisal method so that the rent paid by them is compensated by the exemption available in the allowance received;

b) even if employees remain in their own house, the company should take the house on lease-basis and either pay HRA to the employee or provide it as rent-free accommodation based on the situation;c) employees can be given housing loan and the house can b e taken on lease basis before doing (b) above;

d) since there is no specific definition about `uniform', employers can pay uniform allowance to employees which is exempt from tax;

e) since transport of allowance up to Rs. 800 is tax free, the employer can pay the transport allowance;

f) when the motor car owned by the employees is used for both official and personal purposes, only the portion of expenses borne by the employer is taxable as perquisite;

h) training of employees by sponsoring them to various courses will be free from tax; and

i) reimbursement of expenses incurred in discharge of duties will be tax-free, and if the job of the employee is such that he has to travel frequently it is better to reimburse the expenses than fixing the allowances as the liability to tax would arise i f it is a fixed allowance. For example, when development officers of the LIC are paid `additional conveyance allowance', it is saddled with tax liability because there is no such allowance in the Act that is eligible for exemption.

7) An entrepreneur can form either a partnership or a limited company to share the earnings. However, tax laws have there own domain which go to influence the structure to be opted for. A partnership firm can plan the appropriation of income by means of working partners' salary or interest on capital. And once a tax is suffered on the income without any further tax liability, the sums can be withdrawn. However, in case of a company, if the dividend is declared, tax under Sec. 115 O has to paid. A partne rship firm can have fluctuating capital with the introduction/withdrawal of funds by the partners, whereas in the case of a company, share capital remains a locked-up sum with the enterprise.

8 a) The income-tax and wealth tax liabilities are not deductible as they are not incurred directly in relation to assets chargeable to wealth tax.

Loan of Rs. 2 lakhs on car is eligible for deduction as the car is chargeable to wealth tax.

Overdraft taken for financing working capital is circulating in business, hence, for computing the wealth, it is deductible.

Loan towards purchase of shares is not includible as the shareholding is not an asset. Outstanding wages is a deductible debt.

b) Net wealth, as on the valuation date, is chargeable to tax. If the net wealth is negative, then there will be no tax in that year. However, it cannot go to reduce the net wealth of the subsequent year by means of set off procedure.

c) Sec. 4 contains certain situations where the net wealth of the assessee will include certain assets. In respect of a company, if it is a partner in a firm or AOP, the value of interest in the firm or AOP will be computed in accordance with Schedule II I, and the appropriate fraction will be taken as the company's share of net wealth.

Where any asset is obtained by the company under an irrevocable transfer, it will be included. Similarly, where the company is a member in a co-operative society, company and so on, and if a building is allotted, then such building will be includible in the net wealth. Similarly, where the company obtains possession of immovable property covered by Sec. 53 A of the Transfer of Property Act, then that also will be included in net wealth as deemed asset of the company.

d) Where assets are not disclosed in the balance-sheet, then, presuming them as disclosed, they will be valued in accordance with Schedule III of the Wealth Tax Act and includible in the net wealth.

If disclosed in the balance-sheet, the WDV will be taken as value for valuation of business for depreciable asset. In case no depreciation is admissible, the book value will be taken. In respect of inventory, the value disclosed for income-tax will be ad opted. Even if disclosed, certain items on the assets side of the balance-sheet will not be considered -- advance income-tax, assets on which wealth tax is not payable, non-business assets, profit and loss account, debit balance, and so on.

On the liability side, capital employed, reserves, future or contingent provisions, non-business liability and debts towards assets on which wealth tax is not payable will be excluded.

(Concluded)