Raju

Income of Other Persons, Included in Assessee’s Total Income – CA Final DT Question Bank is designed strictly as per the latest syllabus and exam pattern.

Income of Other Persons, Included in Assessee’s Total Income – CA Final DT Question Bank

Question 1.
State the situations under which the clubbing provisions of income-tax operate as to the incomes of husband and wife. [CA Final May 2010] [4 Marks]
Answer:
As per section 64(1), in computing the total income of any individual, there shall be included all such income arising directly or indirectly to the spouse by way of –

1. salary, commission, fees or any other form of remuneration, whether in cash or in kind, from a concern in which such individual has substantial interest;
2. income from any asset transferred to the spouse by the individual otherwise than for adequate consideration or in connection with an agreement to live apart.

As per section 27 (i), an individual who transfers, otherwise than for adequate consideration, any house property, to his or her spouse, not being a transfer in connection with an agreement to live apart, is deemed to be the owner of the house property so transferred. Accordingly, in such a case, the income from house property would be taxable in the hands of the Individual.

Question 2.
Mrs. E, wife of Mr. F, is a partner in a firm. Her capital contribution in the firm as on 01-04-2020 was ₹ 5 lakhs, out of which ₹ 3 lakhs was contributed out of her own sources and ₹ 2 lakhs was contributed out of gift from her husband. As further capital was needed by the firm, she further invested ₹ 2 lakhs on 01.05.2020 out of the funds gifted by her husband. The firm paid interest on capital of ₹ 80,000 and share of profit of ₹ 60,000 for the financial year 2020-21. Advise Mr. F as to the applicability of section 64(1)(iv) and the manner thereof in respect of the above j referred transactions. [CA Final Nov. 2010] [5 Marks]
Answer:
Section 64(1)(iv) provides for the clubbing of all such income as arises, directly or indirectly, to the spouse of an individual from assets (other than house property) transferred directly or indirectly to the spouse by such individual otherwise than for adequate consideration or in connection with an agreement to live apart.

Further, as per Explanation 3 to section 64(1), for the purpose of clubbing under section 64(1)(iv), where the assets transferred are invested by the spouse as capital contribution as a partner in a firm, proportionate interest on capital will be clubbed with the income of the transferor.

Such proportion has to be computed by taking into account the value of the aforesaid investment as on the first day of the previous year to the total investment by way of capital contribution as a partner in the firm as on that day.

Now in view of the above provision, interest received by the spouse Mrs. E from the firm shall be included in total income of Mr. F to the extent of ₹ 32,000 i.e., ₹ 80,000 × ₹ 2,00,000/₹ 5,00,000. (assumed that rate of interest on capital contributed by Mrs. E does not exceed 12% p.a.). Any amount further invested in the-business of the firm during the mid of the year by the spouse out of the money gifted by her husband shall be ignored for the proportion of the income to be clubbed for the year.

Share of profit amounting to ₹ 60,000 is exempt u/s 10(2A). The provisions of section 64 will not apply, if the income from the transferred asset itself is exempt from tax.

Practical Questions

Question 3.
Mr. Ashish has gifted a house property valued at ₹ 50 lakhs to his wife, Mrs. Asha, who in turn has gifted the same to Mrs. Swati, their daughter-in-law. The house was let out at ₹ 25,000 per month throughout the year. Compute the total income of Mr. Ashish and Mrs. Swati. Will your answer be different if the said property was gifted to his son, husband of Mrs. Swati? [CA Final May 2013] [4 Marks]
Answer:
As per section 27, where any house property is transferred by an individual to his spouse otherwise than for adequate consideration or not being a transfer in connection with an agreement to live apart, the individual shall be deemed to be the owner of the house property so transferred.

Further, as per section 64(1)(vi), income arising to the son’s wife from assets transferred, directly or indirectly, to her otherwise than for adequate consideration would be included in the total income of such individual.

In light of above provision, Mr. Ashish would be the deemed owner of the house property transferred to his wife Mrs. Asha without consideration. Income from let-out property of ₹ 2,10,000 [i.e., ₹ 3,00,000, being the actual rent calculated at ₹ 25,000 per month less ₹ 90,000, (deduction u/s 24 @ 30%)] arising to Mrs. Swati, being Mr. Ashish’s son’s wife, shall be clubbed in the income of Mr. Ashish. Such income would not be taxable in the hands of Mrs. Swati.

In case the property was gifted to Mr. Ashish’s son, the clubbing provisions u/s 64 would not apply, since the son is not a minor child. Therefore, the income of ₹ 2,10,000 from letting out of property gifted to the son would be taxable in the hands of the son.

Note: Section 56(2)(x) would not be attracted in the above case, since the receipt of property was from a “relative” of such individual. Therefore, the stamp duty value of house property would not be chargeable to tax in the hands of the recipient of immovable property, even though the house property was received by her or him without consideration.

The first part of the question can also be answered by applying the provisions of section 64(1)(vi) directly to include the income of ₹ 2,10,000 arising to Mrs. Swati in the hands of Mr. Ashish, since section 64(1)(vi) provides for clubbing of income arising to son’s wife even from indirect transfer of assets to her by her husband’s parent, without consideration. Gift of house property by Mr. Ashish to Mrs. Swati, via Mrs. Asha, can be viewed as an indirect transfer by Mr. Ashish to Mrs. Swati.

Question 4.
Raju gifted amount of ₹ 5,00,000 to the wife of his brother which was used by her for the purchase of a house and simultaneously, on the same day, Raju’s brother gifted shares owned by him in a foreign company worth ₹ 5,00,000 to the minor son of Raju. What will be the impact of i such transfers in the hands of both the transferors and the transferees? [CA Final May 2014, Nov 2013, May 2011] [4 Marks]
Answer:
In the given case, Raju gave a gift of ₹ 5,00,000 to his brother’s wife for the purchase of a house by her and simultaneously, his brother gave a gift of shares owned by him in a foreign company worth ₹ 5,00,000 to I the minor son of Raju. These transfers are in the nature of cross transfers.

In the case of CIT vs. Keshavji Morarji (1967), the Supreme Court held that if two transactions are inter-connected and are part of the same transaction in such a way that it can be said that the circuitous method was adopted as a device to evade tax, the implication of clubbing provisions would be attracted.

Accordingly, the income arising to the wife of Raju’s brother from the house property would be included in the total income of his brother and the dividend from shares transferred to Raju’s minor son would be included in the total income of Raju because both Raju and his brother are the indirect transferors of the income yielding assets to their minor child and spouse, respectively, with an intention to reduce their burden of taxation.

However, as per section 56(2)(x), since husband’s brother and father’s brother fall within the definition of “relative”, the sum of money and property, respectively, received from them would be exempt in the hands of the concerned transferee.

Question 5.
Examine the correctness of the claim made by the assessee in the below mentioned case.

Mr. Johny has business income of ₹ 4,28,000 and salary income of ₹ 1,30,000 for the financial year 2020-21. His minor son has agricultural income of ₹ 1,00,000 for the same year. The Assessing Officer clubbed the agricultural income of minor son for determining the income tax liability of Mr. Johny. Mr. Johny contends that the agricultural income is exempt u/s 10(1) and not covered by section 2(24) and hence, should not be clubbed even for adopting higher income-tax rate. [CA Final May 2015] [4 Marks]
Answer:
The facts of the case are similar to Suresh Chand Talera v. Union of India (2006) (M.P.) in which the High Court observed that even though agricultural income has not been specifically included in section 2(24), it does not mean that agricultural income is not an “income”, because the definition of income given u/s 2(24) is inclusive and not exhaustive.

Further Section 10(1) of the Act provides that in computing the income of the previous year of a person, “agricultural income” shall not be included. Thus, Section 10(1) makes it clear that agricultural income is income but by express provision therein, agricultural income has been excluded from the total income of the assessee for the purpose of levy of income-tax.

Section 4(1), which is the charging section, provides that while the total income of person is to be determined, the rate at which income-tax will 1 be paid on such income will be stipulated in the relevant Finance Act. The Annual Finance Act provides [under Chapter II section 2] that the net agricultural income shall be taken into account in the manner provided therein for the purpose of determining the rates of income-tax applicable to the income of the assessee.

Therefore, in view of the above provisions, the High Court held that agricultural income of the minor son of the assessee has to be clubbed in the income of the assessee for the purpose of determining the rate of income-tax applicable to the assessee.

Applying the above rationale of High Court ruling, the contention of Mr. Johny is incorrect. The agricultural income of his minor son, has to be included in the income of Mr. Johny for rate purposes, since the words “income as arises or accrues to his minor child” used in section 64(1A) includes agricultural income also.

Question 6.
Mr. Ravi has gifted his only house property to his wife, Mrs. Ravi, and his minor married daughter, Mrs. Divya. The Assessing Officer has served a notice of demand on Mr. Ravi for payment of tax for the income derived from the said house property. Examine the validity of the Assessing Officer’s action. [CA Final May 2016] [2 Marks]
Answer:
As per sec. 21 (i), if an individual transfers any house property to his or her spouse (except with an agreement to live apart) or to a minor child (except to minor married daughter), otherwise than for adequate consideration, the transferor in that case is deemed to be the owner of the property so transferred.

But here, in this case, the assessee Mr. Ravi has gifted his house property to his wife Mrs. Ravi and his minor married daughter Mrs. Divya. So Mr. Ravi will be taxable only to the extent of Mrs. Ravi share in the house property as he is the deemed owner as per sec. 21 (i). And for the share of minor married daughter, Mr. Ravi shall not be the deemed owner and therefore, he shall not be taxable in respect of share of minor married daughter in the house property.

Further as per sec. 64(1 A), all income which accrues or arises to a minor shall be clubbed in the income of that of his parent whose total income excluding the income clubbed under this sub-section) is greater except when the minor is suffering from any disability u/s 80U or when the income accrues or arises to a minor child is by way of manual work done by him or by application of his/her skill, talent or specialized knowledge and experience.

Therefore, the income of minor married daughter shall also be clubbed in the hands of Mr. Ravi by assuming that his income is higher than the income of Mrs. Ravi (excluding such income). But he shall be eligible for exemption upto ₹ 1,500 as per sec. 10(32) in respect of minor child income clubbed in his hands.

So the contention of the A.O. is valid in this case.

Question 7.
Parmatma settled 1/4th share of his property under a trust for the education and maintenance of his minor daughter, Moni. Under the terms of the trust deed, the income accruing to the trust, after meeting the expenses of maintenance and education of Moni, was to be accumulated and paid over to her on her attaining majority. The Assessing Officer assessed the income arising from 1/4th share of the property, settled for the benefit of Moni, in the hands of Parmatma. Examine the correctness of the assessment. [CA Final May 2016, Nov. 2013, May 2009] [5 Marks]
Answer:
As per section 64(1A), the income of a minor child shall be clubbed in the total income of that parent, whose total income before such inclusion is higher.

Now the Supreme Court in the case of CIT v. M.R. Doshi (1995), held that clubbing of income is applicable only where the income accrues to the minor during his minority and it is enjoyed by the minor during the i period of minority. Thus, where a trust is created for the benefit of a minor child and the income from the trust was to be accumulated until the child attained majority, the clubbing provisions would not get attracted, since 1 no benefit accrues to the minor child during the period of his minority.

However, in the given question, the minor daughter Moni is eligible for the benefits during her minority, since income from the trust is being used for meeting her education and maintenance expenses. Only the remaining income is to be accumulated and paid over to her on her attaining majority. Therefore, since benefit under the terms of the trust deed is accruing, even though to a limited extent, the above decision of Supreme Court cannot be applied, in full, in this case.

Only so much of income as is used for meeting the education and maintenance expenses of Moni during the current year should be clubbed in the hands of Parmatma after providing for an exemption of ₹ 1,500 under section 10(32) ; assuming that Parmatma’s total income is greater than his spouse’s total income. The income accumulated and to be paid to her op her attaining majority shall not be clubbed.

Thus the contention of the Assessing Officer is partly correct.

Question 8.
In 2014, Brijesh borrowed ₹ 15 lakhs at 15% interest per annum from Ashok for his business purpose. This loan has not been repaid so far by Brijesh. His average bank balance in current account was around ₹ 7 lakhs on which the bank was not paying him any interest. On 1st June, 2020 Brijesh’s wife, Tina borrowed from him ₹ 7.50 lakhs repayable on demand at 7.5% interest per annum. She lent this money and received interest @ 18% per annum. In course of assessment of Brijesh, the A.O. disallowed 50% of this interest paid to Ashok on the ground that the loan to the extent of 50% has been diverted for non-business purpose i.e. for lending to wife. Further, interest earned by Tina by advancing ₹ 7.50 lakhs was included in the hands of Brijesh by invoking section 64(1 )(iv). Examine the correctness of the action of the Assessing Officer. [CA Final Nov 2017] [4 Marks]
Answer:
There are two issues involved in the case which are dealt with as follow:
1. Advancing a loan is not a transfer of asset, so no clubbing shall be done for the interest earned on further advancing of loan, hence section 64(1)(iv) shall not be attracted. Hence, interest income earned by Tina @18% from the amount borrowed from the Brijesh shall not be clubbed.

2. As 50% of interest expense is not incurred wholly and exclusively for the purpose of business or profession, the contention of A.O. to disallow 50% of the interest paid to Ashok on the ground that the loan to the extent of 50% has been diverted for non-business purpose i.e. for lending to wife is correct in law as per sec. 37(1).

Tax On Conversion of Unaccounted Money – CA Final DT Question Bank is designed strictly as per the latest syllabus and exam pattern.

Tax On Conversion of Unaccounted Money – CA Final DT Question Bank

Question 1.
Kala purchased a residential flat from her friend Bala at ₹ 10 lakhs in the city of Jaipur on 3rd October, 2020. The value determined by the Stamp Duty Authority for stamp duty purpose amounted to ₹ 15 lakhs. Bala had purchased the flat on 1st August, 2019 at a cost of ₹ 3.50 lakhs. Kala sold the flat for ₹ 20 lakhs on 30th March, 2021.

Determine the effect of the above transactions on the assessments of Bala and Kala for assessment year 2021-22, assuming that value for stamp duty purpose in case of the second sale was not more than the sale consideration. [CA Final May 2010] [5 marks]
Answer:
Tax treatment in the hands of the seller, Mr. Bala:
As per Sec. 50C, where the stamp duty value exceeds 110% of the actual sale consideration, the stamp duty value shall be deemed to be the full value of consideration received or accruing as a result of transfer of a capital asset, being land or building or both for computing capital gain.

In the instant case, Bala sold the residential flat at Jaipur to his friend Kala for ₹ 10 lakhs, whereas the stamp duty value was ₹ 15 lakhs which exceeds 11096 of actual sale consideration. Therefore, stamp duty value shall be deemed to be the full value of consideration for sale of the property. Therefore, short-term capital gains arising to Bala for A.Y. 2021-22 will be ₹ 11.50 lakhs (i.e. ₹ 15 lakhs – ₹ 3.50 lakhs).

Tax treatment in the hands of the buyer, Ms. Kala:
As per Sec. 56(2)(v), if an immovable property is received by an individual for inadequate consideration, and the stamp duty value exceeds the consideration by more than higher of ₹ 50,000 or 1096 of the consideration, the difference of stamp duty value and the consideration shall be taxable as “Income from other sources”.

Income from other sources
In this case, since the stamp duty value exceeds the consideration by more than higher of ₹ 50,000 or 10% of the consideration, the difference of ₹ 5 lakhs (i.e. ₹ 15 lakhs – ₹ 10 lakhs) shall be taxable in the hands of Ms. Kala as “Income from other sources”.

Capital Gains
Kala sold the flat for ₹ 20 lakhs on 30th March, 2021. Section 49(4) provides that where the capital gain arises from the transfer of such property which has been subject to tax u/s 56(2)(x), the cost of acquisition of the property shall be deemed to be the value taken into account for the purpose of section 56(2)(x).

Therefore, the cost of acquisition of the flat, in this case, would be ₹ 15 lakhs. The short-term capital gain of Kala from sale of the property is, therefore, ₹ 5 lakhs (i.e. ₹ 20 lakhs – ₹ 15 lakhs).

Question 2.
Compute the income of Mr. Y chargeable under the heads “Capital Gains” and “Income from other sources” for Assessment Year 2021-22. Mr. X transferred his’residential house to Y for ₹ 10 lakh on 1st April, 2020. The value of the said house as per Stamp Valuation Authority was ₹ 16 lakh. Mr. Y is a childhood friend of Mr. X.

Mr. X gifted a plot of land (purchased by him on 1st August, 2017) to Mr. Y on 1st July, 2020. The value as per Stamp Valuation Authority is ₹ 8 lakh. Mr. Y sold the land on 1st March, 2021 at ₹ 15 lakh.
Cost Inflation Index – 2017-18 : 272; 2020-21 : 301. [CA Final Nov. 2011] [5 Marks]
Answer:
Computation of income for the A. Y. 2021-22

Notes:
(1) Transfer of immovable property for inadequate consideration attracts the provisions of section 56(2)(x), if the stamp duty value exceeds the consideration by more than higher of ₹ 50,000 or 10% of the actual consideration. Since, in this case, the stamp duty value exceeds the consideration by more than higher of ₹ 50,000 or 10% of the actual consideration, the difference of ₹ 6 lakhs between stamp duty value and actual consideration will be taxable u/s 56(2)(v).

(2) Section 56(2)(x) is also attracted in respect of transfer of immovable property without consideration, if the stamp duty value of such property exceeds ₹ 50,000. In this case, since Mr. Y has received a plot of land from Mr. X, a non-relative, without consideration and the stamp duty value of ₹ 8 lakhs exceeds ₹ 50,000, the entire stamp duty value of ₹ 8 lakh is chargeable to tax u/s 56(2)(v).

(3) Section 49(4) provides that where the capital gain arises from the transfer of such property which has been subject to tax u/s 56(2) (x), the cost of acquisition shall be deemed to be the value taken into account for the purpose of section 56(2)(.x). Therefore, ₹ 8 lakhs would be the cost of acquisition of land.

(4) The resultant capital gains will be short-term capital gains since for calculating the period of holding, in a case where cost is computed under section 49(4), the period of holding of the previous owner is not to be included. As per section 2(42A), the period of holding will include the period of holding of the previous owner only in the case 1 of a capital asset which becomes the property of the assessee in the circumstances mentioned in section 49(1) [i.e., where cost to previous owner would be deemed as the cost of acquisition].

Question 3.
Mr. X borrowed on Hundi, a sum of ₹ 30,000 by way of bearer cheque on 12.06.2020 and repaid the same with interest amounting to ₹ 35,000 by account payee cheque on 13.07.2020.

The Assessing Officer (AO) wants to treat the amount borrowed as income during the previous year. Is the action of AO valid? [CA Final May 2012] [3 Marks]
Answer:
As per section 69D, where any amount is borrowed on a hundi or any amount due thereon is repaid otherwise than by way of an account payee cheque drawn on a bank, the amount so borrowed or repaid shall be deemed to be the income of the person borrowing or repaying the amount for the previous year in which the amount was so  borrowed or repaid, as the case may be.

In this case, Mis X has borrowed ₹ 30,000 on Hundi by way of bearer cheque and therefore, it shall be deemed to be his income for the P Y. 2020-21. So, the action of the Assessing Officer treating the amount borrowed as income dining the previous year is valid in law.

But, since the repayment of the same along with interest was made by way of account payee cheque, the provisions of section 69D shall not be attracted here on repayment.

Question 4.
Mr. Y received the following gifts/amounts during the previous year 2020-21:
(a) Gift of Bullion worth ₹ 51,000 on his Birthday from his friend.
(b) Received a car from his cousin on payment of ₹ 2 Lakhs, FMV of ; which was ₹ 4 Lakhs.
(c) Received cash gift of ₹ 36,000 each from three of his friends A, B & C on 24.09.2020.
(d) In respect of land of Mr. Y compulsorily acquired by Railways in the b year 2018, he received the following amount on 25.12.2020 as Interest on enhanced compensation on the order of the Court,
Relating to Previous Year
2018-19 : ₹ 2,90,000
2019-20 : ₹ 3,50,000
2020-21 : ₹ 2,20,000
(e) 50 shares of Beta Ltd., the FMV of which was ₹ 50,000, on his marriage anniversary from his cousin. He also received 100 shares of Alpha Ltd., the FMV of which was ₹ 70,000 on the date of transfer. This gift was received on the occasion of Diwali. Mr. Sundar had originally purchased the shares on 10.8.2020 at a cost of ₹ 50,000.

(f) On 15th February, 2021, he sold the 100 shares of Alpha Ltd. for ₹ 1,00,000.
You are required to compute the Income of Mr. Y under the head “Income from Other Sources” and Capital gains, if any, for the Assessment Year 2021-22 assuming that he has no other Income. [CA Final May 2012] [7Marks]
Answer:

Notes:
1. Bullion is received without consideration and aggregate FMV exceeds ₹ 50,000 and hence full value of the bullion is taxable u/s 56(2)(x).

2. Car is not included in the definition of ‘property’ as specified in the Explanation to Section 56(2)(x) and therefore nothing shall be taxable.

3. Any sum of money received without consideration and aggregate value if exceeds ₹ 50,000 is taxable u/s 56(2)(x).

4. Interest on Enhanced Compensation is taxable in the year of receipt after a deduction of 50% as provided by section 57 (i.e. ₹ 8,60,000 – ₹ 4,30,000).

5. If shares of any company are received without consideration and aggregate FMV of shares exceeds ₹ 50,000, the whole of such aggregate FMV of shares is taxable u/s 56(2)(x). Although the FMV of shares of Beta Ltd. does not exceed ₹ 50,000, but the aggregate of the FMV of the shares of Alpha Ltd. and Beta Ltd. is ₹ 1,20,000 which exceeds ₹ 50,000. Hence, their aggregate value shall be taxable. Cousins are not included in the definition of relatives for the purpose of sec. 56(2) (.x) and so shares received without consideration from them shall be taken for the purpose of taxability under this section.

6. Section 49(4) provides that where the capital gain arises from the transfer of such property which has been subject to tax u/s 56(2)(v), the cost of acquisition shall be deemed to be the value taken for the purpose of section 56(2)(x). Therefore ₹ 70,000 would be the cost of acquisition in this case.

Question 5.
Discuss the taxability of the following transactions under section 56(2) of the Income-tax Act, 1961:
(i) Bharat is the Karta of Bharat HUF. Sujata, daughter of Bharat is a member of the HUF. She transferred a house property to the HUF without any consideration. The value of the house property for stamp duty purpose is ₹ 10 lakhs.
(ii) JD Private Limited issued 50,000 equity shares of face value of ₹ 10 per share at a premium of ₹ 70 per share. The FMV of the share as per prescribed rule is ₹ 50 per share. [CA Final May 2013] [4 Marks]
Answer:
(i) Where any assessee receives immovable property, being land or building or both, without consideration from its relative (i.e. for HUF – the members of the HUF), the same is not taxable under section 56(2)(x). Since, Sujata is a member of Bharat HUF, she is a “relative” of the HUF. Therefore, if Bharat HUF receives a house property from its member, Sujata, without consideration, the stamp duty value of such property will NOT be taxable in the hands of the HUF.

(ii) Section 56(2)(viib) is attracted in this case since the shares of a closely held company are issued at a premium (i.e., the issue price of ₹ 80 per share exceeds the face value of ₹ 10 per share) and the consideration received by the company exceeds the FMV of the shares.

The consideration received by the company in excess of the fair market value of the shares; i.e. ₹ 15,00,000 [i.e., (₹ 80 – ₹ 50) × 50,000 shares] would be taxable under section 56(2)(viib) as “Income from other sources” in the hands of JD Private Limited.

Question 6.
In the course of scrutiny assessment of Mr. A, the Assessing Officer, on the basis of information available with him, sought an explanation for the source of the expenditure of ₹ 25 lakhs incurred on the wedding of his son. The said expenditure was neither recorded in the books of account maintained nor was the explanation offered by Mr. A satisfactory. What are the consequences? [CA Final May 2013] [6 Marks]

As per section 69C, where an assessee has incurred any expenditure in any financial year and he offers no explanation about the source of such expenditure or part thereof, or the explanation, if any, offered by him is not satisfactory in the opinion of the Assessing Officer, then the amount of such expenditure or part thereof, as the case may be, may be deemed to be the income of the assessee for such financial year.

In this case, the expenditure was neither recorded in the books of account of Mr. A nor the explanation offered by Mr. A was satisfactory. Therefore, the expenditure of ₹ 25 lakhs incurred by Mr. A on the wedding of his son may be deemed by the Assessing Officer as the income of Mr. A as per section 69C.

Practical Question 7:
From the following particulars, compute the gross total income of Mr. Z for the assessment year 2021-22.
(i) Mr. Y transferred his residential house to Mr. Z for ₹ 10 lakh on 1.4.2020. The value of the said house as per stamp valuation authority was ₹ 18 lakhs. Mr. Z is a childhood friend of Mr. Y.
(ii) Mr. Z received a car from his cousin on payment of ₹ 2,50,000, fair market value of which was ₹ 4,00,000.
(iii) Land of Mr. Z was acquired by railways in 2018. On 15.12.2020, he received ₹ 1,70,000 as interest on enhanced compensation on the order of court.
(iv) On a fixed deposit of ₹ 10 lakhs, in a bank, Mr. Z received an interest of ₹ 90,000. He had also borrowed ₹ 50 lakhs from the same bank, on security of the fixed deposit and was liable,to pay ₹ 50,000 by way of interest to the bank. He, therefore, offered the difference between the two amounts i.e. ₹ 40,000 as “Income from Other Sources”. [CA Final Nov. 2014] [4 Marks]
Answer:
Computation of gross total Income of Mr. Z for the A.Y. 2021-22

Question 7.
Discuss the liability of the following receipts, during the year ended 31 st March, 2021, in the hands of Miss Jyoti under the Income-tax Act, 1961:
(i) Gift of ₹ 60,000 in cash from her father’s sister on her birthday.
(ii) Acquired the paintings from grandfather’s younger brother. The FMV of the paintings was ₹ 3 lakhs but the consideration paid was ₹ 2 lakhs.
(iii) Received a car from her friend on payment of ₹ 2,50,000, the market value of which Was ₹ 3,00,000.
(iv) Interest on enhanced compensation on the order of court, from NHAI in respect of her land which was compulsorily acquired, was received ₹ 3,50,000 on 12.11.2020 which includes interest of ₹ 2,00,000 pertaining to previous year 2018-19.
(v) Received cash gift of ₹ 15,000 each from three of her friends. [CA Final May 2016] [4 Marks]
Answer:
(i) As per sec. 56(2)(x), where any assessee receives any sum of money from a person or persons, without consideration in excess of ₹ 50,000, then he shall be taxable for whole of such amount received under “Income from Other Sources”. However, such amount is not taxable if it is received from any relative and here, Miss Jyoti has received gift of ₹ 60,000 in cash from her father’s sister and father’s sister is included in the definition of relative u/s 56(2)(x). Therefore, Miss Jyoti shall not be taxable in this case.

(ii) As per sec. 56(2)(x), any property other than the immovable property received from any person or persons for inadequate consideration shall be taxable, if the difference between the FMV of the property and consideration exceeds by more than ₹ 50,000. The definition of property given under the said section include paintings and therefore, the difference of ₹ 1,00,000 (₹ 3,00,000 – ₹ 2,00,000) shall be taxable.

(iii) As per sec. 56(2)(x), any property other than the immovable property received from any person or persons for inadequate consideration shall be taxable, if the difference between the FMV of the property and consideration exceeds by more than ₹ 50,000. But the definition of property given under the said section does not include car. Therefore the value of car received by Miss Jyoti from her friend shall no be taxable. This case shall also be applicable even if the difference between the FMV of the property and the consideration paid by Miss Jyoti exceeds ₹ 50,000 which is not so in this case.

(iv) Interest on enhanced compensation received on the order of the court shall be taxable in the year in which it is received after providing deduction of 5096 of such interest amount as per Sec. 57(i). Therefore, Miss Jyoti shall be taxable for 50% of the amount received as interest on enhanced compensation i.e. 50% of ₹ 3,50,000 = ₹ 1,75,000 shall be taxable in her hands under the head “Income from Other Sources”.

(v) As per Sec. 56(2)(v) where any assessee receives any sum of money without consideration from any person or persons in excess of ₹ 50,000, then he shall be taxable for whole of such amount received. This means the total amount receives from any person or persons during the whole year shall be aggregated. Miss Jyoti had received ₹ 15,000 each from her three friends which makes the total of ₹ 45,000 (₹ 15,000 × 3) which is less than ₹ 50,000. Therefore, such ₹ 45,000 shall not be taxable in the hands of Miss Jyoti.

Question 8.
Discuss the tax implications u/s 56(2) in respect of each of the following transactions:
(i) Mr. Anaimudi received a painting by Raja Ravi Verma worth 165,000 from his nephew by way of gift on his 25th wedding anniversary.
(ii) Dodabetta’s son transferred shares of Pir Panjal Ltd. to Dodabetta HUF without any consideration. The fair market value of the shares is ₹ 3 lakhs.
(iii) ABC Private Ltd. purchased 8,000 equity shares of Satarupas Private Ltd. at ₹ 72 per share from Ms. Yamuna. The fair market value per share on the date of transaction is ₹ 90. [CA Final Nov 2016] [6 Marks]
Answer:
(i) As per section 56(2)(x), where any assessee receives any property from any person or persons without consideration and the aggregate FMV of such property exceeds ₹ 50,000, then he shall be taxable for whole of the FMV amount of such property under the head ‘Income from Other Sources’.

In this case, Mr. Anaimudi has received paintings, which is included in the definition of property given u/s 56(2)(x), from his nephew worth ₹ 65,000 which exceeds ₹ 50,000 and therefore, he shall be taxable for whole of such amount of ₹ 65,000. However, if such property is received from any relative, then the FMV of the property received shall not be taxable. But, here, Mr. Anaimudi has received paintings from his nephew and definition of relative u/s 56(2)(x) does not include nephew. Therefore, Mr. Anaimudi shall be taxable for ₹ 65,000 worth paintings received from his nephew.

(ii) As per section 56(2)(x), where any assessee receives any property from any person or persons without consideration and the aggregate FMV of such property exceeds ₹ 50,000, then he shall be taxable for whole of the FMV amount of such property under the head ‘Income from Other Sources’.

In this case, Dodabetta HUF has received shares of Pir Panjal Ltd. having FMV of ₹ 3 lakhs from Dodabetta’s son and the shares are included in the definition of property given u/s 56(2) (x). However, such tax liability shall not arise when the property is received from any relative and for HUF, relative means any member of the HUF. Therefore, shares received from Dodabetta’s son shall not be taxable in the hands of Dodabetta HUF as the son is a member of HUF.

(iii) As per section 56(2)(x), where any assessee receives any property front any pet son or persons for inadequate consideration and the aggregate difference between the FMV and consideration of the shares exceeds ₹ 50,000, then such difference between the FMV and consideration of shares shall be taxable in the hands of such assessee under the head Income from Other Sources.

In this case, the FMV of the shares of Satarupas Pvt. Ltd. received by ABC Pvt. Ltd. is ₹ 7,20,000 (8,000 shares × ₹ 90 per share) and the consideration of the shares is ₹ 5,76,000 (8,000 shares × ₹ 72 per share). The difference between the FMV and consideration of the shares of ₹ 1,44,000 (₹ 7,20,000 – ₹ 5,76,000) exceeds ₹ 50,000 and therefore, such difference of ₹ 1,44,000 shall be taxable in the hands of ABC Pvt. Ltd.

Question 9.
The assessee M/s Career Network is a partnership firm comprising of four partners, who have contributed capital in the books of the firm, but failed to explain satisfactorily the source of receipt in their individual hands. The A.O. has proposed to tax the amounts credited in their accounts in the books of the firm as cash credit in the hands of the partnership firm. Is the action of the Assessing Officer valid? [CA Final May 2017] [4 Marks]
Answer:
The issue under consideration is whether capital contribution of the individual partners credited to their accounts in the books of the firm can be taxed as cash credit in the hands of the firm, where the partners have admitted their capital contribution but failed to explain satisfactorily the source of receipt in their individual hands.

As per section 68, if an assessee fails to explain the nature and source of credit entered in its books of account of any previous year, the sum so credited shall be charged tax in the hands of the assessee of that previous year.

The facts of the case are similar to the facts in CIT v. M. Venkateswara Rao (2015), where the Telangana & Andhra Pradesh High Court observed that the amount sought to be treated as income of the firm is the contribution made by the partners to the capital. Where the firm explains that the partners have contributed capital, section 68 cannot be pressed into service.

The Court further observed that when the amount so contributed constitutes the very substratum for the business of the firm, it is difficult to treat the pooling of such capital as cash credit. In the absence of any material to indicate that they are the profits of the firm, the cash credits cannot be assessed in the hands of the firm, though they may be assessed in the hands of individual partners.

Hence, applying the rationale of the Telangana and Andhra Pradesh High Court, the action of the A.O., in proposing to tax the amounts credited in the partners accounts in the books of the firm as cash credit in the hands of the firm is not valid.

Question 10.
Discuss the taxability or otherwise of the following transactions:
(i) Mr. A purchased 10 acres of agricultural lands from Mr. B at the rate of ₹ 2 lakh per acre on 10-05-2020. The guideline value of the land on the date of the transaction was ₹ 3 lakhs per acre. However he had entered into an agreement for purchase of the land on 10-03-2020 when the guideline value was ₹ 2.50 lakhs per acre. He had paid a token advance of ₹ 1 lakh by account payee cheque.

(ii) Mr. A received cash gift of ₹ 4.75 lakhs from B on the occasion of his 61st birthday which was celebrated like marriage as per tradition, and ₹ 25,000 from C. Both B and C are his distant relatives.

(iii) Mr. Dileep contributed ₹ 2 lakhs to a Trust created for the purpose of marriage of his friend’s daughter.
Note: (Guideline value means Assessable stamp duty value)    [CA Final May 2018 (New Syllabus)] [6 Marks]
Answer:
(i) As per Sec. 56(2)(v), where any person receives any immovable property for inadequate consideration from a person (other than relative) and the stamp duty value exceeds the consideration by more than higher of ₹ 50,000 or 10% of the consideration, then such difference of stamp duty value and consideration is chargeable to tax as income under the head “Income from Other Sources”.

Here, Mr. A purchased 10 acres of agricultural lands from Mr. B at the rate of ₹ 2 lakhs per acre. The guideline value on the date of agreement i.e. ₹ 2.50 lakhs per acre, may be taken as the stamp duty value instead of guideline value on the date of transaction i.e. ₹ 3 lakhs per acre, since the advance in respect of agricultural lands has been paid by way of an account payee cheque on the date of agreement.

The total consideration paid by Mr. A to Mr. B is ₹ 20 lakhs (₹ 2 × 10 acres) but the stamp duty value of the agricultural lands is ₹ 25 lakhs (₹ 2.5 lakhs × 10 acres). The stamp duty value exceeds the consideration by more than higher of ₹ 50,000 or 10% of the consideration and therefore, such difference of ₹ 5 lakhs (₹ 25 lakhs – ₹ 20 lakhs) shall be taxable in the hands of Mr. A as ‘Income from Other Sources.’

(ii) As per Sec. 56(2)(v), where any assessee receives any sum of money from a person or persons, without consideration in excess of ₹ 50,000, then he shall be taxable for whole of such amount received under the head “Income from Other Sources”. However, he shall not be taxable if such sum of money is received on the occasion of the marriage of the Individual.

Here, Mr. A received cash gift of ₹ 4,75,000 and ₹ 25,000 from C on the occasion of his 61st birthday which was celebrated like marriage as per tradition. Since, the amount has.been received on the occasion of birthday of Mr. A, sum amount of ₹ 5,00,000 (₹ 4,75,000 + ₹ 25,000) shall be taxable in the hands of Mr. A under the head “Income from Other Sources”, even though the birthday was celebrated like marriage as per the tradition.

(iii) As per Sec. 56(2)(x), where any assessee receives any sum of money from a person or persons, without consideration in excess of ₹ 50,000, then he shall be taxable for whole of such amount received under the head “Income from Other Sources”.

However, he shall not be taxable if such sum of money is received from an individual by a trust created or established solely for the benefit of relative of the individual. Here, Mr. Dileep contributed ₹ 2,00,000 to a trust created for the purpose of marriage of his friend’s daughter. Since, the amount contributed to the trust is not for the benefit of relative of the individual creating trust, ₹ 2,00,000 shall be taxable in the hands of trust.

Income From Other Sources – CA Final DT Question Bank is designed strictly as per the latest syllabus and exam pattern.

Income From Other Sources – CA Final DT Question Bank

Question 1.
Land owned by Ganesh was acquired by NHAI in 2017 and since then litigation was going on for enhancement of compensation. The issue was resolved on 11.09.2020 and the court ordered finally to make payment to Ganesh of the enhanced compensation and following interest on such enhanced compensation was received:
Financial Year : ₹
2017- 2018 : 1,15,000
2018- 2019 : 2,25,000
2019- 2020 : 3,75,000
2020- 2021 : 2,14,000
Explain the provisions of the Act and also work out the amount of interest and the assessment year in which the same shall be taxed. [CA Final May 2010] [4 Marks]
Answer:
As per section 56(2)(vii) the income by way of interest received on compensation or on enhanced compensation shall be assessed as “Income from other sources” in the year in which it is received.

Further, Sec. 145B( 1) provides that the interest received by an assessee on compensation or on enhanced compensation shall be deemed to be the income for the year in which it is received, irrespective of the method of accounting followed by the assessee.

Section 57 allows a deduction of 50% of such interest income. It is further clarified that no other deduction would be allowable under any other clause of section 57 in respect of such income.

Therefore, the entire interest income of ₹ 9,30,000, subject to deduction of 50% of the interest received by Ganesh for the different years would be taxable under the head “Income from other sources” in the year of receipt i.e., in the previous year 2020-21 as under:

	₹
Interest on enhanced compensation taxable u/s 56(2)(viii) Less: Deduction u/s 57(iv) @ 50% Interest chargeable under the head “Income from other sources”	9,30,000 4,65,000
	4,65,000

Question 2.
Dhaval is in business of manufacturing customized kitchen equipments. He is also the Managing Director and held nearly 65% of the paid-up share capital of Aarav Ltd. A substantial part of the business of Dhaval is obtained through Aarav Ltd. For this purpose, Aarav Ltd. passed on the advance received from its customers to Dhaval to execute the job work j entrusted to him.

The Assessing Officer held that the advance money received by Dhaval is in the nature of loan given by Aarav Ltd. to him and accordingly is deemed dividend within the meaning of provisions of section 2(22)(e) of j the Income-tax Act, 1961. Examine whether the action of the Assessing Officer is tenable in law. [CA Final May 2012] [4 Marks]
Answer:
As per section 2(22)(e), payment of any sum by way of advance or loan by a company, in which public are not substantially interested, to its share-holder holding not less than 10% of voting power of the company, shall be deemed as dividend to the extent of accumulated profits ol the company.

In the given case, Dhaval is holding 65% of the paid-up capital of Aarav Ltd. Aarav Lid. has passed on advance received from its customers to Dhaval for execution of job work entrusted to Dhaval.

Assuming that Aarav Ltd. is not a company in which public are substantially interested, the applicability of the provisions of section 2(22)(e) in respect of such transaction has to be examined.

In CIT v. Rajkumar (2011) (Del.), it was field that trade advance given to the shareholder which is in the nature of money transacted to give effect to a commercial transaction, would not be deemed to be dividend u/ s 2(22) (e). The Delhi High Court ruling in CIT v. Ambassador Travels (P) Ltd, (2009) also supports the above view.

In the present case, the payment is made to Dhaval by Aarav Ltd. for execution of work is in the course of commercial business transaction and therelore, it shall not be deemed as dividend u/s 2(22)(e). Hence, the action ; of the Assessing Officer is not tenable in law.

Note: If it is assumed that Aarav Ltd., being a public limited company, is a company in which the public are substantially interested, then, the provisions of section 2(22)(e) shall not be applicable and the said amount paid to Dhaval shall not be treated as dividend u/s 2(22)(e).

Question 3.
Mr. Manas is a distributor of lottery tickets. He won ₹ 6,00,000 as prize money on unsold lottery tickets. It was offered as business income, The Assessing Officer wants to tax the same as lottery winning at the rate prescribed under section 115BB. Is he justified? [CA Final May 2015] [4 Marks]
Answer:
The issue under consideration is whether winnings of prize money on unsold lottery tickets held by the distributor of lottery tickets can be subject to tax at the rate of 30% prescribed u/s II5BB.

In CIT v. Manjoo and Co. (201 1), the Kerala High Court observed that the receipt of winnings from lottery by the distributor was not on account of any physical or intellectual effort made by him and therefore cannot be said to be “income earned” by him in business.

The unsold lottery tickets cease to be stock-in-trade of the distributor i because it will have no value after the draw and the distributor will get nothing on sale of the same except any prize winning ticket held by him which will entitle him for the prize money. Hence, the receipt of the prize money is not in his capacity as a lottery distributor but as a holder of the lottery ticket which won the prize.

Further, winnings Irom lotteries are taxable under the special provisions of section 115BB, irrespective of the head under which such income falls.

Therefore, the Kerala High Court held that the rale of 30% prescribed u/s @ 115BB would be applicable on prize money winnings received by a distributor on unsold lottery tickets held by him.

Applying the rationale of the Kerala High Court ruling to the case on hand, the Assessing Officer’s intention to tax the prize money received by the distributor on unsold lottery tickets held by him at the rate prescribed u/s 115BB is justified.

Question 4.
Mr. Santhanam holding 25% voting power in VKS Private Limited permitted his own land to be mortgaged to a bank for enabling the company to obtain a loan. Mr. Santhanam requested the company to release the property from the mortgage. The company failed to do so, but for retaining the benefit of bank loan it gave an advance of ₹ 10 lakhs to Mr. Santhanam, which was authorized by a resolution, passed by the Board of Directors. The company’s accumulated profit on the date of payment of advance was ₹ 50 lakhs. The A.O. proposes to tax the amount of ₹ 10 lakhs by invoking the provision of Sec. 2(22)(e). Is the proposition of the Assessing Officer correct in law? [CA Final Nov. 2015] [4 Marks]
Answer:
The issue under consideration is whether loan or advance given to a j shareholder by the company, in return of an advantage or benefit conferred on the company by the shareholder, can be deemed as dividend u/s 2(22)(e).

The facts of the case are similar to the facts in Pradip Kumar Malhotra v. CIT (2011) where the Calcutta High Court observed that the phrase “by way of advance or loan” appearing in section 2(22)(e) must be construed to mean those advances or loans which a shareholder enjoys being a person who is the beneficial owner of shares holding not less than 10% of the voting power.

But, in case such, loan or advance is given to such shareholder for a further consideration which is beneficial to the company and therefore, such advance or loan cannot be said to be deemed dividend u/s 2(22)(e). Hence, as the advance given by the company was not in the nature of a gratuitous advance but instead it was given to protect the interest of the company, it was held that such advance cannot be treated as deemed dividend u/s 2(22)(e).

In this case, advance of ₹ 10 lakhs was given by VKS Manufacturing (P.) Ltd. to Mr. Santhanam holding 25% of voting power in lieu of non-release of his personal property from mortgage thereby enabling the company to i§ retain the benefit of loan obtained from bank.

Applying the above rationale of the Calcutta High Court ruling in this gi case, such advance cannot be brought within the purview of section 2(22) (e), since it was not in the nature of gratuitous advance but was given to protect the interest of the company. The proposition of.the A.O. to tax the amount of ₹ 10 lakhs by invoking the provisions of section 2(22)(e) in this case is, therefore, not correct.

Question 5.
Mr. Vivek, a resident assessee holds 80% of equity shares in a company and is the executive director of the company. In his personal capacity, he is the owner of certain premises (building) in which he was carrying on a proprietary business. Subsequently, the assessee ceased to carry on the business of proprietary firm and leased the building to the company for its business. The company incurred ₹ 3.2 crores towards construction and improvement of this premises, which it continued to use otherwise than as the owner of the premises. The Assessing Officer held that the amounts spent by the company towards repairs and renovation of the building is taxable as deemed dividend in the hands of the assessee. Is the action taken by the Assessing officer valid? [CA Final Nov 2017] [4 Marks]
Answer:
Issue involved: The issue under consideration is whether repair and renovation expenses incurred by a company in respect of premise leased out by a shareholder having substantial interest in the company, be treated as deemed dividend.

Provisions applicable: As per section 2(22)(e), in case a company, not being a company in which the public are substantially interested, makes payment of any sum by way of advance or loan to a shareholder holding not less than 10% of voting power/share capital of the company, then, the payment so made shall be deemed to be dividend in the hands of such shareholder to the extent to which the company possesses accumulated profits.

Analysis: The facts of the case are similar to the facts in CIT v. Vir Vikram Vaid (2014) (Bom.), wherein the above issue came up before the Bombay High Court. The High Court observed that no money had been paid by way of advance or loan to the shareholder who has substantial interest in the company. Further, the amount spent was towards repairs and renovation of the premises owned by the assessee but occupied by the company as lessee. There is no dispute that the company had taken on rent the aforesaid premises.

The High Court observed that the expenditure incurred by virtue of repairs and renovation on the premises cannot be brought within the definition of advance or loan given to the shareholder having substantial interest in the company, though he is the owner of the premises. It cannot be treated as payment by the company on behalf of the shareholder or for the individual benefit of such shareholder. If held in such manner, it is a mere assumption not tenable in law.

The High Court, accordingly, held that the repair and renovation expenses in respect of premises occupied by the company cannot be treated as deemed dividend in the hands of shareholder being the owner of the building.

Conclusion: Thus, applying the rationale of the Delhi High Court ruling to the present case, contention of the Assessing Officer that the amounts spent by the company towards repairs and renovation of the building is taxable as deemed dividend in the hands of the assessee is not tenable in law.

Question 6.
HLI Private Limited is a company with three shareholders H (40%), L (20%) and I on behalf his HUF (40%). I (HUF) is a Hindu Undivided Family whose members are Mr. I, Mrs. I and their two sons, G and J. The company gave a loan of ₹ 9 lakhs to I (HUF) on 30th April, 2020, on which date the accumulated profits of the company was ₹ 6 lakhs. What is the tax consequence of this transaction? [CA Final Nov. 2018 (Old Syllabus), Nov. 2012] [4 Marks]
Answer:
The issue under consideration in this case is whether, where the Karta is a shareholder (on behalf of his HUF) of a company in which public are not substantially interested, the loan advanced by the company to the HUF would constitute deemed dividend u/s 2(22)(e) to the extent to which the company possesses accumulated profits.

The facts of the case are similar to the facts in Gopal & Sons (HUF) v. CIT (2017), where the Supreme Court held that loans and advances given by the closely held company to the HUF holding more than 10% shares shall be treated as deemed dividend u/s 2(22)(e) in both the cases whether HUF is treated as a shareholder or HUF’s Karta is treated as a shareholder.

If the HUF was the shareholder, sec. 2(22)(e) would be attracted since the HUF holds more than 10% shares and if the Karta was the shareholder, sec. 2(22)(e) would be attracted since the HUF would be the concern in which the Karta has substantial interest. The Supreme Court, accordingly, held that the loan amount is to be assessed as deemed dividend u/s 2(22)(e).

By applying the above rationale in the present case, the loan advanced by HLI Pvt. Ltd. to I (HUF) upto the accumulated profits of the company i.e. ₹ 6 lakhs shall be treated as deemed dividend u/s 2(22)(e). As per the amendment made by the Finance Act, 2020, such deemed dividend shall be taxable in the hapds of HUF.

Question 7.
Luminous Pvt. Ltd., whose accumulated profits are ₹ 20 lakhs wants to disburse a loan of ₹ 25 lakhs to Mrs. Nisha, a resident shareholder holding 20% of the equity shareholding in the company. Can the entire amount of loan be disbursed to the shareholder keeping HI mind the provisions of the Income-tax Act, 1961? The Finance Manager feels that this being a pure loan transaction, there is no bar for disbursing the entire amount. Is his view correct? [CA Final Nov. 2018 (New Syllabus)] [4 Marks]
Answer:
As per Sec. 2(22)(e), if a company not being a company in which public are substantially interested makes any payment by way of loans or advances, to a shareholder, being the beneficial owner of shares, carrying not less than 10% of voting power, then such payment shall be as deemed dividend to the extent of accumulated profits.

In this case, Luminous Pvt. Ltd. has disbursed a loan of ₹ 25 lakhs to Mrs. Nisha, a resident shareholder holding 20% of the equity shareholding in the company and therefore such loan shall be treated as deemed dividend to the extent of ₹ 20 lakhs (accumulated profits). As per the amendment made by the Finance Act, 2020, the dividends including deemed dividends are taxable in the hands of shareholders w.e.f. A.Y. 2021-22 as per their regular slab rates.

Therefore, the view of the Finance Manager that this being a pure loan transaction, there is no bar for disbursing the entire amount, is correct but Mrs. Nisha shall be liable to pay tax on it.

Question 8.
SRM Tech Ltd. is engaged in the manufacture of multi-layer tubes and other specialty packaging and plastic products. It came out with an initial public issue of shares during the relevant assessment year and deposited the share application money received in banks. The share capital was received by the SRM Tech Ltd. to meet capital expenditure for setting up of its factory. As the funds were not immediately required, it made temporary deposits with bank which earned interest.

This interest income of ₹ 1.71 crores was treated as abatement of capital cost of the project factory by the company and set off such interest earned against public issue expenses, in the books of account. The AO is of the opinion that the same should be treated as revenue receipt and taxed the j same as income from ‘Other Sources’. Decide the correctness of action of the Assessing Officer. [CA Final May 2019 (Old Syllabus)] [4 Marks]
Answer:
The issue under consideration is whether the interest income from share application money is taxable under the head ‘Income from Other Sources’, or can the same be set-off against public issue expenses.

The facts of the case are similar to the facts in CIT v. Sree Rama Multi Tech Ltd. (2018), where the Supreme Court observed that the assessee-company was statutorily required to keep share application money in a separate account till the allotment of shares was completed. The interest earned was inextricably linked with the requirement of raising share capital. Only the surplus money deposited in the bank for earning interest is liable to be taxed as “Income from Other Sources”.

But, here, the share application money was deposited with the bank not to make additional income but to comply with the statute and the interest accrued on such deposit is merely incidental. Moreover, the issue of shares relates to capital structure of the company and hence, expenses incurred in connection with the issue of shares are to be capitalized. Accordingly, the accrued interest is not liable to be taxed as “Income from Other Sources” and the same is eligible to be set-off against public issue expenses.

Thus, the contention of the A.O. that the interest accrued by SRM Tech Ltd. of ₹ 1.71 crores on deposit of share application money with bank is taxable as income from other sources is not correct. Such interest is eligible for set off against the public issue expenses and hence, not taxable as ‘Income from Other Sources’.

Capital Gains – CA Final DT Question Bank is designed strictly as per the latest syllabus and exam pattern.

Capital Gains – CA Final DT Question Bank

Question 1.
On 25.11.2020, A gave power of attorney and possession to B in respect of a vacant land acquired 10 years ago. The sale deed was executed in April, 2021. In which assessment year, the capital gain is chargeable to tax? [CA Final May 2010] [4 Marks]
Answer:
As per section 45(1), the charging section for the head ‘Capital gains’, any profits and gains arisirtg from transfer of a capital asset shall be chargeable to income-tax under the head capital gains in the previous year in which transfer took place.

Further the definition of ‘Transfer’ as contained in section 2(47) includes, inter alia:

• any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of the Transfer of f Property Act, 1882;

Also in section 50C, Explanation 2 to section 50C provides as under:

For the purpose of this section, the expression “assessable” means the price which the stamp valuation authority would have, notwithstanding contained in any other law for a time being in force, adopted or assessed, if it were I referred to such authority for the purposes of the payment of stamp duty.

The term assessable also covers transfers executed through power of attorney within the scope of section 50C. Thus, when the assessee executes power of attorney and possession is given, the transfer is chargeable to capital gain in such year.

Thus, on combine reading of above provisions, capital gain shall be chargeable to tax in the year when the power of attorney and possession was given to Mr. B in respect of the vacant land.

Question 2.
Can reference be made to the Valuation Officer u/s 55A where the A.O. is of the view that in the context of computation of capital gains, the value of asset as on 1.4.2001 adopted by the assessee is more than the FMV? [CA Final May 2010] [4 Marks]
Answer:
Section 55A dealing with ‘Reference to Valuation Officer’ provides that the A.O. may refer the valuation of a capital asset to the valuation officer with a view to ascertain the FMV of the capital asset for the purpose of computation of capital gain, in a case where the value of asset as claimed by the assessee is in accordance with the estimate made by a registered valuer, and the A.O. is of the opinion that the value so claimed is at variance with the FMV of the asset.

Therefore, the A.O. can make a reference to the Valuation Officer for valuation of the capital asset in a case where the FMV of the asset as on 1.04.2001 is taken as the cost of the asset and he is of the view that there is a variance between the value as on 1.04.2001 claimed by the assessee in accordance with the estimate made by a registered valuer and the fair market value of the asset on that date.

Question 3.
A sold a house to his friend B on 01.11.2020, for a consideration of ₹ 25,00,000. The Sub-Registrar refused to register the document for the said value, as according to him, Stamp Duty had to be paid of ₹ 45,00,000 which was the Government Guideline Value. Mr. A preferred an appeal to the Revenue Divisional Officer, who fixed the value of the house as ₹ 32,00,000 (₹ 22,00,000 for Land, balance for Building portion). The differential Stamp Duty was paid, accepting the said value determined. Assuming that the FMV is ₹ 32,00,000, what are the tax implications in the hands of Mr. A and Mr. B for the A.Y. 2021-22? Mr. A had purchased the Land on 01.06.2016 for ₹ 5,19,000 & completed the construction of house on 01.12.2018 for ₹ 14,00,000.

CII: FY 2015-16: 254, FY 2016-17: 264, FY 2017-18: 272, FY 2019-20: 289, FY 2020-21; 301 [CA Final May 2010] [4 Marks]
Answer:

Note: Value fixed in appeal i.e. ₹ 32,00,000 (₹ 22,00,000 for Land and ₹ 10,00,000 for Building) shall be taken as Sale Consideration.

Tax Implication:
Mr. A: STCL can be Set-off against LTCG u/s 70. Therefore, LTCG of ₹ 12,08,261 (₹ 16,08,261 – ₹ 4,00,000) is taxable at 20%.

Mr. B: Receipt of immovable property for inadequate consideration, i.e. stamp duty value exceeds the consideration by more than higher of ₹ 50,000 or 10% of consideration, will be chargeable u/s 56(2)(v) as ‘Income from Other Sources’. Taxable amount = Stamp duty – Consideration = ₹ 32,00,000 – ₹ 25,00,000 = ₹ 7,00,000.

Question 4.
A resident woman (individual) sold a house property on 16.01.2021. On the said transaction, she earned a long-term capital gain of ₹ 1,01,50,000, She invested a sum of ₹ 50,00,000 in capital gains bonds specified in section 54EC on 05.03.2021. She further invested a sum of ₹ 50,00,000 in the x same bonds on 05.05.2021. Her other income for the financial year 2020-21 was ₹ 56,000. Compute the tax payable by her for the A.Y. 2021-22. Assume the assessee has not opted for Sec. 115BAC.  [CA Final Nov. 2010] [6 Marks]
Answer:
To claim exemption u/s 54EC, the assessee has to invest in specified bonds of RECL or NHAI within 6 months from the date of transfer of the long term capital asset.

However, the amount of investments in the bonds by the assessee during the financial year in which such transfer has taken place and in subsequent financial year shall not exceed ₹ 50 lakhs in aggregate. Therefore, exemption in respect of amount invested in the bonds on 05.05.2021 shall not be available.

Computation of Income-Tax Payable:
As per section 112, in case of a resident individual, the unexhausted basic exemption limit can be exhausted against long-term capital gains, and tax would be leviable on the balance long-term capital gains @ 20%.

Therefore, the basic exemption limit of ₹ 2,50,000 should be first adjusted against other income of ₹ 56,000 and the unexhausted basic exemption limit of ₹ 1,94,000 should be adjusted against the long-term capital gains of ₹ 51,50,000.

The balance long-term capital gains of ₹ 49,56,000 would be taxable @ 20% = ₹ 9,91,200 plus Surcharge @10% plus Cess @ 4%. Therefore, the tax payable by the assessee would be ₹ 11,33,933.

Question 5.
ari has acquired a residential house property in Delhi on 1st April, 2008 for ₹ 10,00,000 and decided to sell the same on 3rd May, 2010 to Ms. Pari and an advance of ₹ 25,000 was taken from her. The balance money was not paid by Ms. Pari and Hari has forfeited the entire advance sum. On 3rd June, 2020, he sold this house to Mr. Suri for ₹ 35,00,000. In the meantime, on 4th April, 2020, he had purchased a residential house in Delhi for ₹ 8,00,000, where he was staying with his family on rent for the last 5 years and paid the full amount as per the purchase agreement. However, Hari does not possess any legal title till 31st March, 2021, as such transfer was not registered with the registration authority.

Hari has purchased another old house in Surat on 14^th October, 2020 from Mr. X, an Indian resident, by paying ₹ 5,00,000 and the purchase was registered with the appropriate authority.

Determine the taxable capital gain arising from above transactions in the hands of Hari for A.Y. 2021-22. [CA Final Nov. 2010] [5 Marks]
Answer:
Computation of taxable capital gain of Mr. Hari for the A.Y. 2021-22.

Notes:
1. Computation of indexed cost of acquisition

2. In order to avail exemption u/s 54, the residential house property should be purchased within 1 year before or within 2 years after the date of transfer or it should be constructed within a period of 3 years after the date of transfer of the original LT residential HP.

As per the amendment made by the Finance Act, 2019, an individual can claim exemption u/s 54 in respect of purchase of two residential : house properties in India provided the capital gains does not exceed ₹ 2 crore. Here, in this case, since the capital gains does not exceed (₹ 2 crores, Hari can claim exemption in respect of both the house properties u/s 54. Where the assessee exercised the option to claim exemption in respect of two residential house properties, he cannot subsequently entitled to exercise the option for the same or any other assessment year.

In this case, Hari has purchased the residentialhouse in Delhi within one year before the date of transfer and paid the full amount of ₹ 8,00,000 as per the purchase agreement, though he does not possess, any legal title till 31.3.2021 since the transfer was not registered with the registration authority. However, for the purpose of claiming exemption under section 54, holding of legal title is not necessary. If the taxpayer pays the full consideration in terms of the purchase agreement within the stipulated period, the exemption under section 54 would be available.

Hari has also purchased old house in Surat on 14.10.2020 by paying ₹ 5,00,000 and therefore, he shall be eligible to claim exemption u/s 54 in respect of both the house property purchased i.e. ₹ 13,00,000 (₹ 8,00,000 + ₹ 5,00,000)

Question 6.
“Any transfer of a capital asset or intangible asset by a private company or unlisted public company to a LLP or any transfer of share or shares held in a company by a shareholder on conversion of a company into a LLP in accordance with section 56 and section 57 of the Limited Liability Partnership Act, 2008, shall not be regarded as a transfer for the purposes of levy of capital gains tax under section 45 subject to fulfilment of certain conditions”. Explain in the context of the provisions contained in the Act. [CA Final May 2011] [6 Marks]
Answer:
Any transfer of a capital asset or intangible asset by a private company or unlisted public company to an LLP or any transfer of a share(s) held in a company by a shareholder on conversion of a company into an LLP shall not be regarded as a transfer for the purpose of levy of capital gains on fulfilment of the following conditions:

(a) All the assets and liabilities of the company immediately before the conversion become the assets and liabilities of the LLP;

(b) All the shareholders of the company immediately before the conversion become the partners of the LLP and their capital contribution and profit sharing ratio in the LLP are in the same proportion as their shareholding in the company on the date of conversion;

(c) The shareholders of the company do not receive any consideration or benefit, directly or indirectly, in any form or manner, other than by way of share in profit and capital contribution in the LLP;

(d) The aggregate of the profit sharing ratio of the shareholders of the company in the LLP shall not be less than 50% at any time during the period of 5 years from the date of conversion;

(e) The total sales, turnover or gross receipts in business of the company in any of the 3 P.Y. preceding the P.Y. in which the conversion takes place does not exceed ₹ 60 lakhs;

(ea) The total value of the assets as appearing in the books of account of ‘ the company in any of the three previous years preceding the previous year in which the conversion takes place does not exceed ₹ 5 crores; and

(f) No amount is paid, either directly or indirectly, to any partner out of balance of accumulated profit standing in the accounts of the company on the date of conversion for a period of 3 years from the date of conversion.

Question 7.
Mr. X transferred his residential house to Y for ₹ 11 lakh on 1st April, 2020. The value of the said house as per Stamp Valuation Authority was ₹ 16 lakh. Mr. Y is a childhood friend of Mr. X.

Mr. X gifted a plot of land (purchased by him on 1^st August, 2017) to Mr. Y on 1st July, 2020. The value as per Stamp Valuation Authority is ₹ 8 lakh. Mr. Y sold the land on 1st March, 2021 at ₹ 14 lakh.

Compute the income of Mr. Y chargeable under the heads “Capital Gains” and “Income from other sources” for Assessment Year 2021-22.       [CA Final Nov 2011] [5 Marks]
Answer:
Computation of income of Mr. Y for A.Y. 2021-22

Notes:
(1) As per Sec. 56(2)(x), where any immovable property is acquired for inadequate consideration and if the stamp duty value exceeds the consideration by more than higher of ₹ 50,000 or 10% of the consideration, the difference between stamp duty value of the property and the consideration shall be taxable as income from other sources. The higher in ₹ 50,000 and 10% of the consideration [i.e. ₹ 1,10,000 (₹ 11,00,000 × 10%)] is ₹ 1,10,000 and since the difference between the stamp duty value and consideration exceeds ₹ 1,10,000, the difference of ₹ 5,00,000 (i.e. ₹ 16,00,000 – ₹ 11,00,000) is chargeable to tax in the hands of Mr. Y.

(2) Sec. 56(2)(x) is also attracted where the immovable property is transferred without consideration, if the stamp duty value of such property exceeds ₹ 50,000. In this case, since Mr. Y has received a plot of land from Mr. X, a non-relative, without consideration and the stamp duty value of ₹ 8 lakh exceeds ₹ 50,000, the entire stamp duty value of ₹ 8 lakh is chargeable to tax u/s 56(2)(x).

(3) Section 49(4) provides that where the capital gain arises from the transfer of such property which has been subject to tax u/s 56(2) (x), the cost of acquisition shall be deemed to be the value taken into account for the purpose of section 56(2)(v). Therefore, ₹ 8 lakh would be the cost of acquisition in this case.

(4) Where cost is computed as per Sec. 49(4), the period of holding of previous owner is not to be included and therefore, the resultant capital gains will be short-term capital gains.

Question 8.
What are the consequences if the amount deposited in Capital Gains Account Scheme to avail exemption from capital gains is not utilised within the stipulated time? Is there any difference in the tax treatment in the event of death of the assessee before the stipulated time? [CA Final May 2012] [3 Marks]
Answer:
Where the amount deposited in Capital Gains Accounts Scheme to avail exemption is not utilized for the specified purpose mentioned under the respective section (i.e., sections 54, 54B, 54G, etc.) within the specified period of two years or three years, as the case may be, then the unutilized amount shall be chargeable as capital gain in the previous year in which the specified period of two years or three years, as the case may be, expires. The nature of the capital gain shall be same as the nature of the capital gain which was claimed as exemption under the section earlier.

The tax treatment in the event of death of the assessee before the stipulated time which results in receiving of the amount by his legal heirs will be different. The CBDT has, in Circular No.743 dated 6.5.1996, clarified that in the event of death of an individual before the stipulated period, the unutilized amount would not be chargeable to tax in the hands of the legal heirs of the deceased individual, since such unutilized amount is not income but is a part of the estate devolving upon them.

Question 9.
State the cases where the benefit of indexation of cost is not available for determination of capital gains. [CA Final May 2012] [7 Marks]
Answer:
Cases where benefit of indexation of cost is not available for determination of capital gains are as follows:

1. Transfer of capital assets held for not more than 36 months (12 months in case of listed shares, units, etc. and 24 months in case of unlisted shares and immovable property), since capital gains arising therefrom would be a short term capital gains.
2. Transfer of depreciable assets where computation is governed by section 50, since capital gains arising therefrom would always be short term capital gains, even if they are held for more than 36 months.
3. Transfer of undertaking or division in a slump sale u/s 50B.
4. Transfer of bonds debentures other than capital indexed bonds issued by the Government (Third proviso to section 48).
5. Transfer of shares in or debentures of an Indian company, acquired by a non-resident in foreign currency (First proviso to section 48).
6. Transfer of a foreign exchange asset by a non-resident Indian, who opts to be governed by the provisions of Chapter XII-A (Section 115D).
7. Transfer of bonds and GDRs by non-resident referred to in Sec. 115AC.
8. Transfer of units of Unit Trust of India or a Mutual Fund specified u/s 10(23D) purchased in foreign currency by an overseas financial organisation referred to as Offshore Fund (Section 115AB).
9. Transfer of securities by Foreign Institutional Investors (Section 115 AD).
10. Transfer of unlisted securities by a non-resident as per provisions of Sec. 112.
11. Long term capital gains referred to in Sec. 112A.

Question 10.
PQR Ltd. has two units-one engaged in manufacture of Computer Hardware and the other involved in developing Software. As a restructuring drive, the Company has decided to sell its Software Unit as a going concern by way of slump sale for ₹ 385 Lakhs to a new Company called S Ltd., in which it holds 74% Equity Shares. The Balance Sheet of PQR Ltd. as on 31^st March 2021, being the date on which software unit has been transferred, is as under:

Following additional information are furnished by the Management:

1. The Software Unit is in existence since May, 2017.
2. Fixed Assets of Software Unit includes land which was purchased at ₹ 40 Lakhs in the year 2014 and revalued at ₹ 60 Lakhs as on March 31,2021.
3. Fixed Assets of Software Unit mirrored at ₹ 140 Lakhs (₹ 200 Lakhs minus land value ₹ 60 Lakhs) is Written Down Value of Depreciable Assets as per books of account. However, the Written Down Value of these Assets u/s 43(6) of the Income Tax Act is ₹ 90 Lakhs.

Required:
(a) Ascertain the tax liability, which would arise from slump sale to PQR Ltd.
(b) What would be your advice as a Tax Consultant to make the restructuring plan to the Company more tax savvy, without changing the amount of sale consideration? [CA Final Nov. 2012, May 2011] [10 Marks]
Answer:
(a) As per section 50B, any profits or gains arising from the slump sale shall be taxable as- long term capital gains, if the undertaking is held for more than 36 months or more. Indexation benefit is not available.

Capital gains = “Slump sale consideration” minus “Net worth of the Undertaking or division”

“Net worth” = Aggregate value of total assets of the undertaking/division minus Value of total liabilities of such undertaking or division as appearing in the books of account.

For computing the ‘Net Worth’, non-depreciable assets are to be taken at their book values. In case of depreciable assets, the written down value of such assets shall be computed as per section 43(6).

Change in the value of assets on account of revaluation of assets shall be ignored for the purposes of computing the net worth.

Computation of Tax Liability arising on Slump Sale

NOTE:
1. Net Worth of Software Unit:

2. Benefit of indexation is not available as the transfer is on slump sale basis.

(b) Modification in the Restructuring Plan
Option 1: S Ltd – 100% Subsidiary
PQR Ltd may hold 100% Equity Shares of S Ltd (i.e. 100% Holding Company) and then the Software Unit to be transferred after 100% Shares are acquired by PQR Ltd.
Conditions: But the above transfer requires fulfilment of following conditions.
(a) Holding Co. should not cease to hold 100% Shares for 8 Years from date of transfer of such business, or
(b) Subsidiary Co. shall not convert the Capital Assets into Stock in Trade within 8 years.

Result: Assets transferred by the Holding Company to its 100% Indian ) Subsidiary Company is not a transfer u/s 47(iv), and the transaction would not attract Capital Gains.

Option 2: S Ltd – Demerger
PQR Limited may go in for Demerger and transfer the Software Unit to S Ltd.
Result: Transfer of Capital Assets by a Demerged Company (PQR Ltd.) to a Resulting Company is not a transfer u/s 47(vib) if the Resulting Company is an Indian Company.

Question 11.
Mr. Shakti purchased a residential house in March, 2009 for ₹ 22 lakhs. He sold the house on 1^st December, 2020 for ₹ 100 lakhs. He paid brokerage at 2% on sale price. He invested ₹ 80 lakhs in April, 2021 in equity shares of Shakti Private Limited, an eligible start-up. Mr. Shakti holds 80% of share capital of the company.

The company utilised the sum of ₹ 80 lakhs in the following manner:

1. Purchase of new machinery during April, 2021 ₹ 70 lakhs (including ₹ 10 lakhs for purchase of computers).
2. Deposit in specified bank on 25th September, 2021 ₹ 6 lakhs.
3. Remaining ₹ 4 lakhs was held as Cash balance.

The due date for filing return of income for Mr. Shakti for Assessment Year 2021-22 is 31sl October, 2021. Assume that he files the return on 28^th October, 2021.
Compute the taxable capital gain arising from the above transaction for Assessment Year 2021-22. [CA Final May 2013] [6 Marks]
Answer:
Computation of taxable capital gains of Mr. Shakti for AY. 2021-22

Deemed cost of new plant and machinery for exemption u/s 54GB:

	₹
Purchase cost of new plant and machinery acquired in April, 2021 (including computers) Amount deposited in the specified bank before the due date of filing of return	70,00,000 6,00,000
Deemed cost of new plant and machinery for exemption u/s 54GB	76,00,000

NOTES: Exemption under section 54GB can be availed on long-term capital gains on transfer of a residential house, since all the conditions given below are fulfilled by Mr. Shakti:
(i) The sale proceeds are used for subscription in the equity shares of an eligible start-up.

Notes:
(1) The conversion of a capital asset into stock-in-trade is treated as a transfer under section 2(47) in the year in which the capital asset is converted into stock-in-trade.

(2) However, as per section 45(2), the capital gains arising from the transfer by way of conversion of capital assets into stock-in-trade will be chargeable to tax only in the year in which the stock-in-trade is sold.

(3) The indexation benefit for computing indexed cost of acquisition would, however, be available only up to the year of conversion of capital asset to stock-in-trade and not up to the year of sale of stock-in-trade.

(4) For the purpose of computing capital gains in such cases, the FMV of the capital asset on the date on which it was converted into stock-intrade shall be deemed to be the full value of consideration received or accruing as a result of the transfer of the capital asset.

In this case, since only 75% of the stock-in-trade (15 flats out of 20 flats) is sold in the P.Y. 2020-21, only proportionate capital gains (i.e., 75%) would be chargeable to tax in the A.Y. 2021-22.

(5) On sale of such stock-in-trade, business income would arise. The business income chargeable to tax would be the difference between the price at which the stock-in-trade is sold and the fair market value on the date of conversion of the capital asset into stock-in-trade.

(6) In case of conversion of capital asset into stock-in-trade and subsequent sale of stock-in-trade, the period of 6 months is to be reckoned from the date of sale of stock-in-trade for the purpose of exemption u/s 54EC. In this case, since the investment in bonds of RECL has been made within 6 months of sale of flats, the same qualifies for exemption under section 54EC.

Question 13.
The proprietary firm of ‘Mr. Amolak’ a practicing Chartered Accountant, was converted into partnership on 01.09.2020 when his son joined him in the firm for 50% share. All the assets and liabilities of the erstwhile proprietary firm were transferred into the newly constituted partnership firm.

“Mr. Amolak” was credited and paid an amount of ₹ 5 lakhs in his account from the firm. Explain as to chargeability of this amount of ₹ 5 lakhs in the hands of “Mr. Amolak” when it stands paid for:

1. transfer of business into partnership;
2. goodwill by the incoming partner. [CA Final Nov. 2013] [4 Marks]

Answer:
(i) If the amount was paid for transfer of business/profession to partnership:
On conversion of a proprietary business into a partnership, there is a transfer of interest in the assets of the proprietor’s business as the exclusive interest of the proprietor is reduced and the business assets become assets of the firm. Also, section 47 which lists the transactions not regarded as “transfer” does not include within its scope, transfer of capital assets consequent to succession of a sole proprietary concern by a partnership firm. Therefore, the transfer of capital assets by a sole proprietary concern consequent to its conversion into partnership firm is a transfer.

In the given question, as per section 45(3), the amount of ₹ 5 lakhs, recorded in the books of account of the firm, would be the full value of consideration received as a result of transfer and the capital gains resulting from this transfer would be chargeable to tax in the hands of Mr. Amolak.

(ii) If the amount is paid by the incoming partner for Goodwill:
The Supreme Court, in CIT v. B. C. Srinivasa Setty (1981), observed that where “the cost of acquisition of the capital asset” is not possible to ascertain, then, transfer of such asset is not chargeable to tax. Section 55(2)(a) provides that the cost of acquisition of certain self-generated assets, including goodwill of a business, is Nil. Therefore, for such assets, the decision of the Supreme Court in B.C. Srinivasa Setty’s case would not apply.

However, in respect of other self-generated assets, including goodwill of profession, the decision of the Supreme Court in B. C. Srinivasa Setty’s case, would continue to be applicable.

In effect, in case of self-generated assets not covered u/s 55(2)(a), since the cost is not ascertainable, there would be no capital gains tax liability. Therefore, in this case, since the consideration of ₹ 5 lakhs is paid towards goodwill of a profession, whose cost is NOT to be taken as ‘Nil’ since it is not covered u/s 55(2)(a), there will be no capital gains.

Question 14.
Mr. X had a leasehold property since 5th May, 2013. The leasehold rights were converted into freehold on 20th May, 2020. The said property was sold on 10th January, 2021. The assessee claimed the capital gain as long-term capital gain. The A.O. contended the same as short-term as the property was acquired by converting the leasehold right into freehold [ right only on 20th May, 2020. Is Mr. X justified in his claim? [CA Final May 2015] [4 Marks]
Answer:
The issue under consideration in this case is where a leasehold property is purchased and converted into freehold property at a later point of x time and then sold, should the period of holding be reckoned from the date r of purchase or from the date of conversion for determining whether the resultant capital gains is short-term or long-term.

The facts of the case are similar to the facts in CIT v. Smt. Rama Rani Kalia (2013) (All). in that case, it was observed that the ‘conversion of leasehold property into freehold property was nothing but improvement of the title over the property, as the assessee was the owner prior to conversion. Further, the difference between “short-term capital asset” and “long-term capital asset” is the period for which the property has been held by the assessee and not the nature of title over the property.

The lessee of the property has rights as the owner of the property subject to the covenants of the lease deed. Accordingly, the lessee may, subject to covenants of the lease deed, transfer the leasehold rights of the property with the consent of the lessor.

The Allahabad High Court, thus, held that conversion of rights of the lessee from leasehold to freehold is only by way of improvement of his rights i over the property, which he enjoyed. It would not have any effect on the taxability of gain from such property, which is related to the period for which the property is held, both as leasehold and as freehold.

Therefore, in this case, the period of holding of the property by Mr. X would be reckoned from 5lh May 2013 to 10th January 2021, which is more than 36 months. Consequently, the resultant capital gains would be long-term.

Thus, the claim of Mr. X to treat the capital gain as long term capital gain, is justified.

Question 15.
Mr. Ramesh purchased a plot of land in Chennai in June 2011 for ₹ 50 lakhs. He decided to sell the property to Mr. Mahesh for ₹ 80 lakhs and received an advance of ₹ 2 lakhs in May, 2013. Mr. Mahesh was unable to complete the agreement and hence, the entire advance was forfeited by Mr. Ramesh.

Again Mr. Ramesh entered into an agreement to sell the property to Mr. Rakesh for ₹ 95 lakhs and received advance money of ₹ 2.50 lakhs in August, 2020. But again the transfer did not materialise due to which the advance money was again forfeited.

On 4^th January, 2021, the property was finally sold to Mr. Mukesh for ₹ 105 lakhs and the stamp duty value on that date was ₹ 125 lakhs. During financial year 2020-21, Mr. Ramesh earned business income of ₹ 25 lakhs.

He acquired a new residential property for ₹ 130 lakhs by investing entire g sale consideration and his business income. Determine the total income of Mr. Ramesh for the assessment year 2021-22 [CA Final May 2015] [7Marks]
Answer:
Computation of total income of Mr. Ramesh for the A.Y. 2021-22

Notes:
(1) As per Sec. 50C, where the stamp duty value does not exceed 110% of the actual consideration, the actual consideration so received or accruing as a result of transfer shall be deemed to be the full value of consideration. Here, the stamp duty value exceeds 110% of the actual consideration and therefore, stamp duty value shall be deemed to be the full value of consideration.

(2) Computation of indexed cost of acquisition:

(3) As per Sec. 54F, the exemption available to the assessee shall be the amount of capital gains which bears the same proportion, which the amount invested in the new house bears to the net consideration price of the asset transferred i.e. capital gains x amount invested/net sale consideration. In this case as the entire sale consideration has been reinvested in the new house within the prescribed period by the Ramesh, therefore he is eligible for exemption of entire capital gains, irrespective of the source of funds for such reinvestment [Gouli Mahadevappa v. ITO (2013) (Kar.)].

(4) ₹ 2.50 lakhs forfeited by Mr. Ramesh in August, 2020 shall not to be reduced from the cost of the asset while computing indexed cost of acquisition as it was received on or after 1.4.2014 and hence it is taxable as per section 56(2)(ix) under the head “Income from other sources”.

Question 16.
SS(P) Ltd., a domestic listed Indian company having two undertakings engaged in manufacture of cement and steel, decided to hive off cement division to RV(P) Ltd., a domestic Indian company, by way of demerger. The net book value of assets of SS(P) Ltd. before demerger was ₹ 40 crores. The net book value of assets transferred to RV(P) Ltd. was ₹ 10 crores. The demerger was made in January 2021. In the scheme of demerger, it was fixed that for each equity share of ₹ 10 each (fully paid up) of SS(P) Ltd., two equity shares of ₹ 10 each (fully paid up) were to be issued.

One Mr. N.K. held 25,000 equity shares in SS(P) Ltd. which were acquired in the F.Y. 2007-08 for ₹ 6,00,000. Mr. N.K. received 50,000 equity shares from RV(P) Ltd. consequent to demerger in January 2021. He sold all the shares of RV(P) Ltd. for ₹ 8,00,000 in March, 2021. In this background answer the following:

1. Does the transaction of demerger attract any income tax liability in the hands of SS (P) Ltd. and RV(P) Ltd.?
2. State the conditions in brief, which are to be satisfied under the Act for a demerger.
3.  Compute the capital gain that could arise in the hands of Mr. N.K. on receipt of shares of RV(P) Ltd.
4. Compute the capital gain that could arise in the hands of Mr. N.K. on sale of shares of RV(P) Ltd.
5. Will the sale of shares by Mr. N.K. affect the tax benefits availed by SS(P) Ltd. and/or RV(P) Ltd.?
6.  Is Mr. N.K. eligible to avail any tax exemption under any of the provisions of the Income-tax Act, 1961 on the sale of shares of RV(P) Ltd.? If so, state in brief. [CA Final Nov. 2015] [10 Marks]

Answer:
(i) As per sec. 4H(vib), capital gains arising on any transfer of a capital asset, in a demerger, by the demerged company to the Indian resulting company shall not be regarded as transfer for the demerged company. Hence, in this case, no capital gains shall arise on transf er of cement division by SS (P) Ltd. to RV(P) Ltd. and therefore, no income tax liability would be attracted in the hands of SS (P) Ltd. and RV(P) Ltd.

(ii) As per sec. 2(19AA) of the Income-tax Act, demerger should be in such a manner that:
(a) All the property of the undertaking, being transferred by the demerged company, immediately before the demerger, becomes the property of the resulting company by virtue for the demerger;

(b) All the liabilities related to the undertaking, being transferred by the demerged company, immediately before the demerger, become the liability of the resulting company by virtue of the demerger;

(c) The property and the liabilities of the undertaking, being transferred by the demerged company, are transferred at values appearing in its books of account immediately before demerger:

Provided that this sub-clause shall not be applicable where the resulting company records the value of the property and liabilities at a value different from the value appearing in the books of account of the demerged company, immediately before the demerger, in compliance to the Ind AS specified in Annexure to the Companies (Ind AS) Rules, 2015.

(d) The resulting company issues, in consideration of the demerger, its shares to the shareholder of the demerger company on a proportionate basis except where the resulting company itself is a shareholder of the demerged company;

(e) The shareholders holding not less than 75% in value of the shares in the demerged company (other than shares already held therein immediately before the demerger; or by a nominee for, the resulting company or, its subsidiary) become shareholders of the resulting company or company by virtue of the demerger; otherwise than as a result of the acquisition of the property or assets of the demerged company or any undertaking thereto by the resulting company;

(f) The transfer of the undertaking is on a going concern basis;

(g) The demerger is in accordance with the conditions, if any, notified u/s 72A(5) by the Central Government in this behalf.

(iii) As per sec. 47(vid), any transfer or issue of shares by the resulting company, in a scheme of demerger to the shareholders of the demerged company is not regarded as transfer, if the transfer or issue is made in consideration of demerger of the undertaking. Therefore, no capital gain shall be calculated for Mr. N.K. on receipt of shares of RV(P) Ltd. (ie. resulting company) in consideration of shares of SS (P) Ltd. (i.e. demerged company).

(iv) As per sec. 49(2C), where the shares are issued in the scheme of demerger, the cost of acquisition of such shares in the hands of shareholders shall be computed as follows:

On subsequent transfer of above shares, the period of holding, as per Explanation 1 to Sec. 2(42A), shall also include the period for which such shares were held in the demerged company by the shareholders.

Therefore, the cost of acquisition of shares received by Mr. N.K. in the resulting company shall be:
= ₹ 6,00,000 × ₹ 10,00,00,000/ ₹ 40,00,00,000 = ₹ 1,50,000

Computation of Capital Gains	₹
Sale consideration (assuming sold at FMV) Less: Cost of acquisition [₹ 1,50,000 × 301/129]	8,00,000 3,50,000
Long Term Capital Gains	4,50,000

(v) No, the sale of shares by Mr. N.K does not affect the tax benefits availed by SS (P) Ltd. and/or RV(P) Ltd.

(vi) Exemption u/s 10(38) shall not be available in respect of long term capital gains arises from transfer of equity share or unit of an equity oriented fund or unit of business trust made on or after 01.04.2018.

However, Mr. N.K. can claim exemption u/s 54EE and 54F by making the specified investments and by fulfilling the conditions specified under these sections.

Question 17.
K and Co. (firm) had sold all its assets and liabilities as a slump sale on 31.03.2021 to SVPC & Co. (firm) for a lump sum consideration of ₹ 600 lakhs.
The statement of affairs of K & Co. as on 31.03.2021 is as below:

Additional Information:

1. Cost of land in March 2010 was ₹ 100 lakhs.
2. WDV of Plant & Machinery u/s 43(6) was ₹ 200 lakhs.
3. Cost Inflation Index for the financial year 2009-10 was 148 and for 2020-21 is 301.
4. Stock is overvalued by 10%

Compute capital gain arising from slump sale and tax on such gain. [CA Final May 2016] [10 Marks]
Answer:
As per section 50B, any profits and gains arising from the slump sale shall be taxable as long term capital gains, if the undertaking is held for more than 36 months or more. Indexation benefit is not available.

Capital gains = “Slump sale consideration” minus “Net worth of the Undertaking or division”
“Net worth” = Aggregate value of total assets of the undertaking/division minus Value of total liabilities of such undertaking or division as appearing in the books of account.

For computing the “Net Worth”, non-depreciable assets are to be taken at their book values. In case of depreciable assets, the written down value of such assets shall be computed as per section 43(6).

Change in the value of assets on account of revaluation of assets shall be fe ignored for the purposes of computing the net worth.

Computation of Tax Liability arising on Slump Sale

NOTE:
1. Net Worth of the undertaking:

2. Benefit of indexation is not available as the iransfer is on slump sale basis.

Question 18.
Mr. Raghu purchased 10,000 equity shares of AB Avenues Pvt. Ltd. on 25.05.2009 for 1,20,000. The company went into liquidation on 3 1.07.2020. The following is the summarized financial position of the company as on 31.07.2020.

Liabilities               ‘	₹	Assets	₹
60,000 equity shares of ₹ 10 each	6,00,000	Agricultural lands in ur­ban area	22,00,000
General reserve	40,00,000	Cash at bank	32,22,200
Liability for income tax	8,22,200
	54,14,305		54,14,305

The assets remaining after discharging liability for income tax were distributed to the shareholders in the proportion of their shareholding. The market value of agricultural land as on 3 1.07.2020 is ₹ 60,00,000.

The agricultural land received as above was sold by Mr. Raghu on 28.02.2021 for ₹ 15,00,000.

Discuss the tax implications in the hand of the company and Mr. Raghu.
The cost inflation indices are F.Y. 2009-10: 148 and F.Y. 2020-21: 301 [CA Final Nov 2016] [10 Marks]
Answer:

Note:
As per section 46(2), where the shareholder receives money or other assets from the company in lieu of the shares held by him, on the liquidation of the company, he shall be chargeable under the head ‘Capital gains’.

The value of monies received and the FMV of the assets received on the % date of distribution, is reduced by the amount deemed as dividend u/s 2(22)(c) shall be deemed to be the full value of consideration in the hands of the shareholders for the shares transferred on liquidation.

Now, as per section 2(22)(c), any distribution by a company to its shareholders at the time of its liquidation shall be treated as deemed dividend in the hands of the shareholders to the extent of accumulated profits of the company, whether capitalized or not.

Mr. Raghu has 10,000 shares out of total 60,000 shares, so he will be receiving 1 /6th of total distribution. .
Therefore, money value (₹ 32,22,200 reduced by tax liability paid ₹ 8,22,200) = 24,00,000 × 1/6 = ₹ 4,00,000 + FMV of the agricultural land ₹ 60,00,000 × 1/6 = ₹ 10,00,000 shall be deemed to be full value of consideration in hands of Mr. Raghu for the shares transferred on liquidation.

After the amendment made by the Finance Act, 2020, the companies are not required to pay DDT on dividends distributed to the shareholders and such dividends shall be taxable in the hands of the shareholders. Thus, in this case, the deemed dividends u/s 2(22)(e) shall be taxable in the hands of Mr. Raghu under the head ‘Income from Other Sources’.

Question 19.
Mr. Ankit sold a plot during the EY. 2020-21 and invested the sale proceeds in purchase of a new house in the name of his wife by the end of the financial year i.e. 31st March, 2021. He claimed deduction u/s 54F in respect of the new house purchased by him in the name of his wife. The A.O. while making assessment for the A.Y. 2021 -22 denied such deduction on the ground that in order to avail benefit u/s 54F, it is necessary to invest the sale proceeds in the name of the assessee.

Comment on the validity of action taken by the Assessing Officer. [CA Final Nov 2016] [4 Marks]
Answer:
The facts of this case are similar to the facts of the case CIT v. Kamal Wahal (2013), where the Delhi High Court observed that for the purpose of section 54F, a new residential house need not necessarily be purchased by the assessee in his own name.

The Delhi High Court observed that the assessee had not purchased the new house in the name of a stranger or somebody who is unconnected with him, but had purchased it in the name of his wife and the entire investment for purchase of new residential house had come out of the sale proceeds of the capital asset (of the assessee) and there was no contribution from his wife.

Hence, the Delhi High Court, having regard to the rule of purposive con-struction and the object of enactment of section 54F, held that the asses-see is entitled to claim exemption u/s 54F in respect of utilization of sale proceeds of capital asset for investment in residential house property in the name of his wife.

Applying the rationale of the above judicial decision in this case, Mr. Ankit is eligible for exemption u/s 54F even though the sale proceeds has been invested in purchase of new house in the name of his wife. Therefore, the contention of the A.O. that in order to avail deduction u/s 54F, it is necessary to invest the sale proceeds in the name of the assessee is incorrect.

Question 20.
A manufacturing company was transporting two of its machines from unit ‘X’ to unit ‘Y’ on 1st September, 2020 by a truck. On account of a civil disturbance, both the machines were damaged. The insurance company paid ₹ 5 lakhs for the damaged machines. On these facts, for submitting the return of income for the previous year ending 31st March, 2021, your advice is sought as to:

1. Whether the damage of machines results in any transfer, vis-a-vis eligibility to capital gains.
2. How the amounts received from the insurance company are to be treated for taxability.
3. Whether there will be any impact on the written down value of the block of plant and machinery as at 31.03.2021? [CA Final May 2017] [3 Marks]

Answer:
As per section 45( I A), where any person receives any money or other assets from an insurer on account of damage to, or destruction of any capital asset as a result ol, inter alia, civil disturbance, then receipt of insurance compensation in the form of money or any asset is to be treated as consideration and capital gain is accordingly to be charged to tax.

In the present case, compensation was received from insurance company for ; damaged machines on account of civil disturbance and thus, it will treated i as consideration to be taxable as ‘Capital Gains’ u/s 45(1 A). By applying 1 the provisions of section 45(1A), our advice to the company regarding the issues raised is as follows:

(i) Where there is damage or destruction to a capital asset as a result of civil disturbance, there is no actual transfer; but it will be treated as deemed transfer and profit and gains from receipt of insurance compensation will be chargeable to tax as capital gain.

(ii) The receipt of insurance compensation of ₹ 5 lakhs has to be treated as the lull value ol consideration received as a result of transfer of such capital asset.

(iii) The receipt of compensation of ₹ 5 lakhs shall be reduced from the WDV of the block of assets as per Sec. 43(6)(c). If the written down value is more than ₹ 5 lakhs, then, ₹ 5 lakhs should be deducted from written down value and if it is less than ₹ 5 lakhs, the dillerence would be treated as short term capital gain.

Question 21.
Alpha Ltd. has two industrial undertakings. Unit 1 is engaged in the production of television sets and Unit 2 is engaged in the production of refrigerators. The company has, as part of its restructuring program, decided to sell Unit 2 as a going concern, by way of slump sale for ₹ 300 lakhs to a new company called Beta Ltd., in which it holds 85% equity shares. The following are extracted from the balance sheet of Alpha Ltd as on 31^st March 2021:

	₹ (in lakhs)
	Unit-1	Unit-2
Fixed assets	112	158
Debtors	88	68
Inventories	85	22
Liabilities	33	65

	₹ (in lakhs)
Paid-up share capital	231
General Reserve	160
Share premium	39
Revaluation reserve	105

The company had set up Unit 2 on 1 st April, 2016. The written down value of the block of fixed assets for tax purpose as on 31st March, 2021 is ₹ 130 lakhs out of which ₹ 75 lakhs are attributable to Unit 2.

Determine what would be the tax liability of Alpha Ltd, on account of this slump sale.
How can the restructuring plan of Alpha Ltd. be modified, without changing the amount of consideration, in order to make it more tax efficient? [CA Final May 2017, May 2012] [10 Marks]
Answer:
(a) As per section 50B, any profits or gains arising from the slump sale shall I be taxable as capital gains in the previous year in which the transfer took place. If the undertaking transferred under slump sale is held for more than 36 months before slump sale, the capital gain shall be deemed to be long-term capital gain.

Indexation benefit is not available in case of slump sale.

Capital gains= “Slump sale consideration” minus “Net worth of the ‘ Undertaking or division”
“Net worth” = Aggregate value of total assets of the undertaking/ division minus
Value of total liabilities of such undertaking or division as appearing in its books of account.

Change in the value of assets on account of revaluation of assets shall be ignored for the purposes of computing the net worth.

For computing the “net worth”, non-depreciable assets are to be taken at their book values and in case of depreciable assets, the written down value of such assets shall be computed as per section 43(6).

Computation of Net Worth of Unit II

Net worth of Unit II	₹
WDV of depreciable assets under section 43(6)	75,00,000
Book value of non-depreciable assets:
(i) Debtors	68,00,000
(ii) Inventories	22,00,000

Net worth of Unit II	₹
Aggregate value of total assets Less : liabilities	1,65,00,000 65,00,000
Net worth of Unit II	1,00,00,000

Calculation of Capital gains	₹
Slump sale consideration Less: Cost of acquisition (net worth)	3,00,00,000 1,00,00,000
Long-term Capital Gain	2,00,00,000

Calculation of tax liability	₹
Income tax @ 20% on ₹ 2,00,00,000	40,00,000
Surcharge @ 7%	2,80,000
	42,80,000
Health & Education Cess @ 4%	1,71,200
Tax liability	44,51,200

(b) Tax Advice:
(i) Transfer of capital asset by a holding company to its 100% Indian subsidiary company is exempted from tax u/s 47(iv). Therefore, if it is possible for Alpha Ltd., it should try to acquire the entire shareholding of Gamma Ltd. and thereafter make a slump sale, so that the resultant capital gain shall not attract tax liability. However, in such case also, Alpha Ltd. should not transfer any shares in Gamma Ltd. for 8 years from the date of slump sale.

(ii) Alternatively, if acquisition of 15% share is not feasible, Alpha Ltd. may think about demerger plan of Unit II to get benefit of section 47(vib).

Question 22.
Avimanyu, a resident individual held 25% equity shares in FMC Ltd., an Indian company. The company’s paid up share capital as on 31st March, 2020 was ₹ 10 each issued at a premium of ₹ 20 each. The shares were allotted to the shareholders on 1^st October, 2015. The company had gone for buyback of 30% of its shares on 30th July, 2020 as per the provisions of the Companies Act, 2013.
The company paid ? 60 per share on buy back.

Explain and compute the tax effect in the hands of FMC Ltd. and Avimanyu if the shares of FMC Ltd. are not listed on recognised stock exchange.

Whether the answer would be different if the shares of FMC Ltd. are listed on recognised stock exchange.
Cost Inflation Index: 254 for F.Y. 2015-16; 301 for F.Y. 2020-21 [CA Final Nov 2017] [10 Marks]
Answer:
(i) If shares of FMC Ltd. are not listed on recognized stock exchange:
Tax effect in the hands of shareholders (i.e. Avimanyu): On buy-back of shares, there shall be no capital gains in the hands of shareholder as it is exempt u/s 10(34A).

Tax effect in the hands of the company (i.e. FMC Ltd):
As per section 115QA on buy-back of shares, company shall be chargeable to additional tax @ 20% plus surcharge @ 12% and cess @ 4% = 23.296% on the distributed income (i.e. the consideration paid by the company on buy-back as reduced by the amount received by the company on issue of such shares).

(ii) If shares of FMC Ltd. are listed on recognized stock exchange:
The answer would remain the same even if the shares of FMC Ltd. are listed on recognised stock exchange. As per the amendment made by the Finance (No. 2) Act, 2019, even the buyback of listed shares shall be chargeable to additional tax u/s 115QA in the hands of the company with effect from 05.07.2019. Therefore, after this amendment, buyback of both i.e. listed and unlisted shares, shall be chargeable to additional tax u/s 115QA in the hands of the company and the capital gains in the hands of the shareholders shall be exempt u/s 10(34A).

Question 23.
Shri Chandok is running a factory in Nagpur for the past 10 years. He sold the factory building for ₹ 80 lakhs and the consideration was appropriated as ₹ 20 lakhs for the building and ₹ 50 lakhs for the land underneath the building. The factory building is the only asset of the block on which depreciation was claimed and whose WDV was ₹ 1,80,000. The indexed cost of acquisition of land is ₹ 22 lakhs. He deposited ₹ 48 lakhs in capital gain bonds of NHAI within 2 months after the sale of the factory building. The A.O. disallowed the claim of exemption on the reasoning that capital gain on transfer of depreciable asset being short-term is not eligible for exemption u/s 54EC. Is the action of the A.O. valid in law? [CA Final May 2018 (Old Syllabus), May, 2014] [4 Marks]
Answer:
Issue Involved: The issue under consideration is whether the benefit of exemption u/s 54EC can be available where the capital gains arises on sale of depreciable asset being land or building or both, held for more than 36 months, is reinvested in long term specified assets within the specified time considering Sec. 50 which provides that capital gains in respect of depreciable asset shall always be short term.

Provisions applicable: As per Sec. 54EC, where the capital gains arising from a transfer of long term capital asset being land or building or both, is invested within a period of 6 months after the date of such transfer, in long term specified assets which, inter alia, includes the bonds of NHAI redeemable after 5 years, then the assessee shall be eligible to claim exemption u/s 54EC for the amount deposited in such bonds or ₹ 50,00,000, whichever is less.

Analysis: The facts of the case are similar to the case of CIT v. V.S. Dempo (2016), where the Supreme Court observed that Sec. 50 is a special provision for computation of capital gains in case of depreciable asset and has a limited application in the context of computation of capital gains. It does not deal with exemption which is provided in a totally different provision i.e. Sec. 54EC. Also, Sec. 54EC does not make any distinction between depreciable and non-depreciable asset for the purpose of re-investment of capital gains in long term specified assets for availing the exemption thereunder and therefore, the exemption u/s 54EC cannot be denied to the assessee on account of the fiction created in Sec. 50. The Apex Court, therefore, held that since the depreciable asset being land or building or both is held for more than 36 months and the capital gains are re-invested in long-term specified assets within the specified period, exemption u/s 54EC cannot be denied to the assessee.

Conclusion: By applying the above rationale, the action of the A.O. to disallow the claim of exemption on the reasoning that the transfer of de-preciation asset, being short-term, is not eligible for exemption u/s 54EC, is not valid in law.

Question 24.
X Ltd., a company in which the whole of its share capital was held by Y Ltd. Both X Ltd. and Y Ltd. are Indian companies. X Ltd. had made investment in shares of ABC Ltd., in 1980 for t 3,00,000 which it sold to Y Ltd. on April 1, 2012 for a consideration of ₹ 30,00,000.

The fair market value of these shares of ABC Ltd., as on April 1, 2001 is ₹ 20,00,000. Y Ltd. disinvested 5% of the shares held by it in X Ltd., in January 2021 by sale to public. It sold the shares in ABC Ltd. in March 2021 acquired by it from X Ltd. for a sum of ₹ 70,00,000.

Discuss the issue with relevant provisions and tax effects of these transactions in the hands of X Ltd. and Y Ltd. in the relevant assessment years.
The cost inflation Index Value for the Financial Year 2020-21 is 301. [CA Final May 2018 (New Syllabus)] [7Marks]
Answer:
A.Y. 2013-14:
As per Sec. 47(v), any transfer of a capital asset by a wholly owned subsidiary to its holding company, being an Indian company shall not be regarded as transfer and therefore, shall not taxable as capital gains. Therefore, the transfer of shares in ABC Ltd. by X Ltd. to Y Ltd. shall not be taxable in the hands of X Ltd. Also, there will be no tax effects in the hands of Y Ltd.

A.Y. 2021-22:
For X Ltd.
As per Sec. 47A(1), yvhere at any time before the expiry of 8 years from the date of the transfer of a capital asset referred to in Sec. 47(v), the holding company ceases to hold the whole of the share capital of the subsidiary company, then the amount of capital gains arising from the transfer of such capital asset not charged to tax earlier by virtue of Sec. 47(v), shall be charged to tax as the income of the transferor company in the previous year in which such transfer took place. However, in this case, Sec. 47A(1) shall not apply since the 8 year period from the date of transfer expires on 31.03.2020 and the disinvestment of 5% shares held in X Ltd. was made in January, 2021.

For Y Ltd.
Transfer oi shares of ABC Ltd. by Y Ltd. in March, 2021 would attract capital gains in the hands of Y Ltd. for the A.Y. 2021 -22. The cost of acquisition for the Y Ltd. shall be the cost of acquisition of such shares for X Ltd. i.e. ₹ 3,00,000 or the FMV as on 01.04.2001 i.e. ₹ 20,00,000, whichever is higher. Therefore, the cost of acquisition for Y Ltd. shall be ₹ 30,00,000.

Computation of capital gains

Note: It is assumed that the shares are not listed on recognised stock ex-change and therefore, Sec. 112A shall not be applicable.

Question 25.
Eden Fabs Private Ltd. went into liquidation on 31.07.2020. The company was seized and possessed of the following funds prior to the distribution of assets to the shareholders:

There are 8 shareholders, each of whom received 12,25,000 from the liquidator in full settlement. You are required to examine the various issues and advice the shareholders about their liability to Income tax. [CA Final Nov 2018 (New Syllabus)] [6 Marks]
Answer:
As per Sec. 46(1), where the assets of a company are distributed to its shareholders on its liquidation, such distribution shall not be regarded as transfer in the hands of the company for the purpose of section 45. However, sec. 46(2) provides that where the shareholder, on liquidation of a company, receives any money or other assets from the company, he shall be chargeable under the head “capital gains”, in respect of the money so received or the market value of the other assets on the date of distribution as reduced by the amount of dividend deemed u/s 2(22)(c) and the sum so arrived at shall be deemed to be the full value of the consideration for the purposes of section 48.

As per section 2(22)(c), dividend includes any distribution made to the shareholders of a company on its liquidation, to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation, whether capitalized or not.

In this case, the accumulated profits immediately before liquidation is ₹ 4,00,000 and the share of each shareholder is ₹ 50,000 (being 1 /8th of ₹ 4,00,000). Such amount of ₹ 50,000 shall be treated as deemed dividend u/s 2(22)(c) and the same shall be taxable in the hands of shareholder.

Therefore, ₹ 1,75,000 [i.e. ₹ 2,25,000 minus ₹ 50,000, being the deemed dividend u/s 2(22)(c)] is the full value of consideration in the hands of each shareholder as per section 46(2). Against this, the investment of ₹ 1,00,000 by each shareholder is to be deducted to arrive at the capital gains of ₹ 75,000 of each shareholder. The benefit of indexation is available to the shareholders (since the shares are unlisted and held for more than 24 months and hence long-term capital asset), but could not be computed in the absence of required information.

Since, the equity shares are not listed, it would not be liable for securities transaction tax and hence, such long  term capital gains shall be taxable u/s 112. The benefit of concessional rate of tax @ 10% without indexation would also not be available. Hence, such long term capital gain would be taxable @ 20% with indexation benefit.

Exemption under section 54EC is available only where there is an actual transfer of capital assets and not in the case of deemed capital gain as per , the decision rendered in the case of CIT v. Ruby Trading Co. (P.) Ltd. (2003) 259ITR 54 (Raj). Therefore, exemption under section 54EC will not be available in this case since it is deemed transfer and not actual transfer. Also, exemption u/s 54EC is available only on transfer of long term capital asset, being land or building or both.

Profits and Gains of Business or Profession – CA Final DT Question Bank is designed strictly as per the latest syllabus and exam pattern.

Profits and Gains of Business or Profession – CA Final DT Question Bank

Question 1.
Explain in brief, the treatment as to the taxability and/or allowability, under the provisions of Income-tax Act, 1961:
‘C’ Ltd., which did not have any active business carried on by it incurred capital expenditure on scientific research amounting to ₹ 5,00,000 that related to its subsidiary companies. [CA Final May 2010] [3 Marks]
Answer:
As per section 35(1)(iv), deduction in respect of capital expenditure on scientific research shall be allowed only if the scientific research relates to the business carried on by the assessee.

However, in the given case, ‘C’ Ltd., did not have any active business carried on by it to which the said scientific research related to. The capital expenditure incurred by ‘C’ Ltd. related to its subsidiary companies and therefore, ‘C’ Ltd. is not eligible for deduction.

Question 2.
Indian Gas Limited commenced its operation of the business of laying and operating a cross country natural gas pipeline network for distribution on 1st July, 2019. The company incurred capital expenditure of ₹ 300 lakhs (including cost of land ₹ 45 lakhs and cost of financial instrument ₹ 5 lakhs) during the period from 1st April, 2018 to 30th June, 2019. The company did not claim deduction for such expenditure in the earlier assessment years. The entire expenditure was capitalised on 1st July, 2019. Further, during the previous year 2020-21, the company incurred capital expenditure of ? 200 lakhs exclusively for the said business.

(i) Compute the amount of deduction allowable under section 35AD assuming that the company has fulfilled all the conditions specified in section 35AD.
(ii) If the company has loss from such business in the assessment year 2021-22, how the same is to be set off and carried forward? [CA Final May 2010] [6 Marks]
Answer:
(i) As per Sec. 35AD, where the assessee commences the business of laying and operating a cross-country natural gas or crude or petroleum pipeline network for distribution, including storage facilities, he shall be eligible for, if it has opted, 100% of the capital expenditure incurred during the previous year, wholly and exclusively for the above business as deduction from the business income. However, expenditure incurred on acquisition of any land, goodwill or financial instrument would not be eligible for deduction.

If the capital expenditure is incurred before commencement of such specified business, then deduction shall be
allowed in the year of commencement provided such expenditure is capitalized in books of account on the date of commencement.

Therefore, the deduction admissible under section 3 5AD for A.Y. 2021 – 22 would be:

	₹ in lakhs
Capital expenditure incurred during the previous year 2020-21 Capital expenditure incurred prior to commencement of business and capitalized in the books of account on 01.07.2019 (₹ 300 lakhs – ₹ 50 lakhs i.e. cost of land and financial instrument)	200 250
Total deduction under section 35AD for A.Y. 2021.-22	450

(ii) As per Sec. 73A, loss in respect of the specified business shall be set off only against profits and gains of any specified business and the unabsorbed loss can be carried forward indefinitely and restriction ‘ of carry forward of loss for 8 assessment years is not applicable.

Question 3.
Aditya, Avirup and Avigyan carried on business of running hotels in partnership from 1st April, 2011 to 31st March, 2018. In order to increase its scale of operation and meet its fund requirement, the firm decided to carry on its business through corporate route. For that purpose, a company under the name and style “Triple A Hospitality Private Limited” was formed on 1st April, 2019 and the business of the partnership firm as a whole was succeeded to by the company with effect from 1st June, 2019.

The company’s profit and loss account for the year ended 31 st March, 2021 shows a net profit of ₹ 450 lakhs after debit/credit of the following items:
(i) Interest of t 3 lakhs paid to Allahabad Bank on a term loan taken for the purpose of acquiring a land at Bhubaneswar for a new hotel to be set up.
(ii) Depreciation charged ₹ 40 lakhs.
(iii) ₹ 2 lakhs credited on account of waiver of dues obtained from a supplier of the erstwhile firm against supply of certain materials.
(iv) ₹ 1.18 lakhs being the aggregate of amounts paid in cash to Rajaram, a transport contractor as follows:
Date of Payment – ₹ in lakhs
5th June, 2020 – 15,000
20th July, 2020 – 21,000
20th September, 2020 – 22,000
3rd November, 2020 – 26,000
5th November, 2020 – 36,000
Tax was not deducted at source as Rajaram submitted a certificate u/s 197(1) which he had obtained from the TDS circle of the Income-tax Department. .
(v) ₹ 0.50 lakh, being proportionate part of the cost of animals (purchased and kept for entertainment of the guests of hotel) amortised as per the accounting policy of the company.
(vi) ₹ 0.10 lakhs credited on account of sale proceeds of carcass of animal which died during the year.
(vii) Provision for bad and doubtful debts ₹ 12 lakhs.
(viii) Payment of ₹ 25 lakhs to some employees as compensation for voluntary retirement, as per scheme

Other Information:
(i) Depreciation as per the Income-tax Act, 1961 ₹ 65 lakhs.
(ii) Cost of animal died as referred to in (f) above was ₹ 2 lakhs.
(iii) Debt of ₹ 4 lakhs due from one corporate customer for three months I has been written off during the year after giving few reminders by debiting provision for bad and doubtful debts account.
(iv) The erstwhile firm was allowed exemption of ₹ 50 lakhs u/s 47(xiii) in respect of long-term capital assets transferred to the company.
(v) The company’s voting rights till 31st March, 2020 were held as follows:
Aditya – 40%
Avirup – 30%
Avigyan – 15%
Others – 15%
During the year, shares constituting 36% voting rights were sold by Aditya to his son-in-law, Avishek.
(vi) Unabsorbed business loss and unabsorbed depreciation of ? 10 lakhs each have been carried forward from Assessment Year 2019-20.
(vii) The company has a subsidiary company, Tours & Travels Private Limited (a closely held company). During the year, the company obtained a temporary loan of ₹ 12 lakhs from its subsidiary company. Accumulated profit of the subsidiary company was ₹ 30 lakhs at the time of payment of the loan. The loan was repaid by the company before the end of the year.

Compute total income of Triple A Hospitality Private Limited for the A.Y. 2021-22 indicating reason for treatment of each of the items. Ignore the provisions relating to minimum alternate tax. [CA Final May 2010] [20 Marks]
Answer:
Computation of Total Income of Triple A Hospitality (P) Ltd. for the A.Y. 2021-22

Notes:
(1) As per proviso to section 36(1)(iii), interest paid in respect of capital borrowed for acquisition of an asset (whether capitalized in the books of account or not) for the period till the date on which such asset is first put to use shall not be allowed as deduction. Since, the land is yet to be put to use, deduction for interest is not allowable.

(2) As per Sec. 41(1), where any trading liability was allowed as deduction to the predecessor-firm and the successor has obtained some benefit by way of remission or cessation of such trading liability, such benefit obtained by the successor shall be deemed to be profits and gains of business or profession and would be chargeable to tax in the year in which the benefit accrued. In this case, waiver of ? 2,00,000 obtained from the supplier of the predecessor firm shall be deemed as business income of the assessee company. Since the amount is already credited to profit and loss account, no adjustment is necessary.

(3) As per Section 40A(3), where the assessee incurs any expenditure for which a payment or aggregate of payments made to a person in a single day, otherwise than by account payee cheque or account payee bank draft or use of ECS through a bank account or through such other electronic mode as may be prescribed, exceeds ₹ 10,000, no deduction shall be allowed in respect of such expenditure.

However, if the payment is made for plying, hiring or leasing goods carriages, then limit is ₹ 35,000 instead of ₹ 10,000. In this case, only the amount paid to Rajaram, a transporter on 5th Nov, 2020 exceeds ₹ 35,000 and therefore, ₹ 36,000 shall be disallowed and shall be added’ back.
Since, Rajaram has submitted a certificate u/s 197(1), no taxis required to be deducted and sec. 40(a)(id) shall not be attracted.

(4) As per Sec. 3 6( 1)(vi), in respect of animals which have been used in the business or profession, otherwise than as stock-in-trade, the difference between the actual cost of the animals and the amount, if any, realized in respect of the animals or carcasses shall be allowed as deduction in the year when they die or become permanently useless.

Therefore, ₹ 50,000 debited to profit and loss account has to be added back and ₹ 10,000 credited to profit and loss account has to be deducted. The difference between the cost of animal died (₹ 2 lakh) and the sale proceeds of carcasses (₹ 0.10 lakh) is allowable as deduction u/s 36(l)(vi). Therefore, ₹ 1,90,000, is allowable as deduction u/s 36(1)(vi).

(5) Provision for bad and doubtful debts is allowable as deduction u/s 36(1)(viia) only in the case of specified banks and financial institutions. Therefore, a company engaged in hotel business is not eligible for deduction in respect of provision for bad and doubtful debts and accordingly, ₹ 12 lakh, debited to profit and loss account has to be added back.

A bad debt written off is allowed as deduction u/s 36(1 )(vii) if such debt is written off as irrecoverable in the books of account. Therefore, the amount of ₹ 4 lakhs written off during the year by debiting provision for bad and doubtful debts is allowable as deduction u/s 36(1)(vii).

(6) As per section 35DDA, where in any previous year, any expenditure is incurred in connection with voluntary retirement of any employee, 1 /5th of the amount so paid shall be deducted in computing profits and gains of business for that previous year, and the balance shall be deducted in four equal instalments in the immediately succeeding four previous years. Therefore, out of ₹ 25,00,000, ₹ 5,00,000 is deductible in assessment year 2021-22 and the balance of ₹ 20 lakhs shall be added back.

(7) As per Sec. 47A(3), where any of the conditions laid down in proviso to Sec. 47(xiii) are not complied with, the capital gains which was not charged to tax u/s 45 earlier shall be chargeable to tax in the hands of the successor company for the previous year in which the requirements of the proviso to Sec. 47(xiii) are not complied with.

In this case, before the expiry of 5 years fronTthe date of succession, Aditya sold shares carrying 36% voting rights to his son-in-law which reduces the aggregate of shareholding of the partners in the company to below 50% of the total voting power in the company. Therefore, the long-term capital gain which was not charged to tax in the hands of the firm in the year of succession shall be deemed to be long term capital gain of the assessee company in the A.Y. 2021-22.

(8) As per Sec. 2(22)(e), where any company, in which public are not sub-stantially interested, makes any payment by way of loan or advance, to the extent of accumulated profits of the company, to any shareholder holding beneficial ownership of shares carrying not less than 10% of the voting power, then such loans or advances shall be treated as deemed dividends. As per the amendment made by the Finance Act, 2020, dividends including deemed dividends are taxable in the hands of shareholders. Therefore, ₹ 12,00,000 shall be the deemed dividend taxable in the hands of Triple A Hospitality Pvt. Ltd. under the head ‘Income from Other Sources’.

(9) As per Sec. 72A(6), accumulated loss and depreciation of the predecessor firm would become the loss and depreciation of the successor company of the previous year in which the conversion takes place provided the conditions laid down in section 47(xiii) are fulfilled. In this case, the conditions are fulfilled in the P.Y. 2019-20 and it appears that the assessee-company did not have sufficient profits during the P.Y. 2019-20, against which the brought forward loss and unabsorbed depreciation can be set-off and for this reason, the same has been carried forward to the P.Y. 2020-21.

However, in the P.Y. 2020-21, one of the conditions as per the proviso to Sec. 47(xiii) is not satisfied i.e. aggregate shareholding of erstwhile partners falls below 50%, and therefore, the business loss and unabsorbed depreciation cannot be set-off.

Question 4.
Della Limited is engaged in manufacturing pipes and tubes. The profit and loss account of the company for the year ended 31st March, 2021 shows a net profit of ₹ 405 lakhs. The following information and particulars are furnished to you. Compute the total income of the company for Assessment Year 2021-22 indicating reasons for treatment of each item.

(i) A group free air ticket was provided by a supplier for reaching a certain volume of purchase during the financial year 2020-21. The same is encashed by thfe company for ₹ 10 lakhs in April 2021.

(ii) A regular supplier of raw materials agreed for settlement of ₹ 8 lakhs instead of ₹ 10 lakhs for poor quality of material supplied during the previous year which was not given effect in the running account of the supplier.

(ii) Andhra Bank sanctioned and disbursed a term loan in the financial year 2017-18 for a sum of ₹ 50 lakhs. Interest of ₹ 8 lakhs were in arrears. The bank has converted the arrear interest into a new loan repayable in ten equal instalments. During the year, th6 company has paid two instalments and the amount so paid has been reduced from Funded Interest in the Balance Sheet.

(iv) The company remitted ₹ 5 lakhs as interest to a company incorporated in USA on a loan taken two years ago. Tax deducted under section 195 from such interest has been deposited by the company on 15th July, 2021. The said interest was debited to profit and loss account.

(v) Liquidated damage of ₹ 3 lakhs received from KS Limited for delay in supply of plant and machinery has been shown under the head “Other income” in Profit & Loss Account.

(vi) Sandeep, a sales executive stationed at HO at Delhi, was on official tour in Bangalore from 31st May, 2020 to 18th June, 2020 and 28th September, 2020 to 15th October, 2020 for the business development. The company has paid Sandeep’s salary in cash, from its local office at Bangalore for the month of May, 2020 (payable on 1st June) and September 2020 (payable on 1st October), amounting to ₹ 25,000 and ₹ 27,000 respectively (net of TDS and other deduction), as Sandeep has no bank account at Bangalore. These were included in the amount of “salary” debited to Profit and Loss Account.

(vii) The company has taken up initiative to restructure its debt and paid ₹ 20,000 to a finance company, M/s ABC Ltd., towards pre-payment premium. As per the scheme, ₹ 50,000 loans was waived against its loan and Della Limited directly credited it to its reserve account, considering loan waiver amount as capital receipt.

(viii) The company has contributed ₹ 50,000 by cheque to an electoral trust and the same stands included under the head “General Expenses”. [C4 Final Nov. 2010] [10 Marks]
Answer:
Computation of total income of Della Ltd. for the A.Y. 2021-22

Notes:
Since the question is silent as to whether the net profit of ₹ 405 lakhs is after taking into account the adjustments in (i) to (viii), the problem has been worked out on the assumption that except for items (iv), (v) (vi) and (viii) in respect of which there is a specific mention about inclusion, all other adjustments i.e. (i), (ii), (iii) and (viz) have not been given effect to in the profit and loss account.

1. Tax deducted by the assessee on interest payable outside India to a foreign company is deposited within the time limit under section 139(1) is not disallowed [Section 40(a)(i)].

2. Salary paid to sales executive in cash is not disallowable as he was temporarily posted for a continuous period of more than 15 days in Bangalore, not being the place of his normal duty, tax was deducted from such salary u/s 192 and he does not maintain any bank account in Bangalore. Therefore, no disallowance u/s 40A(3) is attracted in respect of such salary as per Rule 6DD.

3. Remission of principal amount of loan does not amount to income u/s 41(1) or u/s 28(iv), where there is a waiver of loan taken from a bank or financial institution, unless the loan is taken for a trading activity. It is assumed that such loan is not taken for a trading activity and therefore, waiver of loan cannot be treated as income.

Question 5.
ITP Limited is engaged in growing and manufacturing tea in India. It commenced its operation from 1st April, 2020. It acquired plant and machinery, factory building and furniture at cost of ₹ 40 lakhs, ₹ 25 lakhs and ₹ 10 lakhs, respectively, in the P.Y. 2020-21. All the assets were put to use for more than 180 days during 2020-21. Compute the written down value of each block of assets as on 1st April, 2021, [CA Final Nov 2010] [3 Marks]
Answer:
As per Rule 8 of the Income-tax Rules, 1962, only 40% of income from business of growing and manufacturing of tea in India is deemed to be income liable to tax. The balance 60% would be agricultural income, which is not chargeable to tax.

As per Explanation 7 to section 43(6), in cases of composite income, for the purpose of computing WDV of assets acquired before the previous year, the total amount of depreciation shall be computed as if the entire composite   income of the assessee is chargeable to tax under the head “Profits and § gains of business or profession”. The depreciation so computed shall be § deemed to have been “actually allowed” to the assessee.

Therefore, even if only 40% of ITP Ltd.’s income from sale of tea grown and manufactured in India is taxable, full depreciation (and not 40%) should be taken as “actually allowed” for the purpose of computing’WD V. Accordingly, the WDV of each block as on 1st April 2021 will be as follows:

Plant & Machinery = ₹ 40 lakhs – ₹ 6 lakhs (15% of 40 lakhs) = ₹ 34 lakhs; Building (Factory) = ₹ 25 lakhs – ₹ 2.50 lakhs (10% of 25 lakhs) = ₹ 22.50 lakhs; Furniture = ₹ 10 lakhs – ₹ 1 lakh (10% of 10 lakhs) = ₹ 9 lakhs.

Question 6.
Can brought forward losses and unabsorbed depreciation be set off against the profit determined u/s 44B? [CA Final May 2011] 4 Marks]
Answer:
Sec. 44B provides that notwithstanding anything contained in Secs. 28 to 43A, in case of a non-resident engaged in the business of operation of ships, a sum equal to 7.5% of

(a) The amounts paid or payable whether in or out of India to the assessee, on account of carriage of passengers, livestock, mail or goods shipped at any port in India, and

(b) Any amount received or deemed to be received in India by or on behalf of the assessee, on account of carriage of passengers, livestock, mail or goods shipped at any port outside India, shall be deemed to be the profit of such business.

Sec. 44B overrides Secs. 28 to 43A and therefore it overrides sec. 32 which deals with the unabsorbed depreciation. So, the unabsorbed depreciation cannot be set-off against the income deemed u/s 44B.

However, it does not override Chapter VI which relates to carry forward and set off of brought forward losses and therefore, the brought forward business losses can be set off against the income determined u/s 44B.

Question 7.
X Co. Ltd. was amalgamated with Y Co. Ltd. on 30.04.2020. X Co. Ltd. was engaged in real estate whereas Y Co. Ltd. was engaged in manufacture of textile articles. Y Co. Ltd. on amalgamation altered its objects clause of Memorandum of Association, to carry on real estate business.

The stock in trade of X Co. Ltd. (being vacant lands) was taken over at ₹ 140 lakhs by Y Co. Ltd. as against their original cost of ₹ 125 lakhs to X Co. Ltd. for the purpose of amalgamation. Y Co. Ltd incurred ₹ 25 lakhs towards development of those lands obtained on amalgamation. It sold the entire land for ₹ 160 lakhs during the year ended 31.03.2021. Determine the tax implication of the transaction in hands of Y Co. Ltd. for the assessment year 2021-22. [CA Final May 2011] [4 Marks]
Answer:
In this case, since the stock-in-trade of X Co. Ltd. is taken over by Y Co. Ltd. on amalgamation, the provisions of section 43C are attracted and the cost of acquisition of vacant lands to Y Co. Ltd. (the amalgamated company) will be ₹ 125 lakhs, being the original cost of such lands to X Co. Ltd., the amalgamating company.

Since the amalgamated company i.e. Y Ltd. has altered its object clause so as to include real estate business, it is clear that the vacant land which were hitherto stock-in-trade for the amalgamating company continues to be in the nature of stock-in-trade for Y Ltd. Thereby, the provisions of section 45(2) i.e. conversion of capital asset into stock-in-trade is not attracted in this case.

Business income of Y Co. Ltd. on sale of such lands would be calculated as under:

Question 8.
XYZ Private Limited is engaged in manufacturing and selling ceramic tiles. The net profit of the company as per its profit and loss account for the year ended 31st March, 2021 is ₹ 150 lakh after debiting or crediting the following items:
(i) One-time license fee of ₹ 20 lakh paid to a foreign company for obtaining franchise on 1st June, 2020.
(ii) ₹ 29,000 paid to A & Co., a goods transport operator, in cash on 31st January, 2021 for distribution of the company’s products to its warehouse.
(iii) Rent of ₹ 6 lakh received from letting out a part of its office premises. Municipal tax in respect of the said part of the building amounting to ₹ 15,000 remains unpaid.
(iv) ₹ 2 lakh, being contribution to a University approved and notified u/s 35(1)(ii).
(v) ₹ 3 lakh, being loss due to destruction of a machinery caused by a fire due to short circuit. The Insurance Company did not admit the claim of the company.
(vi) ₹ 4 lakh and ₹ 1 lakh, being amounts waived by a bank out of principal and arrear interest, respectively, in an one-time settlement. The loan was obtained for meeting working capital requirement four years back.
(vii) ₹ 1 lakh, being amount payable to a contractor (who does not have Permanent Account Number) for repair work at the company’s factory. Tax of ₹ 2,000 was deducted and paid in time.
(viii) Depreciation on tangible fixed assets ₹ 1 lakh.

Additional Information:
(i) Depreciation on tangible fixed assets as per Income-tax Rules ₹ 1.75 lakh.
(ii) The company has obtained a loan of ₹ 2 lakh from ABC Private Limited in which it holds 16% voting rights. The accumulated profits of ABC Private Limited on the date of receipt of loan was ₹ 0.50 lakh.

Compute total income of XYZ Private Limited for the Assessment Year 2021-22 indicating reasons for treatment of each item. Ignore the provisions relating to minimum alternate tax. [CA Final Nov. 2011] [16 Marks]
Answer:
Computation of total income of XYZ Private Ltd. for the A.Y. 2021-22

Notes:
(1) Rental income from letting out a part of the office premises is taxable under income from house property”. Therefore, it has to be deducted while calculating business income, since the income has been credited to profit and loss account. Likewise, municipal taxes due in respect of such property, debited to profit and loss account has to be added back to compute business income.

(2) Franchise is an intangible asset eligible for depreciation @ 25%. Since one-time licence fees of ₹ 20 lakh paid to a foreign company for obtaining franchise has been debited to probt and loss account, the same has to be added back. Depreciation @ 25% has to be provided in respect of the intangible asset since it has been used for more than 180 days during the year.

(3) ₹ 29,000 paid to A & Co., a goods transport operator in cash is deductible while computing business income, since the limit above which disallowance u/s 40A(3) would be attracted in case of payment to a transport contractor engaged in the business of plying, leasing goods carriages is ₹ 35,000.

(4) Contribution to a university approved and notified u/s 35(1)(n) is eligible for deduction of 100% from P.Y. 2020-21. Therefore, since the contribution of ₹ 2,00,000 already been debited to profit and loss account, no adjustment is required. Loss of ₹ 3 lakh due to destruction of machinery caused by fire is not deductible since, it is capital in nature.

(6) Non-furnishing of PAN to deductor results in attracting provisions of section 206AA, which require tax to be deducted at a higher rate of 20%. Since, the company has deducted tax @ 2% and not @ 20% as per the requirement u/s 206AA, disallowance u/s 40(a)(ia) would be attracted @ 30% in respect of payment of ₹ 1 lakh made to contractor i.e. ₹ 30,000.

Note: There is a possibility of alternate views regarding the tax treatment of disallowance u/s 40(a)( ia) for short-deduction of tax. It is possible to take a view that only proportional disallowance u/s 40(a) (ia) would be attracted in such a case. Another view is that disallowance u/s 40(a)(za) is only for non-deduction of tax at source and not short-deduction of tax and therefore, no disallowance should be made in case of short-deduction of tax. The computation of total income would, accordingly, change.

(7) Depreciation as per Income-tax Rules, 1962, is deductible while calculating business income. Therefore, depreciation of ₹ 1.75 lakh on tangible fixed assets and ₹ 5 lakh on intangible assets shall be deducted and ₹ 1 lakh shall be added back.

(8) Since, the loan is for meeting working capital requirement, it shall be the trading activity and the waiver of principal amount of loan taken for trading activity is a benefit in respect of a trading-liability by way of remission or cessation thereof and is, hence, taxable u/s41(1). Since, the loan waiver has already been credited to profit and loss account, no adjustment is required.

However, the treatment is different in respect of interest on loan. Since, interest on such loan would have not been allowed as deduction in the earlier years as per section 43B due to non-payment of such interest, waiver of interest will not be taxable. Since ₹ 1,00,000 representing interest waiver has already been credited to profit and loss account, the same has to be deducted for computing business income.

(9) As per Sec. 2(22)(e), any advance or loan given by a closely held company, to the extent of accumulated profits of the company, to a share-holder, being the beneficial owner of shares, carrying not less than 10% of voting power, shall be treated as deemed dividends in the hands of shareholder. In this case, XYZ Pvt. Ltd holds 16% voting rights in ABC Pvt. Ltd and therefore, out of the advance of ₹ 2,00,000 obtained from ABC Pvt. Ltd, ₹ 50,000 being the amount upto the accumulated profits of ABC Pvt. Ltd., shall be treated as deemed dividend u/s 2(22)(e) in the hands of XYZ Pvt. Ltd. and shall be taxable under the head ‘Income from ‘Other Sources’.

Question 9.
S Ltd. engaged in the business of manufacturing, having turnover of ₹ 244 crores for the previous year 2018-19 and net profit of ₹ 115 crores for the financial year ended 31.3.2021, after debiting Crediting following items:
(i) On EPABX and mobile phones (exclusively used for the business purpose) purchased during the year, depreciation amounting to ₹ 18 crores was claimed at higher rate of 40% treating them at par with computer.

(ii) ₹ 50 crores paid to N Ltd, towards feasibility study conducted for examining proposals for technological advancement relating to the existing business. The project was abandoned without creating a new asset.

(iii) ₹ 35 crores paid for the higher studies of the director’s son abroad, with a stipulation that he would be appointed as a trainee in the company under ‘apprentice training scheme where there is no evidence of existence of such scheme.

(iv) Payment of ₹ 29 crores towards purchase of software from a non-resident, meant for subsequent resale in the Indian market (no tax deducted at source), was ultimately sold at a profit during’ the year 2020-21.

(v) Dividend of ₹ 10 crores received from a foreign company in which this company holds 28% in nominal value of the equity share capital of the company, ₹ 0.25 crore expended on earning this income.

(vi) A machine in use since past 7 financial years having WDV amounting to ₹ 1.50 crores on 01.04.2019 was discarded on 3.9.2020. The depreciation on the block at 15% has been provided and charged to profit and loss account for the previous year ended 31.3.2021. The entire block is used for the purpose of business.

(vii) ₹ 45 crores were paid on 3.6.2020 to a National Laboratory with a stipulation that the said contribution shall be used for the purpose of an approved scientific research programme only.

(viii) Secret commission of ₹ 13 crores was paid and debited under commission account.

Additional Information:
A debt of ₹ 10 crores was claimed as bad debt in the previous year 2019-20. Assessing Officer allowed only a sum of ₹ 5 crores as bad debts. In 2020-21, a sum of ₹ 4 crores is recovered ultimately in respect of the debt.

Compute total income of S Ltd. for the Assessment Year 2021-22 and work out tax payable on such income, indicating reasons for treatment of each item. [CA Final May 2012] [16 Marks]
Answer:
Computation of total income of S Ltd. for the 4-Y. 2021-22 (₹ in crores)

Tax liability of S Ltd. for the A.Y. 2021-22

Notes:
1. EPABX and mobile phones are not computers and therefore, are not entitled to higher depreciation @ 40% as for computers [Federal Bank Ltd. v. ACIT (Ker)]. Hence, normal depreciation @15% shall be allowed.

2. As per Delhi High Court in case of Priya Village Roadshows Ltd. it was held that if there is no creation of a new asset, then the expenditure incurred on feasibility study for the technological advancement of the project which was abandoned without creating a new asset, would be of revenue nature.

As the expenditure is already debited to profit and loss account, no further treatment is required.

3. As per sec. 115BBD, dividends received by Indian companies from Specified foreign company i.e. foreign company in which the Indian company holds 26% or more of the nominal value of equity share cap-ital, shall be taxable @ 15%. Also, no expenditure in respect of earning such income shall be available.

Further, as per section 56(2) dividend income is taxable only under the head ‘Income from other sources’.

In this case, as S Ltd. holds 28% of equity in foreign company, section 115BBD shall be attracted and therefore, expenditure debited on earning such dividend shall be added back.

Note: If the S Ltd. had distributed dividends during the previous year, then it may claim deduction u/s 80M in respect of such dividends received from specified foreign company upto the amount of dividend distributed by it.

4. Section 9(1)(vi) provides that the consideration for use or right to use of computer software is royalty and consequently tax has to be deducted at source in respect of such payments. Since no TDS was deducted, ₹ 29 crores is to disallowed under section 40(a)(i).

5. Contribution to a National Laboratory shall be eligible for 100% de-duction. Since, it has already been debited to profit and loss account, no further adjustment is required.

6. With regard to the discarded machine, no amount has been adjusted in block of asset as no money is receivable in respect of discarded machine. Thus, depreciation would be allowed assuming that there are other assets in the block.

7. As per Explanation to section 37(1) any expenditure incurred for a purpose which is an offence or which is prohibited by law, shall not be deemed to have been incurred for the purposes of business or profession and no deduction or allowance shall be made in respect of such expenditure. Therefore, secret commission being in the nature of bribe is not allowable as expenditure.

Question 10.
KLM limited has gone for pension scheme referred to in section 80CCD. It contributes 20% of basic salary to the account of each employee under the scheme. Dearness allowance paid is 40% of basic salary. 50% of dearness allowance forms part of pay for retirement benefits. Total basic salary of employees during the year ended 31st March, 2021 amounted to ₹ 100 lakhs. You are a finance executive of the company and get a basic salary of ₹ 20,000 per month and contribute 20% of basic salary to the pension scheme. On these facts:

(i) Compute the amount admissible as deduction u/s 36(1)(iva) and the amount inadmissible u/s 40A(9) in computation of business income of KLM Limited.
(ii) Explain the tax treatment. [CA Final Nov. 2012] [5 Marks]
Answer:
(i) Computation of deduction allowable u/s 36(1)(iva) and disallowance u/s 40A(9) while computing business income of KLM ltd. ‘

(ii) Tax treatment in the hands of the finance executive in respect of employer’s and own contribution to pension scheme referred to in section 8OCCD.

(a) Own contribution to pension scheme is allowed as deduction u/s 8OCCD maximum upto 10% of salary. For this purpose, basic salary means basic salary plus dearness allowance, if it forms part of salary for retirement benefits. Therefore, salary for the purpose of deduction u/s 8OCCD, in this case, would be:

(as against actual contribution of ₹ 48,000, being 20% of basic salary of ₹ 2,40,000)
₹ 28,800 is deductible u/s 80CCD(1), subject to the overall limit of ₹ 1,50,000 u/s 80CCE. The balance of ₹ 19,200 (₹ 48,000 – ₹ 28,800) can be claimed as deduction u/s 80CCD(1B) as this deduction is available over and above the deduction claimed u/s 80CCD(1) and is also outside the limit of ₹ 1,50,000 as provided in section 80CCE.

(b) Employer’s contribution to pension scheme would be treated as salary as per the definition of “salary” u/s 17. Therefore, ₹ 48,000, being 20% of basic salary of ₹ 2,40,000, will be included in salary.

Deduction allowable in respect of employer’s contribution u/s 80CCD(2) shall be restricted to 10% of salary (i.e. ₹ 28,800).

However, this deduction of employer’s contribution of ₹ 28,800 to pension scheme would be outside the overall limit of ₹ 1.50 lakh u/s 80CCE i.e., this deduction would be over and above the other deductions which are subject to the limit of ₹ 1.50 lakh.

Question 11.
XYZ Limited purchased a machine on 1st April, 2020 for ₹ 10 crores by availing 70% loan facility from bank. The machine was required for extension of the business of the company and was put to use into effective production on 1st February, 2021. Interest on loan is charged at 12% per annum.

Advise XYZ Limited on the treatment of interest payment made on this loan and depreciation allowable for the Assessment Year 2021 -22. Assume that this machine is the only machine in the related block of assets. [CA Final Nov. 2012] [4 Marks]
Answer:
Treatment of Interest on loan for purchase of machinery:
As per section 36(1)(iii), interest paid in respect of capital borrowed for acquisition of an asset for the period beginning from the date of borrowing of loan for acquiring the asset till the date on which such asset is first put to use is not allowable as deduction. Interest for such period has to be capitalized, by adding the same to the cost of the as,set. Therefore, interest @12% p.a. for the period of 10 months from 1 st April, 2020 to 31 st January, 2021 on ₹ 7 crores, being the amount of loan, has to be capitalized.

Question 12.
P. Ltd. has two divisions, engineering division and tea division. It has transferred engineering division to Q. Ltd. pursuant to a scheme of demerger which satisfies the conditions of section 2(19AA). P. Ltd had a debt of ₹ 5 lakhs in engineering division which stood transferred to Q. Ltd. The said debt has been written off as bad in the accounts of 0 Ltd. Can Q. Ltd. claim deduction on account of the bad debt? [CA Final Nov. 2012] [4 Marks]
Answer:
In the case of CIT v. T Veerbhadra Rao (1985), the Supreme Court held that a successor to a business will be entitled to claim an allowance for bad debt even though the debt did not relate to the business of the assessee but to the business it has succeeded. The court held that even if the relevant debt had been taken into account in computing the income of the predecessor only and had been written off as irrecoverable in the accounts of the successor assessee, the assessee will be entitled to the deduction of bad debt.

Therefore, in this case, deduction u/s 36(1)(vi) on account of bad debts of ₹ 5 lakh shall be allowed to Q. Ltd. in relation to a debt incurred by P. Ltd. for the engineering division transferred to Q. Ltd., even though the same is not taken into account in computing the income of Q. Ltd. of the current previous year or any of the earlier previous years, provided the identity of the business in the hands of Q Ltd remains the same.

Question 13.
ACFS Ltd. is a Non-Banking Financial Company (NBFC). The company has not credited interest of ₹ 25 lakhs due on certain Loan Accounts which had become Non-Performing Assets in its Profit & Loss Account. As per NBFC Prudential Norms (RBI) Direction, 1998, which is binding on the Company, Interest or Discount or any other charges on NPA shall be recognized as Income only when it is actually realized. Can the A.O. make addition of such interest on the ground that the assessee follows Mercantile System of Accounting? [CA Final Nov. 2012] [4 Marks]
Answer:
As per section 43 D, Interest on those advances which have been categorized as Bad & Doubtful Debts as per RBI Guidelines are taxable in the year in which such interest is –
(a) Credited to Profit & Loss Account or
(b) Received by the assessee,
whichever is earlier, and not on accrual basis.
Interest on NPA is to be recognized on cash basis (as permitted by RBI) even though the assessee follows mercantile system of accounting.

Such Interest Income accrues only on actual realization. [DIT v. Brahmputra Capital Financial Services Ltd (Del.)] Hence, the contention of the Assessing Officer is not valid.

Question 14.
Mr. S, a lawyer by profession, incurred expenditure on his heart surgery. He claimed such expenditure arguing that the repair of vital organ i.e. the heart has directly impacted his professional competence as his gross income from profession increased manifold after the surgery, the heart should be treated as a plant and hence such expenses should be allowed u/s 31 as current repairs to plant and machinery or section 37(1) as an expenditure incurred wholly and exclusively for the purpose of his profession. Is the claim of Mr. S tenable in law? [CA Final Nov. 2012] [4 Marks]
Answer:
The issues under consideration are whether the expenses incurred on heart surgery can be regarded as:
(a) Current repairs to plant, allowable u/s 31 or
(b) A revenue expenditure, incurred wholly and exclusively for the purposes of the assessee’s profession and hence, allowable u/s 37(1).

The facts of the case are similar to the facts in Shanti Bhushan v. CIT (2011), where the Delhi High Court observed that to allow the heart surgery expenditure as repair expenses to plant, the heart should have been first included in the assessee’s balance sheet as an asset in the previous year and in the earlier years. Also, a value needs to be assigned for the same.

The assessee would face difficulty in arriving at the cost of acquisition of such an asset for showing the same in his books of account. Though the definition of plant u/s 43(3) is inclusive in nature but the plant must have been used as a tool for profession, which is not true in case of heart. Therefore, the heart cannot be said to be plant for the business or profession of the assessee. Therefore, the expenditure on heart surgery is not allowable as repairs to plant u/s 31.

According to the provisions of section 37(1), inter alia, the said expenditure must be incurred wholly and exclusively for the purposes of the assessee’s profession. However, a healthy heart will increase the efficiency of human being in every field including its professional work. Therefore, there is no direct nexus between the expenses incurred by the assessee on the heart surgery and his efficiency in the professional held. Therefore, the claim for allowing the said expenditure u/s 37(1) is also not tenable.

Therefore, applying the rationale of the above court ruling to the case on hand, the claim of S is not tenable in law.

Question 15.
Rolla Ltd. was engaged in the business of manufacturing and trading activities. The company was declared a sick industrial company and as a part of a restructuring programme, a part of the term loan for purchase of machinery and cash credit and interest was waived. The A.O. was of the view that the waiver of loans and interest amounted to remission or cessation of liability and was taxable u/s 41(1). Give your views on the correctness of the action of the A.O. [CA Final May 2013] [4 Marks]
Answer:
The term loan taken for purchase of machinery is not a trading liability. Therefore, the provisions of deemed profits u/s 41(1) cannot be applied in this case; since the waiver is in respect of a term loan taken for a capital asset and hence, cannot be treated as remission or cessation of a trading liability. Thus, the waiver of such term loans cannot be treated as income of Rolla Ltd.

However, such waiver of loan amounts to meeting of cost of asset directly or indirectly by any person other than the assessee and therefore will go to reduce the actual cost of plant and machinery as per section 43(1).

Further, where the loan is written off in the cash credit account, the benefit is in the nature of remission of a trading liability as the money had been borrowed for regular business operations. Thus, being in the nature of a revenue income, such amounts shall be treated as deemed income in the hands of R Ltd. by virtue of section 41(1). This conclusion has been drawn from the Delhi High Court decision in Rollatainers Ltd. v. CIT.

It is to be noted that interest due but not paid would not have been allowed as deduction in the earlier years or current year, on account of the provisions of section 43B. Thereby, waiver of interest on term loan is not taxable u/s 41(1).

Question 16.
The Profit & Loss Account of ST Private Limited for the year ended 31st March, 2021 shows a profit of ₹ 75 lakhs after debiting the following items. Total Turnover of ST Pvt. Ltd. for P.Y. 2018-19 is ₹ 52 crores.
(i) ₹ 2 lakhs contributed to Employees’ Welfare Trust.
(ii)₹ 12 lakhs paid towards course fee and hostel expenses for MBA course of a close relative of a director. The relative is not in employment with the company.
(iii) ₹ 3.50 lakhs, being expenses incurred on installation of a traffic signal, so as to facilitate its employees coming to office to overcome traffic jam and save office time.
(iv) ₹ 3 lakhs spent on gift items distributed to various dealers under the company’s sales incentive scheme.
(v) ₹ 6 lakhs, being expenses incurred on the travelling of the wife of MD, who accompanied him on tour to Singapore on invitation of Trade and Commerce Chamber, Singapore.
(vi) ₹ 3 lakhs, being amount paid in March 2021 consequent upon change in currency rate due to exchange fluctuation in excess of the amount due to the supplier of machinery.
(vii) ₹ 18,000 and₹ 9,000 paid in cash on 25th October, 2020 by two separate vouchers to a contractor who carried out certain repair work in the office premises.
(viii) Interest of ₹ 2 lakhs was paid in March, 2021 to a company on a loan taken from a company. Tax deducted at source from such interest was deposited in July, 2021.

Additional Information:
(a) Provision for audit fee of ₹ 6 lakhs was made in the books for the year ended 31st March, 2020 without deducting tax at source. Such fee was paid to the auditors in September, 2020 after deducting tax under section 194J and the tax so deducted was. deposited on 7th November, 2020.

(b) During the year, the company purchased 10,000 shares of.VK Private Limited at ₹ 40 per share. The fair market value of such shares on the date of transaction was f 60 per share.
Compute total income of ST Private Limited for Assessment Year 2021 – 22 and tax payable on such income indicating reasons for treatment of each item. Ignore the provisions relating to minimum alternate tax. [CA Final May 2013] [16 Marks]
Answer:
Computation of total income of Dhyan Ltd. for the A.Y. 2021-22

Computation of tax liability for A.Y. 2021-22

Notes:
1. Increase in liability due to change in currency rate and paid to the suppliers of machine shall be added to the cost of the block of asset as per section 43A and is eligible for depreciation. Hence, it should be added back to compute business income.

2. As per Gujarat State Road Transport Corporation case (2014)(Guj.), deduction for employees contribution made by the employer after the due date under the relevant Act shall be disallowed even if remitted before the due date of filing Return of Income. So, accordingly employees’ contribution to PF not remitted before the due date under the PF Act shall be disallowed.

But if the Contrary Judgments of AIMIL Ltd. and Kichha Sugar Ltd. is followed which provides that even the employees’ contribution to PF remitted after the due date under the relevant Act but before the due date of filing return of Income shall be allowed as deduction, then deduction of further ₹ 2,00,000 shall be allowed.

3. If the aggregate of payments made to a person in a single day otherwise than by an account payee cheque or account payee bank draft or use of electronic clearing system or through such other electronic mode as may be prescribed exceeds ₹ 10,000, then such whole payment shall g be disallowed as per section 40A(3). Where the payment is made for an expenditure to one person in one day, then the different vouchers are irrelevant. So, the aggregate shall be disallowed. Further, as it has not been debited to P&L A/c, it shall have no treatment.

4. As per section 56(2)(x), where the difference between the aggregate FMV of shares and the consideration paid for purchase pf such shares exceeds ₹ 50,000, then such difference shall be deemed as in the hands of person purchasing it. In this case, the company purchased 10,000 shares of VK Pvt. Ltd. at ₹ 40 per share whereas the FMV of the shares is ₹ 60 per share. Therefore the difference of ₹ 2,00,000 [(₹ 60 – ₹ 40) × 10,000 shares] shall be taxable in the hands of the company as Income from Other Sources.

Question 17.
MNO Limited is engaged in manufacturing activities. It received liquidated damages of ₹ 10 lakh from supplier of machinery due to delay in supply of machinery. State, with reasons, whether or not the income by way of liquidated damages is assessable as income from business. [CA Final Nov 2013, Nov 2011] [4 Marks]
Answer:
The issue under consideration in this case is whether the liquidated damages received by a company from the supplier of machinery for delay in supply of machinery is revenue in nature i.e., whether the same can be assessed as business income.

The Apex Court, in the case of CIT v. Saurashtra Cement Ltd. (2010), held that such liquidated damages were directly attributable to and intimately linked with the procurement of a capital asset. Therefore, it is a capital receipt in the hands of the assessee and hence not taxable under any head of income.

Applying the rationale of the above Apex Court ruling in this case, the income by way of liquidated damages of ₹ 10 lakh received by MNO Ltd. from the supplier of machinery is a capital receipt and hence, not assessable as income from business.

Question 18.
“Rameshwarm” after purchase put to use on 15.12.2018 a machine worth ₹ 3,00,000 which is eligible for depreciation (a 15%. He sold this machine to “Ganesham” on 1.1.2020 for ₹ 3,20,000 (FMV on that date was ₹ 2,50,000), who after having used the machine for his business purposes again sold it back to “Rameshwarm” on 15.11.2020 for ₹ 3,10,000.

Compute the amount of allowable depreciation and of chargeable capital gain, if any, for assessment years 2019-20 to 2021-22 assuming that this was the only machine in the block of asset held by both “Rameshwarm” and “Ganesham”. [CA Final Nov 2013] [7 Marks]
Answer:
Computation of allowable depreciation /chargeable capital gains

Notes:
1. As per Explanation 4 to section 43(1), where an asset which had once belonged to the assessee and had been used By him for the purpose of his business and thereafter, ceased to be his property by reason of transfer or otherwise, is reacquired by him, the actual cost to the assessee shall be lower of the following:
(a) Actual cost when he first acquired the asset minus the depreciation actually allowable to him till the date of transfer (i.e., ₹ 2,77,500, in this case); or
(b) Actual price for which it is reacquired (i.e., ₹ 3,10,000).
Therefore, in this case, the actual cost of machinery reacquired by Rameshwarm would be ₹ 2,77,500, being the lower of the two amounts given above.

2. As per Explanation 3 to section 43(1), where the assets were at any time, before the date of acquisition by the assessee, used by any other person for the purposes of business or profession and the A.O. is satisfied that the main purpose of the transfer of such assets was the reduction of his liability (by claiming excess depreciation with reference to enhanced cost), the actual cost to the assessee shall be such an amount as determined by the Assessing Officer, with the previous approval of the Joint Commissioner.

Consequently, the cost of machinery in the hands of Ganesham would be ₹ 2,50,000, assuming that the fair market value given in the question is the amount determined by the Assessing Officer, with the previous approval of the Joint Commissioner.

Question 19.
Examine the taxability or allowability or otherwise in the following cases while computing income under the head “Profits and gains from business or profession” to be declared in the return of income for the financial year ended on 31.3.2021.
(i) Amount received by A Ltd. towards power subsidy with a stipulation that the same is to be adjusted in the electricity bills.
(ii) Profit derived by an assessee engaged in carrying the business as dealers in shares on exchange of the shares held as stock-in-trade of one Company with the shares of other Company. [CA Final May 2014, May 2011][4 Marks]
Answer:
(i) Power subsidy received by A Ltd. is revenue in nature as it reduces the amount of the electricity bills. Thus, it is in the nature of compensation for the expense incurred by A Ltd. and therefore taxable as per ICDS-VII Government Grants, as ICDS is applicable to the company-assessee. Hence, the subsidy is taxable under the head PGBP.

(ii) As per ICDS VIII “Securities”, dealing with securities held as stock-in trade provides that where a security is acquired in exchange for other securities, the Fair value of the security acquired would be its actual cost for initial recognition. Subsequently, at the end of the year, the securities would be valued at lower of actual cost or NRV prevailing at the end of that year.

On exchange of shares held as stock-in-trade of a company with the shares of another company, the profit derived by the dealer in shares
i.e.

• difference between the cost of shares of the first company and the market value of shares of the new company on the date of exchange

shall be treated as business income for the dealer in the shares as derived in the normal course of his business. This was also earlier held by Supreme Court in the case of Orient Trading Co. Ltd. v. CIT.

Question 20.
Compute the quantum of depreciation available u/s 32 of the Income-tax Act, 1961 and any other benefit available in respect of the following items of Plant and Machinery purchased by PQR Textile Ltd., which is engaged in the manufacture of textile fabrics, during the year ended 31.03.2021:

The new imported machinery arrived at Chennai port on 30.03.2021 and was installed on 03.04.2021. All other items were installed during the year ended 31.03.2019. The company was newly started during the year. Also, compute the WDV of various blocks of assets.
Will your answer be different if the above assessee were a partnership firm? [CA Final May, 2014] [8 Marks]
Answer:
BLOCK of Plant and Machinery (subject to 15% depreciation)
Computation of Depreciation and the WDV as on 01.04.2020

BLOCK OF Plant and Machinery (subject to 40% depreciation).

Computation of Depreciation and the WDV as on 01.04.2020

Notes:
(1) As per Motor Vehicles Act, 1988, the definition of vehicle excludes, inter alia, a vehicle of special type adapted for use only in a factory or in any enclosed premises. Therefore, fork-lift trucks used only inside the factory shall not be considered as a vehicle but as just a regular plant and machinery. Hence, it is eligible for additional depreciation under section 32(1)(iia) and deduction under section 32AC.

(2) As per the third proviso to section 32(1)(ii), the balance of additional depreciation of ₹ 0.40 crores being 50% of ₹ 0.80 crore (20% of ₹ 4.00 crore) and ₹ 0.20 crores being 50% of ₹ 0.40 crore (20% of ₹ 2.00 crore) would be allowed as deduction in the A.Y. 2022-23.

Question 21.
XYZ Ltd. is engaged in the business of manufacturing garments having turnover of ₹ 765 lakhs for the previous year 2018-19. Its P & L account shows a net profit of ₹ 500 lakhs for the year ended 31.03.2021 after debiting and crediting the following items:
Depreciation provided in accounts as per straight line basis is ₹ 30 lakhs.
Normal depreciation allowable is ₹ 28 lakhs. The company has made addition to machinery during the year to the extent of ₹ 100 lakhs, in June, 2020.

The company has made cash payments for purchases and expenditure as below:
On 04-06-2020 ₹ 5 lakhs (Due to strike by bank staff)
On 05-06-2020 ₹ 7 lakhs (Due to cash demanded by the supplier)
On 30-09-2020 ₹ 10 lakhs (Half yearly closing for bank; a bank holiday)
Payment made to transport operator for hiring of lorry as follows:
07-05-2020 ₹ 50,000; 08-01-2021 ₹ 75,000; 02-03-2021 ₹ 32,000.

♦ GST of ₹ 1.45 lakhs, pertaining to the year ended 31-03-2020, was paid on 10-12-2020.

♦ Rent paid and professional charges to a consultant including GST was ₹ 5,61,800 and ₹ 2,24,720 respectively. Tax was not deducted on the service tax portion for both the payments.

♦ The company has imported 1,000 kgs raw materials from a supplier in US at the rate $ 75/kg on 29-03-2020. The exchange rate was ₹ 59/$ when the imports were made. The payment to the supplier was made on 20-01-2021 when the exchange rate was ₹ 62/$. The company had not entered into a forward contract to hedge the risk.

♦ The company has also purchased goods of ₹ 55 lakhs from M/s. ABC Ltd. in which Directors have substantial interest. The market value of the goods is ₹ 54 lakhs.

♦ The company has incurred legal expenses for the following:
Issue of Bonus shares ₹ 10 lakhs. ,
Alteration of Memorandum of Association ₹ 2 lakhs (in connection with increase of authorized capital).
Donation paid to a political party is ₹ 25 lakhs.
Compute the total income and tax payable by the company for the A.Y. 2021-22. Ignore MAT provisions. [C!4 Final May 2014] [16 Marks]
Answer:
Computation of Total Income of XYZ Ltd. for the A.Y. 2021-22

Computation of Tax liability of XYZ Ltd. for A.Y. 2021-22

Notes:
(1) As per sec. 40A(3), cash payments exceeding ₹ 10,000 in a day is wholly disallowed. However, Rule 6DD provides for certain exceptions, which includes, payments which are required to be made on a day on which the banks were closed either due to holiday or strike. Hence, cash payments of ₹ 5 lakhs made on the day of strike by bank staff and cash payment of ₹ 10 lakhs made on a bank holiday would not be disallowed u/s 40A(3), assuming such payments were required to be made on those specific dates. However, cash payment of ₹ 7 lakhs made on 5.6.2020 due to demand of supplier would attract disallowance u/s 40A(3).

(2) Depreciation provided in the accounts on straight line basis (i.e., ₹ 30 lakhs) shall be added back and depreciation as per Income-tax of ₹ 28 lakhs is allowable as deduction u/s 32.
Further, as per sec. 32(1)(iia), additional depreciation @ 20% shall be allowed on the actual cost of ₹ 100 lakhs of new plant and machinery purchased in June 2020. Hence, the total depreciation is ₹ 48 lakhs [i.e., ₹ 28 lakhs + ₹ 20 lakhs].

(3) Where the payment of an expenditure is made in cash to a transport operator, the disallowance u/s 40A(3) is attracted only if the payment exceeds ₹ 35,000 so the cash payment of ₹ 32,000 would not be disallowed. However, cash payments of ₹ 50,000 and ₹ 75,000 on 7.5.2020 and 8.1.2020, respectively, would be disallowed under section 40A(3) as they exceed ₹ 35,000 in a day.

(4) As per section 43B, where any tax is not paid till the due date of filing the return of income, the same shall be disallowed. But it will be allowed as deduction where it is paid in any subsequent year. Hence, the GST liability of ₹ 1.45 lakhs pertaining to previous year 2019-20 is deductible in the year of payment (i.e., P.Y. 2020-21). Since it is already debited to profit and loss account, no further adjustment is required.

(5) Where the service tax component comprised in the amount payable to a resident is indicated separately, tax shall be deducted at source on the amount paid/payable without including such service tax component.

Assuming that, the service tax component is indicated separately in the agreement between the company and the consultant, tax shall be deducted without including such service tax component. Therefore, no disallowance is attracted for non-deduction of tax at source on the service tax component.

(6) As per Sec. 43AA, subject to provisions of sec. 43A, any gain or loss arising on account of any change in foreign exchange rates shall be treated as income or loss and such gain or loss shall be computed as per the ICDS’s notified u/s 145(2). Sec. 43AA also provides that gain or loss on account of the effects of change in foreign exchange rates shall be in respect of all foreign currency transactions including those relating to monetary items and therefore, here sec. 43AA will be applicable.

As per ICDS-VI – The Effects of Changes in Foreign Exchange Rates,
the loss which arises on settlement of monetary items will be allowed as expense in the previous year when the said loss arises.
In this case, the foreign exchange loss of ₹ 2,25,000 (1,000 kgs × $75 × ₹ 3) has accrued and actually been incurred during the P.Y. 2020-21. Hence, the same is allowable as deduction in the A.Y. 2021-22. Since the same has already been debited to profit and loss account, no further adjustment is required.

Note: ICDS is applicable to all the company-assessees. In this case, it is assumed that XYZ Ltd. follows mercantile system of accounting and therefore, ICDS would be applicable. Further, it is also assumed that the rate of exchange on 31.3.2020 was the same as on 29.3.2020 and hence, no exchange loss is required to be provided for in P.Y. 2019-20.

(7) ABC Ltd. is a related person under section 40A(2), since the directors of the XYZ Ltd. have substantial interest in ABC Ltd. Therefore, excess payment of ₹ 1 lakh to ABC Ltd. for purchase of goods would attract disallowance under section 40A(2).

(8) As per Supreme Court in CIT v. General Insurance Corpn. (2006) on issue of bonus share, there is no fresh inflow of funds or increase in capital employed. There is only reallocation of the company’s fund. Consequently, legal expenses of ₹ 10 lakhs in connection with issue of bonus shares is revenue expenditure and is hence, allowable as deduction.

However, legal expense in relation to alteration of memorandum and in connection with increase in Authorised Capital is directly related to expansion of the capital base of the company and is, hence, a capital expenditure. Therefore, the same is not allowable as deduction. It has been so held in Punjab State Industrial Development Corporation Ltd v. CIT (1997) (SC).

(9) Donation paid to a political party is disallowed as per sec. 37 as not incurred wholly and exclusively for business. However, the same shall be allowed as deduction u/s 80GGB if the payment is made not by way of cash.

Question 22.
X & Co. Diagnostic Centre P. Ltd. has claimed referral fee paid to doctors as revenue expenditure for the assessment year 2021-22. Tax has been deducted u/s 194H for the said payments. The A.O. proposes to disallow such expenditure. Examine the correctness of the action of the A.O. [CA Final May 2014] [4 Marks]
Answer:
As per Explanation to section 37(1), any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business and profession and no deduction or allowance shall be made in respect of such expenditure. As per the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002, no physician shall give, solicit, receive or offer to give, solicit or receive any gift, gratuity, commission or bonus in consideration of a return for referring any patient for medical treatment.

The demand as well as payment of such referral fee is bad in law. It is not a fair practice and is opposed to public policy. Applying the rationale and considering the purpose of Explanation to section 37(1), the assessee would not be entitled to deduction of such payments made in contravention of law or opposed to public policy or have pernicious consequences to the society as a whole. This view has been upheld by the Punjab & Haryana High Court in CIT v. Kap Scan and Diagnostic Centre P. Ltd. (2012).

Thus, the action of the Assessing Officer in disallowing the referral fee paid by X & Co. Diagnostic Centre P. Ltd. to doctors is correct. The fact that tax has been deducted u/s 194H is of no consequence.

Question 23.
(i) Rahul Ltd. is engaged in the business of growing and manufacturing tea in India. For the previous year ending on 31.03.2021, its composite business profit before allowing deduction u/s 33AB is ₹ 70,00,000. On 01.09.2021 it deposited a sum of ₹ 10,00,000 in the Tea Development Account. During the previous year 2018-19, Rahul Ltd. had incurred a business loss of ₹ 14,00,000 which has been carried forward. On 25.01.2022, it withdraws ₹ 10,00,000 which is utilized as under:
₹ 6,00,000 for purchase of non-depreciable asset as per the scheme specified.
₹ 3,00,000 for purpose other than specified in the scheme.
₹ 1,00,000 was spent for the purpose of scheme on 05.04.2022.
(a) Compute the business income of Rahul Ltd. for A.Y.2021-22.
(b) What are the tax consequences of money misutilized/not utilized?
(c) What will be the consequence if the asset purchased for ₹ 6,00,000 is sold for ₹ 8,00,000 in April, 2022?

(ii) Assume that the asset which was purchased for ₹ 6,00,000 was a depreciable asset and it is the only asset in the block and it was sold for ₹ 8,00,000 in April, 2022. [CA Final Nov. 2014] [9 Marks]
Answer: (i)
(a) As per rule 8, before disintegrating the business profits into agricultural income and non-agricultural income, the income is to be computed under the head “Profit and Gains from Business and Profession”, which means besides other deductions, the deduction u/s 33AB shall also be allowed.

Computation of Total Income of Rahul Ltd.


Since, the asset is sold within 8 years, the cost of the asset i.e. ₹ 6,00,000 shall be treated as business income as the entire cost had been allowed as deduction in the earlier year but out of this ₹ 6,00,000, 60% shall be agricultural income and balance 40% i.e. ₹ 2,40,000 will be the income taxable under the head PGBP.

(ii)
A.Y. 2022-23: Depreciation on machinery acquired and put to use for less than 180 days = 50% of 15% of ₹ 6,00,000 = ₹ 45,000.
A.Y. 2023-24:

Short term capital gain ₹ 8,00,000 – ₹ 5,55,000 = ₹ 2,45,000
Business income shall be ₹ 6,00,000; but out of this 60% shall be exempt as agriculture income and balance 40% i.e. ₹ 2,40,000 will be the income taxable under the head PGBP.

Question 24.
PQR Ltd., a non-banking finance company was engaged in the business of leasing and hire purchase. It purchased motor cars from Ramaha motors and leased out these vehicles to its customers. The lease agreement with the customer stated that PQR Ltd. was empowered to repossess the vehicle, in case the lessee committed a default. Registration of the vehicle in the name of lessee, during the period of lease is mandatory as per the Motor Vehicles Act, 1988. PQR Ltd. claimed ₹ 5,00,000 as depreciation on the vehicles leased out for the year ending 31.3.2021.

H The claim was rejected by the A.O. on the ground that the assessee had merely financed the purchase of motor cars and was neither the owner nor the user of these assets. Is the action of the A.O. valid? Discuss. [CA Final Nov. 20J4] [4 Marks].
Answer:
The issue under consideration in this case is whether depreciation on leased vehicles can be denied to the lessor (PQR Ltd.) on the grounds that the vehicles are registered in the name of the lessee and that the lessor is not the actual user of vehicles.

The facts of the case are similar to the facts in I.C.D.S Ltd. v. CIT (2013), where the Supreme Court observed that section 32 imposes a twin requirement of “ownership” and “usage for business” as conditions for claim of depreciation thereunder. As far as usage of the asset is concerned, the section requires that the asset must be used in the course of business. It does not mandate actual usage by the assessee itself.

The Supreme Court further observed that the Motor Vehicle Act, 1988 contains a deeming provision which creates a legal fiction of ownership in favour of the lessee only for that Act and not for the purpose of law in general. No inference could be drawn from the registration certificate as to ownership of the vehicles, since registration in the name of the lessee during the period of lease is mandatory as per the Motor Vehicles Act, 1988.

Therefore, as long as the lessor has a right to retain the legal title against the rest of the world, it would be the owner of the asset in the eyes of law.

By applying the above rationale, the action of the A.O. in denying the depreciation claim of PQR Ltd. is not valid since PQR Ltd. has used the vehicles in the course of its leasing business even though it was not the actual user of the vehicles. Also, PQR Ltd. is the exclusive owner of the vehicle at all points of time as he is empowered to repossess the vehicle, in case the lessee committed a default. The proof of ownership lies in the lease agreement itself, which clearly points in favour of PQR Ltd.

Question 25.
Riddhi Corporation LLP, is carrying on two businesses viz. Textile manufacture and Operation of cold chain facility. It gives you the following information for the year ended 31st March, 2021:

The following items are debited to Profit & Loss Account:
(i) Interest on capital payable to partners @ 15% on total capital of ₹ 120 lakhs.
(ii) Working partner salary ₹ 54 lakhs (i.e., ₹ 1.5 lakhs each per month for 3 partners).
(iii) Depreciation on textile factory building ₹ 8 lakhs.
(iv) Depreciation on Plant & Machineries of textile business ₹ 40 lakhs.
(v) Keyman insurance policy premium paid ₹ 1,60,000.

Other Information:
Eligible depreciation u/s 32 for the previous year 2020-21 are-
(i) On Plant & Machineries of textile business ₹ 30 lakhs.
(ii) On factory building relating to textile business ₹ 6 lakhs.

The assessee set up and operating a cold chain facility since 1st April, 2019. It incurred capital expenditure towards construction of cold chain facility during the period from 1st June, 2017 to 31st March, 2019 as under:
Cost of land (acquired on 1st June, 2017) ₹ 40 lakhs.
Cost of construction of building and machineries installed till 31st March, 2019 ₹ 90 lakhs.
The income of the firm for the previous year 2019-20 (A.Y 2020-21) is given below:
Income from Textile manufacture ₹ 15 lakhs.
Income from cold chain facility ₹ 80 lakhs (before deduction u/s 35AD)

The firm originally had 4 equal partners and one partner retired on 31-32020. The partnership agreement authorizes payment of salary and interest on capital which are debited to Profit & Loss Account.

You are requested to compute the total income of the firm for the A.Y. 2021-22.
Ignore Alternate Minimum Tax (AMT) u / s 115JC. [CA Final May 2015] [10 Marks]
Answer:
Computation of Total Income of Riddhi Corporation LLP for the A.Y. 2021-22

Notes:
(1) Computation of loss of specified business of setting up and operating a cold chain facility for P.Y. 20 19-20 relevant to A.Y. 2020-21:

(2) Expenditure incurred on acquisition of land is not available as deduction u/s 35AD(8). Therefore, only cost of ₹ 90 lakhs on construction of building and machinery installed would qualify for deduction u/s 35AD, [assuming such expenditure has been capitalized in the books as on 1.42019 (date of commencement of operations)1, as it was incurred prior to commencement of operations [Proviso to section 35AD(1)].

(3) Section 78(1) does not permit carry forward of losses pertaining to the share of a retired or deceased partner. Therefore, in this case, since one of the four partners have retired on 31.3.2020, his share of loss (₹ 2,50,000, being 1/4th of ₹ 10 lakh) for the P.Y. 2019-20 (A.Y. 2020-21) cannot be carried forward to the P.Y. 2020-21 (A.Y. 2021-22).

(4) Computation of profit from textile manufacturing business

(5) Loss of specified business can be carried forward indefinitely for set-off only against profits of any specified business. Therefore, it becomes necessary to segregate the income of ₹ 53.10 lakhs computed under the head “Profits and gains of business or profession”, so that brought forward loss from specified business relating to P.Y. 2019-20 can be set-off against profits of specified business of the P.Y. 2020-21.

For this purpose, while computing profits of textile manufacturing business included in the business income of ₹ 53.10 lakhs, the depreciation as per books of account has to be added back and the depreciation as per the Income-tax Act, 1961 has to be reduced from the net profit of ₹ 12.50 lakhs pertaining to textile business, since the depreciation adjustments clearly relate to textile business.

The entire remuneration is allowable as deduction because it is with- in the limits as per section 40(6)(v). It is only the interest on capital amounting to ₹ 3.6 lakhs (which has been added back while computing business income) which has to be apportioned between textile manufacturing business and specified business.

The interest on capital is to be apportioned in the ratio of 1 : 2 (ratio of the net profit of these two businesses as per P&L A/c) between textile manufacturing and specified business. The solution can also be worked out by apportioning interest on capital on any other logical basis.

Question 26.
Star India Ltd., a listed company, engaged in manufacturing activity furnishes the following details:
Net profit as per Profit and Loss Account ₹ 60,00,000.
(i) The company took a loan of ₹ 15,00,000 in the P.Y. 2016-17 for the purpose of relocation of its office premises. The lender waived ₹ 10,00, 000 in the P.Y. 2020-21 and it is credited in the P & L A/c.

(ii) Depreciation charged to Profit and Loss Account is ₹ 18,00,000. Depreciation as per Income-tax Act, 1961 amounts to ₹ 30,00,000 which includes the following:
Depreciation rate meant for computers has been adopted for (i) accessories like printers and scanners; and (ii) EPABX. The written down value of these as on 1-4-2020 is given below:
(a) Printers and Scanners – ₹ 60,000
(b) EPABX – ₹ 3,00,000
Assume that there were no additions during the year.
(iii) It incurred ₹ 3,00,000 as expenditure for public issue of shares. The public issue could not materialize on account of non-clearance by SEBI. This amount is charged to Profit & Loss Account.

(iv) It incurred expenditure of ₹ 2,50,000 towards issue of debentures. This amount has been capitalized in the books.

(v) The company paid ₹ 1,50,000 as compounding fee for violations in the pollution control regulations. This has been charged as revenue expenditure.

(vi) The company lost cash of ₹ 28,00,000 due to theft when it was with-drawn from bank and taken to administrative office. It is not insured and hence, fully charged as revenue expenditure.

(vii) ₹ 6,00,000 was spent during the year towards permitted CSR activities as per 135 of the Companies Act, 2013 This is charged to Profit and Loss Account.

(viii) It paid ₹ 2,50,000 to share broker for transacting shares listed in stock exchange and ₹ 2,00,000 to commodity broker for commodity transactions at MCX. Both the amounts are debited to Profit and Loss Account and no tax was deducted at source on these payments.

(ix) The company has 200 employees as on 31.03.2020. During the be-ginning of the year, the company removed some of the employees and employed 115 new employees which makes the total number of employees as 295 as on the last day of the P.Y. 2020-21. It paid ₹ 3,000 p.m. to all the employees.

(x) It paid ₹ 60,000 to an electoral trust by cash and ₹ 1,20,000 by cheque to a registered political party. Both these are debited to Profit and Loss Account.
Compute the total income of the company for the assessment year 2021-22. Give reasons in brief for treatment of each of the above items. Ignore MAT provisions. [CA Final May 2015] [16 Marks]
Answer:
Computation of Total Income of Star India Ltd. for the A.Y. 2021-22

Notes:
(1) Depreciation as per books of account charged to P&L A/c (i.e., ₹ 18 lakhs) has to be added back and depreciation calculated as per Income-tax Rules, 1962 (i.e. ₹ 29.25 lakhs) is allowable as deduction u/s 32. Computer accessories and peripherals like printer and scanner form an integral part of the computer system and they cannot be used without the computer; hence, they are eligible for depreciation @ 40% [CIT v. BSES Yamuna Powers Ltd. (2013) (Del.)].

However, EPABX is not a computer and is, hence, not entitled to higher depreciation @ 40% [Federal Bank Ltd. v. ACIT (2011) (Kerala)].

Therefore, depreciation as per Income-tax Act, 1961 would be ₹ 28.65 lakhs, which is computed as follows –

(2) Share issue expenses constitute a capital expenditure, even though the company could not go in for the public issue on account of non-clear ance by SEBL Though the efforts were aborted, the fact remains that the expenditure incurred was only for the purpose of expansion of the capital base. The capital nature of the expenditure would not be lost on account of the abortive efforts [Mascon Technical Services Ltd. y. CIT (2013) (Mad.)]. Since the expenditure has been charged to profit and loss, the same has to be added back.

(3) The amount paid for compounding an offence is inevitably a penalty and the mere fact that it has been described as compounding fee cannot, in any way, alter the character of the payment which is in the nature of penalty and hence, is not allowable as revenue expenditure [Millennia Developers P. Ltd. v. Deputy CIT (2010) (Kar.)]. Since the compounding fee has been charged to P & L A/c, the same has to be added back.

(4) The loss incurred by theft, dacoity, embezzlement etc., if incidental to the carrying on of the business whether committed by the employees of the assessee or by strangers is deductible. [G.G. Dandekar Machine Works Ltd. v. CIT (1993) (Bom.)]. In this case, the loss due to theft took place when cash was withdrawn from bank and taken to administrative office is incidental to business and thus, allowable as revenue expenditure.

(5) Any expenditure incurred by an assessee on the activities relating to CSR referred to in section 13 5 of the Companies Act, 2013 is disallowed as per Explanation 2 to section 37. Since the expenditure has been charged to profit and loss account, the same has to be added back for computing business income.

It is assumed that the CSR expenditure is not of the nature described in sections 30 to 36 of the Income-tax Act, 1961, and hence, does not qualify for deductions under those sections.

(6) The payments to share broker and commodity broker are in the nature of commission. However, payment for transaction in securities has been particularly excluded from the scope of section 194H. Hence, payment of ₹ 2.5 lakhs to a share broker for transacting shares listed in stock exchange (which falls within the meaning’of securities) would not be disallowed for non-deduction of tax at source.

However, payment of ₹ 2 lakh to a commodity broker for commodity transactions at MCX would attract disallowance @ 30% under section 40(a)(ia), due to non deduction of tax at source under section 194H.

(7) Donation to an electoral trust and a registered political party is not deductible u/s 37 since it is not laid out wholly and exclusively for the purposes of business or profession. However, donation made by a company to an electoral trust or registered political party is allowable deduction u/s 80GGB from gross total income, subject to the condition that payment is made otherwise than by way of cash. Since, the donation to electoral trust is made in cash, the same does not qualify for deduction u/s 80GGB. But donation of ₹ 1.2 lakh by cheque to a registered political party would be eligible for deduction u/s 80GGB.

(8) Since the loan was taken by Star India Ltd. for the purpose of relocating its office premises i.e., for acquisition of a capital asset, namely, a new office, the waiver of the same cannot be said to be a waiver or remission of trading liability to attract taxability u/s 41(1). Waiver of such loan, being capital in nature, is not taxable [CIT v. Softworks Computers P Ltd. (2013) (Bom.)]. So as the loan of ₹ 10 lakh waived is credited to profit and loss account, the same must be deducted for computing business income. But the same would be reduced from the actual cost of the office premises.

(9) The expenditure on issue of debentures is not in the nature of capital expenditure and is laid out or expended wholly and exclusively for the purpose of the assessee’s business and is therefore, allowable as a deduction. The act of borrowing money is incidental to the carrying on of business, the loan obtained is not an asset or an advantage of enduring nature, the expenditure is made for securing the use of money for a certain period, and it is irrelevant to consider the object with which the loan was obtained [India Cements Ltd. v. CIT (1966) (SC)]. Since the said expenditure has been capitalized in the books of account, the same has to be deducted to compute business income.

(10) Besides the normal deduction of employee cost under the relevant head of income, an additional deduction of 30% of ‘Additional employee cost’ is allowable u/s 80JJAA , where the assessee is a company and its gross total income includes any profits and gains derived from a 5 business and to whom Sec. 44AB applies.

“Additional Employee” means an employee who has been employed § during the previous year and whose employment has the effect of increasing the total number of employees employed by the employer j as on the last day of the preceding year.

In this case, the company has employed 115 new employees during the P.Y. 2020-21, but only 95 (295 i.e. as on last day of P.Y. 2020-21 – 200 i.e. as on last day of P.Y. 2019-20) employees has the effect of increasing the total number of employees employed by the employer as on the last day of the preceding year. Also, the amount of emoluments paid to the additional employees is ₹ 3,000 which is less than 25,000 and are employed during the previous year for more than 240 days. Therefore, the deduction u/s 80JJAA shall be available for the emoluments paid to the 95 employees.

So, Additional cost shall be ₹ 34,20,000 (95 additional employees × ₹ 3,000 p.m. × 12 months)
Therefore, deduction under section 80JJAA would be ₹ 10,26,000, being 30% * ₹ 34,20,000.
Note: Assumed that Sec. 44AB is applicable to the Star India Ltd. and the other conditions of additional employee are being satisfied.

Question 27.
Parik Hospitality Ltd. is engaged in the business of running hotels of 3-star category. The Company’s P & L A/c for the P.Y. ended 31.03.2021 shows a net profit of ₹ 152 lakhs after debiting or crediting the following j items:

(a) Payment of ₹ 0.25 lakh and ₹ 0.30 lakh in cash on 3rd December, 2020 and 10th December, 2020 respectively for purchase of crab, lobster and squid to Mr. Raja, a fisherman and Mr. Khalid, a middleman for these products respectively.

(b) Contribution towards employees’ pension scheme notified by the Central Government u/s 80CCD for a sum of ₹ 3 lakhs calculated at 12% of basic salary and Dearness Allowance payable to the employees,

(c) Payment of ₹ 6.50 lakhs towards transportation of various materials procured by one of its hotels to M/s Bansal Transport, a partnership firm without deduction of tax at source. The firm has furnished its Permanent Account Number in the tender document.

(d) Profit of ₹ 12 lakhs on sale of a plot of land to Avimunya Limited, a domestic company, the entire shares of which are held by the assesseed company. The plot was acquired by Parik Hospitality Limited on 1st June, 2020.

(e) Contribution of ₹ 2.50 lakhs to Indian Institute of Technology with a specific direction for use of the amount for scientific research programme approved by the prescribed authority.

(f) Expense of ₹ 10 lakhs incurred on foreign travel of two directors for a collaboration agreement with a foreign company for a brewery project to be set up. The negotiation did not succeed and the project was abandoned.

(g) Fees of ₹ 1 lakh paid to independent directors for attending Board meeting without deduction of tax at source u/s 194J.

(h) Depreciation charged ₹ 10 lakhs.

(i) ₹ 10 lakhs, being the additional compensation received from the State Government pursuant to an interim order of Court in respect of land acquired by the State Government in the year 2016-17.

(j) Dividend received from a foreign company ₹ 5 lakhs,

Additional information:
(i) As a corporate debt restructuring, the bank has converted unpaid j interest of ₹ 10 lakhs upto 31st March, 2019 into a new loan account repayable in five equal annual instalments. The first instalment of ₹ 2 lakhs was paid in March, 2020 by debiting new loan account.
(ii) Depreciation as per Income-tax Act: ₹ 15 lakhs.
(iii) The company received a bill for ₹ 2 lakhs on 31st March, 2021 from a supplier of vegetables for supply made in March, 2021. The bill was omitted to be recorded in the books m March, 2021. The bill was paid in April, 2021 and the necessary entry was made in the books then.

Compute total income of Parik Hospitality Limited for the A.Y. 2021-22 indicating the reason for treatment of each item. Ignore the provisions relating to minimum alternate tax. [CA Final Nov. 2015] [6 Marks]
Answer:
Computation of Total income of Parik Hospitality Ltd. for A.Y. 2021 -22

Notes:
1. As per sec. 40A(3), paYment or aggregate of payments made for an expenditure on a single day, otherwise than by an account payee cheque or account payee bank draft or use of electronic clearing system through a bank account or through such other electronic mode as may be prescribed, exceeding 10,000. shall be wholly disallowed. But, Rule 6DD provides, inter alia., that disallowance u/s 40A(3) shall not apply in respect of payments made to cultivator or producer for the purchase of dairy or poultry farming fish or fish products. In this case cash of ₹ 25,000 directly paid to Mr. Raja, a fisherman shall not be disallowed but cash paid ₹ 30,000 to Mr. Khalid, middle man for these products will be disallowed.

2. As per Sec. 36(1)(iva), in case of an employer other than Central Government, contribution made towards pension scheme referred to in Sec. 80CCD on account of employee shall be allowed as deduction to the extent of 10% of salary of the employee. Here ‘salary’ includes dearness allowance, if the terms of employment so provide, but excludes all other allowances and perquisites. Hence, deduction shall be allowed only upto ₹ 2,50,000 [₹ 3,00,000/12% × 10%] and ₹ 50,000 [₹ 3,00,000 – ₹ 2,50,000] is not deductible and hence added back..

3. As per sec. 40(a)(ia), 30% of any sum payable to a resident on which tax is deductible at source under Chapter XVII-B, shall be disallowed if tax has not been deducted or after deduction has not been paid on or before the due date u/s 139(1).

But, as per sec. -194C, no tax is required to be deducted for payments made to “Transport Operator” i.e. engaged in the business of plying & hiring of goods carriage where such contractor owns ten or less goods carriages at any time during the previous year and furnishes a declaration to that effect along with his PAN;

Thereby, no tax is to be deducted on payment of ₹ 6,50,000 made to M/s Bansal Transport for transportation of materials, assuming that M/s Bansal Transport does not own more than 10 goods carriage vehicle at any time during 2020-21.

However, 30% of the payment made to independent directors for attending board meeting, without deducting tax shall be disallowed u/s 40(a)(ia).

4. As per sec. 47(iv), any transfer of a capital asset by a holding company to its wholly owned subsidiary company, being an Indian company, is exempt in the hands of holding company. In this case, Parik Hospitality Ltd. had sold plot of land to Avimunya Ltd. which is 100% subsidiary company of Parik Hospitality Ltd. and also an Indian company. Therefore, the capital gain from such transfer is exempt in the hands of Parik Hospitality Ltd. As the profit was already credited to P & L account, it shall be reduced from the profit.

5. As per sec. 35(2AA), an assessee is eligible for deduction of 100% of the amount contributed to National Laboratory, IIT, University, persons approved by prescribed authority (whether related with assessee’s business or not) for undertaking scientific research. Since, the amount has already debited, no further adjustment is required.

6. The expense incurred on foreign travel of two directors for entering into collaboration agreement with a foreign company for setting up a new project where the negotiation did not succeed and the project was abandoned shall be allowed as revenue expenditure as no new asset or business came into existence. Hence, not added back as already debited to P & L account. Similar issue was decided by the Delhi high court in the case of CIT v. Priya Village Roadshows Ltd. (2011).

7. As per the proviso to Sec. 45(5), where any amount of compensation received in pursuance of an interim order of a court, Tribunal or other authority shall be deemed to be income chargeable under the head “Capital gains” of the previous year in which the final order of such court, Tribunal or other authority is made. Hence, the additional compensation received on interim order shall not be treated income as Final order is still not passed.

8. Conversion of unpaid interest into a new loan shall not be deemed as actual payment of interest for the purpose of deduction u/s 43B. Consequently such converted interest will not be deductible, but on repayment of such loan, it shall be allowed as deduction in the year of payment. [Kalpana Lamps and Components Ltd. (2002) (Mad.)]

Question 28.
Mr. Janak is proprietor of M/s. Yash Texnit which is engaged in garment manufacturing business. The entire block of Plant & Machinery chargeable to depreciation @ 15%, has 15 different machinery items as at 31.03.2020. One of the machinery used for packing had become obsolete and was discarded by Mr. Janak in July, 15th. Assessee filed its return for A.Y. 2021-22 claiming total depreciation of ₹ 40 lakhs which includes ₹ 4.0 lakhs being the depreciation claimed on the machinery item discarded by Mr. Janak. The A.O. disallowed the claim of depreciation of ₹ 4.00 lakhs during the course of scrutiny assessment. Comment on the validity of action taken by A.O. [CA Final May 2016] [4 Marks]
Answer:
The facts of this case are similar to the facts of the case CIT v. Yamaha Motor India Pvt. Ltd. (2010), where Delhi High Court has held that the phrase “used for purpose of business” in respect of discarded machine includes use of such asset even in the earlier years for claiming depreciation u/s 32. It is not necessary that the asset must have been used in the relevant previous year and therefore, its use even in the earlier financial years shall make it eligible for depreciation.

As per Sec. 43(6), “moneys payable” means the sale price, in case of sale, or the insurance, salvage or compensation moneys payable in respect of the asset. In this case, the machinery has not been sold as machinery or scrap or disposed off, and it continues to exist. Hence, there is no “moneys payable” deductible from the WDV of the block.

Applying the rationale of the above case, the assessee Mr. Janak is eligible for depreciation of full ₹ 40 lakhs including depreciation of ₹ 4.00 lakhs in respect of discarded machinery. Therefore, the action taken by the A.O. to disallow the claim of depreciation in respect of discarded machine is invalid.

Question 29.
XYZ Ltd. is engaged in the manufacture of fertilizers since 01-042013. Its Statement of Profit & Loss shows the total turnover of ₹ 1,500 lakhs for the P.Y. 2018-19 and a net profit of ₹ 700 lakhs after debit/credit of the following items:
(1) Depreciation calculated on the basis of useful life of assets as per provisions of the Companies Act, 2013 is ₹ 50 lakhs.
(2) Normal Depreciation calculated as per Income-tax Rules is ₹ 80 lakhs.
(3) Employer’s contribution to EPF of ? 2 lakhs together with the Employees’ contribution of ₹ 2 lakhs for the month of March, 2020 was
remitted on 8th, May 2020.

(4) The company appended a note to its Income Statement that industrial power tariff concession of ₹ 2.5 lakhs was received from the State Government and treated the same as capital receipt.

(5) The company had provided an amount of ₹ 25 lakhs being sum estimated as payable to workers based on agreement to be entered with the workers union towards periodical wage revision once in 3 years. The provision is based on a fair estimation on wage and probable revision.

(6) The company had made a provision of 10% of its debtors towards bad and doubtful debts. Total sundry debtors of the company as on 31.03.2021 was ₹ 200 lakhs.

(7) A debtor who owed the company an amount of ₹ 40 crores was declared insolvent and hence, was written off.

(8) Sundry creditors include an amount of ₹ 50 lakhs payable to A & Co, towards supply of raw materials, which remained unpaid due to quality issues. An agreement has been made on 31.03.2021, to settle the amount at a discount of 75% of the outstanding.

(9) The opening and closing stock for the year were ₹ 200 lakhs and ₹ 250 lakhs, respectively. They were overvalued by 10%.

(10) Provision for gratuity based on actuarial valuation was ₹ 5 crores. Actual gratuity paid was ₹ 3 crores.

(11) Commission of ₹ 1 lakhs paid to a recovery agent for realization of a debt. Tax has been deducted and remitted as per Chapter XVIIB of the Act.

(12) The company has purchased 500 tons of industrial paper as packing j material at a price of ₹ 30,000/ton from PQR, a firm in which majority of the directors are partners. PQR’s normal selling price in the market for the same material is ₹ 28,000/ton.

Additional Information:
(1) There was an addition to Plant & Machinery amounting to ₹ 50 lakhs on 10.06.2020.
(2) The company had credited a sub-contractor an amount of ₹ 8 lakhs on 31.03.2020 towards repairing a machinery component. The tax so deducted was remitted on 30.11.2020.

Compute total income and tax payable. Ignore MAT provisions. [CA Final May 2016] [16 Marks]
Answer:
Computation of Total Income of XYZ Ltd. for the A.Y. 2021-22

Computation of tax liability of XYZ Ltd. for A.Y. 2021-22

Notes:
1. In the case of CIT v. Gujarat State Road Transport Corporation (2014), the Gujarat High Court held that the employees contribution to provident fund deposited after the due date mentioned under the Provident Fund Act is not allowable as deduction as per Sec. 36(1)(va) and hence, it has been disallowed while computing business income.

However an alternate view has been taken in CIT v. Kiccha Sugar Co. Ltd. (2013) (Uttarakhand) and CIT v. AIMIL Ltd (2010) (Del), where it was held that the employees contribution to PF, shall be allowed as deduction from the income of the employer-assessee, if the same is deposited on or before the due date of filing of return for the relevant previous year. If this view is considered, then no disallowance would be attracted in this case, since the employees’ contribution has been remitted before the due date of filing of return of income.

2. As per sec. 2(24)(xviii), income shall include assistance received in the form of a subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement (by whatever name called) from the Central Government or a State Government or any authority or body or agency in cash or in kind to the assessee other than the subsidy or grant or reimbursement which is taken into account for determination of the actual cost of the asset in accordance with the provisions of Explanation 10 to sec. 43(1). Therefore, the Industrial Power Tariff Concession received by XYZ Ltd. shall be taxable and to be included in the Income Statement,

3. If the provision is made for the present obligation resulting from the past events and which may require outflow of resources to settle and reliable estimate can be made, then such provision is allowable as deduction u/s 37(1). Therefore, the provision made, to be paid as wage revision on a fair estimation and probable revision basis shall be allowed as deduction u/s 37(1) to XYZ Ltd. Since the same has already been debited to profit and loss account, no further adjustment is required.

4. Provision for doubtful debts is allowable as deduction u/s 36(1)(viia) only in case of banks, public financial institutions, state financial corporations and state industrial investment corporations. Such provision is not allowable as deduction in the case of a manufacturing company. Since, the same has been debited to profit and loss account, it has to be added back for computing business income.

5. Bad debts write off in the books of account is allowable as deduction u/s 36(1)(vii). Since the same has already been debited to profit and loss account, no further adjustment is required.

6. As per sec. 41(1), where in any earlier year, deduction was allowed in respect of loss, expenditure or trading liability incurred by the asses- see and during the current previous year, the assessee has obtained a refund of such trading liability or has obtained some benefit in respect of such trading liability by way of remission or cessation, then the value of such benefit accruing shall be deemed to be profits and gains of the business and thus chargeable as income of that previous year. Therefore, in this case, discount on settlement of sundry creditors shall be taxable as deemed income u/s 41(1).

7. It is assumed that the given figures of opening and closing stock of ₹ 200 lakhs and ₹ 250 lakhs respectively are at overvalued figure.

8. As per sec. 40A(7), provision for Gratuity shall be available to the assessee only if it is made for payment to Approved Gratuity Fund or made for Gratuity which has become due and payable during the current previous year. Therefore, in this case, only the actual gratuity paid by XYZ Ltd. shall be eligible for deduction and provision of ₹ 2 crores [₹ 5 crores – ₹ 3 crores] shall be disallowed.

9. Commission paid to Recovery Agent for realizing the amount of debt shall be allowed as deduction u/s 37, as it is incurred wholly and exclusively for the purpose of business [DCIT v. Super Tannery (India) Ltd. (2005) (AH.)]

10. As per sec. 40A(2), where in case an assessee being a company, incurs any expenditure for which the payment has been made or is to be made to a specified person i.e. in this case, to a firm in which the director or directors of the company has substantial interest, and such expenditure in the opinion of A.O. is excessive and unreasonable having regard to the fair market value of the goods, then such expenditure shall be disallowed to the extent considered as excessive or unreasonable by the A.O.

Therefore, in this case, by assuming that the Directors of XYZ Ltd. are having substantial interest in the firm PQR, the excess amount of ₹ 10,00,000 [(₹ 30,000 – ₹ 28,000) × ₹ 500 per ton] shall be disallowed.

11. It is assumed that depreciation as per IT rules has not been deducted from the statement of profit and loss account of XYZ Ltd.

12. 30% of ₹ 8 lakhs, being payment to a sub-contractor, would have been disallowed under section 40(a)(ia) while computing the business income of A.Y. 2020-21, since tax deducted was remitted after the due date of filing of return. However, the same is allowable in A.Y. 2021-22, since the remittance has been made on 30.11.2020.

Question 30.
X Ltd. issued debentures in the P.Y. 2020-21, which were to be matured at the end of five years. The debenture holder was given an option of one time upfront payment of ₹ 60 per debenture on account of interest which was to be immediately paid by the company. As per the option “ exercised by the debenture holders, company paid interest upfront to them in the first year itself and the same was claimed as deduction in the return of the company.

But in the accounts, the interest expenditure was shown as deferred expenditure to be written off over a period of five years.

During the course of assessment, the A.O. spread the upfront interest paid over a period of five year term of debentures and allowed only one fifth of the amount in the P.Y. 2020-21. Examine the correctness of the action of A.O. [CA Final May 2016] [4 Marks]
Answer:
The issue under consideration is whether the entire upfront interest paid by the company to the debenture holders exercising the option of one time upfront payment, be claimed as deduction in the first year or should the same be deferred over a period of debentures and whether the treatment of such interest as deferred revenue expenditure in the books of account have any impact on the tax treatment.

The Supreme Court in the case of Taparia Tools Ltd. v. Joint CIT (2015) (SC) observed that while examining the allowability of deduction, genuineness of borrowing should be considered. Also, u/s 36(1)(iii), any amount paid as interest is an admissible deduction, if the capital was borrowed by the j assessee for the purpose of business or profession. In the present case, the A.O. has not disputed the issue of debentures and use of funds for business purposes.

The Supreme Court also noted that there is no concept of deferred revenue expenditure in the Income-tax Act except under specified sections such as I section 35D meant for amortization over a period of time. Normally, revenue expenditure is deductible in the year in which it is incurred. When assessee had issued debentures with two options for payment of interest and if the interest is allowed by spread over it would amount to treating both the j methods of interest payment at par, which was clearly unsustainable. By discharging the liability in the first year itself, the assessee had benefited by making payment of a lesser amount of interest in comparison to the interest which was payable under the first option over a period of five years.

The Supreme Court, accordingly, held that the assessee would be entitled to deduction of the entire upfront interest paid in the same year in which the amount was actually paid.

Accordingly, the action of the A.O. spreading the upfront interest paid over j the five year term of debentures and restricting the deduction in the P.Y. 2020-21 to one-fifth of the upfront interest paid is not correct. The company is eligible to claim the entire amount of interest paid upfront as deduction 1 under section 36(1)(m) in the RY. 2020-21.

Question 31.
A non-resident aviation company flying an aircraft in India and paid y; tax u/s 44BBA claims that the employees deputed for flying this aircraft shall not be subjected to tax on the remuneration to the extent paid out . of such income. Is the claim justified? [CA Final May 2016] [3 Marks]
Answer:
Section 44BBA provides for deeming 5% of aggregate of amounts received by/paid or payable to a non-resident assessee engaged in the business of operation of aircrafts, for carriage of passengers, livestock, mail or goods, as profits and gains of such business chargeable to tax under the [ head “Profits and gains of business or profession”.

The same issue came up before the Advance Ruling Authority in the case of Lloyd Helicopters International Pty. Ltd. (2001), wherein it was observed that as per DTAA between India and Australia, one of the conditions for exemption of remuneration of employees resident of Australia is that such remuneration should not be deductible in determining the profits chargeable to tax of the non-resident aviation company.

In this regard, the AAR observed that the profits determined u/s 44BBA, though arrived at on a statutory basis, cannot be considered to exclude such expenses as non-deductible merely because the statute fixes a percentage in this regard. Also the low fixed rate of 5% of gross receipts indicates the statutory attempt at estimating and allowing expenses normally likely to be incurred in such business, which includes remuneration of employees.

Therefore, applying the rationale of the AAR ruling, the remuneration paid to employees is deemed to have been deducted while computing the profits chargeable to tax of the non-resident aviation company u/s 44BBA. Accordingly, the said remuneration paid to non-resident employees shall not be exempt from tax in India.

The claim of the non-resident aviation company is, therefore, not justified.

Note: The question is silent about the country of residence of the employees of the aviation company. Employees may be resident or non-resident in India. In case the remuneration is paid to resident employees, the same is taxable in their hands.

Also, the aviation company can be incorporated in a country with which India has no treaty. Therefore, it is possible to answer the question on the basis of the provisions of section 9(1) alone. Since, the services were rendered in India, salary of the employees shall be deemed to accrue or arise in India and therefore, the same attracts tax liability in India, irrespective of the fact that remuneration was paid out of income of the non-resident company chargeable to tax in India as per the provisions of section 44BBA.

Question 32.
Statement of Profit & Loss of BM Private Ltd., a resident company engaged in manufacturing, shows net profit of ₹ 90,00,000 for the financial year ended on 31st March, 2021 after debit/credit of following items:
A. Credited to the Statement of Profit and Loss:
(i) Rent received from vacant land ₹ 1,20,000
(ii) Rent received (gross) from a commercial property owned by the company ₹ 2,50,000 (Tax deducted by tenant @ 10%)
(iii) Interest received on income tax refund ₹ 1,00,000
(iv) Profit on sale of unused land ₹ 10,00,000

B. Debited to the Statement of Profit and Loss:
(i) Depreciation charged to the Statement of Profit and Loss ₹ 12,00,000.
(ii) Donation of ₹ 1,00,000 paid to Swachh Bharat Kosh.
(iii) Contribution to Political Party amounting to ₹ 2,00,000 paid in cash.

(iv) Payment made to transporter ₹ 1,00,000 by account payee cheque, but no tax has been deducted at source. (Transporter is having PAN and furnished declaration that he is covered u/s 44AE and not having more than 10 goods carriages at any time during the previous year)

(v) Bonus to employees ₹ 2,00,000 provided. However, payment was made on the occasion of Diwali festival on 14th November, 2021.
(vi) Provision made for income tax ₹ 3,00,000 (including interest of ₹ 50,000 thereon)

(vii) Loss of ₹ 2,50,000 incurred by way of trading in futures and options (derivatives) in stocks in a recognized stock exchange.

Additional information:
(1) Depreciation as per Income Tax Act, 1961 ₹ 20,00,000. However, while calculating such depreciation rate applicable to computers has been adopted for (i) accessories like printers and scanners, and (ii) EPABX. The written down value of these items as on 01.04.2020 is given below:
a. Printers and scanners – ₹ 3,00,000
b. EPABX – ₹ 5,00,000
(2) Additional Depreciation on Plant and machinery purchased for ₹ 20,00,000 on 15th October, 2020 has not been considered while cal culating depreciation as per Income-tax Act, 1961 as above.

(3) Provision for audit fee ₹ 1,00,000 was made in the books for the year ended on 31st March, 2020 without deducting tax at source.
Such fee was paid to auditors in September 2020 after deducting tax at source u/s 194J and tax so deducted was deposited on 6th November, 2020.

(4) The Company during the financial year 2018-19 made a provision for an outstanding bill of ₹ 1,00,000 for purchase of raw material. Out of such outstanding amount the company has paid ₹ 50,000 in cash on 15th September, 2020.

(5) During the year the company has issued 1,00,000 equity shares of face value of ₹ 10 each at premium of ₹ 90 each. The fair market value is ₹ 60 per share at the time of issue of shares.

(6) Unused land which was sold during the year for ₹ 50,00,000 was acquired by the Company in the financial year 2017-18 for ₹ 40,00,000.

(7) Cost Inflation Index: FY 2017-18: 272, FY 2020-21:301

Compute total income of the company for the Assessment Year 2021-22 j stating reasons for treatment of each item. Ignore provisions relating to Minimum Alternate Tax, [CA Final Nov 2016] [16 Marks]
Answer:
Computation of Total Income of BM Pvt. Ltd. for A.Y. 2021-22

Notes:
(1) Donation made to Swachh Bharat Kosh and contribution to political party is not an allowable expenditure while computing business income. Hence, the same has to be added back, since it is debited from the profit and loss account.

(2) As per section 40(a)(za), 30% of the sum payable to a resident shall not be allowed as a deduction to the assessee, if he has not deducted tax from such payment which is deductible under Chapter XVII-B or after deducting such tax, has not deposited it to the account of the Central Government on or before the due date u/s 139(1). In this case, BM. Pvt. Ltd. has made payment to the contractor on which TDS is deductible u/s 194C of Chapter XVII-B, but no tax was deducted by BM. Pvt. Ltd. and therefore, 30% of the amount paid to transporter shall be disallowed. However, as per section 194C, no tax shall be deducted in case of assessee, engaged in the business of plying & hiring of goods carriage where such contractor owns ten or less goods carriages at any time during the previous year and furnishes a declaration to that effect along with his PAN. Therefore, in this case, no disallowance shall be made from payment made to the transporter by the BM Pvt. Ltd. as the transporter has furnished the declaration to the effect that he is having not more than 10 goods carriages at any time during the previous year along with his PAN.

(3) As per section 43B, any sum payable as bonus or commission to the employees shall be allowed as a deduction to the employer only if it is paid on or before the due date for furnishing the ROI u/s 139(1) and the due date for furnishing ROI u/s 139(1) for the company is 31st October every year (w.e.f. A.Y. 2021-22). In this case, the asses- see-employer BM Pvt Ltd has made payment of bonus to employees on
18.10.2021 which is after the due date of furnishing ROI and therefore, disallowance of bonus paid to employees shall be attracted.u/s 43B.

(4) Provision for income tax (including interest) is not an allowable ex-penditure while computing business income.

(5) As per section 43(5), an eligible transaction of trading in derivatives in stocks in a recognized stock exchange is not a speculative transaction. In this case, the company is engaged in the business of manufacturing and hence, the loss on account of trading in derivatives is not incurred wholly and exclusively in relation to such business and hence, has to be disallowed while computing profits from the business of manufacturing. Trading in derivatives in stocks is also not incidental to the business of manufacturing. Therefore, it has to be assumed that the company is also carrying on the business of trading in derivatives in stocks in addition to its manufacturing business.

In this case, the loss has to be disallowed at the first instance while computing income from the business of manufacturing since it is not wholly and exclusively incurred for the said business and thereafter, loss from trading in derivatives has to be set-off against the profits from manufacturing business applying the provisions of section 70(1) permitting inter-source set-off of losses.

(6) EPABX cannot be included in the block of computers and therefore, are not entitled to higher depreciation @ 40% as for computers [Federal Bank Ltd. v. ACIT (Ker)J. Hence, normal depreciation @ 15% shall be allowed and balance shall be added back.

(7) As per Sec. 40(a)(ia), 30% of any sum payable to a resident on which tax is deductible at source under Chapter XVII-B shall not be allowed as a deduction on which tax has not been deducted or after deduction has not been paid to the credit of Central Government on or before the due date mentioned u/s 139(1) (i.e. due date of filing ROI). ₹ 30,000 being 30% of audit fees of ₹ 1,00,000 provided for in the books of account of F.Y. 2019-20 would have been disallowed due to tax deposited after due date of filing ROI. However 30% of such sum (disallowed in F.Y. 2019-20) shall be allowed as a deduction in the previous year in which such tax has been paid. Therefore ₹ 30,000 shall be allowed as deduction in the previous year 2020-21.

(8) Section 40A(3A) provides that where an allowance has been made in the assessment for any year in respect of any liability for any expenditure incurred by the assessee and subsequently the assessee makes any payment in respect of such liability for a sum exceeding ₹ 10,000 otherwise than by account payee cheque or account payee bank draft or use of electronic clearing system through a bank account or through such electronic mode as may be prescribed, the payment so made shall be deemed to be the Profits and gains of business or profession of the year in which the payment is made. Therefore, payment of outstanding amount of ₹ 50,000 shall be wholly disallowed as it is made in cash in excess of ₹ 10,000.

(9) As per section 32(1)(iia), an assessee engaged in the business of manufacturing of any article or thing shall be eligible for additional depreciation @ 20% on actual cost of any new plant and machinery acquired and installed on or after 01.04.2005. However, such depreciation shall be half of 20%, in case the new plant and machinery is acquired and put to use for less than 180 days during the previous year. In this case, by assuming that the new plant and machinery acquired on 15.10.2020 has been put to use in the same previous year, the assessee BM Pvt Ltd is eligible for additional depreciation of half of 20% on ₹ 20,00,000 i.e. ₹ 2,00,000 and the balance additional depreciation of ₹ 2,00,000 shall be available in the immediately succeeding financial year.

(10) As per section 56(2)(viib), where a closely held company receives in any previous year, from any person, being a resident, any consideration for issue of shares, which exceeds the face value of such shares, then the aggregate consideration received by the company as reduced by the FMV of the shares shall be ‘Income from other sources’ in the hands of the company. In this case, the consideration received by the company is ₹ 1,00,00,000 (1,00,000 shares × ₹ 100 per share) and the FMV of the shares is ₹ 60,00,000 (1,00,000 shares ₹ 60 per share) and therefore, the difference of ₹ 40,00,000 (₹ 1,00,00,000 – ₹ 60,00,000) shall be “Income from Other Sources” in the hands of BM Pvt. Ltd.

(11) Donation paid to Swachh Bharat Kosh is eligible for 100% deduction, without any limit u/s 80G, if it is paid by any mode other than cash., In this case, it is assumed that such donation to Swachh Bharat Kosh is made by any mode other than cash and therefore; BM Pvt. Ltd. is eligible for deduction u/s 80G.

(12) Contribution to political party is allowed as deduction u/s 80GGB from gross total income, subject to the condition that payment is made otherwise than by way of cash. Since the contribution to political party is made in cash, the same does not qualify for deduction u/ s 80GGB.

Question 33.
Jupiter Construction Ltd., an Indian company is engaged in the business of executing civil contracts awarded by various Companies, Central Government and State Governments in relation to infrastructure facility.

Statement of Profit & Loss for the year ended 31st March, 2021 reveals a net profit (before tax) amounting to ₹ 85,00,000 after debiting/’credlting the following items:
(a) Interest of ₹ 3,00,000 due to a public financial institution for the last quarter of the financial year 2020-21 paid on 20th November, 2021.

(b) ₹ 6,00,000 paid in India to Mr. Philip, a non-resident towards fee for technical services without deduction of tax at source. TDS was, however, paid on 30th November, 2021.

(c) Damages amounting to ₹ 25,00,000 paid to the government of West Bengal as per the terms of contract for defects found in construction of a flyover after 5 years of its construction.

(d) Depreciation charged ₹ 20,00,000.

(e) Marked to market loss amounting to ₹ 6,00,000 in respect of an unsettled derivative contract. The contract was settled in May, 2021 with a gain of ₹ 1,00,000. Such loss or gain has not been recognised as per the ICDS.

(j) Profit of ₹ 10,00,000 on sale of land to Neptune Inc., U.S.A., which is a wholly owned subsidiary company.

(g) Retention money amounting to ₹ 10,00,000 held by a public sector undertaking which can be released after expiry of two years on the satisfaction of certain performance criteria as per the terms of contract.

(h) ₹ 3,00,000 being interest on fixed deposit with a bank as margin money for obtaining a guarantee required by a State Government for a particular contract.

(i) Dividend of ₹ 10,00,000 received from Real Estate Investment Trust (REIT), break-up of which is as follows:

• Component of short-term capital gain on sale of development properties by the REIT ₹ 6,00,000.
• Component of rental income from properties owned by the REIT ₹ 4,00,000.

Other Information:
(i) Depreciation as per Income-Tax Rules ₹ 25,00,000.

(ii) Land sold to Neptune Inc. was acquired at a cost of ₹ 30,00,000 in the financial year 2015-16. Value on the date of sale assessed by the Stamp Valuation Authority was ₹ 50,00,000 (Cost Inflation Index Financial Year 2015-16: 254: Financial Year 2020-21: 301)

(iii) The company informs you that till Assessment Year 2020-21 the company did not include retention money in its total income in absence of right to receive such money based on judicial pronouncements, which has also been accepted by the Assessing Officer consistently,

(iv) During the year, 20 new employees (qualifying as “workman” under the Industrial Disputes Act, 1947) were recruited. All these new employees contribute to recognized provident fund. 15 employees out of 20 employees joined on 1st May, 2020 and the other 5 employees joined in November, 2020.10 employees, who joined on 1st May, 2020 were offered salary of ₹ 24,500 per month and the other employees who joined on the same date drew salary of ₹ 32,000 per month. One employee who joined on 1st May, 2020 at salary of ₹ 24,500 per month drew his salary by bearer cheques of ₹ 12,500 and ₹ 12,000 every fortnight in a month.

(v) The company’s.accounts are required to be audited under section 44AB of the Income-Tax Act.

Compute total income for the Assessment Year 2021-22 indicating reasons for treatment for each item and ignoring the provisions relating to minimum alternate tax (MAT). [CA Final Nov 2017] [16 Marks]
Answer:
Computation of total income of Jupiter Construction Ltd. for the A.Y. 2021-22

Notes:
(1) As per section 43B, any sum payable as interest on any loan or borrowing from any Public Financial Institution (PFI) shall be allowed as a deduction only if it is paid on or before the due date for furnishing the ROI u/s 139(1) and the due date for furnishing ROI u/s 139(1) for the company is 31st October every year (w.e.f. A.Y. 2021-22). In this case, the assessee company Jupiter Construction Ltd has made payment of interest to the financial institution on 20.11.2021 which is after the due date of furnishing ROI and therefore, the same shall be disallowed u/s 43B.

(2) Section 40(a) disallows any interest, royalty, fees for technical services or any other sum chargeable under Act which is payable outside India; or in India to a non-resident (not being a company), or to a foreign company on which tax has not been deducted or, after deduction, has not been paid during the previous year, or before the expiry of the time prescribed u/s 139(1). Therefore, amount paid to Mr. Philips (non-resident) without deduction of tax at source and after deduction not deposited within due date of return (31.10.2021) shall be disallowed u/s 40(a).

(3) As per Explanation to section 37(1), any expenditure incurred for an offence or which is prohibited by law, shall not be allowed as deduction. Assuming that the damages of ₹ 25,00,000 paid to the Government of West Bengal for defects found in construction is paid under a law framed by the Government, it will not be allowed as deduction. However, if assumed that the damages are not paid as a penalty for breach of law, but only for the breach of contract, it shall be allowed as deduction.

(4) As per Sec. 36(1)(xviii), Marked to Market loss or other expected loss as computed as per ICDS shall be allowed as deduction. Further, similar consideration applies to recognition of MTM gain or expected income. Therefore, MTM loss of ₹ 6,00,000 shall not be allowed as it is not as per ICDS and hence, to be added back. MTM gain is not recorded in the books of account as arise in May 2021, so no further adjustment is required.

(5) Interest income earned on the margin money deposited with bank for obtaining bank guarantee to carry on the business shall be taxable as business income. CIT v. K and Co. (2014) (Del). As such interest income is already taken in calculation of net profit no further adjustment is required.

(6) As per ICDS III – Construction Contracts, Contract Revenue shall comprise of the initial amount of revenue agreed, including retentions i.e. ICDS III specifically requires retention money to be treated as part j of contract revenue. As such income is already taken in calculation of net profit no further adjustment is required.

Alternative: In CIT v. Associated Cables (P) Ltd. (2006) (Bom.) and CIT v. Ignifluid Boilers Ltd. (2006) (Mad), it was held that the payment of retention money in the case of contract is dependent on satisfactory completion of contract work. The right to receive the retention money accrues only after the obligations under the contract are fulfilled and, therefore, it would not amount to income of the assessee in the year in which the amount is retained.

(7) Short-term capital gain on sale of development properties by the REIT shall be taxable in the hands of Real Estate Investment Trust and the same shall be exempt in the hands of unit holders u/s 10(23FD) read , with section 115UA(1). Rental income from properties owned by the REIT is exempt in the hands of REIT u/s 10(23FCA). The same shall be taxable in the hands of unit holders u/s 115UA(3).

(8) As per Sec. 47(iv), any transfer of capital asset by holding company to j its 100% subsidiary company, being an Indian Company shall not be j regarded as transfer by holding company. Here, in this case, wholly owned subsidiary company is Foreign Company (Neptune Inc. U.S.A). Therefore, benefit of Sec. 47(iv) is not available to Jupiter Construction Ltd. and such transaction shall be treated as transfer and capital gain on such transaction is taxable. Since, profit on such transaction shall be taxable in the head “Capital Gain” the same should be reduced from the net profit of the business.

(9) As per Sec. 50C, where the stamp duty value does not exceed 110% of the actual consideration, the actual consideration so received shall be deemed to be the full value of consideration. But, here, the stamp duty value exceeds 110% of the actual consideration and therefore, the stamp duty value shall be deemed as full value of consideration i.e. ₹ 50,00,000.

(10) Besides the normal deduction of employee cost under the relevant head of income, an additional deduction of 30% of ‘Additional employee cost’ is allowable u/s 80JJAA, where the assessee is a company and its gross total income includes any profits and gains derived from a business and to whom Sec. 44AB applies.

“Additional Employee” means an employee who has been employed during the previous year but does not include:
(a) An employee whose total emoluments are more than ₹ 25,000 per month; or
(b) An employee employed for a period of less than 240 days during the previous year; or
In this case, the company has employed 20 new employees during the P.Y. 2020-21, but only 10 employees has who has been employed during the previous year is to be treated as “Additional Employee” as amount of emoluments paid to this employees is ₹ 24,500 (being less than ₹ 25,000) and are employed during the previous year for more than 240 days.

Further, additional employee cost shall be NIL, if emoluments are paid by any mode other than account payee cheque or account payee bank draft. Therefore, one employee drawing salary by bearer cheques is ineligible for the deduction u/s 80JJAA and deduction shall be available for the emoluments paid to the 9 employees only

Hence, Additional cost shall be ₹ 24,25,500 (9 additional employees × ₹ 24,500 p.m. × 11 months)

Therefore, deduction u/s 80JJAA would be ₹ 7,27,650 (being 30% × ₹ 24,25,500)

Question 34.
BG (P) Ltd. is engaged in multiple businesses. The Net Profit as per the statement of profit and loss was ₹ 52 Iakhs for the year ended 31.03.2021. A scrutiny of the statement of profit and loss revealed the following Items which were debited/credited therein:
(i) Share income @ 25% from a partnership firm ABC & Co. of Pune ₹ 9,50,000.
(ii) The company paid ₹ 1,00,000 as service charges to a call centre for attending the calls of customers and suppliers. Tax was deducted at source on such payment 2%.

(iii) Expenditure Incurred ₹ 8,00,000 for digging of wells near the factory for use by public under Corporate Social Responsibility Scheme as per the Companies Act, 2013.

(iv) Grant received from State Government for acquisition of generator ₹ 10 lakhs. The generator was acquired on 01.06.2020 for ₹ 35 Lakhs. A sum of ₹ 5 lakhs was paid as advance by cash to the supplier of generator. The grant amount received is credited to statement of profit and loss. Depreciation charged on ₹ 35 lakhs @ 15%.
Note: Assume that the company is not eligible for additional depreciation.

(v) During the year, the company bought textile goods from local suppliers. Cash payment was made exceeding ₹ 10,000 but below ₹ 20,000 in a day to 15 suppliers aggregating to ₹ 2,00,000.

(vi) Depreciation debited to statement of profit and loss ₹ 10 lakhs (it includes ₹ 8 lakhs being depreciation on assets revalued).

(vii) Provision for deferred tax debited to statement of profit and loss ₹ 6,50,000.

(viii) Trade creditors ₹ 5,00,000 were outstanding for more than 5 years and there is no business relationship with them. The amount was unilaterally transferred to credit of statement and profit and loss.

(ix) Royalty income in respect of patents chargeable u/s 115BBF ₹ 12,00,000.

(x) Depreciation eligible u/s 32 (before considering adjustment of any of the items described above) ₹ 12,25,000.

Additional Information: ‘
(a) The assessee executed only one civil construction contract of the value of ₹ 15 lakhs. The contractee withheld 20% of the contract amount
which would be released only after 2 years. The amount withheld has not been credited to statement of profit and loss.

(b) During the year 1,00,000 equity shares of ₹ 10 each was issued for ₹ 25 per share. The fair market value of the shares as per rule 11UA of the Income-tax Rules, 1962 was determined @ ₹ 17 per share.

(c) During the year, the company advanced ₹ 5,50,000 to one of the directors (having 22% of equity shares and equivalent voting rights in the company) to meet his personal expenses. The company has accumulated profit of ₹ 25 lakhs as on 31.03.2020.

You are required to compute the total income for the A.Y. 2021-22 stating clearly the reasons for treatment for each of the items given above. [CA Final May 2018 (Old Syllabus)] [16 Marks]
Answer:
Computation of Total Income of BG(P) Ltd. for the A.Y. 2021-22

Notes:
1. The share of income received from partnership firm ‘is exempt u/s 10(2A) and therefore, ₹ 9,50,000 being the share of income from ABC & Co. has been deducted from the net profit.

2. As per Sec. 194J, any payment made to a person engaged only in the business of operation of a call centre is liable for deduction of tax at source @ 2%. Since, the company has correctly deducted the tax at source 2%, there is no need of any adjustment.

3. As per Explanation 2 to Sec. 37, any expenditure incurred by an assessec on the activities relating to CSR shall not be deemed to be expenditure incurred by the assessee for the purposes of the business or profession and thereby shall not be allowed as deduction u/s 37. Since, the company has deducted it from the net profit, it has been added back.

4. As per Explanation 10 to Sec. 43(1), where the portion of the cost of an asset acquired is met directly or indirectly by Government or any authority or any other person in the form of a subsidy or grant or reimbursement, then it shall be reduced from the actual cost of an asset. Also, where the assessee incurs any expenditure for acquisition of any asset or part thereof and the payment in respect of which is made to a person in a day otherwise than by an account payee cheque drawn on a bank or an account payee bank draft or use of electronic clearing system through a bank account or through such other electronic mode as may be prescribed exceeds ₹ 10,000, then such expenditure shall be ignored for the purposes of determination of actual cost. Therefore, the grant received from State Government of ₹ 10,00,000 and payment made in cash of ₹ 5,00,000 shall be reduced from the actual cost of the asset and ₹ 20,00,000 (₹ 35,00,000 – ₹ 10,00,000 – ₹ 5,00,000) shall be eligible for depreciation @ 15%.

Here, in the question, it is given that the depreciation eligible u/s 32 of ₹ 12,25,000 is before considering the adjustments relating to the items described therein and therefore, it is possible to assume that the depreciation relating to generator has not been provided yet. So, depreciation relating to generator of ₹ 3,00,000 (₹ 20,00,000 × 15%) shall be provided which makes the total depreciation eligible u/s 32 of ₹ 15,25,000.

Alternative: If it is assumed that the depreciation relating to the generator has been included in the figure of ₹ 12,25,000, then excess depreciation on generator of ₹ 2,25,000 (₹ 15,00,000 × 15%) shall be reduced from ₹ 12,25,000 and the depreciation allowable u/s 32 will be ₹ 10,00,000.

5. As per Sec. 40A(3), where the assessee incurs any expenditure in respect of which payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on a bank or account payee bank draft or use of electronic clearing system through a bank account or through such other electronic mode as may be prescribed exceeds ₹ 10,000, then no deduction shall be allowed in respect of such expenditure. Therefore, the cash payment by the company to the suppliers of textile goods exceeding ₹ 10,000 in a day shall be disallowed and it shall be added back.

6. Provision for deferred tax is not an allowable expenditure and therefore, it shall be added back.

7. Sec. 41(1) provides that where any deduction was allowed to the assessee in earlier year in respect of any trading liability incurred by the assessee and subsequently, the assessee has obtained some benefit in respect of such trading liability by way of remission or cessation, then the value of benefit accruing shall be deemed to be the profits and gains of business or profession and accordingly, chargeable to tax in the year in which benefit obtained.

Here, the company has outstanding trade creditors of ₹ 5,00,000 of more than 5 years and there is no business relationship and therefore, the company has unilaterally transferred the amount to the credit of statement of profit and loss account. Since, the amount has been outstanding for more than 5 years and there is no business relationship with the trade creditors, it may be assumed that the creditors had waived off the amount and therefore, the treatment given by the company is correct and no adjustment is required.

8. Royalty income in respect of patent chargeable to tax u/s 115BBF can be treated as business income or income from other sources, depending upon the facts of the case. Here, the question mentions that BG (P) Ltd. is engaged in multiple business, it may be assumed that the same is in respect of business income. Since, the same has already been added to statement of profit and loss account, no further adjustment has been made.

9. As per ICDS-III “Construction Contracts”, retention money shall be treated as part of contract revenue and shall be recognised on the basis of percentage of completion method. In this case, since it is given that the assessee has executed the contract of ₹ 15 lakhs, it is possible to assume that 100% of the contract has been completed in this year and therefore, entire retention money of ₹ 3 lakhs has to be recognised during the previous year.

Alternative: In the question, it is given that the retention money of ₹ 3 lakhs (₹ 15 lakhs × 20%) would be realised after two years, it is also possible to assume that the contract is yet to be completed and therefore, the solution will be work out accordingly.

10. As per Sec. 56(2)(viib), where a closely held company receives from any person, being a resident, any consideration for issue of shares exceeding the face value of such shares, then the aggregate consideration received by the company as reduced by the FMV of the shares shall be treated as “Income from Other Sources” in the hands of the company. Therefore, ₹ 8,00,000 [1,00,000 × (₹ 25 – ₹ 17)], being the excess of consideration over the FMV of the shares shall be treated as “Income from Other Sources” in the hands of BG (P) Ltd.

11. As per Sec. 2(22)(e), any advance or loan given by a closely held company, to the extent of accumulated profits of the company, to a shareholder, being the beneficial owner of shares, carrying not less than 10% of voting power, shall be treated as deemed dividends.

Therefore, the advance of ₹ 5,50,000 given by BG (P) Ltd. to one of the directors having 22% of equity shares with voting rights shall be treated as deemed dividend as BG (P) Ltd. is having the accumulated profits of ₹ 25,00,000. As per the amendment made by the Finance Act, 2020, such deemed dividends will be taxable in the hands of shareholder at regular income tax rates and no DDT shall be payable by the company. Therefore, it will not be included in the total income of the company.

Question 35.
Bose & Co. is a partnership firm consisting of 4 partners with equal shares. The partnership firm is engaged in execution of civil construction contracts with State Government authorities. The partnership firm deposited ₹ 50 lakhs in State Bank of India (SBI) for the purpose of obtaining guarantee as and when the tenders were applied by the firm. It also kept ₹ 10 lakhs in fixed deposit with Canara Bank being the surplus funds of the firm. The firm credited interest on bank deposits of ₹ 4,00,000 from SBI and ? 80,000 from Canara Bank in Profit and Loss account and computed working partners’ salary based on the resultant book profit. The Assessing Officer wants to tax interest incomes as income under the head ‘other sources’ and accordingly reduced the amount allowable by way of working partners’ salary. Is the action of the Assessing Officer tenable in law? [CA Final May 2018 {Old Syllabus)] [4 Marks]
Answer:
Issue involved: The issue is whether the interest on amount deposited with the bank for the purpose of obtaining guarantees and when the tenders were applied by the firm and interest on surplus funds deposited with the bank is taxable as “Profits and Gains of Business or Profession” or “Income from Other Sources”.

Provisions applicable: As per the provisions of Sec. 40( b), salary to a working partner is deductible based on the book profits of the firm. In computing the book profits, only items chargeable as business income alone will be considered, and not those chargeable under the head “Income from Other Sources”.

Income which is chargeable to tax under the Income-tax Act, 1961 would be chargeable under the residuary head “Income from Other Sources, only if such income is not chargeable to tax under any of the four heads of income,”

Analysis: The facts of the case are similar to the case of CIT v. K & Co. (2014), where the Delhi High Court noted that the interest income from the deposits made by the assessee is inextricably linked to the business of the assessee and such income, therefore, cannot be treated as income under the head ‘Income from other sources’.

The margin money requirement was an essential element for obtaining the bank guarantee which was necessary to apply for tenders. If the assessee had not furnished the bank guarantee, it would not be eligible for applying for the tenders. The High ! Court, accordingly, held that such interest income would be taxable under | the head “Profits and gains of business or profession”.

However, in respect of the interest income on fixed deposits made out of surplus funds available with the assessee, it was held by the Supreme Court in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. CIT (1997) that it would be chargeable to tax under the head “Income from Other Sources” since such surplus funds were deposited with the bank solely for the purpose of earning interest. Such interest income is taxable under the Income Tax Act, 1961 but, since, it does not fall within the scope of the four heads of income, it will be taxable under the head “Income from Other Sources”.

Conclusion: By applying the above rationale, the contention of the A.O. to taxed the interest income of ₹ 4 lakhs on deposits made with the bank for obtaining bank guarantee to apply for tenders under the head “Income from Other Sources” and reducing the amount allowable by way of working partner’s salary is not tenable in law.

However, the action relating to interest income of ₹ 80,000 on fixed deposits made out of surplus funds with the firm, is correct in law.

Question 36.
SDK Ltd. is engaged in the manufacture of textile since 01-04-2012. Its Statement of Profit and loss for the previous year ended 31 March, 2021 shows a profit of ₹ 600 Lakhs after debiting or crediting the following items:
(i) Depreciation charged on the basis of useful life of’assets as per Companies Act is ₹ 40 Lakhs.
(ii) Industrial power tariff concession of ₹ 3.5 Lakhs, received from State Government was credited to P&L Account.

(iii) The company had provided ₹ 25 Lakhs being sum fairly estimated as payable with reasonable certainty, to workers on agreement to be entered with the workers union towards periodical wage revision once in every 3 years.

(iv) Dividend received from a foreign company ₹ 10 Lakhs.

(v) Loss of f 25 Lakhs, due to destruction of a machine worth ₹ 30 Lakhs by fire due to short circuit and ₹ 5 Lakh received as scrap value. The insurance company did not admit the claim of the company on charge of gross negligence.

(vi) Provision for gratuity based on actuarial valuation was ₹ 400 Lakhs. Actual gratuity paid debited to gratuity provision account was ₹ 275 lakhs.

(vii) The company has purchased 500 tons of industrial paper as packing material at a price of ₹ 30,000 per ton from M/s. Shivbramha, a firm
in which majority of the directors of SDK Ltd. are partners. The firm’s normal selling price of the same material in market is ₹ 28,000 per ton.

(viii) Advertisement charges ₹ 1.5 Lakhs, paid by cheque for advertisement published in the souvenir of a political party registered with the Election Commission of India.

(ix) Long-term capital gain ₹ 4.5 Lakhs on sale of equity shares on which Securities Transaction Tax (STT) was paid at the time of acquisition and sale.

Additional Information:
(i) Normal depreciation as per Income Tax Rules is ₹ 65 Lakhs.
(ii) The GST of ₹ 11 Lakhs collected from its customers was paid by the company on the due dates. On an appeal the High Court directed the GST department refund ₹ 4 Lakhs to the company. The company in turn refunded ₹ 3 lakhs to the customers from whom it was collected and the balance ₹ 1 lakh is still lying under the head “Current Liabilities”.

Compute the total income of SDK Ltd. for the A.Y. 2021-22 by analyzing and applying the relevant provisions of income tax law. Briefly explain the reasons for treatment of each item. Ignore the provisions relating to MAT. [CA Final May 2018 (New Syllabus)] [14 Marks]
Answer:
Computation of Total Income of SDK Ltd. for the A.Y. 2021-22

Notes:
1. As per sec. 2(24)(xviii), income shall include assistance received in the form of a subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement (by whatever name called) from the Central Government or a State Government or any authority or body or agepcy in cash or in kind to the assessee other than the subsidy or grant or reimbursement which is taken into account for determination of the actual cost of the asset in accordance with the provisions of Explanation 10 to sec. 43(1).

Therefore, the Industrial Power Tariff Concession received by SDK Ltd. from the State Government shall be taxable and to be included in the Income Statement. Since, it has been already credited to statement of profit and loss account, no adjustment is required.

2. If the provision is made for the present obligation resulting from the past events and which may require outflow of resources to settle and reliable estimate can be made, then such provision is allowable as deduction u/s 37(1). Therefore, the provision made to be paid as wage revision on a fair estimation basis shall be allowed as deduction u/s 37(1) to SDK Ltd. Since, the same has already been debited to P&L account, no further adjustment is required.

3. Dividend received from a foreign company shall be taxable in the hands of SDK Ltd. under the head “Income from Other Sources”. If the SDK Ltd. had distributed dividends during the previous year, then it may claim deduction u/s 80M in respect of such dividends received from foreign company upto the amount of dividend distributed by it.

4. As per sec. 40A(7), provision for Gratuity shall be available to the assessee only if it is made for payment to Approved Gratuity Fund or made for Gratuity which has become due and payable during the current previous year. Therefore, in this case, only the actual gratuity paid by SDK Ltd. shall be eligible for deduction and provision of ₹ 125 lakhs [₹ 400 lakhs – ₹ 275 lakhs] shall be disallowed.

5. As per sec. 40A(2), where in case an assessee being a company, incurs any expenditure for which the payment has been made or is to be made to a specified person i.e. in this case, to a firm in which the director or directors of the company has substantial interest, and such expenditure in the opinion of A.O. is excessive and unreasonable having regard to the fair market value of the goods, then such expenditure shall be disallowed to the extent considered as excessive or unreasonable by the A.O.

Therefore, in this case, by assuming that the Directors of SDK Ltd. are having substantial interest in the firm Shivbrahma, the excess amount of ₹ 10,00,000 [(₹ 30,000 – ₹ 28,000) × ₹ 500 per ton] shall be disallowed.

6. Expenditure incurred on advertisement published in the souvenir of registered political party shall be disallowed u/s 37(2B). However, it shall be allowed as a deduction from the gross total income of the company-assessee u/s 80GGB for the amount contributed by any mode other than cash. Therefore, deduction shall be available to the SDK Ltd. in respect of expenditure incurred on advertisement published in the souvenir of registered political party u/s 80GGB, since the payment has been made by way of cheque.

7. As per the amendment made by the Finance Act, 2018, the exemption u/s 10(38) shall not be available for the transfer made on or after 01.04.2018. The long term capital gains exceeding ₹ 1,00,000 arising from transfer of equity shares made on or after 01.04.2018, where the STT has been paid on acquisition and transfer of such shares, shall be taxable @ 10% u/s 112A, as inserted by the Finance Act, 2018.

8. It was held in the case of Thirumalaiswamy Naidu & Sons that the re-fund of sales tax (now GST) shall be taxable to the extent not refunded to the customers, since it is a remission of liability to be taxable u/s 41(1). Therefore, SDK Ltd. shall be taxable for refund of GST of ₹ 1 lakh [₹ 4 lakhs – ₹ 3 lakhs] not refunded to the customers u/s 41(1).

9. Scrap value of machinery shall be reduced from the WDV of machinery. Since, it has been credited to the statement of profit and loss, it shall be deducted while computing business income.

Question 37.
M/s. Gomati P Ltd., a closely held company is in the business of growing rubber. The Profit & Loss account for the year ended 31.03.2021, of the company shows a Net profit f 37.65 crores after debiting Depreciation of ₹ 30 crores.
The company has provided the following additional information:
(i) The company has deposited ₹ 30 crores in a special Account with NABARD on 29.04.2021.

(ii) The company has brought forward losses of ₹ 6 crores pertaining to Assessment Year 2018-19. Mr. A who continuously held 60% of shares carrying voting power since incorporation of the company, had sold his entire holding to Mr. B on 01-08-2020.

(iii) The company had an accumulated balance of ₹ 200 crores in the special account with NABARD as on 01-04-2020. It has withdrawn 40 crores and utilized the same for the following purposes.

• Purchase of a new sprinkling machine for use in its operation ₹ 10 crores.
• Purchase of office appliances for corporate office at Chennai ₹ 10 crores.
• Purchase of computers and accessories ₹ 5 crores.
• Construction of a godown at a cost of ₹ 1 crore near the rubber estate to store raw rubber.
• Repairs to machinery ₹ 35 lakhs.

(iv) On 31 -03-2021, the company has sold machinery which was purchased on 10-05-2012 for ₹ 10 crores. The purchase of the said machinery was in accordance with the scheme of deposit.
(v) Depreciation allowable as per Tax Audit Report is ₹ 28 crores. Compute Taxable and Exempt income of M/s. Gomati (P) Ltd.  [CA Final May 2018 (New Syllabus)] [8 Marks]
Answer:
Computation of Taxable and Exempt income of M/s. Gomati (P) Ltd. for AY. 202 1-22

Notes:
1. Where any amount standing to the credit of the assessee in the special account with NABARD is utilised by the assessee for the purposes of any expenditure in connection with the business of the assessee as per the scheme, then such expenditure shall not be allowed in computing the income under the head “Profits and Gains of Business or Profes-sion”.

Therefore, the amount withdrawn from the special account with NABARD and utilised for the purpose of repairs to machinery shall not be allowed as deduction in computing the income under the head “Profits and Gains of Business or Professions by assuming that it has been incurred in accordance with the scheme. However, if the same has not been incurred in accordance with the scheme, then it may be taxable as profits and gains of business of the assessee. Here, it is assumed that M/s. Gomati P. Ltd. has debited ₹ 35 lakhs in respect of repairs to machinery to statement of profit and loss account and therefore, it has been added back.

2. As per sec. 33AB, where any assessee carrying on the business of growing and manufacturing of tea, coffee or rubber in India, deposits any amount with NABARD under a scheme approved by the Tea/ Coffee/Rubber Board within 6 months from the end of previous year or before the due date of furnishing return of income, whichever is earlier, then he shall be allowed a deduction of 40% of profits from such business (before deducting b/f business loss) or the amount deposited, whichever is lower.

3. Where any amount standing to the credit of the assessee in the special account with NABARD is withdrawn during any previous year and utilised for the purchase any office appliances (not being computers), then the amount so utilised shall be deemed to be profits and gains of business of that previous year and shall accordingly be chargeable to tax as income of that previous year.

Therefore, the amount withdrawn from the special account with NABARD and utilised for purchase of office appliances for corporate office at Chennai shall be deemed to be profits and gains of business of the RY. 2020-21 and shall accordingly be chargeable to tax as income of P.Y. 2020-21. However, the amount utilised for purchase of a new sprinkling machine and for purchase of computers and accessories shall not be deemed as income of M/s. Gomati (P.) Ltd., since, there is no restriction on purchase of such machinery u/s 33AB.

4. Where any amount standing to the credit of the assessee in the special account with NABARD is withdrawn during any previous year but not utilised by the assessee within the previous year in which it is withdrawn, then the amount not so utilised shall be deemed to be profits and gains of business of the previous year in which the amount is withdrawn. Therefore, ₹ 13.65 crores not so utilised during the P.Y. 2020-21 shall be deemed as profits and gains of business of M/s. Go-mati P Ltd. for the P.Y. 2020-21.

5. Where any asset acquired as per the scheme is sold or otherwise transferred within 8 years from the end of the previous year in which it was acquired, then the deduction so allowed earlier in respect of such asset u/s 33AB shall be deemed to be the profits and gains of business or profession of the previous year in which the asset is sold or otherwise transferred. Here, the machinery purchased on 10.05.2012 is sold on 31.03.2021 by M/s Gomati (P.) Ltd. i.e. within 8 years from the end of the previous year in which acquired, and therefore, it shall be deemed as profits and gains of business or profession for the P.Y. 2020-21.

6. As per Sec. 79, where there has been a change in shareholding of a company in which the public are not substantially interested i.e. closely held company, any loss which is to be carried forward shall be allowed to be carried forward and set off against the income of the previous year only if the shares carrying atleast 51 % of the voting power on the last day of such previous year and as on the last day of the previous year in which the loss is incurred were beneficially held by the same shareholders.

Here, Mr. A who continuously held 60% shares carrying power in Gomati P Ltd. since incorporation, has sold his entire share-holding to Mr. B on 01.08.2020. Therefore, the loss pertaining to A.Y. 2018-19 of ₹ 6 crores shall not allowed to be set-off against the income of Gomati P Ltd. for the P.Y. 2020-21, since atleast 51% of the shares carrying voting power were not beneficially held by the same persons as on the last day of such previous year i.e. 2020-21 and as on the last day of the previous year in which the loss is incurred i.e. 2020-21.

Question 38.
Dr. Juhi reports to you that her gross receipt from her medical profession for the year ended 31.03.2021 is ₹ 49,20,000. Her net income as per income and expenditure account is ₹ 26,40,000 before adjustment of depreciation of ₹ 2,10,000. She did not pay any amount by way of advance tax during the financial year 2020-21. She has two residential house properties, of which one is self-occupied for residence and another is let out for the monthly rent of ₹ 10,000 during the financial year 2020-21.

Advise Dr. Juhi with reference to section 44ADA on filling of return with optimal tax liability besides compliance cost.
Assume that she approached you in April, 2021 and you have given your advise then. Ignore Sec. 115BAC. [CA Final May 2018 (New Syllabus)] [7 Marks]
Answer:
As per Sec. 44ADA, where gross receipts of a resident assessee engaged in the profession does not exceed ₹ 50,00,000, he can opt for presumptive tax provisions u/s 44ADA.

Also, all the deductions allowable u/s 30 to 38 are deemed to have been given full effect to and therefore, no deduction in respect of depreciation would be available from the income computed on presumptive basis u/s 44ADA.

Calculation of Total Income u/s 44 ADA

Calculation of tax and interest liability under presumptive taxation scheme as per Sec. 44ADA

Calculation of Total Income under normal provisions

Calculation of tax and interest liability under normal provisions

Notes:
1. As per Sec. 234B, where in any financial year, an assessee who is liable to pay advance tax has failed to pay such tax or where the advance tax paid is less than 90% of the assessed tax, the assessee shall be liable to pay simple interest @ 1% for every month or part of a month from 1st. April next following such financial year to the date of determination of total income u/s 143(1) and where a regular assessment is made, to the date of such regular assessment, on an amount equal to the assessed tax or on the amount by which the advance tax paid falls short of the assessed tax. In this case, Dr. Juhi has not paid her advance tax during the F.Y. 2020-21 and therefore, she will be liable to pay interest u/s 234B on the assessed tax. Since, Dr. Juhi has approached in April, 2021, it may be assumed that she will pay the tax on or before 30.04.2021 and therefore, she will be liable for interest u/s 234B only for 1 month under both the options i.e. normal provisions or presumptive income scheme u/s 44ADA.

Calculation of interest u/s 234B

2. Interest u/s 234C under presumptive taxation scheme u/s 44ADA
Where the assessee has opted to pay the tax as per the provisions of Sec. 44ADA, then he is required to pay the whole of the advance tax in one instalment on or before the 15th March of each financial year. As per sec. 234C, where the assessee fails to pay the whole of the advance tax upto 15th March, then he shall be liable to pay the simple interest @1% for 1 month on the amount of advance tax due.

Interest u/s 234C under normal provisions
As per Sec. 234C, where in any financial year, the assessee (other than the assessee who declares profits and gains in accordance with Sec. 44AD or 44ADA) failed to pay the advance tax, then the assessee shall be liable to pay the simple interest @ 1% on the amount of shortfall of the advance tax due as follows:

Question 39.
Y. Ltd. was amalgamated with X Ltd. in accordance with a scheme of amalgamation. Assets and liabilities were transferred and vested with X. Ltd. X. Ltd. is of the view that excess consideration paid by it over the value of net assets acquired from Y. Ltd. should be considered as goodwill arising on amalgamation. X. Ltd. claimed depreciation on such goodwill, but the claim was rejected by the A.O. on the ground that goodwill is not an asset falling under Explanation 3 to section 32(1). Is the action of the Assessing Officer valid? [CA Final Nov. 2018 (Old Syllabus), May 2013] [4 Marks]
Answer:
The issue under consideration is whether X Ltd. can claim depreciation on the excess consideration paid by it over the value of net assets acquired from Y Ltd. in a scheme of amalgamation, by treating the same as goodwill, and considering it as an intangible asset within the meaning of Explanation 3 to section 32(1).

The facts of the case are similar to the facts in CIT v. Smifs Securities Ltd. (2012), where the Supreme Court observed that Explanation 3 to section 32(1) states that the expression ‘asset’ shall mean an intangible asset, being know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature.

A reading of the words ‘any other business or commercial rights of similar nature’ in Explanation 3(b) indicates that goodwill would fall under the said expression. In the process of amalgamation, the amalgamated company had acquired a capital [ right in the form of goodwill. Therefore, it was held that ‘Goodwill’ is an asset under Explanation 3(b) to section 32(1) and depreciation thereon is I allowable under the said section as an intangible asset.

By applying the above rationale, the action of the A.O. in rejecting the claim I of depreciation made by X Ltd. is, therefore, not valid.

Question 40.
Anil Food Products (P) Ltd. is engaged in manufacturing and selling various food products. It engaged two transporters for carrying its products to various distributors. In previous year 2020-21, it made payments to two transporters towards freight charges without deduction of tax at source. In course of assessment, the Assessing Officer disallowed 30% freight charges invoking section 40(a)(ia) for failure to deduct tax at source. The assessee contends that section 40(a)(ia) is not applicable as the amount of freight was not ‘payable’ at the year-end, but had been actually paid during the previous year. Examine the correctness of the contention of the assessee. [CA Final Nov. 2018 (Old Syllabus)] [4 Marks]
Answer:
The issue under consideration is whether the provisions of section 40(a) (ia) would be attracted on the amount of freight which was not ‘payable’ at the year-end but has been actually paid during the previous year.

The facts of the case are similar to the facts in Palam Gas Service v. CIT [2017] where the Supreme Court observed that when the entire scheme of obligation to deduct tax at source and paying it over to the Central Government is read holistically, it cannot be held that the word ‘payable’ occurring in Sec. 40(a)(ia) refers to only those cases where the amount is yet to be paid and does not cover the cases where the amount is actually paid. Therefore the Supreme Court held that the word ‘payable’ usgd in Sec. 40(a)(ia) includes not only the amount which is payable as of 31st March but also includes the amount ‘paid’ during the year.

Applying the above rationale, the contention of Anil Food Products (P) Ltd. that the provisions of section 40(a)(ia) would not be attracted on the amount of freight which was not ‘payable’ at the year-end but has been actually paid during the previous year is, thus, not correct.

Question 41.
Statement of Profit and Loss account of BAS Industries Ltd. engaged in production and marketing of diversified products, shows a net profit (before tax) of ₹ 72,00,000 for the financial year ended 31st March, 2021 after charge of the following items:
A : Items debited to the Statement of Profit and Loss:
(i) Depreciation as per Companies Act, 2013: ₹ 24,00,000

(ii) Interest amounting to ₹ 60,000 for short payment of advance tax paid as per section 234B relating to the assessment year 2019-20.

(iii) Interest and borrowing costs amounting to ₹ 9,50,000 and 7,00,000 though not meeting the criteria for recognition as a j component of cost, included in cost of opening and closing inventory, respectively.

(iv) Expenditure of ₹ 41,000 paid in cash comprising of ₹ 22,000 directly paid to producer of dairy farming products and ₹ 19,000 paid towards printing and stationery items to a trader.

(v) ₹ 3,50,000 paid to a contractor for carrying out repair work at factory premises. Tax was not deducted at source on this payment.

(vi) ₹ 35,000 towards expenditure for earning income from transfer p of carbon credits.

(vii) Contribution to electoral trust: ₹ 3,00,000 paid by way of cheque.

(viii) Expenditure towards advertising charges in a brochure of a political party registered u/s 29A of Representation of People Act, 1951: ₹ 40,000 paid by way of cheque.

(ix) Interest on term loans obtained from Cooperative Bank not paid I before the due date of filing of return of income (due date being 31.10.2021): ₹ 2,60,000

(x) Actual contribution to the pension scheme of employees: ₹ 1,50,000

B: Items credited to the Statement of Profit and Loss:
(i) Unrealised rent of ₹3,80,000 pertaining to financial years 2017-18 & 2018-19 recovered during the year in respect of a commercial property owned by the company, which was sold by the company on 23.03.2020.
(ii) Profit of ₹ 3,00,000 received from hedging contract entered into for meeting out loss in foreign currency payments towards an
imported printing machinery valued at ₹ 95 lakhs, installed on 15th December, 2020 and put to use from that date.
(iii) Interest from banks on fixed deposits net of TD Sat 10%: ₹ 1,35,000

Additional Information:
(1) Depreciation as per Income-tax Rules: ₹ 28,00,000 exclusive of depreciation on the imported printing machine referred to in item B (iii)
(2) Expenditure pertaining to previous financial year allowed on due basis, but paid in current financial year in cash on 18.01.2021: ₹ 35,000
(3) Audit fee for the previous year 2019-20: ₹ 75,000. TDS deducted but not paid in the relevant previous year. However, TDS was paid on 31.12.2020.
(4) Income from transfer of Carbon Credits amounting to ₹ 4,00,000 included in Net Profit (before tax).
(5) The eligible salary and dearness allowance for the pension scheme referred to u/s 80CCD is ₹ 10,00,000.

Compute the total income of BAS Industries Ltd., for assessment year 2021-22. Give brief reasons for the treatment given to each of the items taken into consideration in computation of income of the company. [CA Final Nov. 2018 (Old Syllabus)] [16 Marks]
Answer:
Computation of Total Income of BAS Industries Ltd..for the A.Y. 2021-22

Notes:
1. Any interest payable for default committed by assessee for discharging his statutory obligations under Income-tax Act, 1961 is not allowable as deduction.

2. As per ICDS II, interest and borrowing cost which does not meet the criteria for recognition as a component of the cost, cannot be included in the cost of inventory. Since the same have been included in the opening and closing inventory, the difference of ₹ 2,50,000 (₹ 9,50,000 – ₹ 7,00,000) has to be added back.

3. Disallowance u/s 40A(3) is attracted in respect of expenditure, for which payment exceeding ₹ 10,000 in a day has been made in cash. Therefore, expenditure of ₹ 19,000 towards printing and stationery items for which payment is made in cash has to be disallowed. However, payment of ₹ 22,000 to producer for dairy farming products is not disallowed since it is covered under the exceptions specified in Rule 6DD.

4. 30% of the amount of ₹ 3,50,000 paid for carrying out repair work to a contractor without deduction of tax at source shall be disallowed u/s 40(a)(ia).

5. Income by way of transfer of Carbon Credits is chargeable to tax u/s 115BBG at a flat rate. No deduction is allowed under any provision of the Act in respect of any expenditure or allowance in relation thereto. Since such expenditure is debited to the statement of profit and loss, the same has to be added back.

6. Contribution to electoral trust and advertisement charges in respect of brochure published by a political party is not deductible u/s 37 since it is not laid out wholly and exclusively for the purposes of business or profession. However, donation made by a company to an electoral trust or registered political party is allowable deduction u/s 80GGB from gross total income, subject to the condition that payment is made otherwise than by way of cash. Since, the contribution to an electoral trust and payment in respect of advertisement charges for a political party is made by way of cheque, the same shall be allowed if as deduction u/s 80GGB.

7. Interest on term loans obtained from Co-operative bank shall be dis-allowed u/s 43B, since the interest was not paid on or before the due date of filing of return i.e. 31.10.2021.

8. Contribution towards pension scheme, referred to in section 80CCD, of employees is allowed only to the extent of 10% of salary of the employee in the previous year i.e., ₹ 1,00,000 being 10% of ₹ 10,00,000. Therefore, the excess contribution of ₹ 50,000 [i.e., ₹ 1,50,000 – ₹ 1,00,000] shall be disallowed u/s 36(1 )(iva).

9. Cash payment in excess of ₹ 10,000 made in the current year in respect of expenditure allowed on mercantile basis in the previous year, would be deemed as income in the current year u/s 40A(3A).

10. Hedging contract is entered into for safeguarding against any loss that may arise due to currency fluctuation. The profit from such contract entered into for meeting loss in foreign currency payments towards imported printing machinery has to be adjusted against the cost of machinery. Since the said profit has been credited to the statement of profit and loss, the same has to be deducted while computing business income.

11. 30% of ₹ 75,000, being the audit fees disallowed in the P.Y. 2019-20 for non-remittance of TDS on or before due date of filing for P.Y. 2019-20 would be allowed in the year of payment of TDS i.e., P.Y. 2020-21.

12. Income by way of transfer of Carbon Credits chargeable u/s 115BBG can be treated as business income or income from other sources, depending upon the facts of the case. In this case, since the question mentions that BAS Industries Ltd. is engaged in production and marketing of diversified products, it is logical to assume that the same is in the nature of business income. Since the amount of ₹ 4 lakh has already been credited to statement of profit and loss, no further adjustment is necessary

13. Calculation of Depreciation:

14. Contribution by a company to an electoral trust, and registered political party is allowable as deduction u/s 80GGB, since payment is made otherwise than by cash. Also, expenditure incurred by an Indian I company on advertisement in brochure published by political party tantamount to contribution to such political party. Therefore, BAS j Industries Ltd. is eligible for deduction of ₹ 3,40,000 (₹ 3,00,000 + ₹ 40,000).

Question 42.
SG Securities Private Ltd. is engaged in the business of trading in shares and securities. The details of shares held by it as stock-in-trade as on 31st March, 2021 are given below:

The company values its year-end stock-in-trade in accordance with Accounting Standard (AS) 13 – “Accounting for investments of the Companies (Accounting Standards) Rules, 2006”.

Determine the amount of adjustments, if any, required to be made in computation of income for A.Y. 2021-22. [CA Final Nov 2018 (Old Syllabus)] [5 Marks]
Answer:
As per AS 13, current investments are carried in the financial statements at the lower of cost and fair value determined either on an individual investment basis or by category of investment. However, the more prudent and appropriate method is to carry investments individually at the lower i of cost and fair value. Here, net realizable value (NRV) can be taken as fair value.

Valuation of shares held as stock in trade as per AS 13

ICDS-VH1 on securities requires securities held as stock-in-trade to be valued at actual cost initially recognised or net realisable value (NRV) at the end of that previous year, whichever is lower. It also requires the comparison of actual cost initially recognised and net realisable value to be done category wise and not for each individual security.

Valuation of shares held as stock in trade as per ICDS VIII

SG Securities Pvt. Ltd. is required to value its shares held as stock in trade at ₹ 75,750 as per ICDS VIII for income-tax purpose. Accordingly, its income would be increased by ₹ 5,100 (₹ 75,750 – ₹ 70,650).

Note: AS 13 also permits valuation of shares on category of investment basis, in which case, there would be no increase in total income under the Income-tax Act, 1961.

Question 43.
M/s. Hind Udyog, a manufacturing partnership firm, consisting of three partners namely X, Y and Z, provides following information relating to the year ending on 31.03.2021:

Net profit of ₹ 28.75 Lakhs, as per profit and loss account, was arrived at after debiting/crediting the following items:
(i) The firm had provided an amount of ₹ 2 lakhs being sum estimated as payable to workers based on agreement to be entered with the workers union towards periodical wage revision once in three years. The provision is based on a fair estimation on wage and reasonable certainty of revision once in three years.

(ii) Sale proceeds of import entitlements amounting to ₹ 1 lakh have been credited to profit and loss account which the firm claims as capital receipt not chargeable to income tax.

(iii) Goods and Services Tax demand paid includes an amount of ₹ 5,300 charged as penalty for delayed filing of returns and ₹ 12,750 towards interest for delay in deposit of tax.

(iv) A free air ticket was provided by a supplier for reaching a certain volume of purchase during the F.Y. 2020-21. The same is not credited in profit & loss account because it was encashed by the firm for ₹ 2 lakhs in April 2021.

(v) Interest amounting ₹ 20,000 paid to X as a Karta of HUF @ 18% per annum.

(vi) The firm had taken on lease an old building for the purpose of locating its business. Due to old age of building, it was demolished and a new building put up, which was used by the firm from September, 2020. The cost of new building ₹ 10 lakh was written off as revenue expenditure. The lessor permitted the firm to have an extension of the lease by another 20 years.

(vii) Loss incurred in transactions of purchase and sale of shares (without delivery) of various companies ₹ 3 lakhs.

(viii) A scheduled bank sanctioned and disbursed a term loan in the financial year 2017-18 for a sum of ₹ 50 lakhs. Interest of ₹ 8 lakhs was in arrears. The bank has converted the arrear of interest into a new loan repayable in 10 equal instalments. During the year, the company has paid 2 instalments and the amount so paid has been reduced from Funded Interest in the Balance Sheet.

The firm furnishes following additional information relating to it:
(1) Provision for audit fees ₹ 2.5 lakhs was made in the books for the year ended on 31.03.2020 without deducting tax at source. Such fees were paid to the auditors in September, 2020 after deducting tax u/s 194J and the tax so deducted was deposited on 7th November, 2020.

(2) The firm had made an investment of ₹ 23 lakhs and ₹ 12 lakhs on the construction of two warehouses (excluding the cost of land), in rural areas for the purpose of storage of agricultural produce and edible oil respectively. These were made available for use from 15.09.2020. The profits from setting of these warehouses (before claiming deduction u/s 35AD and 32) for the A.Y. 2021-22 is ₹ 15 lakhs and ₹ 5 lakhs respectively.

(3) In July, 2020 firm received a dividend of ₹ 11 lakhs from A Ltd. in which it holds 10% of shares.

Compute the total income of M/s Hind Udyog for the A.Y. 2021-22 by analysing, integrating and applying the relevant provisions of Income tax law. Explain in brief, the reasons for the treatment of each item. [CA Final Nov. 2018 (New Syllabus)] [14 Marks]
Answer:
Computation of Total Income of Hind Udyog for the A.Y. 2021-22

Notes:
1. If the provision is made for the present obligation resulting from the past events and which may require outflow of resources to settle and reliable estimate can be made, then such provision is allowable as deduction u/s 37(1). Therefore, the provision made to be paid as wage revision on a fair estimation and probable revision basis shall be allowed as deduction u/s 37(1) to M/s. Hind Udyog. Since, the same has already been debited to profit and loss account, no further adjustment is required.

2. Sale proceeds of import entitlements are taxable as business income under section 28. As the amount has already been credited to Profit and Loss Account, no further adjustment is required.

3. Interest on GST demand is an allowable expenditure since it is incurred wholly and exclusively for the purpose of business of the assessee.

4. As per Sec. 37(1), any expenditure incurred by an assessee which is for an offence or which is prohibited by law shall not be deemed to be an expenditure incurred by the assessee for the purposes of business or profession and thereby shall not be allowed as deduction. Hence, Penalty on GST shall not be allowed as deduction.

5. As per Sec. 28(iv), the value of any benefit, whether convertible into money or not, arising from business is taxable as business income. Therefore, the value of free air ticket provided by a supplier for reaching a certain volume of purchase is taxable as business income in the A.Y. 2021-22 though it is encashed in A.Y. 2022-23.

6. Since X is a partner in his individual capacity, interest paid to the X as a karta of Hindu Undivided Family will not be subjected to the provisions of Sec. 40(b) and the same will be allowed as deduction u/s 36(l)(m) to M/s. Hind Udyog.

7. As per Explanation 1 to Sec. 32, depreciation can be claimed on the Capital Expenditure incurred on a Building; even though the building is not owned by the assessee but in respect of which he holds a lease or any other right of occupancy. Such capital expenditure will be deemed as the building owned by the assessee. Since, the cost of the new building shall be capitalized and shall not be allowed as revenue expenditure, ₹ 10,00,0000 debited to statement of profit and loss shall be added back and depreciation of ₹ 1,00,000 (₹ 10,00,000 × 10%) shall be deducted from statement of profit and loss.

8. Loss incurred in transactions of purchase and sale of shares (without delivery) is a loss on speculative transaction and can be set-off only against profit op speculative transaction.

9. Conversion of unpaid interest into loan shall not be construed as payment of interest for the purpose of section 43B. The amount of unpaid interest converted into a new loan will be allowable as deduction only in the year in which such converted loan is actually paid. Since ₹ 1,60,000 (2 Instalment) has been paid in the P.Y. 2020-21, the same is allowable as deduction.

10. As per section 40(a)(ia), 30% of any sum payable to a resident on which tax is deductible at source shall not be allowed as a deduction on which tax has not been deducted or after deduction has not been paid to the credit of Central Government on or before the due date of filing ROI u/s 139(1).

However, if tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified u/s 139(1), then 30% of such sum (disallowed earlier) shall be allowed as a deduction in the previous year in which such tax has been paid.

In this case, the tax deducted at source on audit fees of P.Y. 2019-20 was deposited on 07.11.2020 and therefore, 30% of such sum will be disallowed for the P.Y. 2019-20. But, since, it is paid in the P.Y. 2020-21, it will be allowed as deduction in the P.Y. 2020-21.

11. As per Sec. 3 5AD, where the assessee incurs any capital expenditure wholly and exclusively for the specified business, he shall be allowed deduction, if he so opts, for the whole of such capital expenditure in the previous year in which such expenditure is incurred. Specified business includes “setting up and operating a warehousing facility for storage of agricultural produce” and therefore, M/s. Hind Udyog will be allowed deduction of ₹ 23,00,000 u/s 35AD incurred on construction of warehouse for storage of agricultural produce. However, no deduction shall be available for capital expenditure incurred on construction of warehouse for storage of edible oil, since it is not a specified business u/s 35AD. Also, the loss of a specified business shall be set off only against the profits of specified business and therefore, the loss of ₹ 8,00,000 shall not be set off against the profits of other business and it shall be carried forward to the following years.

Question 44.
M/s. Jonga and Jonga decided to expand its jeep product line and entered into an agreement with K Inc., an American company, which agreed to sell its dies, welding equipment and die models. The purchase consideration was agreed at $ 65,000 including cost, insurance and freight and K Inc., agreed to advance a loan to the assessee at 6% interest per annum repayable after 10 years in instalments. The Reserve Bank of India j and the concerned Ministry approved the loan agreement.

Later on, XL Inc., took over K Inc., and agreed to waive the principal amount of loan advanced by K Inc., to Jonga and Jonga and to cancel the promissory notes as and when they matured. This was communicated to the assessee-company which filed its return showing ₹ 35 Lakh as cessation j of liability in its books of account.

The Income-tax Officer concluded that the waiver of the loan amount represented income and held that the sum of ₹ 35 Lakh is taxable u/s 28(iv) as income. The alternate argument of the Revenue authorities was that the sum would be taxable u/s 41(1) as a waiver of a trading liability, Examine the validity of Assessing Officer’s action. [CA Final May 2019 (Old Syllabus)] [4 Marks]
Answer:
The issue under consideration is whether the sum due by the assessee, : M/s. Jonga and Jonga, to K Inc, which has been waived off later on by XL Inc. (which took over K Inc.), constitutes taxable income in the hands of the assessee.

The fasts of the case are similar to the facts in CIT v. Mahindra and ; Mahindra Ltd. (2018), wher e the Supreme Court observed that Sec. 28(iv) is applicable only if the income arises Ironi business or profession and the benefit received is in non-monetary form. The amount of ₹ 57,74,064, being j a cash receipt, therefore, does not fall u/s 28(iv). Fair applicability of Sec. 41(1), the assessee-company should have claimed an allowance or deduction in any assessment year in respect of a trading liability and subsequently, the creditor has waived such liability. In this case, the loan was taken for procurement of capital assets (plant, machinery and tooling equipment) and therefore, waiver of such loan would not tantamount to cessation of a trading liability. The Supreme Court, accordingly, held that the amount of loan waived w’ould not be taxable either u/s 41(1) or u/s 28(iv).

In the instant case, the loan was taken for procurement of capital assets, namely, plant, machinery and tooling equipment. The purchase amount had not been debited to the trading account or to the profit and loss account in any of the assessment years. Hence, waiver of such loan would not tantamount to cessation of a trading liability. Thus, the action of Assessing Officer is not correct. The amount of loan waived would not be taxable either under section 41(1) or under section 28(iv).

Notes:
(1) As per section 2(24)(xviii), assistance in the form of waiver by the Central Government or State Government or any authority or body or agency in cash or kind to the assessee would be included in the definition of “income”. In this case, the waiver is by a foreign company, and hence, is not included within the scope of definition of “income” under section 2(24).

(2) Further, it may be noted that as per Explanation 10 to section 43(1), deduction on account of, subsidy or grant or reimbursement, by whatever name called, received from any person has to be made while computing actual cost. Since waiver has not been expressly included in the said Explanation, it is possible to take a view that the same is not deductible while computing the actual cost. However, if a view is taken that “waiver” is included within the scope of the phrase “by whatever name called” in the said Explanation, then, the same has to be deducted while computing actual cost.

Question 45.
Mr. Robert, a non-resident, (aged 38) operates a ship for the carriage of goods, passengers and livestock between Dubai, Mumbai and Chennai, i He provides you the following particulars for the previous year 2020-21:
(i) Received ₹ 200 Lakhs in India on account of carriage of livestock from Mumbai to London.
(ii) Received ₹ 50 Lakhs in India on account of carriage of passengers from Dubai to Colombo.
(iii) Received ₹ 65 Lakhs in Dubai on account of carriage of goods from Chennai to Dubai.
(iv) Expenses incurred during the year in respect of operation of such ships 195 Lakhs.
(v) Winning from horse races in India ₹ 25 Lakhs

Compute the total income of Mr. Robert Chargeable to tax in India for the ! assessment year 2021 -22. Also, calculate the tax payable thereon assuming j that he does not opt for Sec. 115BAC. [CA Final May 2019 (Old Syllabus)] [6 Marks]
Answer:
As per Sec. 44B, notwithstanding anything to the contrary contained in the provisions of sections 28 to 43A, the profits and gains of a non-resident engaged in the business of operation of ships are to be taken (w 7.5% of the aggregate of the following amounts:

(i) paid or payable, whether in or out of India, to the assessee or to any person on his behalf on account of carriage of passengers, livestock, mail or goods shipped at any port in India; and

(ii) received or deemed to be received in India by or on behalf of the assessee on account of the carriage of passengers, livestock, mail or goods shipped at any port outside India.
Accordingly, profits from shipping business of Mr. Robert ₹ in lakhs computed as follows:

Computation of total income and tax payable by Mr. Robert

Note: The tax payable would get further reduced by the amount of tax paid u/s 172(4). The amount of tax payable u/s 172 would be 41.6% (being the rate applicable to a foreign company) of 7.5% of ₹ 265 lakhs (being the amounts payable for goods shipped at a port in India) = ₹ 8,26,800. After reducing this amount, the tax ref undable on total income would be ₹ 2,84,700.

Question 46.
On, 1.4.2020, Binu Ltd. of Delhi, a domestic company, engaged in the business of manufacturing of metro rail seats, converted into an LLP by name M/s. Soumya LLP fulfilling all the conditions specified in section 47(xiiib) of the Income-tax Act, 1961. Some of the relevant information is given below in respect of Binu Ltd., as on 31.3.2020:

(a) Voluntary Retirement Scheme (VRS) expenditure incurred by the company during‘the P.Y. 2018-19 is ₹ 20 lakhs. The company was allowed deduction of ₹ 4 lakhs each for the P.Ys 2018-19 & 2019-20 under section 35DDA.
(b) 150 equity shares in Toyo Ltd., an Indian company listed in Bombay Stock Exchange was acquired for ₹ 1,900 per share on 31.7.2017. On conversion, these share become the property of M/s. Soumya LLP.
(c) Besides other assets transferred to M/s. Soumya LLP by M/s. Binu j Ltd., it also transferred two factory buildings. On 1.4.2020, M/s. Soumya LLP leased out one factory building along with plant and machineries and furniture etc. at a consolidated lease rent of ₹ 50,000 per month.

During the previous year 2020-21, the M/s. Soumya LLP earned a profit of ₹ 25,40,000 after debit/credit of the following items to its Profit and loss account:
(i) Mr. Binu is the working partner of the LLP. He is also a working partner in another firm. He is actively engaged in the business of both the firms. Binu gets, a salary of ₹ 55,000 p.m. from M/s. Soumya LLP and the same is authorised in the deed of LLP.

(ii) Mr. Ayushman, an employee, was deputed to work in the client’s office j in Mumbai for three months. The LLP has paid his salary in cash for the months when he was in Mumbai, amounting to ₹ 3,45,000 (net of TDS and other deductions), since he did not have a bank- account in Mumbai. This payment was included in amount of “salary” debited to profit and loss account. Mr. Ayushman is normally posted in Delhi being the headquarter of M/s. Soumya LLP.

(iii) Amount of ₹ 25,000 was paid towards penalty for non-fulfilment of delivery conditions of a contract for sale for the reasons beyond its control.

(iv) The LLP had provided an amount of ₹ 18 lakhs being the sum estimated as payable to workers based on agreement to be entered with workers union towards periodical wage revision once in 3 years. The provision, is based on a fair estimation of wage and reasonable certainty of revision once in 3 years.

(v) Depreciation debited to profit and loss account ₹ 5,40,000.

(vi) Gratuity provisions based on actuarial valuations ₹ 6.5 lakhs. (Gratuity actually paid ₹ 4 lakhs to retired employees debited in Gratuity provision account).

(vii) Profit on sale of shares of M/s. Toyo Ltd. ₹ 1,27,500. These shares were sold on 31.5.2020 for ₹ 2,750 per share. The highest price of Toyo Ltd. quoted on the stock exchange as on 31.1.2018 was ₹ 2,500 per share.

(viii) Repairs to plant and machinery include ₹ 59,000 in respect of plant and machinery given on lease.
(ix) Factory licence fee paid ₹ 15,000 for each factory building.
(x) Legal fee includes ₹ 26,000 paid to an advocate for drafting and registering the lease agreement.

Additional Information:
(1) Under an agreement of debt restructuring, the bank has converted j unpaid interest amounting to ₹ 9,00,000 up to 31.7.2020 into a new loan account repayable in 3 equal annual instalments. The first instalment was paid in March 2021 by debiting the new loan account.

(2) Mr. Binu, being a working partner, bought a car which is registered in his own name out of the funds of LLP. The car was used exclusively for the purposes of the business of the LLP only. The depreciation on the car amounts to ₹ 15,000 for the P.Y. 2020-21 which is not included in the depreciation amount debited to profit and loss account.

(3) Depreciation as per Income-tax Rules ₹ 8,10,000 (including depreciation on the assets given on lease amounting to ₹ 90,000). It does not include depreciation on car.

(4) The LLP sold import entitlements on 1.5.2019 for ₹ 1,50,000. This sum is not included in profit and loss account by treating it as capital receipt.

You are required to discuss the implication of such conversion and calculate the total income in the hands of M/s Soumya LLP for the Assessment Year 2021 -22. [CA Final May 2019 (Old Syllabus)] [14 Marks]
Answer:
Implication on conversion of company into LLP
Transfer of capital asset or intangible asset by a private company or unlisted public company to a LLP or any transfer of share held by shareholder to LLP in a conversion of private company into an LLP is not regarded as transfer u/s 47 provided the conditions specified therein are satisfied.

Accordingly, transfer of capital asset by Binu Ltd., Delhi to M/s. Soumya LLP is not regarded as transfer since the conditions specified in section 47 (xiiib) as stated in the question stand satisfied and fulfilled.

Computation of Total Income in the hands of M/s. Soumya LLP for the A.Y. 2021-22

Notes:
1. As per Sec. 40A(3), disallowance is attracted in respeçt of expenditure for which cash payment exceeding ₹ 10,000 is made on a day to a person. However, no disallowance shall be attracted where payment of salary is made to an employee after deducting tax at source and such employee is temporarily posed for a continuous period of 15 days or more in a place other than his normal place of duty and does not maintain any bank account at such place. Therelore, payment of ₹ 3,45,000 after deducting tax at source to Mr. Avushman, an employee, who is temporarily posted in Mumbai and does not have a bank account in Mum bai shall not be disallowed. Since the same has been debited to profit and loss account, 110 adjustment is required.

2. Penalty for non-fulfilment of delivery conditions of a contract for sale is not on account of infraction of law. Penalty for breach of contract is business or commercial loss and would be allowable expenditure u/s 37. Since the same has been debited to profit and loss account, no adjustment is required.

3. The provision is based on fair estimate of wages and reasonable certainty of revision, and thus is allowable as deduction, as ICDS-X requires ‘reasonable certainty for recognition of a provision, which is present in this case. As the provision has been debited to prolit and loss account, no adjustment is required while computing business income.

4. Provision of ₹ 6,50,000 for gratuity based on actuarial valuation is not allowable as deduction as per section 40A(7). However, actual gratuity of ₹ 4,00,000 paid is allowable as deduction. Hence, the difference is to be added back being of ₹ 2,50,000 (₹ 6,50,000 – ₹ 4,00,000).

5. Lease rent from factory building along with plant and machinery and furniture is chargeable to tax under the head income from other sources, since the main business of the M/s Soumya LLP is manufacturing of metro rail seats and not letting out the properties. Therefore, repairs to such plant and machinery, factory license fee paid in respect of leased out factory building and legal fee to advocate for drafting and registering lease agreement is to be deducted from lease income taxable under thy head “income from Other Sources. Since, the same has been debited to profit and loss account, it has to be added back.

6. Profit on sale of import entitlements is chargeable to tax under the head “Profits and gains from business and profession” u/s 28. Since the same has not been credited to profit and loss account, it has to be added.

7. 1 /5th deduction is available in respect of payment for voluntary retirement scheme for 5 years. Where a private company or unlisted company is succeeded by a LLP fulfilling the conditions laid down in section Al{xiiib), then, deduction in respect of voluntary retirement scheme is available to the LLP for the balance years from the year of succession. Hence, deduction of ₹ 4,00,000 is allowable in P.Y. 2020-21 to M/s Soumya LLP being for 3rd year.

8. Conversion of unpaid interest into loan shall not be construed as payment of interest for the purpose of section 43B. The amount of unpaid interest converted into a new7 loan will be allowable as deduction only in the vear in which such converted loan is actually paid. Since ₹ 3 lakhs has been paid in the P.Y. 2020-21, the same is allowable as deduction.

9. Depreciation on motor car bought and used exclusively for the purposes of business is allowable though not registered in the name of the firm.

10. Depreciation on leased out asset to be deducted from lease income taxable under the head “Income from Other Sources. Since the same has been included in depreciation of ₹ 8,10,000, it has to be reduced from it.

11. On first ₹ 3,00,000 of book profit, 90% of book profit or ₹ 1,50,000, whichever is higher and on the balance of book profit, 60% of balance book profit ₹ 16,96,500 (2,70,000, being 90% of ₹ 3,00,000 + ₹ 14,26,500, being 60% of ₹ 23,77,500) restricted to actual remuneration paid to Binu.

12. As per Sec. 55(2)(ac), the cost of acquisition of an equity share acquired before 01.02.2018 shall be higher of the following:
(i) Actual cost; and
(ii) Lower of:
(A) FMV of such share on 31.01.2018, and
(B) Sale consideration
In this case, since FMV on 31.01.2018 is higher, it shall be taken as cost of acquisition and the capital gains shall be long term since shares are held for more than 12 month [Period of holding of Binu Ltd. is also included].

Question 47.
Sankar Ltd. engaged in the manufacture of footwear and leather products, for the past 8 years, reported a net profit of ₹ 272 lakhs as per the statement of profit and loss for the year ended 31st March, 2021. The company was subject to tax audit u/s 44AB of Income Tax Act. The net profit is arrived at after debiting or crediting the following amounts:

(i) Depreciation charged on the basis of useful life of assets as per Companies Act is ₹ 32 lakhs.

(ii) A sundry creditor whose amount of ₹ 32 lakhs was outstanding since long time, has been settled for ₹ 26 lakhs on 31st March, 2021 based on compromise settlement. The amount waived has been credited to the statement of profit and loss.

(iii) Employers’ contribution to EPF of ₹ 3 lakhs for the month of March, 2021 was deposited on 29th July, 2021.

(iv) Interest payments debited 30 lakhs (Includes interest on term loan of ₹ 25 lakhs availed on 1-4-2020 at interest rate of 12% p.a. towards purchase of machinery during the year).

(v) Payment of ₹ 30 lakhs to A & Co., a subcontractor for processing raw leather without deduction of tax is debited to statement of profit loss. This amount includes ₹ 20 lakhs for purchase of chemicals and ₹ 10 lakhs towards labour charges which is separately shown in bills’ submitted.

Additional Information:
(1) The company has not made provision for an amount of ₹ 12 lakhs being a fair estimate of the amount as payable to workers towards periodical wage revision once in 3 years in respect of existing employees. The provision is estimated on a reasonable certainty of the revision once in 3 years.

(2) The written down values of assets before allowing depreciation as per Income Tax Rules are as under:
Factory Buildings: ₹ 180 lakhs
Plant & Machinery: ₹ 170 lakhs (inclusive of ₹ 30 lakhs of machinery acquired on 1.11.2020 and put to use)
Computers: ₹ 15, lakhs
It may be noted that the above values have been duly recognised while providing depreciation in the books of account.

(3) During the year 2020-21, the company has employed 24 additional employees (qualified as “workman” under the Industrial Disputes Act, 1947). All these employees contribute to a rectfgnized provident fund. 12 out of 24 employees joined on 1.6.2020 on a Salary of ₹ 23,000 per month, 4 joined on 1.7.2020 on a salary of ₹ 26,000 per month, and 8 joined on 1.11.2020 on a salary of ₹ 20,000 per month. The salaries of 2 employees who joined on 1.6.2020 are being settled by bearer cheques every month.

(4) Sales include 5000 leather bags sold to M/s Sankar (firm) a related party at a price of ₹ 1,000 each. The selling price to others in the market is at ₹1,300 each.

(5) Employees contribution to EPF of ₹ 3 lakhs recovered from their salaries for the month of March 2021 and shown in the Balance Sheet under the head Sundry Creditors was remitted on 31st May, 2021.

Compute the total income and tax payable of Sankar Ltd. for the Assessment Year 2021-22. The turnover of the company for the year ended 31.3.2019 was ₹ 52 crores. Ignore the provisions of MAT. [CA Final May 2019 (New Syllabus)] [14 Marks]
Answer:
Computation of Total Income of Sankar Ltd. for A.Y. 2021-22

Computation of Total Liability of Sankar Ltd. for A.Y. 2021-22

Notes:
(1) As per Sec. 41(1), where in any earlier year, deduction was allowed in respect of loss, expenditure or trading liability incurred by the asses- see and during the current previous year, the assessee has obtained any amount or benefit in respect of such loss, expenditure or trading liability by way of remission or cessation or waiver, then the amount obtained or benefit accruing shall be deemed lo be the profits and gains of business or profession and accordingly. In this case, a sundry creditor whose amount of ₹ 32 lakhs was outstanding since long time, has been settled for ₹ 26 lakhs based on compromise settlement.

Therefore, waiver of ₹ 6 lakhs shall be deemed to be profits and gains of business or profession as per Sec. 41(1). Since, it is already credited to statement of profit and loss, no adjustment is required.

(2) As per Sec. 43B, any sum payable by an employer by way of contribution to provident fund shall be allow ed as deduction only if it is paid on or before the due date for furnishing the ROI u/s 139(1) in respect of the previous year in which the liability to pay such sum was incurred. Since, in this case, employer’s contribution to EPF was deposited on 29.07.2021 which is before the due date of filing ROI u/s 139(1) and therefore, deduction shall be allowed. Since, it is already debited, no adjustment is required.

(3) As per Sec. 36(l)(z7i), interest on capital borrowed for the purposes of business or profession shall be allowed as deduction. However, interest on capital borrowed for acquisition of an asset (whether capitalized in the books of account or not) for the period till the asset was first put to use, shall no 1 be allowed as deduction. In this case, term loan was availed on 01.04.2020 at interest rate of 12% for purchase of machinery and machinery was acquired and put to use on 01.11.2020. Therefore, interest for the period 01.04.2020 to 01.11.2020 shall not be allowed as deduction and it shall be capitalized in the actual cost of machinery. The interest that shall be disallowed will be ₹ 1,75,000 (₹ 25,00,000 × 12% × 7/12).

(4) As per Sec. 40(a)(ia), 30% of any sum payable to a resident on which tax is deductible at source under Chapter XVII-B, shall be disallowed if tax has not been deducted or after deduction has not been paid on or before the due date u/s 139(1). In this case, Sankar Ltd. has made payment to sub-contractor for processing raw le’ather without deducting tax at source u/s 194C and therefore, 30% of ₹ 30 lakhs (i.e. ₹ 9 lakhs) shall be disallowed u/s 40(a)(ia). Even though the purchase of chemicals has been shown separately, tax has to be deducted on the whole amount.

(5) If the provision is made for the present obligation resulting from the past events and which may require outflow’ of resources to settle and reliable estimate can be made, then such provision is allowable as deduction u/s 37(1). Therefore, the company should make provision of ₹ 12 lakhs being a fair estimate of the amount as payable to workers towards periodical wage revision since, it can be estimated on a reasonable certainty. Since, no provision has been made, the provision for periodical wage revision should be debited to statement of profit and loss.

(6) Calculation of Depreciation under Income Tax Act:

(7) As per Sec. 40A(2), where the assessee incurs any expenditure for which payment Has been made or is to be made to any specified person and the A.O. is of the opinion that such expenditure is excessive or unreasonable having regard to the FMV of the goods, the A.O. shall disallow the expenditure to the extent he considers it excessive or unreasonable. In this case, Sankar Ltd. has sold leather bags to M/s Sankar (firm), a related party, at a price less than the market price. Here, no disallowance u/s 40A(2) shall be attracted since, Sankar Ltd. has not purchased the goods instead sold the good to its related party.

(8) In the case of CIT v. Gujarat State Road Transport Corporation (2014), the Gujarat High Court held that the employees contribution to provident fund deposited after the due date mentioned under the Provident Fund Act is not allowable as deduction as per Sec. 36(1)(va) and hence, it has been disallowed while computing business income.

However, an alternate view has been taken in CIT v. Kiccha Sugar Co. Ltd. (2013) (Uttarakhand) and CIT v. AIMIL Ltd. (2010) (Del), where it was held that the employees contribution to PF, shall be allowed as deduction from the income of the employer-assessee, if the same is deposited on or before the due date of filing of return for the relevant previous year. If this view is considered, then no disallowance would be attracted in this case, since the employees contribution has been remitted before the due date of filing return of income.

(9) As per Sec. 80JJAA, any assessee whose gross total income includes any profits and gains derived from a business and to whom Sec. 44AB applies, deduction shall be allowed @ 30% of additional employee cost incurred in the course of such business. ‘Additional Employee Cost’ means the total emoluments paid or payable to additional employees employed during the previous year. Deduction shall available only if the emoluments are paid by way of an account payee cheque or account payee bank draft or by use of electronic clearing system through a bank account.

Additional employee cost:

Deduction u/s 80JJAA = 30% of ₹ 31,00,000 = ₹ 9,30,000

Note: Additional employee shall not include an employee employed for less than 240 days during the previous year. However, in respect of an assessee engaged in the manufacturing of footwear or leather products, 150 days should be considered instead of 240 days.

Since, all the employees have been employed for 150 days or more during the previous year, deduction shall be available in respect of all the employees except those whose emoluments 2 are paid by bearer cheques. Also, additional employee shall not include employees whose total emoluments are more than ₹ 25,000 per month. Therefore, deduction shall not be available in respect of 4 employees joined on 01.07.2020 since their salary is more than 25,000 per month.

Question 48.
M/s. XYZ Private Ltd., located in Mysore is in the business of manufacturing confectionery items which is listed in the Eleventh schedule. The Company had also set up a chocolate manufacturing unit during the year 2018 at Cheruvu village in Ranga Reddy District, a notified backward area in the State of Telangana.

The Statement of Profit and Loss for the year ended 31st March, 2021 showed a net profit of ₹ 500 lakhs after debit/credit of the following items:
Items debited: ,
(1) Depreciation based on useful life of assets ₹ 300 lakhs.
(2) Repairs and maintenance expenses include ₹ 0.20 lakhs spent on an air conditioner installed in the residence of a director.
(3) An amount of ₹ 10 lakhs were spent on salaries and materials purchased for scientific research and development.
(4) An amount of ₹ 10 lakhs was paid to an employee on his voluntary retirement in accordance with a scheme of voluntary retirement.
(5) Purchase of raw materials includes purchase of wheat in cash for ₹ 20 lakhs from a Mandi on different dates exceeding ₹ 10,000 per day.
(6) The Company has paid ₹ 5 lakhs as regularization fee to the Municipal Corporation of Mysore to regularize the deviation from the sanctioned plan in construction of the factory building.

Additional Information:
(1) The Company has capitalized glow sign board ₹ 10 lakhs installed in the premises of a dealer

(2) Closing stock includes 1000 pieces of imported machinery spares at its landed cost as on the date of import at US $ 20 per piece. Exchange rate on the date of import was 1 US $ = 68. Exchange rate on 31.3.2021 was 1 US $ = 70. The market value per piece as on 31.3.2021 was US$21.

(3) One of the sundry creditors for supply of rice flour was settled on 28.3.2021 for 25 lakhs as against his outstanding balance of ₹ 30 lakhs due to non-supply of the required quality.
However the entire amount was offset against an amount recoverable from the sister concern of the sundry creditor.

(4) The written down value of assets as on 1.4.2020 was as follows:
1. Factory buildings ₹ 500 lakhs
2. (a) Plant and machinery ₹ 1,000 lakhs
(b) New plant and machinery installed and put to use at Cheruvu, on 1.12.2019 ₹ 300 lakhs and on 1.5.2020 ₹ 600 lakhs.
(c) Machinery which was sold to M/s ABC Ltd. on 1.4.2014 at its WDV for 25 lakhs were re-acquired on 1.8.2020 for ₹ 50 lakhs.
3. Lorries and Vans ₹ 100 lakhs.
4. Office Equipment ₹ 50 lakhs. ‘
5. Computers purchased and installed in office on 2.1.2021 ₹ 25 lakhs.

Compute total income of XYZ Private Ltd. for the A.Y. 2021-22. Ignore MAT. [CA Final Nov 2019 (Old Syllabus)] [14 Marks]
Answer:
Computation of Total Income of M/s. XYZ Private Ltd for the A.Y. 2021-22

Notes:
1. Repairs and maintenance expenses spent on an air conditioner installed in the residence is a personal expense and therefore, shall be disallowed.

2. Amount spent on salaries and materials purchased for scientific research and development shall be allowed as 100% deduction u/s 35.

3. As per Sec. 35DDA, where any assessee incurs expenditure by way of payment to employee in connection with his Voluntary Retirement, then deduction shall be allowed as 1 / 5th of the amount for 5 successive years beginning with the year in which such payment is made. Therefore, only 1 / 5th of ₹ 10 shall be allowed as deduction for A.Y. 2021-22 and balance of ₹ 8 lakhs shall be disallowed for the current year.

4. Since, the payment for purchase of wheat from a mandi has been made in cash exceeding ₹ 10,000 per day, it shall be disallowed u/s 40A(3).

5. The amount paid as regularisation fee to the municipal corporation of Mysore to regularise the deviation from the sanctioned plan is inevitably a penalty and the mere fact that it has been described as regularisation fee cannot, in any way, alter the character of the payment which is in the nature of penalty and hence, is not allowable as revenue expenditure [Millennia Developers P Ltd. v. Deputy CIT (2010) (Kar.)].

6. The Delhi High Court in the case of CIT v. Orient Ceramics and Industries Ltd. held that expenditure incurred on glow sigh boards displayed at dealer’s premises is revenue expenditure and shall not be capitalized.

7. ICDS V Tangible Fixed Assets provides that machinery spares which can be used only in connection with an item of tangible fixed asset and their use is expected to be irregular shall be capitalized. Therefore, imported machinery spares which are included in closing stock shall be deducted from closing stock and shall be capitalized. Therefore, 13,60,0 (1,000 pieces × $ 20 per piece × ₹ 68/$) shall be capitalized and shall be eligible for depreciation. Since, tangible fixed asset is a ; non-monetary item, no adjustment shall be made under ICDS VI Effects of Changes in Foreign Exchange Assets.

8. As per Sec. 41(1), where in any earlier year, deduction was allowed in respect of loss, expenditure or trading liability incurred by the assessee and during the current previous year, the assessee has obtained any amount or benefit in respect of such loss, expenditure or trading liability by way, of remission or cessation or waiver, then the amount obtained or benefit accruing shall be deemed to be the profits and gains of business or profession and accordingly.

In this case, a sundry creditor whose amount of ₹ 30 lakhs was outstanding has been settled for ₹ 25 due to non-supply of the required quantity and therefore, waiver of ₹ 5 lakhs shall be deemed to be profits and gains of business or profession as per Sec. 41(1). However, the company has off set such i amount against an amount recoverable from the sister concern of the sundry creditor and therefore, ₹ 5 lakhs shall be bad debt for the company and is allowable as deduction u/s 36(1 )(vii).

9. Calculation of Depreciation and Deduction u/s 32AD:

Since, the company has set up a chocolate manufacturing unit at Cheruvu village, a notified backward area in the State of Telangana, it shall be eligible for additional depreciation @ 35% of actual cost of eligible asset.

The company may have already claimed half of the additional depreciation in respect of new plant & machinery installed and put to use at Cheruvu on 01.12.2019 for RY. 2019-20 and therefore, balance 50% of additional depreciation of ₹ 52.50 lakhs (₹ 300 lakhs × 35% × 50%).

Deduction u/s 32AD is allowed only if the New Plant and Machinery acquired and installed between 01.04.2015 to 31.03.2020. In this case, the new plant and machinery were acquired and installed after I 31.03.2020 and therefore, no deduction u/s 32AD shall.be allowed to the company.

Additional depreciation shall not be available in respect of computers installed in office and machinery re-acquired from M/s. ABC Ltd.

Question 49.
Rama Cements Ltd., is a company engaged in the manufacturing of cement. The company issued 20 lakh equity shares of ₹ 100 each to the general public. The shares were issued at a premium of ₹ 150 per share. The assessee claimed deduction u/s 35D in respect of preliminary expenses at 5% of capital employed and added the amount of share premium to the capital employed to arrive at 5% as eligible amount of deduction u/s 35D. The Assessing Officer, however, disallowed the said expenditure, on the basis that capital employed does not include the share premium amount. Is the action of the Assessing Officer tenable in law? [CA Final Nov 2019 (New Syllabus)] [4 Marks]
Answer:
The issue under consideration is whether premium on subscribed share j capital should be treated as a part of “capital employed in the business of | the company” for the purpose of deduction u/s 35D.

The facts of the case are similar to the facts in case of Berger Paints Indian ; Ltd. v. CIT (2017), where the Supreme Court observed that the share j premium collected by the assessee on its subscribed issued share capital could not form part of “capital employed in the business of the company” for the purpose of section 35D. If it were the intention of the legislature to treat share premium as being “capital employed in the business of the company”, it would have been explicitly mentioned. Also the form of Annual Return under the Companies Act, 2013 dealing with capital structure of the company provides the break-up of “issued share capital” which does not include share premium at the time of subscription.

Applying the above rationale, the action of the A.O. to not include share , premium amount in the capital employed is not tenable in law.

Question 50.
Anamika Builders and Constructions Ltd., a company resident in India is engaged in the business of construction and real estate. Net profit as per profit and loss account is ₹ 54,80,000 (prepared in accordance with ICDS) after debiting/crediting the following items:
(i) Depreciation debited to books, ₹ 8,47,000.

(ii) Gross revenue includes ₹ 5,00,000 in respect of a service contract f for maintenance of the office building for Nitup Ltd. for the period from 1st March, 2021 to 30th April, 2021. The expenses incurred on the project till 31.3.2021 amounts to ₹ 1,27,000 which.is included in other expenses.

(iii) The amount of employee benefits include a sum of ₹ 4,41,000 in respect of bonus payable to employees. In the previous year 2020-21, the company and its employee’s union had a dispute over payment of bonus. In order to avoid late payment of bonus, the company formed trust and transferred the amount of bonus payable to employees to the said trust. The dispute was settled in the month of November, 2020 and the trust paid the amount of bonus to the employees on 30th December, 2021.

(iv) Capital gains on sale of shares in Yara Ltd. ₹ 3,77,500.

(v) In respect of one of its on-going projects, the assessee had made some structural changes contrary to what was earlier approved by the municipal authorities. Assessee hence paid a sum of ₹ 98,000 as regularization fee in respect of such changes made in the construction plan.

(vi) Other expenses include ₹ 1,45,000 as expenditure incurred on CSR.

(vii) During the previous year, 2020-21 the assessee entered into an agreement with Bat Ltd. As per the agreement, Bat Ltd. has agreed to not to engage in the business of real estate trading. The assessee paid 11 lakhs without deduction of tax at source on 1-6-2020 as non-compete fee.

Additional Information:
(i) Depreciation as per Income-tax Act, ₹ 5,14,000. This includes an amount of ₹ 78,000 in respect of fire fighting equipments installed in various business premises /offices of the assessee. During the year, as there was no incidence of fire, these equipments were not used.

(ii) On 26th October, out of 5 unsold office spaces in a mall, the assessee converted one such space into its own office. The fair market value of that space as on that date was ₹ 15,00,000. The cost incurred originally to construct such space was ₹ 10,00,000.

(iii) In respect of ongoing construction contracts, there was a claim for escalation of prices, to the tune of ₹ 8,50,000. The company had filed a lawsuit in the yehr 2019. In the previous year 2020-21, the court gave its judgment in favour of the company. The company has received ₹ 2,00,000 till 31.03.2021. Gross receipt in the profit and loss account H includes ₹ 2,00,000 in respect of such claims.

(iv) The assessee held 250 shares in Yara Ltd. On 1.4.2017, Yara Ltd. I allotted bonus shares in the ratio of 1:1. The company sold all the shares in Yara Ltd. on 24th September 2020 for ₹ 2,050 per share. The company had acquired the original shares for ₹ 540 on 23-06-2016. The fair market value of the shares as at 31 st January 2018 was 1,980 per share.

You are required to compute the total income chargeable to tax in the hands of Anamika Builders and Constructions Ltd., for the Assessment [ Year 2021-22 giving a brief explanation to each item of additions or deletions. Ignore provisions of MAT. [CA Final Nov 2019 (New Syllabus)] [14 Marks]
Answer:
Computation of Total Income of Anamika Builders and Constructions Ltd. for A.Y. 2021-22

Notes:
1. As per Sec. 43 CB, profits and gains from contract for providing services with duration of not more than 90 days shall be determined on the basis of project completion method. However, ICDS IV provides that revenue from service contracts with duration of not more 90 days may be recognised on the completion of the contract or on percentage completion method.

Whenever, there is conflict between the provisions of the Act and the notified ICDSs, the provisions of Act shall prevail. Therefore, Sec. 43CB shall be applicable and the revenue and expense ; of a service contract for maintenance of the office building shall be recognised when the contract gets completed i.e. on 30th April, 2021. Hence, revenue from service contract shall be reduced and expenses in respect of service contract which are included in other expenses shall be added back.

2. The Supreme Court in the case of Shasun Chemicals & Drugs Ltd. held that where payment of Bonus to employees is paid to a trust and subsequently paid to employees from such trust before the stipulated due date as per section 43B, the same would be allowable u/s 36(1) (ii) while computing business income. As the amount transferred to trust is paid to the employees after the due date for filing the return of income as per section 43B, the same shall not be allowed as deduction and as it is debited to profit & loss account, it needs to be added back.

3. The amount paid as regularisation fee in respect of changes made in the construction plan is inevitably a penalty and the mere fact that it has been described as regularisation fee cannot, in any way, alter the character of the payment which is in the nature of penalty and hence, is not allowable as revenue expenditure [Millennia Developers P Ltd. v. Deputy CIT (2010) (Kar.)].

4. Any expenditure incurred on CSR shall not be deemed to be an expense incurred for the purpose of business and profession and shall not be allowed as deduction u/s 37.

5. Assessee has deposited 1,75,000 with the concerned authority for the expansion of the business and opening a retail petrol outlet. However, as the assessee could not start this operation, the amount has been forfeited. It was held in the case of Priya Village Roadshows Ltd. that where the expenditure has been incurred for expansion of the project and the same does not result into a new asset, it shall be classified as Revenue expenditure only. Since, the assessee could not start the operation in respect of new petrol outlet, the amount forfeited shall be treated as revenue expenditure.

6. Section 40( ia) disallows 30% of any sum payable to a resident on which tax has not been deducted or after deduction has not been paid to the credit of central government on or before the due date mentioned u/s 139(1). The assessee paid 11 lakhs without deduction of tax at source on 1.6.2020 as non-compete fee on which tax was required to be deducted u/s 194J and thus 30% of the same (i.e. 11,00,000 × 30%= 3,30,000) shall be added back to the statement of profit & loss.

7. In the case of Southern Petrochemicals Industries, it was held that the assessee is entitled to depreciation on spare parts which are stand by items like Firefighting equipment even though they were not taken for use during the previous year.

8. As per section 28, where an inventory is converted into capital asset, the FMV of the inventory as on the date of conversion shall be treated as Business Income. Therefore, ₹ 5,00,000 (₹ 15,00,000 – ₹ 10,00,000) shall be added to the net profits.

9. ICDS III Construction Contracts provides that contract revenue shall comprise of initial amount agreed and variations in contract work, I claims and incentive payments to the extent it is probable that they I will result into revenue and they are capable of being reliably measured.

In this case, in respect of claim for escalation price, the court gave its judgment in favour of the company and so there is certainty that the claim shall be received. The company has credited ₹ 2,00,000 in respect of such claim to the statement of profit and loss and by assuming that this has been recognised by following the percentage completion method, no further adjustment is required.

10. As per section 55(2)(ac), Cost of acquisition for Long term equity shares acquired before 01.02.2018 shall be higher of:
(a) Actual cost of acquisition, or
(b) Lower of :

• FMV as on 31.01.2018, or
• Actual sale consideration received or accrued.

Therefore, the cost of acquisition shall be higher of ₹ 1,980 per share, 2 being the FMV on 31.01.2018 and ₹ 540, being the actual cost per share, Hence, cost of acquisition u/s 55(2)(ac) shall be ₹ 1,980 per share. In f respect of bonus shares also, the FMV of shares as on 31.01.2018 may be taken as the cost of acquisition.

International Financial Management – CA Final SFM Study Material is designed strictly as per the latest syllabus and exam pattern.

International Financial Management – CA Final SFM Study Material

Part – 1 (Theory)

Question 1.
What are the instruments of International Finance? [Nov. 2015] [4 Marks]
Answer:
The following are the financial instruments dealt with in the international market:

• Euro Botids: A Euro bond is an international bond that is denominated in a currency not native to the country where it is issued. Also called external bond.
• Foreign Bonds: These are debt instruments denominated in a currency which is foreign to the borrower and is denominated in a currency that is native to the country where it is issued.
• Fully Hedged Bonds.ln foreign bonds, the risk of currency fluctuations exists. Fully hedged bonds eliminate that risk by selling in forward markets, the entire stream of interest and principal payments.
• Floating Rate Notes: These are debt instruments issued up to 7 years maturity. Interest rates are adjusted to reflect the prevailing exchange rates. They provide cheaper money than fixed rate debt instruments; however, they suffer from inherent interest rate volatility risk.
• Euro Commercial Papers: Euro Commercial Papers (ECPs) are shortterm money market instruments usually designated in US dollars. They are for maturities for less than a year.

Question 2.
Write short note on Global Depository Receipts. [May 2015] [4 Marks]
Answer:
A depository receipt is basically a negotiable certificate, denominated in a currency not native to the issuer, that represents the company’s publicly – traded local currency equity shares. Through the issue of depository receipts, companies in India have been able to tap global equity market to raise foreign currency funds by way of equity. GDR is an instrument in the form of a depository receipt or certificate by overseas depository bank outside India.

The GDR may be of two types:
(a) ADR: The Depository Receipts issued in the US are called American Depository Receipts (ADRs), which any way are denominated in USD
(b) GDR: The depository receipts issued outside of USA are called GDRs.

The DRs (depository receipts) are created when the local currency shares of an Indian company are delivered to the depository’s local custodian bank, against which the Depository bank issues depository receipts in US dollar. These depository receipts may trade freely in the overseas markets like any other dollar-denominated security, either on a foreign stock exchange, or in the over-the-counter market, or among a restricted group such as Qualified Institutional Buyers (QIBs).

Question 3.
What is the impact of GDR’s on Indian Capital Market? [Nov. 2009] [4 Marks]
Answer:
Since the inception of GDRs a remarkable change in Indian capital market has been observed as follows:

• Indian stock market to some extent is shifting from Bombay to Luxemburg.
• There is arbitrage possibility in GDR issues.
• Indian stock market is no longer independent from the rest of the world. This puts additional strain on the investors as they now need to keep updated with worldwide economic events.
• Indian retail investors are completely sidelined. GDRs/Foreign Institutional Investors’ placements free pricing imply that retail investors can no longer expect to make easy money on heavily discounted rights/public issues.
• As a result of introduction of GDRs a considerable foreign investment has flown into India.

Question 4.
Explain American depository Receipts. [Nov. 2012, May 2014] [4 Marks]
Answer:
An American Depository Receipts (ADR) is a stock that trade in the United States of America (USA) but represents a specified number of shares in a foreign corporation. Such receipts must be issued in accordance with the provisions stipulated by the Securities and Exchange Commission of USA (SEC) which are very stringent. The first ADR was introduced by J.R Morgan in 1927 for the British Retailer “Selfridges” on the New York Stock Exchange.

An ADR is generally created by the deposit of the securities of a non-United States company with a custodian bank in the country of incorporation of the issuing company. The custodian bank informs the depository in the United States that the ADRs can be issued. ADRs are United States dollar denominated and are traded in the same way as are the securities of United States companies. The ADR holder is entitled to the same rights and advantages as owners of the underlying securities in the home country.

Question 5.
Write the meaning and advantages of Netting. [May 2012] [4 Marks]
Answer:
The Optimization of Cash Flow movements is one of the basic objectives of International Cash Management. There are numerous ways of-optimizing cash inflows, netting is one of them. Netting is a technique of optimizing cash flow movements with the combined efforts of the subsidiaries thereby reducing administrative and transaction costs resulting from currency conversion.

There are two types of Netting:
(a) Bilateral Netting System – It involves transactions between the parent and a subsidiary or between two subsidiaries.
(b) Multilateral Netting System – Each affiliate nets all its inter affiliate receipts against all its disbursements. It transfers or receives the balance on the position of it being a net receiver or a payer.

Advantages from netting system include the following:

• Reduced administrative cost: The number of cross-border transactions
  between subsidiaries is reduced, which decreases the overall administrative costs of such cash transfers. :
• Reduced foreign currency conversion cost: Reduces the need for foreign exchange conversion and hence decreases transaction costs associated with foreign exchange conversion.
• Forecasting is possible: Improves cash flow forecasting since net cash transfers are made at the end of each period.
• Settlement of accounts: Gives an accurate report and settles accounts through co-ordinated efforts among all subsidiaries.

Question 6.
Write short note on Euro Convertible Bonds. [May 2013] [4 Marks]
Answer:
Euro convertible bonds are issued by Indian Companies in foreign market with the option to convert them into pre-determined number of equity shares of the company. Usually, the price of the equity shares at the time of conversion will have a premium element. The bonds carry a fixed rate of interest.

If the issuer company desires, the issue of such bonds may carry two options viz.
(i) Call Options: (Issuer’s option) – The issuer company has the option of calling (buying) the bonds for redemption before the date of maturity of the bonds. Where the issuer’s share price has appreciated substantially, i. e. far in excess of the redemption value of the bonds, the issuer company can exercise the option. This call option forces the investors to convert the bonds into equity.

(ii) Put options: – A provision of put option gives the holder of the bonds a right to put (sell) his bonds back to the issuer company at a pre-determinea price and date. In case of Euro-convertible bonds, the payment of interest on and the redemption of the bonds will be made by the issuer company in US dollars.

Question 7.
What are P-Notes? Why it is preferable route for foreigners to invest in India? [Nov. 2017] [4 Marks]
Answer:
The Fils registered with SEBI have the international access to the Indian Capital Markets. The other investors, interested in investing in India can open their account with any registered FII and the FII gets itself registered with SEBI as its sub-account. There are some investors who do not want to disclose their identity or who do not want to get themselves registered with SEBI. FII are not allowed to issue P-Notes to Indian nationals, person of Indian origin or overseas corporate bodies.

The foreign investors prefer P-Notes route for the following reasons:
(a) To hide identity: Some investors do not want to reveal their identities. P-Notes serve this purpose.
(b) Fewer Formalities: They can invest in Indian Shares without any formalities like registration with SEBI, submitting various reports etc.
(c) Cost Effective: Saving in cost of investing as no office is to be maintained.
(d) FOREX: No currency conversion is required.

Part – 2 (Numerical Problems)

Question 1.
XYZ Ltd., a company based in India, manufactures very high quality modern furniture and sells to a small number of retail outlets in India and Nepal. It is facing tough competition. Recent studies on marketability of products have clearly indicated that the customer is now more interested in variety and choice rather than exclusivity and exceptional quality. Since the cost of quality wood in India is very high, the company is reviewing the proposal for import of woods in bulk from Nepalese supplier.

The estimate of net Indian (₹) and Nepalese Currency (NC) cash flows for this proposal is shown below:
Net Cash Flows (in millions)

The following information is relevant:
(i) XYZ Ltd. evaluates all investments by using a discount rate of 9% p.a. All Nepalese customers are invoiced in NC. NC cash flows are converted to India (₹) at the forward rate and discounted at the Indian rate.
(ii) Inflation rates in Nepal and India are expected to be 9% and 8% p.a. respectively. The current exchange rate is ₹ 1 = NC 1.6
Assuming that you are the finance manger of XYZ Ltd., calculate the net present value (NPV) and modified internal rate of return (MIRR) of the proposal.
You may use following values with respect to discount factor for ₹ 1 @ 9%.

	Present Value	Future Value
Year 1	0.917	1.188
Year 2	0.842	1.090
Year 3	0.772	1

[Nov. 2015] (8 Marks)
Answer:
Computation of Forward Rates

NC Cash Flows converted in Indian Rupees

Net Present Value (C Million)

Modified internal Rate of Return

Question 2.
A manufacturing unit engaged in the production of automobile parts is considering a proposal of purchasing one of the two plants, details of which are given below:

The annual costs of the two plants are as follows:

Will it be advantageous to buy Plant A or Plant B? Substantiate your answer with the help of comparative units cost of the plants. Assume interest on
capital at 10 percent. Make other relevant assumptions:

[May 2015] [7 Marks]
Answer:
Computation of Cost per Unit

Decision: As the unit cost is less in proposed Plant B, it may be recommended that it is advantageous to acquire Plant B.

Working Notes:
Calculation of Equivalent Annual Cost

Question 3.
A multinational company is planning to set up a subsidiary company in India (where hitherto it was exporting) in view of growing demand for its product and competition from other MNCs. The initial project cost (consisting of Plant and Machinery including installation) is estimated to be US $ 500 million. The net working capital requirements are estimated at US $ 50 million.
The company follows straight line method of depreciation. Presently, the company is exporting two million units every year at a unit price of US $ 80, its variable cost per unit being US $ 40.
The Chief Financial Officer has estimated the following operating cost and other data in respect of proposed project:
(i) Variable operating cost will be US $ 20 per unit of production.
(ii) Additional cash fixed cost will be US $ 30 million p.a. and project’s share of allocated fixed cost will be US $ 3 million p.a. based on principal of ability to share;
(iii) Production capacity of the proposed project in India will be 5 million units;
(iv) Expected useful life of the proposed plant is five years with no salvage value;
(v) Existing working capital investment for promotion & sale of two milbon units through exports was US $ 15 million;
(vi) Export of the project in the coming year will decrease to 1.5 million units in case the company does not open subsidiary company in India, in view of the presence of competing MNCs that are in the process of setting up their subsidiaries in India;
(vii) Applicable Corporate Income Tax rate is 35%, and (viit) Required rate of return for such project is 12%.
Assuming that there will be no variation in the exchange rate of two currencies and all profits will be repatriated, as there will be no withholding tax, estimate Net Present Value (NPV) of the proposed project in India.
Present Value Interest Factors (PVIF) @ 12% for five years are as below:

[May 2014] [10 Marks]
Answer:
Financial Analysis, whether to set up the manufacturing units in India or not, may be carried using NPV technique as follows:
I Initial Cash Outflows:

	$ Million
Cost of Plant and Machinery	500.00
Working Capital	50.00
Release of existing Working Capital	(15.00)
	535.00

II Incremental Cash Inflow after Tax (CFAT):
(a) Generated by investment in India for 5 years

	$ Million
Sales Revenue (5 Million × 80) Less. Costs	400.00
Variable Cost (5 Million × $ 20)	100.00
Fixed Cost	30.00
Depreciation	100.00
EBIT	170.00
Taxes @ 35%	59.50
EAT	110.50
Add: Depreciation	100.00
CFAT (1-5 years)	210.50
Cash flow at the end of the 5 years (release of Working Capital) (50-15 released earlier)	35.00

(b) Cash generation by exports

	$ Million
Sales Revenue (1.5 Million × $ 80)	120.00
Less: Variable Cost (1.5 Million × $ 40)	60.00
Contribution before tax	60.00
Tax @ 35%	21.00
CFAT (1-5 Years)	39.00

(c) Additional CFAT attributable to Foreign Investment

	$ Million
Through setting up subsidiary in India Through Exports in India	210.50 (39.00)
Additional CFAT (1-5 years)	171.50

III. Determination of NPV:

Conclusion: Since NPV is positive the proposal should be accepted.

Question 4.
TG Ltd. a multinational company is planning to set up a subsidiary com-pany in India (where hitherto it was exporting) in view of growing demand for its product and competition from other MNCs, The initial project cost (consisting of plant and machinery including installation) is estimated to be US $ 500 million. The net working capital requirements are estimated at US $ 100 million. The company follows straight line method of depreciation. Presently, tne company is exporting 2 million units every year at a unit price of US $ 100, its variable cost per unit being US $ 50.
The Chief Financial Officer has estimated the following operating cost and other data in respect of the proposed project:
(a) Variable operating cost will be US $ 25 per unit of production.
(b) Additional cash fixed cost will be US $ 40 million per annum.
(c) Production and Sales capacity of the proposed project in India will be 5 million units.
(d) Expected useful life of the proposed plant is 5 years with no salvage value.
(e) Existing working capital investment for production and sale of 2 million units through exports was US $20 million.
(f) Export of the product in the coming year will decrease to 1.5 million units in case the company does not open subsidiary company in India, in view of the presence of competing MNCs that are in the process of setting up their subsidiaries in India.
(g) Applicable Corporate Income Tax rate is 30%.
(h) Required rate of return for such project is 12%.
Assume that there will be no variation in the exchange rate of two countries, all profits will be repatriated and there will be no withholding tax.
Estimate the Net Present Value (NPV) of the proposed project in India. Present Value Interest Factors (PVIF) @ 12% for 5 years are as under :

(Compute your workings to 4 decimals) [Nov. 2019] [8 Marks]
Answer:
Financial Analysis, whether to set up the manufacturing units in India or not, may be carried using NPV technique as follows:
I. Initial Cash Outflows:

	$ Million
Cost of Plant and Machinery	500.00
Working Capital	100.00
Release of existing Working capital	(20.00)
Total Initial Cash outflow	580.00

II. Incremental Cash Inflow after Tax (CFAT):
(a)

	$ Million
Sales Revenue (5 Million × 100)	500.00
Less: Costs
Variable Cost (5 Million × $ 25)	125.00
Fixed Cost	40.00
Depreciation	100.00
EBIT	235.00
Taxes (5) 30%	70.5
EAT	164.50
Add: Depreciation	100
CFAT (1-5 years)	264.50
Cash flow at the end of the 5 years (release of Working	80.00
Capital) (100-20 released earlier)

(b) Cash generation by exports

	$ Million
Sales Revenue (1.5 Million × $100)	150.00
Less: Variable Cost (1.5 Million × $ 50)	75.00
Contribution before tax	75.00
Tax @ 30%	22.50
CFAT (1-5 Years)	52.50

(c) Additional CFAT attributable to Foreign Investment

	$ Million
Through setting up subsidiary in India Through Exports in India	264.50 52.5
Additional CFAT (1-5 years)	212.00

(III) Determination of NPV:

Conclusion: Since NPV is positive the proposal should be accepted.

Question 5.
XY Limited is engaged in large retail business in India. It is contemplating for expansion into a country of Africa by acquiring a group of stores having the same line of operation as that of India.
The exchange rate for the currency of the proposed African country is extremely volatile. Rate of inflation is presently 40% a year. Inflation in India is currently 10% a year. Management of XY Limited expects these rates likely to continue for the foreseeable future.
Estimated projected cash flows, in real terms, in India as well as African country for the first three years of the project are as follows:

XY Ltd. assumes the year 3 nominal cash flows will continue to be earned each year indefinitely. It evaluates all investments using nominal cash flows and a nominal discounting rate. The present exchange rate is African Rand 6 to ₹ 1.
You are required to calculate the net present value of the proposed investment considering the following:
(i) African Rand cash flows are converted into rupees and discounted at a risk adjusted rate.
(ii) All cash flows for these projects will be discounted at a rate of 20% to reflect its high risk.
(iii) Ignore taxation.

	Year 1	Year 2	Year 3
PVIF @ 20%	.893	.694	.579

[May 2013] [10 Marks]
Answer:
Calculation of NPV:

NPV of 3 years = -59,320 (₹ ‘000)
NPV of Terminal Value = \(\frac{16.637}{0.20}\) × 0579 = 48,164 (₹ ‘000)
Total NPV of the Project = -59,320 (₹ ‘000) + 48,164 (₹ ‘000) = -11,156 (₹ ‘000)

Question 6.
Supreme Limited is interested in expanding its business and planning to install manufacturing plant in US, for which it requires funds of $ 1 million, net of issue expenses which amount to 1.5% of the issue size. To finance this project, it proposes to issue GDRs. As a financial consultant, you are required to compute the number of GDRs to be issued and cost of the GDR with the help of following additional information.
(i) The expected market price of the share at the time of issue of GDR is ₹ 1065.25.(Face Value being Rs. 100)
(ii) 3 shares shall underlay each GDR and priced at 5% discount to the market price.
(iii) 30% dividend is expected to be paid with a growth rate of 7%.
(iv) Expected exchange rate is ₹ 69$
Answer:

(a) Number of GDR to be issued
\(\frac{\$ 1.01523 \text { million }}{\$ 44}\) = 23073.40

(b) Cost of GDR to Omega Ltd.
Dividend Per GDR (D) = ₹ 30 × 3= ₹ 90
Net Proceeds Per GDR = ₹ 3036 × 0.985 = ₹ 2990.46
K_e = \(\frac{D}{N P}\) + g
K_e = \(\frac{90}{2990.46}\) + 0.070 = 0.03009 + 0.07 = 0.10009 = 10% (approx)

Question 7.
Odessa Limited has proposed to expand its operations for which it requires funds of $ 15 million, net of issue expenses which amount to 2% of the issue size. It proposed to raise the funds though a GDR issue. It considers the following factors in pricing the issue:
(i) The expected domestic market price of the share is ₹ 300
(ii) 3 shares under each GDR
(iii) Underlying shares are priced at 10% discount to the market price
(iv) Expected exchange rate is ₹ 60/$
You are required to compute the number of GDR’s to be issued and cost of GDR to Odessa Limited, if 20% dividend is expected to be paid with a growth rate of 20%. [Nov. 2014] [8 Marks]
Answer:

(b) Cost of GDR to Odessa Ltd.
Dividend Per GDR (D) = ₹ 2 × 3 = ₹ 6
(It is assumed each share to be of Face value Rs. 10)
Net Proceeds Per GDR = ₹ 810 × 0.98 = ₹ 793.80
K_e = \(\frac{D}{N P}\) + g
K_e = \(\frac{6.00}{793.80}\) + 0.20 = 20.76%

Question 8.
Omega Limited is interested in expanding its operations and planning to install manufacturing plant in US, for which it requires funds of $ 10 million, net of issue expenses which amount to 2% of the issue size. To finance this project, it proposes to issue GDRs. As a financial consultant, you are required to compute the number of GDRs to be issued and cost of the GDR with the help of following additional information.
(i) The expected market price of the share at the time of issue of GDR is ₹ 250. (Face Value being Rs. 100)
(ii) 2 shares shall underlay each GDR and shall be priced at 4% discount to ‘ the market price.
(iii) 15% dividend is expected to be paid with a growth rate of 12%.
(iv) Expected exchange rate is ₹ 64/$ [May 2018] [8 Marks]
Answer:

(a) Number of GDR to be issued
\(\frac{\$ 10.204 \text { million }}{\$ 7.50}\) = 1.3605 million

(b) Cost of GDR to Omega Ltd.
Dividend Per GDR (D) = ₹ 15 × 2 = ₹ 30
Net Proceeds Per GDR = ₹ 480 × 0.98 = ₹ 470.4
K_e = \(\frac{D}{N P}\) + g
K_e = \(\frac{30.00}{470.40}\) + 0.120 = 18.38%

Question 9.
Honey and Co. Ltd. is a Canadian Corporation with head quarters in Quebec. It has its operations in FMCG products, target markets in North American and Europe. Manufacturing operations are being carried out in Europe and Canada. The company intends to expand its operations and is willing to build a new plant in Belgium. For this purpose, it needs financing for one year. It subsidiary can borrow locally, i.e., in Belgium or use surplus cash of other subsidiaries. However, the Belgium Government imposes a 10% withholding tax on intra-corporate loans. This would add about 1.5% to the cost of such loans. The finance subsidiary of Honey and Co. Ltd. in Nassan has recently generated a surplus US Dollar 20 million, which may be used for the project. The company is willing to avoid payment of withholding tax. At the same time, it is anxious not to create a foreign exchange exposure for any of its subsidiaries. One year interest rates available in the market are as under:
Belgium Francs/EURO

External and Domestic	14%	Canadian Dollar	9%
US Dollar	15%	S Fr	3%

In case of a bank loan, a 1.5% spread is charged above these rates. On the basis of the above case, answer the following questions with justification:
(i) What are the available financing alternatives?
(ii) Among the available alternatives which is the best alternative? [Practice Question]
Answer:
(i) Available financing alternatives and its effective of financing
Alternative I: Borrow Locally in Belgium

Cost of borrowing Belgium Frances/Euro locally in Belgium	14.0%
Add: Cost of withholding	1.5%
Net cost	15.5%

Alternative II: Borrow from Finance Subsidiary of Honey and Co. Ltd. in Nassan

Cost of borrowing US dollars	15.0%
Add: Cost of withholding	1.5%
	16.5%
Less: Forward premium obtained by selling US dollars	1.0%
Net Cost	15.5%

Alternative III: Convert surplus dollars into S Fr and lend S Fr to the Belgium company at market rate of 3% and purchase interest rate forward

Cost of borrowing S Fr	3.0%
Add: Cost of withholding	0.3
	3.3%
Add: Convert S Fr into Belgium Francs/Euro against future receiv­ables by paying forward premium on S Fr @ 11% (ie. 14% – 3%)	11.0%
Net cost	14.3%

(ii) Analysis: The third alternative is suggested, since the net cost of financing is lowest. The forward premium is due to interest rate differential.

Question 10.
A German subsidiary of an US based MNC has to mobilize 1,00,000 Euro’s working capital for the next 12 months. It has the following options :

Loan from German Bank :	@ 5% p.a.
Loan from US Parent Bank :	@ 4% p.a.
Loan from Swiss Bank :	@ 3% p.a.

Banks in Germany charge an additional 0.25%. p.a. towards loan servicing. Loans from outside Germany attract withholding tax of 8% on interest payments. If the interest rates given above are market determined, examine which loan is the most attractive using interest rate differential. [Nov. 2019 Old Syllabus] [5 Marks]
Answer:
(i) Available financing alternatives and its effective of financing
Alternative I: Borrow Locally in Germany

Cost of borrowing Euro locally in Germany	5%
Add: Loan servicing	0.25%
Net cost	5.25%

Alternative II: Borrow from US parent Bank

Cost of borrowing US dollars	4%
Add: Cost of withholding @ 8% on interest (8% of 4%)	0.32%
Total	4.32%
Add: Forward premium on buying US dollars (596-496 i.e. interest rate dif­ferential )	1.0%
Net Cost	5.32%

Alternative III: Borrow from Swiss Bank

Cost of borrowing S Fr	3.0%
Add: Cost of withholding tax @ 8% on Interest (8% of 3%)	0.24%
Total	3.24%
Add: Forward premium on S Fr @ 2% (ie. 5% – 3%)	2.0%
Net cost	5.24%

(ii) Analysis: The third alternative is suggested, since the net cost of financing is lowest. The forward premium is due to interest rate differential.

Question 11.
K Ltd. currently operates from 4 different building and wants to consoli-date its operations into one building which is expected to cost Rs.9G Crores. The Board of K Ltd. had approved the above plan and to fund the above cost, agreed to avail an external commercial Borrowing (ECB) of GBP 10m from G Bank Ltd. on the following conditions:
1. The loan will be availed on 1st April, 2019 with interest payable on half yearly rest.
2. Average Loan maturity life will be 3.4 years with an overall tenure of 5 years.
3. Upfront Fee of 1.20%.
4. Interest Cost is GBP 6 months LIBOR + Margin of 2.50%.
5. The 6 months LIBOR is expected to be 1.05%
K Ltd. also entered into a GBP-INR hedge at 1 GBP=INR 90 to cover the exposure on account of the above ECB Loan and the cost of the hedge is coming to 4% p.a. and taking 1 GBP=I\R 90:
As a finance manager, given the above information
(i) Calculate the overall cost both in percentage and rupee terms on an annual basis.
(ii) What is the cost of hedging in rupee terms?
(iii) If K Ltd. wants to pursue an aggressive approach, what would be the net gain/loss for K Ltd. if the INR depreciates/appreciates against GBP by 10% at the end of the 5 years assuming that the loan is repaid in GBP at the end of 5 years?
Ignore time value and taxes and calculate to two decimals. [May 2019] [8 Marks]
Answer:
(i) Calculation of Overall Cost

10 M @ 1.20%)	Rs. 1,20,000
Interest Payment (GBP 10M × 3.55% × 3.4)	Rs. 12,07,000
Hedging Cost (GBP 10M × 4% × 3.4)	Rs. 13,60,000
Total	Rs. 26,87,000

Or Rs. 2.687 million
Overall cost in % terms on Annual Basis
= \(\frac{2.687 \text { million }}{(1,00,00,000-1,20,000)} \times \frac{1}{3.4}\)
= \(\frac{2.687}{9.88} \times \frac{1}{3.4}\) × 100 = 8%
Overall Cost in Rupee terms @ GBP1 = Rs. 90 × \(\frac{2.687}{3.4}\) × 100
= Rs.711.26 lakhs
OR
Overall cost in % terms on Annual Basis = \(\frac{2.687 \text { million }}{(1,00,00,000)} \times \frac{1}{3.4}\)
= \(\frac{2.687}{1.00} \times \frac{1}{3.4}\) × 100 = 7.9%

Overall Cost in Rupee terms @ GBP 1 = 10,000.000 × 7.90% × 90
= Rs. 71,100,000
OR
Calculation of overall cost
Internet & Margin (A) = 3.55%
Hedging cost (B) = 4%
= 7.55%
One time free = 1.20%
Average loan maturity = 3.4 years
Per annum cost 1.2/3.4 (C) = 0.35
Annual overall cost in % terms (A + B+C) = 7.9%
Overall Cost in Rupee terms @GBP 1 = 10,000,000 × 7.90% × 90
= Rs. 71,100,000

(ii) Cost of Hedging in terms of Rupees
Rs. 13,60,000 × 90 = Rs. 12,24,00,000 = Rs. 12.24 crores in Total
OR
GBP 10,000,000 × 90 × 4% = Rs. 3,60,00,000 on Annual Basis

(iii) If K Ltd. pursues an aggressive approach then Gain/Loss in INR Depreciation/Appreciation shall be computed as follows:
(a) If INR depreciates by 10%
Re. loss per GBP = 90 × 10% = Rs. 9
Total Losses GBP 10M = Rs. 90 Million
Less: Cost of Hedging = Rs. 36 Million
Net Loss = Rs. 54 million

(b) If INR appreciates by 10%
Rs. Gains per GBP = Rs. 90 × 10% = Rs. 9
Total Gain on Repayment of loan = 90 Million
Add: Saving in Cost of Hedging = 36 Million
Net Gain = 126 Million

Income from House Property – CA Final DT Question Bank is designed strictly as per the latest syllabus and exam pattern.

Income from House Property – CA Final DT Question Bank

Question 1.
Sakshi purchased a residential flat from Dev in November 2020. However, the deed of conveyance has not been registered in the name of Sakshi till 31.03.2021. Sakshi has let out the flat at a monthly rent of ₹ 30,000 to Mohan. Sakshi claims that rent received is not chargeable un-der the head “Income from house property”, but the same is chargeable under the head “Income from other sources” and she can claim deduction for expenses on repair and insurance premium on actual basis and also depreciation. Examine the correctness of Sakshi’s claim. [CA Final May 2009] [3 Marks]
Answer:
In order to assess income under the head “Income from house property” the assessee must be the owner of the house property. In the case of CIT vs. Poddar Cement Pvt. Ltd. (1997) the Supreme Court held that so long as a person is entitled to receive income from the house property in his own right, it is not necessary that the sale deed must be registered in his name to treat him as the owner of the property for the purpose of section 22.

In such a case, the income derived from the property is chargeable to tax under the head “Income from house property”. The fact that registration ‘ is not yet complete does not affect the chargeability of such income under the head “Income from house property”.

Therefore, the claim of Sakshi that rent should be assessed under the head “Income from other sources” and deduction of various expenses and depreciation should be allowed there on is not tenable.

Question 2.
Ankit Private Limited has, in its return of income, claimed a sum of ₹ 40,000 as a deduction on account of payments for stamp duty and registration charges from the income shown under the head “Income from house property”. The Assessing Officer disallowed the claim of the assessee company in the assessment order passed u/s 143(3). Examine the correctness of the action of the Assessing Officer. [CA Final May 2010] [3 Marks]
Answer:
After determining the Gross Annual Value (GAV), sec. 23 provides for deducting the municipal taxes paid by the owner in the determination of the Net Annual Value (NAV) of the property. Once the NAV is determined, sec. 24 provides for statutory deduction @ 30% of net annual value and deduction in respect of interest on borrowed capital taken for the purpose of acquiring, constructing, renewing or repairing the house property. Thus, the amount spent by the assessee towards stamp duty and registration charges cannot be allowed as deduction in determining the income from house property.

Therefore, the action of the Assessing Officer in disallowing the deduction in respect of stamp duty and registration charges, is correct.

Question 3.
Following arc the details of income provided by Mr. Singh, the assessee for the year ended 31s1 March, 2021:

1. Rental income from property at Bangalore – ₹ 3,00,000, Standard rent – ₹ 2,50,000, Fair rent – ₹ 2,80,000.
2. Municipal and water tax paid during 2020-21: Current year – ₹ 35,000, Arrears – ₹ 1,50,000.
3. Interest on loan borrowed towards major repairs to the property – ₹ 1,50,000.
4. Arrears of rent of ₹ 30,000 received during the year, which was not charged to tax in earlier years. [CA FinaLNov. 2014] [4 Marks]

Answer:

Question 4.
Wellcare Warehousing Ltd. is engaged in the business of warehousing, handling and transport along with the relevant auxiliary services like pest control, rodent control, fumigation and security etc. Statement of profit and loss of company shows that the main source of income is storage charges and maintenance or user charges. The substantial part of expenses relate to salaries of employees engaged in maintenance and upkeep of warehouses. The company has filed return of income showing income from letting out of buildings and godown space as “Income from Business’*. The Assessing Officer rejected the view of the assessee and assessed the same as “Income from House Property”.

Comment on the validity of action taken by Assessing Officer. [CA Final Nov 2016] [4 Marks]
Answer:
The issue is whether the income from letting out of buildings and godown space by the company, engaged in the business of warehousing, handling and transport having the main source of income as storage charges and maintenance or user charges, is chargeable to tax under the head “Income from Business” or under the head “Income from House Property”.

The facts of this case are similar to the facts of CIT v. NDR Warehousing P. Ltd. (2015), where the Madras High Court observed that the assessee’s activity was not merely letting out of warehouses but also storage of goods with provision of several auxiliary services such as pest control, fumigation service to prevent the goods stored from being affected by moisture and temperature and provision of security and protection to the goods stored. Therefore, the assessee carries on the activity including provision of auxiliary services which is more than mere letting out of the godown.

The court also noted that the profit and loss account of the assessee-company shows that its main source of income is storage and maintenance charges or usage charges. Even substantial part of the expenses also relate to the salaries of employees engaged in the maintenance and upkeep of the godowns and warehouses.

Accordingly, the High Court held that the income earned by the assessee from letting out of godowns and provision of warehousing services is chargeable to tax under the head “Profits and gains of business or profession” and not under the head “Income from house property”.

Applying the rationale of the above judicial decision, the income from letting out of buildings and godown space earned by Wellcare Warehousing Ltd. shall be chargeable to tax under the head “Profits and Gains of Business or Profession”. Therefore, the view of the Assessing Officer to tax such income under the head “Income from House Property” is not correct.

Insolvency and Bankruptcy Code, 2016 – CA Final Law Study Material is designed strictly as per the latest syllabus and exam pattern.

Insolvency and Bankruptcy Code, 2016 – CA Final Law Study Material

Introductory Topics of IBC, 2016

Question 1.
Discuss the Principles on the basis of which the Insolvency Professional Agency (IPA) is enrolled and regulate insolvency professionals as its members in accordance with the fwB Code, 2016. [MTP-Aug. 18]
Answer:
Principles on the basis of which the Insolvency Professional Agency (IPA) is enrolled and regulate insolvency professionals:
As per Sec. 200, the Board shall have regard to the following principles while registering the insolvency professional agencies under this Code, namely:

(a) to promote the professional development of and regulation of insolvency professionals;
(b) to promote the services of competent insolvency professionals to cater to the needs of debtors, creditors and such other persons as may be specified;
(c) to promote good professional and ethical conduct amongst insolvency professionals;
(d) to protect the interests of debtors, creditors and such other persons as may be specified;
(e) to promote the growth of insolvency professional agencies for the effective resolution of insolvency and bankruptcy processes under this Code.

Structure of IBC, 2016, its applicability and definitions

Question 2.
When will the provisions of insolvency and liquidation of corporate persons be applicable on a corporate person?
Answer:
Applicability of Provisions of Insolvency and Liquidation: –

• As per Sec. 4 of IBC, 2016, provisions relating to the insolvency and liquidation of corporate debtors shall be applicable only when the amount of the default is ₹ 1 Lac or more.
• However, C.G. may, by notification, specify the minimum amount of default of higher value which shall not be more than ₹ 1 crore.

Question 3.
The financial creditor, Mr. Raman, was an investor and a debenture holder of ‘Optionally Convertible Debenture Bond (OPDB)’ payable on maturity, was issued by the M/s Asset Ltd. (corporate debtor). The zero interest OCD bonds amounted to 2 Cr. matured in 2019. The liability to redeem the debentures on maturity along with a redemption premium lay on the debtor, which was not made. Mr. Raman filed the Corporate Insolvency resolution process before the NCLT. Advise in the light of the given facts, the following situations:

1. State whether Mr. Raman is eligible for filing of application for initiation of CIRP?
2. Do the redemption of debenture payable on the maturity date amounts to debt? [RTP-May 19]

Answer:
Eligibility to file application for CIRP:
As per Sec. 5(7] of the IBC, 2016, the term financial creditor means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to.

As per Sec. 5(8) of the IBC, 2016 the term financial debt means a debt along with interest, if any which is disbursed against the consideration for the time value of money and includes any amount raised pursuant to the issue of bonds, notes, debentures, loan stock or any similar instrument.

In the present case, Mr. Raman, was an investor and a debenture holder of ‘Optionally Convertible Debenture Bond (OPDB)’ issued by the Asset Ltd. Debentures are issued against consideration for the time value of the money and hence debentures on maturity will come under that purview of Section 5(8).

Conclusion: Since Mr. Raman is a person to whom a financial debt is owed, he will come within the definition of Financial creditor. Hence, Mr. Raman is entitled to file an application to initiate CIRP against the M/s Asset Ltd.

Debentures are issued against consideration for the time value of the money and hence debentures on maturity will be covered within definition of financial debt.

Question 4.
MF Capital Private Limited accepted inter-corporate deposits from JS financial Services Private Limited. MF Capital Private Limited is a Non-banking financial company which has obtained a certificate from the Reserve Bank of India for carrying on the business of providing financial services. As there was a default in repayment of deposits. JS Financial Services Private Limited filed an application with the NCLT under Section 7 of the Insolvency and Bankruptcy Code, 2016. Examine the validity of the Application. [May 19 – Old Syllabus (4 Marks)]
Answer:
Validity of application for CIRP against a financial service provider:
As per Sec. 3(7) of the IBC, 2016, the term Corporate Person means
(a) a company as defined u/s 2(20) of the Companies Act, 2013;
(b) a LLP as defined u/s 2(l)(n) of Limited Liability Partnership Act, 2008; or,
(c) any other person incorporated with limited liability under any law for the time being in force but shall not include any financial service provider.

It was held in case ofJindaiSaxena Financial Services Vs. Mayfair Capital, NBFC which has obtained a certificate from the Reserve Bank of India will be considered as a financial service provider.

In the present case, MF Capital Private Limited is a NBFC carrying on the business of providing financial services.

Conclusion: Application filed u/s 7 will be treated as invalid as IBC does not cover Bank, Financial Institutions, Insurance Company, AssetReeonstruction Company, Mutual Funds, Collective Investment Schemes or Pension Funds.

Corporate Insolvency Resolution Process (Sec. 6 – Sec. 32)

Question 5.
Who may initiate corporate insolvency process against a corporate person?
Answer:
Persons who may initiate corporate insolvency resolution Process (CIRP) :
As per Sec. 6 of IBC, 2016, where any corporate debtor commits a default, following persons:
(a) a financial creditor (any person to whom a financial debt is owed & includes a person to whom such debt legally assigned or transferred);.
(b) an operational creditor (a person to whom an operation debt is owed & includes any person to whom such debt legally assigned or transferred); or
(c) the corporate debtor itself, may initiate corporate insolvency resolution process in respect of such corporate debt.

Question 6.
State the manner of initiation of corporate insolvency resolution process (CIRP) by financial creditor under the Insolvency and Bankruptcy Code, 2016. [MTP-March 18]
Or
What is the Insolvency Resolution Process for financial creditors? [RTP-Nov. 18]
Answer:
Initiation of corporate insolvency resolution process by financial creditor:
Sec. 7 of the Insolvency and Bankruptcy Code, 2016 deals with the provisions relating to initiation of CIRP by financial creditor. Accordingly, a financial creditor either by itself or jointly with other financial creditors, or any other person on behalf of the financial creditor, as may be notified by the Central Government may file an application for initiating CIRP against a corporate debtor before the Adjudicating Authority (NCLT) when a default has occurred.

The financial creditor shall, along with the application furnish
(a) record of the default recorded with the information utility or such other record or evidence of default as may be specified;
(b) the name of the resolution professional proposed to act as an interim resolution professional; and
(c) any other information as may be specified by the Board.

The Adjudicating Authority shall, within 14 days of the receipt of the application, ascertain the existence of a default from the records of an information utility or on the basis of other evidence furnished by the financial creditor. Adjudicating Authority if, satisfied that a default has occurred and complying with other requirements of the section, it may, by order, admit such application; or if, default has not occurred, it may, by order, reject such application.

The CIRP shall commence from the date of admission of the application. The Adjudicating Authority shall communicate the order to the financial creditor within seven days of admission or rejection of such application and to the corporate debtor.

Question 7.
State the manner of initiation of corporate insolvency resolution process by operational creditor under the Insolvency and Bankruptcy Code, 2016.
Answer:
Initiation of corporate insolvency resolution process by Operational creditor:
Secs. 8 & 9 of the Insolvency and Bankruptcy Code, 2016 deals with the provisions relating to initiation of CIRP by operational creditor. Accordingly,

An operational creditor may, on the occurrence of a default, deliver a demand notice of unpaid operational debtor copy of an invoice demanding payment of the amount involved in the default to the corporate debtor in such form and manner as may be prescribed.

The corporate debtor shall, within a period of 10 days of the receipt of the demand notice or copy of the invoice bring to the notice of the operational creditor
(a) existence of a dispute, if any, or record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute;

(b) the payment of unpaid operational debt.
After the expiry of the period of 10 days from the date of delivery of the notice or invoice demanding payment u/s 8, if the operational creditor does not receive payment from the corporate debtor or notice of the dispute u/s 8, the operational creditor may file an application before the Adjudicating Authority for initiating a C1RR

The Adjudicating Authority shall within fourteen days of receipt of the application, admit or reject the application. However, before rejecting the application, an opportunity shall be given to the applicant to rectify the defect within seven days of receipt of rejection.

Question 8.
What is the procedure of Insolvency Resolution Process for a Corporate Applicant?
Answer:
Procedure of Insolvency Resolution Process for a Corporate Applicant:
Sec. 10 of the Insolvency and Bankruptcy Code, 2016 deals with the provisions relating to initiation of CIRP by corporate applicant. Accordingly,

• Where a corporate debtor has committed a default, a corporate applicant thereof may file an application for initiating CIRP with the Adjudicating Authority.
• The corporate applicant shall, along with the application, furnish-

(a) the information relating to its books of account and such other documents for such period as may be specified;
(b) the information relating to the resolution proposed to be appointed as an interim resolution professional; and
(c) the special resolution passed by shareholders of the corporate debtor or the resolution passed by at least three-fourth of the total number of partners of the corporate debtor, as the case may be, approving filing of the application.

Question 9.
State the circumstances when persons are not entitled to make an application to initiate corporate insolvency resolution process.
Suppose a corporate debtor has committed a default and is undergoing a corporate insolvency resolution process. A corporate applicant Mr. X thereof files an application for initiating corporate insolvency resolution process with an Adjudicating Authority. State whether he (Mr. X) is entitled to make an application to initiate corporate insolvency resolution process?
Answer:
Persons not entitled to make an application to initiate CIRP:
As per Sec. 11 of IBC, 2016, the following persons shall not be entitled to make an application to initiate CIRP under this Chapter, namely:

(a) a corporate debtor undergoing a corporate insolvency resolution process; or
(b) a corporate debtor having completed CIRP, 12 months preceding the date of making of the application; or
(c) a corporate debtor or a financial creditor who has violated any of the terms of resolution plan which was approved 12 months before the date of making of an application; or
(d) a corporate debtor in respect of whom a liquidation order has been made.

Entitlement of Mr. X to make an application for CIRP:
As per the facts Mr. X seems to be a separate individual and not a corporate applicant in respect of such corporate debtor who is undergoing a corporate insolvency resolution process. So, he shall not be entitled to make an application to initiate corporate insolvency resolution process.

Question 10.
Is there any time limit for completion of the Insolvency Resolution Process?
Or
Explain in the light of the Insolvency and Bankruptcy Code, 2016, time limit for completion of the Corporate Insolvency Resolution Process? [MTP-Oct. 18]
Answer:
Time Limit for Completion of Insolvency Resolution Process:
As per Sec. 12 of the IBC, 2016, CIRP shall be completed within a period of 180 days from the date of admission of the application to initiate the process.

The resolution professional shall file an application to the Adjudicating Authority to extend the period of the corporate insolvency resolution process beyond 180 days, if instructed to do so by a resolution passed at a meeting of the committee of creditors by a vote of 66% of the voting shares.

On receipt of an application, if the Adjudicating Authority is satisfied that the subject matter of the case is such that CIRP cannot be completed within 180 days, it may by order extend the duration of such process beyond 180 days by such further period as it thinks fit, but not exceeding 90 days.

Provided that any extension of the period of corporate insolvency resolution process under this section shall not be granted more than once.

Provided further that the CIRP shall mandatorily be completed within a period of330 days from the insolvency commencement date, including any extension of the period ofCIRPgranted under this section and the time taken in legal proceedings in relation to such resolution process of the corporate debtor:

Provided also that where the insolvency resolution process of a corporate debtor is pending and has not been completed within the period referred to in the second proviso, such resolution process shall be completed within a period of 90 days from the date of commencement of the IBC Code (Amendment) Act, 2019, i.e. 16.08.2019.

Question 11.
Wisdom Ltd. commits a default against the debts taken from the financial creditors. Mr. F, a financial creditor initiated the corporate insolvency resolution process (CIRP) against the Wisdom Ltd. Mr. X, another financial creditor, thereof files an application for initiating corporate insolvency resolution process with the Adjudicating. Authority. Examine with reference to the validity as to the filing of an application by Mr. X for initiation of corporate insolvency resolution process? [RTP-May 18, MTP-Oct. 19]
Answer:
Corporate Insolvency Resolution Process:
As per Sec. 6 of the IBC, 2016, where any corporate debtor commits a default, a financial creditor, Operational creditor or the Corporate debtor itself may initiate C1RP against such corporate debtor.

As per Section 13 of the Code, once an application is admitted by the Adjudicating authority, it shall by an order
(a) declare a moratorium for the purposes referred to in Sec. 14.
(b) causes a public announcement of the initiation of CIRP by IRP and call for the submission of claims under Sec. 15 and
(c) appoint an Interim Resolution Professional in the manner as laid down in Sec.

Public announcement lays down all the relevant information related to the CIRP. So that the all creditors entitled under the law can raise their claim in this case.

In the given problem, on commission of default by the Wisdom Ltd., Mr. F filed an application for initiating CIRP before adjudicating authority. Further, Mr. X another financial creditor moved an application for initiation of CIRP against the Wisdom Ltd.

Conclusion: Application for initiation of CIRP cannot be initiated by Mr. X., however he is entitled under the law to raise his claim against the Wisdom Ltd.

Question 12.
What is the effect of order of moratorium?
Answer:
Effect of Moratorium:
Sec. 14 of the Insolvency and Bankruptcy Code, 2016, deals with the provisions relating to Moratorium. In accordance with Sec. 14, On the insolvency commencement date, the Adjudicating Authority shall by order declare moratorium for prohibiting all of the following, namely:
(a) the institution of suits or continuation of pending suits or proceedings against the corporate debtor including execution of any judgment, decree or order in any court of law, tribunal, arbitration panel or other authority;

(b) transferring, encumbering, alienating or disposing of by the corporate debtor any of its assets or any legal right or beneficial interest therein;

(c) any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of its property including any action under the SARFAESI Act, 2002;

(d) the recovery of any property by an owner or lessor where such property is occupied by or in the possession of the corporate debtor.

Question 13.
Mr. Madhyam, was appointed as an Interim resolution professional during the Corporate Insolvency Resolution Process. What are the duties to be performed by Mr. Madhyam in the given capacity?
Answer:
Duties of Interim Resolution Professional (IRP):
As per Sec. 18 of the IBC, 2016, the IRP shall perform the following duties, namely:
(a) collect all information relating to the assets, finances and operations of the corporate debtor for determining the financial position of the corporate debtor.

(b) receive and collate all the claims submitted by creditors to him, pursuant to the public announcement made under sections 13 and 15;

(c) constitute a committee of creditors;

(d) monitor the assets of the corporate debtor and manage its operations until a resolution professional is appointed by the committee of creditors;

(e) file information collected with the information utility, if necessary;

(f) take control and custody of any asset over which the corporate debtor has ownership rights as recorded in the balance sheet of the corporate debtor, or with information utility or the depository of securities or any other registry that records the ownership of assets; and

(g) to perform such other duties as may be specified by the Board.

Question 14.
Nature India Limited filed a petition under the Insolvency and Bankruptcy Code, 2016 with National Company Law Tribunal (NCLT) against Tulip Limited and the petition was admitted. After that, Nature India Limited wanted to withdraw the petition based on a settlement arrived between the parties. Whether it is permissible to withdraw the petition after it has been admitted? Decide.
Also explain the rules relating to the admission and rejection of application by an adjudicating authority under the Insolvency and Bankruptcy Code, 2016. [Nov. 17 (6 Marks)]
Answer:
Withdrawal of Application/Petition:
As per Sec. 12A of IBC, 2016, the Adjudicating Authority may allow the withdrawal of application admitted under section 7 or section 9 or section 10, on an application made by the applicant with the approval of 90% voting share of the committee of creditors, in such manner as may be specified.

In the given instance, Nature India Limited wanted to withdraw the petition after it was admitted by the adjudication authority.

Conclusion: Petition may be withdrawn subject to compliance of conditions as stated in Sec. 12A.
Rules relating to admission and rejection of application:
As per Sec. 9 of the IBC, 2016, the Adjudicating Authority shall, within 14 days of the receipt of the application, by an order:
(a) admit the application and communicate such decision to the operational creditor and the corporate debtor if:

• the application made is complete;
• there is no payment of the unpaid operational debt;
• the invoice or notice for payment to the corporate debtor has been delivered by the operational creditor;
• no notice of dispute has been received by the operational creditor or there is no record of dispute in the information utility; and
• there is no disciplinary proceeding pending against any Resolution Professional (RP) proposed, if any.

(b) reject the application and communicate such decision to the operational creditor and the corporate debtor, if—

• the application made is incomplete;
• there has been payment of the unpaid operational debt;
• the creditor has not delivered the invoice or notice for payment to the corporate debtor;
• notice of dispute has been received by the operational creditor or there is a record of dispute in the information utility; or
• any disciplinary proceeding is pending against any proposed RP.

Question 15.
Standard International Ltd. who is a foreign trade creditor having its office in Hong Kong wanted to file a petition under Insolvency and Bankruptcy Code, 2016 on default of the debtor in India. It moved a petition under section 9 of the code seeking commencement of insolvency process. The foreign company was not having any office or bank account in India. Because of this, it couldn’t submit a “certificate from financial institution” as required under the code. Examine whether the petition is permissible under the Insolvency & Bankruptcy Code, 2016? [Nov. 17 (4 Marks), RTP-May 18]
Answer:
Validity of Petition filed without Certificate from Financial Institution:
As per Sec. 3(10) of the Insolvency and Bankruptcy Code, 2016, a creditor means any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor, and a decree holder.

As per Sec. 9 of the Code, operational creditor shall along with application furnish certain documents to the Adjudicating authority. Among other documents, a copy of the certificate from the financial institutions maintaining accounts of the operational creditor confirming that there is no payment of an unpaid operational debt by the corporate debtor need to be submitted, if available

In the present case, Standard International Ltd. who is a foreign trade creditor having its office in Hong Kong wanted to file a petition under Insolvency and Bankruptcy Code, 2016 on default of the debtor in India. Standard International Ltd. was not having any office or bank account in India.

The requirement of the certificate from the financial institution is subject to availability.
Conclusion: Petition u/s 9 of the IBC, 2016 is permissible, as furnishing of certificate from financial institution is not mandatory.

Question 16.
M/s TAS Constructions Private Limited, an operational creditor on 2nd April, 2019 being the default date issued a demand notice through speed post to M/s Dheeraj Constructions Private Limited, ail unpaid operational/corporate debtor demanding payment of its invoice dated 19th March, 2019 for ₹ 5,60,000 (15 days payment terms) towards supply of certain works contract services as per the provisions of section 8(1) of the insolvency and Bankruptcy Code, 2016 and rules framed there under/s.

Dheeraj Constructions Private Limited on receipt of the demand notice informed the operational creditor, that vide their e-mail dated 30tli March, 2019, addressed to the company and all its directors, they have disputed the invoice on the quality of the services rendered and were withholding payment till the dispute is settled but without initiating any legal proceedings under any law for the time being in force.

The operational creditor on expiry of the period of 10 days from the date of delivery of the demand notice and non-payment of its dues approached the Adjudicating Authority for the initiation of the corporate insolvency resolution process under section 9(1) insolvency and Bankruptcy Code, 2016. Will the application of the operational creditor filed u/s 9(1) of the read with section 8(2)(a) of the insolvency and Bankruptcy Code, 2016 be permitted? [May 18 – Old Syllabus (4 Marks)]
Answer:
Application for initiation of Corporate Insolvency Resolution Process by Operational Creditor:
Sec. 8 of the Insolvency and Bankruptcy Code, 2016 provides that an operational creditor may, on the occurrence of a default, deliver a demand notice of unpaid operational debtor copy of an invoice demanding payment of the amount involved in the default to the corporate debtor in such form and manner as may be prescribed. The corporate debtor shall, within a period of 10 days of the receipt of the demand notice or copy of the invoice bring to the notice of the operational creditor—

(a) existence of a dispute, if any, or record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute;
(b) the payment of unpaid operational debt.

Sec. 9 of the Insolvency and Bankruptcy Code, 2016 provides the provisions relating to application for Corporate Insolvency Resolution Process. Accordingly, after the expiry of the period of 10 days from the date of delivery of the notice or invoice demanding payment, if the operational creditor does not receive payment from the corporate debtor or notice of the dispute, the operational creditor may file an application before the Adjudicating Authority for initiating corporate insolvency resolution process.

In the present case, Dheeraj Constructions Private Limited on receipt of the demand notice, informed M/s TAS Constructions Private Limited (Operational Creditor) that through e-mail dated 30th March, 2019, addressed the company and all its directors, of the dispute on the invoice and withholding of the payment till the settlement of the dispute.

Conclusion: Application filed by TAS Constructions Private Limited, operational creditor is not maintainable due to existence of dispute.

Question 17.
Rose Garden Ltd. was incurring continuous losses and its financial position went bad to worse. Black Stone (Private) Ltd., a trade creditor, issued notice under section 271 of the Companies Act, 2013 for winding up of Rose Garden Ltd. on the ground that Rose Garden Ltd. was unable to pay its debts. After some time, Black Stone (Private) Ltd. being an operational creditor filed a petition before the Adjudicating Authority to initiate insolvency process under the insolvency and Bank! ruptcy Code, 2016.

Demand Notice and copy of invoice were not served to Rose Garden Ltd. since a . notice was earlier issued for winding up. All other formalities were complied with. The adjudicating authority initiated insolvency resolution process by admitting the application and appointed resolution professional. After complying required formalities, the adjudicating authority issued orders for moratorium and other relief within the stipulated time. Being aggrieved by the order of Adjudicating Authority, Rose Garden Ltd. (Corporate debtor) filed an appeal before NCLAT under the insolvency and bankruptcy Code, 2016. Determine will the company succeed in its appeal? [May 18 – New Syllabus (6 Marks), MTP – April 19]
Answer:
Insolvency Resolution by Operational Creditor:
Section 8 of IBC, 2 016 provides that, an operational creditor may, on the occurrence of a default, deliver a demand notice or copy of the invoice demanding payment of the amount involved in the default to the corporate debtor in such form and manner as may be prescribed.

The corporate debtor shall, within a period of 10’days of the receipt of the demand notice or copy of the invoice bring to the notice of the operational creditor
(a) existence of a dispute, if any, or record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute;
(b) the payment of unpaid operational debt.

For this purpose, “demand notice” means a notice served by an operational creditor to the corporate debtor demanding payment of the operational debt in respect of which the default has occurred.

Sec. 9 of IBC, 2016 provides that after the expiry of the period of 10 days from the date of delivery of the notice or invoice demanding payment u/s 8, if the operational creditor does not receive payment from the corporate debtor or notice of the dispute u/s 8, the operational creditor may file an application before the Adjudicating Authority for initiating a corporate insolvency resolution process.

In the present case, demand Notice and copy of invoice were not served to Rose Garden Ltd. on the ground that a notice was earlier issued for winding up. Notice issued earlier for winding up cannot be treated as demand notice u/s 8 of IBC, 2016.

Conclusion: As demand notice and copy of invoice was not served, orders issued by adjudicating authority does not seems proper. Hence it may be concluded that Rose Garden Ltd. will succeed in its appeal.

Question 18.
M/s Systemtek India Private Limited (Appellant-Corporate Debtor) has challenged the order dated 3rd July, 2019 passed by the Adjudicating Authority (National Company Law Tribunal) Mumbai Bench, Mumbai, in the National Company Law Appellate Tribunal (NCLAT).

NCLT had admitted the application preferred by appellant under Section 10 of the Insolvency and Bankruptcy Code, 2016 and an order of Moratorium was passed and Insolvency Resolution Professional was ordered to be appointed by the Ld. Adjudicating Authority (NCLT).

The only grievance of the appellant in its challenge is that the movable and immovable property of Guarantor (promotor) has been attached pursuant to a Corporate Insolvency Resolution Process initiated u/s 10 against the Appellant by the Ld. Adjudicating Authority (NCLT) which is violative of section 14(l)(c) of the Insolvency and Bankruptcy Code, 2016 though the Code prescribes a Moratorium for certain types of transactions. Decide: [May 18 – Old Syllabus (4 Marks)]
Answer:
Validity of Moratorium w.r.t. attachment of promoter property:
Section 14(1)(c) of IBC, 2016 provides moratorium in its respect of any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of its property including any action under the SARFAESI Act, 2002.

In the present case, NCLT has passed an order for Moratorium and appointment of Insolvency Resolution Professional. Pursuant to Insolvency Resolution Process initiated u/s 10, movable and immovable property of Guarantor (promotor) has been attached, which is challenged before NCLAT on the grounds of Moratorium.

Facts of this case are similar to the case of Schweitzer Systemtek India Pvt. Ltd. v. Phoenix ARC Pvt. Ltd. & Ors., wherein NClAT dismiss the appeal on the ground that Moratorium u/s 14(1) (c) is not extended to promoter properties. Effect of Moratorium is limited to the properties of corporate debtor, not its promoter.

Conclusion: Appellant will not succeed as moratorium u/s 14(1)(c) of IBC, 2016 is limited to properties of corporate debtor, not its promoters.

Question 19.
You are appointed as Interim resolution professional in XYZ company Ltd. under the Insolvency and Bankruptcy Code, 2016. State the time limit to make public announcement? Also state the protocol for issuance of public notice. Who shall bear the expenses of public announcement? [May 18 – New Syllabus (4 Marks)]
Answer:
Public Announcement:
Regulation 6 of Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 provides the provisions related to public announcement. Accordingly,

(i) Time Limit to make public announcement: Interim Resolution Professional shall make the Public Announcement immediately after his appointment. “Immediately” refers to not more than 3 days from the date of appointment of the Interim Resolution Professional.

(ii) Protocol of Public Announcement: The public announcement shall:
(a) be in Form A of the Schedule to the Regulations;
(b) be published:
(i) in one English and one regional language newspaper with wide circulation at the location of the registered office and principal office, if any, of the corporate debtor and any other location where in the opinion of the IRP, the corporate debtor conducts material business operations;
(ii) on the website, if any, of the corporate debtor; and
(iii) on the website, if any, designated by the Board for the purpose,
(ba) state where claim forms can be downloaded or obtained from, as the case may be
(bb) offer choice of three insolvency professionals identified under regulation 4A to act as the authorised representative of creditors in each class
(c) provide the last date for submission of proofs of claim, which shall be fourteen days from the date of appointment of the interim resolution professional.

(iii) Expenses of Public Announcement: The expenses of public announcement shall be borne by the applicant which may be reimbursed by the Committee of Creditors, to the extent, it ratifies them.

Note: Answer given in suggested answer of ICAI w.r.t. Protocol of Public Announcement differs from the answer given above. Suggested Answer of ICAI covers the requirements of public announcement as per Section 15.

Question 20.
Mr. Ramlal, an Insolvency professional was appointed as a resolution professional for a corporate insolvency process initiated against the corporate debtor, Monotech Ltd. Mr. Ramlal is a partner of consulting firm M/s supervision and company which is entity recognized under the IBBI. It was discovered that M/s supervision and company had a transaction with the Monotech Ltd. amounting to 11% of its gross turnover in the last financial year 2018-2019.

Analyse the given situation as per the Insolvency and Bankruptcy Code, 2016, and advise on the validity of appointment of Mr. Ramlal as resolution professional against Monotecli Ltd.
What if, the creditor of the Monotech Ltd. opines that the resolution professional appointed is required to be replaced. „ [MTP-Aug. 18]
Answer:
Eligibility for Resolution Professional:
As per Regulation 3 of IBBI (Insolvency Resolution Process for Corporate Persons) Regulation, 2016, an insolvency professional shall be eligible for appointment as a resolution professional for a corporate insolvency process if he and all partners and directors of the insolvency professional entity of which he is partner or director are independent of the corporate debtor.

A person shall be considered independent of the corporate debtor, if he is not an employee or proprietor or a partner:
(i) of a firm of auditors or secretarial auditors in practice or cost auditors of the corporate debtor; or
(ii) of a legal or a consulting firm, that has or had any transaction with the corporate debtor amounting to 5% or more of the gross turnover of such firm, in the last 3 financial years, subject to compliance of other requirements.

In the instant case, Mr. Ramlal, was appointed as Resolution professional for a corporate insolvency process initiated against the Monotech Ltd. During the process, it was discovered that Mr. Ramlal is a partner of a consultant firm M/s supervision and company, which has made transaction of 11% of the gross turnover of the firm in the financial year 2018-2019 with Monotech Ltd.

Conclusion: Mr. Ramlal being a partner of the Firm had made a transaction of more than 5% of the gross turnover of the firm in the previous financial year 2 018-2 019. So, his appointment as resolution professional against Monotech Ltd for initiation of CIRP, is not valid.

Replacement of Resolution Professional:
Section 27 of IBC, 2016 deals with the provisions relating to replacement of Resolution Professional by Committee of Creditors (CoC). Accordingly,

• Where, at any time during the corporate insolvency resolution process, the CoC is of the opinion that a RP appointed u/s 22 is required to be replaced, it may replace him with another RP in the manner provided under this section.
• The CoC may, at a meeting, by a vote of 66% of voting shares, resolve to replace the RP appointed u/s22 with another RP, subject to a written consent from the proposed resolution professional in the specified form.
• The CoC shall forward the name of the insolvency professional proposed by them to the Adjudicating Authority.
• The Adjudicating Authority shall forward the name of the proposed RP to the Board for its confirmation and a RP shall be appointed in the same manner as laid down in Sec. 16.
• Where any disciplinary proceedings are pending against the proposed RP, the RP appointed u/s 22 shall continue till the appointment of another RP under this section.

Question 21.
Best bank, a financial creditor sent a demand notice for a claim of ₹ 10.2 crores on XYZ Ltd., a corporate debtor on 6th February, 2019. When the petition was filed before NCLT under Insolvency and Bankruptcy Code, 2016, Best Bank claimed that the XYZ limited has defaulted ₹ 29.8 crores instead of original amount of ₹ 10.2 crores. NCLT appointed an interim insolvency resolution professional. XYZ Limited made an appeal with NCLAT demanding that the Best Bank’s claim is Not maintainable as there is a difference in the amount mentioned in the demand notice and the application filled under the Code. Decide whether the contention of XYZ Limited is correct. Also, state who can file : Corporate Insolvency Resolution process under the code. [Nov. 18-Old Syllabus (6 Marks)]
Answer:
Requirement of demand notice in case of financial creditor:
Sec. 7 of the Insolvency and Bankruptcy Code, 2016 deals with the provisions relating to initiation of CIRP by financial creditor. Accordingly, a financial creditor either by itself or jointly with other financial creditors, of any other person on behalf of the financial creditor, as may be notified by the Central Government may file an application for initiating CIRP against a corporate debtor before the Adjudicating Authority (NCLT] when a default has occurred.

The financial creditor shall, along with the application furnish
(a) record of the default recorded with the information utility or such other record or evidence of default as may be specified;
(b) the name of the resolution professional proposed to act as an interim resolution professional; and
(c) any other information as may be specified by the Board.

A default includes a default in respect of a financial debt owed not only to the applicant financial creditor but to any other financial creditor of the corporate debtor.

There is no requirement under the provisions of Sec. 7 to deliver demand notice by financial creditor.
Conclusion: Contention of XYZ Limited is not correct as there is no requirement of demand notice in case of financial creditor.

Persons who may initiate Corporate Insolvency Resolution Process (CIRP)
As per Sec. 6 of IBC, 2016, where any corporate debtor commits a default, following persons:
(a) a financial creditor (any person to whom a financial debt is owed & includes a person to whom such debt legally assigned or transferred);
(b) an operational creditor (a person to whom an operation debt is owed & includes any person to whom such debt legally assigned or transferred); or
(c) the corporate debtor itself, may initiate corporate insolvency resolution process in respect of such corporate debt.

Question 22.
Mr. SP booked office space with Elegant Construction Limited. At the time of booking ₹ 136 lakhs was paid. Remaining amount of ₹ 710 lakhs was paid at the time of taking delivery. He entered into a Memorandum of Understanding (MoU) with the company having various terms and conditions of the sale/allotment. According to the MoU, Elegant Construction Limited was required to build and deliver the possession of the unit within 2 years from the date of execution of the MoU. It also stipulated payment of an assured return of ₹ 4,82,000 per month (subject to TDS u/s 194A of IT Act, 1961) till possession of the unit was delivered to MR. SP. Elegant Construction Limited failed to pay the assured return. Thereafter, Mr. SP filed an application for initiating insolvency resolution process. Decide about the validity of the said application on view of the provisions of Insolvency and Bankruptcy Code, 2016 as regards the definition of a “Financial Creditor” under Section 5(7) read with Section 5(8) of the Code. [Nov. 18-Old Syllabus (4 Marks)]
Answer:
Determination of validity of application filed in capacity of financial debtor:
As per Sec. 5(7) of the IBC, 2016, the term financial creditor means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to.

As per Sec. 5(8) of the IBC, 2016 the term financial debt means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing.

In the given case, Mr. SP booked office space with Elegant Construction Limited. He entered into MoU with the condition stating to build and deliver the possession of the unit within 2 years from the date of execution of MoU. MoU also stipulated payment of an assured return of ₹ 82,000 per month till possession of the unit was delivered. Elegant Construction Limited failed to pay the assured sum. Mr. SP filed an application for initiating insolvency resolution process against the Elegant Construction Limited.

As per Sec. 7 of the IBC, 2016, a financial creditor by itself, may file an application for initiating CIRP against a corporate debtor before the Adjudicating Authority when a default has occurred. A default includes a default in respect of a financial debt owed to the applicant financial creditor of the corporate debtor.

Conclusion: Assured returns are regular payment and qualify as financial debt as promise to pay the assured return of ₹ 1,15,68,000 (i.e. 4,82,000 × 24 months) by Elegant Construction Limited to Mr. SP makes the Mr. SP (applicant) as Financial creditor.

Question 23.
XY Ltd. filed a petition under Insolvency and Bankruptcy Code, 2016 with NCLT against DF Ltd. (Corporate Debtor) and the petition was admitted. There were only three financial creditors including XY Ltd. During the corporate insolvency Resolution process, the Corporate Debtor settled the claims of all the 3 financial creditors. Whether such settlement agreement could be termed as a valid resolution plan? Also discuss whether a financial creditor in respect of whom there is no default can file an application before Adjudicating Authority (NCLT) for initiating corporate insolvency resolution process. Discuss. [Nov. 18-New Syllabus (6 Marks)]
Answer:
Corporate Insolvency Resolution Process:
As per Clause 26 of Sec. 5 of IBC, 2016, a resolution plan means a plan proposed by resolution applicant for insolvency resolution of the corporate debtor as a going concern in accordance with Part II.

Hence, it appears that the settlement agreement cannot be termed as a valid resolution plan and Resolution Professional has to follow the process prescribed under the Code.

Application for initiating CIRP by financial creditor:
Sec. 7 of the IBC, 2016 provides that a financial creditor either by itself or jointly with other financial creditors or any other person on behalf of the financial creditor, as may be notified by the Central Government, may file an application for initiating CIRP against a corporate debtor before the Adjudicating Authority when a default has occurred.

Explanation to Sec. 7 provides that a default includes a default in respect of a financial debt owed not only to the applicant financial creditor but to any other financial creditor of the corporate debtor.

Hence, a financial creditor in respect of whom there is no default can file an application before Adjudicating Authority (NCLT) for initiating corporate insolvency resolution process.

Note: Answer as given in Suggested Answers issued by ICAI is different stating that a financial creditor in respect of whom there is no default, cannot file an application for initiating insolvency resolution process.

Question 24.
Mr. IP was proposed to be appointed as a resolution professional for the insolvency resolution process initiated against BMR Ltd. Mr. R, a relative of director of BMR Ltd. is a partner in the insolvency professional entity in which Mr. IP is partner. In the light of the given facts, examine the nature of the proposal of the appointment of Mr. IP for the conduct of the CIRP as per the Insolvency and Bankruptcy Code, 2016. [MTP-March 19, May 20; RTP-May 20]
Answer:
Eligibility for resolution professional:
As per Regulation 3 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, an insolvency professional shall be eligible to be appointed as a resolution professional for a corporate insolvency resolution process of a corporate debtor if he, and all partners and directors of the insolvency professional entity of which he is a partner or director, are independent of the corporate debtor.

A person shall be considered independent ofthe corporate debtor, if he:
(a) is eligible to be appointed as an independent director on the board of the corporate debtor u/s 149 ofthe Companies Act, 2013, where the corporate debtor is a company;
(b) is not a related party of the corporate debtor; or
(c) is not an employee or proprietor or a partner:

1. of a firm of auditors or secretarial auditors in practice or cost auditors ofthe corporate debtor; or
2. of a legal or a consulting firm, that has or had any transaction with the corporate debtor amounting to 5% or more of the gross turnover of such firm, in the last 3 financial years.

In the instant case, Mr. IP was proposed to be appointed as a resolution professional for the insolvency resolution process initiated against BMR Ltd. Whereas, Mr. R, a relative of director of BMR Ltd. is a partner in the insolvency professional entity in which Mr. IP is partner.

Conclusion: As Mr. R is a partner in IP Entity in which Mr. IP is also a partner, so Mr. IP is not eligible for appointment as Resolution Professional as he is not independent of the corporate debtor.

Question 25.
Mr. Ram, an operational creditor tiled an application for corporate insolvency resolution process. He does not proposed for appointment of an interim resolution professional in the application. State the provisions given by the Code in the given situation. State the period of IRP holding the said office. [MTP-March 19, May 20]
Answer:
Appointment of IRP:
As per Sec. 16 of IBC, 2016 where the application for corporate insolvency resolution process is made by an operational creditor and no proposal for an interim resolution professional is made, the Adjudicating Authority shall make a reference to the Board for the recommendation of an insolvency professional who may act as an interim resolution professional.

The Board shall, within 10 days of the receipt of a reference from the Adjudicating Authority, recommend the name of an insolvency professional to the Adjudicating Authority against whom no disciplinary proceedings are pending. Period of appointment of IRP: The term of the interim resolution professional shall continue till the date of appointment of the resolution professional u/s 22 of the IBC, 2016.

Question 26.
Mr. Atul was appointed as the Insolvency Resolution Professional for XYZ Ltd. An application to replace the Insolvency resolution professional was filed before the Adjudicating Authority by some Financial Creditors. The Financial Creditors propose to appoint Mr. K as the insolvency professional instead of Mr. Atul. Referring to the relevant provisions of the Insolvency and Bankruptcy Code, 2016, decide whether Mr. Atul can be replaced and if so, state the procedure to be followed to appoint another IRP in place of existing one. [May 19 – Old Syllabus (4 Marks)]
Answer:
Replacement of Resolution Professional
Sec. 27 of the Insolvency and Bankruptcy Code, 2016 deals with the provisions relating to replacement of Insolvency professional. Accordingly,
(1) Where, at any time during the corporate insolvency resolution process, the committee of creditors (comprising all financial creditors of the corporate debtor) is of the opinion that a resolution professional appointed under section 22 is required to be replaced, it may replace him with another resolution professional.

(2) The committee of creditors [COC] may, at a meeting, by a vote of sixty-six per cent of voting shares, resolve to replace the resolution professional appointed under section 22 with another resolution professional, subject to a written consent from the proposed resolution professional in the specified form.

(3) The committee of creditors shall forward the name of the insolvency professional proposed by them to the Adjudicating Authority.

(4) The Adjudicating Authority shall forward the name of the proposed resolution professional to the Board for its confirmation and a resolution professional shall be appointed in the same manner as laid down in section 16.

(5) Where any disciplinary proceedings are pending against the proposed resolution professional, the resolution professional appointed under section 22 shall continue till the appointment of another resolution professional under this Section.

Conclusion : Mr. Atul can be replaced by the COC comprising of financial creditors of corporate debtors, by following the procedure as stated above.

Question 27.
Continental Rubber Limited is a supplier of raw materials to Smooth Latex Limited. It filed a petition before the NCLT for the recovery of ₹ 10,00,000 from Smooth Latex Limited. Smooth Latex Limited, the Corporate Debtor, has other financial creditors to the extent of ₹ 1,50,00,000 and they also joined together and filed petitions to NCLT. The Corporate Debtor has a total of 40 financial creditors and 2 operational creditors. Further, all the financial creditors are having equal voting rights/shares.

Notice was issued on 1^st August, 2019 for the conduct of the first meeting to be held of 5^th August, 2019 at a common venue. The meeting was attended by all 40 financial creditors and 2 operational creditors. A resolution was passed to appoint Mr. TK as a Resolution Professional. 2 5 of the financial creditors voted in favour of the resolution and 10 voted against the resolution and 5 financial creditors and 2 operational creditors abstained from voting. Decide whether the resolution passed is valid? In the light of the provisions of Insolvency and Bankruptcy Code, 2016 read with rules framed thereunder, explain the requirements of issue of notice and quorum for the conduct of the meeting. [May 19 – New Syllabus (3 Marks), RTP-Nov. 20]
Answer:
Appointment of Resolution Professional:
As per Sec. 22 of IBC, 2016, the committee of creditors, may, in the first meeting, by a majority vote of not less than 66% of the voting share of the financial creditors, either resolve to appoint the Interim Resolution Professional (IRP) as a Resolution Professional (RP) or to replace the IRP by another RP.

It is not specified in Sec. 22 that 66% of voting share required for passing a resolution is of all financial creditors or financial creditors present and voting. The age old practice for corporate meetings have been that only “present and voted” is counted for the purpose of drawing conclusion for any agenda item. The reason for the same is that the ones who were present and still chose to abstain from voting were unable to make up their mind to either go for the resolution or against, hence they choose to remain with the majority.

Conclusion: In the given case, out of 35 votes, 25 votes are in favour, resolution is considered to be passed as votes cast in favour are more than 66%.

Requirements for Issue of Notice and Quorum:
As per Regulation 19 of IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, a meeting of the committee shall be called by giving not less than 5 days’ notice in writing to every participant, at the address it has provided to the resolution professional and such notice may be sent by hand delivery, or by post but in any event, be served on every participant by electronic means in accordance with Regulation 20.

The committee may reduce the notice period from 5 days to such other period of not less than 24 hours, as it deems fit.

As per Regulation 22 of IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, a meeting of the committee shall be quorate if members of the committee representing at least 33% of the voting rights are present either in person or by video conferencing or other audio and visual means.

Question 28.
Rose Garden Limited filed its financial statements for the year ending 31stMarch, 2019 with Registrar of Companies, Chennai which disclosed that the liabilities amounted to $ 3.87 crores as against the assets of ₹ 1.37 crores. On the basis of the scrutiny of the financial statements, the Registrar filed an application for Corporate Insolvency Resolution Process under Insolvency & Bankruptcy Code, 2016 against the company that the company is unable to pay its debts on the ground that the value of liabilities far exceeded the value of assets. Examine whether the company has any case to defend against the application filed by the Registrar. [Nov. 19 – Old Syllabus (4 Marks)]
Answer:
Initiation of CIRP by Registrar:
As per Sec. 6 of IBC, 2016, where any corporate debtor commits a default, below mentioned persons may initiate corporate insolvency resolution process in respect of such corporate debt:
(a) a financial creditor (any person to whom a financial debt is owed & includes a person to whom such debt legally assigned or transferred);

(b) an operational creditor (a person to whom an operation debt is owed & includes any person to whom such debt legally assigned or transferred); or

(c) the corporate debtor itself.

Application for CIRP can be filed only where corporate debtor commits a default. As per Sec. 3(12)ofIBC,2016, default means non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not paid by the debtor or the corporate debtor, as the case may be.

In the present case, Registrar filed an application for CIRP under IBC, 2016 against the company that the company is unable to pay its debts on the ground that the value of liabilities far exceeded the value of assets.

Conclusion: Registrar cannot initiate CIRP as he is not authorised under Sec. 6 to file an application for CIRP and further there is no default within the meaning of Sec. 3(12).

Hence, Rose Garden Ltd., on the basis of grounds as stated above can defend the application filed by the Registrar.

Question 29.
Venus Limited owes a sum of 12,00,000 to Mr. Khan, who assigns this debt to his two creditors Viz., Mr. Joseph – to an extent of 4,00,000 and Mr. Pratap to an extent of 8,00,000. Mr. Pratap makes a demand for his money from the company by giving a legal notice. The company could not meet Mr. Pratap’s demand or otherwise satisfy him till the expiry of four weeks from the date of notice. Mr. Pratap, therefore, moves to NCLT with an application for initiation of insolvency of the company. Referring to the provisions of the Insolvency and Bankruptcy Code, 2016, decide whether Mr. Pratap’s application can be accepted by the NCLT. [Nov. 19 – Old Syllabus (4 Marks)]
Answer:
Assignment of Financial Debt:
As per Sec. 7 of IBC, 2016, a financial creditor either by itself or jointly with other financial creditors, or any other person on behalf of the financial creditor, may file an application for initiating CIRP against a corporate debtor before the Adjudicating Authority (NCLT) when a default has occurred.

As per Sec. 5(7) of IBC, 2016, a financial creditor means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to.

In the present case, Venus Limited owes a sum of 12,00,000 to Mr. Khan, who assigns this debt to his two creditors Viz., Mr. Joseph – to an extent of 4,00,000 and-Mr. Pratap to an extent of 8,00,000. Mr. Pratap makes a demand for his money from the company by giving a legal notice. The company could not meet Mr. Pratap’s demand or otherwise satisfy him till the expiry of four weeks from the date of notice. Mr. Pratap, therefore, moves to NCLT with an application for initiation of insolvency of the company.

Conclusion: Application of Mr. Pratap can be accepted by NCLT if company fails to pay debt within stipulated time. Application should be supported with a copy of the assignment or transfer agreement and other relevant documents as may be required to demonstrate the assignment or transfer.

Note: It is assumed that debt owed is financial debt. Alternatively, answer may be based on assumption of operational debt.

Question 30.
In view of the deep recession prevailing in the market for the past three years, M/s. Infra Limited (Corporate Debtor), which was facing he brunt of financial crisis, could not pay salaries and wages to its workmen and employees for the past 6 months. The workmen and the employees, who are the members of a recognized Trade Union “Infra Labour Federation”, made a complaint in this regard.

Thereafter, the Trade Union approached and urged the Management of the Company in person and through representations in writing to settle the arrears of wages and salaries due to its members. The Corporate Debtor neither disputed nor took any actions to settle the amount. Under the circumstances, Infra Labour Federation filed an application before the Adjudicating Authority i.e. with the National Company Law Tribunal for initiating a Corporate Insolvency Resolution Process under the Insolvency and Bankruptcy Code, 2016.

In the light of the provisions of the Insolvency and Bankruptcy Code, 2016, examine the following:
(i) Validity of the Application.
(ii) What will be the “Initiation date” for initiating the Corporate Insolvency Resolution Process? [Nov. 19 – New Syllabus (6 Marks)]
Answer:
Application for C1RP by Trade Union:
As per Sec. 5(20) of IBC, 2016, an operational creditor means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.

As per Sec. 5(21) of IBC, 2016, an operational debt means a claim in respect of the provision of goods or services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority.

As per Sec. 3(23) of IBC, 2016, the term “person” includes “any other entity established under any statute”. A trade union, when registered under the Trade Union Act, 1926 would come within the purview of any other entity “established” under the statute.

As per Sec. 8 of IBC, 2016, an operational creditor may, on the occurrence of a default, deliver a demand notice of unpaid operational debtor copy of an invoice demanding payment of the amount involved in the default to the corporate debtor in such form and manner as may be prescribed.

The corporate debtor shall, within a period of 10 days of the receipt of the demand notice or copy of the invoice bring to the notice of the operational creditor—
(a) existence of a dispute, if any, or record of the pendency of the suit or arbitration proceedings , filed before the receipt of such notice or invoice in relation to such dispute;
(b) the payment of unpaid operational debt.

As per Sec. 9 of IBC, 2016, After the expiry of the period of 10 days from the date of delivery of the notice or invoice demanding payment u/s 8, if the operational creditor does not receive payment from the corporate debtor or notice of the dispute u/s 8, the operational creditor may file an application before the Adjudicating Authority for initiating a CIRP.

In the present case, application for CIRP is filed by a recognized Trade Union. Facts of this case are similar to case of J.K. Jute Mill Mazdoor Marcha v. Juggilal Kamlapat Jute Mills Company Ltd & Others wherein it was held by the Supreme Court that a trade union is an operational creditor for the purpose of initiating the CIRP.

Conclusion: Application made by the Trade Union “Infra Labour Federation” is valid.

Initiation date: As per Sec. 5(11) of the IBC, 2016, initiation date means the date on which a financial creditor, corporate applicant or operational creditor, as the case may be, makes an application to the Adjudicating Authority for initiating corporate insolvency resolution process.

Question 31.
The Committee of Creditors of M/s XYZ Limited proposes to appoint Mr. Ajit, an Insolvency Professional, as Insolvency Resolution Professional in the matter of corporate insolvency process of M/s XYZ Limited. Mr. Ajit was a promoter of M/s ABC Limited which is a holding company of M/s XYZ Limited. Examine and decide whether Mr. Ajit is eligible for appointment as an Insolvency Resolution Professional under the Provisions of Insolvency and Bankruptcy Code, 2016. [Nov. 19 – New Syllabus (3 Marks)]
Answer:
Eligibility to be appointed as Insolvency Resolution Professional:
As per Regulation 3 of IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, an insolvency professional shall be eligible to be appointed as a resolution professional for a CIRP of a corporate debtor if he, and all partners and directors of the insolvency professional entity of which he is a partner or director, are independent of the corporate debtor.

A person shall be considered independent of the corporate debtor, if he is eligible to be appointed as an independent director on the board of the corporate debtor u/s 149 of the Companies Act, 2013, where the corporate debtor is a company.

As per Sec. 149 (6) of Companies Act, 2 013, a person is not eligible to be appointed as independent director in a company if he is a promoter of the company or its holding company or its subsidiary company or its associate company.

In the present case, the Committee of Creditors of M/s XYZ Limited proposes to appoint Mr. Ajit, an Insolvency Professional, as Insolvency Resolution Professional in the matter of corporate insolvency process of M/s XYZ Limited. Mr. Ajit was a promoter of M/s ABC Limited which is a holding company of M/s XYZ Limited.

Conclusion: Mr. Ajit is not eligible for appointment as an Insolvency Resolution Professional as he cannot be considered as independent of the corporate debtor.

Question 32.
NYM Garments Limited was incorporated under the Companies Act, 1956. Now, the company is under the Insolvency proceedings and the application is pending before the Adjudicating Authority. AVR ; Fabrics Limited is the supplier to NYM Garments Limited and a sum of 10,00,000 is outstanding as on 31st January, 2020. A notice was issued by the advocate of AVR Fabrics Limited to NYM Garments on 1st February, 2020 to make the payments. The notice was delivered at the registered office of NYM Garments Limited on 4th February, 2020. AVR Fabrics Limited has not received any payment or reply from the corporate debtor, NYM Garments Limited till 13th February, 2020. The Corporate Creditor, AVR Fabrics Limited, seeks your advice regarding the admission of application by NCLT on the following issues:

1. The procedure for filing the application and the documents submitted to the Tribunal.
2. If the Cqrporate Debtor, NYM Garments Limited, disputed the amount of claim by a reply -on 25th February, 2020, stating the amount outstanding was 8,00,000 only and not Rs. 10,00,000 as claimed by AVR Fabrics Limited.
3. If the Corporate Debtor, NYM Garments Limited, has paid an amount of Rs. 7,00,000 in full settlement of the outstanding due. [Nov. 20 – Old Syllabus (6 Marks)]

Answer:
Insolvency Resolution by Operational creditor:
(i) Procedure for filing the application and the documents submitted to the Tribunal:
Secs. 8 & 9 of the Insolvency and Bankruptcy Code, 2016 deals with the provisions relating to initiation of CIRP by operational creditor. Accordingly,

An operational creditor may, on the occurrence of a default, deliver a demand notice of unpaid operational debtor copy of an invoice demanding payment of the amount involved in the default to the corporate debtor in such form and manner as may be prescribed.

The corporate debtor shall, within a period of 10 days of the receipt of the demand notice or copy of the invoice bring to the notice of the operational creditor-
(a) existence of a dispute, if any, or record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute;
(b) the payment of unpaid operational debt.

After the expiry of the period of 10 days from the date of delivery of the notice or invoice demanding payment u/s 8, if the operational creditor does not receive payment from the corporate debtor or notice of the dispute u/s 8, the operational creditor may file an application before the Adjudicating Authority for initiating a CIRP.

Documents to be filed with the Application:
The operational creditor shall, along with the application furnish-
(a) a copy of the invoice demanding payment or demand notice delivered by the operational creditor to the corporate debtor;

(b) an affidavit to the effect that there is no notice given by the corporate debtor relating to a dispute of the unpaid operational debt;

(c) a copy of the certificate from the financial institutions maintaining accounts of the operational creditor confirming that there is no payment of an unpaid operational debt by the corporate debtor, if available;

(d) a copy of any record with information utility confirming that there is no payment of an unpaid operational debt by the corporate debtor, if available; and

(e) any other proof confirming that there is no payment of any unpaid operational debt by the corporate debtor or such other information, as may be prescribed.

(ii) If the Corporate Debtor, NYM Garments Limited, disputed the amount of claim by a reply on 25th February, 2020, stating the amount outstanding was 8,00,000 only and not Rs. 10,00,000 as claimed by AVR Fabrics Limited, application for CIRP can be admitted as dispute was raised after the specified period.

(iii) If the Corporate Debtor, NYM Garments Limited, has paid an amount of ₹ 7,00,000 in full settlement of the outstanding due, application will not be admitted as full settlement taken place.
Note: Alternate answers possible with different assumptions.

Question 33.
Abhi Limited entered into an agreement with Atuiya Gas Limited for purchase of natural gas, which is not specified as an essential supply. On failure of Abhi Limited to make payments, Atuiya Gas Limited issued notice to Abhi Limited that further supply of gas would be stopped if payments are not made immediately. On further non-payment, Atuiya Gas Limited filed a petition before NCLT for initiating Corporate insolvency Resolution process against Abhi Limited. On 15th March, 2020 the petition was admitted. On 30th April, 2020, Atuiya Gas Limited disconnected gas supply to Abhi Limited for non-payment. As a result of disconnection of gas supply, operations of Abhi Limited came to a halt. The Resolution professional filed a petition to NCLT seeking Atuiya Gas Limited to resume the supply of natural gas, as natural gas was an important material for production of electricity by Abhi Limited.

Referring to the provisions of Insolvency and Bankruptcy Code, 2016, answer the following:
(i) When the moratorium period will expire in this case?
(ii) Whether Resolution Professional will be successful in his petition filed with NCLT? [Nov. 20 – New Syllabus (3 Marks)]
Answer:
Provisions related with the Moratorium:
Sec. 14 of IBC, 2016 deals with the provisions relating to Moratorium. Accordingly,
(i) The order of moratorium shall have effect from the date of such order till the completion of the CIRP:
Provided that where at any time during the CIRP, if the Adjudicating Authority approves the resolution plan u/s 31(1) or passes an order for liquidation of corporate debtor u/s 33, the moratorium shall cease to have effect from the date of such approval or liquidation order, as the case may be.

(ii) It is provided in Sec. 14 that the supply of essential goods or services to the corporate debtor as may be specified shall not be terminated or suspended or interrupted during moratorium period.

Where the resolution professional considers the supply of goods or services critical to protect and preserve the value of the corporate debtor and manage the operations of such corporate debtor as a going concern, then the supply of such goods or services shall not be terminated, suspended or interrupted during the period of moratorium, except where such corporate debtor has not paid dues arising from such supply during the moratorium period.

In the given case, Atulya Gas Limited disconnected gas supply to Abhi Limited for non-payment. As per agreement, natural gas is not specified as an essential supply.

Conclusion: Resolution Professional will not succeed as corporate debtor has not paid dues arising from the supply during the moratorium period.

Liquidation Process

Question 34.
Mr. X, a Resolution professional in a liquidation process, on an examination of sale of property of Corporate debtor finds that a transaction was made by the corporate debtor to his relative within 6 months preceding the Insolvency Commencement date, was undervalued. Give the following answers in reference to the above situation:

(a) State the validity of the conduct of such transaction by corporate debtor to his relative.
(b) What will be the consequences when resolution professional determines such transactions undervalue and fails to report that same to NCLT?
(c) What order NCLT shall pass when Corporate Debtor entered into an undervalued transaction? [MTP-April 18]
Answer:
(a) Validity of the conduct of undervalued transaction:
As per Sec. 45 of the IBC, 2 016, if the liquidator or the Resolution Professional, on an examination of the transactions of the Corporate Debtor, determines that certain transactions were made by Corporate Debtor with a related party, within the period of 2 years preceding the insolvency commencement date, which were undervalued, he, shall make an application to the NCLT to declare such transactions as void and reverse the effect of such undervalued transaction and requiring the person who benefits from such transaction to pay back any gains he may have made as a result of such transaction.

Hence the conduct of such transaction by corporate debtor to his relative is not valid.

(b) Consequences of failure to report to NCLT of undervalued transactions:
As per Sec. 47 of the Insolvency and Bankruptcy Code, where an undervalued transaction has taken place and the liquidator or the Resolution Professional has not reported it to the NCLT, a creditor, member ora partner of a Corporate Debtor, as the case may be, may make an application to the NCLT to declare such transactions void and reverse their effect in accordance with the relevant provisions of this Code.

(c) Order of NCLT:
Where the NCLT, after examination of the application, is satisfied that undervalued transactions had occurred and the Resolution Professional after having sufficient information or opportunity to avail information of such transactions did not report such transaction, there it shall pass an order of —

1. restoring the position as it existed before such transactions and reversing the effects thereof. As per Sec. 48, the order of the Adjudicating Authority may provide for the following:
   • require any property transferred as part of the transaction, to be vested in the corporate debtor;
   • release or discharge (in whole or in part) any security interest granted by the corporate debtor
   • require any person to pay such sums, in respect of benefits received by such person, to the Mr. X (RP), as the Adjudicating Authority may direct; or
   • require the payment of such consideration for the transaction as may be determined by an independent expert.
2. requiring the Board (IBBI) to initiate disciplinary proceedings against Mr. X.

Question 35.
The following particulars relate to Big Rammy (Private) Ltd. which has gone into Corporate Insolvency Resolution Plan (CIRP)

Sr. No.	Particulars	Amount in ₹
1	Amount realized from the sale of liquidation of assets	14,00,000
2	Secured creditor who has relinquished the security	5,00,000
3	Unsecured financial creditors	4,00,000
4	Income-tax payable within a period of 2 years preceding the liquidation commencement date	50,000
5	Cess payable to state government within a period of one year preceding the liquidation commencement date	20,000
6	Fees payable to resolution professional	75,000
7	Expenses incurred by the resolution professional in running the business of the Big Rammy (Private) Ltd. on going concern	25,000
8	Workmen salary payable for a period of 30 months preceding the liquida­tion commencement date. The workmen salary is equal p.m.	3,00,000
9	Equity shareholders	10,00,000

State the priority order in which the liquidator .shall distribute the proceeds under the Insolvency and Bankruptcy Code. [MTP-Oct. 18]
Answer:
Distribution of Assets:
As per Sec. 53 of the IBC, 2016, the proceeds from the sale of liquidation assets shall be distributed in the following order of priority:

S.No.	Particulars	Amount
(i)	Fees payable to Resolution Professional in full	75,000
(ii)	Expenses incurred by the Resolution professional in running the business on going concern.	25,000
(iii)	Workmen salary outstanding for a period of 24 months (proportionate to 24 months only). The balance ₹ 60,000 is considered as remaining debts and dues and will be settled before preference shareholder/equity shareholder.	2,40,000
(iv)	Secured creditor who has relinquished the security	5,00,000
(v)	Unsecured Financial Creditors	4,00,000
(vi)	Income- tax payable within the period 2 years	50,000
(vii)	Cess to State Government payable with in a period of one year	20,000
(viii)	Balance amount in workmen salary	60,000
Total distribution		13,70,000
Amount realized from the sale of liquidation of assets		14,00,000
Balance available to Equity shareholder on pro rata basis		30,000

Question 36.
The following particulars relate to M/S. Star House (P) Limited which has gone into Corporate Insolvency Resolution Process (CIRP):

S. No.	Particulars	Amount (₹)
1.	Amount realized from the sale of liquidation of Assets	7,00,000
2.	Secured Creditors who has relinquished the security	2,50,000
3.	Unsecured Financial Creditors	2,00,000
4.	Income Tax Payable within a period of two years preceding the liquidation commencement date.	25,000
5.	Cess Payable to State Government within a period of one year preceding the liquidation commencement date.	10,000
6.	Fees payable to resolution professional	37,500
7.	Expenses incurred by the resolution professional in running the business of M/s. Star House (P) Limited on going concern.	17,500
8.	Workmen salary payable for a period of thirty months preceding the liq­uidation commencement date. The workmen salary is equal per month.	1,50,000
9.	Equity Shareholders	5,00,000

State the priority order in which the liquidator shall distribute the proceeds under the Insolvency & Bankruptcy Code, 2016. [May 19 – New Syllabus (6 Marks), MTP-Oct. 20]
Answer:
Distribution of Assets:
As per Sec. 53 of the IBC, 2016, the proceeds from the sale of liquidation assets shall be distributed in the following order of priority:

S.No.	Particulars	Amount
(i)	Fees payable to Resolution Professional in full	37,500
(ii)	Expenses incurred by the Resolution professional in running the business on going concern.	17,500
(iii)	Workmen salary outstanding for a period of 24 months (proportionate to 24 months only). The balance Rs. 30,000 is considered as remaining debts and dues and will be settled before preference shareholder/equity shareholder.	1,20,000
(iv)	Secured creditor who has relinquished the security	2,50,000
(v)	Unsecured Financial Creditors	2,00,000
(vi)	Income- tax payable with in the period 2 years	25,000
(vii)	Cess to State Government payable with in a period of one year	10,000
(viii)	Balance amount in workmen salary	30,000
Total distribution		6,90,000
Amount realized from the sale of liquidation of assets		7,00,000
Balance available to Equity shareholder on pro rata basis		10,000

Question 37.
Pursuant to Section 33 of the Insolvency and Bankruptcy Code, 2016 (IBC, 2016) a liquidation order was passed against Luci Soya Limited (LSL) (Corporate Debtor) by the Adjudicating Authority (NCLT). Mr. Solanki, was appointed as the liquidator by the NCLT. Upon resuming his mantle, Mr. Solanki started collecting claims from all the creditors within the time frame as prescribed in the IBC, 2016. While initiating the liquidation process as per provisions of the IBC, 2016, Mr. Solanki proposed to include the equity shares of one of its subsidiary as part of the liquidation estate in relation to the corporate debtor. Besides this, one of the unsecured financial creditor demanded that, at the time of distribution of liquidation proceeds, his dues may he paid before the government dues are paid. Mr. Solanki also observed that pending legal proceedings against the corporate debtor, A Ltd., an operational creditor, has filed a case with the Arbitral Tribunal praying for an arbitral award against LSL.

On the basis of the above information and in the light of the Insolvency and Bankruptcy Code, 2016, answer the following:

1. Whether the proposal of Mr. Solanki to include the equity shares of the subsidiary Company of LSL as part of liquidation estate tenable?
2. How should Mr. Solanki deal with the demand of the unsecured financial creditor?
3. Whether A’ Ltd. will succeed in its prayer for an arbitral award against LSL? [Nov. 20 – New Syllabus (6 Marks)]

Answer:
Misc. provisions of IBC, 2016
(i) Liquidation Estate:
As per Sec. 36 of IBC, 2016, for the purposes of liquidation, the liquidator shall form an estate of the assets, which will be called the liquidation estate in relation to the corporate debtor. The liquidation estate shall comprise all liquidation estate assets which shall include any assets over which the corporate debtor has ownership rights, including shares held in any subsidiary of the corporate debtor.

Conclusion: Proposal to include the equity shares of the subsidiary Company of LSL as part of liquidation estate is tenable.

(ii) Distribution of Assets:
As per Sec. 53 of IBC, 2016, proceeds from the sale of the liquidation assets shall be distributed in the order specified in that section. In accordance with the priority set by Sec. 53, dues of unsecured financial creditor will be paid before the payment of government dues.

(iii) Status of Arbitral Award:
As per Sec. 14 of IBC, 2016, on the insolvency commencement date, the Adjudicating Authority shall by order declare moratorium for prohibiting the institution of suits or continuation of pending suits or proceedings against the corporate debtor including execution of any judgment, decree or order in any court of law, tribunal, arbitration panel or other authority.

Conclusion: A Ltd. will not succeed due to effect of declaration of Moratorium.

Fast Track Corporate Insolvency Resolution Process

Question 38.
As on March 31, 2019, the audited balance sheet of M/s Sharp Industries Limited, revealed total assets of ₹ 1 crore. M/s Sharp Industries Limited, in the capacity of a Corporate Debtor, filed an application on July 1, 2019 with the Adjudicating Authority for initiating a fast track corporate insolvency resolution process. Explain under the provisions of Insolvency and Bankruptcy Code, 2016 the following:

1. Whether the application made by M/s Sharp Industries Ltd. for initiating a fast track corporate insolvency resolution process is admissible?
2. The time period including the extension of time period, if any, within which the fast track corporate insolvency resolution process shall be completed? [Nov. 18-New Syllabus (4 Marks)]

Answer:
Fast Track Corporate Insolvency Resolution Process:
As per Sec. 55 of Insolvency and Bankruptcy Code, 2016, an application for fast track corporate insolvency resolution process may be made in respect of the following corporate debtors, namely:

(a) a small company as defined u/s 2(85) of Companies Act, 2013; or
(b) a Startup (other than the partnership firm); or
(c) an unlisted company with total assets, as reported in the financial statement of the immediately preceding financial year, not exceeding ₹ 1 crore.

Conclusion: Based on the provisions as stated above, M/s. Sharp Industries Ltd. can initiate a fast track corporate insolvency resolution process as its total asset as reported in the financial statement of the immediately preceding financial year, not exceeding ₹ 1 crore.

Time period for completion of fast track corporate insolvency resolution process: Sec. 56 of Insolvency and Bankruptcy Code, 2016 provides the following:
Fast track corporate insolvency resolution process shall be completed within a period of 90 days from the insolvency commencement date.

The Resolution Professional shall file an application to the Adjudicating Authority to extend the period of the fast track corporate insolvency resolution process beyond 90 days if instructed to do so by a resolution passed at a meeting of the committee of creditors and supported by a vote of 75% of the voting share.

On receipt of an application, if the Adjudicating Authority is satisfied that the subject matter of the case is such that fast track corporate insolvency resolution process cannot be completed within a period of 90 days, it may, by order, extend the duration of such process beyond the said period of 90 days by such further period, as it thinks fit, but not exceeding 45 days.

Question 39.
ABZ Ltd. an unlisted company with total assets of ₹ 1 crore as per financial statement as on 31st March, 2018, defaulted in the payment of the financial debt against the financial creditor X. X filed an application for initiation of insolvency process against ABZ Ltd. under the fast track C1RP on 31st May 2019. Discuss the relevancy for disposal through the mechanism of the fast track CIRP and the legal position of holding of fast track CIRP by X in the term of the IBC, 2016. Compute the time period for completion of fast track process in the said situation. [RTP-May 20]
Answer:
Fast Track Corporate Insolvency Resolution Process:
As per Sec. 55 of Insolvency and Bankruptcy Code, 2016, an application for fast track corporate insolvency resolution process may be made in respect of the following corporate debtors, namely:
(a) a corporate debtor with assets and income below a level as may be notified by the C.G.; or
(b) a corporate debtor with such class of creditors or such amount of debt as may be notified by the C.G.; or
(c) such other category of corporate persons as may be notified by the C.G.

Central Government notifies that an application for fasttrack corporate insolvency resolution process may be made in respect of the following corporate debtors, namely:

1. a small company as defined u/s 2(85) of Companies Act, 2013; or
2. a Startup (other than the partnership firm); or
3. an unlisted company with total assets, as reported in the financial statement of the immediately preceding financial year, not exceeding ₹ 1 crore.

Time period for completion of fast track corporate insolvency resolution process: Sec. 56 of Insolvency and Bankruptcy Code, 2016 provides the following:
Fast track corporate insolvency resolution process shall be completed within a period of 90 days from the insolvency commencement date.

The Resolution Professional shall file an application to the Adjudicating Authority to extend the period of the fast track corporate insolvency resolution process beyond 90 days if instructed to do so by a resolution passed at a meeting of the committee of creditors and supported by a vote of 75% of the voting share.

On receipt of an application, if the Adjudicating Authority is satisfied that the subject matter of the case is such that fast track corporate insolvency resolution process cannot be completed within a period of 90 days, it may, by order, extend the duration of such process beyond the said period of 90 days by such further period, as it thinks fit, but not exceeding 45 days.

Conclusion: As per the provisions states above, fast track CIRP shall be completed by 29.08.2019. It can be further extended until by 13.10.2019.

Voluntary Liquidation of Corporate Persons – Sec. 59

Question 40.
X Ltd. was intending to initiate voluntarily liquidation proceedings. A declaration was made on affidavit of the some of the directors of the X Ltd. verifying full inquiry of the affairs of the company. They gave the opinion that the company will be able to pay its debts in full from the proceeds of assets to be sold in the voluntary liquidation.

Analysing the given situation, comment whether X Ltd. can initiate voluntary liquidation proceeding I in compliance with the conditions given in the Insolvency and Bankruptcy Code, 2016. What are the required documents to be accompanied with the declaration? .

Also, state the consequences, where if the articles fixed the period of duration for which company may be carried and that period expires. [MTP-March 18]
Answer:
Voluntary Liquidation of Corporate Persons:
Section 59 of the Insolvency & Bankruptcy Code, 2016 deals with the provisions relating to voluntary liquidation proceedings. Accordingly, a corporate person who intends to liquidate itself voluntarily and has not committed any default, may initiate voluntary liquidation proceedings under the provisions of this Code.

Conditions for Voluntary Liquidation:
Any corporate person registered as a company shall meet the following conditions to initiate a voluntary liquidation process:
(a) A declaration from majority of the directors of the company verified by an affidavit stating that
they have made a full inquiry into the affairs of the company and have formed an opinion that either the company has no debts or that it will be able to pay its debts in full from the proceeds of assets to be sold in the voluntary liquidation; and

the company is not being liquidated to defraud any person.

(b) declaration shall be accompanied with the following documents, namely:

• audited financial statements and a record of business operations of the company for the previous two years or for the period since its incorporation, whichever is later;
• a report of the valuation of the assets of the company, if any, prepared by a registered valuer.

(c) After making the declaration the corporate debtor shall within four weeks –
pass a special resolution at a general meeting stating that the company should be liquidated voluntarily and insolvency professional to act as the liquidator may be appointed.

pass a resolution at a general meeting stating that the company be liquidated voluntarily as a result of expiry of the period of its duration (fixed by its articles or on the occurrence of any event in respect of which the articles provide that the company shall be dissolved, if any) and appointing an insolvency professional to act as the liquidator.

In the present case, a declaration was made on affidavit of the some of the directors of the X Ltd. verifying full inquiry of the affairs of the company, is not in compliance as the majority was the requirement for initiation of the voluntary liquidation proceedings.

Consequences if the articles fixed the period of duration for which company may be carried and that period expires:
If the articles fixed the period of duration of continuation and that period expires, X Ltd. after making declaration, shall within 4 weeks pass a resolution at a general meeting stating that the company be liquidated voluntarily as a result of expiry of the period of its duration as fixed by its articles and appointing an insolvency professional to act as the liquidator.

Question 41.
BDLK Limited decided to go for voluntary winding up and accordingly the Board of Directors at a meeting of the Board arc about to take the necessary steps to initiate the winding up proceedings. The Board of Directors of the company approached you for guidance in this regard. Please list out the steps required under the Insolvency & Bankruptcy Code, 2016 before approval of such liquidation proposal with specific reference to meetings and actions of relevant stakeholders. [May 18 – Old Syllabus (4 Marks)]
Answer:
Conditions for Voluntary Liquidations:
Section 59 of the Insolvency and Bankruptcy Code, 2016 prescribes that the voluntary liquidation
proceedings of a corporate person registered as a company shall meet the following conditions, namely:
(a) a declaration from majority of the directors of the company verified by an affidavit stating that-

1. they have made a full inquiry into the affairs of the company and they have formed an opinion that either the company has no debt or that it will be able to pay its debts in full from the proceeds of assets to be sold in the voluntary liquidation; and
2. the company is not being liquidated to defraud any person;

(b) the declaration under sub-clause (a) shall be accompanied with the following documents,
namely:

1. audited financial statements and record of business operations of the company for the previous two years or for the period since its incorporation, whichever is later;
2. a report of the valuation of the assets of the company, if any prepared by a registered valuer;

(c) within four weeks of a declaration under sub-clause (a), there shall be –
(i) a special resolution of the members of the company in a general meeting requiring the company to be liquidated voluntarily and appointing an insolvency professional to act as the liquidator; or

(ii) a resolution of the members of the company in a general meeting requiring the company to be liquidated voluntarily as a result of expiry of the period of its duration, if any, fixed by its articles or on the occurrence of any event in respect of which the articles provide that the company shall be dissolved, as the case may be and appointing an insolvency professional to act as the liquidator:

Provided that the company owes any debt to any person, creditors representing 2/3rd in value of the debt of the company shall approve the resolution passed within 7 days of such resolution.

Audit under Fiscal Laws – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

Audit under Fiscal Laws – CA Final Audit Question Bank

Audit of Public Trusts

Question 1.
Draft an Audit programme for conducting the audit of a Public Trust registered under section 12A of the Income-tax Act, 1961. [May 09 (8 Marks)]
Answer:
Audit Programme for conducting audit of a public trust:
1. Preliminary: Obtain the following from the trust:

• A copy of resolution frorn the trust so as to determine the scope of audit.
• A list of accounting records maintained by the trust.
• A certified true copy of trust deed.
• Trial Balance as at end of accounting period.
• Balance Sheet and Profit & Loss account of the trust authenticated by the trustee.

2. Compliance and Substantive Checking

1. Examine the system of accounting and internal control.
2. Vouch the transactions of the trust so as to ensure the following:
   (a) transaction falls within the ambit of the trust;
   (b) transaction is properly authorized by the trustees or other delegated authority;
   (c) Proper accounting of all incomes and expenses on the basis of the system of accounting followed by the trust;
   (d) Amount applied towards the object of the trust are covered by the objects of trust as specified in the trust deed.
3. Check whether the financial statements agrees with the trial balance.

3. Issuing Audit Report

• Audit Report shall be furnished in Form No. 10B.
• Annexure to Form 10B requires certain information to be provided by the auditor, which need to be obtained from the trustees.

Tax Audit u/s 44AB

Question 2.
A Co-operative Society having receipts above ₹ 100 lakhs get its accounts audited by a person eligible to do audit under Co-operative Societies Act, 1912, who is not a C.A. State with reasons whether such audit report can be furnished as tax audit report u/s 44AB of the Income Tax Act, 1961? [Nov. 09 (3 Marks)]
Or
A Co-operative society having receipts over ₹ 2 crores have appointed Mr. D as the statutory auditor : – Mr. D is eligible to do the same under the state Co-operative Societies Act. Mr. D is not a chartered l accountant. Mr. D is also appointed to conduct the tax audit of the society under section 44AB of the Income Tax Act, 1961. Comment. [Nov. 17 (4 Marks)]
Answer:
Tax Audit Report in case of Co-operative society:
Proviso to Sec. 44AB of Income Tax Act, 1961 lays down that where the accounts of an assessee are required to be audited by or under any other law, it shall be sufficient compliance with the provisions of this section, if such person get the accounts of such organisation audited under such other law before the specified date and furnishes by that date, the report of the audit as required under such other law and a further report by an Accountant in the form prescribed under this section.

The term “accountant” as defined in Explanation to Sec. 288[2)’of the Income Tax Act, 1961 means a chartered accountant within the meaning of the Chartered Accountants Act, 1949, who holds a valid certificate of practice.

Accordingly, the person who is not a Chartered Accountant as mentioned in the question, though is eligible to act as auditor of Cooperative Society under the Cooperative Society Act, 1912, but is not eligible to carry out tax audit under Section 44AB of the Income Tax Act, 1961.

Conclusion: Audit report by a person other than Chartered Accountant cannot be furnished as tax audit report under Section 44AB of the Income-tax Act, 1961.

“ICAI Examiner Comments”
Even though many examinees have given correct conclusion, few examinees failed to refer Sec. 288(2) of the Income-tax Act, 1961 and its explanation while some of them mistakenly related with Professional misconduct under CA Act, 1949.

Question 3.
Mr. X deals in a commodity and purchase and sales of that commodity is ultimately settled otherwise than by the actual delivery. During the financial year 2020-21 he purchased the commodity worth ? 95 Lacs and sold the same commodity for ₹ 104 Lacs and the contract was settled otherwise than by the actual delivery. X seeks your advice whether he is liable for tax audit u/s 44AB of the Income Tax Act.
Answer:
Liability for Tax Audit in case of Speculative Transactions:
Mr. X deals in commodity as a speculator. A speculative transaction means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery.

As such, in such transaction the difference amount is ‘turnover’. In the given case the difference of ₹ 104 lacs and ₹ 95 lakhs i.e., ₹ 9 Lakhs is the turnover.

In such transactions though the contract notes are issued for full value of the purchases or sales, but the entries in the books of account are made only for the differences.

Conclusion: Mr. X is not liable for Tax audit u/s 44AB of the Income Tax Act, 1961.

Question 4.
Concession Ltd. is engaged in the business of manufacturing of threads. The company recorded the turnover of ₹ 1.13 crore during the financial year 2020-21 before adjusting the following:
Discount allowed in the Sales Invoice – ₹ 8,20,000
Cash discount (other than allowed in Cash memo/sales invoice) – ₹ 9,20,000
Trade discount – ₹ 2,90,000
Commission on Sales – ₹ 6,00,000
Sales Return (F.Y. 2019-20) – ₹ 1,60,000
Sale of Investment – ₹ 6,60,000
You are required to ascertain the effective turnover to be considered for the prescribed limit of tax audit and guide-the company whether the provisions relating to tax audiL applies.
Answer:
Computation of Turnover for the purpose of determining requirement of Tax Audit:
As per section 44AB of the Income Tax Act, 1961, audit is required in case of every person carrying on business, if his total sales, turnover or gross receipts in business exceed ₹ 1 crore and in case of every person carrying on a profession, if his gross receipts from profession exceed ₹ 50 lakhs in any previous year.

As per Guidance Note on Tax Audit issued by the ICAI, the following points merit consideration for the purpose of computing turnover:

1. Discount allowed in the sales being in the nature of trade discount will be deducted from the turnover.
2. Cash discount otherwise than that allowed in a cash memo/sales invoice is in the nature of a financing charge and hence should not be deducted from the turnover.
3. Special rebate allowed to a customer can be deducted from the sales if it is in the nature of trade discount. If it is in the nature of commission on sales, the same cannot be deducted from the figure of turnover.
4. Price of goods returned should be deducted from the turnover even if the returns are from the sales made in the earlier year/s.
5. Sale proceeds of any shares, securities, debentures, etc., held as investment will not form part of turnover. However, if the shares, securities, debentures etc., are held as stock-in-trade, the sale proceeds thereof will form part of turnover.

Accordingly, the turnover of concession limited may be computed as under:

Conclusion: As the effective turnover of Concession Ltd. is more than ₹ 1 Crore, the provisions related to tax audit are applicable to the company.

Question 5.
Mr. A engaged in business as a sole proprietor presented the following information to you for the FY 20-21. Turnover made during the year ₹ 124 lacs. Goods returned in respect of sales made during FY 19-20 is ₹ 20 lacs not included in the above. Cash discount allowed to his customers ₹ 1 lac for prompt payment. Special rebate allowed to customer in the nature of trade discount ₹ 5 lacs. Kindly advise him whether he has to get his accounts audited u/s 44AB of the Income Tax Act, 1961. [Nov. 13 (4 Marks)]
Answer:
Computation of Turnover for the purpose of determining requirement of Tax Audit:
As per section 44AB of the Income Tax Act, 1961, audit is required in case of every person carrying on business, if his total sales, turnover or gross receipts in business exceed ₹ 1 crore and in case of every person carrying on a profession, if his gross receipts from profession exceed ₹ 50 lakhs in any previous year.

As per Guidance Note on Tax Audit issued by the ICAI, the following points merit consideration for the purpose of computing turnover:

1. Discount allowed in the sales being in the nature of trade discount will be deducted from the turnover.
2. Cash discount otherwise than that allowed in a cash memo/sales invoice is in the nature of a financing charge and hence should not be deducted from the turnover.
3. Special rebate allowed to a customer can be deducted from the sales if it is in the nature of trade discount.
4. Price of goods returned should be deducted from the turnover even if the returns are from the sales made in the earlier year/s.
   Accordingly, the turnover of Mr. A may be computed as under:
   

Conclusion: As the effective turnover of Mr. A is less than ₹ 1 Crore, the provisions related to tax audit are not applicable to Mr. A.

Question 6.
Comment with respect to computation of total sales, turnover or gross receipts in business exceeding the prescribed limit under section 44AB of Income Tax Act, 1961.

1. Discount allowed in the sales invoice
2. Cash discount
3. Price of goods returned related to earlier year
4. Sale proceeds of fixed assets. [May 15 (4 Marks)]

Answer:
Computation of Total Sales:

1. Discount allowed in the sales invoice: Deducted from turnover as it reduces the sale price.
2. Cash discount: Not to be deducted being in the nature of financing charge.
3. Price of goods returned related to earlier year: Deducted from turnover.
4. Sale proceeds of fixed assets: Will not form part of turnover as these are not held for resale.

Question 7.
Write short note on: Circumstances in which Chartered Accountant in practice or firm of Chartered Accountants cannot conduct tax audit u/s 44AB of the Income Tax Act, 1961 of the concern.
Answer:
Circumstances in which CA in Practice cannot conduct tax audit:
As per Explanation to Sec. 288, the following persons cannot conduct tax audit:

• In case of a company, the person who is not eligible for appointment as an auditor of as per provisions of Sec. 141(3) the Companies Act, 2013 cannot conduct tax audit.
• In case of assessee other than company, following persons cannot conduct tax audit:
  1. the assessee himself or in case of the firm or AOP or HUF, any partner of the firm, or member of the AOP or the HUF;
  2. in case of the assessee, being a trust or institution, any person referred to in Sec. 13(3);
  3. the person who is competent to verify the return in accordance with the provisions of section 140;
  4. arty relative of any of the persons referred above;
  5. an officer or employee of the assessee;
  6. an individual who is a partner, or who is in the employment, of an officer or employee of the assessee;
  7. an individual who, or his relative or partner
     (a) is holding any security of, or interest in, the assessee: Provided that the relative may hold security or interest in the assessee of the face value not exceeding ₹ 1,00,000;
     (b) is indebted to the assessee: Provided that the relative may be indebted to the assessee for an amount not exceeding ₹ 1,00,000;
     (c) has given a guarantee or provided any security in connection with the indebtedness of any third person to the assessee: Provided that the relative may give guarantee or provide any security in connection with the indebtedness of any third person to the assessee for an amount not exceeding ₹ 1,00,000;
  8. a person who, whether directly or indirectly, has business relationship with the assessee of such nature as may be prescribed;
  9. a person who has been convicted by a court of an offence involving fraud and a period of ten years has not elapsed from the date of such conviction.

Question 8.
M/s. SB & Co. has been appointed as tax auditor under section 44AB of Income Tax Act, 1961 by Woodcraft Interior Consultants, a professional partnership firm, having turnover ₹ 1.25 Crores. M/s RS & Co. are the statutory auditors of the firm but they are unable to give their report on the financial statements of the firm. M/s. SB & Co., have, however, completed their tax audit and want to issue their reports. Comment. [May 17 (4 Marks)]
Answer:
Tax Audit Report in case of Partnership firm :
Proviso to Sec. 44AB of Income Tax Act, 1961 lays down that where the accounts of an assessee are required to be audited by or under any other law, it shall be sufficient compliance with the provisions of this section, if such person get the accounts of such organisation audited under such other law before the specified date and furnishes by that date, the report of the audit as required under such other law and a further report by an Accountant in the form prescribed under this section.

There is no statutory requirement of audit of a firm under the provisions of Partnership Act, 1932. So, appointment of two auditors one as tax auditor and another as statutory auditor does not appears to be correct.

It is also provided under Section 44AB that the tax auditor should report whether in his opinion the particulars in respect of Form 3CD are true and correct. The audit report is in the form of 3CA if accounts are being examined under the requirements of provisions of any other Act, otherwise report should be in Form 3CB.

In the present case, assessee is a partnership firm and appoints separate persons as tax auditor and statutory auditor. Statutory auditor is not able to give their report on financial statements of firm.

Conclusion: Form No. 3CA requires the tax auditor to enclose a copy of the audit report conducted by the statutory auditor. Where the report of the statutory auditor is not available for whatever reasons, it will be possible for the tax auditor to give his report in Form No. 3CB and to certify the relevant particulars in Form No. 3CD.

Note: There is no requirement of statutory audit under Partnership Act, 1932.Hence while answering the question, this fact also need to be stated.

“ICAI Examiner Comments”
Majority of candidates failed to discuss the circumstances in which Form 3CA and Form 3CB are furnished by a Tax auditor. Some candidates wrongly discussed the relationship between , the statutory auditor and tax auditor and concluded wrongly that Tax auditor has to wait till statutory audit is completed.
It seems that Candidates failed to understand the requirement of the question.

Question 9.
Mr. PK is conducting the Tax audit u/s 44AB of the Income Tax Act, 1961 of MG Ltd. for the year ended 31st March, 2021. There is a difference of opinion between Mr. PK and the Management in respect of certain information to be furnished in Form No. 3CD. As a tax auditor, Mr. PK has to report whether the statement of particulars in Form 3CD are true and correct and the same is to ; be annexed to the report in Form No. 3CA. Advise on the matters to be considered by Mr. PK while furnishing the particulars in Form No. 3CD. [Nov. 19 – New Syllabus (4 Marks)]
Answer:
Form 3CD – Considerations for auditor while furnishing particulars in Form 3CD:
While furnishing the particulars in Form No. 3CD it would be advisable for the tax auditor to consider the following:
1. If a particular item of income/expenditure is covered in more than one of the specified clauses, care should be taken to make a suitable cross reference to such items at the appropriate places.

2. If there is any difference in the opinion of the tax auditor and that of the assessee in respect of any information furnished in Form No. 3CD, the tax auditor should state both the view points and also the relevant information in order to enable the tax authority to take a decision in the matter.

3. If any particular clause in Form No. 3CD is not applicable, he should state that the same is not applicable.

4. In computing the allowance or disallowance, he should keep in view the law applicable in the relevant year, even though the form of audit report may not have been amended to bring it in conformity with the amended law.

5. In case the prescribed particulars are given in part to the tax auditor or relevant form is incomplete and the assessee does not give the information against all or any of the clauses, the auditor should not withhold the entire audit report. In such a case, he can qualify his report on matters in respect of which information is not furnished to him.

6. The information in Form No. 3CD should be based on the books of account, records, documents, information and explanations made available to the tax auditor for his examination.

7. In case the auditor relies on a judicial pronouncement, he may mention the fact as his observations in Form No. 3CA or Form No. 3CB, as the case may be.

Methods of Accounting & ICDSs (See. 145)

Question 10.
As the tax auditor of a non-corporate entity u/s 44AB of the Income Tax Act, 1961, how would you ensure compliance of section 145 of the Income Tax Act, 1961? [May 09 (8 Marks)]
Answer:
Compliance of Section 145:
Sec. 145(1) of Income Tax Act,1961 requires that the income chargeable under the head ‘PGBP’ or ‘Other sources’ shall, be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.

Sec. 145(2) provides that the C.G. may notify in the Official Gazette from time to time Income Computation and Disclosure Standards to be followed by any class of assessee or in respect of any class of income.

Sec. 145(3) provides that where the A.O. is not satisfied about the correctness or completeness of the accounts of the assessee, or where method of accounting provided u/s 145(1) have not been regularly followed by the assessee or income has not been computed in accordance with thq Standards notified u/s 145(2), the A.O. may make an assessment in a manner provided in Sec. 144 of the Income Tax Act.

Auditor has to therefore ensure the following:
(a) That the entity follows either the cash or accrual method of accounting and same is to be reported in clause 13(a) of form 3CD.„
(b) Accounting policies has been disclosed separately.
(c) Provisions as stated in Income Computation and Disclosure Standards (ICDS) notified by Central Government u/s 145(2) has been complied with.

Question 11.
Discuss briefly Income Computation and Disclosure Standards to be followed by assessee under the Income-tax Law. [Nov. 09 (4 Marks)]
Answer:
Income Computation and Disclosure standards to be followed by assessee under Income Tax Law:
The Central Government has prescribed the following Income Computation and Disclosure Standard:

I	Accounting Policies
II	Valuation of Inventories
III	Construction Contracts
IV	Revenue Recognition
V	Tangible Fixed Assets
VI	Effects of Changes in Foreign Exchange Rates
VII	Government Grants
VIII	Securities
IX	Borrowing Costs
X	Provisions, Contingent Liabilities and Contingent Assets

The above Standards are to be followed by all assessee following mercantile system of accounting for computation of income under the head “PGBP” and “Other Sources”. Therefore, it is clear that those assessees who are following cash system of accounting need not follow the ICDSs notified above.

Form 3CD

Question 12.
Mr. A, is a renowned lawyer. During the previous year, he collected GST of ₹ 25 lakhs but utilized it for his personal use. The department issued a show cause notice to him as to why the tax, collected by him, is not deposited to the government account. He appeared before the department and stated his inability to pay the sum due to financial crisis. The proceedings are still pending.

Mr. A instructed his tax auditor not to disclose his GST registration details, while filling particulars to be furnished in Form No. 3CD, believing that the income tax department might trace his scrutiny proceedings details pending before department which would bring disrepute to his profession.
Or
You are appointed as tax auditor of Mr. X a practicing advocate in Agra. During the previous year he collected GST of ₹ 7 lakhs but utilized for personal use. The department issued a show cause notice to him why the tax collected by him in not deposited to the Government account. He appeared before the department and stated his inability to pay the sum due to financial crisis. The proceedings are still pending. Mr. X requests you not to disclose his GST registration details while filling particulars to be furnished in From No. 3CD.
As a tax auditor how would you deal with this? [May 16 (4 Marks)]
Answer:
Reporting Requirement of Form 3CD:
Clause (4) of Form 3CD, requires tax auditor to mention the registration number or any other identification number, if any, allotted, in case the assessee is liable to pay indirect taxes like excise duty, service tax, sales tax, G§T, customs duty, GST etc. Auditor is required to furnish the details of registration numbers as provided to him by the assessee.

The reporting is however, to be done in the manner or format specified by the e-filing utility in this context. The information may be obtained and maintained in-the following format:

Sr. No.	Relevant Indirect Tax Law which requires registration	Place of Business/profession/ service unit for which registration is in place/or has been applied for	Registration/Identification number

In the present case Mr. X has defaulted in payment of GST for the previous year. Consequently, the department issued a show cause notice for such non-payment of tax. The arguments are still going on between the department and assessee. He also restrained his tax auditor from disclosing GST registration details in tax audit report.

Conclusion: Instruction of Mr. X is not acceptable as clause 4 of Form 3CD requires tax auditor to furnish the details of registration number or other identification number of assessee, if assessee is required to pay indirect taxes like excise duty, service tax, GST etc.

“ICAI Examiner Comments”
Most of the candidates failed to visualize the requirement of the question and answered about reporting requirement due to non-payment of GST under clause 41 instead of GST registration number under clause 4.

Question 13.
BB Ltd., a non-resident company, is engaged in the business of extraction of mineral oils, having i turnover of ₹ 20 lakhs during the financial year 2020-21. The company claims that its profits and gains chargeable to tax under the head “Profits and gains of business or profession” is lower than the deemed income chargeable under section 44BB of the Income Tax Act, 1961. Therefore, it decided to get its accounts audited under section 44AB of the Income Tax Act, 1961. Discuss reporting requirement of Form 3CD in this behalf.
Answer:
Reporting Requirement of Form 3CD:
BB Ltd., is a non-resident company which is engaged in the business of extraction of mineral oils, hence, its income is chargeable in accordance with the provisions of section 44BB of the Income Tax Act, 1961. But as the company is claiming lower income in comparison to deemed income u/s 44BB, provisions of Section 44AB in relation to audit has to be complied with.

Clause (8) of Form 3CD, requires tax auditor to mention the relevant clause of section 44AB under which the audit has been conducted. Accordingly, auditor is required to mention clause (c) of Section 44AB which requires tax audit.

Further, as per Clause (12) of Form 3CD, if the profit and loss account of the assessee includes any profits and gains assessable on presumptive basis, the tax auditor has to indicate the amount and the relevant sections.

Conclusion: Under Clause 8, auditor is required to indicate the relevant clause of Section 44AB under which audit is to be conducted and in addition under clause 12, auditor is required to indicate the amount of profits of business covered u/s 44BB and the relevant section.

Question 14.
State the reporting requirement regarding books of account (prescribed, maintained and examined) in Form No. 3CP of Tax Audit under Section 44AB of the, Income Tax Act, 1961.
Answer:
Reporting Requirement regarding books of account in Form 3CD:
Clause 11 of Form 3CD requires the following reporting requirements in Form 3CD w.r.t. books of account:
(a) Whether books of account are prescribed under section 44AA, if yes, list of books so prescribed.

(b) List of books of account maintained and the address at which the books of account are kept. (In case books of account are maintained in a computer system, mention the books of account generated by such computer system. If the books of account are not kept at one location, please furnish the addresses of locations along with the.details of books of account maintained at each location.)

(c) List of books of account and nature of relevant documents examined.

Question 15.
Write a short note on: Method of Accounting in Form No. 3CD of Tax Audit.
Answer:
Method of Accounting in Form No. 3CD:
Clause 13 of Form 3CD requires the following reporting requirements w.r.t. Methods of accounting:
(a) Method of accounting employed in the previous year

(b) Whether there had been any change in the method of accounting employed vis-a-vis the method employed in the immediately preceding previous year.

(c) If answer to (b) above is in the affirmative, give details of such change, and the effect thereof on the profit or loss.

Serial number	Particulars	Increase in profit (₹)	Decrease in profit (₹)

(d) Details of deviation, if any, in the method of accounting employed in the previous year from accounting standards prescribed under section 145 and the effect thereof on the profit or loss.

Question 16.
A leading manufacturing concern valued its inventory following a method not in line with the provisions of Income Computation and Disclosure Standard (ICDS)- 2 ‘Valuation of Inventories’.
In such a situation, discuss the relevant clause of Form No. 3CD under which the tax auditor is required to report?
Or
ABC Ltd., is consistently following accounting standards as required u/s 133 of the Companies Act, 2013. During your tax audit u/s 44AB of the Income-tax Act, 1961, the board of directors informed ! you that profits of the company is properly arrived at and the ASs applicable to it have been followed consistently and as such, there need not be any adjustments to be made as per ICDS notified u/s 145 of Income-tax Act, 1961. Based on the requirement of Law in this regard, examine the validity of the stand of management in this regard. [May 18-New Syllabus (5 Marks)]
Answer:
Reporting for Adjustment to be made to the Profits or Loss for complying with ICDSs:
Central Government has, in exercise of the powers conferredu/s 145(2) of Income-tax Act, 1961, notified ten income computation and disclosure standards (ICDSs) to be followed by all assesses (other than an individual or a HUF who is not required to get his accounts of one previous year audited in accordance with the provisions of section 44AB), following the mercantile system of accounting, for the purposes of computation of income chargeable to income-tax under the head “Profit and gains of business or profession” or “Income from other sources”.

Clause 13(d) of Form No. 3CD of the tax audit report requires the tax auditor to state whether any adjustment is required to be made to the profits or loss for complying with the provisions of income computation and disclosure standards notified under section 145(2) of the Income- tax Act, 1961.

Further, the tax auditor is also required to report under Clause 13(e), if answer to Clause 13(d) above is in the affirmative i.e. the auditor is required to give details of such adjustments as follows:

		Increase in Profit (₹)	Decrease in Profit (₹)	Net Effect (₹)
ICDS 1	Accounting Policies
ICDS II	Valuation of Inventories                      •	–
ICDS III	Construction Contracts                      :
ICDS IV	Revenue Recognition
ICDS V	Tangible Fixed Assets
ICDS VI	Changes in Foreign Exchange Rates
ICDS VII	Governments Grants
ICDS VIII	Securities
ICDS IX	Borrowing Costs
ICDS X	Provisions, Contingent Liabilities & Contingent Assets
	Total

Conclusion: Contention of the management that they are following Accounting Standards and need not to make any adjustments as per ICDS, is not correct. Thus, ABC Ltd. is required to adjust the profits in compliance with ICDS.

Question 17.
A leading jewellery merchant used to value his inventory at cost on LIFO basis. However, for the current year, in view of requirements of AS-2, he changed over to FIFO method of valuation. The difference in value of stock amounted to ₹ 55 lakhs which is higher than that under the previous method. In such a situation, what are the reporting responsibilities of a Tax Audit u/s 44AB of Income Tax Act, 1961.
Answer:
Reporting of Changes in Valuation of Inventory:

• As per the provisions of Income Tax Act, 1961, if the change in method of valuation is bona fide, and is regularly and consistently adopted in the subsequent years as well, such change would be permitted to be made for tax purposes.
• In the instant case, the change in the valuation of stock is pursuant to mandatory requirements of the AS-2 ‘Valuation of Inventories’ and therefore should be viewed as bona fide change and allowed.
• Clause 14 of Form 3CD also requires in this regard reporting over the following:
  1. Method of valuation of closing stock employed in the previous year.
  2. In case of deviation from the method of valuation prescribed under section 145A, and the effect thereof on the profit or loss.
• In reference to Section 145A, auditor is not required to report change in the method of valuation of purchases, sales and inventories which is regularly employed by the assessee. Auditor is required to adjust the valuation for any tax, duty, cess or fee actually paid or incurred by the assessee, if the same had not already been adjusted.

Question 18.
T Ltd’s previous year ended on 31st March 2021. During that period, it made a claim for refund of customs duty which was admitted as due by the customs authorities during April 2021. T Ltd. neither credited the claim in the profit and loss account nor reported the same in clause 16(h) of Form 3CD for the reason that this has been admitted as due by the authorities only in the next financial year. Further T Ltd. had changed the method of determination of cost formula for the purpose of stock valuation from FIFO basis to Weighted Average Cost basis, but that was also not reflected in clause 13(b) of Form 3CD which requires reporting on change in accounting method employed. Comment. [May 12 (6 Marks)]
Answer:
Reporting requirement of Claim of Custom Duty Refund and change in Accounting policy:
As per Clause 16(b) of form 3CD, the details of custom duty refund, if admitted as due but not
reported in Profit and Loss account, are to be stated. But the claim which have been admitted as due after the relevant previous year need not be reported.

Hence non-reporting of claim of refund of custom duty in Form 3 CD is in order.

Clause 13 (b) of Form 3CD required reporting in case of change in method of accounting employed. But in the present case there is a change in accounting policy. Change in Accounting policy cannot be treated as change in method of accounting, hence does not require any reporting under clause 13(b) in Form 3CD.

Hence non-reporting of method of valuation in Form 3CD is in order.

Question 19.
While conducting the tax audit of A & Co. you observed that it made an escalation claim to one of its customers but which was not accounted as income. What is your reporting responsibility? [May 11 (4 Marks)]
Answer:
Clause 16(c) of Form 3CD:
A tax auditor has to report under clause 16(c) of Form 3CD on any escalation claim accepted during the previous year and not credited to the profit and loss account under clause 16(c) of Form 3CD.

The escalation claim accepted during the year would normally mean “accepted during the relevant previous year.’’ If such amount is not credited to Profit and Loss Account the fact should be reported. The system of accounting followed in respect of this particular item may also be brought out in appropriate cases. If the assessee is following cash basis of accounting with reference to this item, it should be clearly brought out since acceptance of claims during the relevant previous year without actual receipt has no significance in cases where cash method of accounting is followed.

Escalation claims should normally arise pursuant to a contract (including contracts entered into in earlier years), if so permitted by the contract. Only those claims to which the other party has signified unconditional acceptance could constitute accepted claims. Mere making claims by the assessee or claims under negotiations cannot constitute accepted claims. After ascertaining the relevant factors as outlined above, a decision whether to report or not, can be taken.

Question 20.
While writing the audit program for tax audit in respect of A Ltd. you wish to include possible in; stances of capital receipt if not credited to Profit & Loss Account which needs to be reported under clause 16(e) of Form 3CD. Please elucidate possible instance. [May 13 (4 Marks)]
Or
What can be the possible instance of capital receipt which, if not credited to the profit and loss account, needs to be reported in form 3CD? [Nov. 15 (4 Marks)]
Or
In the course.ofyour tax audit assignment u/s44AB of the Income-tax Act, 1961 of Dream Bank Ltd. You have instructed your assistant to find out receipt of capital nature which might not have been credited to Profit & Loss Account and needs to be reported in Para 16(e) of 3CD. Your audit assistant seeks your guidance in reporting the same. Specify any four illustrative examples of such receipt. [May 19 – New Syllabus (4 Marks)]
Answer:
Instances of Capital receipt:
(a) Capital subsidy received in the form of Government grants, which are in the nature of promoters’ contribution i.e., they are given with reference to the total investment of the undertaking or by way of contribution to its total capital outlay. For e.g., Capital Investment Subsidy Scheme.

(b) Government grant in relation to a specific fixed asset where such grant is shown as a deduction from the gross value of the asset by the concern in arriving at its book value.

(c) Compensation for surrendering certain rights.
(d) Profit on sale of fixed assets/investments to the extent not credited to the profit and loss account.

Audit procedures:
Capital receipts are not generally credited to profit and loss account hence the auditor should take enough care to check out any transaction generating the capital receipts by –

• Enquiring whether the assessee is in receipt of any amount of capital nature during the previous year.
• Going through the financial statements, in particular reserve account, to ascertain whether the assessee has received any such receipts and credited them directly to reserve account.
• Enquiring whether the assessee has credited such receipts to profit and loss account.
• Checking that any such receipts is accounted for in terms of method of accounting followed by the assessee.

“ICAI Examiner Comments”
Some examinees wrote about Form No. 3CD. Also, few examinees discussed about the items of profit and loss account which was not required.

Question 21.
ABC Ltd., a manufacturing concern, sold a house property in Mumbai for a consideration of ₹ 48 lakh, to Mr. X on 1.8.2020. ABC Ltd. had purchased the house property in the year 2014 for ₹ 30 lakh. The stamp duty value on the date of transfer, i.e., 01.08.2020, is ₹ 65 lakh for the house property. How would you deal this matter in tax audit report?
Answer:
Reporting of Sale of property at a price lower than value adopted for the purpose of stamp duty:
Clause 17 of Form 3CD requires tax auditor to furnish certain information if land or building or both is transferred during the previous year for a consideration less than value adopted by any authority of a State Government as under:

Details of Property	Consideration Received or Ac­crued	Value adopted or assesses or assessable

For this purpose, auditor should obtain a list of all properties transferred by the assessee during the previous year and furnish the amount of consideration received or accrued, as disclosed in the books of account of the assessee.

For reporting the value adopted or assessed or assessable, the auditor should obtain from the assessee a copy of the registered sale deed. In case the property is not registered, the auditor may verify relevant documents from relevant authorities or obtain third party expert like lawyer, solicitor representation to satisfy the compliance of section 43CA/section 50C of the Act.

Conclusion: ABC Ltd. has sold the house property to Mr. X at a price lower than value adopted for stamp duty purpose, tax auditor is required to report on the same under Clause 17 of Form 3CD.

Question 22.
A is proprietor of a firm M/s ABC & Co. The firm has a turnover of ₹ 500 lakhs during the financial year ended 31.03.2021. The firm sold land and building during the year for a consideration of ₹ 15 lakhs, whose value for stamp duty purpose was ₹ 16 lakhs. As the Tax Auditor of the said firm, is the above to be reported? If yes, how will you report the same? [Nov. 19 – Old Syllabus (4 Marks)]
Answer:
Reporting of Sale of property at a price lower than value adopted for the purpose of stamp duty:
Clause 17 of Form 3CD requires tax auditor to furnish certain information if land or building or both is transferred during the previous year for a consideration less than value adopted by any authority of a State Government as under:

Details of Property	Consideration Received or Accrued	Value adopted or assesses or assessable

For this purpose, auditor should obtain a list of all properties transferred by the assessee during the previous year and furnish the amount of consideration received or accrued, as disclosed in the books of account of the assessee.

For reporting the value adopted or assessed or assessable, the auditor should obtain from the assessee a copy of the registered sale deed. In case the’ property is not registered, the auditor may verify relevant documents from relevant authorities or obtain third party expert like lawyer, solicitor representation to satisfy the compliance of section 43CA/section 50C of the Act.

Conclusion: ABC & Co. has sold the house property to Mr. X at a price lower than value adopted for stamp duty purpose, tax auditor is required to report on the same under Clause 17 of Form 3CD.

Note: Suggested answer oflCAI also requires reporting under Clause 29B. Reporting under clause 29B is required when the assessee receives any property. But in this case the assessee, i.e.firm ABC and Co. sold its property, hence no reporting required under Clause 29B.

Question 23.
As an auditor of a partnership firm under section 44AB of the Income Tax Act, 1961, how would you report on the following: Capital Expenditure incurred for scientific research assets. [Nov. 12 (2 Marks)]
Answer:
Reporting of Capital Expenditure incurred on Scientific Research Assets in Form 3CD:
Clause 19 of Form 3CD requires the auditor to report the following:

1. Amount debited to profit and loss account.
2. Amounts admissible as per the provisions of the Income Tax Act, 1961 and also fulfils the conditions, if any specified under the relevant provisions of Income Tax Act, 1961 or Income Tax Rules, 1962 or any other guidelines, circular, etc., issued in this behalf.

Question 24.
As a tax auditor how would you deal and report the following: An assessee has incurred payments to clubs. [Nov. 11 (2 Marks)]
Or
As an auditor of a partnership firm under section 44AB of the Income Tax Act, 1961, how would you report on the following: Expenditure incurred at Clubs. [Nov. 12 (2 Marks)]
Answer:
Reporting of Payment to Club in Form 3CD:

• Clause 21(a) of Form 3CD requires the tax auditor is required to furnish the details of amounts debited to the profit and loss account, being in the nature of capital, personal, advertisement expenditure etc.
• Such reporting requires the tax auditor to report on the
  (a) Expenditure incurred at clubs being-entrance fees and subscriptions; and
  (b) Expenditure incurred at clubs being cost for club services and facilities used.
• The payments made may be in respect of directors and other employees in case of companies, and for partners or proprietors in other cases .
• The fact whether such expenses are incurred in the course of business or whether they are of personal nature should be ascertained.

Question 25.
M/s PQRS& Associates is appointed for conducting tax audit as per Income Tax Act, 1961 of QW Ltd., a cotton textile company. The Company had incurred ₹ 6 lac towards advertisement expenditure on a brochure/pamphlet published by a political party in Pune. Advise the auditor whether such expenditure should be included in the tax audit report or not. [RTP-Nov. 20]
Answer:
Expenses on Advertisement in the Media of a Political Party:
Clause 21(a) of Form 3 CD requires the tax auditor to furnish the details of amounts debited to the Profit and Loss Account, being in the nature of advertisement expenditure in any souvenir, brochure, tract, pamphlet or the like published by a political party in his tax audit report.

In the given situation, M/s PQRS & Associates is appointed for conducting tax audit as per Income Tax Act, 1961 of QW Ltd., a cotton textile company. The Company had incurred ? 6 lac towards advertisement expenditure on a brochure/pamphlet published by a political party.

Conclusion: Advertisement expenditure of ₹ 6 lac on brochure/pamphlet published by a political party shall be reported in the tax audit report as per Clause 21(a) of Form 3CD.

Question 26.
ABC Ltd., engaged in the manufacturing of goods carriage, appointed you as the tax auditor for the financial year 2020-21. How would you deal with the following matters in your tax audit report:

1. Payments of 6 invoices of ₹ 5,000 each made in cash to Mr. X, engaged in leasing of goods carriages on 4th July, 2020.
2. Payments of 2 invoices of ₹ 18,000 each made in cash to Mr. Y, engaged in leasing of goods carriages on 5th July, 2020 and 6th July, 2020 respectively.
3. Payment of ₹ 40,000 made in cash to Mr. Z, engaged in leasing of goods carriages on 7th July, 2020 against an invoice for expenses booked in 2019-20.

Answer:
Reporting of Payments Exceeding ₹ 35,000 in Cash:
Clause 21(d) (A) and 21(d)(B) of Form 3CD, requires tax auditor to scrutinize on the basis of the examination of books of account and other relevant documents/evidence, whether the expenditure covered under section 40A(3) and 40A(3A) respectively read with rule 6DD were made by account payee cheque drawn on a bank or account payee bank draft. If not, the same has to be reported under above mentioned clauses.

As per section 40A(3) of the Income Tax Act, 1961, an expenditure is disallowed if the assessee incurs any expenses in respect of which payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on bank or account payee draft, exceeds ? 10,000. However, in case of payment made for plying, hiring or leasing of goods carriage, limit is ₹ 35,000 instead of ₹ 10,000.

As per section 40A(3A) of the Income Tax Act, 1961, where an allowance has been made in the assessment for any year in respect of any liability incurred by the assessee for any expenditure and subsequently during any previous year the assessee makes payment in respect thereof, otherwise than by an account payee cheque drawn on a bank or account payee bank draft, the payment so made shall be deemed to be the profits and gains of business or profession and accordingly chargeable to income-tax as income of the subsequent year if the payments made to a person in a day, exceeds ₹ 10,000 (₹ 35,000 in case of plying, hiring or leasing of goods carriages).

Based on the above mentioned provisions, following conclusion may be drawn:

1. Payments of 6 invoices of ₹ 5,000 each aggregating ₹ 30,000 made in cash on 4th July, 2020 need not be reported as the aggregate of payments do not exceed ₹ 35,000.
2. Payments of 2 invoices of ₹ 18,000 each made in cash on 5th July, 2020 and 6th July, 2020 respectively aggregating ₹ 36,000 need not be reported as the payment do not exceed ₹ 35,000 in a day.
3. Payment of ₹ 40,000 made in cash against an invoice for expenses booked in 2019-20 is likely to be deemed to be the profits and gains of business or profession under section 40A(3A) of the Income Tax Act, 1961. Thus, the details of such amount need to be furnished under clause 21(d)(B) of Form 3CD.

Question 27.
Mr. R, the Tax Auditor finds that some payments inadmissible under Section 40A(3) were made, and advised the client to report the same in Form 3CD. The client contends that cash payments were made since the other parties insisted upon the same and did not have Bank Accounts. Comment. [Nov. 10 (5 Marks)]
Answer:
Reporting for Cash payments above ₹ 10,000:
Clause 21(d) of Form 3CD requires tax auditor to report on disallowance under section 40A(3). Disallowance u/s 40A(3) of the Income Tax Act, 1961 is attracted if the assessee incurs any expenses in respect of which payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on bank or account payee draft, exceeds ₹ 10,000.

However, there are certain cases as specified in Rule 6DD, in which, disallowance under section 40A(3) would notbe attracted. Cash payment made on insistence of other parties on the contention that they do not have bank accounts is not covered under the list of exceptions provided under Rule 6DD.

In the present case, tax auditor is required to scrutinize on the basis of the examination of books of account and other relevant documents/evidence, whether the expenditure covered under section 40A(3) read with rule 6DD were made by account payee cheque drawn on a bank or account payee bank draft. If not, the same has to be reported under abovementioned clause.

Conclusion: Payments made by the XYZ Ltd. are inadmissible u/s 40A(3) of the Income Tax Act, 1961 and hence, needs to be reported under clause 21(d) of Form 3CD.

Question 28.
XYZ Ltd. pays ₹ 90,000 for its 10 employees to a Hotel as boarding and lodging expenses of such employees for a conference. The Company pays the amount in cash to the Hotel. The Hotel gives 10 bills each amounting to ₹ 9,000. The Company contends that each bill is within the limit, so there is no violation of the provisions of the Income Tax Act, 1961. As the tax auditor, how would you deal with the matter in your tax audit report for the Assessment Year 2021-22? [Nov. 14 (4 Marks)]
Answer:
Reporting for Cash payments above ₹ 10,000:
Clause 21(d) of Form 3CD requires tax auditor to report on disallowance under section 40A(3). Disallowance u/s 40A(3) of the Income Tax Act, 1961 is attracted if the assessee incurs any expenses in respect of which payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on bank or account payee draft, exceeds ₹ 10,000.

In the given case, the tax auditor found that a hotel issued 6 bills to XYZ Ltd. Each amounting to ₹ 9,000 for boarding & lodging expenses of 6 employees. XYZ Ltd. In aggregate has paid ₹ 90,000 to the hotel in cash. Consequently, no expenditure shall be allowed for deduction as per the provisions of section 40A(3).

Contention of the company that each bill is within the limit is not tenable since aggregate of payments need to be considered.

Conclusion: Payments made by the XYZ Ltd. are inadmissible u/s 40A(3) of the Income Tax Act, 1961 and hence, needs to be reported under clause 21(d) of Form 3CD.

Question 29.
Answer the following: As the tax auditor of a Company, how would you report on payments exceeding ? 10,000 made in cash to a supplier against an invoice for expenses booked in an earlier year?
Answer:
Reporting of payments exceeding ₹ 10,000 in cash:

• Reporting is required under clause 21(d) of Form 3CD for the payments exceeding ₹ 10,000 made in cash against an invoice for expenses booked in an earlier year.
• Section 40A(3A) disallowed an expense payment exceeding ₹ 10,000 made in cash against an invoice booked in an earlier year.
• Clause 21(d) of Form 3CD requires furnishing of the amount inadmissible u/s 40A(3) read with rule 6DD along with computation.
• The entire amount paid, is likely to be disallowed u/s 40A(3A) of the Income Tax Act, 1961.

Question 30.
You are the Tax auditor of BL & Co., a partnership firm engaged in the business of plying of Goods Carriages for the financial year 2020-21 having a turnover of Rs. 20 crores. How would you deal and report on the following:
(i) Payment of Rs. 50,000 in cash to Mr. R on 10th September, 2020 towards settlement of invoice for expenses accounted in financial year 2019-20.
(ii) Payments of 3 invoices of Rs. 15,000 each made in cash to Mr. Y on 8th, 9th, 10th, July, 2020 respectively. [Nov. 18-Old Syllabus (4 Marks)]
Answer:
Reporting of Payments Exceeding Rs. 10,000 in Cash:
Clause 21(d)(A) and 21(d)(B) of Form 3CD, requires tax auditor to scrutinize on the basis of the examination of books of account and other relevant documents/evidence, whether the expenditure covered under section 40A(3) and 40A(3A] respectively read with rule 6DD were made by account payee cheque drawn on a bank or account payee bank draft. If not, the same has to be reported under above mentioned clauses.

As per section 40A(3) of the Income-tax Act, 1961, an expenditure is disallowed if the assessee incurs any expenses in respect of which payment or aggregate of payments made to a person in a day, otherwise than by an account payee cheque drawn on bank or account payee draft, exceeds Rs. 10,000. However, in case of payment made for plying, hiring or leasing of goods carriage, limit is Rs. 35,000 instead of Rs. 10,000.

As per section 40A(3A) of the Income-tax Act, 1961, where an allowance has been made in the assessment for any year in respect of any liability incurred by the assessee for any expenditure and subsequently during any previous year the assessee makes payment in respect there of, otherwise than by an account payee cheque drawn on a bank or account payee bank draft, the payment so made shall be deemed to be the profits and gains of business or profession and accordingly chargeable to income-tax as income of the subsequent year if the payments made to a person in a day, exceeds Rs. 10,000 (Rs. 35,000 in case of plying, hiring or leasing of goods carriages).

Based on the above-mentioned provisions, following conclusion may be drawn:

1. Reporting required under Clause 21(d)(B) w.r.t. payment of ₹ 50,000.
2. Reporting required under Clause 21(d) (A) w.r.t. each payment as individual payment made on a day exceeds ₹ 10,000.

Note: Limit of ₹ 35,000 is not applicable as this limit is applicable when the payee is engaged in the business of plying of goods carriages. In this case, payer is engaged in the business of plying of goods carriages hence, limit of ₹ 10,000 will be applicable assuming that payee is not engaged in business of plying of goods carriages.

Question 31.
Mr. Sharma carries on the business of dealing and export of diamonds. For the year ended 31st March 2021, you as the tax auditor find that the entire exports are to another firm in U.S.A. which is owned by Mr. Sharma’s brother. Comment.
Answer:
Export Payments to a Relative:

• Clause 23 of Form 3CD, requires the tax auditor to specify particulars of payments made to persons specified u/s 40(A)(2)(b) of the Income Tax Act, 1961. Persons specified in the said section are relatives of an assessee and sister concerns, etc.
• In the instant case, however, Mr. Sharma has not made any payments to his brother. On the contrary, he must have received payments from him against exports made and, thus, this clause would not be applicable to him.

Auditor will nonetheless be still as a part of his normal audit planning would be required to verify whether the exports are genuine, i.e., whether the diamonds have been delivered by verifying the necessary delivery documents, relevant invoices, etc., the reasonableness of the price and whether the export realisations have been received.

Question 32.
As a tax auditor how would you deal and report the following: An assessee has paid rent to his brother ₹ 2,50,000 and paid interest to his sister ₹ 4,00,000. [Nov. 11 (2 Marks)]
Or
As an auditor appointed under section 44AB of the Income Tax Act, 1961, how would you verify and report on the following: The assessee has paid rent of ₹ 5 lakhs for premises to his brother. [Nov. 17 (3 Marks)]
Answer:
Reporting of payment of rent and interest to relative:
Clause 23 of Form 3CD requires the tax auditor to furnish the particulars of payments made to persons specified under Section 40A(2)(b) of the Income Tax Act, 1961. In relation to an individual, the specified persons include any relative of the assessee (i.e. Husband, Wife, Brother, Sister or any other Lineal Ascendant or Descendant).

In the present case, an assessee has paid rent to his brother and interest to his sister which may be disallowed if, in the opinion of the Assessing Officer, such expenditure is excessive or unreasonable having regard to:

1. the fair market value of the goods, services or facilities for which the payment is made; or
2. for the legitimate needs of business or profession of the assessee; or
3. the benefit derived by or accruing to the assessee from such expenditure.

Conclusion: Auditor is required to report the payments made to specified persons.

“ICAI Examiner Comments”
Examinees have discussed generally on vouching and verification aspects instead of mentioning the reporting requirements of Tax auditor. Some examinees failed to explain with reference to Clause 23 of Form 3CD for reporting the particulars of payments made to persons : specified under section 40A(2)(b) of the Income Tax Act, 1961. Instead of explaining Tax audit ; requirements few examinees wrongly discussed AS 18 and SA 550 on “Related parties”.

Question 33.
You are doing Tax Audit of Private Limited Company for the financial year.ending 31st March, 2021. During audit, you notice that the company is not regular in deposit of VAT/GST and there remains pendency every year. The details of VAT/GST payable are:

1. GST payable as on 31/03/2020 of FY 2019-20 was ₹ 200 Lakh and out of which ₹ 100 Lakh was paid on 15/09/2020 and ₹ 50 Lakh on 30/03/2021 and balance of ₹ 50 Lakh is outstanding.
2. GST payable of current financial year 2020-21 was ₹ 100 lakh and out of this, 40 Lakh was paid on 25/05/2020 and balance of ₹ 60 Lakh remained unpaid till the due date of return.

The date of Tax Audit report and due date of return was 30th September.
Now as a Tax Auditor, how/where the said transaction will be reflected in Tax Audit Report under Section 43B(a)? [MTP-Oct. 19, RTP-Nov. 19]
Answer:
Reporting in Tax Audit Report:
Any amount of GST/Tax payable on the last day of previous year (opening balance) as well as on the last day of current year has to be reported in Tax Audit Report under clause 26(A) and 26(B) in reference of section 43B.

Clause 26(A) dealt GST/VAT payable on the pre-existed of the first day of the previous year but was not allowed in the assessment of any preceding previous year and was either paid (clause 26(A)(a))/or and, not paid during the previous year (clause 26(A)(b)}

The details will be as under in regard to opening balances:
Liability Pre-existed on the previous year.

It has been assumed that 100 lakh was allowed in last year as it was paid before the due date of return.
Liability incurred during the previous year

Question 34.
How will you verify the Income & Expenditure of earlier years credited/debited in current year for reporting under clause 27(b) of 3CD while carrying out Tax Audit u/s 44AB of the Income Tax Act, 1961? [Nov. 19 – Old Syllabus (5 Marks)]
Answer:
Reporting under Clause 27(b) of Form 3CD:
Clause 2 7 (b) requires the tax auditor to report particulars of income or expenditure of prior period credited or debited to the profit and loss account. Information under clause 27(b) would be relevant only in those cases where the assessee follows mercantile system of accounting.

The tax auditor may perform following procedures for the purpose of reporting under clause 2 7(b):
(i) Ask the assessee to furnish a schedule indicating particulars of expenditure/incdme of any earlier year debited/credited to the Profit & Loss account of the relevant previous year.

(ii) Verify various expenses account to see whether any expenditure pertaining to any earlier year has been debited to the profit and loss account. For example, an assessee might have paid some certification fee etc., for four years in the year under audit. In that case payment of expenses for previous three years would be prior period payment.

(iii) Also see that all such items are properly disclosed.

(iv) Check while conducting the routine audit, that there is no expenditure/income relating to earlier years that has not been mentioned in the particulars furnished by the assessee.

(v) In case of cash system of accounting, there will be no amount to be disclosed under this head.

Question 35.
ABC Pvt. Ltd. was XYZ Pvt. Ltd. are the Companies in which public are not substantially interested. During the previous year 2020-21, ABC Pvt. Ltd. received some property being shares of XYZ Pvt. Ltd. The details of which are provided below:
No. of shares – 1000
Face Value – ₹ 10 per share
Aggregate Fair Market Value – ₹ 1,00,000
Consideration Value – Nil
As the tax auditor how would you deal with the situation? [May 16 (4 Marks), MTP-April 18]
Answer:
Reporting requirement in Form 3CD:
Clause 28 of Form 3CD requires the auditor to report “Whether during the previous year the assessee has received any property, being share of a company not being a company in which the public are substantially interested, without consideration or for inadequate consideration as referred to in section 56(2) (viia), if yes, please furnish the details of the same”

Section 56(2) (viia) provides that where a firm or a company not being a company in which the public are substantially interested, receives, in any previous year any property being shares of a company (not being a company in which the public is substantially interested, without consideration, the aggregate fair value of which exceeds ₹ 50,000, the whole of the aggregate fair market value of such property shall be chargeable to income-tax under the head “Income from other sources”. Finance Act, 2017 amends Sec. 56(2), in accordance with which provisions of Section 56(2)(viia) are not applicable for transactions taken place on or after 01.04.2017.

This transaction now, falls under clause (x) of Sec. 56(2). For transactions falling u/s 56(2)(x), reporting is required as per Clause No. 29B, which provides as follow:
(a) Whether any amount is to be included as income chargeable under the head ‘income from other sources’ as referred to in clause (x) of sub-section (2) of section 56? (Yes/ No)

(b) If yes, please furnish the following details:

1. Nature of income;
2. Amount (in Rs.) thereof.

“ICAI Examiner Comments”
Candidates, in general, were not aware of the Section 56(2) (viia) of the Income Tax Act, 1961 and clause 28 of Form 3CD. Quite a few treated it as capital gain instead of “income from other sources”

Question 36.
While doing Tax Audit, under section 44AB of the Income-tax Act, 1961, of the accounts of Glue Private Limited for the Assessment Year 2021-22, it was found that during the Financial Year 202021, Glue Private Limited had received 9,000 shares, the market value of which was Rs. 90,000 on the date of transfer, at a price of Rs. 45,000 from Stick Private Limited. The Management of Glue Private Limited maintained that the transaction was-as per the terms of negotiations and there would be no cause for the Auditor to bring this matter in his Tax Audit Report-Comment. [Nov. 18 – New Syllabus (5 Marks)]
Answer:
Reporting requirement in Form 3CD:
Clause 28 of Form 3CD requires the auditor to report “Whether during the previous year the assessee has received any property, being share of a company not being a company in which the public are substantially interested, without consideration or for inadequate consideration as referred to in section 56(2) (viia), if yes, please furnish the details of the same”.

Section 56(2) (viia) provides that where a firm or a company not being a company in which the public are substantially interested, receives, in any previous year any property being shares of a company (not being a company in which the public is substantially interested, without consideration, the aggregate fair value of which exceeds Rs. 50,000, the whole of the aggregate fair market value of such property shall be chargeable to income-tax under the head “Income from other sources”. Finance Act, 2017 amends Sec. 56(2), in accordance with which provisions of Section 56(2)(viia) are not applicable for transactions taken place on or after 01.04.2017.

This transaction now, falls under clause (x) of Sec. 56(2). For transactions falling u/s 56(2) (x), reporting is required as per Clause No. 29B, which provides as follow:
(a) Whether any amount is to be included as income chargeable under the head ‘income from other sources’ as referred to in clause (x) of sub-section (2) of section 56? (Yes/ No)

(b) If yes, please furnish the following details:

1. Nature of income;
2. Amount (in Rs.) thereof.

As per Sec. 56(2) (x), where any person receives, in any previous year, from any person or persons on or after the 1st day of April, 2017, any property, other than immovable property, for a consideration which is less than the aggregate FMV of the property by an amount exceeding ? 50,000, the aggregate FMV of such property as exceeds such consideration, shall be chargeable to income-tax under the head “Income from other sources”.

Conclusion: In the present case, difference of Fair Market Value and consideration paid is lower than Rs. 50,000, auditor is required to state the answer with “No”.

Question 37.
AB Ltd. is a company in which public are not substantially interested. During the previous year 2020-21, the company issued shares to residents of India and provides you the following data related to such issue:
No. of shares issued – 1,00,000
Face Value – ₹ 10 per share
Fair Market’Value (FMV) – ₹ 60 per share
Consideration received – ₹ 80 per share
The management of the company contends that, it is a normal issue of shares, thus, needs not to be reported. As the tax auditor of AB Ltd., how would you deal with the matter in your tax audit report?
Answer:
Reporting for Issue of Shares for Value Exceeding Fair Market Value:
Clause 29 of Form 3CD requires tax auditor to report whether, the assessee received any consideration for issue of shares which exceeds the fair market value of the shares as referred to in section 56(2)(viib) of the Income Tax Act, 1961.

Section 56(2)(viib) provides that where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be chargeable to income-tax under the head “Income from other sources”.

In the present case, AB Ltd. is a company, in which public is not substantially interested. Company has received consideration for issue of shares of ₹ 80 per share (Face value ₹ 10 per share + Premium ₹ 70 per share) which exceeds the face value of ₹ 10 per share and fair market value of the shares of ₹ 60 per share, and hence the case covered u/s 56(2)(viib).

Conclusion: Tax auditor of AB Ltd. is required to furnish the details of shares issued under clause 29 of Form 3CD.

Question 38.
As a tax auditor how would you deal and report the following: An assessee has borrowed ₹ 50 Lakhs from various persons. Some of them by way of cash and some of them by way of Account payee cheque/draft. (Nov. 11 (3 Marks)]
Or
As an auditor appointed under section 44AB of the Income Tax Act, 1961, how would you verify and report on the following: The assessee has borrowed ₹ 50 lakhs from various persons partly in cash and partly by account payee cheque. [Nov. 17 (3 Marks)]
Answer:
Reporting of Borrowing in Form 3CD:
Clause 31(a) of Form 3CD requires tax auditor to report on below mentioned particulars of each loan or deposit for an amount exceeding the limit specified in section 269SS taken or accepted during the previous year:

1. name, address and permanent account number (if available with the assessee) of the lender or depositor;
2. amount of loan or deposit taken or accepted;
3. whether the loan or deposit was squared up during the previous year;
4. maximum amount outstanding in the account at any time during the previous year;
5. whether the loan or deposit was taken or accepted by cheque or bank draft or use of electronic clearing system through a bank account;
6. in case the loan or deposit was taken or accepted by cheque or bank draft, whether the same was taken or accepted by an account payee cheque or an account payee bank draft.

Conclusion: Auditor should verily the compliance with the provisions of section 2 69SS of the Income Tax Act and report the same under Clause 31(a) of Form 3CD.

“ICAI Examiner Comments”
Examinees failed to explain with reference to clause 31 of Form 3CD for reporting on the mode of amount borrowed. Few examinees have discussed generally on vouching and verification aspects instead of mentioning the reporting requirements of Tax auditor. Few examinees mixed up section 40A(3) of the Income-tax Act, 1961 on disallowance of cash payments i exceeding ₹ 20000 instead of explaining the provisions of section 269SS.

Question 39.
Discuss the reporting requirements in Form 3CD of the Tax Audit Report u/s 44AB of the Income-tax Act, 1961 for the Brought forward loss or depreciation allowance.
Answer:
Reporting requirements for Brought forward loss or depreciation allowance in Form 3CD:
Clause 32(a) of Form 3CD requires the following details of brought forward loss or depreciation allowance, in the following manner, to the extent available:

1	Serial Number
2	Assessment Year
3	Nature of loss/allowance (in rupees)
4	Amount as returned (in rupees)*
5	All losses/allowances not allowed u/s 115BAA
6	Amount as adjusted by withdrawal of additional depreciation on account of opting for taxation u/s 115BAA^
7	Amounts as assessed (give reference to relevant order)
8	Remarks

*If the assessed depreciation is less and no appeal pending than take assessed.
To be filled in for assessment year 2020-21 only.”

Question 40.
Tiger Ltd., is a company engaged in the production of wool. Along with its production business, it is also engaged in buying and selling of securities with the expectation of a favourable price change. During the year, its speculation loss on account of purchase and sale of securities was to the tune of ₹ 12 lacs.

As a tax auditor, what is the reporting requirement in Form 3CD u/s 44AB of the Income Tax Act, 1961? [May 18 – Old Syllabus (4 Marks)]
Answer:
Reporting Requirement Under Clause (32)(e) of Form 3CD:
Clause 32(e) of Form 3CD requires the auditor to furnish the details of speculation loss if any incurred during the previous year, in case of a company which is deemed to be carrying on a speculation business.

Explanation to section 73 provides that where any part of the business of a company consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carrying on a speculation business to the extent to which the business consists of the purchase and sale of such shares.

In the present case, SL Pvt. Ltd. is engaged in production business and side by side dealing in buying and selling of securities with the intention of speculation and during the current financial year, hence the company will be deemed to be carrying on a speculation business.

Conclusion: Tax auditor of is required to furnish the details under Clause 32(e) of Form 3CD with respect to the speculation loss of? 12 lakhs made during the year.

Question 41.
Discuss the reporting requirement in Form 3CD of Tax Audit Report under Section 44AB of the Income-tax Act, 1961 for the Tax Deducted at Source.
Answer:
Reporting requirement for Tax Deducted at Source in Form 3CD:
Clause 34(a) of Form 3CD requires the auditor to furnish below mentioned information if the assessee is required to deduct or collect tax as per the provisions of Chapter XVII-B or Chapter XVII-BB:

1. Tax deduction and collection Account Number (TAN)
2. Section
3. Nature of payment
4. Total amount of payment or receipt of the nature specified in (3)
5. Total amount on which tax was required to be deducted or collected out of (4)
6. Total amount on which tax was deducted or collected at specified rate out of (5)
7. Amount of tax deducted or collected out of (6)
8. Total amount on which tax was deducted or collected at less than specified rate out of (7)
9. Amount of tax deducted or collected on (8)
10. Amount of tax deducted or collected not deposited to the credit of the Central Government out of (6) and (8)

Question 42.
ABC Printing Press, a proprietary concern, made a turnover of above ₹ 103 lacs for the year ended 31.03.2021. The Management explained its auditor Mr. Z, that it undertakes different job work orders from customers. The raw materials required for every job are dissimilar. It purchases the raw materials as per specification/requirements of each customer, and there is hardly any balance of raw materials remaining in the stock, except pending work-in-progress at the year end. Because of variety and complexity of materials, it is rather impossible to maintain a stock-register. Give your comments. [Nov. 09 (5 Marks), RTP-May 20]
Answer:
Non-maintenance of stock register:
As per requirement of Para 35(b) and Para 11(b) of Form 3CD, auditor is required to report on the details of stock and account books (including stock register) maintained.

Auditor need to verify the closing stock of raw materials and finished products and by-products of the entity. In case the details are not properly maintained, he has to specifically mention the same, with reasons for non-maintenance of stock register by the entity.

The explanation of the entity for the use of varieties of raw materials for different jobs undertaken may be valid. But the auditor needs to verily the specified job-orders received and the different raw materials purchased for each job separately. The auditor may also enquire with the other similar printers in the locality to ensure the prevailing custom.

Conclusion: Auditor is required to report under Para 35(b) and 11(b) about non-maintenance of stock register.

Question 43.
Discuss the reporting requirements in Form 3CD of the Tax Audit Report u/s 44AB of the Income-tax Act, 1961 for the Tax on distributed profits.
Answer:
Reporting for tax on distributed profits in Form 3CD:
Clause 36 of Form 3CD requires the following reporting requirements in the case of a domestic company, w.r.t. tax on distributed profits under section 115-0 in the following form:
(a) total amount of distributed profits;
(b) amount of reduction as referred to in section 115-0(1A)(i);
(c) amount of reduction as referred to in section 115-0(1A)(ii);
(d) total tax paid thereon;
(e) dates of payment with amounts.

Question 44.
ABC Ltd., having principal place of business in Delhi, is engaged in the generation, transmission, distribution and supply of electricity throughout the India. The management of the company came to know that the provisions related to maintenance of cost records and cost audit are applicable to the company. The company, therefore, appointed a cost auditor for the financial year 2020-21.

The cost auditor reported certain disqualifications in Form CRA-3 of the cost audit report to which the management of the company disagreed.

The management of ABC Ltd. instructed its tax auditor not to reveal any of the disqualifications related to the cost audit while filling particulars to be furnished in Form No. 3CD contending that the disqualifications are not relevant and there is no correlation between tax audit and cost audit as well. As a tax auditor, how would you deal with the matter? [MTP-Aug. 18]
Answer:
Reporting Requirement for Disqualifications in Cost Audit Report:
Clause (3 7) of Form 3 CD requires cost auditor to comment upon whether cost audit was carried out and if yes, details of disqualification or disagreement on any matter/item/value/quantity as may be identified by the cost auditor should be reported.

For this purpose, tax auditor should obtain the copy of cost audit report from the assessee. Tax auditor is not required to make any detailed study of such report, he is required to take note of the details of disqualification on any matter/item/value/quantity as may be reported by the cost auditor.

In the present case, the cost auditor of ABC Ltd. has reported certain disqualifications in Form CRA-3 of the cost audit report. Tax auditor of is required to provide the details of disqualifications reported by the cost auditor as per Clause (37) of the Form 3CD.

Conclusion: Contention of management is not acceptable as auditor is required to provide the details of disqualifications on any matter/item/value/quantity as may be reported/identified by cost auditor under clause 37 of Form 3CD.

Question 45.
Write a short note on – Accounting ratios in Form 3 CD of Tax Audit.
Or
As a tax auditor, which are the accounting ratios required to be mentioned in the report in case of manufacturing entities? Explain in detail any one of the above ratios and how does it help the tax auditor in his analytical review.
Answer:
Accounting Ratios in Form 3CD:
Clause 40 of Form 3CD requires the details regarding turnover, gross profit, etc., for the previous year and preceding previous year as mentioned below:

Serial number	Particulars	Previous year	Preceding previous year
1.	Total turnover of the assessee
2.	Gross profit/turnover
3.	Net profit/turnover
4.	Stock-in-trade/turnover
5.	Material consumed/finished goods produced

The details required to be furnished for principal items of goods traded or manufactured or services rendered. These ratios have to be given for the business as a whole and not product wise.

Details of Profitability Ratio: By relating sales with the Gross profit or net profit, auditor may ascertain the operating efficiency of an enterprise. Auditor is required to inquire any variations in any of these ratios. The fall in the gross profit ratio and net profit ration alert the auditor who, in turn should ask the management for the reasons thereof and which should be’ carefully examined by him.

Details of Stock in trade/Turnover Ratio: The relationship of stock-in-trade to turnover over a period of time would reveal whether the entity has been accumulating stocks or there is a decline in the same. The auditor may obtain data for about 4-5 years, compute ratio of stock-in-trade/turnover and compare the change made. A study of this relationship would reveal whether stocks are being accumulated or they are dwindling over a period. Such information would provide an input to tax auditor as to whether figures of either stock or turnover are being manipulated.

Question 46.
ABC Ltd. is engaged in providing certain services on which it did not pay any service tax. As per company, said services were not liable to service tax. However, Department issued a show cause notice to company demanding service tax along with interest worth ₹ 5,45,000 on the same and such demand was also confirmed. An appeal was filed to the Commissioner of Central Excise (Appeals) which passed an order which upheld the demand on company. Company, being aggrieved by the order of the Commissioner of Central Excise (Appeals), decided to file an appeal to the CESTAT against such order. ABC Ltd. has also requested the tax auditor not to report as those services were not liable for service tax and it has also filed an appeal for the same.
Answer:
Reporting of Taxation demands in Form 3CD:
Clause 41 of Form 3CD requires auditor to furnish the details of demand raised or refund issued during the previous year under any tax laws other than Income Tax Act, 1961 and Wealth tax Act, 1957 along with details of relevant proceedings.

In the instant case, ABC Ltd. is engaged in providing certain services on which it did not paid any service tax. Therefore, Department issued a show cause notice and demand for Service Tax along with interest thereon. ABC Ltd. has also filed an appeal mentioning that said services are not liable to service tax, but Central Excise (Appeals) has passed an order confirming the demand and ABC Ltd. being aggrieved by the order of Commissioner of Central Excise (Appeals) decided to file an appeal against the same. ABC Ltd. also requested the tax auditor not to report on the same as the concerned services were not liable for any service tax and they have also decided to file an appeal to CESTAT against the order of Commissioner of Central Excise (Appeals).

Tax auditor should obtain a copy of all the demand/refund orders issued by the Excise Authorities. It may be noted that even though the demand/refund order is issued during the previous year, it may pertain to a period other than the relevant previous year.

Conclusion: Request of ABC Ltd. is not acceptable as clause 41 of Form 3CD requires tax auditor to furnish the details of demand raised during the previous year under any tax law other than Income Tax Act, 1961.

General Questions

Question 47.
Comment on the following: The Statutory Auditor of P Ltd. is also appointed to undertake its Tax Audit. After the completion of Statutory Audit, he finalizes Tax Audit without referring to Standards on Auditing and Guidance Notes of Institute as lie is of the opinion that Tax Audit relates only to tax matters with which the Income tax department is concerned. Moreover, the assessee furnishes to the auditor only the requisite information and records for the purpose of Tax Audit. [MTP-Aug. 18]
Answer:
Applicability of Standards on Auditing and Guidance Note in case of Tax Audit:
In the case of a statutory audit, auditor is required to express his opinion as to whether the financial statements give a true aiffl fair view of the state of affairs in the case of the balance sheet and in the case of the profit and loss account/income and expenditure account, of the profit/loss or income/expenditure.

While carrying out tax audit u/s 44AB, the tax auditor is required to state whether in his opinion, the particulars as stated in Form 3CD.are true and correct. The audit report given u/s 44AB assist the income-tax department in ensuring compliance of provisions of Income Tax Act by the assessee. In order that the tax auditor may be in a position to explain any question which may arise later on, it is necessary that he should keep necessary working papers about the evidence on which he has relied upon while conducting the audit and also maintain all his necessary working papers.

While carrying out the audit, auditor is required to refer the “Standards on Auditing” as well as the “Guidance Note on Audit Reports and Certificate for Special Purposes”. If the statutory auditor is also appointed to undertake tax audit, it is advisable to carry out both the audits concurrently.

SA 210, “Agreeing the Terms of Audit Engagements” requires an auditor to establish whether the precondition for an audit are present so as to accept or continue an audit engagement. Accordingly, the auditor is required to obtain agreement of management that it acknowledges and understands its responsibilities to provide the auditor with:
(a) Access to all information of which the management is aware that is relevant to the preparation of the financial statements such as records, documentation and other matters.
(b) Additional information that the auditor may request the management for the purpose of the audit, and
(c) Unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence.

Conclusion: Opinion of the auditor that Tax Audit relates only to tax matters with which the Income tax department is concerned and there is no need to refer the Standards on Auditing and Guidance Notes of Institute is not correct. Moreover, since the appointment of the tax auditor is made by assessee, it will be in the interest of the assessee to furnish all the information and explanation and produce books of account and records required by the tax auditor.

Question 48.
State with reasons whether an auditor conducting tax audit ‘certifies’ or ‘reports’ on information contained in the statement of particulars attached to the tax audit report under Section 44AB of Income-tax Act, 1961.
Answer:
Tax Audit report u/s 44AB – Certification/Reporting:
Section 44AB of the Income-tax Act, 1961 requires the auditor to submit the audit report in the Form 3CA/Form 3CB. The statement of particulars as required in Form 3CD are required to be annexed to the main audit report. In Form 3CA, auditor is required to report whether the particulars in Form 3CD are true and correct. Form 3CB, in addition, requires the auditor to give his opinion as to whether or not the accounts audited by him give a true and fair view.

The term “certificate” is used where the auditor verifies the accuracy of facts while the term “report” is used in case the auditor is expressing an opinion. Form 3CA/Form 3CB requires the auditor to report on true and correct aspects of particulars stated in Form 3CD, it can be said that an auditor conducting tax audit “certifies” the information contained in the statement of particulars.

However, it is significant to examine whether all 41 clauses included in the statement of particulars are capable of being simply certified en the basis of books of account or there are some clauses in respect of which different auditor(s) may hold different opinion.

There are several matters (Clause 14/Clause 18) on which the auditor is required to exercise judgment while giving his report on various amounts included in the statement of particulars, which may at times lead to different figures by different persons reporting thereon. There can also be situations leading to difference of opinion between the tax auditor and the assessee.

Conclusion: Auditor conducting tax audit “reports” on certain information, apart from “certifying” factual information contained in the statement of particulars annexed to the tax audit report under section 44AB of the Income-tax Act, 1961.

Question 49.
State whether a Tax audit report can be revised and If so state those circumstances. [Nov. 08 (4 Marks), RTP-Nov. 19]
Or
You are doing the tax audit of a Limited Company. After submission of Tax Audit Report, management notices that there was apparent mistake of law and due to this mistake, revised the final accounts. As a tax auditor, company seeks your opinion whether the tax audit can also be revised or not. [RTP-Nov. 18]
Answer:
Revision of Tax Audit Report:
Normally, the report of the tax auditor cannot be revised later. However, when the accounts are revised in the following circumstances, the tax Auditor may have to revise his Tax audit report also.

1. Revision of accounts of a company after its adoption in the AGM.
2. Changes in law with retrospective effect.
3. Changes in interpretation of law through CBDT Circular, Notifications, Judgments, etc.

The Tax Auditor should state that it is a revised Report, clearly specifying the reasons for such revision with a reference to the earlier report.

Audit under GST Laws

Question 50.
Define the term Audit under CGST Act. Describe the statutory requirements of audit under CGST Act based on threshold limit.
Answer:
Meaning of Audit and Statutory Requirements of audit under CGST Act, 2017:
Sec. 2(13) of CGST Act, 2017 defines the term Audit as Audit means the examination of records, returns and other documents maintained or furnished by the registered person under this Act or the rules made thereunder or under any other law for the time being in force to verily the correctness of turnover declared, taxes paid, refund claimed and input tax credit availed, and to assess his compliance with the provisions of this Act or the rules made there under.

Statutory Requirements:
Sec. 35(5) of CGST Act, 2017: Every registered person whose turnover during a financial year exceeds the prescribed limit shall get his accounts audited by a Chartered Accountant or a Cost Accountant and shall submit
(a) a copy of the audited annual accounts,
(b) the reconciliation statement u/s 44(2) and
(c) such other documents in such form and manner as may be prescribed.

Rule 80(3) of CGST Rules, 2017: Every registered person whose aggregate turnover during a financial year exceeds ₹ 2 Cr. shall get his accounts audited and he shall furnish a copy of audited annual accounts and a reconciliation statement, duly certified, in FORM GSTR-9C.

Sec. 44(2) of CGST Act, 2017: Every registered person who is required to get his accounts audited in accordance with the provisions of Sec. 35(5) shall furnish, electronically, the annual return along with a copy of the audited annual accounts and a reconciliation statement, reconciling the value of supplies declared in the return furnished for the financial year with the audited annual F.S., and such other particulars as may be prescribed.

Question 51.
XYZ Limited is looking for an auditor for getting it accounts audited as per GST. Being an expert in the indirect taxes field XYZ Limited is seeking your advice on types of audit to be envisage as per GST Law. Explain. [RTP-Nov. 18]
Answer:
Types of Audit under GST Law:
Under GST Law, three types of audit may be conducted:
(1) Audit under based on turnover: As per Sec. 35(5) of CGST Act, 2017, Every registered person whose turnover during a financial year exceeds the prescribed limit shall get his accounts audited by a Chartered Accountant or a Cost Accountant and shall submit
(a) a copy of the audited annual accounts,
(b) the reconciliation statement u/s 44(2) and
(c) such other documents in such form and manner as may be prescribed.

As per Rule 80 (3) of CGST Rules, 2 017, every registered person whose aggregate turnover during a financial year exceeds Rs. 2Cr. shall get his accounts audited and he shall furnish a copy of audited annual accounts and a reconciliation statement, duly certified, in FORM GSTR-9C.

(2) Audit by Tax Authorities: As per Sec. 65 of CGST Act, 2017, the Commissioner or any officer authorised by him, by way of a general or a specific order, may undertake audit of any registered person for such period, at such frequency and in such manner as may be prescribed. Audit may be conducted at the place of business of the registered person or in their office.

(3) Special Audit: As per Sec. 66 of CGST Act, 2017, if at any stage of scrutiny, inquiry, investigation or any other proceedings, any officer not below the rank of Assistant Commissioner, having regard to the nature and complexity of the case and the interest of revenue, is of the opinion that the value has not been correctly declared or the credit availed is not within the normal limits, he may, with the prior approval of the Commissioner, direct such registered person by a communication in writing to get his records including books of account examined and audited by a chartered accountant or a cost accountant as may be nominated by the Commissioner.

Question 52.
Briefly discuss the provisions given under section 66 regarding special audit required under CGST Act.
Answer:
Provisions regarding Special Audit u/s 66:
(A) Directions for Special Audit
If at any stage of scrutiny, inquiry, investigation or any other proceedings, any officer not below the rank of Assistant Commissioner, having regard to the nature and complexity of the case and the interest of revenue, is of the opinion that the value has not been correctly declared or the credit availed is not within the normal limits, he may, with the prior approval of the Commissioner, direct such registered person by a communication in writing to get his records including books of account examined and audited by a chartered accountant ora cost accountant as may be nominated by the Commissioner.

Direction shall be issued in FORM GST ADT-03.

(B) Time limit for completion of Audit
The chartered accountant or cost accountant so nominated shall, within the period of 90 days, submit a report of such audit duly signed and certified by him to the said Assistant Commissioner mentioning therein such other particulars as may be specified.

(C) Extension of Time Limit
Assistant Commissioner may,
on an application made to him in this behalf by the registered person or the chartered accountant or cost accountant
or

for any material and sufficient reason, extend the said period by a further period of 90 days

(D) Opportunity to the registered person

• The registered person shall be given an opportunity of being heard in respect of any material gathered on the basis of special audit which is proposed to be used in any proceedings against him under this Act or the rules made thereunder.
• The registered person shall be informed of the findings of the special audit in FORM GST ADT-04.

(E) Audit Expenses and Remuneration
Expenses of examination and audit, including the remuneration of such chartered accountant or cost accountant, shall be determined and paid by the Commissioner and such determination shall be final.

(F) Action on basis of Audit Report
Where the special audit conducted results in detection of tax not paid or short paid or erroneously refunded, or input tax credit wrongly availed or utilised, the proper officer may initiate action under section 73 or section 74.

Question 53.
List the best practice that can be adopted for GST Audit.
Answer:
Best Practices for GST Audit:
Auditor should evaluate internal control so as to identify the areas to be focused. For this purpose, following practices may be adopted:

1. Auditor may verify the following:
   (a) Statutory Audit report which has specific disclosure w.r.t. to maintenance of record, stock and fixed assets.
   (b) Information System Audit report and the Internal Audit Report.
2. Internal Control questionnaire may be designed for GST compliance.
3. Generalised audit software may be used for GST audit which would ensure adoption of modern practice of risk based audit.
4. Reconciliation of the books of account or reports from the ERP’s to the return is also useful.
5. Trial balance should be reviewed for detecting any set off of expenses against incomes.
6. Purchases/expenses are to be reviewed to examine applicability of reverse charge applicable to goods/services.
7. Reconciliation of foreign exchange outgo would also be necessary to identify the liability of import of services.
8. Ratio analysis may also provide important information on areas of non-compliance.

Question 54.
Mr. X, an articled trainee in KPL and Associates, is assigned on a GST Audit assignment of Mohan Industries in Delhi. He is confused with the applicability of GST audit on Mohan Industries considering the definition of turnover in Sec. 35(5). Mohan Industries is a company with operations spread across India with aggregate annual turnover amounting to ₹ 8 crores (this turnover is spread across various cities). Will GST audit be applicable on Mohan Industries? Substantiate.
Answer:
Applicability of GST Audit:
As per Sec. 35(5) of CGST Act, 2017 read with Rule 80(3) of CGST Rules, 2017, the total turnover calculation for assessment of applicability of GST audit must be done on a PAN India basis, which means that once the turnover under the PAN India level is more than ₹ 2 crores, all business entities registered under GST for that PAN will be liable for GST audit for the financial year.

In the present case, aggregate annual turnover of Mohan industries amounting to ₹ 8 crores.

Conclusion: GST Audit will be applicable on Mohan Industries.

Question 55.
Radha Enterprises, a handloom shop with registered GST premise in Delhi, is having turnover of ₹ 55 lakhs, ₹ 45 lakhs and ₹ 50 lakhs for the quarter 2,3 and 4 respectively of the financial year 2017-18. It had good fortune turnover in quarter 1 of 2017-18 for ₹ 70 lakhs. Mr. Vasu, a Chartered Accou ntant, is appointed as tax consultant of Radha Enterprises. He is perplexed whether GST audit is applicable for his client. If so, substantiate with relevant section.
Answer:
Applicability of GST Audit:
As per Sec. 35(5) of CGST Act, 2017 read with Rule 80(3) of CGST Rules, 2017, if the annual turnover of a registered taxpayer is more than ₹ 2 crores in a financial year, he is required to get his accounts audited by a Chartered Accountant or Cost Accountant every year.

A financial year covers the 12-month period beginning from April of a calendar year to March of the next calendar year. However, for the financial year 2017-18, CBIC had clarified that the aggregate turnover for purpose of filing of reconciliation statement shall be reckoned for the period July, 2017 to March, 2018.

In the present case, turnover of the Radha enterprises for the financial year 2017-18 will be considered as ? 150 Lacs. Turnover for the period April to June will not be considered.

Conclusion: GST Audit will not be applicable to Radha Enterprises.

Question 56.
Mr Rohit, a practicing Chartered Accountant, has been appointed as GST auditor by ABC Ltd. The management has asked Mr. Rohit for GST audit along with compliance of GSTR 3B filing for the month of July and August 2020 and filing of annual return Form 9. Mr. Rohit contended that he has been appointed only for GST audit and the above are his scope limitations and cannot be conducted as the compliances and returns are to be filed by the management. In context of above dispute, you have to suggest whether the contention of Mr. Rohit is correct or not. Justify. [RTP-Nov. 20]
Answer:
Filing of annual return by GST Auditor:
Return filing and preparation of annual returns and their filing is the responsibility of entity’s management.

In the given case, auditor clearly states that the preparation and filing of returns does not fall within his scope of duties. Auditor’s scope of work under this assignment will not involve any management functions.

GST auditor’s prime responsibility on this engagement is limited to GST audit, audit of reconciliation statement between books of accounts vis a vis GST returns prepared by the entity and the GST auditor is not responsible for preparation of any such statements, uploading GST periodic returns for the relevant audit period.

Conclusion: Contention of Mr. Rohit is correct as return filing and preparation of annual returns and their filing was the responsibility of management.

Question 57.
PQR Ltd. is a textile company with aggregate turnover exceeding ₹ 2 crores. XYZ & Associates is a Chartered Accountant firm which has been appointed for GST audit of PQR Ltd. Mr. Sandhu, Chartered Accountant from XYZ & Associates, observes on 23 July 2020 that PQR Ltd. has not filed its GSTR 3B for the month of Feb. & its GSTR-1 return is also not complied with. What should Mr. Sandhu advise the client before conducting GST audit of PQR Ltd. [RTP-May 20, MTP-May 20]
Answer:
Conducting GST Audit:
The auditor should advise the company to file all the returns, i.e. GSTR-3B, GSTR-1 and annual returns (GSTR 9) before conducting GST audit so that auditor can validate and verify the returns filed by the company, verify the ITC claimed, verify output GST liability discharged by the company and to collate the data and reconciliations.

Auditor needs to have a comprehensive picture of –

1. Understanding of the back-up of monthly returns as well as annual return and understanding of reports generated by the GSTN portal as well as internal records of the company.
2. Understanding of the eligibility of Input Tax Credit (ITC) availed i.e. whether ITC availed by the company is creditable or not and understanding of reversal of ITC undertaken or applicable (if any).
3. Understanding of the taxability of outward supplies and transactions covered under Reverse Charge Mechanism and other miscellaneous/specific transactions and understanding of the positions taken on various transactions by the company.

Question 58.
SSM & Co. is a leading electronics company having multiple branches registered under GST in different states. The total aggregate turnover of all such branches exceed ₹ 2 crores. However, the Delhi branch has a turnover of 75 lakhs per annum. Pankaj Gupta, Finance officer of Delhi branch, is contending that GST audit is not applicable on Delhi branch as the turnover for that branch does not surpass the threshold. Whether the contention of Mr. Pankaj Gupta is correct or not. Substantiate. [MTP-May 20]
Answer:
Applicability of GST Audit:
As per Sec. 35(5) ofCGST Act, 2017 read with Rule 80(3) of CGST Rules, 2017, the total turnover calculation for assessment of applicability of GST audit must be done on a PAN India basis, which means that once the turnover under the PAN India level is more than ₹ 2 crores, all business entities registered under GST for that PAN will be liable for GST audit for the financial year.

In the present case, the total aggregate turnover of all branches of SSM & Co. exceed ₹ 2 crores. Finance officer of Delhi branch, is contending that GST audit is not applicable on Delhi branch as the turnover for that branch is only ₹ 75 Lacs.

Conclusion: Contention is not correct, as turnover calculation must be PAN-based, which means that once the turnover under the PAN is more than ₹ 2 crores, all business entities registered under GST for that PAN will be liable for GST audit for a financial year.

Question 59.
In terms of SI. No. 5G of Form GSTR 9C, the turnovers included in the audited financial statement for the period April 2017 to June 2017 shall be declared and deducted from the annual turnover to arrive at the turnover as per the GST Laws. Please specify which of the following supplies would i form part of reporting under turnover for the period April 2017 to June 2017:

(a) Goods were manufactured and cleared from a factory on 1.6.2017 on sale or approval basis. The goods were not approved by the recipient and returned back on 25.12.2017.

(b) Goods were manufactured and cleared from a factory located in Bangalore on 30.4.2017. The goods were cleared to its showroom located in Hyderabad and eventually been sold from there on 30.8.2017. The audit under the GST Law will be conducted for Bangalore GSTIN.

(c) Continuous supply of service in the nature of telecommunication service has been provided for the period 1.6.2017 to 30.6.2017. The bill is raised on 3.7.2017. The bill is payable by the customer only on 21.7.2017. Should the revenue be recognised in the month of June 2017 and reduced from total turnover or should it form part ofturnoverfortheperiodjuly2017 to March 2018 since the due date for payment of consideration is 21.7.2017. The entity recognised the revenue in the month of June 2017.

(d) Services were provided during the period June 2017. The service was completed on 20.6.2017, but invoice for the service was raised only on 1.8.2017.

(e) Service has been provided in the month of May 17 amounting to ₹ 1,00,000. Invoice has been raised within 30 days. There was a deficiency in the provision of service. The customer has paid only ₹ 20,000. The company has issued credit note amounting to ₹ 80,000 on 31.3.2018 and closed the customer’s account. Should any amount be reduced for the period April 2017 to June 2017. Are any adjustments required to be made for the period July 2017 to March 2018?
Answer:
Supplies to be reporting under turnover for the period April 2017 to June 2017 as per Table 5G of GSTR 9C:
(a) Since the goods were not approved and returned after the stipulated period of 6 months, the value of the said supplies would not be included in turnover in the audited financial statements. However, as perthe 2nd proviso to Section 142(12) ofthe CGST Act since thegoods were returned after 6 months from appointed date (i.e. 1.6.2017), GST would be payable for the tax period December 2017. Though the transaction originated in the period April 2017 to June 2017, the turnoverwill not be reflected under this SI. No. However, one may reflect such adjustment under Part II, SI. No. 5 Clause 0 – ‘Adjustments in turnover due to reasons not listed above’ as addition.

(b) The said goods are liable to excise duty since the goods have been cleared on 30.4.2017. The goods would not form part of turnover as per the financial statements since it is a branch transfer. It would stand reflected as branch transfers under the State Level VAT laws. Since audit is being conducted for Bangalore GSTIN and since supply has occurred from Hyderabad GSTIN, it would not be necessary to make adjustments for the period April 2017 to June 2017.

(c) As per proviso to Rule 3(b) of the Clause of Taxation Rules, 2011, the point of taxation in the impugned case would be the date on which bill has been raised i.e. 3.7.2017. Though invoice has been raised in the GST regime, service tax is payable since service has been provided during the currency of the Finance Act, 1994. The date for payment of service tax as per the machinery provision i.e. POTR, 2011 may be 3.7.2017 but the said service would be liable to service tax because the charge u/s 66B gets attracted for the period June 2017. Further as per Section 142(11)(b) since if a transaction is liable for service tax, then tax would not be payable under the GST Laws. Hence the said amount should be deducted as turnover under this SI. No. for the period April 2017 to June 2017.

(d) Since the invoice was raised after a period of thirty days, service tax is liable to be paid for the period ending June 2017 as per the proviso to Rule 3(a) of the Clause of Taxation Rules. Since the said transaction is liable to service tax, it is not liable to GST as per Section 142(ll)(b) of the CGST Act, though the invoice is raised during the GST regime. Therefore, the said value of invoice must be deducted for the period April 17 to June 2017.

(e) As per Sec. 142 (2) (b) of the GST Act, where in pursuance of contract entered into prior to the appointed date, where the price of service is revised downwards after 1.7.2017 and the provider issues a credit note within 30 days of such price revision, such credit note shall be deemed to have been issued in respect of outward supply, provided the recipient has reduced his input tax credit.

Assuming the input tax credit is reduced by the recipient, the credit note shall be reduced from outward supply for the tax period March 2018. Thus ₹ 80,000 would be reduced from the GST turnover for the period of March 2018. The said amount of ₹ 80,000 would be reduced from the turnover in the month of March 2018 because credit note is issued in the month of March 2018. Thus, only ₹ 20,000 is required to be reduced for the period April 2017 to June 2017, though invoice for ₹ 1,00,000 is issued in the month of May 2017 and service tax is paid on ₹ 1,00,000 in the month of May 2017.

Question 60.
As the auditor appointed under the GST Act, 2017, how would you verify’ Unbilled transactions at the beginning of the financial year’? [May 19 – Old Syllabus (5 Marks)]
Answer:
Verification of Unbilled transactions at the beginning of the financial year:
As per Table 5B of Form GSTR 9C unbilled revenue at the beginning of Financial Year is to be added to Turnover as per audited financial statements for the State/UT.

Unbilled revenue is the revenue recognized in the books of account before the issue of an invoice at the end of a particular period. AS-9/IND AS-115 provides for recognition of revenue on full completion/partial completion of the services though the due date for issuing invoice as per the contract would be on a later date.

Unbilled revenue which was recorded in the books of account on the basis of accrual system of accounting in the last financial year and was carried forward to the current financial year shall be declared in Table 5B. In other words, when GST is payable during the financial year on such revenue (which was recognized earlier), the value of such revenue shall be declared here.

For example, if ₹ 10 Crores of unbilled revenue existed for the financial year 2016-17, and during the current financial year, GST was paid on ₹ 4 Crores of such revenue, then value of ₹ 4 Crores shall be declared in Table 5B.

Unbilled revenue would appear in the profit and loss account of the previous year. For information of unbilled revenue at the beginning of a Financial Year, reference may be made to previous year’s audited financial statements.

Question 61.
While conducting GST audit of PQR Ltd. you have observed the following:
PQR Limited has exported goods to a Company located in USA. The value of goods is $100,000. The exchange rate on the date of filing Shipping Bill is:
CBEC notified ₹ 65 and RBI Reference rate ₹ 68.
At the time of receiving money, the bank exchanged the foreign currency at ₹ 70.
How would you report the adjustments in turnover due to foreign exchange fluctuations in Reconciliation statement in Form GSTR 9C prescribed in terms of Rule 80(3) of CGST Rules, 2017. [May 19 – Old Syllabus (5 Marks)]
Answer:
Adjustments in turnover due to foreign exchange fluctuations (+/-)
Table 5N of GSTR 9C requires reporting of any difference between the turnover reported in the Annual Return (GSTR 9) and turnover reported in the audited Annual Financial Statement due to foreign exchange fluctuations.

For the purpose of GST Returns, the exchange rate would be ₹ 65 and the exports to be disclosed in the GST Returns would be ₹ 65,00,000. For the purpose of accounting records, the exchange rate would be ₹ 68 and the exports recorded in the books would be ₹ 68,00,000. The difference in revenue being ₹ 300,000 would have to be reduced from the Annual turnover as per the financials to arrive at the revenue as per GSTR 9.

Additionally, difference in the amount booked in the accounts and actual amount received being ₹ 70 – ₹ 68 = ₹ 2 × $100,000 = ₹ 2,00,000 would be credited to the Profit and Loss Account as Forex Gain which again needs to be reduced from the Annual turnover as per the financials to arrive at the revenue as per GSTR 9.

Question 62.
PQR Limited has exported goods to a Company located in USA. The value of goods is $100,000. The exchange rate (Rs./$) on the date of filing Shipping Bill is
CBEC Notified ₹ 65
RBI Reference Rate ₹ 68
At the time of receiving money, the bank exchanged the foreign currency at ₹ 66.
State the adjustment to be reported by GST Auditor as per Table 5N of GSTR 9C.
Answer:
Adjustments in turnover due to foreign exchange fluctuations (+/-)
Table 5N of GSTR 9C requires reporting of any difference between the turnover reported in the Annual Return (GSTR 9) and turnover reported in the audited Annual Financial Statement due to foreign exchange fluctuations.

For the purpose of GST Returns, the exchange rate would be ₹ 65 and the exports to be disclosed in the GST Returns would be ₹ 65,00,000. For the purpose of accounting records, the exchange rate would be ₹ 68 and the exports recorded in the books would be ₹ 68,00,000. The difference in revenue being ₹ 300,000 would have to be reduced from the Annual turnover as per the financials to arrive at the revenue as per GSTR 9.

Additionally, the difference in the amount booked in the accounts and actual amount received being ₹ 66 – ₹ 68 = (-) ₹ 2 × $100,000 = (-) ₹ 200,000 would be debited to the Profit and Loss Account as Forex Loss which again needs to be added from the Annual turnover as per the financials to arrive at the revenue as per GSTR 9.

Question 63.
While conducting GST Audit of RST Limited, you have observed the following:
(i) RST Limited has exported goods to MNP Limited located in USA. The value of goods is $2,00,000.
The exchange rate (₹ /$) on the date of filing Shipping Bill is-
CBEC notified rate ₹ 65
RBI reference rate ₹ 68
At the time of receiving money, the bank exchanged the foreign currency at ₹ 70.
How would you report the adjustments, if any, in turnover due to foreign exchange fluctuations in Reconciliation statement in Form GSTR 9C prescribed in terms of Rule 80(3) of CGST Rules, 2017.

(ii) Will your answer be different if exchange rate (₹ /$) at the time of receiving money, the bank . exchanged the foreign currency at ₹ 66. [MTP-Oct. 20]

Question 64.
Please state whjch of the following are liable to reverse charge
(a) GTA issued a consignment note on 1.1.18. The consignment notes charges GST @ 12%. The 1 consignor has booked the GTA. The recipient has paid the freight to GTA on ‘to collect’ basis. Would this turnover be mentioned in Table 7D? ”
(b) GTA issued a consignment note on 1.1.18. The consignment note does not charge GST. The consignor has booked the GTA. The recipient has paid the freight to GTA on ‘to collect’ basis. Would this turnover be mentioned in Table 70?
(c) Advocate Mr. X has provided legal service and charged GST of ₹ 18 on his invoice of ₹ 100. The p advocate’s client has paid 118 to the advocate. The advocate has remitted ₹ 18 to government g and is of the opinion that the aforesaid transaction should not be reduced in Table 7D. Is the stand taken by the advocate correct?
Answer:
Liability of Reverse Charge: ‘
(a) The Consignment note contains GST @ 12 %, so reverse charge does not attract as per N.No. 13/17 CT(R) w.e.f. 22.8.10. Hence tax has to be paid by GTA under forward charge, and this transaction should not be entered in Table 7D.

(b) Since consignment note has not charged GST @ 12%, reverse charge provisions would apply.
Tax is to be paid by the person liable to pay freight, that is, the recipient and not the GTA under forward charge. Because of this, the impugned transaction has to be entered in Table 7D.

(c) Supplies by a Registered Person, whose suppliers are liable for reverse charge, are to be inserted in Table 7D. Legal service provided by the advocate to his client is liable for reverse charge (assuming all other conditions in reverse charge notification stand satisfied). Hence the impugned transaction should be inserted in Table 7D. GST wrongly collected and paid by the advocate under forward charge will not change the fact that the aforesaid service is liable to reverse charge and hence merits insertion in Table 7D.

 

Management and Operational Audit – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

Management and Operational Audit – CA Final Audit Question Bank

Management Audit

Question 1.
Management Audit and Operational Audit are complementary and supplementary to one another. Discuss. [Nov. 15 (4 Marks)]
Answer:
Management Audit and Operational Audit:
Management audit and Operational Audit are complementary and supplementary to one another. Management audit is concerned with the quality of managing, whereas operational audit is concerned with the quality of operations.

The basic difference between the two audits, is not in method, but in the level of appraisal. In management audit, the auditor evaluates decisions taken at the level of top management w.r.t. formulation of objectives, plans and policies whereas in operational audit auditor evaluates effectiveness, efficiency and economy of operations under management’s control along with recommendations for improvement.

In addition to what would normally be covered in an operational audit, management audit would also encompass the relevance and effectiveness of the aims, duties and decisions of management at various levels. Every aspect of the functions of Board of Directors should be in conformity with the objects set out in the constituting document.

Conclusion: From the above discussion which recognises management audit and operational audit as two identifiable exercises having a large area of overlapping jurisdiction, it may be convenient to consider them together to avoid duplication; and for this purpose, the expression “management and operational audit” may be acceptable as a management audit which includes within its scope all the elements of operational auditing.

“ICAI Examiner Comments”
Examinees failed to emphasize how the Operational audit and Management audit are complementary and supplementary to one another instead examinees merely wrote the meaning of Operational and Management audit.

Question 2.
K Ltd. requires you to organize a Management audit program. Briefly state a plan of action.
Answer:
Management Audit Program:
Management Audit Program may be based on the following plan of action:

1. Devising a statement of policy: in consultation with the top Management. The policy should ideally cover the scope, objective, the authority of the management audit function.
2. Location of audit function within the organization: The hierarchical status of management auditor and his team should be clearly defined.
3. Allocation of personnel: The management audit team should comprise of personnel who have adequate experience on various aspects of the organization.
4. Staff Training: In order to maintain qualitative standards, adequate and continuous training should be offered to the management audit team.
5. Time and other aspects: Adequate consideration should be given to time & cost involved in conducting the audit.
6. Frequency of audit: Should be determined on the basis of changes in industry and in consultation with the top management.

Question 3.
Write short note on: Management Audit Questionnaire. [Nov. 18 – Old Syllabus (4 Marks)]
Answer:
Management Audit Questionnaire:
A management audit questionnaire is an important tool for conducting the management audit. Through these questionnaires auditors make an inquiry into important facts by measuring current performance.

Objective of Management Audit Questionnaire:

• Comprehensive and Constructive examination of an organisation’s managementand its assigned tasks.
• Appraisal of management actions in accomplishing the organisation’s objectives.
• Highlight weaknesses and deficiencies of the organisation.
• Review of management functions of planning, organising, directing and controlling.
• Evaluation of effectiveness of decision making process in accomplishing the organisation objectives.

Working: There are three possible answers to the management audit questions – “Yes”, “No” and “N.A.”. “Yes” answer indicates that the specific area or function under study is functioning in an acceptable manner; no written explanation is needed in that case. “No” answer indicates unacceptable performance and requires explanation in writing. Those questions that are not applicable and should be ignored in the audit are checked in the “N.A.” column.

Importance: Management Audit Questionnaire not only serves as a management tool to analyse the current situation; but also, it enables the management auditors to identify the elements that are causing organisational difficulties and deficiencies.

Question 4.
Write a short note on – Management Audit Reports.
Answer:
Management Audit Reports:
Management Audit Reports are of following types:

1. Oral Reports: Oral reports are required in case of emergency. But they not considered reliable as no permanent record. Oral Reports helps in taking corrective steps timely.
2. Interim written report: These reports are issued in case of matters requiring early consideration so as to inform management before regular report.
3. Regular written reports: These are the formal report submitted after completion of work.
4. Summary written report: Summary reports are also known as “Flash” reports. These reports summarize various individual reports on integrated approach and facilitates management by exception.

Question 5.
Write short note on: Summary Written Report.
Answer:
Summary Written Report:
Summary Reports are also known as Flash Reports. These reports summarize various individual reports on integrated approach and facilitates management by exception.

They are significant highlights for immediate attention of top management. Generally suspected defalcations are reported briefly to the appropriate management official on the ‘flash’ basis, often ending up in referral for criminal investigation and legal action.

It is common practice in number of companies of issuing a report quite frequently summarising the various individual reports issued and describing the range of their contents in a very brief and comprehensive manner where only important points are highlighted.

Such reports are primarily issued for audit committees and other Top-level managers who do not have sufficient time to go through the elaborate reports and matters which are required to be brought to their notice for immediate action.

Question 6.
Briefly describe the general guidelines that may be observed while drafting a management audit report.
Answer:
General guidelines while drafting a management audit report:
Management Audit Reports may be drafted considering following guidelines:

1. Title: Title of the management audit report needs to be short but descriptive so that its subject matter can be easily identified.
2. Objectives: Management audit report may describe the objectives of the audit assignment.
3. Scope: Management audit report may give a brief description of the activities audited.
4. Findings, conclusions and opinions: Findings should be discussed comprehensively. Conclusions and opinions should normally follow the findings.
5. Recommendations: Management audit report may include recommendations for potential improvements. Management Auditor should avoid providing detailed procedures in the capacity of an auditor.
6. Auditee’s views: Auditee’s views about audit conclusions or recommendations may also be included in the audit report in appropriate circumstances.
7. Summary: In case of long reports, a summary of conclusions and recommendations may be given at the end.

Question 7.
Explain in brief the behavioural aspects encountered in the management audit and state the ways to solve them.
Answer:
Behavioral aspects encountered in management Audit:
1. Staff/Line conflict: Management auditors are staff people while the members of other departments are line people. Management auditors has superiority complex and they may think their approach and solutions are the only answers. Staff do not consider the line before advising, as a result Line may not use advice of staff properly. Line does not co-operate with staff and do not provide sufficient information to staff.

2. Control: The management auditor is expected to evaluate the effectiveness of controls, there is an instinctive reaction from the auditee that the report of the auditor may affect them. There is a fear that the action taken based on the management audit report will affect the line people.

Solution to behavioral problems

1. Demonstrate that audit is part of an overall programme of review for protective and constructive benefit.
2. Demonstrate the objective of review is to provide maximum service in all feasible managerial dimensions.
3. Perform the review to ensure minimum interference with regular operation.
4. Involve responsible officers in the process of review of the findings and recommendations before the audit report is formally released.
5. Create an atmosphere of trust and friendliness.

Operational Audit

Question 8.
Write short note on: Meaning and Types of Operational Audit.
Or
What are the types of Operational Audits? [Nov. 17 (6 Marks)]
Answer:
Meaning and Types of Operational Audit:
Operational Audit is the review and appraisal of operations of an organization conducted by competent independent person. It analyse the regular operations like production, purchase, sales etc. to check whether they are in tune with company’s policies, objectives and goals or not. It focuses more on Qualitative aspects of operations rather than regular accounting aspects.

Types of Operational Audit:
1. Functional Audits: A functional audit deals with one or more functions in an organization, for example, the payroll function for a division or for the company as a whole. A functional audit has the advantage of permitting specialization by auditors. They can more efficiently spend all their time auditing in that area. A disadvantage of functional auditing is the failure to evaluate interrelated functions.

2. Organizational Audits: An operational audit deals with an entire organizational units, such as a department, branch, or subsidiary. It emphasizes how efficiently and effectively functions interact. The plan of organization and the methods to coordinate activities are especially important in this type of audit.

3. Special Assignments: In operational auditing, special assignments arise at the request of management, for example, investigating the possibility of fraud in a division, making recommendations for reducing the cost of a manufactured product, etc.

“ICAI Examiner Comments”
Examinees have explained the functional audit but could not explain the other types of operational audits namely Organizational Audits and Special Assignments. Some examinees unnecessarily explained the objectives of operational audit and various types of audits viz., management audit, internal audit, cost audit, environmental audit, energy audit, compliance audit etc.

Question 9.
Briefly explain the objectives of Operational Audit. [May 11 (4 Marks)]
Answer:
Objectives of Operational Audit:
1. Appraisal of Controls: Operational auditing deals with the administrative controls and its purpbse is to determine whether the controls are adequate.

2. Evaluation of performance: In the task of performance evaluation, an operational auditor is heavily dependent upon availability of acceptable standards. The operational auditor cannot be expected to possess technical background in so many diverse technical fields obtaining even in one enterprise.

3. Appraisal of objectives and plans: In performance appraisal, the operational auditor is basically concerned not so much with how well technically the operations are going on, but with accumulating information and evidence to measure the effectiveness, efficiency and economy with which the operations are being carried on.

4. Appraisal of organisational structure: In evaluating organisational structure, the operational auditor should consider whether the structure is, in conformity with the management objectives and it is drawn up on the basis of matching of responsibility and authority.

Question 10.
In evaluating the organisational structure of a company, what aspects may be considered by the operational auditor to achieve his objectives? [May 18 – Old Syllabus (4 Marks)]
Answer:
Appraisal of Organisational Structure:
Organisational structure is an important area for appraisal by operational auditor as it provides the line of relationships and delegation of authority and tasks. In evaluating organisational structure, the operational auditor should consider the following:

1. Whether the organizational structure is in conformity with the management objectives
2. Whether it is drawn up on the basis of matching of responsibility and authority.
3. Whether the line of responsibility from the top to the bottom is clearly discernible from the structure?
4. Whether the delegation of responsibility and authority at each stage is clear and overlapping are avoided?

Question 11.
Mr. ‘P’ have been appointed as operational auditor of M/s Books & Magazine Ltd. And observed a totalling error in invoice of ₹ 1,000. He has not taken care of the same saying that this is out of scope of his work. Comment. [May 14 (3 Marks)]
Answer:
Scope of Operational Audit:
Operational Audit is the review and appraisal of operations of an organization conducted by competent independent person. It analyse the regular operations like production, purchase, sales etc. to check whether they are in tune with company’s policies, objectives and goals or not. It focuses more on Qualitative aspects of operations rather than regular accounting aspects.

In carrying out his work, operational auditor will have to exercise judgment to evaluate evidence in connection with the situations and issues; he will have to get the assistance of norms and standards in every operating field to be able to objectively judge a situation.

To a financial auditor, a loss of ₹ 1,000 caused by a wrong totalling of invoice is important, but for an auditor engaged in the review of operations, it does not assume so much importance. But simultaneously, it should not be assumed, that, an operational auditor is not concerned with the financial aspects of transaction and controls.

Conclusion: Contention of operational auditor that totalling error in invoice of ₹ 1,000 is out of scope is not correct as operational audit is being carried out to ensure that all the management functions like planning, organizing, staffing, directing and controlling are working effectively and efficiently. Such kind of error is very much in scope because such an existence of error indicates that control system (controlling function) is not sound.

Question 12.
Write short note on: Operational auditing arose from the need of mangers responsible for areas beyond their direct supervision. [May 15 (4 Marks)]
Or
Operational Auditing is a systematic process involving logical, structured and organized series of procedures. It concentrates on effectiveness, efficiency and economy of operations and therefore it is future oriented. In this perspective, state the Need of operational auditing.
Answer:
Need of Operational Audit:
Operational auditing arose from the need of managers responsible/or areas beyond their direct observation to be fully, objectively and currently informed about conditions in the units under control.

Traditional sources of information remain inadequate for an effective management of the company where the management is at a distance from actual operations due to layers of delegation of responsibility, separating it from actualities in the organisation.

Operational audit as a specialised management information tool fill the void that conventional information sources fail to fill. Conventional sources of management information are departmental managers, routine performance report, internal audit reports, and periodic special investigation and survey. These conventional sources fail to provide information for the best direction of the departments all of whose activities do not come under direct observation of managers.

Operational auditing has filled a very significant vacuum; it has come to provide the management with inexpensive, continuous and objective appraisal of activities, operations and controls to inform the management about achievement of standards and, if otherwise, to inform the management about what has gone wrong and how it has gone wrong. Also, it enlightens the management about possible dangers, constraints and opportunities that may be of immense value to the management.

“ICAI Examiner Comments”
The need for operational auditing are not properly highlighted. Instead candidates explained operational Auditing.

Question 13.
Perfect Steel Ltd. has reported a higher turnover of? 560 crores in the year 2020-21 as compared ‘ to earlier years but its sales return has also increased to 10% from only 4% upto the last year. The management is concerned about the high sales returns and feels a need to get the operational audit done for sales and production department of the company. The company is also having an internal audit system in the company. Elaborate the possible reason/s, why management is getting operational audit done when internal audit has already been done for both the departments by stating the shortcomings of conventional information sources. [RTP-Nov. 19]
Answer:
Need of Operational Audit:
The need for operational auditing has arisen due to the inadequacy of traditional sources of information for an effective management of the company where the management is at a distance \ from actual operations due to layers of delegation of responsibility, separating it from actualities in the organisation.

Operational audit as a specialised management information tool fill the void that conventional information sources fail to fill. Conventional sources of management information are departmental managers, routine performance report, internal audit reports, and periodic special investigation and survey. These conventional sources fail to provide information for the best direction of the departments all of whose activities do not come under direct observation of managers.

The shortcomings of these sources can be stated as under:
(i) Executives and managers are too preoccupied with implementation of plans and achieving of targets. They are left with very little time to collect information and locate problems. They may come across problems that have come to surface but they are hardly aware of problems that are brewing and potential.

(ii) Managers or their aides are generally relied upon for transmitting information than for booking for information or for analysing situations.

(iii) The information that is transmitted by managers is not necessarily objective – often it may be biased for various reasons.

(iv) Conventional internal audit reports are often routine and mechanical in character and have a definite leaning towards accounting and financial information. They are also historical in nature.

(v) Other performance reports contained in the annual audited accounts and the routine reports prepared by the operating departments have their own limitations. The annual audited accounts are good as far as an overall evaluation is concerned in monetary terms.

(vi) Operations of controls in a satisfactory manner cannot be relied upon to bring to light the environmental conditions. Controls are specific and their satisfactory operation is related to the specific situation under control. Also monitoring of the breakdown or non-operation of controls is a periodic phenomenon.

(vii) Surveys and special investigations, no doubt, are very useful but these are at the best occasional in character. Also, they are costly, time consuming and keep the departmental key personnel busy during the period they are on. These are basically an attempt to carry out a post-mortem rather than to enlighten the management about the ways on improvement or for better “ performance or to give a signal for dangers and disasters to come.

Question 14.
“Operational Auditing is not different from Internal Auditing” Discuss.
Answer:
Operational Audit vs. Internal Auditing:

Operational Auditing	Internal Auditing
It is concerned with the review and appraisal of operations of an organization carried on by a competent independent person	It is concerned with determining whether other internal controls are well designed and in place
It is not a part of internal control	It is a part of internal control system
It is an constructive function i.e. to provide sug­gestions for improvement	It is an protective function i.e to safeguard the assets of the enterprise.
It analyses all aspects of operations whether they are in tune with management policies, objectives and Goals	It is primarily concerned with financial account­ing and internal control
It mainly deals with qualitative aspects	It focuses more on quantitative aspects

NOTE: Over a period of time, scope of internal auditing has been widened so as to cover all operations besides accounting and financial operations. So in the present time, there is no difference in internal auditing and operational auditing.

Question 15.
State the key differences between financial and operational audit. [May 12 (4 Marks)]
Or
The main objective of operational auditing is to verify the fulfilment of plans, and sound business requirements. While in financial auditing, the concentration is more in the financial and accounting areas to ensure that possibilities of loss, wastage and fraud are minimized or removed.
In the light of above, state the major differences between Financial and Operational Auditing.
Or
Write short note on: Financial vs. Operational Audit. [Nov. 17 (4 Marks)]
Answer:
Financial Auditing vs. Operational Auditing:

	Financial Auditing	Operational Auditing
Purpose	11 concerned with the opinion that wheth­er the historical information recorded is correct or not	It emphasizes on effectiveness and efficiency of operations for future per­formance.
Area	It is restricted to the matters directly affecting the appropriateness of the pre­sented financial statements	It covers all the activities that are related to efficiency and effectiveness of business operations.
Reporting	Financial audit report is sent to all stock holders, bankers and other persons hav­ing interest in the organization.	Operational audit report is primarily for the management
End Task	Financial audit reports the findings to the persons as its end objectives.	Operational audit is not limited to the reporting only, but includes suggestions for improvements also.

Question 16.
Many modern enterprises have become huge and sophisticated. This has resulted in decentralisation of their activities and different type of audits. You are required to explain the difference to the management:
(i) Internal & Operational Audit.
(ii) Management Audit & Operational Audit.
(iii) Financial Audit & Operational Audit. [RTP-Nov. 18]

Question 17.
The Operational audit is carried out effectively when the operational auditor responds with positive traits in a scenario which is blended with behavioural issues. Explain few positive traits that help to conclude an Operational Audit, a success. [May 18 – New Syllabus (4 Marks)]
Answer:
Positive traits of an Operational Auditor:
1. Operational auditor should be more inquisitive’as, his knowledge ordinarily would be scanty in areas beyond accounting and finance.

2. Operational auditor is required to visualise whether simpler alternative means are available to do a particular work. He should ask the who, why, how of everything.

3. Operational Auditor should possess an attitude of skepticism. He should try to see everything as to whether particular operational aspects properly fit in the business frame and organisational policy.

4. He should imbibe a constructive approach rather than a fault-finding approach and should give a feeling that his efforts are to help attaining an improved operation and not merely fault finding. If the auditor succeeds in giving a feeling of help and assistance through constructive criticism, he will be able to obtain co-operation of the persons who are involved in the operations.

5. He should try to develop a team comprised of people of different backgrounds.

Question 18.
Employees of GIG Ltd. have to travel frequently for business purposes, so the company entered into a contract with a Simony Travels Ltd. for managing booking, cancellation and other services required by their employees. As per contract terms, Simony travels has to raise its monthly bills for the tickets booked or cancelled during the period and the same are paid by GIG Ltd. within 15 days of the bill date. The bills raised by Simony travels were of huge amount, so the management of GIG Ltd. decided to get an audit conducted of the process followed for booking/cancellation of tickets and verify the accuracy of bills raised by the travel agency. Which audit do you feel the management should opt for? Also briefly discuss the qualities the auditor should possess for such audit. [RTP-May 19]
Answer:
Audit Requirement for verification of bill raised by travel agency:
In the case mentioned in the question, management should opt for operational audit. Operational auditor will ensure verification of effectiveness, efficiency and economy of operations done by the Simony travels for the organisation.

Qualities an operational auditor should possess:
The operational auditor should possess some very essential personal attributes to be effective in his work. Such personal attributes comprise of:

1. Operational auditor should be more inquisitive as, his knowledge ordinarily would be scanty in areas beyond accounting and finance.

2. Operational auditor is required to visualise whether simpler alternative means are available to do a particular work. He should ask the who, why, how of everything.

3. Operational Auditor should possess an attitude of skepticism. He should try to see everything as to whether particular operational aspects properly fit in the business frame and organisational policy.

4. He should imbibe a constructive approach rather than a fault-finding approach and should give a feeling that his efforts are to help attaining an improved operation and not merely fault finding. If the auditor succeeds in giving a feeling of help and assistance through constructive criticism, he will be able to obtain co-operation of the persons who are involved in the operations.

5. He should try to develop a team comprised of people of different backgrounds.

Miscellaneous Questions

Question 19.
In an operational audit performance evaluation, what factors can cause unsatisfactory production performance?
Answer:
Factors causing unsatisfactory production:

1. Inadequate or unskilled personnel
2. Non-availability of raw materials
3. Lack of proper supervision
4. Lack of proper machine maintenance
5. Strikes and/or lock out
6. Problems of power supply
7. Non-availability of essential machine spares
8. Lack of proper quality control
9. Poor quality of raw materials
10. Other causes like fire, earthquake etc.

Question 20.
You have been appointed to carry out Management-cum-OperationalAuditofa Public Ltd. company. State whether the use of quantitative ratios is more effective than the use of financial ratios to gain real insight into the financial statements.
Answer:
Use of Quantitative Ratio:
The objective of management-cum-operational audit is not only to verify compliance with the control but to suggest measures to improve operational environment & increase overall productivity.

Financial ratios keep changing with the variations in the price level. In a dynamic economy, price levels seldom remain constant and hence comparison of financial ratios over the years becomes vitiated. Quantitative ratios and reconciliations remain unaffected by changes in price. They reflect certain basic relationships and change only if there is a change in the method of operation, technology, degree of automation, product mix, etc.

A comparison of quantitative ratio over the years can reveal pertinent and leading indications of the real state of affairs.

The various quantitative ratios which maybe calculated are input-output ratio for a manufacturing concern, occupancy ratio for hotels, etc.

The nature of quantitative ratios and reconciliations that an auditor can work out in a particular audit would depend upon the actual circumstances of the case. However, the auditor must keep a few general considerations in mind while using quantitative data.

Firstly, he should analyse and use such data mainly as an evidence to support the figures in the statements under audit.

Secondly, the auditor should try to correlate vital relationships between physical quantities. In this regard the auditor should establish the cause and effect relationship between activities.

Thirdly, the auditor may attempt to link a physical quantity with its corresponding monetary figure through an estimated average rate.

Conclusion: Though working out quantitative ratios involves greater strain on the auditor, but it is more rewarding.

Question 21.
You have been appointed Management Auditor of a large manufacturing company suffering from working capital crunch. Enlist and discuss the related areas which you would probe into to overcome the company’s problem.
Answer:
Action Plan for management audit of a company facing financial crunch
(a) Working Capital Estimation: Prepare a statement of the projected working capital requirements. It should be based on the functional budgets in sales, production, expenses, capital expenditure and the master budget consisting of projected profit and loss and the balance sheet.

(b) Cash Flow Statement/Cash Budget: Month-wise cash budgets showing inflows and outflows of cash heading-wise should be prepared to analyse the major inflows and outflows affecting the entity.

(c) Inventory/Stock Management: Raw materials and inventories should be classified properly to determine the level of stock of materials. The system of inventory management needs to be looked at so as to check the avoidable wastes/scraps generated during storage and handling.

(d) Credit Management: The company should lay down a proper policy for evaluating customers, determining the credit period and offering discounts for early payment. An age-wise analysis of debtors should also be prepared so as to avoid credit to defaulters. The sale department needs to be geared up so that realisation can be made in time.

(e) Funds Flow Analysis: The company should prepare a funds flow analysis, distinguishing between long-term and short-term sources and applications.

(f) Investment Management: The idle funds of the company, if any, should be invested in shortterm securities to augment the income

(g) WIP Analysis: W1P should be monitored and for the purpose it is necessary to ensure that no bottlenecks develop at any stage during the production process.

Question 22.
XYZ, a manufacturing unit does not accept the recommendations for improvements made by the Operational Auditor. Suggest an alternative way to tackle the hostile management. [Nov. 10 (5 Marks), MTP-Oct. 20]
Answer:
Way to tackle the Hostile Management:

• To tackle the hostile management, auditor is advised to follow participative approach. In this approach the auditor discuss the ideas for improvements with those managers that have to implement them and make them feel that they have participated in the recommendations made for improvements.
• This approach encourages the auditee to develop a friendly attitude towards the auditors and
  look forward to their guidance in a more receptive fashion. ‘
• The proposed recommendations are discussed with the auditee and modifications as may be agreed upon are incorporated in the operational audit report.
• With this attitude of the auditor it becomes absolutely easy to implement the proposed suggestions as the auditee themselves take initiative for implementing and the auditor do not have to force any change on the auditee.

Question 23.
You have been appointed as an internal auditor of a company RSM Ltd. The Managing Director of X Ltd. is concerned about high employee attrition rate in his company. As the internal auditor of the company he requests you to analyze the cause for the same. What factors would you consider in such analysis? [May 13 (4 Marks), MTP-May 20]
Answer:
The factors responsible for high employee attrition rate are as under:

1. Job Stress & work life imbalance
2. Wrong policies of the Management
3. Unbearable behaviour of Senior Staff
4. Safety factors
5. Limited opportunities for promotion
6. Low monetary benefits
7. Lack of labour welfare schemes
8. Whether the organization has properly qualified and experienced personnel for the various levels of works?
9. Is the number of people employed at various work centres excessive or inadequate?
10. Does the organization provide facilities for staff training so that employees and workers keep themselves abreast of current techniques and practices?

Question 24.
The Board of Directors of XYZ Ltd. is concerned with decreasing operating efficiency in material consumption. As an Auditor entrusted with investigating the causes for this poor state, what may be the areas of your focus in this respect. [Nov. 18 – New Syllabus (5 Marks)]
Answer:
Focus Area while investigating the causes of decreasing operating efficiency in material consumption:
To determine the reasons for decreasing efficiency in material consumption, the auditor is required to understand the manufacturing operations from the initial stage of purchase of materials, issue of material, consumption of material and conversions into finished goods. For this purpose, auditor may focus on following aspects:

1. Obtain a list of raw materials used in the production process mentioning therein the names and detailed characteristics of each raw material.

2. Ascertain the basis of computation of normal wastage figures and its consistency as compared to previous months.

3. Obtain internal control reports, in respect of manufacturing costs incurred with reference to predetermined standards or budgets.

4. Examine the stock records so as to determine the raw material purchased, material issued to production.

5. Examine the production records so as’to determine the material received from the stores and actual material consumed in the production and waste produced in the production process.

6. Study the Maintenance Programme of machinery to ensure that the machinery does not consume more raw material and quality of goods manufacture. is wot of sub-standard nature.

7. As certain whether employees engaged in production are properly trained and working efficiently.

8. Determine the existence and effectiveness of quality control techniques employed in the entity.

9. Examine inventory controls in respect of storage, pilferage, issues etc.

10. Obtain a statement showing break up of wastage figures in storage, handling and production for the period under reference and compare the results of the analysis for each of the month.

11. Consider the existence of following situations that may also cause the abnormal wastage:
(a) Purchase of poor quality of raw materials.
(b) Machinery breakdown or power failure.
(c) High rate of rejections of finished goods
(d) Deterioration of raw material lying in godowns
(e) Abnormal wastages in storage and handling.
(f) Commencing new production line.

Company Audit – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

Company Audit – CA Final Audit Question Bank

Appointment of Auditors

Question 1.
CA X is a partner in M/s AB & Associates and M/s MN & Associates simultaneously. M/s AB & Associates has completed its tenure of 10 years as an auditor in XYZ Ltd. immediately preceding the current financial year. It may be noted that the provisions for applicability of rotation of auditors are applicable to XYZ Ltd. Now, the company wants to appoint M/s MN & Associates as auditor for 5 years.

(a) Whether M/s MN & Associates is allowed to accept the appointment as auditor of XYZ Ltd.?
(b) Would your answer be different from above if CA X, being in-charge of M/s AB & Associates and certifying authority of financial statements of XYZ Ltd., retires from the partnership in M/s AB & Associates and joins M/s MN & Associates?
Answer:
Appointment of Firm as auditor having common Partner:
As per Second Proviso to sec. 139(2) of Companies Act, 2013, as on the date of appointment no audit firm having a common partner or partners to the other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall be appointed as auditor of the same company for a period of five years.

In the present case, CA X is common partner in the firm AB & Associates and MN & Associates.

Conclusion: MN & Associates is disqualified for appointment as auditor of XYZ Ltd. for a period of 5 years.

Appointment of firm as auditor having one of partner was in-charge in previous audit firm:
As per Explanation given in Rule 6 of Companies (Audit & Auditors] Rules, 2014 if a partner, who is in charge of an audit firm and also certifies the financial statements of the company, retires from the said firm and joins another firm of chartered accountants, such other firm shall also be ineligible to be appointed for a period of five years.

In the present case, CA. X was incharge of M/s AB & Associates and certifying authority of financial statements of XYZ Ltd. Retires from the M/s AB 7 associates and joins MN & Associates.

Conclusion: MN & Associates is disqualified for appointment as auditor of XYZ Ltd. for a period of 5 years.

Question 2.
ABC Pvt. Ltd., a new company, incorporated on 01.07.2020 is engaged in the manufacturing business. On 30.07.2020, the Managing Director of ABC Pvt. Ltd. himself appointed CA Mohan, his daughter’s husband, as the first auditor of the company. You are required to –
(i) State the provisions of the Companies Act, 2013 relating to appointment of first auditor.
(ii) Comment on the action of the Managing Director.
Answer:
Appointment of First Auditor of Non-Govt. Company:

• Section 139(6] of the Companies Act, 2013 lays down that “the first auditor or auditors of a company shall be appointedby the Board of directors within 30 days fromthe date ofregistration of the company”.
• In the instant case, the appointment of CA Mohan, a practicing Chartered Accountant as first auditors by the Managing Director of ABC Pvt. Ltd. by himself is in violation of Section 139(6] of the Companies Act, 2013, which authorizes the Board of Directors to appoint the first auditor of the company.

Conclusion: In view of the above, the Managing Director of ABC Pvt. Ltd. should be advised not to appoint the first auditor of the company.

Note: As the appointment of CA, Mohan as such is not valid, there is no relevance of any discussion with regard to his relationship with the managing director.

Question 3.
KM Pvt. Ltd., engaged in the manufacturing business of Silk Shirts, is a newly incorporated company dated 01.09.2020. On 28.09.2020, the members of KM Pvt. Ltd. themselves appointed CA Raj, a renowned practitioner, as the first auditor of the company opposing that Board is not authorised to appoint the auditor. You are required to comment on the action of the Members.
Answer:
Appointment of First Auditor of Non-Govt. Company:

• Section 139(6) of the Companies Act, 2013 lays down that “the first auditor or auditors of a company shall be appointed by the Board of directors within 3 0 days from the date ofregistration of the company”.
• In the case of failure of the Board to appoint the auditor, it shall inform the members of the company. The members of the company shall within 90 days at an extraordinary general meeting appoint the auditor. Appointed auditor shall hold office till the conclusion of the first annual general meeting.
• In the instant case, the appointment of CA Raj, a practicing Chartered Accountant as first auditors by the members of the company, opposing that Board is not authorised to appoint the auditor, is not in order

Conclusion: Appointment of CA Raj as first auditor, within 30 days of registration by the members of the company is not in order.

Question 4.
The first auditor of M/s Healthy Wealthy Ltd., a Government company, was appointed by the Board of Directors.
Answer:
Appointment of First Auditor of Govt. Company

• Section 139(7) of the Companies Act, 2013 lays down that in the case of a Government company or any other company owned or controlled, directly or indirectly, by the CG, or by any SG, or SGs, or partly by the CG and partly by one or more SGs, the first auditor shall be appointed by the CAG of India within 60 days of registration of the company.
• In case the CAG of India does not appoint such auditor within the said period, the BOD of the [ company shall appoint such auditor within the next 30 days.
• In the case of failure of the Board to appoint such auditor within the next 30 days, it shall inform the members of the company who shall appoint such auditor within the 60 days at an EGM.
• Hence in the case of M/s Healthy Wealthy Ltd., being a government company, the first auditors shall be appointed by the CAG of India.

Conclusion: The appointment of first auditors made by the Board of Directors of M/s Healthy Wealthy Ltd., is null and void.

Question 5.
Nick Ltd: is a subsidiary of Ajanta Ltd., whose 20% shares have been held by Central Government, 25% by Uttar Pradesh Government and 10% by Madhya Pradesh Government. Nick Ltd. appointed Mr. P as statutory auditor for the year. [MTP-Oct. 19]
Answer:
Appointment of Auditor of Govt. Company:
As per Sec. 2 (45] of the Companies Act, 2 013, a Government company is defined “as any company in which not less than 51% of the paid-up share capital is held by the Central Government or by any State Government or Governments or partly by the Central Government and partly by one or more State Governments and includes a company which is a subsidiary of a Government Company as thus defined”.

Sec. 139(7) requires that the auditors of a government company shall be appointed or reappointed by the Comptroller and Auditor General of India.

In the given case Ajanta Ltd. is a government company as its 20% shares have been held by Central Govt., 25% by U.P. State Government and 10% by M.P. State Govt. Total 55% shares have sj* been held by Central and State Governments.

Nick Ltd. will also be a Government company, being subsidiary company of Ajanta Ltd. and hence the Auditor of Nick Ltd. can be appointed only by C & AG.

Conclusion: Appointment of ‘P’ is invalid and ‘P’ should not give acceptance to the Directors of Nick Ltd.

Question 6.
At the AGM of ICI Ltd., Mr. X was appointed as the statutory auditor. He, however, resigned after 3 months since he wanted to give up practice and join industry. State, how the new auditor will be appointed by ICI Ltd. and the conditions to be complied for.
Answer:
Filling of Casual vacancy:

• As per Sec. 139(8) of the Companies Act, 2013, any casual vacancy in the office of an auditor may be filled by Board of Directors within thirty days.
• However, if casual vacancy has been created by the resignation of the auditor, such appointment shall also be approved by the company at a general meeting convened within three months of the recommendation of the board.
• The auditor so appointed shall hold office till the conclusion of the next annual general meeting.

Conclusion: In this case, the casual vacancy has been created on account of resignation. Therefore, Board of Directors will have to fill the vacancy within thirty days and such appointment shall be approved by the company at the general meeting within three months of the recommendations of the board. The new auditor so appointed shall hold office only till the conclusion of the next AGM.

Question 7.
Due to the resignation of the existing auditor (s), the Board of directors of X Ltd. appointed Mr. Hari as the auditor. Is the appointment of Hari as auditor valid?
Answer:
Board’s Powers to Appoint an Auditor:

• As per Sec. 139(8) of the Companies Act, 2013, any casual vacancy in the office of an auditor may be filled by Board of Directors within thirty days.
• However, if casual vacancy has been created by the resignation of the auditor, such appointment shall also be approved by the company at a general meeting convened within three months of the recommendation of the board.
• The auditor so appointed shall hold office till the conclusion of the next annual general meeting.

Conclusion: Appointment of Hari by Board of Directors will be Valid if it is made within 30 days of casual vacancy and such appointment is approved by the company at a general meeting within three months of the recommendations of the Board.

Question 8.
At an AGM of a listed company, Mr. R a retiring auditor after completing the tenure of 5 consecutive years of his service claims that he has been reappointed automatically, as the intended resolution of which a notice had been given to appoint Mr. P, could not be proceeded with, due to Mr. P’s death.
Answer:
Restrictions over tenure of Auditor (Rotation of Auditor)

• As per Sec. 139(2) of the Companies Act, 2013, listed companies and other prescribed class of companies shall not appoint or reappoint an individual as auditor for more than one term of five consecutive years.
• Sec. 139(10) of Companies Act, 2013 provides that if no auditor is appointed or reappointed at AGM, existing auditor will continue.
• In the given case, notice has been given of an intended resolution to appoint some person or persons in the place of a retiring auditor, and by reason of the death, incapacity or disqualification of that person or of all those persons, as the case may be, the resolution cannot be proceeded with.
• In the instant case, if Sec. 139(10) of the Companies Act, 2013 is invoked, it results into violation of Sec. 139(2). Hence, Mr. R cannot continue as auditor due to restrictions of Sec. 139(2).

Conclusion: Mr. R cannot continue as auditor of the company due to rotation provisions. Companies Act, 2013 does not provide any provision for such kind of situation, hence it can be concluded that vacancy arises in the office of auditor which need to be filled by company in EGM.

Question 9.
No AGM was held for the year ended 31st March, 2020, in XYZ Ltd., Mr. X is the auditor for the previous 5 years, whether he should continue to hold office for current year or not.
Answer:
Auditor’s position if no AGM is held:

• Sec. 139(1) of the Companies Act, 2013 provides that every company shall, at the first AGM appoint an individual or a firm as an auditor who shall hold office from the conclusion of that meeting till the conclusion of its 6th AGM and thereafter till the conclusion of every 6th meeting.
• In case the AGM is not held within the period prescribed, the auditor will continue in office till the AGM is actually held and concluded.

Conclusion: Mr. X shall continue to hold office till the conclusion of the AGM.

Question 10.
M/s Young & Co., a Chartered Accountant firm, and Statutory Auditors of Old Ltd., is dissolved on 1.4.2020 due to differences of opinion among the partners. The Board of Directors of Old Ltd. in its meeting on 6.4.2020 appointed another firm M/s Sharp & Co. as their new auditors for one year.
Answer:
Filling of Casual Vacancy:

• As per Sec. 139(8) of the Companies Act, 2013, any casual vacancy in the office of an auditor may be filled by Board of Directors within thirty days.
• However, if casual vacancy has been created by the resignation of the auditor, such appointment shall also be approved by the company at a general meeting convened within three months of the recommendation of the board.
• The auditor so appointed shall hold office till the conclusion of the next annual general meeting.

Conclusion: In the instant case the action of the board of directors in appointing M/s Sharp & Co. to fill up the casual vacancy due to dissolution of M/s Young & Co., is correct.

However, the board of directors are not correct in giving them appointment for one year. M/s Sharp & Co. can hold office until the conclusion of next AGM only.

Question 11.
X Ltd. is an unlisted public company. Its balance sheet shows paid up share capital of ₹ 7.5 crore and public deposits of ₹ 70 crores. The company appointed M/s ABC & Co., a CA firm, as the statutory auditor in its AGM held at the end of September 2020 for 11 years. Comment.
Answer:
Rotation of Auditor & Cooling Off Period Provisions:

• As per Section 139(2) of the Companies Act, 2013, no listed company or a company belonging to such class or classes of companies as prescribed, shall appoint or re-appoint-
  • an individual as auditor for more than one term of five consecutive years; and
  • an audit firm as auditor for more than two terms of five consecutive years.
• Rule 5 of Companies (Audit and Auditors) Rules, 2014, prescribes the following classes of companies (excluding OPC and small companies) for the purpose of rotation:
  a. ’ all unlisted public companies having paid up share capital of ₹ 10 crore or more;
  b. all private limited companies having paid up share capital of ₹ 50 crore or more;
  c. all companies having paid up share capital of below threshold limit mentioned above, but having public borrowings from financial institutions, banks or public deposits of ₹ 50 crores or more.
• In the given case, X Ltd. is an unlisted public company having paid up share capital of ₹ 7.50 crore and public deposits of ₹ 70 Crore, the provisions relating to rotation of auditor will be applicable.

Conclusion: X Ltd. cannot appoint the auditor for more than two terms of five consecutive years each, i.e. M/s ABC & Co. shall hold office from the conclusion of this meeting upto conclusion of 6th AGM to be held in the year 2025 and thereafter can be re-appointed as auditor for one more term of five years i.e. upto year 2030. As a result, the appointment of M/s ABC & Co. made by X Ltd. for 11 years is void.

Question 12.
While auditing, CA Mr. X, the statutory auditor of Y Ltd. encounters exceptional circumstances that bring into question his ability to continue performing the audit. Considering it appropriate, CA Mr. X resigned from the office of auditor of Y Ltd. Due to the resignation of the existing auditor, the Board of Directors of Y Ltd. itself appointed CA Mr. Y, a practicing Chartered Accountant, as the statutory auditor till the conclusion of 6th meeting.
You are required to state the provisions related to rilling of casual vacancy as per the Companies Act, 2013 and comment upon the validity of appointment made by the Board.
Answer:
Filling of Casual Vacancy: ,
As per Section 139(8) of the Companies Act, 2013, any casual vacancy in the office of an auditor shall-
(i) In the case of a non-government company, be filled by the Board of Directors within 30 days. But, if such casual vacancy is as a result of the resignation of an auditor, such appointment shall also be approved by the company at a general meeting convened within 3 months of the recommendation of the Board and the auditor so appointed shall hold the office till the conclusion of the next AGM.

(ii) In the case of a government company, the casual vacancy be filled by the CAG of India within 30 days. But if the CAG does not fill the vacancy within the said period the Board of Directors shall fill the vacancy within next 30 days.

In the given case, CA Mr. X, the statutory auditor of Y Ltd. has resigned from the office of auditor. Therefore, such casual vacancy can be filled by the Board of Directors subject to approval by the company at a general meeting convened within 3 months of the recommendation of the Board.

Conclusion: The appointment of CA Mr. Y made by the Board of Directors without the approval of the company at a general meeting is invalid and further, if appointment is approved by the company, CA Mr. Y can hold office only till the conclusion of the next AGM.

Question 13.
C.A. Ashwin was appointed as auditor of Bristol Ltd. for the year 2020-21. Since he declined to accept the appointment, the Board of Directors appointed CA John as the Auditor in place of C.A. Ashwin and the appointment was accepted by C.A. John. Discuss. [May 15 (4 Marks)]
Answer:
BOD Powers to fill the Vacancy:

• Board of Directors of the company has been empowered to appoint the auditor other than first auditor in case any casual vacancy arises in the office of auditor. [Sec. 138(8)]
•  The present case does not fall u/s 139(8); hence BOD does not have power to fill up the vacancy.
• Under the circumstances, it may be deemed that no auditor appointed at AGM and provisions of Sec. 139(10) may be invoked which provides that where at any AGM, no auditor is appointed or re-appointed, the existing auditor shall continue to be the auditor of the company.
• Further, Clause (9) of Part I of the First Schedule to the Chartered Accountants Act, 1949 provides that a member in practice shall be deemed to be guilty of professional misconduct if he accepts an appointment as auditor of a company without first as certaining from it whether the requirements of Sections 139 and 140 of the Companies Act, 2013, in respect of such appointment have been duly complied with.
• In the present case, appointment of Mr. John by Board of Directors is notin line with the provisions of Sec. 139 of Companies Act, 2013.
• Vacancy so remains due to non-acceptance by Mr. Ashwin can only be filled by the Company in General Meeting.

Conclusion: Board of Directors are not authorised to fill up the vacancy in case the auditors appointed at the AGM refuse to accept the appointment.

Mr. John will be guilty of professional misconduct by virtue of clause 9 of Part 1 of First Schedule of Chartered Accountants Act, 1949.

“ICAI Examiner Comments”
Candidates have not touched upon Clause (9) of Part I of the First Schedule to the Chartered ; Accountants Act, 1949 regarding professional misconduct for accepting the audit without complying with the provisions of Companies Act, 2013.

Question 14.
M/s 10 Ltd. is registered with Registrar of Companies on 1st of May 2020. The company’s 27% of paid up share capital is held by Central Government; 28% by State Government and the remaining 45% by public. The Board of Directors appointed RMG, Chartered Accountants as statutory auditors for the financial year 2020-21 by passing a resolution at the Board Meeting held on 25th May, 2020. Comment whether appointment is valid or not. [May 16 (4 Marks)]
Answer:
Appointment of First Auditor of Government Company:
As per Sec. 2 (45) of the Companies Act, 2 013, a Government company is defined “as any company in which not less than 51% of the paid-up share capital is held by the Central Government or by any State Government or Governments or partly by the Central Government and partly by one or more State Governments and includes a company which is a subsidiary of a Government Company as thus defined”.

As per Sec. 139(7) of Companies Act, 2013, in the case of a Government company or any other company owned or controlled, directly or indirectly, by the CG, or by any SG, or SGs, or partly by the CG and partly by one or more SGs, the first auditor shall be appointed by the CAG of India, within 60 days of registration of company.

In case the CAG of India does not appoint such auditor within the said period, the BOD of the company shall appoint such auditor within next 30 days; In the case of failure of the Board to appoint such auditor within the next 30 days, it shall inform the members of the company who shall appoint such auditor within 60 days at an EGM.

In the present case, 55% of share capital is held by Central Government and State Government, hence it is a case of Government Company and the first auditor need to be appointed by CAG within 60 days of registration of company.

Conclusion: Appointment of First Auditor within 60 days of registration of government company by Board of Directors is not valid.

Question 15.
M/s. ABC & Co. is an audit firm having partners Mr. A, Mr. B and Mr. C, whose tenure as statutory auditor in R Ltd. a listed entity, has expired as per the Companies Act, 2013. M/s XY is another audit firm which is appointed as the statutory auditor of R Ltd. for the subsequent year. Mr. A joins M/s. XY as partner, 3 months after it was appointed as the statutory auditor of R Ltd. Comment. [May 17 (5 Marks)]
Answer:
Applicability of Rotation provisions:
Sec. 139(2) of Companies Act, 2013 provides that no listed company or other prescribed companies, shall appoint or re-appoint an audit firm as auditor for more than two terms of five consecutive years

An audit firm which has completed its term, shall not be eligible for re-appointment as auditor in the same company for five years from the completion of such term:

It is also provided that as on the date of appointment no audit firm having a common partner or partners to the other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall be appointed as auditor of the same company for a period of five years.

In the present case, on completion of tenure of M/s ABC & Co., retiring auditor, company has appointed M/s XY as their auditor. After three months of appointment of XY Ltd. as auditor, Mr. A, joins M/s XY as partner. As per provisions of Sec. 139(2), incoming auditor shall not be eligible for appointment in case of common partner as on date of appointment. But in this case, there were no common partner as on date of appointment. Mr. A joins after 3 months of appointment.

Conclusion: Applying the provisions of Sec. 139(2), no issue arises as there were no common partners as on date of appointment.

Note: Interpretation of this provision appears to be against the intention of law, which intends for the cooling off period of retiring auditor for a period of 5 years in case of listed and other prescribed companies.

Removal of Auditor

Question 16.
Comment: “M/s. PQR, audit firm has been re-appointed as sole statutory auditor of a listed company in the ACM, where till last year M/s. LMN, audit firm was also one of the joint auditors along with M/s. PQR. One tenure of consecutive five years of both the firms get completed in the mentioned 1 AGM. Mention the steps that should be taken by M/s. PQR before commencing the audit”.
Answer:
Appointment of Sole Auditor:
When one of the joint auditors of the previous years is considered for re-appointment by the members as the sole auditor for the next tenure, it is similar to non-re-appointment of one of the retiring joint auditors. As per Sec. 140(4) of the Companies Act, 2013, special notice shall be required for a resolution at an AGM appointing as auditor a person other than a retiring auditor or providing expressly that a retiring auditor shall not be re-appointed, except where the retiring auditor has completed a consecutive tenure of five years or, as the case may be, ten years, as provided u/s 139(2).

Accordingly, provisions of the Companies Act, 2013 to be complied with are as under:

1. Special Notice: Ascertain that special notice u/s 140(4) of the Companies Act, 2013 was received by the company from requisite number of members (1% of total voting power or paid up capital not less than ₹ 5 Lacs) at least 14 days before the AGM date.
2. Sending copy of notice: Check whether the said notice has been sent to all the members at least 7 days before the date of the AGM.
3. Contents of Notice: Verify that the notice contains an express intention of a member for . proposing the resolution for appointing a sole auditor in place of both the joint auditors who retire at the meeting but are eligible for re-appointment.
4. Notice to Auditor: Ensure that the notice has also been sent to the retiring auditor.
5. Sending the Representation: Verify whether any representation, received from the retiring auditor was sent to the members of the company.
6. Consideration of representation: Verify from the minutes book whether the representation received from the retiring joint auditor was considered at the AGM.

In addition to requirements of Companies Act, 2013, auditor is required to ensure compliance of Clauses 8 and 9 of Part I of First Schedule to Chartered Accountants Act, 1949.

Question 17.
PQR Company Ltd. removed their first auditor by passing a resolution in the meeting of the Board of Directors for his removal without obtaining prior approval from the Central Government. Offer your comments in this regard.
Answer:
Removal of first Auditor:

• As per Sec. 140(1) of the Companies Act, 2013, an auditor appointed u/s 139 may be removed from his office before the expiry of his term only by a special resolution of the company, after obtaining the prior approval of the Central Government.
• For this purpose, an application to the Central Government for removal of auditor shall be made in Form ADT-2 and shall be accompanied with prescribed fees.
• The application shall be made to the Central Government within thirty days of the resolution passed by the Board.
• The company shall hold the general meeting within sixty days of receipt of approval of the Central Government for passing the special resolution.
• In the instant case the first auditor appointed by the Board of Directors was removed by a resolution in the meeting of the Board of Directors inspite of the Special resolution of the Company and without the prior approval of the Central Government in that behalf.

Conclusion: Removal of Auditor is Invalid as Special Resolution has not been passed and approval of Central Govt, not obtained.

Question 18.
What are the professional obligations of the auditor who has resigned from the audit before completion of his term due to non-co-operation of the Management in completing certain audit procedures? [Nov. 14 (5 Marks)]
Answer:
Professional Obligations in case of resignation by auditor:

• Section 140(2) of Companies Act, 2013 requires that the auditor who has resigned from the company shall file within a period of 30 days from the date of resignation, a statement in the prescribed form (ADT-3) with the company and the Registrar.
• In case of Government companies, such statement is also required to be filed with the Comptroller and Auditor-General of India.
• Statement must indicate the reasons and other facts as may be relevant with regard to his resignation.
• Section 140(3) of Companies Act, 2013 provides that if the auditor does not comply with Sec. 140(2), he shall be punishable with fine of ₹ 50,000 or the remuneration of the auditor, whichever is less, and in case of continuing failure, with further penalty of ₹ 500 for each day after the first during which such failure continues, subject to a maximum of ₹ 5 lakh.

Question 19.
Elucidate the power of tribunal to change the auditor of a company if found acted in a fraudulent manner as provided under sub-section (5) of section 140 of the Companies Act, 2013. [MTP-April 18]
Or
Write short note on: Direction by Tribunal [p case auditor acted in a fraudulent manner. [May 18 – Old Syllabus (4 Marks)]
Or
The Auditor of M/s Quick Limited succumbed to the pressure of the Management in Certifying the financials with an over stated figure of turnover by not adhering to the cut-off principles of the time scale for the transaction of the year. On taking cognizance of this act of the Auditor, the Tribunal under the companies Act, 2013 initiated the proceedings against him. Briefly list the powers of the tribunal in this respect including those relating to making orders against the auditor found to be guilty. [May 18 – New Syllabus (4 Marks)]
Or
Anvisha Ltd. is a company engaged in the business of software development. It is one of the largest companies in this sector with a turnover of ₹ 25,000 crores. The operations of the company are increasing constantly, however, the focus of the management is more on cost cutting in the coming years to improve its profitability. In respect of the financial statements of the company which are used by various stakeholders, some fraud was observed in respect of assets reported therein due to which those stakeholders suffered damages. As a result, those stakeholders applied to Tribunal for change of auditor on the basis that auditor is colluded in the fraud.
Elucidate the power of tribunal to change the auditor of a company if found acted in a fraudulent manner as provided under sub-section (5) of section 140 of the Companies Act, 2013. [MTP-Oct. 19, RTP-Nov. 19]
Or
On the advice of Management of M/s Quick Ltd., the auditor of the Company overlooked and did not report on shifting of certain current year’s sales transactions to the next year. The National Company Law Tribunal (NCLT) wants to take action against you. Describe the powers of the NCLT under Section 140(5) of the Companies Act, 2013 for such action and consequences to the auditor. [Nov. 19 – Old Syllabus (5 Marks)]
Answer:
Power of Tribunal in case Auditor acted in a Fraudulent Manner:
Sec. 140(5) of the Companies Act, 2013, provides that the Tribunal either suo motu or on an application made to it by the Central Government or by any person concerned, if it is satisfied that the auditor of a company has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers, it may, by order, direct the company to change its auditors.

However, if the application is made by the Central Government and the Tribunal is satisfied that any change of the auditor is required, it shall within 15 days of receipt of such application, make an order that he shall not function as an auditor and the Central Government may appoint another auditor in his place.

It may be noted that an auditor, whether individual or firm, against whom final order has been passed by the Tribunal under this section shall not be eligible to be appointed as an auditor of any company for a period of five years from the date of passing of the order and the auditor shall also be liable for action under section 447 of the said Act.

It is hereby clarified that the case of a firm, the liability shall be of the firm and that of every partner or partners who acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its director or officers.

Qualifications and Disqualifications of Auditor (Sec. 141)

Question 20.
“Mr. A”, a practicing Chartered Accountant, is holding securities of “XYZ Ltd.” having face value of ₹ 900. Whether Mr. A is qualified for appointment as an Auditor of “XYZ Ltd.”?
Would your answer be different, if instead of Mr. A, Mr. B the step father of Mr. A is holding the securities.
Answer:
Disqualification as to Security: ,
As per section 141 (3) (d) (i) an auditor is disqualified to be appointed as an auditor if he, or his relative or partner holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company.

However, the relative of the auditor may hold the securities or interest in the company of face value not exceeding ₹ 1,00,000.

Conclusion: In the present case, Mr. A. is holding security of ₹ 900 in the XYZ Ltd., therefore he is not eligible for appointment as an Auditor of “XYZ Ltd”.

However, in second case, Mr. A is eligible, as relative may hold securities of face value upto ₹ 1 Lac.

Question 21.
“Mr. P” is a practicing Chartered Accountant and “Mr. Q”, the relative of “Mr. P”, is holding securities of “ABC Ltd.” having face value of ₹ 90,000. Whether “Mr. P” is Qualified from being appointed as an Auditor of “ABC Ltd.”?
Or
Mr. P, a practicing Chartered Accountant, has been offered for appointment as an auditor of ABC Ltd., a leading company. Later on, Mr. Q, the step-brother of Mr. P, purchased securities of the company having face value of ₹ 90,000. Comment, whether Mr. P may accept the offer of appointment as an auditor?
Answer:
Disqualifications as to Securities:

• As per section 141(3)(d)(i) an auditor is disqualified to be appointed as an auditor if he, or his relative or partner holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company.
• However, the relative of the auditor may hold the securities or interest in the company of face value not exceeding ₹ 1,00,000.

Conclusion: In the present case, Mr. Q (relative of Mr. P, an auditor), is having securities of ₹ 90,000 face Value in the ABC Pvt. Ltd., which is as per requirement of proviso to section 141(3)(d)(i), Therefore, Mr. P will not be disqualified to be appointed as an auditor of ABC Ltd.

Question 22.
“BC & Co.” is an Audit Firm having partners “Mr. B” and “Mr. C”, and “Mr. A” the relative of “Mr. C”, is holding securities of”MWF Ltd.” having face value of? 1,01,000. Whether “BC & Co.” is qualified from being appointed as an Auditor of “MWF Ltd”?
Answer:
Disqualifications as to security:

• As per section 141 (3) (d) (i) an auditor is disqualified to be appointed as an auditor if he, or his relative or partner holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company.
• However, the relative of the auditor may hold the securities or interest in the company of face value not exceeding of ₹ 1,00,000.

Conclusion: In the instant case BC & Co., will be disqualified for appointment as an auditor of MWF Ltd. as the relative of Mr. C i.e. partner of BC & Co., is holding the securities in MWF Ltd. which is exceeding the limit mentioned in proviso to section 141(3)(d)(i).

Question 23.
A, a chartered accountant has been appointed as auditor of Laxman Ltd. in the ACM of the company held in Sep. 2020, which assignment he accepted. Subsequently in January, 2021 he joined B, another chartered accountant, who is the Manager Finance of Laxman Ltd., as partner.
Answer:
Disqualification as to partner of employee:

• Section 141(3)(c) of the Companies Act, 2013 prescribes that any person who is a partner or in employment of an officer or employee of the company will be disqualified to act as an auditor of a company.
• Sec. 141(4) provides that an auditor who becomes subject, after his appointment, to any of the disqualifications specified in Sec. 141(3), he shall be deemed to have vacated his office as an auditor.

Conclusion: In the present case, A, an auditor of M/s Laxman Ltd., joined as partner with B, who is Manager Finance of M/s Laxman Limited, will be disqualified by Sec. 141(3)(c) and, therefore, he shall be deemed to have vacated office of the auditor of M/s Laxman Limited.

Question 24.
An auditor purchased goods worth ₹ 501,500 on credit from a company being audited by him. The company allowed him one month’s credit, which it normally allowed to all known customers.
Answer:
Disqualification as to indebtedness:

• Section 141(3)(d) of the Companies Act, 2013 specifies that a person shall be disqualified to act as an auditor if he is indebted to the company for an amount exceeding ₹ 5 Lacs.
• Where an auditor purchases goods or services from a company audited by him on credit, he is definitely indebted to the company and if the amount outstanding exceeds ₹ 5 Lacs, he is disqualified for appointment as an auditor of the company.
• It will not make any difference if the company allows him the same period of credit as it allows to other customers on the normal terms and conditions of the business.

Conclusion: In instant case, auditor has become indebted to the company and consequently he has deemed to have vacated his office.

Question 25.
Ram and Hanuman Associates, Chartered Accountants in practice have been appointed as Statutory Auditor of Krishna Ltd. for the accounting year 2020-21. Mr. Hanuman holds 100 equity shares of Shiva Ltd., a subsidiary company of Krishna Ltd.
Answer:
Auditor holding securities of a company:

• As per Sec. 141 (3) (d) of the Companies Act, 2013, a person shall not be eligible for appointment as an auditor of a company, who, or his relative or partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company.
• In the present case, Mr. Hanuman, Chartered Accountant, a partner of M/s Ram and Hanuman Associates, holds 100 equity shares of Shiva Ltd. which is a subsidiary of Krishna Ltd.

Conclusion: The firm, M/s Ram and Hanuman Associates would be disqualified to be appointed as statutory auditor of Krishna Ltd., which is the holding company of Shiva Ltd., because one of the partner Mr. Hanuman is holding equity shares of its subsidiary.

Question 26.
Mr. Amar, a Chartered Accountant, bought a car financed at ₹ 7,00,000 by Chaudhary Finance Ltd., which is a holding company of Charan Ltd. and Das Ltd. He has been the statutory auditor of Das Ltd. and continues to be even after taking the loan.
Answer:
Disqualification as to indebtedness:

• As per Sec. 141(3}(d}(ii} of the Companies Act, 2013, a person is not eligible for appointment as auditor of any company, If he is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of rupees ₹ 5 Lacs.
• In the given case Mr. Amar is disqualified to act as an auditor u/s 141(3)d}(ii) as he is indebted to M/s Chaudhary Finance Ltd. for more than ₹ 5 Lacs.
• Further he cannot act as an auditor of any subsidiary of Chaudhary Finance Ltd. i.e. he is.also disqualified to work in Charan Ltd. & Das Ltd.
• Further Sec. 141 (4) provides that a person appointed as auditor incurs any of the disqualification mentioned u/s 141(3) after his appointment, he shall vacate the office immediately and it will be treated a casual vacancy.

Conclusion: Mr. Amar should vacate his office immediately and Das Ltd. must have to appoint any other CA as an auditor of the company.

Question 27.
Praveen, a member of the ICA1, does not hold a Certificate of practice. Is his appointment as an auditor valid? .
Answer:
Qualifications of an Auditor:

• As per Sec. 141(1} a person shall be qualified for appointment as an auditor of a company, only if he is a Chartered Accountant within the meaning of the Chartered Accountants Act, 1949.
• Under the Chartered Accountants Act, 1949, only a Chartered Accountant holding the certificate of practice can engage in public practice.

Conclusion: Mr. Praveen does not hold a certificate of practice and hence cannot be appointed as an auditor of a company.

Question 28.
‘B’ owes ₹ 5,01,000 to ‘C’ Ltd., of which he is an auditor. Is his appointment valid? Will it make any difference, if the advance is taken for meeting-out travelling expenses?
Answer:
Indebtedness to the Company:
As per Section 141(3) (d) (ii) of the Companies Act, 2013, a person who, or his relative or partner is indebted to the company, or its subsidiary, or its holding or associate company, or a subsidiary of its holding company, for an amount exceeding ₹ 5 Lacs, then he is not qualified for appointment as an auditor of a company.

Even if the advance was taken for meeting out travelling expenses particularly before commencement of audit work, his appointment is not valid because in such a case also the auditor shall be indebted to the company. The auditor is entitled to recover fees on a progressive basis only.

Conclusion: B’s appointment is not valid and he is disqualified as the amount of debt exceeds ₹ 5,00,000.

Question 29.
Mr. Aditya, a practising chartered accountant is appointed as a “Tax Consultant” of ABC Ltd., in which his father Mr. Singhvi is the Managing Director.
Answer:
Appointment of relative as tax consultant:

• Sec, 141(3)(f) of Companies Act, 2013 disqualifies a person to be appointed as auditor whose relative is a director or is in employment of the company as director or key managerial personnel.
• However, no such disqualification is prescribed under the law for appointing a person as a tax consultant, therefore sec. 141(3)(f) will not be attracted.

Conclusion: Mr. Aditya can be appointed as tax consultant irrespective that his father is the managing director of the company.

Question 30.
Mr. Ram, a relative of a Director was appointed as an auditor of the company. Comment. [Nov. 10 (6 Marks)]
Answer:
Appointment of director’s relative as auditor:
Section 141 (3)(f) explicitly disqualifies a person from being appointed as an auditor of a company whose relative is a director or is in the employment of the company as director or key managerial personnel.

This term relative has been defined u/s 2(77) of and explained under Rule 4 of the Companies (Specification of Definitions Details) Rules, 2014. As per Sec. 2(77) the term relative with reference to any person, means who anyone who is related to another, if they are members of HUF; they are husband and wife; or related to the other in prescribed manner. Rule 4 provides that a person shall be deemed to be relative of another, if he or she is related to another as father, mother, son, son’s wife, daughter, daughter’s husband, brother or sister.

Conclusion: Assuming that Mr. Ram falls within the above-mentioned relations, he should not accept the appointment as an auditor of that company.

Question 31.
Comment on the following: Sri & Company, a firm of Chartered Accountants was appointed as statutory auditors of Aaradhana Company Ltd. Aaradhana Company Ltd. holds 51 % shares in Sarang Company Ltd. Mr. Sri, one of the partners of Sri & Company, owed ₹ 1,500 as on the date of appointment to Sarang Company Ltd. for goods purchased in normal course of business.
Answer:
Disqualification as to indebtedness:
As per Section 141(3)(d)(ii) of the Companies Act, 2013, a person who, or his relative or partner is indebted to the company, or its subsidiary, or its holding or associate company, or a subsidiary of its holding company, for an amount exceeding ₹ 5,00,000 then he is not qualified for appointment as an auditor of a company.

Conclusion: Mr. Sri is not disqualified to be appointed as auditor of the company as he is indebted to the company for an amount not exceeding ₹ 5,00,000, consequently, Sri & Co., is not disqualified to be appointed as an auditor of Aaradhana Company Ltd.

Question 32.
Dabloo Ltd. offered appointment as its auditor to Mr. Bee, a practicing Chartered Accountant. Later on, Mr. Dee, the step-brother of Mr. Bee, purchased securities of the company having face value of ₹ 4,99,000. Comment, whether Mr. Bee may accept the offer of appointment as an auditor?
Answer:
Disqualification as to holding of security by relatives:
As per section 141(3)(d)(i) of the Companies Act, 2013 read with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, a person is disqualified to be appointed as an auditor if he, or his relative or partner holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company.

However, the relative of the auditor may hold the securities or interest in the company of face value not exceeding of ₹ 1,00,000. The term “relative” as defined under the Companies Act, 2013 includes step-brother.

In the present situation, Mr. Dee, the step-brother of Mr. Bee, is holding the securities having face value of ₹ 4,99,000 in Dabloo Ltd. Thus, holding of securities in Dabloo Ltd. by Mr. Dee having face value exceeding ₹ 1,00,000, will disqualify Mr. Bee from being appointed as an auditor of Dabloo Ltd.

Conclusion: Mr. Bee may not accept the offer of appointment as an auditor of Dabloo Ltd.

Question 33.
M/s Duster & Co., Chartered Accountants, appointed as a statutory auditor of R Ltd. for the financial year 2020-21. The company is also in need of some actuarial services. Consequently, the Board of Directors of the company offered the same to M/s Srivastava & Co., an associate to M/s Duster & Co., which has been duly accepted by the firm. Comment.
Answer:
Services not to be rendered By Auditor:

• Section 141(3)(i) of the Companies Act, 2013 disqualify a person who directly or indirectly, renders any service referred to in sec. 144 to the company or its holding company or its subsidiary company.
• Section 141 [4) of the Act provides that where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in sec. 141(3) after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.
• As per Section 144 of Companies Act, 2 013 an auditor appointed under this Act shall not provide certain service, directly or indirectly to the company or its holding company or subsidiary company. List of such services include actuarial services.
• In the given case, M/s Duster & Co., Chartered Accountants, was appointed as an auditor of R Ltd. and, the company offered actuarial services to M/s Srivastava & Co., an associate to M/s Duster & Co., which has also been duly accepted by the firm.

Conclusion: M/s Duster & Co. is disqualified to hold office as an auditor of R Ltd. u/s 141(3)(i), as its associate is involved in providing such services, to R Ltd., as mentioned in Sec. 144. Subsequently, M/s Duster & Co. shall have to vacate the office of auditor of R Ltd.

Question 34.
X & Associates, a Chartered Accountant firm, has been appointed as Statutory Auditor of H Ltd. for the financial year 2020-2021. Mr. Y, the relative of Mr. X, a partner in X & Associates, is indebted for ₹ 5,50,000 to S Ltd., a subsidiary company of H Ltd. Comment.
Answer:
Disqualification as to indebtedness to the Subsidiary Company:
Section 141(3)(d)(ii) of the Companies Act, 2013 provides that a person shall not be eligible for appointment as an auditor of a company, if he, or his relative or partner is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of ₹ 5 lakhs.

Section 141(4) of the Companies Act, 2013 provides that where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in Section 141(3) after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

In the present case, Mr. Y, the relative of Mr. X, a partner in X and Associates, has been indebted to S Ltd., a subsidiary company of H Ltd., for ₹ 5,50,000.

Conclusion: X & Associates would be disqualified to be appointed as statutory auditor of H Ltd. as per section 141(3)(d)(ii), which is the holding company of S Ltd., because Mr. Y, the relative of Mr. X, a partner in X and Associates, has been indebted to S Ltd. for an amount exceeding ₹ 5 Lacs.

Question 35.
R and M is an audit firm having partners CA R, CA M and CA G. Mr. S is the relative of CA R holding shares of STP Ltd. having a face value of ₹ 1,51,000 Whether CA R and CA M are qualified to be appointed as auditors of STP Ltd.? [May 15 (4 Marks)]
Answer:
Disqualifications as to security:

• As per section 141(3)(d)(i) a person is disqualified to be appointed as an auditor if he, or his relative or partner holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company
• However, the relative of the auditor may hold the securities or interest in the company of face value not exceeding of ₹ 1,00,000.
• In the instant case Mr. S relative of CA R, is holding the securities in STP Ltd. which is exceeding the limit mentioned in proviso to section 141(3)(d)(i). Therefore Audit firm is disqualified for appointment as an auditor of STP Ltd.

Conclusion: CA R and CA M are not qualified to be appointed as auditor of STP Ltd.

Question 36.
CA Mr. X was indebted to ABC Ltd. for a sum of ₹ 5,50,000 as on 01.04.2020. However, Mr. X having come to know that he might be appointed as auditor of the company, he squared up the amount on 10.7.2020. Later on, he was appointed as an auditor of the company at the Annual General Meeting held on 16.07.2020. Subsequently, one of the shareholders complains that the appointment of Mr. X as an auditor is invalid because he incurred disqualification under section 141 of the Companies Act, 2013. Comment. [Nov. 16 (4 Marks)]
Answer:
Auditor’s Disqualifications as to Indebtedness:

• Section 141(3)(d)(ii) of the Companies Act, 2013 provides that a person who is indebted to the company for an amount exceeding ₹ 5,00,000 shall be disqualified to act as an auditor of such company.
• However, where the person proposed to be appointed as auditor, liquidated the debt before the date of appointment, no disqualification arises as to appointment.
• In the given case, CA Mr. X was indebted to ABC Ltd. for a sum of ₹ 5,50,000 as on 01.04.2020. He repaid the loan amount fully to the company on 10.7.2020. He was appointed as an auditor of the company at the Annual General Meeting held on 16.07.2020. At the time of appointment, he was not indebted to the company hence, not disqualified.

Conclusion: The appointment of CA Mr. X as an auditor is valid and the shareholder’s complaint is not acceptable.

Question 37.
Comment on the validity of the appointments of Mr. A as an auditor of ABC Ltd. in the following situations:
(i) Mr. B, a partner of Mr. A held shares of face value of.Rs. 1,00,000 in DEF Ltd., the holding company of ABC Ltd. Mr. B has sold the securities after a period of 45 days from the date of appointment of Mr. A as an auditor of ABC Ltd.
(ii) Mrs. A, wife of Mr. A had given a financial guarantee for the principal amount of a debt owed by Mr. X to ABC Ltd. for Rs. 6 lakhs. Mr. X has repaid Rs. 5 lakhs to ABC Ltd. 2 days before the date of appointment of Mr. A as an auditor of the company. [Nov. 18-Old Syllabus (6 Marks)]
Answer:
Validity of Appointments:
(a) Auditor’s disqualifications as to security:
As per section 141 (3)(d) (i) a person is disqualified to be appointed as an auditor if he, or his relative or partner holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company.

However, the relative of the auditor may hold the securities or interest in the company of face value not exceeding of Rs. 1,00,000. It is also provided that in the event of acquiring and security or interest by a relative above the threshold limit, the corrective action to maintain the limits as specified above shall be taken by the auditor within 60 days of such acquisition or interest.

In the present case, Mr. B, a partner of Mr. A held shares of face value of Rs. 1,00,000 in DEF Ltd., the holding company of ABC Ltd. Mr. B has sold the securities after a period of 45 days from the date of appointment of Mr. A as an auditor of ABC Ltd.

Conclusion: Appointment of Mr. A as auditor in ABC Ltd. is not valid as he is disqualified by virtue of provisions as stated in Sec. 141(3)(d)(i). Subsequent sale of securities by the partner is of no relevance in this case.

(ii) Auditor’s disqualifications as to security:

• As per section 141 (3)(d) [iii) a person is disqualified to be appointed as an auditor if he, or his relative or partner has given a guarantee or provided any security in connection with, the indebtedness of any third person to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of ₹ 1 Lac.
• These disqualifications need to be examined as at the time of appointment.
• In the present case, Mrs. A, wife of Mr. A had given a financial guarantee for the principal amount of a debt owed by Mr. X to ABC Ltd. for Rs. 6 lakhs. Mr. X has repaid Rs. 5 lakhs to ABC Ltd. 2 days before the date of appointment of Mr. A as an auditor of the company.

Conclusion: Appointment of Mr. A as auditor in ABC Ltd. is valid as the amount of guarantee given by the Mrs. A for indebtedness of Mr. X in the company does not exceed Rs. 1 lac as on date of appointment.

Question 38.
Mr. Y, a practicing Chartered Accountant, has been appointed as an auditor of M/s Z Ltd. on 12th June, 2020 for the year ended 31st March, 2021. Following persons have done following transactions in securities of M/s Z Ltd.:

• Daughter of Mr. Y: Purchase of Securities on 10th September, 2020 of face value of Rs. 45,000 (market value Rs. 90,000)
• Husband of daughter of Mr. Y: Purchase of Securities on 10th December, 2020 of face value of Rs. 90,000 (Market value Rs. 1,90,000).

All the above securities were sold on 10th March, 2021 for Rs. 3,00,000. Discuss the implications of the above on the appointment of Mr. Y. [May 19 – Old Syllabus (5 Marks)]
Answer:
Auditor’s disqualifications as to security:
As per section 141(3)(d)(0 of Companies Act, 2013, a person is disqualified to be appointed as an auditor if he, or his relative or partner holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company.

As per Rule 10 of Companies (Audit and Auditor’s) Rules, 2014, the relative of the auditor may hold the securities or interest in the company of face value not exceeding of Rs. 1,00,000. It is also provided that in the event of acquiring and security or interest by a relative above the threshold limit, the corrective action to maintain the limits as specified above shall be taken by the auditor within 60 days of such acquisition or interest.

The term relative as defined in Sec. 2(77) includes daughter and daughter’s husband.

In the present case, Mr. Y, has been appointed as an auditor of M/s Z Ltd. on 12th June, 2020 for the year ended 31st March, 2021. His daughter purchases securities of Z Ltd. on 10th Sep., 2020 of face value of Rs. 45,000, whereas husband of daughter of Mr. Y purchases securities of Z Ltd. on 10th Dec., 2020 of face value of Rs. 90,000.

Aggregate face value of securities held by relatives of Mr. Y amounts to Rs. 1,35,000. Mr. Y was required to take corrective action within 60 days of 10th Dec. 2020 to bring the value of securities held by relatives to Rs. 1,00,000. However, securities were sold on 10th March, 2021 after expiry of 60 days from 10th Dec. 2020.

Conclusion: Mr. Y becomes disqualified on expiry of 60 days from 10th Dec. 2020 as he fails to take corrective action so as to bring the shareholding of relatives within prescribed limit of ₹ 1 Lac (face Value).

Question 39.
PQ and Co. is an audit firm with P and Q as partners. For the financial year 2020-21, the firm has been appointed as statutory auditor of M/s Mango Orchards Hotel Ltd. The audit firm is a regular customer of the hotel and the partners usually stay in the same hotel at various locations in the course of travelling for their various professional assignments. Normally, payments for such stay are settled against quarterly bills raised by the company. Give your comment with respect to the Companies Act, 2013. [May 19 – New Syllabus (4 Marks)]
Answer:
Auditor’s disqualifications as to business relationship:
As per Sec. 141(3)(c/)(z7) of the Companies Act, 2013 read with Rule 10 of Companies (TVudit and Auditor’s) Rules, 2014, a person who is indebted to the company for an amount exceeding t 5 Lacs shall be disqualified to be appointed as auditor.

As per section 141(3)(e) of Companies Act, 2013, a person or a firm who, whether directly or indirectly, has business relationship with the company, or its subsidiary, or its holding or associate company or subsidiary of such holding company or associate company of such nature as may be prescribed, is disqualified to be appointed as auditor of that company.

As per Rule 10 of Companies (Audit and Auditor’s) Rules, 2014, the term “business relationship” shall be construed as any transaction entered into for a commercial purpose, except:

Commercial transactions which are in the nature of professional services permitted to be rendered by an auditor or audit firm under the Act and the Chartered Accountants Act, 1949 and the rules or the regulations made under those Acts;

Commercial transactions which are in the ordinary course of business of the company at arm’s length price – like sale of products or services to the auditor, as customer, in the ordinary course of business, by companies engaged in the business of telecommunications, airlines, hospitals, hotels and such other similar businesses.

In the present case, audit firm is a regular customer of the client running a hotel and th e partners usually stay in the same hotel at various locations in the course of travelling for their various professional assignments. Normally, payments for such stay are settled against quarterly bills raised by the company.

Conclusion: No disqualification arises as the services availed are in ordinary course of business of client and cannot be considered as business relationship. (It is assumed that outstanding does not exceed ₹ 5 lakh)

Ceiling on Number of Audits |Sec. 141(3)(g)]

Question 40.
“ABC & Co.” is an Audit Firm having partners “Mr. A”, “Mr. B” and “Mr. C”, Chartered Accountants. “Mr. A”, “Mr. B” and “Mr. C” are holding appointment as an Auditor in 4,6 and 10 Companies respectively.

1. Provide the maximum number of Audits remaining in the name of “ABC & Co.”
2. Provide the maximum number of Audits remaining in the name of individual partner i.e. Mr. A, Mr. B and Mr. C.
3.  Can ABC & Co. accept the appointment as an auditor in 60 private companies having paid- up share capital less than ₹ 100 Cr. which has not committed default in filing its financial statements u/s 137 or annual return u/s 92 of Companies Act with the Registrar, 2 small companies and 1 dormant company?
4. Would your answer be different, if out of those 60 private companies, 45 companies are having paid-up share capital of ₹ 110 crore each [MTP-Oct. 18, RTP-Nov. 19]

Answer:
Ceiling on Number of Audit:
As per section 141(3)(g) of the Companies Act, 2013, a person shall not be eligible for appointment as an auditor if he is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such person or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies other than one person company, dormant companies, small companies and private companies having paid up share capital less than ₹ 100 Crores, which has not committed default in filing its financial statements u/s 137 or annual return u/s 92 of Companies Act with the Registrar.

As per section 141(3)(g), this limit of 20 company audits is per person. In the case of an audit firm having 3’partners, the overall ceiling will be 3 × 20 = 60 company audits. Sometimes, a chartered accountant is a partner in a number of auditing firms. In such a case, all the firms in which he is partner or proprietor will be together entitled to 20 company audits on his account.

Conclusion:
(i) ABC & Co. can hold appointment as an auditor of 40 more companies as computed below:
Total Number of Audits available to the Firm = 20 × 3 = 60
Number of Audits already taken by all the partners
In their individual capacity = 4 + 6 + 10 = 20
Remaining number of Audits available to the Firm = 40

(ii) Mr. A can hold: 20 – 4 = 16 more audits.
Mr. B can hold 20 – 6 = 14 more audits and
Mr. C can hold 20 – 10 = 10 more audits.

(iii) M/s ABC & Co. can hold appointment as an auditor in all the 60 private companies having paid up share capital less than ₹ 100 crores, 2 small companies and 1 dormant company as these are excluded from the ceiling limit of company audits given under section 141 (3) (g) of the Companies Act, 2013.

(iv) M/s ABC & Co. can also accept the appointment as an auditor for 2 small companies, 1 dormant company, 15 private companies having paid-up share capital less than ₹ 100 crores and 40 private companies having paid-up share capital of ₹ 110 crore each in addition to above 20 company audits already holding.

Question 41.
KBC & Co. a firm of Chartered Accountants has three partners, K, B & C; K is also in whole time employment elsewhere. The firm is offered the audit of ABC Ltd. and is already holding audit of 40 companies. Comment
Answer:
Ceiling on Number of Company Audits:
As per section 141 (3) (g] of the Companies Act, 2013, a person shall not be eligible for appointment as an auditor if he is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such person or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies.

In the firm of KBC & Co., K is in whole-time employment elsewhere, therefore, he will be excluded in determining the number of company audits that the firm can hold.

If B and C do not hold any audits in their personal capacity or as partners of other firms, the total number of company audits that can be accepted by KBC & Co., is forty, and in the given case company is already holding forty audits.

Conclusion: KBC & Co. can’t accept the offer for audit of ABC Ltd.

Question 42.
What are the steps to be taken by a firm of Chartered Accountant to ensure that its appointment as Statutory Auditor of a Company is valid?
Answer:
Validity of appointment as a statutory auditor:
To ensure that the appointment is valid, the incoming auditor should take the following steps before accepting his appointment:

1. Ceiling limit: Ensure that a certificate has been issued u/s 139 of the Companies Act, 2013 so that the total number of company audits held by the firm (including the new appointment) will not exceed the specified number.
2. Resolution at AGM: Verify that, a proper resolution is passed at AGM of the Company. For this purpose, minutes book of general meeting may be inspected.
3. Compliance with law: Ensure compliance of provisions of sections 139 and 140 of the Companies Act 2013, relating to appointment of auditor and removal of existing auditor.
4. Code of conduct: Ensure compliance of Clause 8 of Part I of First Schedule of Chartered Accountants Act, 1949 requiring communication with the previous auditor, in writing, to ascertain whether there are any professional reasons for not accepting the appointment.

Question 43.
KSY & Co. Chartered Accountants is an audiGfirm having two partners CA K and CA Y. KSY & Co. is already holding appointment as auditors of 36 public companies.
KSY & Co. seeks your advice in the following situations:
(i) KSY & Co. has been offered the appointment as Auditors of 7 more Private Limited Companies. Of the seven, one is a company with a paid-up share capital of 150 crores, five are “small companies” as per the Act and one is a “Dormant Company”.
(ii) Would your answer be different, if out of those 7 Private Companies, 3 Companies have paid up capital of ₹ 90 crores each?

Note: None of the private companies has committed default in filing its financial statements under section 137 or annual return under section 92 of the Companies Act with the Registrar. [May 16 (4 Marks)]
Answer:
Ceiling on Number of Audits:
Section 141(3) (g) of Companies Act, 2013 provides that a person is not eligible to be appointed as auditor of a company if he at the date of such appointment or reappointment holding appointment as auditor of more than 20 Companies other than one-person company, dormant companies, small companies and private companies having paid up share capital less than 100 Crores which has not committed default in filing its financial statements u/s 137 or annual return u/s 92 of Companies Act with the Registrar.

In the case of firm of auditors, it has been further provided that specified number of companies shall be construed as the number of companies specified for every partner of the firm who is not in full time employment elsewhere.

In the present case, KSY & Co. has two partners and hence eligible for audit of 40 Companies. Firm is already holding audit of 36 Public companies. It can accept the audit of 4 more companies other than One-person company, dormant companies, small companies and private companies having paid up share capital less than 100 Crores.

Conclusion:

1. KSY & Co. can accept audit of all 7 Private companies, because 5 small companies and one dormant company will not be considered for the purpose of ceiling limit. Total number of audit after acceptance of all seven audits remains at 37.
2. Answer will remain same, as the private companies having paid up capital less than 100 Crores are not considered for the purpose of ceiling limit. Total number of audit after acceptance of all seven audits remains at 40 assuming that other four companies having paid up capital in excess of ₹ 100 Crores.

Question 44.
M/s ABC and Co., a firm of Chartered Accountants, comprising of three partners A, B, and C are Statutory Auditors of 50 Companies as per details given below:

1. Small Companies – 10
2. Private Companies having paid up share capital of less than ₹ 100 Crores – 20
3. Private Companies having paid up share capital of more than ₹ 100 Crores – 15
4. Public Companies – 5

Mr. A signs the Balance Sheet of 10 Small Companies and 10 Private Companies having paid up share capital of less than ₹ 100 Crores. Mr. B signs the Balance Sheet of 10 Private Companies having paid up share capital of less than Rs. 100 Crores and 5 private Companies having paid up share capital of more than ₹ 100 Crores. Mr. C signs the Balance Sheet of 10 Private Companies having paid up share capital of more than ₹ 100 crores and 5 Public Companies.

What is the maximum number of audits that the firm as a whole can accept and what is the maximum number of audits each individual partner can accept?

Note: None of the private companies has committed default in filing its financial statements under section 137 or annual return under section 92 of the Companies Act with the Registrar. [May 18 – Old Syllabus (6 Marks)]
Answer:
Ceiling on Number of Audit:
As per section 141(3)(g) ofthe Companies Act, 2013, a person shall not be eligible for appointment as an auditor if he is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such person or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies other than one person company, dormant companies, small companies and private companies having paid up share capital less than ₹ 100 Crores, which has not committed default in filing its financial statements u/s 137 or annual return u/s 92 of Companies Act with the Registrar.

As per section 141(3)(g), this limit of 20 company audits is per person. In the case of an audit firm having 3 partners, the overall ceiling will be 3 × 20 = 60 company audits.

Conclusion:
Firm can accept 40 more audits of Public companies and private companies having paid up capital of more than ₹? 100 Crores. Audit of Small companies and private companies having paid up share capital less than ₹ 100 cr. are not considered for the purpose of ceiling.

Partner A can accept 20 audits of Public companies and private companies having paid up capital of more than ₹ 100 Crores. Partner B can accept 15 audits of Public companies and private companies having paid up capital of more than ₹ 100 Crores. Partner C can accept 5 audits of Public companies and private companies having paid up capital of more than ₹ 100 Crores. Audit of Small companies and private companies having paid up share capital less than ₹ 100 cr. are not considered for the purpose of ceiling.

Powers and Duties of Auditor – Sec. 143, Sec. 144, Sec. 145, Sec. 146

Question 45.
CA. G, was appointed by DP Ltd., as Statutory Auditor. While doing the audit of DP Ltd., CA. G observed that certain loans and advances were made without proper securities; certain trade receivables and trade payables were adjusted inter se; and personal expenses were charged to revenue. As a company auditor comment on the reporting responsibilities of CA. G. [Nov. 19 – New Syllabus (5 Marks)]
Answer:
Inquiry into Propriety Matters u/s 143(1):
Section 143(1] of the Companies Act, 2013 requires the auditor to conduct inquiry into certain matters and if the auditor finds answer of any of these matters in adverse, auditor is required to report, otherwise no reporting is required. In relation to observations stated in the question, auditor should inquire as follows:

1. Clause (a) of Section 143(1) requires the auditor to inquire “Whether loans and advances made by the company on the basis of security have been properly secured and whether the terms on which they have been made are prejudicial to the interests of the company or its members”.
2. Clause (b] of section 143(1), requires the auditor to inquire “whether transactions of the company which are represented merely by book entries are prejudicial to the interests of the company”.
3. Clause (c) of section 143(1) requires the auditor to inquire “Whether personal expenses have been charged to revenue account”.

If the auditor finds that the loans and advances have not been properly secured, he may enter an adverse comment in the report without modifying opinion on financial statements if the loans and advances are properly described and presented in terms of Part I of Schedule III to the Companies Act.

If relation to his observation regarding inter se adjustment of trade receivables and trade payables, being a book entry, auditor should have inquired into the legitimate interests of the company. If appears prejudicial, he may enter adverse comment in the report.

Regarding charging of personal expenses to revenue account auditor should inquire whether such expenses are incurred on the basis of the company’s contractual obligations, or in accordance with accepted business practice. If personal expenses incurred by the company are not covered by contractual obligations or by accepted business practice and charged to revenue account, it would be the duty of the auditor to report thereon.

Conclusion: In the instant case, Mr. G, the statutory auditor of DP Ltd., needs to enquire in light of above provisions, as a result of the enquiries if he is satisfied then there is no further duty to report on these matters.

Question 46.
Asan auditor, how would you deal with the following: In the audit of ABC Private Limited, auditor came across cases of payments to Directors, whereby, expenses of a personal nature were re-imbursed.
Answer:
Personal Expenses of Directors:

• All payments to Directors as remuneration or perquisites whether in the case of a public or private company need to be authorised in accordance with the Companies Act as well as Articles of Association of the company.
• If the terms of appointment of a Director include payment of expenses of a personal nature, then such expenses can be incurred by the company; otherwise, no such expense can be incurred or reimbursed by the company.
• In the instant case the auditor has to ensure that the payment is authorized by the Articles of Association and the same has been covered by terms of appointment.
• Further as this payment is also covered u/s 143 (1), and hence auditor is also required to inquire into the matter and make a disclosure in his report accordingly.

Question 47.
Director of T Ltd. draws an advance of US$ 200 per day in connection with the foreign trip undertaken on behalf of the company. On his return he files a declaration stating that entire advance was expended without any supporting or evidence. T Ltd. books the entire expenses on the basis of such declaration. As the auditor of T Ltd. how do you deal with this? [May 11 (8 Marks)]
Answer:
Personal Expenses Charged to revenue Account:

• Section 143(1)(e) of the Companies Act, 2013 requires an auditor to inquire and report whether personal expenses have been charged to revenue account.
• SA500 “Audit Evidence” states that an auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base his option.
• All payments to Directors as remuneration or perquisites whether in the case of a public or private company need to be authorised in accordance with the Companies Act as well as Articles of Association of the company.
• In the present case, company has booked foreign trip expenses of director in its revenue account. In the context, auditor is required to inquire whether the payment made by the company for the foreign trip is personal expense or not and collect the necessary supporting evidences.
• If it appears to be personal expense, auditor is required to ascertain whether such expense is properly authorized or not. If not authorized, auditor should state the matter in his report.

Question 48.
What are the statements of facts that an auditor has to report u/s 143 of the Companies Act, 2013.
Answer:
Statement of Facts to be reported u/s 143:
Section 143 (3) of Companies Act, 2013 requires the auditor the comment on the following in addition to opinion on true and fair view of financial statements:
(a) Whether he has sought and obtained all the information and explanations which to the best of his knowledge and belief were necessary for the purpose of his audit and if not, the details thereof and the effect of such information on the financial statements;

(b) Whether, in his opinion, proper books of account as required by law have been kept by the company so far as appears from his examination of those books and proper returns adequate for the purposes of his audit have been received from branches not visited by him;

(c) Whether the report on the accounts of any branch office of the company audited u/s 143(8) by a person other than the company’s auditor has been sent to him under the proviso to that sub-section and the manner in which he has dealt with it in preparing his report;

(d) Whether the company’s balance sheet and profit and loss account dealt with in the report are in agreement with the books of account and returns;’

(e) Whether, in his opinion, the financial statements comply with the accounting standards;

(f) The observations or comments of the auditors on financial transactions or matters which have any adverse effect on the functioning of the company;

(g) Whether any director is disqualified from being appointed as a director under sub-section (2) of section 164;

(h) any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith;

(i) whether the company has adequate internal financial controls with reference to financial statements in place and the operating effectiveness of such controls;

(j) such other matters as may be prescribed.

Further, Rule 11 of the Companies (Audit and Auditors) Rules, 2014 prescribes the other matters to be included in auditor’s report. The auditor’s report shall also include their views and comments on the following matters, namely:
(a) whether the company has disclosed the impact, if any, of pending litigations on its financial position in its financial statement;

(b) whether the company has made provision, as required under any law or accounting standards, for material foreseeable losses, if any, on long term contracts including derivative contracts;

(c) whether there has been any delay in transferring amounts, required to be transferred, to the Investor Education and Protection Fund by the company.

Question 49.
While conducting the audit of a limited company for the year ended 31st March, 2021, the auditor wanted to refer to the Minute Books. The Board of Directors refused to show the Minute Books to the auditor
Answer:
Right of Access to Books of Account:

• Sec. 143(1) of the Companies Act, 2013 grants powers to the auditor that every auditor has a right of access, at all times, to the books of account and vouchers of the company.
• The term books of account include all books which have any bearing or are likely to have any bearing on the accounts, whether these be the usual financial books or the statutory or statistical books.
• In order to verify actions of the company and to vouch and verify some of the transactions of
  the company, it is necessary for the auditor to refer to the decisions of the shareholders and/ or the directors of the company.
• It is, therefore, essential for the auditor to refer to the Minute Books. In the absence of the Minute Books, the auditor may not be able to vouch/verify certain transactions of the company.

Conclusion: In case the directors have refused to produce the Minute Books, the auditor may consider extending the audit procedure as also consider qualifying his report in any appropriate manner.

Question 50.
The auditor of X Ltd. did not report on the matters, specified u/s 143 (1) of the Companies Act, 2013, on which he inquired into, because of the reason that he was satisfied. But the management of the company wanted the auditor to report on those matters so that the members can also be aware of the true position of the company. Comment as to whether the auditor is required to report the matters, specified under the Act, he inquired into and whether the contention of the management is sustainable.
Answer:
Reporting of Matters contained under Section 143(1) of the Companies Act, 2013:
Sec. 143(1) of the Act deals with the duties of an auditor requiring him to make an inquiry in respect of specified propriety matters.

The matters in respect of which the inquiry has to be made by the auditor are relating to loans and advances on the basis of security, transactions represented merely by book entries, investments sold at less than cost price, loans and advances shown as deposits, personal expenses charged to revenue account etc.

The law requires the auditor to make an inquiry, the Research Committee of the Institute opined that the auditor is not required to report on these matters unless he has any special comments to make on any of the items referred to therein. If the auditor is satisfied as a result of the inquiries, he has no further duty to report that he is so satisfied.

Therefore, it could be said that the auditor should make a report to the members in case he finds answer to any of these matters in adverse.

Conclusion: The auditor of X Ltd. is correct in non-reporting on the matters specified in Sec. 143(1) of the Act and hence, the contention of the management is not sustainable.

Question 51.
M/s XYZ & Co., auditors of Goodwill Education Foundation, a recognised non-profit organisation feels that the standards on auditing need not to be applied as Goodwill Education Foundation is a non-profit making concern.
Answer:
Compliance with Standards on Auditing:
As per Sec. 143(9) of the Companies Act, 2013, every auditor shall comply with the auditing standards. Further as per Sec. 143(10), the Central Government may prescribe the standards of auditing or any addendum thereto, as recommended by the ICAI, in consultation with and after examination of the recommendations made by the NFRA.

However, until any auditing standards are notified, standards of auditing specified by the ICAI shall be deemed to be the auditing standards.

Further, the Preface to Standards on Auditing requires that while discharging their attest function; it is the duty of the Chartered Accountant to ensure that SAs are followed in the audit of financial information covered by their audit reports.

Conclusion: In the given case, even though the client is a non-profit oriented entity the SAs shall apply and the auditor is required to ensure their compliance. In case he fails to discharge his duty he shall be guilty of professional misconduct.

Question 52.
An auditor became aware of a matter regarding a company, only after he had issued his audit opinion. Had he become aware of the same prior to his issuing the audit report, he would have issued a different opinion.
Answer:
Auditor’s duties w.r.t. subsequent events:

• Sec. 146 of the Companies Act, 2013 requires the auditors of a company to attend the general meeting of the company unless otherwise exempted by the company.
• Auditor shall have the right to be heard at such meeting on any part of the business which concerns him as auditors.
• The discovery of a fact after issuance of the financial statements that existed at the date of the audit report which would have caused the revision of the audit report, requires the auditor to bring this to the notice of shareholders.
• Further SA 560 “Subsequent Event” also prescribes the procedures which the auditor is required to perform.

Conclusion: It will be advisable for the auditor to attend the meeting with a view to bringing to the notice of the shareholders the matter which came to his knowledge subsequent to his signing the report and perform procedures are per the requirement of SA 560.

Question 53.
Y, is the auditor of X Pvt. Ltd. In which there are four shareholders only, who are also the Directors of the company. On account of bad trade and for reducing the expenses in ail directions, the directors asked Y to accept a reduced fee and for that he has been offered not to carry out such full audit as he has done in the past. Y accepted the suggestions of the directors.
Answer:
Restricting Scope of Audit:

• Auditor’s duties are governed by the provisions of Sec. 143 of Companies Act, 2013, which cannot be restricted either by the director or even by the entire body of shareholders.
• Further, remuneration is a matter of arrangement between the auditor and the shareholders. Section 142 specifies the remuneration of an auditor, shall be fixed by the company in general meeting or in such manner as the company in general meeting may determine.
• Duties of auditor may not necessarily commensurate with his remuneration.

Conclusion: Y, should not accept the suggestions of the directors regarding the scope of the work to be done. If he accepts the suggestions of the directors regarding the scope of work to be done, it would not reduce his responsibility as an auditor under the law and he will be violating the provisions of the Companies Act, 2013.

Question 54.
At the Annual General Meeting of the Company, a resolution was passed by the entire body of shareholders restricting some of the powers of the Statutory Auditors. Whether powers of the Statutory Auditors can be restricted?
Answer:
Restrictions on Powers of Statutory Auditors:
Section 143 of the Companies Act, 2013 provides that an auditor of a company shall have right of access at all times to the books and account and vouchers of the company whether kept at the Head Office or other places and shall be entitled to require from the offices of the company such information and explanations as the auditor may think necessary for the purpose of his audit.

These specific rights have been conferred by the statute on the auditor to enable him to carry out his duties and responsibilities prescribed under the Act, which cannot be restricted or abridged in any manner.

Further it was held in the case of Newton vs. Birmingham Small Arms Co. that any resolution even if passed by entire body of shareholders which preclude the auditors from availing themselves of all the information for which they are entitled to under the Company Law are inconsistent with the Act and therefore null and void.

Conclusion: Any resolution restricting the scope of statutory right of auditor even if passed by entire body of shareholders is ultra vires and therefore void.

Question 55.
Mr. Rajendra, a fellow member of the Institute of Chartered Accountants of India, working as Manager of Shrivastav and Co., a Chartered Accountant firm, signed the audit report of Om Ltd. on behalf of Shrivastav & Co.
Answer:
Signature on Audit Report:
Section 145 of the Companies Act, 2013 requires that the person appointed as an auditor of the company shall sign the auditor’s report or sign or certify any other document of the company in accordance with the provisions of Sec. 141 (2), i.e. where a firm including a LLP is appointed as an auditor of a company, only the partners who are CAs shall be authorized to act and sign on behalf of the firm.

In the present case, Mr. Rajendra, a fellow member of the Institute and a manager of M/s Shrivastav & Co., Chartered Accountants, cannot sign on behalf of the firm in view of the specific requirements of the Companies Act, 2013.

If any auditor’s report or any document of the company is signed or authenticated otherwise than in conformity with the requirements of Section 145, the auditor concerned and the person, if any, other than the auditor who signs the report or signs or authenticates the document shall, if the default is wilful, be punishable with a fine.

Question 56.
The members of C. Ltd. preferred a complaint against the auditor stating that he has failed to send the auditor’s report to them.
Answer:
Dispatch of Auditor’s Report to Shareholders:
Section 143 of the Companies Act, 2013 lays down the powers and duties of auditor. As per provisions of the law, it is no part of the auditor’s duty to send a copy of his report to members of the company.

The auditor’s duty concludes once he forwards his report to the company. It is the responsibility of company to send the report to every member of the company.

In case of Allen Graig and Company (London] Ltd., it was held that duty of the auditor after having signed the report to be annexed to a balance sheet is confined only to forwarding that report to the secretary of the company. It will be for the secretary or the director to convene a general meeting and send the balance sheet and report to the members (or another person] entitled to receive it.

Conclusion: Auditor cannot be held liable for the failure to send the report to the shareholders.

Question 57.
What are the duties of an auditor regarding disqualifications of directors under section 164(2) of Companies Act, 2013. (May 09 (8 Marks)]
Answer:
Auditor’s duties w.r.t. Director’s disqualifications:

• Section 143(3](g] of the Companies Act, 2013 imposes a specific duty on the auditor to report whether any director is disqualified from being appointed as directors under section 164(2] of the Companies Act, 2013.
• As per Section 164(2] of Companies Act, 2013, no person who is or has been a director of a company which
  (a) has not filed financial statements or annual returns for any continuous period of three financial years; or
  (b) has failed to repay the deposits accepted by it or pay interest thereon or to redeem any debentures on the due date or pay interest due thereon or pay any dividend declared and such failure to pay or redeem continues for one year or more, shall be eligible to be re-appointed as a director of that company or appointed in other company for a period of five years from the date on which the said company fails to do so.
• Rule 14(1] of Companies (Appointment and Qualification of Directors) Rules, 2014 requires every director to inform to the company concerned about his disqualification under Sec. 164(2), if any, in Form DIR-8 before he is appointed or re-appointed.
• The auditor is required to ensure whether the director has submitted DIR-8 to the company at the time of appointment or reappointment.
• Auditor may also request for the inspection of DIR-8 available with the company and obtain a copy of the same for the purpose of his record.

Question 58.
One of the directors of Hitech Ltd. is attracted by the disqualification under Section 164(2) of the Companies Act, 2013.
Answer:
Disqualification of a Director under section 164(2) of the Companies Act, 2013:

• Section 143(3)(g) of the Companies Act, 2013 imposes a specific duty on the auditor to report whether any director is disqualified from being appointed as directors under section 164(2) of the Companies Act, 2013.
• The auditor has to ensure that written representation have been obtained by the Board from each director that one is not hit by Section 164(2).

Conclusion: In this case, one of the director is attracted by disqualification u/s 164(2) of the Act, the auditor shall state in his report as per Sec. 143 about the disqualification of the particular director.

Question 59.
The Board of Directors of a company have filed a complaint with the 1CAI against their statutory auditors for their failing to attend the AGM of the Shareholders in which audited accounts were considered.
Answer:
Auditor’s Attendance at Annual General Meeting:

• Section 146 of the Companies Act, 2013 requires the auditor of a company to attend either by himself or through his qualified authorised representative to attend the general meeting, unless exempted.
• The said section provides that all notices and other communications relating to any general meeting of a company shall also be forwarded to the auditor.
• Further, it has been provided that the auditor shall have right to be heard at such meeting on any part of the business which concerns him as an auditor.

Conclusion: Complaint filed by the Board of Directors is valid if the auditor was not being exempted by the company.

Question 60.
Mr. X, a Director of M/s KP Private Ltd., is also a Director of another company viz., M/s GP Private Ltd., which has not filed the financial statements and annual return for last three years 2017-18 to 2019-20. Mr. X is of the opinion that he is not disqualified u/s 164(2) of the Companies Act, 2013, and auditor should not mention disqualification remark in his audit report.
Answer:
Disqualification of a Director under section 164(2) of the Companies Act, 2013:
Section 143(3)(g) of the Companies Act, 2013 imposes a specific duty on the auditor to report whether any director is disqualified from being appointed as director u/s 164(2) of the Companies Act, 2013.

As per provisions of Section 164(2), if a director is already holding a directorship of a company which has not filed the financial statements or annual returns for any continuous period of 3 financial years shall not be eligible to be reappointed as a director of that company or appointed in other company for a period of five years from the date on which the said company fails to do so.

Conclusion: In this case, Mr. X is a director of M/s KP Private Ltd. as well as of M/s GP Private Ltd., And, M/s GP Private Ltd., has not filed the financial statements and annual return for last three years. Hence the provisions of section 164(2) are applicable to him and as such he is disqualified from directorship of both the companies. Therefore, the auditor shall report about the disqualification u/s 143(3)(g) of the Companies Act, 2013.

Question 61.
Comment: Contravene Ltd. appointed CA Innocent as an auditor for the company for the current financial year. Further the company offered him the services of actuarial, investment advisory and investment banking which was also approved by the Board of Directors. [MTP-Oct. 19]
Answer:
Services not to be rendered by the Auditor:
Section 144 of the Companies Act, 2013 prescribes certain services not to be rendered by the auditor. An auditor appointed under this Act shall provide to the company only such other services as are approved by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company or its holding company or subsidiary company), namely:

1. accounting and book keeping services;
2. internal audit;
3. design and implementation of any financial information system;
4. actuarial services;
5. investment advisory services;
6. investment banking services;
7. rendering of outsourced financial services;
8. management services; and
9. any other kind of services as may be prescribed.

Further section 141(3)(i) of the Companies Act, 2013 also disqualify a person for appointment as an auditor of a company who, directly or indirectly, renders any service referred to in Sec. 144 to the company or its holding company or its subsidiary company.

In the given case, CA Innocent was appointed as an auditor of Contravene Ltd. He was offered additional services of actuarial, investment advisory and investment banking which was also approved by the Board of Directors.

Conclusion: The auditor is advised not to accept the services as these services are specifically notified in the services not to be rendered by him as an auditor as per section 144 of the Act.

Question 62.
When can a company be said to have ‘Not maintained’ proper books of account? What is the role of the statutory auditor for the same?
or
The auditor report of company states that proper books of account as required by law have been maintained by the company. What is the role of statutory auditor of the company, when a company be said to have not maintained proper books of account? [May 15 (4 Marks}}
Or
Write short note on: Proper Books of Account as per Companies Act, 2013. [May 17 (4 Marks)]
Answer:
Auditor’s duties in case of non-maintenance of proper books of account:
Section 143(3) (b) of Companies Act, 2 013 requires that the auditor’s report shall state whether, in his opinion, proper books of account as required by law have been kept by the company so far as appears from his examination of those books and proper returns adequate for the purposes of his audit have been received from branches not visited by him.

As per Section 128 of the Companies Act, 2013, every company shall prepare and keep at its registered office books of account and other relevant books and papers and financial statement for every financial year which give a true and faif view of the state of the affairs of the company, including that of its branch office or offices, if any.

Such books shall be kept on accrual basis and according to the double entry system of accounting.

Conclusion: The Auditor is required to check that the company has complied with all the provisions related to maintenance of books of account prescribed under section 128. If the statutory auditor finds that the books are not maintained properly, he will have to modify his report and shall state the reasons for the same.

“ICAI Examiner Comments”
Many Candidates failed to explain the provisions of section 143(3)(b). Few candidates laid ^ stress on various books of account, records and document as per section 2(13).

Question 63.
Write short note on: Obligation of the statutory auditor to report frauds to the Central Government during the audit carried out under the Companies Act, 2013. [Nov. 15 (4 Marks)]
Or
An auditor observed a fraud committed by an employee of the company. State the manner and timing of reporting of the fraud by the auditor. [Nov. 16 (4 Marks)]
Or
You have been appointed statutory auditor of a company for the financial year ended 31st March, 2021 in place of the retiring auditor. During the course of audit, you observe that a fraud had been committed by a general manager who retired in March 2021. While going into further details, it was found that the fraud was going on since last 2-3 years and the total amount misappropriated was likely to exceed ₹ 100 lakhs. As statutory auditor, what would be your reporting responsibilities to the government? [Nov. 17 [5 Marks)]
Answer:
Auditor’s duties to report fraud to the Central Government:
Section 143 (12) of Companies Act, 2013 requires that if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed. For this purpose. Rule 13 prescribes the amount of ₹ 1 Cr. or more.

However, in case of a fraud involving lesser than the specified amount, i.e. below ₹ 1 Cr., the auditor shall report the matter to the audit committee constituted u/s 177 or to the Board in other cases within such time and in such manner as may be prescribed.

The companies, whose auditors have reported frauds to the audit committee or the Board but not reported to the Central Government, shall disclose the details about such frauds in the Board’s report in such manner as may be prescribed.

Rule 13 of Companies (Audit and Auditors) Rules, 2014 prescribes the manner of Reporting of Frauds in various cases. Accordingly:
(1) If an auditor of a company, in the course of the performance of his duties as statutory auditor, has reason to believe that an offence of fraud, which involves or is expected to involve individually an amount of ₹ 1 Cr. or above, is being or has been committed against the company by its officers or employees, the auditor shall report the matter to the CG.

(2) The auditor shall report the matter to the CG as under:
(a) the auditor shall report the matter to the Board or the Audit Committee, as the case may be, immediately but not later than 2 days of his knowledge of the fraud, seeking their reply or observations within 45 days;

(b) on receipt of such reply or observations, the auditor shall forward his report and the reply or observations of the Board or the Audit Committee along with his comments (on such reply or observations of the Board or the Audit Committee) to the CG within 15 days from the date of receipt of such reply or observations;

(c) in case the auditor fails to get any reply or observations from the Board or the Audit Committee within the stipulated period of 45 days, he shall forward his report to the CG along with a note containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he has not received any reply or observations;

(d) the report shall be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by Registered Post with Acknowledgement Due or by Speed Post followed by an e-mail in confirmation of the same;

(e) the report shall be on the letter-head of the auditor containing postal address, e-mail address and contact telephone number or mobile number and be signed by the auditor with his seal and shall indicate his Membership Number; and

(f) the report shall be in the form of a statement as specified in Form ADT-4.

(3) In case of a fraud involving amount less than ₹ 1 Cr., the auditor shall report the matter to Audit Committee constituted u/s 177 or to the Board immediately but not later than 2 days of his knowledge of the fraud and he shall report the matter specifying the following:
(a) Nature of Fraud with description;
(b) Approximate amount involved; and
(c) Parties involved.

(4) The following details of each of the fraud reported to the Audit Committee or the Board under sub-rule (3) during the year shall be disclosed in the Board’s Report-
(a) Nature of Fraud with description;
(b) Approximate Amount involved;
(c) Parties involved, if remedial action not taken; and
(d) Remedial actions taken.

“ICAI Examiner Comments”
The procedures to be followed as per Companies (Audit and Auditors) Rules, 2014 to report frauds have not been properly explained by examinees.

Question 64.
RX Ltd. is a sugar manufacturing company. The company appointed Mr. Suresh, a practicing cost accountant, to conduct cost audit of its cost records under section 148 of the Companies Act, 2013. While conducting audit, Mr. Suresh found some misstatement resulting into fraud committed by the officers of the company amounting ₹ 1.5 crore. However, he did not report the matter to the Central Government believing that liability for such reporting lies only with statutory auditor of the company Advise.
Answer:
Reporting of Fraud u/s 142(12) by a Cost Accountant:
Sec. 143(12) of the Companies Act, 2013 along with Rule 13 of the Companies (Audit and Auditors) Rules, 2014 provides that if auditor of a company, in the course of the performance of his duties as statutory auditor, has reason to believe that an offence of fraud, which involves or is expected to involve individually an amount of ₹ 1 crore or above, is being or has been committed against the company by its officers or employees, the auditor shall report the matter to the Central Government as per the prescribed procedure.

Sec. 143(14) of Companies Act, 2013 provides that the provisions related to reporting of fraud shall also apply, mutatis mutandis, to a cost accountant conducting cost audit u/s 148 of the Companies Act, 2013.

In the present case, Mr. Suresh, being the cost auditor of RX Ltd., found misstatement resulting into fraud amounting ₹ 1.5 crore committed by the officers of the company. He was required to report the fraud to the Central Government.

Conclusion: Mr. Suresh failed to perform his duties to report the fraud to C.G.

Question 65.
Write short note on: Auditor’s right to Lien as per Companies Act, 2013. [May 17 (4 Marks)]
Answer:
Auditor’s Right of Lien:

• Lien refers to the right of a person for lawful possession of somebody’s else property on which he has worked. Right of lien is exercised for non-payment of his dues for the work done.
• The auditors can exercise right of lien on the client’s books and documents in his possession for non-payment of fees by the client, for the work done on the books and documents.
• In respect of auditor exercising the lien, The Institute of Chartered Accountants of England and Wales has expressed a similar view subject to the following conditions:
  1. Documents must belong to the client who owes the money,
  2. These documents must come to the possession of the auditor on the client’s authority.
  3. The auditor can retain such documents, only if he has done work on such documents, on which fees have not been paid.

Note: As per Ethical Standard Board of ICAI, a chartered accountant cannot exercise lien over the client documents/records for non-payment of his fees.

“ICAI Examiner Comments”
Many candidates explained Right of Lien of Auditors in a general manner but most of the candidates failed to explain the Auditor’s Right to Lien in the context of Companies Act, 2013. Few candidates wrongly mentioned Rights of an auditor which was not required.

Cost Audit and Companies (Cost Records and Audit) Rules, 2014

Question 66.
Sugar Ltd. isa top sugar manufacturer and exporter in India operating from Noida Specific Economic ! Zone, Uttar Pradesh. Its revenue from sale/export for the immediate preceding year is given below:
Sale within India ₹ 1157 lakhs
Sale outside India (Export) ₹ 1353 lakhs
Total Revenue ₹ 2510 lakhs
Mr. X, the statutory auditor of Sugar Ltd., is of the view that the company is mandatorily required to include cost records in their books of account and consequently conduct cost audit. He also suggested the name of his friend, who is a Cost Accountant in Practice, for the purpose of such cost audit.

However, the management is of the view thatthe company neither required including cost records in their books of account nor conduct cost audit.

Being an expert in cost records and audit rules, you are required to guide the management in this regard.
Answer:
Applicability of provisions related to Cost Records and Audit:
The provisions relating to cost records and audit are governed by section 148 of the Companies Act, 2013 read with the Companies (Cost Records and Audit) Rules, 2014. The audit conducted under this section shall be in addition to the audit conducted under section 143.

Rule 3 of the Companies (Cost Records and Audit) Rules, 2014 provides the classes of companies (including Foreign Companies) required to include cost records in their books of account if they are having turnover ₹ 35 Cr. or more during immediately preceding financial year. The said rule has also divided the list of companies into regulated sectors and non-regulated sectors. Company belonging to sugar industry is one of the types of companies prescribed under the regulated sectors.

Rule 4 of Companies (Cost Records and Audit) Rules, 2014 requires audit of cost records in case of regulated sector industries if annual turnover from all products and services in immediately preceding financial year is ₹ 50 Cr. or more and the turnover of individual product or service is ₹ 25 Cr. or more.

Rule 4 further provides that requirement of cost audit shall not apply to a company whose revenue from exports in foreign exchange exceeds 75% of total revenue or which is operating from a SEZ.

In the given case, Sugar Ltd., a sugar manufacturer and exporter in India, is operating from Noida Specific Economic Zone, Uttar Pradesh and its turnover for the immediate preceding year is just ₹ 25.10 Cr.

Conclusion: Sugar Ltd. is not required to include cost records in their books of account in accordance with Rule 3 of the Companies (Cost Records and Audit) Rules, 2014 and no Cost audit is required.

Question 67.
XYZ Ltd., having place of business in Delhi, is engaged in the production, trading, import and export of orthopedic implants and pacemaker. The company’s revenue from export is usually in foreign currency. Its total revenue classification for the immediate preceding financial year is as below:
Intra-State Sale : ₹ 1400 lakhs
Inter-State Sale : ₹ 1550 lakhs
Export to US : ₹ 4900 lakhs
Export to UK : ₹ 6900 lakhs
Total Revenue : ₹ 14750 lakhs
The management of the company is of the opinion that the company is not required to maintain cost records in their books of account. Consequently, there is no need to appoint cost auditor and conduct cost audit. Comment.
Answer:
Applicability of provisions related to Cost Records and Audit:
The provisions relating to cost records and audit are governed by section 148 of the Companies Act, 2013 read with Companies (Cost Records and Audit) Rules, 2014. The audit conducted under this section shall be in addition to the audit conducted under section 143.

Rule 3 of the Companies (Cost Records and Audit) Rules, 2014 provides the classes of companies (including Foreign Companies) required to include cost records in their books of account if they are having turnover ₹ 35 Cr. or more during immediately preceding financial year.

Rule 4 of Companies (Cost Records and Audit) Rules, 2014 requires audit of cost records in case of non-regulated sector industries if annual turnover from all products and services in immediately preceding financial year is ₹ 100 Cr. or more and the turnover of individual product or service is ₹ 35 Cr. or more.

Rule 4 further provides that requirement of cost audit shall not apply to a company whose revenue from exports in foreign exchange exceeds 75% of total revenue or which is operating from a SEZ.

In the given case, XYZ Ltd. is a foreign company and its total revenue for the immediate preceding financial year is ₹ 14750 lakhs, out of which, export, in foreign currency, comprises ₹ 11800 lakhs (₹ 4900 lakhs + ₹ 6900 lakhs). The proportion of the company’s export to its total revenue is 80% [(₹ 11800 lakhs/₹ 14750 lakhs)*100].

Conclusion: XYZ Ltd. is required to include cost records in their books of account in accordance with Rule 3 of the Companies (Cost Records and Audit) Rules, 2014.

However, the company is not required to conduct cost audit as its revenue from exports, in foreign exchange, exceeds 75 percent of its total revenue.

Question 68.
Electro Ltd. is engaged in generation of electricity for captive consumption through Captive Generating Plant The Company also maintain cost records in their books of account as required under Cost Records and Audit Rules. Mr. X, friend of Managing Director of the company, suggested name of his brother, who is a Cost Accountant in Practice, for the purpose of cost audit. However, the statutory auditor of the company, is of the view that the company is not legally required to conduct cost audit. Now, the Managing Director is in dilemma about the requirement of cost audit.
Being an expert in cost records and audit rules, you are required to guide in this regard. [RTP – Nov. 20]
Answer:
Applicability of provisions related to Cost Records and Audit:

Provisions relating to cost records and audit are governed by section 148 of the Companies Act, 2013 read with the Companies (Cost Records and Audit) Rules, 2014.

Rule 3 of the Companies (Cost Records and Audit) Rules, 2014 provides the classes of companies, engaged in the production of goods or providing services, required to include cost records in their books of account. However, the requirement for cost audit under these rules shall not be applicable to a company which is covered under Rule 3, and,

1. whose revenue from exports, in foreign exchange, exceeds 75 per cent of its total revenue; or
2. which is operating from a special economic zone.
3. which is engaged in generation of electricity for captive consumption through Captive Generating Plant.

In the given case, Electro Ltd. is engaged in generation of electricity for captive consumption through Captive Generating Plant. Electro Ltd. is not required to conduct cost audit as it is falling under the exemption criteria.

Conclusion: The opinion of statutory auditor of the company regarding non-applicability of cost audit is correct and the management should follow the same.

Question 69.
X Ltd. is engaged in the production of Iron and Steel. A CA Firm ‘M/s M & Co.’ was appointed as the statutory auditor of X Ltd. for the current financial year. During the year, the management of the company realized that the company is required to maintain cost records in their books of account and get it audited. Therefore, in a general meeting, the members of the company appointed M/s M & Co. as the cost auditor of the company. You are required to examine the validity of appointment of M/s M & Co. as the cost auditor.
Answer:
Appointment of Statutory Auditor as Cost Auditor:
As per Section 148(3) of the Companies Act,-2013 read with Rule 6 of Companies (Cost Records and Audit) Rules, 2014 –

1. in the case of companies which are required to constitute an audit committee, the Board shall appoint an individual, who is a cost accountant in practice, or a firm of cost accountants in practice, as cost auditor on the recommendations of the Audit committee;
2. in the case of other companies which are not required to constitute an audit committee, the Board shall appoint an individual who is a cost accountant in practice or a firm of cost accountants in practice as cost auditor.

Sec. 148(3) also provides that no person appointed under section 139 as an auditor of the company shall be appointed for conducting the audit of cost records.

In the given case, the members of X Ltd. in general meeting appointed M/s M & Co., the statutory auditor of the company, as the cost auditor.
Therefore, the appointment of the CA firm as cost auditor made by the company is not valid.

Conclusion: Appointment is not valid as a CA firm cannot be appointed as cost auditor. The Board shall appoint a cost accountant in practice or a firm of cost accountants in practice to conduct such cost audit.

Question 70.
On 30.08.2020, the Board of SRE Ltd. proposed to appoint Mr. Elex, a Cost Accountant in practice, for conducting cost audit for the financial year 2020-21. The management came to know about the certificate which needs to be obtained from the auditor before such appointment is made. However, the management is unaware about what certification is required from the auditor. Please guide.
Answer:
Certificate to be obtained from Cost Auditor:
As per Rule 6 of Companies (Cost Records and Audit) Rules, 2014, Companies required to get the cost records audited, shall within 180 Days of the commencement of every financial year, appoint a cost auditor. Before such appointment is made, the written consent of cost auditor to such appointment and a certificate from him or it shall be obtained.

The Cost Auditor appointed shall submit certificate that-
(a) the individual or the firm, as the case may be, is eligible for appointment and is not disqualified for appointment under the Act, the Cost and Works Accountants Act, 1959 and the Rules or regulations made thereunder.

(b) the individual or the firm, as the case may be, satisfies the criteria provided in Sec. 141, so far as may be applicable.

(c) the proposed appointment is within the limits laid down by or under the authority of the Act.

(d) the list of proceedings against the cost auditor or audit firm or any partner of the audit firm pending with respect to professional matters of conduct, as disclosed in the certificate, is true and correct.

Question 71.
Elucidate the provisions relating to submission of Cost Audit Report to the Board and the Central Government as per the Companies Act, 2013.
Answer:
Submission of Cost Audit Report:
Sec. 148(5) of Companies Act, 2013 requires the cost auditor to submit the report on the audit of cost records to the Board of Directors of the company. Sec. 148(6) provides that the company shall within 30 days from the date of receipt of a copy of the cost audit report furnish the Central Government with such report along with full information and explanation on every reservation or qualification contained therein.

Sec. 148(7) of Companies Act, 2013 provides that if, after considering the cost audit report and the information and explanation furnished by the company, the Central Government is of the opinion that any further information or explanation is necessary, it may call for such further information and explanation and the company shall: arnish the same within such time as may be specified by that Government. , –

Rule 6 of Companies (Cost Records and Audit) Rules, 2014 provides the following in this regard:
a. Every cost auditor, who conducts an audit of the cost records of a company, shall submit the cost audit report along with his or its reservations or qualifications or observations or suggestions, if any, in Form CRA-3.

b. Every cost auditor shall forward his report to the Board of Directors of the company within a period of 180 days from the closure of the financial year to which the report relates and the Board of Directors shall consider and examine such report particularly any reservation or qualification contained therein.

c. Every company covered under these rules shall, within a period of thirty days from the date of receipt of a copy of the cost audit report, furnish the Central Government with such report along with full information and explanation on every reservation or qualification contained therein, in Form CRA-4 along with specified fees.

Question 72.
Pearl Ltd. is an exporter of precious and semi-precious stones. The turnover of the company is Rs. 150 crores, out of which Rs. 105 crores are from export business and remaining Rs. 45 crores from domestic sales. Amount received from export business is all in foreign currency. Directors of Pearl Ltd. is of the opinion that cost audit is not applicable to their company as maximum revenue has been generated from export business. Give your opinion. [May 19 – New Syllabus (4 Marks)]
Answer:
Applicability of Cost Audit:

• Provisions relating to cost audit are governed by section 148 of the Companies Act, 2013 read with the Companies (Cost Records and Audit) Rules, 2014.
• Rule 4 of Companies (Cost Records and Audit) Rules, 2014 requires audit of cost records in case of non-regulated sector industries if annual turnover from all products and services in immediately preceding financial year is Rs. 100 Cr. or more and the turnover of individual product or service is Rs. 35 Cr. or more.
• Rule 4 further provides that requirement of cost audit shall not apply to a company whose revenue from exports, in foreign exchange, exceeds 75 per cent of its total revenue.
• In the present case, the turnover of the company is Rs. 15 0 crores, out of which Rs. 105 crores are from export business and remaining Rs. 45 crores from domestic sales. Amount received from export business is all in foreign currency. Revenue from exports in foreign exchange amounts to 70% of total revenue.

Conclusion: Opinion of the Directors that cost audit is not applicable to their company as maximum revenue has been generated from export business is not valid as total revenue from exports in foreign exchange is less than 50% of total revenue. Hence company is required to get its cost records audited.

It is assumed that figures of revenue are given for immediately preceding financial year.

Note: Suggested Answer oflCAI refer Rule 3 instead of Rule 4. Rule 3 is related to applicability of cost records. Provisions related with Cost Audit are covered in Rule 4.

Branch Audit

Question 73.
As a Statutory Auditor, how would you deal with the following: P Ltd. of whom you are the Statutory Auditor appoints M/s XYZ as Branch Auditors for one of its branches. M/s XYZ conducted the audit of the branch without visiting the branch and instead getting the books at the H.O. M/s XYZ has submitted their Branch Audit Report to you.
Answer:
Duties of Company Auditor w.r.t. Branches not audited by him:
As per Sec. 143(8) of the Companies Act, 2013, the accounts of a branch office of a company may be audited either by the company’s auditor or by any other person qualified for appointment as auditor of the company.

The branch auditor shall prepare a report on the accounts of the branch examined by him and send it to the auditor of the company who shall deal with it in his report in the manner as he considers necessary.

It is however not necessary for branch auditor to visit the branch and conduct the audit only at branch’s premises. It is a matter of professional judgment for the branch auditor to decide as to whether he needs to visit the branch.

As per SA 600 “Using the work of another auditor”, the principal auditor is not required to evaluate professional competence because branch auditor happens to be member of 1CAI. The statutory auditor is also required to deal with the Branch Auditor’s report in the manner, he considers necessary.

Under the present circumstances the statutory auditor is entitled to rely on the work of branch auditor unless there are special circumstances to make it essential for him to visit the branch and examine the books of account and voucher records.

Conclusion: The statutory auditor is required to deal with branch auditor’s report in the manner it considers fit under the circumstances.

Question 74.
X Ltd. has a branch office in Malaysia. The company has appointed Mr. X, who is qualified to audit accounts as per Malaysian laws. Mr. Z, the statutory auditor objects to the same, contending that he alone can audit the branch office accounts. Discuss.
Answer:
Eligibility criteria for appointment as Branch Auditor
As per Sec. 143(8] of the Companies Act, 2013, where the branch office is situated in a country outside India, the accounts of the branch office shall be audited either by the company’s auditor or by an accountant or by any other person duly qualified to act as an auditor of the accounts of the branch office in accordance with the laws of that country.

Hence, a company can appoint as auditor of a foreign branch an accountant duly qualified to act as an auditor in accordance with the laws of the foreign country.

Conclusion: Mr. Z contention that he alone can audit the branch office accounts is not valid.

Question 75.
Bhishm Limited decided to appoint Mr. Rajvir, chartered accountant, as the branch auditor for the audit of its Lucknow branch accounts for the year 2020-21. The decision to appoint branch auditor was taken by way of Boa rd Resolution in the meeting of Board of Directors of the company, held in April 2020, subject to shareholders’ approval in AGM of the company scheduled to be held in June 2020. Meanwhile, the Principal Auditor of the company raised an objection that the branch auditor cannot be appointed without his consent. Advise, whether the objection raised by company auditor is valid. , [RTP-Nov.19]
Answer:
Appointment of Branch Auditor:
As per Sec. 143(8] of the Companies Act, 2013, where the branch office is situated in a country outside India, the accounts of the branch office shall be audited either by the company’s auditor or by an accountant or by any other person duly qualified to act as an auditor of the accounts of the branch office in accordance with the laws of that country.

In the instant case, Bhishm Limited decided to appoint Mr. Rajvir, chartered accountant, as the branch auditor for the audit of its Lucknow branch accounts and the decision to appoint branch auditor was taken by way of Board Resolution in the meeting of Board of Directors of the company subject to shareholders’ approval in AGM of the company.

Conclusion: Objection raised by company auditor is not valid as per section 143(8) of the companies Act, 2013 and the Board has authority to appoint branch auditor but should be approved by shareholders in General Meeting.

Question 76.
M/s. Seeman & Co. had been the company auditor for Amudhan Company Limited for the year 2020-21 The company had three branches located at Chennai, Delhi and Mumbai. The audits of branches-Chennai, Delhi were looked after by the company auditors themselves. The audit of Mumbai branch had been done by another auditor M/s Vasan & Co., a local auditor situated at Mumbai.

The branch auditor had completed the audit and had given his report too. After this, but before finalization, the company auditor wanted to visit the Mumbai branch and have access to the inventory records maintained at the branch. The management objects to this on the grounds of the company auditor is transgressing the scope of audit areas agreed. Comment.
Answer:
Right of Access of Company Auditor for Branch Records:
As per Sec. 143(8] of the Companies Act, 2013 the audit of the branches can be done by the company auditor himself or by another auditor. Even where, the branch accounts are audited, the company auditor has right to visit the branch if he deems it necessary to do so for the performance of his duties as auditor.

Company Auditor has also right of access at all times to the books and account and vouchers of the company maintained at the branch office. He can appropriately deal with the report of the branch auditor in framing his main report. He will disclose how he had dealt with the branch audit report.

In this case, the audits of two branches were done by the company auditor and one branch was done by a separate branch auditor.

Conclusion : Management’s objection that the company auditor is transgressing the scope of audit areas agreed, is absolutely, wrong. The right of company auditor in visiting and accessing the records of branch cannot be forfeited. Even where the branch accounts are audited by another local auditor, the company auditor has right to visit the branch and can have access to the books and vouchers of the company maintained at the branch office.

Question 77.
A company has a branch office which recorded a turnover of ₹ 1,90,000 in the financial year 202021. No audit of the branch has been carried out. The statutory auditor of the company has made no reference of the above branch in his report. The total turnover of the company is ₹ 10 crores for the year 2020-21. Comment.
Or
A Ltd. is a Chennai based company. The total turnover of the company is ₹ 10 crores for the year 2020-2li The company has a branch office at an area which was recently affected by flood. The transportation services are not available due to destruction caused by flood. The branch office recorded turnover of ₹ 1,50,000 in the Financial Year 2020-21. No audit of branch has been carried out. The statutory auditor of the company has made no reference of the above branch in his report. Comment. [May 14 (4 Marks)]
Answer:
Requirement of Branch Audit:
As per section 143(8) of the Companies Act, 2013 if a company has a branch office, the accounts of that office shall be audited either by the auditor appointed for the company or by any other person qualified for appointment as an auditor of the company, or where the branch office is situated in a country outside India, the accounts of the branch office shall be audited either by the company’s auditor or by an accountant or by any other person duly qualified to act as an auditor of the accounts of the branch office in accordance with the laws of that country.

Therefore, if any office is described by the company as branch office, the company has to get its branch audited by a person specified u/s 143(8).

In case accounts of the branch has not been audited, company’s auditor is required to mention this fact in the audit report and deal appropriately.

Conclusion: Company’s auditor is required to state the fact of non-audit of branch office in his report and deal appropriately.

Question 78.
Lakshya Ltd. has a branch office located outside India. Company is in the process of appointment of non-Chartered Accountant as an auditor but otherwise qualified person from country where the branch office is situated. Statutory auditor is of the opinion that non-Chartered Accountant cannot be appointed as branch auditor. Comment.

You are also required to discuss the applicability of SA 600 using the work of another auditor by the head office auditor in regard to branch located outside India, if non-Chartered Accountant is appointed.
Answer:
Eligibility criteria for appointment as Branch Auditor
As per Sec. 143(8) of the Companies Act, 2013, where the branch office is situated in a country outside India, the accounts of the branch office shall be audited either by the company’s auditor or by an accountant or by any other person duly qualified to act as an auditor of the accounts of the branch office in accordance with the laws of that country.

Hence, a company can appoint as auditor of a foreign branch an accountant duly qualified to act as an auditor in accordance with the laws of the foreign country.

Conclusion: Contention of statutory auditor that non-Chartered Accountant cannot be appointed as auditor is not valid.

Applicability of SA 600:
SA 600 “Using the work of another Auditor” deals with the principal auditor’s responsibility in relation to his use of the work of the other auditor. SA 600 provides the following:

When planning to use the work of another auditor, the principal auditor should consider the professional competence of the other auditor in the context of specific assignment if the other auditor is not a member of the ICAI.

The principal auditor should perform procedures to obtain sufficient appropriate audit evidence, that the work of the other auditor is adequate for the principal auditor’s purposes, in the context of the specific assignment.

The principal auditor should consider the significant findings of the other auditor.

When the principal auditor has to base his opinion on the financial information of the entity as a whole relying upon the statements and reports of the other auditors, his report should state clearly the division of responsibility for the financial information of the entity by indicating the extent to which the financial information of components audited by the other auditors have been included in the financial information of the entity, e.g., the number of divisions/branches/ subsidiaries or other components audited by other auditors.

Salient Features of Audit of Limited Liability Partnerships (LLP Audit)

Question 79.
Write a short note on: Books of Account to be maintained by a Limited Liability Partnership.
Answer:
Books of Account to be maintained by a LLP:
As per Sec. 34 of LLP Act, 2008, LLP shall maintain such proper books of account as may be prescribed relating to its affairs for each year of its existence. Books may be maintained on cash basis or accrual basis and according to double entry system of accounting. Books shall be maintained at registered office for such period as may be prescribed.

As per Rule 24 of LLP Rules, 2009, the books of account shall contain:
(a) particulars of all sums of money received and expended by the LLP and the matters in respect of which the receipt and expenditure takes place;
(b) a record of the assets and liabilities of the LLP;
(c) statements of cost of goods purchased, inventories, W1P, finished goods and cost of goods sold; and
[d) any other particulars which the partners may decide.

The books of account which a LLP is required to keep shall be preserved for eight years from the date on which they are made.

Question 80.
Write a short note on: Statutory provisions as to Audit of Limited Liability partnerships.
Answer:
Statutory Provisions as to Audit of LLP:
As per Sec. 34 of LLP Act, 2008, accounts of LLP shall be audited in accordance with such rules as may be prescribed.

Rule 24 of LLP Rules, 2009 provides the following in relation to audit:

• Requirement of Audit: A LLP whose turnover does not exceed, in any financial year, ₹ 40 Lacs, or whose contribution does not exceed ₹ 25 Lacs shall not be required to get its accounts audited. If partners of such LLP decide to get the accounts of such LLP audited, the accounts shall be audited in accordance with these rules.
• Eligibility for auditor: A person shall not be qualified for appointment as an auditor of a LLP unless he is a Chartered Accountant in practice.
• Period of Appointment: Auditor of a LLP shall be appointed for each financial year of the LLP for auditing its accounts.
• Appointment of auditor by designated partner: The designated partners may appoint an auditor:
  (a) at any time for the first financial year but before the end of the first financial year,
  (b) at least 30 days prior to the end of each financial year (other than the first financial year),
  (c) to fill a casual vacancy in the office of auditor, including in the case when the turnover or contribution of a LLP exceeds the limits, or
  (d) to fill up the vacancy caused by removal of an auditor.
• Appointment of auditor by partner: Partners may appoint an auditor where the designated partners have power to appoint and have failed to appoint.
• Tenure of Auditor: Auditor shall hold office in accordance with the terms of his or their appointment and shall continue to hold such office till the period the new auditors are appointed, or they are re-appointed.

Question 81.
List the benefits that arise to LLP from getting the accounts audited.
Answer:
Benefits that arise to LLP from getting the accounts audited:
(a) Detection of errors & frauds
(b) Verification of financial statements
(c) Resolving disputed among the partners in relation to accounting matters.
(d) Arranging finance from banks & financial institutions.
(e) Improved management of the LLP
(f) Settlement of accounts between partners at the time of admission, death, retirement, insolvency, insanity, etc

Question 82.
Briefly describe the auditor’s duty regarding audit of LLP
Answer:
Auditor’s duty regarding audit of LLP:
(a) Auditor should obtain instructions in writing as to the work to be performed by him.
(b) Auditor should read the LLP agreement & note the following provisions

• Nature of the business of LLP
• Capital contributed by each partner
• Interest in respect of capital contributions
• Duration of partnership
• Drawings allowed to the partners
• Salaries, commission etc. payable to partners
• Rights & duties of partners
• Method of settlement of accounts between partners at the time of admission, retirement, admission etc.
• Any loans advanced by the partners
• Profit sharing ratio

(c) Auditor should report (a) Whether the records reflects true and fair view (b) Whether he obtains all information & explanation (c) whether any restriction/limitation imposed upon him.

(d) If minute book is being maintained, auditor shall refer it for any resolution passed regarding the accounts.

Question 83.
MKc LLP is a newly set up LLP (Limited Liability Partnership). The operations of the LLP have been picking up and management is currently in the process of setting up processes and procedures in place. As per the understanding of the management of the LLP, its accounts would not be required to be audited mandatory because of its operations but still the management has decided that they would get the accounts audited voluntarily. In this regard/ the management would like to understand some of the aspects which they should consider not only limited to audit but also about the maintenance of books of account as per the relevant laws. Please advise. [RTP-May 19]

Guidance Note on Internal Financial Control over Financial Reporting

Question 84.
Explain the terms:
(i) ‘Internal Financial Control’ and
(ii) ‘Internal Financial Control’ over ‘Financial Reporting’. [Nov. 18-Old Syllabus (6 Marks)]
Answer:
Internal Financial Control and Internal Financial Control over Financial Reporting:
(i) Internal Financial Control:
Explanation to Sec. 134(5) of Companies Act, 2013 defines the term Internal Financial Controls as the policies and procedures adopted by the company for ensuring:

• Orderly and efficient conduct of its business, including adherence to Company’s policies,
• Safeguarding of its assets,
• Prevention and detection of frauds and errors,
• Accuracy and completeness of the accounting records, and
• Timely preparation of reliable financial information.

(ii) Internal Financial Control over Financial reporting:
Guidance Note on Internal Financial Control over Financial Reporting provides the guidance as to the concept of Internal financial control over financial reporting. Accordingly, –

Internal Financial Control over Financial Reporting is a Process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

A Company’s internal financial control over financial reporting includes those policies and procedures which pertain to the maintenance of the records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company.

It provides reasonable assurance that transactions are recorded as necessary to permit preparation of financial statement in accordance with generally accepted accounting principles, and those receipts and expenditures of the company are being made only in accordance with authorizations of management and director of the company.

It provides reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effects of the financial statement.

Miscellaneous

Question 85.
X Ltd. issued 10,000 shares of face value of ₹ 10 each at a premium of ₹ 450 each in May, 2020. The company received the stated minimum amount in the prospectus and transferred a sum equal to the aggregate amount of the premium received on shares (i.e. ₹ 45 lakhs) to the ‘Securities Premium Account*. Unfortunately, in the month of July, the godown of the company caught fire and stock worth ₹ 40 lakhs burnt to ashes. Now, the management desires to adjust the loss due to fire against the said premium account. Comment.
Or ”
X Ltd. is a sick company and has accumulated losses of ₹ 10 crores. The company has ₹ 12 crores in its Securities Premium Account. The Management desires to adjust the accumulated losses against the Securities premium balance. Advise the company giving your reasons. [RTP – Nov. 18]
Answer:
Application of Securities Premium Account:

• As per Section 52 of the Companies Act, 2013, where a company issues shares at a premium, whether for cash or otherwise, a sum equal to the aggregate amount of the premium received on those shares shall be transferred to an account called “Securities Premium Account”.
• The securities premium account may be applied by the company
  1. towards the issue of unissued shares of the company to the members of the company as fully paid bonus shares;
  2. in writing off the preliminary expenses of the company;
  3. in writing off the expenses of, or the commission paid or discount allowed on, any issue of shares or debentures of the company;’
  4. in providing for the premium payable on the redemption of any redeemable preference shares or of any debentures of the company; or
  5. for the purchase of its own shares or other securities under section 68.
• In view of these provisions of the Companies Act, 2013, it is not permitted to adjust its losses against the securities premium account.

Conclusion: X Ltd. is not permitted to adjust its loss against the securities premium account by virtue of provisions of Section 52 of Companies Act, 2013.

Question 86.
Mr. X is a whole-time director of Manthan Ltd. who has a very good relation with the Director (Operations) of the company. Consequently, he entered into a purchase contract for supply of goods of ₹ 5,00,000 with the company without obtaining prior consent of the Board. What is the responsibility of the auditor in relation to the Companies Act, 2013?
Answer:
Auditor’s Responsibility in relation to Director’s contract with companies:
As per Section 188 of the Companies Act, 2013, no company shall enter into any contract or arrangement with a related party with respect to sale, purchase or supply of any goods or materials, except with the consent of the Board of Directors given by a resolution at a Board Meeting.

First proviso to Sec. 188 provides that in the case of a company having specified paid-up share capital, or transactions exceeding prescribed sum, no contract or arrangement shall be entered into except with the prior approval of the company by a resolution.

Third proviso to Sec. 188 provides that Sec. 188 is not applicable to any transactions entered into by the company in ordinary course of business other than transactions which are not on an arm’s length price.

Sec. 189 of Companies Act, 2013 requires that particulars of such contracts or arrangements shall be maintained in one or more registers.

Section 184 of the Companies Act, 2013 requires every director who is in any way whether directly or indirectly interested in a contract or proposed contract shall disclose the nature of his interest at the meeting of the Board in which such contract is discussed and shall not participate in such meeting.

In the present case one of the director of the company has entered into a contract for supply of goods worth ₹ 5,00,000 without obtaining consent of the Board. Auditor is required to determine whether the transactions is in ordinary course of business or entered on arm’s length price.

Conclusion: Auditor is required to ensure compliance of Sections 184,188 & 189 of Companies Act, 2013. In case of any violation, auditor is required to state the fact in his audit report accordingly.

Question 87.
Mr. X, Director of ABC Ltd. made a purchase contract for ? 10,00,000 with the company. Comment. [Nov. 10 (5 Marks)]
Answer:
Auditor’s duties in case of director’s contract with the company:
Section 184 of the Companies Act, 2013 requires every director who is in any way whether directly or indirectly interested in a contract or proposed contract shall disclose the nature of his interest at the meeting of the Board in which such contract is discussed and shall not participate in such meeting.

As per Section 188 of the Companies Act, 2013, no company shall enter into any contract or arrangement with a related party with respect to sale, purchase or supply of any goods or materials, except with the consent of the Board of Directors given by a resolution at a Board Meeting.

First proviso to Sec. 188 provides that in the case of a company having specified paid-up share capital, or transactions exceeding prescribed sum, no contract or arrangement shall be entered into except with the prior approval of the company by a resolution.

Third proviso to Sec. 188 provides that Sec. 188 is not applicable to any transactions entered into by the company in ordinary course of business other than transactions which are not on an arm’s length price.

Sec. 189 of Companies Act, 2013 requires that particulars of such contracts or arrangements shall be maintained in one or more registers.

In the present case one of the director of the company has entered into a purchase contract worth ? 10,00,000 with the company. Auditor is required to determine whether the transactions is in ordinary course of business or entered on arm’s length price.

Conclusion: Auditor is required to ensure compliance of Sections 184,188 & 189 of Companies Act, 2013. In case of any violation, auditor is required to state the fact in his audit report accordingly.

Question 88.
M/s IT Limited has prepared the financial statements for the year 2019-20 and mentioned in the significant accounting policies that depreciation on tangible fixed assets is provided on the straightline method over the useful lives of the assets as estimated by the management. The company has ignored the useful lives of assets mentioned in Schedule 11 of the Companies Act, 2013. As statutory auditor of the company how would you deal with this? [Nov. 15 (4 Marks)]
Answer:
Consideration of useful lives estimated by management:
Schedule II to the Companies Act, 2013 defines the useful life of an asset is the period over which an asset is expected to be available for use by an entity or the number of production or similar units expected to be obtained from the asset by the entity.

The useful life of an asset shall not be longer that the useful life specified in the Part C of Schedule II. If, however where a company uses a different useful life justification for the difference shall be disclosed in the financial statement with justification supported by technical device.

In the present case, auditor is required to examine the appropriateness of disclosures made in the financial statements with respect to difference in estimated useful life. If appropriate not given in the financial statements, auditor need to qualify his report stating the appropriate facts.

Conclusion: Company may use different useful lives, but disclosure is required in financial statements with justification supported by technical advice.

“ICAI Examiner Comments”
Many examinees have not referred to Section 129 of the Companies Act, 2013. They also failed to mention that if the justification has not been disclosed by the management for consideration of different useful life, then the auditor should qualify his report accordingly. Some ^ examinees were not aware about Schedule II of the Companies Act, 2013.

Question 89.
Asan auditor of DEF Ltd., you notice certain and the ‘Offer document’ for the proposed issue of securitIes. The company explains that the same is due to certain adjustments as per the SEBI (Disclosure and Investor Protection) Guidelines. What are such disclosures and adjustments to be incorporated in the financial statements included In the ‘Offer document’? [Nov. 17 (6 Marks)]
Answer:
Disclosures and Adjustments to be incorporated in the financial statements included in the Offer Document:
(A) Disclosures:

1. Principal terms of loan and assets charged as security: Brief terms and conditions of the term loans including re-schedulement, prepayment, penalty, default, etc.
2. Age-wise analysis of sundry debtors.
3. Aggregate book value of quoted investments as well as aggregate market value of quoted investments.
4. All significant accounting policies and standards followed in the preparation of the financial statements
5. Auditors’ qualifications.

(B) Adjustments:
Statements of Assets and Liabilities and Profit and Loss or any other financial information shall be incorporated after making the following adjustments, wherever quantification is possible:
1. Adjustments/rectification for all incorrect accounting practices or failures to make provisions or other adjustments which resulted in audit qualifications.

2. Material amounts relating to adjustments for previous years shall be identified and adjusted in arriving at the profits of the years to which they relate irrespective of the year in which the event triggering the profit or loss occurred.

3. Where there has been a change in accounting policy, the profits or losses of the earlier years (required to be shown in the offer document] and of the year in which the change in the accounting policy has taken place shall be recomputed to reflect what the profits or losses of those years would have been of a uniform accounting policy was followed in each of these years.

4. If an incorrect accounting policy is followed, the re-computation of the financial statements shall be in accordance with correct accounting policies.

5. Statement of profit or loss shall disclose the profit or the loss arrived at before considering extraordinary items and after considering the profit or loss from extraordinary items.

6. The statement of assets and liabilities shall be prepared after deducting the balance outstanding on revaluation reserve account from both fixed assets and reserves and the net worth arrived at after such deductions.

Note: SEBI(DIP) Guidelines replaces by SEBI (ICDR) Regulations in the year 2009. Answer is given on the basis of SEBI (ICDR) Regulations, 2009

“ICAI Examiner Comments”
Majority of the examinees have not attempted this question and those who attempted were not aware of the topic. Examinees were not aware of the adjustments to be incorporated in the Financial Statements included in the Offer Document as per SEBI Guidelines. Few examinees have misunderstood the question and answered in the context of SAE 3420.

Question 90.
Beneath Minerals Limited is a Public-Sector company engaged in extraction of minerals from land. It has to pump out water in the first layer of the soil if the minerals are to be excavated. The company pumps out water and diverts the water through a water course constructed by it to nearby villages and the water is allowed to be used by villagers for drinking purposes. The cost of construction of water course amounted to ₹ 5.2 5 crores and the company had disclosed this amount as CSR expenses in the statement of profit and loss. Comment. [May 18 – New Syllabus (5 Marks)]
Answer:
Treatment of expenses in normal course of business as CSR Expense:
As per Section 135 of Companies Act, 2013, the Board of directors of every company referred to inSec.l35(l) sub-section (1), shall ensure that the company spends, in every financial year, at least two per cent of the average ngt profits of the company made during the three immediately preceding financial years, in pursuance-of its Corporate Social Responsibility Policy.

For this purpose, Schedule VII of Companies Act, 2013 prescribes the activities which may be included in CSR Activities. Ministry of Corporate Affairs also time to time, through various notifications provide clarification as to what kind of expenses will be covered in CSR activities.

However, any expense which is incurred by a company in the normal course of its business activities cannot be considered as CSR Expense.

In the present case, company pump out the water from the soil and construct a water course so as to divert the water to nearby villages and water is being used by villagers for drinking purposes. This kind of expenditure cannot be treated as expenditure incurred for CSR as the expense is being incurred as incidental to its business activities.

Conclusion: Though expenditure incurred in arranging drinking facilities qualifies as CSR expense, but any expenditure incurred in the normal course of business activity is not classified as CSR Expense. In the present case, pumping out the water is an essential part of business activity and for its disposal, a water course is being constructed. So, expenditure cannot be classified as CSR Expense and hence auditor should state the fact in the report and qualify the report.

Note: Alternative answer is possible with different assumptions.