Accounting and Tax SAFA Countries CA Nihar Jambusaria & CA Sanjiv Chaudhary 5 th June 2014
Contents 1 Accounting & Tax aspects of SAFA Countries 2 Divergent Principles of Accounting and Taxation 3 Goodwill-Treatment & Judicial Precedents 4 Preliminary Expenses & Initial Set up cost 2
Glossary S No. Abbreviation Full Form 1 Act Income-tax Act, 1961 2 AO Assessing Officer 3 ICAI Institute of Chartered Accountants of India 4 AS Accounting Standard 5 SC Supreme Court of India 6 IFRS International Financial Reporting Standards 3
Accounting & Tax SAFA Countries Perspective 4
Tax Provisions in SAFA Countries Comparative Analysis India Sri Lanka Pakistan Bangladesh Corporate Tax Domestic companies: 30% Foreign companies: 40% 28% (Venture capital companies: 12%) 35% 27.5% (publicly traded) 37.5% (other) Capital Gains (other than securities) LTCG: 20% (with Indexation) STCG: 30% / 40% NIL <1 year:35% > 1 year: 35% on 75% of the gains 15% Capital Gains (securities) LTCG: NIL STCG: 15% NIL < 6 months:10% 12<; >6 months: 8% >12 months: NIL 15% 5
Tax Provisions in SAFA Countries Comparative Analysis India Sri Lanka Pakistan Bangladesh Carry Forward of Losses *Provisions for carry back of losses Dividend Income 8 years / 4 years Indefinitely and set off is allowed only upto 35% of the statutory income Business losses: 6 years Speculative & Capital Losses: 1 year No No No No Received from Domestic co.: NIL Received from Foreign Co: 30% Received from specified Foreign Co: 15% 6 years Nil 10% 20% Dividend declared > 20% of face value: 10% rebate Dividend declared < 10% of face value: 37.5% * Allowed in Australia, Singapore and European countries like France, Netherland, UK 6
Tax Provisions in SAFA Countries Comparative Analysis India Sri Lanka Pakistan Bangladesh Transfer Pricing Rules Thin Cap. Rule Yes Yes Yes Not specific. No Yes Yes No CFC No No No No No. of treaties with other countries More than 80 More than 38 More than 57 More than 27 7
Tax Provisions in SAFA Countries Comparative Analysis India Sri Lanka Pakistan Bangladesh * Tax Consolidation / Group relief Not permitted Not permitted Permitted Not permitted ** Transparent Entities Partners are exempt from their share of profits and the partnership firm is liable to pay tax. - Partners are exempt from their share of profits and the partnership firm is liable to pay tax. - * Its allowed in Australia, Singapore and few European countries like France, Netherland, UK etc. ** In USA, Mauritius, Switzerland and few other countries Partnership firms are considered as fiscally transparent entities and partners are personally liable to tax on their respective share of profits 8
Tax Provisions in SAFA Countries Comparative Analysis India Sri Lanka Pakistan Bangladesh Dividend 16.995% 10% 10% 20% Royalty 25% 15% 15% 10% Fees for Technical Services 25% NIL 15% 10% Interest 5% / 20% 15% 20% 10% 9
Accounting Provisions in SAFA Countries Comparative Analysis Accounting Principles for preparing Financial Statements Preparation of Financial Statements India Sri Lanka Pakistan Bangladesh *Accounting Standards issued by ICAI. Annually. However, few level of companies are exempt from disclosing the Financial Statements Sri Lankan Auditing and Accounting Standards Annually IFRS and Company Ordinance, 1984 Annually (all private or public companies whose paid-up capital is more than PKR 7.5 M is required to file with SECP) IFRS Annually * ICAI has recommended the consolidated financial statements to be prepared based on Indian AS convergence with IFRS however, the same is yet to be notified. 10
MSME & SME Sectors in India Reservation policy for MSME s reserving exclusive manufacture rights for certain items Compulsory allocation of certain percentage of overall lending by banks to these sectors Advantages to MSME s & SME s Refinancing facilities to these sectors doubled to Rs 10,000 crores 3 year tax relief even after graduating to big companies Various Schemes designed for these sectors to put them in competitive & advantageous position 11
Accounting & Tax INDIA Perspective 12
Divergent Principles of Accounting & Taxation ACCOUNTING Financial statements prescribes accrual system of accounting as the basis of AS-1 issued by ICAI. Assets, liabilities, income & expenditure to be accounted for on mercantile basis. Accounting Vs Tax TAX Section 145 of the Act recognizes both cash or mercantile system of accounting. Typically tax deductions are allowable on accrual basis Exceptions under section 43B and 40(a), wherein tax deductions allowable only on cash basis. 13
Judicial Precedents- Dissonance of accounting and tax treatments Woodward Governor India Pvt Ltd 1.. Accounting standard, which is continuously adopted by an assessee, can be superseded or modified by legislative intervention. However, but for such intervention or in cases falling under section 145(3), the method of accounting undertaken by the assessee continuously is supreme. Kedarnath Jute Mfg Co Ltd 2.Whether the taxpayer is entitled to a particular deduction or not will depend on the provision of law relating thereto and not on the view which the taxpayer might taken of its right nor can the existence or absence of entries in the books of accounts be or conclusive in the matter. Tuticorin Alkali Chemicals & Fertilisers 3 when the question is whether a receipt of money is taxable or not or whether certain deductions from that receipt are permissible in law or not, the question has to be decided according to the principles of law and not in accordance with accounting practice. Accounting practice cannot override any provision of the Act. 1.[2009] 179 taxman 326(SC) 2.[1971] 82 ITR 363 (SC) 3.[1997] 93 taxman 502 (SC) 14
Treatment of Goodwill & Judicial Precedents 15
Goodwill Goodwill is recognized only in a business combination and is measured as excess of sales consideration over the net worth of assets.(as-14) Goodwill can be capitalized and allowed to be amortized over its useful life not exceeding 5 years (AS-14) Self generated goodwill not allowed to be capitalized and amortized in the books ( Sunk cost )- (AS-26) Goodwill not defined under the Act SC in the case of B.C. Srinivasa Shetty held - goodwill denotes the benefit arising from connection and reputation.. A variety of elements goes into its making, and its composition varies in different trades and in different businesses in the same trade Its value may fluctuate from one moment to another depending on changes in the reputation of the business Protracted litigation on whether tax deduction on Goodwill available CIT vs B.C. Srinivasa Shetty (1981) 128 ITR 294(SC) 16
Depreciation on Goodwill Section 32(1) of the Act provides deduction in respect of depreciation on :- Tangible assets being building, machinery, plant, or furniture; and Intangible assets being know-how, patents, copyrights, trade marks, licenses, franchises or any other business or commercial rights of similar nature (#) any other business or commercial rights of similar nature not defined in the Act Principle of ejusdem generis applies for interpretation # - Inserted w.e.f. 1-04-1999 17
Depreciation on Goodwill Favourable Judicial Precedents Judgment Hindustan Coca Cola Beverages (P) Ltd. [2009] 34 SOT 171 (Delhi) Principles laid down Depreciation claim on business or commercial right in the nature of knowhow, patents, copy rights, trademarks, licenses, franchises cannot be denied. The true basis of depreciation allowance is the character of the asset and not its description. Such rights may be termed as goodwill or otherwise in the books of accounts. A.P. Paper Mills Ltd. [2010] 128 TTJ 596 (Hyd) The taxpayer derived advantages in the form of increased market share, acquisition of various licenses and infrastructural benefits. Benefits classified as a commercial right of similar nature enumerated in section 32 entitled to depreciation. Excess consideration paid by the taxpayer on amalgamation over and above the excess of assets over liabilities was goodwill 9
Depreciation on Goodwill Unfavourable Judicial Precedents Judgment R.G. Keswani [2009] 116 ITD 133 (Mum) Borkar Packaging (P) Ltd. [2010] 131 TTJ (Panaji) 99 Principles laid down The expression all business and commercial rights is too generic and does not find similarity with the specific expressions like knowhow, patents, licences etc. Rule of ejusdem generic applies Such a general expression of business and commercial rights cannot be equated with expression any other business or commercial rights of similar nature. Taxpayer was unable to establish it had acquired any rights of either commercial or business nature. Goodwill not purchased by the taxpayer but was appearing as a balancing figure in taxpayer s books of accounts for the assets acquired. Accordingly, the taxpayer s claim of depreciation on goodwill was not allowed. 10
SC in case of Smifs Securities Ltd [2012] 24 taxman 222 (SC) Position prior to SC Judgment Depreciation not allowable on goodwill simplicitor Depreciation could be claimed on goodwill to the extent represented by intangible assets. Generally depreciation was allowed in respect of intangible assets, valuation of which was to be supported by some documentary evidences. Principle laid in SC Judgment The scope of any other business or commercial rights of similar nature as per explanation 3 (b) to section 32(1) includes Goodwill Principle of ejusdem generis would strictly apply Difference between the cost of an asset and amount paid constitutes goodwill, irrespective of the fact that no amount paid towards goodwill 20
Treatment of Preincorporation expenses & Judicial Precedents 21
Illustration X Co was incorporated on 01.04.13 and set up the business of manufacture of rubber products from 01-09-13, diversifying the activities it started manufacturing spare parts w.e.f. 01-02-14. Date of Incorporation of Co (1-04-13) Expenses A What shall be the treatment of expenses incurred? Date of set up of rubber business(1-09- 13) Expenses B Date of setup of spare parts business (01-02- 14) New Set up (Expense A) Expansion (Expense B) Accounts Tax Accounts Tax Capital Expenditure? Revenue Expenditure? 22
Same business or new establishment? Citation Hindustan Times [2012] 27 taxmann 191 (Del) Blue Mountain Estates [1985] 151 ITR 616 (Mad) Facts Taxpayer engaged in business of printing and publishing of newspapers & periodicals. Entered into a new business of life insurance Taxpayer engaged in the business of manufacture of tea and coffee. Started selling fertilizers Relevant principles- New business as a distinct business Mere common funding not sufficient to regard proposed business as a part of existing business. Unified administration and management, resource sharing, personnel sharing also to be examined for deeming the new business as part of existing business. Existing businesses had no inter- connection with the new businesses 23
Same business or new establishment? Citation Modi Industries [1993] 68 taxman 114 (Delhi) Jay Engineering [2008] 166 taxman 115 (Delhi) Facts Taxpayer engaged in manufacture of various commodities like sugar, vanaspati etc Started manufacturing special alloy wire & billets. Taxpayer engaged in manufacture of fans and sewing machines Started a fuel injection equipment project. Relevant principles- New Business as expansion of existing business The nature of activity of manufacture remains the same in new and existing business. There was also unity of control and a common fund. The necessary unity of control leading to an inter-connection, interdependence and inter-lacing of two ventures existed. A new product was added to the existing business and thus new business is merely extension of the existing business and not a new business. 24
New Undertaking-Principles based on Judicial Precedents Based on judicial precedents, the following principles emerge on the basis of which, a new industrial unit is said to have been set up :- Investment of substantial fresh capital Fresh employment of requisite labour Manufacture or production of articles Earning profits attributable to such undertaking Separate and distinct identity of undertaking 25
Divergent Accounting and Taxation Principles Expenditure on know-how Research & Development Expenses Other Areas of diverse treatment of expenses in accounts and taxation Finance Lease Advertisement Depreciation Foreign Exchange Fluctuation 26
Thank You CA Nihar Jambusaria & CA Sanjiv Chaudhary