Deduction Allowed only on Actual Payment Basis - Taxation | Income Tax for assessment (Inter Level) PDF Download

Deduction Allowed only on Actual Payment Basis - Taxation

Where the assessee maintains account on mercantile basis, the assessee can claim deduction on accrual basis even if actual payment is not made. But under section 43B certain expenses like interest, bonus etc. are allowed as deduction only when actual payment is made.

Section 43B is applicable only to following kind of payments

1. Indirect Tax payment: Any sum payable by the assessee by way of tax, duty, cess or fee, by whatever name called, under any law  i.e. Sales tax, Excise duty, custom duty, municipal tax, land revenue etc.

2. Interest payment by way of following :

(a) any sum payable by the assessee as interest on any loan or borrowing from

 • a public financial institution (IDBI, ICICI, IFCI, LIC etc.) or

• a State financial corporation (UPSIDC, DFC, PICUP,  HSFC etc.) or

• a State industrial investment corporation or

(b) any sum payable by the assessee as interest on any term loan or advance from a scheduled bank (SBI, Canara Bank, PNB etc.).

3. Certain payments made to employees.

(a) Employer’s contribution to any provident fund or superannuation fund or gratuity fund or any other fund for the welfare of employees, or

(b) any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee. (Leave salary)

(c) Bonus or commission payable to employees.

4. Payment made to railways for use of railway assets.(Payment of rent of building or coaches or advertising)

In which year deduction is allowed?

1. If the payment is made on or before the relevant due date of furnishing of return, then deduction is allowed in the financial year in which expenditure accrues.

2. If the payment is made after the relevant due date of furnishing of return, then deduction is allowed in the financial year of payment.

P1: Debit side of the profit and loss account of X Ltd. shows the following expenses, which have been due but are outstanding as on March 31, 2017 : 1. Leave encashment expenses Rs 65,000. First payment on June 1, 2017 Rs 15,000. Second payment on Dec. 25, 2017 Rs 50,000.

2. Excise duty payable Rs 14,000. First payment on June 10, 2017 Rs 3,000. Second payment on April 1, 2018 Rs 11,000.

3. Sales tax payable Rs 48,000. First payment on Sept. 5, 2017 Rs 48,000.

4. Bonus payable to employees Rs 87,000. First payment on May 2, 2017  Rs 30,000. Second payment on September 30, 2017 Rs 57,000.

5. Interest payable to LIC on loan Rs 75,000. First payment on May 13, 2018 Rs 50,000. Second payment on January 10, 2019 Rs 25,000.

6. Municipal tax payable Rs 5,000. Not yet paid.

7. Interest on loan taken from Z Ltd Rs 5,00,000. Paid on 7-11-2017.

Due date of filing return of income is September 30, 2017. Find out the previous years in which the aforesaid payment are deduction. The company maintains book of account on the basis of mercantile system of accounting.

Ans:

1. First payment PY 2016-17; Second payment PY 2017-18.

2. First payment PY 2016-17; Second payment PY 2018-19.

3. First payment PY 2016-17.

4. First payment PY 2016-17; Second payment PY 2016-17.

5. First payment PY 2018-19; Second payment PY 2018-19.

6. Deduction not allowed since not yet paid.

7. PY 2016-17 since 43B is not applicable to payment made to companies therefore deduction is allowed on accrual basis. 

Cash Expenditure

1. Where the assessee incurs any expenditure in respect of which payment or aggregate of payments is made to a person

2. in a single day,

3. of sum exceeding Rs 20,000 

4. otherwise than by an account payee cheque or an account payee demand draft,

5. for which deduction is claimed,

6. then 100% of such expenditure shall not be allowed as a deduction.

Note 1: Section 40A(3) shall get attracted only when aggregate of payments to same person in a single day exceeds Rs 20,000.

Note 2: Where the payment is made for plying, hiring or leasing goods carriages, Rs 35,000 shall be taken instead of Rs 20,000. [w.e.f. 1-10-2009]

P1: Following cash payments are found debited in P & L  A/c. Determine the amount which shall be added back to net profit.

1. March 11, 2017 Rs 5,000 paid to Mr. A

2. March 11, 2017 Rs 15,000 paid to Mr. B

3. March 11, 2017 Rs 19,000 paid to Mr. A 4

. March 12, 2017 Rs 8,000 paid to Mr. B

Ans; Rs 24,000 paid to Mr. A shall be added back. Rs 23,000 paid to Mr. B shall not be added back.

P2: Following cash payments are found debited in P & L  A/c. Determine the amount which shall be added back to net profit.

Ans: (1) 54,000; (2) nil; (3) Rs 25,000 shall be added back since capital expenditure; (4) 1,21,000; (5) 2,000; nil; nil; (6) 20,000 is added due to S 40A(2) and Rs 30,000 added due to 40A(3). (7) 40,000 is added due to S 40A(2) and 40A(3) is not applicable. (8) Restriction of S 40A(3) do not apply.

Rule 6DD. Exceptions. Restrictions shall not apply 

1. Payment made to Financial Institutions or Banks.

2. Payment of Sales tax, custom, excise, income tax, etc.

3. Where the payment is made in a village or town, not served by any bank.

4. Payment made on a day on which all banks were closed either on account of holiday or strike.

5. Payment made for the purchase of

(i) agricultural or forest produce; or

(ii) the produce of animal husbandry (including hides and skins) or dairy or poultry farming; or

(iii) fish or fish products; or

(iv) the products of horticulture or apiculture, to the cultivator, grower or producer of such articles, produce or products.

6. Payment made by a book adjustment.

7. Where the payment is made for the purchase of the products manufactured or processed without the aid of power in a cottage industry, to the producer of such products.

P1: Determine the amount of disallowance under the head “Profit and gains of business or profession”:

(i) X Ltd. purchases raw materials on credit from Y who holds 20% equity share capital in X Ltd. The amount of bill is Rs 42,000 (market value : Rs 38,000). The bill is paid in cash on June 15, 2016.

(ii) A Ltd. purchases goods on credit from B Ltd. on April 10, 2016 for Rs 12,000 and on April 16, 2016 for Rs 15,000. Total payment of Rs 27,000 is made by cash on May 1, 2016.

(iii) X Ltd., purchases goods on credit from Y Ltd. on September 9, 2016 for Rs 32,000 which he pays by a bearer cheque on November 11, 2016.

Ans: 42,000; 27,000; 32,000.

Chargeability

1. The profit of any business or profession which was carried on by the assessee at any time during the relevant previous year shall be chargeable to income tax under the head “Profits & Gains of Business or Profession”

note 1: Business includes trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture. [section 2(13)]

note 2: Profession includes vocation. [section 2(36)]

note 3: The person who carries on the business shall be treated as an assessee, he may or may not be the owner of the business.

note 4: The business commences as soon it is set up. When trial run is completed / when he is ready receive the first customer.

note 5: Any income arising before the commencement of business is treated as capital receipt and therefore not chargeable to tax. This is so because business is not being carried on by the assessee during the relevant previous year.

 note 6: Similarly any expenditure incurred before the commencement of business is treated as capital expenditure and therefore not deductible. This is so because business is not being carried on by the assessee during the relevant previous year.

note 7: Any income arising after the closure of the business is not chargeable to tax, since business is not carried on by the assessee during the relevant previous year. Similarly any expenditure incurred after the closure of the business is not deductible, since business is not carried on by the assessee during the relevant previous year.

Exceptions: It says income specified u/s 41, is chargeable to tax under the head Profit from Business, even if the business has been closed down. E.g. Recovery of bad debt after closure of business is chargeable to tax under the business.

2. Export incentives. 

a. Profit on sale of import licence : Profits on sale of a licence granted under the Imports (Control) Order, 1955 made under the Imports and Exports (Control) Act, 1947; [not charged under the head Capital Gain]

b. subsidy : Cash assistance (by whatever name called) received or receivable by any person against exports under any scheme of the Government of India;

c. Duty Drawback : Any duty of customs or excise repaid or repayable as drawback to any person against exports under the Customs and Central Excise Duties Drawback Rules, 1971.

3. The value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession. E.g.  (a) Tax liability of A paid by B was held to be chargeable u/s 28(iv) where A is rendering consultancy service to B.  (b) Tips given to a taxi driver in the ordinary course of his business are profits and gains of employment. (c) Gifts given to company. [Professional Gift]

4. Any interest, salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from such firm.

5. Non - competing fees : Any sum, whether received or receivable in cash or in kind,

(a) under an agreement for not carrying out any activity in relation to any Business / Profession; or

(b) not sharing any know-how, patent, copyright, trademark, licence, franchise or any other business or commercial right of similar nature (KPC TLF b/cr) or information or technique likely to assist in the manufacture or processing of goods or provision for services (Consultancy).

6. Any sum received under a Keyman insurance policy including the sum allocated by way of bonus on such policy.

7. Income from speculative transaction. [Defined u/s 43(5)] (STT is allowed as deduction)

Computation of Business Income

1. As per section 29 the income referred to in section 28 shall be computed in accordance with the provisions contained in sections 30 to 43D. In this chapter the word ‘paid’ means actually paid or payable as per the method of accounting followed by the assessee.

2. The business income is recognised to tax as per the method of accounting followed by the assessee.

Note 1: Section 145. Method of Accounting :

Mercantile System : If the assessee accounts are kept on the mercantile basis, the income would be taxable when it accrues or is earned irrespective of receipt. Even if certain amount of income earned is not likely to be realised, it should nevertheless be included in the accounts.

As per the Companies Act, 1956, companies are required to maintain their accounts only on mercantile system.

Cash System : On the other hand, if the accounts are maintained on the cash basis income would be chargeable in that accounting year in which it is received even if the source of income has ceased to exist. It depends upon the method of accounting followed by the assessee.

E.g.:  Mr. X makes a credit sale of Rs 6,00,000 on PY1 to Mr. Y. The amount of Rs 6,00,000 is received in PY2. Now the question is in which PY sale shall be recognised.

If the assessee follows mercantile system, Rs 6,00,000 shall be taxable in the PY1. However if the assessee follows cash system the income shall be taxable in the PY2.

(You must remember accounting method is important only for two heads of income i.e. ‘Business’ and ‘Other sources’). Ignored in case of salary, house property and capital gain.