Amendments in KVAT in Budget 2010

Major Changes in Karnataka Value Added Tax Act, 2003 effective from April 1, 2010:



• VAT exemption on paddy, rice, wheat, pulses and products of rice and wheat extended for one more year from 1.4.2010.


• Tax on Masala Powder Mixtures, Macaroni, Sports Trophies, Shields and Medals, all kinds of scrap, Electric generators of less than 15 KVA, railway concrete sleepers, school bags costing up to Rs. 200, reduced from 12.5 per cent to 5 per cent.


• The minimum annual turnover limit for registration increased from Rs. 2 lakhs to Rs. 5 lakhs.


• The maximum annual turnover limit for opting for Composition Tax Payment Scheme increased from Rs.15 lakhs to Rs.25 lakhs.


• Annual turnover limit for compulsory audit of accounts of dealers increased from Rs. 40 lakhs to Rs.60 lakhs.


• Optional scheme for dealers in medicines to pay tax based on the MRP even on sale of other goods.


• Advance Ruling Mechanism for dealers to seek clarifications and advance rulings to be introduced.


• VAT rate 4 per cent increased to 5 per cent on all goods except declared goods.


• VAT rate of 12.5 per cent increased to 13.5 percent.


• VAT rate of 12.5 per cent on tobacco products increased to 15 per cent.


• Levy of VAT on tobacco products on MRP basis. and


• VAT at rate of 13 per cent on sale of motor car exceeding 5 Lakhs.


Major Changes in Luxury Tax:


• Luxury tax on hotels with daily room rents from Rs. 1,000 to Rs.2000 increased from 6 per cent to 8 per cent.


• Luxury tax on hotels with daily room rents exceeding Rs. 2,000 increased from 10 per cent to 12 per cent.


Major Changes in Entry Tax:


• Provision for collection of Entry Tax on sugar at the point of sale by sugar factories.

Depreciation - a interesting facet

Depreciation – a non cash expenditure allowed under Income Tax Act, 1961 following block concept. Under the block concept, all the assets falling within the same class and subject to same rate of depreciation are clubbed together and considered as single asset. Any alterations to the value of the block have to be strictly in accordance with the provisions of Chapter IV D of Income Tax Act, 1961.

As per section 32 of Income Tax Act, 1961, a assessee is entitled to claim depreciation on fixed assets only if the following conditions are satisfied:

1. Assessee must be owner of the asset – registered owner need not be necessary.

2. The asset must be used for the purposes of business or profession.

3. The asset must be used during the previous year.

The use of the asset during the previous year may be active use or passive [ie., kept ready for use]. I shall elaborate this topic at later part of this article.

As per the provisions of section 43(6) of the Income Tax Act, the WDV of block of assets as at start of the year has to be adjusted as follows so as to arrive at closing WDV:

• It has to be increased by actual cost [as per section 43(1)] of any asset falling within in the block acquired during the previous year.

• Thereafter, It shall be reduced by ‘moneys payable’ in respect of asset sold/discarded/demolished or destroyed during the previous year.

It has been held in Ashok Betelnut Case [mad.] that moneys payable represents gross sale consideration where as the contrary has been held in the case of Essar Shipping Limited case.

No deletion is permitted from the value of the block except when the asset is sold, discarded, demolished or destroyed. e.g., in case of theft of an asset, no deletion is permitted from the block of asset since the asset is neither sold nor demolished nor destroyed nor discarded.

• Further, scrap value, if any of any asset has to be reduced.

The question of deduction of scrap value from the block arises only when the asset is not sold.

Now lets analyse a interesting concept arising in relation to claiming of depreciation. In earlier part of this article, I have laid down the essential for claiming depreciation. One of the requirements was that asset must be used during the previous year. For the purposes of Income Tax Act, a previous year is a distinct unit. In case an asset is discarded by the business but not sold, section 43(6) permits the scrap value of the asset to be reduced from the block in the previous year in which such asset is discarded. The assessee is entitled to claim depreciation on the residual value of such discarded asset [ie., Opening WDV of such asset less scrap value] even though such discarded asset is not used for the purposes of business or profession in such year and subsequent years.

In case of CIT v. Yamaha Motor India Private Limited (2009) 226 CTR (Del) 304, the assessee claimed depreciation on discarded assets which were written off during the previous year. The AO disallowed the claim on the ground that the assets were not used for the purposes of business during the previous year. It was held that that the term ‘used’ appearing in section 32(1) comprise of both active use and passive use. Further, the expression ‘used for the purposes of business’ used in section 32(1) has to be read harmoniously with the term “discarded” meaning thereby that the assessee is entitled to claim depreciation as far as discarded asset is concerned if the asset has been used for the purposes of business in earlier years. Adopting a realistic approach and harmonious construction, the expression ‘used for the purposes of business’ appearing in section 32 when used in respect of discarded asset would mean that the use in the business need not necessarily be in the relevant previous year but in earlier previous years. Any other interpretation would lead to an incongruous situation because on the one hand the depreciation is allowed on discarded asset after allowing inter alia adjustment for scrap value, yet, on the other hand use would be required of the discarded machinery which use is not possible.

To conclude, the decision of the delhi high court is logical considering the existing provisions of the Act as regards allowability of depreciation on discarded asset. Either the Act must permit the residual value of the discarded asset to be written off completely in the year in which the asset is discarded or the interpretation adopted in the aforesaid judgement has to be accepted.

Concept of Deemed Dividend

Deeming fiction – a fiction resorted to by parliament for defying the law of literal interpretation. Whether it be Central Excise Act, 1944 [concept of deemed manufacture u/s 2(f)(iii)] or Income Tax Act, 1961 [concept of deemed dividend u/s 2(22)(e)], the weapon of deemed concept is adopted either for plugging the loopholes in the Act, or to depart from the natural and ordinary meaning of a so called ‘revenue yielding’ term used in the Act so that the government is not deprived of the revenue from any alluring activity which cannot be other wise brought into the tax net in ordinary sense.

Everything said and done, whenever the law infuses the deemed concept in any provision of law, the same shall be subject to rule of strict construction.

Section 2(22)(e) is one such deeming provision which covers within its ambit the receipt of certain securities or money from a closely held company under certain situation and subject to fulfilment of certain conditions and subject to certain exceptions.

As per clause (e) of section 2(22), any payment made by a closely held company by way of loans or advance shall be deemed to be dividend taxable u/s 56 provided the following conditions are satisfied:

• Payment is made to a shareholder having substantial interest [i.e., holding >10%] of voting power in the company and is beneficial holder of equity shares; and/or

• Payment is made to a concern in which aforesaid substantial shareholder is a member or partner and in which he has substantial interest [i.e., holding or owning >20%]; and/or

• Payment is made on behalf of or for the individual benefit of such substantial shareholder; and

• The company must possess accumulated profits.

The exceptions to the same is discussed in later part of this article.

Now, lets discuss some intricate queries arising out of the aforesaid definition.

Q 1. What kinds of advances are covered within the scope of section 2(22)(e)?

It has been held by Rajasthan High Court in re CIT v. Raj Kumar (2009) 23 DTR (Del) 304 that the word ‘advance’ has to be read in conjunction with the word ‘loan’ i.e., a payment shall be construed as a loan or advance if it involves following attributes–

• Positive act of lending coupled with acceptance by the other side of the money as a loan;

• Generally carries interest

• Obligation of repayment is inherent.

Considering the rule of construction viz., noscitur a sociis and keeping in view the intent of introducing the provisions [i.e., to plug the evasion of tax by payment of dividends in the guise of loans & advances to the principal shareholders], any advance which does not carry with it the obligation of repayment cannot fall within the four corners of the deeming provision. Consequently, trade advances made in then ordinary course of business that are adjusted against supply of goods/services do not fall within the ambit of section 2(22)(e).

Q 2. In whose hands will the payment deemed to be dividend if the loans or advances are made to concern or person on behalf of or for the benefit of substantial shareholder?

It is general principle that a payment can be taxed as dividend only in the hands of a shareholder. The same cannot be taxed as such in the hands of a non shareholder. This view has been reiterated by Rajasthan High Court in re CIT v. Hotel Hilltop (2008) 217 CTR (Raj.) 527 wherein it was held that the essential requirement of section 2(22)(e) is that payment should be made on behalf of or for the individual benefit of substantial shareholder. Thus, the provision is intended to attract the liability of tax on the person on whose behalf or for whose benefit the amount is paid by the company.

In re CIT v. Bhaumik Colour P. Ltd (2009), the special bench of Mumbai tribunal held that the inclusive definition of section 2(22)(e) enlarges the scope of the term dividend by including loans & advances. The legal fiction created by the said section is operative only so long as the deemed dividend is taxed in the hands of the shareholder. If the legal fiction is extended to loans & advance to a non shareholder, the very term ‘dividend’ will lose its identity.

One of the exceptions to section 2(22)(e) is that dividend shall not include any dividend paid by the company which is set off by the company against the whole or any part of the sum previously paid by it and treated as dividend within the meaning of sub clause (e) to the extent it is so set off.

In the event of the payment of loan or advance by a company to a concern being treated as dividend and taxed in the hands of the concern then the benefit of set off cannot be allowed to the concern, because the concern can never receive dividend from the company which is only paid to the shareholder, who has substantial interest in the concern. The above provision, further, contemplate that deemed dividend be taxed in the hands of shareholder only.

Q 3. One of the exceptions to section 2(22)(e) is that dividend shall not include any loans or advance made to a shareholder or the said concern by the company in the ordinary course of its business, where lending money is substantial part of the business of the company. Elaborate?

The term ‘substantial’ appearing in the aforesaid exception is not defined. But the same is defined in explanation 3(b) to section 2(22)(e) as not less than 20% of the income of such concern. Following the judgement of supreme court in CIT v. Venkateshwara Hatcheries (237 ITR 174) wherein it was held that the definition in one section can be used for understanding the meaning of the word in another section if the context justifies it, it can be concluded the definition of term ‘substantial’ used in the aforesaid section means 20% or more of the income of a concern.

Thus, if the income from money lending is 20% or more of the total income of the closely held company and the turnover of the loan funds to total funds of the company is above 20%, any loans or advance made by the said company to its principal shareholder cannot be deemed to be dividend. The same was upheld by Delhi Tribunal in Mrs. Rekha Modi v. ITO (2007) (13 SOT 512) and the same was not further challenged by the revenue.

Further, in deciding whether the company is engaged in money lending business, factual position only for the relevant previous year in question has to be considered i.e., the year in which the loan or advance has been given to principal shareholder holding 10% or more of voting power. The same has been upheld in the aforesaid judgement of the tribunal.

INTRODUCTION:

The concept of CENVAT credit was introduced with an intention to avoid cascading effect of taxes. The Central Value Added Tax [CENVAT] allows the credit of the duty paid on the inputs and capital goods and service tax paid on input services, which is to be utilized for the payment of excise duty on final products or service tax on output services.

FEATURES:

• No one-to-one correlation required between input/input services and final product/output service.

• Excise duty and Additional duty of customs paid on Inputs and capital goods and service tax paid on Input services used in or in relation to the manufacture of final product or rendering output service are eligible for credit.

• No credit shall be allowed in respect of Basic Customs duty paid on inputs or capital goods.

• No credit shall be allowed if the final product or out put service are wholly exempted.

• CENVAT credit shall be allowed only on the basis of specified duty paying documents.

• Credit of excise duty shall be allowed only on receipt of inputs and/or capital goods in the premises of manufacturer or provider of output service irrespective of the fact whether payment is made or not.

• Credit of service tax on input services shall be allowed only on making of payment to service provider.

• Credit of duty paid on capital goods shall be allowed to the extent of 50% in the year of receipt of capital goods and balance in subsequent years subject to the availability of possession of said capital goods. However, the duty component shall be allowed as credit in the subsequent year(s) if the capital goods are in the nature of tools, dies, jigs, etc irrespective of the possession of the said capital goods in such years.

DEFINITION AND ANALYSIS OF DEFINITION OF INPUT SERVICE:

 

As per section 2(l) of CENVAT Credit Rules, 2004, the term “Input Service” means any service:

a. used by the provider of taxable service for providing output service.

b. Used by the manufacturer, whether directly or indirectly, in or in relation to the manufacture of final products and clearance of final products upto the place of removal.

and includes:

a. services used in relation to setting up, modernization, renovation or repairs of a factory, premises of provider of output service or an office relating to such factory or premises

b. services relating to advertisement, sales promotion, market research, storage up to the place of removal, procurement of inputs.

c. Services used in relation to inward transportation of inputs and capital goods and outward transportation up to the place of removal.

d. Activities relating to business such as accounting, auditing, financing, recruitment and quality control, coaching and training, computer networking, credit rating, share registry and security.

 

The term “Input Service” is broadly in two parts – first i.e., main part and second i.e., inclusive part. First part of the definition is restrictive in scope and covers all services directly or indirectly used in providing output service or used in relation to manufacture or clearance of final products. However, second part of the definition expands the scope much beyond the coverage of first part.

The general rule to be applied while deciding on the eligibility of credit of tax paid on a particular service is:

“I am eligible to take credit unless someone reasonably proves as to why I shouldn’t take it”.

The inclusive part of the definition widens the scope given by exhaustive definition of the first part. It has been held by 3 member large bench of CESTAT – Bangalore in ABB Limited case that each of the above list is an independent benefit/concession. Each item in the list has to be read individually and if any service fits into the scope of any item above, the same shall be treated as input service notwithstanding the conditions mentioned in other items of the list.

WHETHER OUTWARD TRANSPORTATION UPTO CUSTOMER PLACE CAN BE DEEMED AS INPUT SERVICE?

The issue arises since the definition of input service specifically includes outward transportation up to the place of removal. However, It has been held by larger bench of Bangalore tribunal that all the items in the inclusive definition are distinct and are to be read accordingly. The Item (d) above uses the term “activities relating to business”. There is no further restriction that activities relating to business should be relating to only main activities or essential activities of the business. Therefore, the definition of “Input Service” has to be interpreted in the light of requirements of the business and cannot be read restrictively so as to confine only up to the place of removal. All the services relating to business will qualify as input service.

However, in the case of Gujarat Ambuja Cements Limited, the tribunal held that outward transportation of goods is not an input service and, therefore, not eligible for credit. Credit beyond the point of removal of goods would be contrary to the scheme of Cenvat Credit Rules, 2004.

Since there is anamoly over the interpretation of the scope of definition of input service, it is necessary to ensure that the outward transportation service is prima facie classified as input service. Following conditions are to be satisfied before classifying outward freight as input service:

• Goods are sold on FOB basis.

• Ownership of goods remain with the seller till delivery at customer’s doorstep.

• Transit insurance is borne by the assessee.

• Property in goods is not transferred till the delivery at doorsteps of the customer.

• Cost of transport is included in the assessable value of the goods.

SECTION 43(6) V. SECTION 45(1A)

Taxability of a receipt is governed by section 2(24) of the Income Tax Act (hereinafter referred to as “Act”) which define the term “Income”. In ordinary parlance, the term income connotes a receipt arising regularly or with some sort of expected regularity. It is well accepted principle that a capital receipt shall not come under the net of Income tax unless otherwise specifically provided in the Act. Section 45 of the Income Tax Act is an enabling provision which enables taxation of capital gains. If a capital receipt fails to satisfy the conditions of section 45 r. w. 48 [held in re B C Srinivas shetty] of the Act, the same cannot be subject to taxation.

I shall try to focus the provisions of section 45(1A) which was enacted to nullify the judgement of Supreme Court in Re Vania Silk Mills Private Limited [1991]. As per the provisions of section 45, a capital receipt shall be subject to taxation only if the same has arisen pursuant of “transfer” of a capital asset. The term ‘Transfer’ has been defined in a inclusive manner in section 2(47) which, inter alia, includes extinguishment of rights in an asset. In the case mentioned supra, the Supreme Court held that capital gains arising on destruction of asset shall not be subject to taxation since the destruction of asset does not amount to transfer.

To nullify the aforesaid judgement, sub section (1A) of section 45 was introduced which provided for the taxation of capital gains arising pursuant to receipt of insurance compensation subject to satisfaction of following two conditions:

1. Compensation is received because of ‘damage’ to or ‘destruction’ of any capital asset.

2. the damage or destruction is a result of four categories of circumstances:

a. flood, typhoon, hurricane cyclone, earthquake or any other convulsion of nature; or

b. riot or civil disturbance; or

c. accidental fire explosion; or

d. action by an enemy or action taken in combating an enemy.

The insurance compensation received shall be treated as a capital receipt and, consequently, shall not be subject to taxation if aforesaid conditions are not satisfied, e.g., theft of a machinery or destruction of machinery on account of road accident. In case of theft of machinery, there is no damage or destruction of property and, therefore, the first condition mentioned supra itself fails. Further, in order to hold a transaction as ‘transfer’, there must be indentified transferor and transferee which is not possible in case of theft.

In case of road accident, though the asset is destroyed, the reason for destruction being other than those mentioned in condition two supra. The compensation received, in these cases, will, therefore, have to be dealt with as per the judgement in re vania silk mill case.

The objective of this article is to demonstrate the impact of following cases in determining WDV of block of assets.

CASE 1: DAMAGE TO AN ASSET – INSURANCE COMPENSATION RECEIVED:

In case of any expenditure incurred to restore the asset to its working condition, the normally accepted principle is that the expenditure is revenue in nature since it does not increase the performance of the asset beyond the previously assessed standard of performance. If any insurance money is received as a re imbursement for such expenditure incurred, the normal accounting practice followed by many is to reduce the expenditure incurred by the amount so received and to debit/credit the profit/loss account with the balance.

What should have been the treatment of such compensation received for the purposes of Income Tax Act?

Damage to an asset may tantamount to extinguishment of rights [in part] in the asset thereby resulting in transfer as contemplated in section 45(1A). But, how shall the cost of the asset transferred be arrived at u/s 48 especially when the asset is restored to working condition after carrying out necessary current repairs. It is judicially accepted [e.g., in re B C Srinivas Shetty case (SC)] that provisions of section 45 has to be read with section 48 and if the latter fails for any reason, the charging section itself fails. The Assessing officer is not allowed to make conjectures or surmises for the purposes of arriving at the cost of the asset transferred. The taxability of such receipt is a ‘?’ requiring solution.

As far as depreciable asset is concerned, the taxability of the same has to be arrived based on the provisions of section 50 r. w. section 43(6). If the insurance compensation so received exceeds the WDV of the block of the said asset, section 50 shall come into motion resulting in short term capital gain. If the compensation is less than the WDV of the block, it is undisputed that the compensation so received is a capital receipt not subject to taxation.

The next question that arises is whether the said insurance money so received can be reduced from the block of assets. The answer is ‘No’. Section 43(6) enables deletion of value from the block only if the asset, whether in whole or in part, is ‘sold or discarded or demolished or destroyed’. It is not applicable where the assets are merely damaged and by repairing the damage is restored to working condition. Thus, the insurance money is not taken in consideration while computing the WDV of block irrespective of fact whether any expenditure is incurred for restoration or the expenditure so incurred exceeds the insurance money.

Now what shall happen to the expenditure incurred? As discussed supra, the said expenditure is revenue in nature. In my opinion, the assessee can claim the same as deduction although the same would amount availment of double benefit by the assessee.

One can always argue the possibility of section 41 being attracted in case of insurance money received to recompense the expenditure incurred on restoration of machinery.

CASE 2: THEFT OF PROPERTY – COMPENSATION RECEIVED:

In case of theft of property, there is no question of destruction of asset involved as it is known that asset is in existence though not in the possession of the assessee. Hence, section 45(1A) fails. If the judgement of vania silk mills is applied, the insurance compensation so received shall be treated as capital receipt not subject to taxation.

In case of depreciable assets, no deletion is required to be made from the block of assets since theft do not fit under any of the situation contemplated in section 43(6), i.e., neither the asset is sold nor discarded nor demolished nor destroyed. The assessee is allowed to claim depreciation on the block provided the block do not cease to exist on happening of theft – else the provision of section 50 shall come into operation.

A question may, however, loiter in mind that doesn’t theft results in extinguishment of rights of the assessee in the said asset? If yes, the provision of section 45 would apply. Next question that arises is that if the compensation is not received in the same previous year in which theft has taken place, how will the computation of capital gains for the purposes of section 45 be made in the assessment for said previous year?

Disregarding these anomalies, the assessee can move forward to claim the benefit of judgement made in vania silks mill case because the provisions of section 45(1A) failed to nullify the said judgement in its entirety.

CASE 3: DESTRUCTION OF A ASSET IN ROAD ACCIDENT:

In case of destruction of asset in a road accident, the provisions of section 45(1A) shall not apply since the destruction took place in circumstances other than those mentioned in condition 2 mentioned supra. Applying the rationale of the judgement of vania silks mill case, the aforesaid receipt shall be treated as capital receipt not subject to taxation.

If the asset so destroyed is a depreciable asset, then the insurance money so received shall be reduced from the WDV of the block of the assets since the conditions mentioned in the provisions of section 43(6) are satisfied. However, if the insurance compensation exceeds the WDV of the block, then the excess shall not be subject to taxation. Similarly, if the block ceases to exist pursuant to such destruction, the excess compensation shall not be subject to taxation u/s 50 r.w. section 45(1A) for reasons mentioned supra. In this case also, the anomalies enumerated above shall arise.

The aforesaid interpretation/treatment/opinion is arrived at based on my knowledge and understanding of law and judicial pronouncements. I welcome the comments of readers on the aforesaid issue.