“BOOK PROFIT FOR THE PURPOSE OF SECTION 40(b)”

TAX TALK-19.11.2012-THE HITAVADA

TAX TALK  

BY CA. NARESH JAKHOTIA

Chartered Accountant

“BOOK PROFIT FOR THE PURPOSE OF SECTION 40(b)”

Query 1]

I am an employee of private research firm. I have to show my trading gains/loses while declaring my investments to my company. The gains or losses from trading need to be shown under which head-other incomes or any other head? What would be the applicable tax rate for such income? [neeraj.palparti@gmail.com]

Opinion:

It is not clear as to the nature of trading gain/loss whether it pertains to trading of any goods or shares or any other items. However, normally most of the salaried assessees are carrying out the trading in shares. Presuming that the trading pertains to shares, the income could be offered for taxation either under the head “Capital Gain” or under the head “Business”. Under which head the income would be taxable depends upon number of facts like the volume of transactions, intention behind the investment, use of borrowed funds or own funds, period of holding etc.

In case of salaried assessee, normally & in most of the cases, the volume/ number of transactions are comparatively less and the period of holding is longer. In such circumstances:
a] Profit / Loss will be taxable under the head “Income from Capital Gain”.
b] Profit arising out of sale of shares after a holding period of more than 12 months would be treated as long term capital gain and the same shall be tax free u/s 10(38) when the sale transactions are subjected to STT (Securities Transactions Tax).

c] Profit arising on sale of shares with a holding period of not more than 12 months would be treated as Short Term Capital Gain. It will be taxable @ 15% u/s 111A of the Income Tax Act -1961. If there is loss, it cannot be set off against the salary income. An assessee can carry forward such loss for set off against the capital gain of subsequent years.

3.  If the Profit / Loss from shares market is taxable under the head “Income from Capital gain”, you can fill the return by using ITR-2.

Query 2]

I want to know whether I should file an appeal on the matter mentioned as under.

In the income Tax scrutiny case of our firm, the rental income and interest income from bank FDR is ignored while allowing the remuneration allowable to the partners. We have claimed remuneration by considering the rental income & interest income as business income whereas while passing the assessment order, the ITO has considered as House property Income & Other source Income. The assessment order categorically has mentioned that the “Book profit” is the foundation for allowability of remuneration to the partners and the book profit means profit as computed in accordance with chapter IV-D, that is to say, Business Profit. The remuneration computed by us by including all the above income has been offered for taxation in the hands of the individual partners in the relevant year also.

Please advise whether the income which is taxable under other head of income (other than business income) & credited to the profit & Loss A/c  can be treated as part of the book profit for working out allowable remuneration u/s 40(b)?  In short, whether income from House property & other source can be included in the definition of book profit for working out allowable remuneration? Whether appeal could be fruitful in such case? [r******@gmail.com]

Opinion:

1.      It is indeed a very interesting issue worth elaborating. Income tax Act is one such complex Act where diverse & multiple interpretations have added further complexity. It is one such query where two divergent views are possible.

2.      As far as Remuneration to partners is concerned, it is to be calculated U/s 40(b) on the basis of “Book profit”. The meaning of expression “Book Profit” is given in Explanation 3 to section 40(b) so as to mean the “net profit as shown in the Profit & Loss A/c computed in the manner laid down in Chapter IV-D of the I.T. Act-1961”.

3.      The entire controversy is emerging from the word “computed in the manner laid down in chapter IV-D”.

4.      The Assessing Officer has taken the view that Section 40(b) requires that “Net Profit” is to be worked out in accordance with Chapter IV-D & the remuneration has to be allowed on the basis of profit computed under chapter IV-D. It may be noted that Chapter IV-D refers to the computation of “Profit & gains of business or profession.” i.e., Business Profit..

5.      The judiciary, however, has taken a quiet liberal view in this matter. It has been held in few decisions that
a] the meaning of the word “Book Profit” needs to be imported from the word “Net Profit” as shown in the Profit & Loss A/c.
b] The term “Net Profit” as mentioned in section 40(b) doesn’t include Business profit but also profit taxable under other head of income.
c] Reference to Chapter IV-D is made at the relevant places in the legislature in order to ensure that the net profit is not reduced by claiming deduction far in excess of limit permissible under section 30 to 43D.
d] Prima-facie the legislature didn’t authorize exclusion of non business receipts & expenditure recorded in the P & L A/c.
e] All the income embedded in the profit & Loss A/c is to be taken in to consideration while computing deduction of remuneration to working partners.
f] Chapter IV-D nowhere provides for the method of accounting for the purpose of ascertaining of net profit & nowhere provides that net profit would mean income from business alone and would not include income from other sources or house property or capital gain income.
In view of this, it may be said that the “Book Profit” for the purpose of section 40(b) will include all income credited to the profit & loss a/c whether they belong to any head of income.

6.      You may file an appeal by relying upon the following cases:
a] ACIT Vs. CC Chokshi & Co. (2010) 35 (II) ITCL 76 (Mum ‘G’ Trib)
b] Asst. CIT Vs. Sheth Corporation (2006) 99 TTJ 189 (Rkt-Trib)
c] Md. Serajuddin & Brothers Vs. CIT (2012) 210 Taxman 84 (Calcutta High Court)
d] S.P. Equipment & Services Vs. Asst. CIT (2010) 36 SOT 325 (JP ‘A’ Tribunal)