Tax Planning

Tax planning is an essential part of financial planning. Efficient tax planning enables one to reduce tax liability to the minimum. This is done by legitimately taking advantage of all tax exemptions, deductions, rebates and allowances while ensuring that investments are in line with long term goals.

How to Plan?

1. Spread the taxable income among various members in your family;
2. Take full advantage of tax exemptions available under the law;
3. Take full advantage of permissible tax deductions and rebates available on stipulated tax saving investments
4. Make optimum use of tax-exempted incomes; and

Utilizing the deductions under Chapter VI A

1. Section 80C
Under Section 80C, the maximum deduction available is Rs 100,000 pa. Ideally, salaried individuals whose gross total income is equal to or more than Rs 250,000 should utilise the entire Rs 100,000 limit.

Let us consider the case of two individual whose taxable income is Rs 600,000 on of who utilises only half of the available Rs 100,000 limit. He would end up paying an additional tax of Rs 10,300 as opposed to an individual with the same taxable income, but has utilised the entire limit.

Following investments/contributions qualify for Section 80C deductions,

  • Public Provident Fund
  • National Saving Certificate
  • Accrued interest on National Saving Certificate
  • Life Insurance Premium
  • Tuition fees paid for children’s education (maximum 2 children)
  • Principal component of home loan repayment
  • Equity Linked Savings Schemes (ELSS)
  • 5-Year fixed deposits with banks and Post Office

2. Beyond Section 80C

For salaried individuals whose gross total income exceeds Rs 250,000 pa, deductions under Section 80C may not be sufficient to reduce the overall tax liability. In such cases following can be considered :

Home loan: Individuals intending to buy a house should consider opting for a home loan. Interest payments of up to Rs 150,000 pa are eligible for deduction under Section 24.

Medical Insurance: An individual who pays medical insurance premium for self or spouse/dependent children is allowed a deduction of up to Rs 15,000 pa under section 80D.

An additional deduction of up to Rs 15,000 pa is allowed for premium payment made for parents. In case the parents are senior citizens, then the maximum deduction allowed is Rs 20,000 per year.

Donations: Subject to the stated limits, donations to specified funds/institutions are eligible for tax benefits under Section 80G.

Section 80E
Salaried individuals who plan to pursue higher education can avail of an education loan as the entire interest is eligible for deduction. The loan can be for self, spouse or child from an approved charitable institution or a notified financial institution.

3. Restructuring the salary
Restructuring the salary and including certain components can help a great deal in reducing the tax liability. Unlike eligible investments which lead to an additional cash outflow, restructuring the salary is a more ‘efficient’ means of claiming tax benefits. The following can form part of one’s salary structure:

  • Food coupons like Sodexo and Ticket Restaurant are exempt from tax up to Rs 15600 p.a
  • Medical expenses reimbursed by the employer are exempt up to Rs 15,000 per year.
  • Individuals living in a rented accommodation can have House Rent Allowance (HRA) as part of their salary.
  • Transport allowance is exempt up to Rs 800 per month.
  • Leave Travel Allowance (LTA) can be claimed twice in a block of four years for domestic travel.

4. Claiming tax benefits on house rent paid
Where HRA doesn’t form part of salary and for individuals having income from sources other than salary, rent paid by them for residential accommodation can be availed as a deduction under Section 80GG. The deduction is restricted to the least of the below:

  • 25% of the total income or,
  • Rs 2,000 per month or,
  • Excess of rent paid over 10% of total income

Please note that the above deduction will be denied if the taxpayer or his spouse or minor child owns a residential accommodation in the location where the taxpayer resides or performs his office duties.

5. Opt for joint Home Loans
As discussed earlier, the principal repayment on a home loan is eligible for a deduction of up to Rs 100,000 pa and the interest paid is eligible for a deduction of up to Rs 150,000 per year.

In cases where the home loan is for a substantial sum, it is not uncommon for the interest and principal repayment to exceed the stated limit. To ensure that the tax benefit is optimally utilised, an individual can consider opting for a joint loan with his spouse or parent or sibling.

This will ensure that both the co-owners can claim tax deductions in the proportion of their holding in the loan. The co-owner falling in the higher tax bracket should hold a higher proportion of home loan to ensure that the tax benefits are maximised.

Benefits of Tax Planning

Tax planning has several advantages, the below listed are few of such advantages:

  • Reduce Tax burdance by strategically planning and sharing income among the family members
  • Helps plan retirement
  • Accumulation of wealth
  • Promotes savings by investing in tax saving schemes

GAAR an Overview

In recent times, the term “GAAR” has been in news a lot, many experts have blamed the recent flight of funds from India by FIIs & FDIs on the same, when the finance minister of India proposed the retrospective applicability of GAAR in his budget speech for the year 2012-13 on March 16, 2012 . GAAR was a part of the proposed Direct Tax Code Bill, but the date of applicability was advanced to April 01, 2012, that too with retrospective effect. The trigger point for the same being the famous Vodafone case.

GAAR stands for General Anti Avoidance Rules, for understanding the meaning of GAAR, first we have to know the meaning of Tax Avoidance. Tax Avoidance is nothing but an attempt to reduce tax liability through legal means, i.e. to regulate your affairs in such a way that you pay the minimum tax imposed by the Act as opposed to the maximum. Anti Avoidance rules can be classified into following:‒

Measures based on general principles in the law

  • This refers to principles which are not codified in the legislation (non-statutory)
  • They include a range of philosophies and approaches including “substance over form” and
    “abuse of law”

General Anti Avoidance rules

  • It has same meaning as “anti avoidance rules based on general principles in law” except that it is codified and included in the legislation

Specific Anti Avoidance rules

  • These are the specific anti-avoidance rules which applies to the specific situations- CFC, Thin Capitalization rules, Exit Tax etc.

As per the proposed General anti avoidance provisions in India:

The Commissioner of Income tax is empowered to declare an agreement as an impermissible avoidance agreement (IAA) if:

  • The whole, a step or a part of the arrangement has been entered with the objective of obtaining tax benefit, and
  • The arrangement creates rights and obligations not normally created in arm’s length transactions, or
  • Results in direct or indirect misuse or abuse of the provisions of the Direct Tax Code or
  • Lacks commercial substance in whole or part, or is not bonafide.

Once an agreement is declared as an impermissible avoidance agreement (IAA):

  • the whole or part of the impermissible avoidance agreement can be disregarded.
  • The related or connected or accommodating parties can be considered as one and the same person.
  • Any accruals, receipts, expense, deductions, rebates etc both revenue and capital can be reallocated amongst the parties.
  • Equity can be reclassified as debt or vice versa.

The impact of GAAR in India on different entities can be summed up as follows:

Foreign Companies

Foreign investors with a holding company in a tax-friendly country are concerned how the Indian tax department will define commercial presence. Normally, if the holding company is doing business in the country of incorporation, has a board of directors that meets in that country and has a predefined threshold turnover, it would satisfy conditions of commercial presence. Mauritius has in recent years become more transparent. It remains to be seen if that is enough to satisfy Indian authorities.

Indian MNCs

Indian companies expanding overseas too have reasons to be worried. Most set up a holding company outside India and will have many offshoots. A holding company overseas may also enable easier access to cheap overseas borrowings. Subsidiary operating companies may pay dividends to the holding company, which it may not transfer to the Indian parent, as that money could be ploughed into other overseas activities. Under GAAR, tax authorities could rule that the Indian parent did not bring the dividend to India to avoid paying taxes.

Domestic Companies

GAAR can prove tricky for domestic companies too, and many of their transactions, done in the normal course of business, can be questioned and tax benefit disallowed. Take for instance the merger of a loss-making company into a profit-making one. On merger, losses would offset profits and the lower net profit, if any, would mean substantially lower tax liability for the company.
The merger may have been driven by pure commercial considerations, better integration of operations or to ensure the loss-making company does not shut down, but tax department can claim it was a tactic to avoid taxes.

In another situation, a company can choose between leasing an asset and purchasing the same. On a leased asset, it can claim deduction on lease rental while on an asset that was bought, it can claim depreciation. Disputes can arise on leasing versus buying.

Likewise, a company can be asked why it raised funds through borrowing when it could have issued equity. On borrowings, a company can claim deduction on interest paid. Both decisions depend on what is more beneficial for the company. There could be cases of the large corporate groups creating a service company to manage all its non-core activities. The service company would then charge each company for the services rendered on a cost plus basis. The tax department could dispute the mark-up in the cost of services and claim it was an instance of shifting profit from one company to another.


This is a grey area. Given the tax avoidance rules are general, tax experts say individuals too would be covered. The finance ministry says the government does not intend to go after the salaried. But company leased cars, a perk senior executives enjoy, can be challenged as a tax avoidance measure. This is because the value of the lease would be far higher than the value used for calculating tax.

After a hue and cry was raised against the retrospective applicability of GAAR, the Finance minister deferred the applicability of GAAR to April 01, 2013. In addition to this, he has announced the formation of a panel for implementation of GAAR and to have a relook on the provisions of GAAR. He also announced that the burden of proving tax evasion will lie with the authorities rather than with overseas investors as opposed to earlier stance of burden of proving non evasion of tax lying with the investor.



A self imposed code of ethics is essential for the success of the profession of accountancy and to command respect and confidence of general public. The preamble of the Chartered Accountants Act, 1949 (The Act) sets the purpose of the act as “An Act to make provision for the regulation of the profession of the Chartered Accountants.” The Institute of Chartered Accountants of India was constituted under the Act whose affairs are managed by the Council. The Council of the Institute has been empowered to discharge the function assigned to it under Act. The Chartered Accountants (Amendment) Act, 2006 has, inter alias, introduced provision for a new Disciplinary Mechanism within its framework which would ensure well considered and expeditious disposal of complaints against members on professional or other misconduct. The provision provided for appointment of a Director (Discipline), to investigate complaints, constitution of a Board of Discipline and Disciplinary Committee to deal with cases and providing for an Appellate Authority, to deal with appeals arising out of decision of the Board of Discipline and the Disciplinary Committee(s), as the case may be.


An objective of the accountancy profession is as follows:

  • To work to the highest standards of professionalism
  • To attain the highest levels of performance
  • To meet public interest requirements.


  • Integrity: A professional accountants should be straightforward and honest in performing professional services.
  • Objectivity: A professional accountants should be fair and should not allow prejudice or bias, conflict of interest or influence of others to override objectivity.
  • Professional Competence: A professional accountant should perform professional services with due care, competence and diligence and has a continuing duty to maintain professional knowledge and skills.
  • Due Professional Care: It does not require ultimate expert but does extend to every aspect of the audit including the evaluation of audit risk, formulation of audit objective.
  • Confidentiality: A professional accountant should respect the confidentiality of information acquired during the course of performing professional services and should not use or disclose any such information without proper and specific authority or unless there is a legal or professional right or duty to disclose.
  • Professional Behaviour: A Professional accountant should act in a manner consistent with the good reputation of the professional and refrain from any conduct which might bring discredit to the profession requires.
  • Technical Standards: A Professional accountant should carry out professional services in accordance with the relevant technical and professional standards.

1.THE FIRST SCHEDULE: the first schedule has four parts. Where the director (Discipline) is of the opinion that member is guilty of any professional or other misconduct mentioned in first schedule, he shall place the matter before Board of Discipline.


Clause – 1: Allows any person to practice in his name as a chartered accountant unless such person is also a chartered accountant in practice and is in partnership with or employed by him.

Objective: To prevent unqualified persons from acting as qualified accountants.

Exceptions: Employee working directly under the supervision and control for the employer.

Clause – 2 : Pays or allows or agrees to pay or allow, directly or indirectly, any share, commission or brokerage in the fees or profits of his professional business, to any person other than member of the Institute or a partner or retired partner or the legal representative of a deceased partner, or a member of any other professional body or with such other persons having such qualification as may be prescribed, for the purpose of rendering such professional services from time to time in or outside India.

Objective: To restrain a member from sharing his fees, whether directly or indirectly, with non-members and / or other non-prescribed persons.
1. Legal representative or widow of the deceased partner can receive share of profits of the firm for some specified period only if the partnership agreement so provides;
2. Widow of the proprietor can receive payment for goodwill of the concern even in instalments, provided that there is no linkage between such payment and the participation in the earnings of the firm.

Clause – 3: Accepts or agrees to accept any part of the profits of the professional work of a person who is not a member of the Institute:

Clause – 4: A Chartered Accountant in practice can enter into partnership with a chartered accountant in practice or a member of any other professional body having prescribed qualifications.

Clause – 5: Secures, either through the services of a person who is not an employee of such chartered accountant or who is not his partner or by means which are not open to a chartered accountant, any professional business.

Objective: A chartered accountant can secure professional business only through his employee or a person who is qualified to be his partner or through any other means open to chartered accountant.

Clause – 6: Solicits clients or professional work either directly or indirectly by circular, advertisement, personal communication or interview or by any other means.

Objective: Professional work should be attained through building confidence, providing quality services to the clients and the satisfaction of the clients towards the services performed.

Exceptions: If work or professional work occurs within the fraternity or if professional work is secured from responding to tenders, or enquiries issued by various users if professional services or organisation.

Prohibited ways of solicitation: The council of ICAI has prohibited the following ways of soliciting work:

1.Advertisement and notes in the press,
2. Application for empanelment for allotment of audit or other professional work
3. Issuing hand bills is prohibited
4. Publication of books or articles, if it indicates his association with a firm of chartered accountants is prohibited.
5. Roving enquires are prohibited,
6. Representation u/s 225(3) of the Companies Act, 1956,
7. Giving public interviews which are intended to secure publicity, rather than highlighting professional achievements are prohibited.

Clause – 7: “Advertises his professional attainments or services, or uses any designation or expressions other than the Chartered Accountant on professional documents, visiting cards, letter heads or sign boards unless it be a degree of a University established by law in India or recognized by the Central Government or a title indicating membership of the Institute of Chartered Accountants or of any other institution that has been recognized by the Central Government or may be recognized by the Council

Provided that a member in practice may advertise through a write up, setting out the service provided by him or his firm and particulars of his firm subject to such guidelines as may be issued by the Council.


(a) Advertisements for recruiting staff in the members’ own office.
(b) Advertisements inserted on behalf of clients requiring staff or wishing to acquire or dispose of business or property.
(c) Advertisement for the sale of a business or property by a member acting in a professional capacity as trustee, liquidator or receiver.

Clause – 8: If he accepts a position as auditor, which was previously held by another chartered accountant or restricted state auditor without communicating with him in writing.

a) To safeguarded own interest, as he will get an opportunity to know reasons for such change.
b) To safeguard interest of public as it will ensure that theres is no injustified removal of existing auditor
c) To safeguard independence of existing accountant.
d) Matter of professional courtesy.

The professional reasons for not accepting an audit could be:

(i) Non-compliance of the provisions of Sections 224 and 225 of the Companies Act as mentioned in clause (9);
(ii) Non-payment of undisputed audit fees by auditees other than in case of sick units for carrying out the statutory audit under the Companies Act, 1956 or various other statutes; and
(iii) Under-cutting of fees;
(iv) Issuance of a qualified report.

Exception: Auditor is appointed u/s 233A of the Companies Act, 1956 for conducting special audit.

Clause – 9: Accepts an appointment as auditor of a company without first ascertaining from it whether the requirements of Section 225 of the Companies Act, 1956, in respect of such appointment have been duly complied with”.

Clause – 10: “Charges or offers to charge, accepts or offers to accept In respect of any professional employment fees which are based on a percentage of profits or which are contingent upon the findings or results of such employment, except as permitted under any regulations made under this Act.”

1. A receiver or a Liquidator can receive fees based on percentage of realisation or disbursement of the assets.
2. Auditor of co-operative society can receive fees based in paid up capital or working capital or gross or net income or profits.
3. A valuer for direct taxes and duties can change fees based on percentage of the value of property valued.

Clause – 11: Engages in any business or occupation other than the profession of chartered accountant unless permitted by the Council so to engage;
Provided that nothing contained herein shall disentitle a chartered accountant from being a director of a company (Not being managing director or a whole time director) unless he or any of his partners is Interested in such company as an auditor.”

Permission granted generally:

1. Employment under Chartered Accountants in practice or firms of such chartered
2. Private tutorship
3. Authorship of books and articles.
4. Holding of Life Insurance Agency License for the limited purpose of getting renewal commission.
5. Attending classes and appearing for any examination.
6. Holding of public elective offices such as M.P., M.L.A. and M.L.C.
7. Honorary office leadership of charitable-educational or other non-commercial organisations.
8. Acting as Notary Public, Justice of the Peace, Special Executive Magistrate and the like.
9. Part-time tutorship under the coaching organisation of the Institute,
10. Valuation of papers, acting us paper-setter, head-examiner or a moderator for any examination.
11. Editorship of professional journals.
12. Acting as Surveyor and Loss Assessor under the Insurance Act, 1938 provided they are otherwise eligible.
13. Owning agricultural land and carrying out agricultural activity (w.e.f. August 9th, 2008)

Permission to be granted specifically:

1. Full-time or part-time employment in business concerns provided that the member and/or his relatives do not hold “substantial interest” in such concerns”.
2. Full-time or part-time employment in non-business cc concern.
3. Office of managing director or a whole-time director o a body corporate within the meaning of the Companies Act, 1956.
4. Interest in family business concerns (including such interest devolving on the members as a result of in inheritance/succession / partition of the family business) or concerns in which interests has been acquired as a result of relationships and in the management of which no active part is taken.
5. Interest in agricultural and allied activities carried on with the help, if required, of hired labour.
6. Interest in an educational institution.
7. Part-time or full-time lectureship for courses other than those relating to the Institute’s examinations conducted under the auspices of the Institute or the Regional councils or their branches.
8. Part-time or full-time tutorship under any educational institution other than the coaching organization of the Institute.
9. Editorship of journals other than professional journals.
10. Any other business or occupation for which the Executive Committee considers that permission may be granted.

Clause – 12: “Allows a person not being a member of the institute in practice or a member not being his partner to sign on his behalf or on behalf of his firm, any balance sheet, profit and loss account, report or financial statements”.

PART II – Professional misconduct in relation to members of the Institute in service
A member of the Institute (other than a member in practice) shall be deemed to be guilty of professional misconduct, if he being an employee of any company, firm or person

Clause – 1: Pays or allows or agrees to pay directly or indirectly to any person any share in the emoluments of the employment undertaken by him;

Clause – 2: Accepts or agrees to accept any part of fees, profits or gains from a lawyer, a chartered accountant or broker engaged by such company, firm or person or agent or customer of such company, firm or person by way of commission or gratification.

PART III – Professional misconduct in relation to members of the Institute generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional misconduct, if he

Clause – 1: Not being a fellow of the Institute, acts as a fellow of the institute;

Clause – 2: does not supply the information called for, or does not comply with the requirements asked for, by the Institute, Council or any of its Committees, Director (Discipline), Board of Discipline, Disciplinary Committee, Quality Review Board or the Appellate Authority;

Clause – 3: while inviting professional work from another chartered accountant or while responding to tenders or enquiries or while advertising through a write up, or anything as provided for in items (6) and (7) of Part I of this Schedule, gives information knowing it to be false.

PART IV- Other misconduct in relation to members of the Institute generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of other misconduct, if he

(1) is held guilty by any civil or criminal court for an offence which is punishable with imprisonment for a term not exceeding six months;
(2) in the opinion of the Council, brings disrepute to the profession or the Institute as a result of his action whether or not related to his professional work.

2. THE SECOND SCHEDULE – Where the Director (Discipline) is of the opinion that a member is guilty of any professional or other misconduct mentioned in the second schedule or in both the Schedule, he shall place the matter before the Disciplinary Committee.

Part I – Professional misconduct in relation to chartered Accountant in practice

A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he

Clause – 1: Discloses information acquired in the course of his professional engagement to any person other than his client so engaging him without the consent of his client or otherwise than as required by any law for the time being in force.

Clause – 2: If he certifies or submits in his name or in the name of his firm a report of an examination of financial statements unless the examination of such statements and the related records has been made by him or by a partner or an employee in his firm or by another chartered accountant in practice.

Clause – 3: Permits his name or the name of his firm to be used in connection with an estimate of earnings contingent upon future transactions in manner which may lead to the belief that he vouches for the accuracy of the forecast.

Clause – 4: Expresses his opinion on financial statements of any business or enterprise in which he, his firm, or a partner in his firm has a substantial interest;

Clause – 5: fails to disclose a material fact known to him which is not disclosed in a financial statement, but disclosure of which is necessary in making such financial statement not misleading where he is concerned with that financial statement in a professional capacity;

Clause – 6: Fails to report a material misstatement known to him to appear in a financial statement with which he is concerned in a professional capacity.

Clause – 7: Does not exercise due diligence, or is grossly negligent in the conduct of his professional duties;

Clause – 8: Fails to obtain sufficient information which is necessary for expression of an opinion or its exceptions are sufficiently material to negate the expression of an opinion.

Clause – 9: Fails to invite attention to any material departure from the generally accepted procedure of audit applicable to the circumstances.

Clause – 10: Fails to keep moneys of his client other than fees or remuneration or money meant to be expended in a separate banking account or to use such moneys for purposes for which they are intended within a reasonable time.

PART II – Professional misconduct in relation to members of the Institute generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of professional misconduct, if he

Clause – 1: Contravenes any of the provisions of this Act or the regulations made there under or any guidelines issued by the Council;

The Regulations under which cases of contravention have generally come to the notice of the Council are the following:

Regulation 43 Engagement of Articled Assistant
Regulation 46 Registration of Articled Assistant
Regulation 47 Premium from Articled Assistant
Regulation 48 Stipend to Articled Assistant
Regulation 56 Termination or assignment of Articles
Regulation 65 Articled Assistant not to engage in any other occupation
Regulation 67 Complaint against the employer (from Articled Assistant)
Regulation 68 to 80 Audit Assistant
Regulation 190 Register of offices and firms
Regulation 190-A Chartered Accountants not to engage in any other business or occupation
Regulation 191 Part time employment’s a Chartered Accountant may accept
Regulation 192 Restriction on fees

Clause – 2: Being an employee of any company, firm or person, discloses confidential information acquired in the course of his employment except as and when required by any law for the time being in force or except as permitted by the employer;

Clause – 3: Includes in any information, statement, return or form to be submitted to the Institute, Council or any of its Committees, Director (Discipline), Board of Discipline. Disciplinary Committee, Quality Review Board or the Appellate Authority any particulars knowing them to be false;

Clause – 4: Defalcates or embezzles money received in his professional capacity.

Part III – Other misconduct in relation to members of the Institute generally
A member of the Institute, whether in practice or not, shall be deemed to be guilty of other mis-conduct, if he is held guilty by any civil or criminal court for an offence which is punishable with imprisonment for a term exceeding six months.

Practical Note on Income Tax Authorities

1. Have you ever wondered as officers of what designation can be an assessing officer, here you go:

Only the following designated officers can be an assessing officer (AO):

Rank 1 – Assessing Officer Joint Commissioner of Income Tax (JC)
Rank 2 – Assessing Officer Deputy Commissioner of Income Tax (DC) / Assistant Commissioner of Income Tax (AC)
Rank 3 – Assessing Officer Income Tax Officer (ITO)

So, Officers in designation of Commissioner of Income Tax (CIT), Commissioner of Income Tax (Appeals) or Chief Commissioner of Income Tax cannot be an assessing officer.
(Note: Above information is adapted from Income Tax module by Vinod Gupta, FCA)

2. Everyone who attends to the hearings of Income Tax Department would come across the jargon particular to the revenue department i.e., range, circle, ward etc., let us run through what exactly they mean:

  • >> Range is 1st division of the IT department. For instance, IT department in Hyderabad is divided into 16 ranges.
  • >> Circles and Wards are the divisions of the Range.
    When we mention circle, we are referring to the assessing officers of designation JC/DC/AC.
    For instance, Circle 3(2), means Assessing officer of rank one or two in range 3 and the assessing officer number is 2.

    When we mention ward, we are referring to the assessing officer of rank 3 i.e., Income Tax Officer. For instance, Ward 3(1), means assessing officer of rank three in range 3 and income tax officer number is 1.

    Usually, all the high income category assesses are divided between Circles and low income category assesses are divided between Wards and mostly depends on the workload of the Range.

3. Did you ever try to know your Income Tax jurisdiction even before you are allotted PAN Number or without the help of PAN Number. In fact, Jurisdiction of a person is pre determined by the Income Tax Department, i.e., even before you are allotted a PAN Number based on category of the person/region the person belongs to:

Please visit this link which is an interactive guide:
Keep selecting the options that are suitable to you as an assessee and it displays the jurisdiction of assessing officer, from whom you can receive letters of love (notices), unconditionally (he is not very much interested in your identity proof and he gets you PAN, if you do not have one)

Note: This interactive guide works only on the browser ‘Internet Explorer’.

Compendium of Opinions — Vol. XXVII

Query No. 2
Subject: Depreciation on buildings, etc., constructed on leasehold land.

A. Facts of the Case

  1. A government company has constructed buildings, roads, etc., on leasehold land, which was taken on lease from an Improvement Trust under a lease agreement which was initially for a period of 30 years only. The land allotment letter (a copy of which has been provided by the querist for the perusal of the Committee) indicates that the land shall be used for office and staff colony.
  2. The querist has stated that under clause 2(b) of the ‘Terms of Transfer in Leasehold Rights of Plots in the Layout of the Improvement Trust’ (a copy of which is provided by the querist for the perusal of the Committee), it has been stated that “the lease shall be renewable at the option of the lessee for further terms of 30 years”. Further, as per the allotment letter, the entire lease premium of Rs. 21 lakh was payable upfront and annual ground rent of 2% of lease premium, i.e, Rs. 42,000 is payable in advance and falls due on 1st June of each year.
  3. The company has been charging depreciation on the buildings, etc., constructed on the leasehold land @ 1.63% on straight-line method (SLM) as per the rates given in Schedule XIV to the Companies Act, 1956 (the ‘Act’), on the basis of which the useful life works out to be 58 years.
  4. During the course of audit of accounts of the company for the year 2005-06, the government auditors have raised provisional comment on the issue relating to charging-off of depreciation on buildings, roads, etc., on the leasehold land. Their contention is that the depreciation on the buildings, etc., constructed on leasehold land should be charged over a period of 30 years only (i.e., over the lease period of the land) and not over a period of 58 years (i.e. @ 1.63% on SLM) as specified in the Act and followed by the company. According to them, the rate prescribed under the Act is applicable in respect of assets constructed on freehold land.
  5. The provisional comment and the management’s reply were as below:
Audit Memo Management’s Reply
Provisional Comment No.1
Profit & Loss Account – Depreciation – Rs.209.00 lakh Buildings, roads, parks and sheds of RJ-IV are constructed on 7.07 hectares of leasehold land taken from the Improvement Trust under two lease agreements entered in the year 1999-2000 for a lease period of 30 years commencing retrospectively from 1983-84. The lease period expires in the year 2014. Depreciation on buildings, roads, parks and sheds is charged at the rate specified under Schedule XIV to the Companies Act, 1956, i.e., @ 1.63%. However, such rates are applicable only in respect of assets constructed on freehold land. All buildings and other structures constructed on leasehold land are to be charged off within the lease period. Due to charging-off of depreciation at rates applicable to assets constructed on freehold landinstead of charging off the cost of the assets within the lease period, depreciation for the year 2005- 06 is understated and profit for the year is overstated by Rs. 9.09 lakh. Further, this has resulted in understatement of depreciation charged and overstatement of previous year’s profit by Rs. 60.05 lakh.
Profit & Loss Account – Depreciation -Rs.209.00 lakh. Buildings of RJ-IV have been constructed on leasehold land taken from the Improvement Trust under lease agreement which is initially for a period of 30 years. Under Clause 2(b) of the “Terms of Transfer in Leasehold Rights of Plots in the Layout of the Improvement Trust” which was forwarded by the Secretary, Improvement Trust at the time of allotment of land, it has been stated that “the lease shall be renewable at the option of the lessee for further terms of 30 years”. As such, the company has the option to renew the lease for the further period of 30 years. Also, it is the standard practice in case of lease made by Government that normally it is initially made for 30 years and thereafter it is renewed for next term of 30 years. Moreover, the cost of the land, i.e., the lease rent is being amortised regularly over the lease period. Further, the depreciation onbuildings constructed on the leasehold land has been charged consistently at the rate specified in Schedule XIV to the Companies Act, 1956, i.e., @ 1.63% on SLM (depreciable life being 58 years). As such, the contention that there is understatement of depreciation and overstatement of profit for the year 2005-06 and for the earlier years is not correct. In view of the above, the memo may kindly be dropped.

The statutory auditors agreed with the above reply of the management.

  1. The issue was discussed in detail with the Principal Director of Commercial Audit (the ‘PDCA’). The PDCA agreed with the reply submitted by the company. However, while issuing a nil comment on the accounts, he advised that the matter may be referred to the Expert Advisory Committee of the Institute of Chartered Accountants of India for its opinion.

B. Query

  1. The querist has sought the opinion of the Expert Advisory Committee as to whether depreciation charged by the company on buildings, etc., constructed on leasehold land @ 1.63% on SLM as specified in Schedule XIV to the Companies Act, 1956 is correct or it should be charged over a period of 30 years (i.e., the initial term of the lease).

C. Points considered by the Committee

  1. The Committee, while expressing its opinion, has considered only the issue raised in paragraph 7 above and has not touched upon any other issue arising from the Facts of the Case, such as, amortisation of the lease premium.
  2. The Committee notes the following paragraphs from Accounting Standard (AS) 6, ‘Depreciation Accounting’, issued by the Institute of Chartered Accountants of India:“5. Assessment of depreciation and the amount to be charged in respect thereof in an accounting period are usually based on the following three factors:

    (i) historical cost or other amount substituted for the historical cost of the depreciable asset when the
    asset has been revalued;

    (ii) expected useful life of the depreciable asset; and
    (iii) estimated residual value of the depreciable asset.”

    “7. The useful life of a depreciable asset is shorter than its physical life and is:
    (i) pre-determined by legal or contractual limits, such as the expiry dates of related leases;
    (ii) directly governed by extraction or consumption;
    (iii) dependent on the extent of use and physical deterioration on account of wear and tear which again
    depends on operational factors, such as, the number of shifts for which the asset is to be used,
    repair and maintenance policy of the enterprise etc.; and
    (iv) reduced by obsolescence arising from such factors
    (a) technological changes;
    (b) improvement in production methods;
    (c) change in market demand for the product or service output of the asset; or
    (d) legal or other restrictions.

    8. Determination of the useful life of a depreciable asset is a matter of estimation and is normally
    based on various factors including experience with similar types of assets. …”

    “13. The statute governing an enterprise may provide the basis for computation of the depreciation.
    For example, the Companies Act, 1956 lays down the rates of depreciation in respect of various
    assets. Where the management’s estimate of the useful life of an asset of the enterprise is shorter than
    that envisaged under the provisions of the relevant statute, the depreciation provision is appropriately
    computed by applying a higher rate. If the management’s estimate of the useful life of the asset is
    longer than that envisaged under the statute, depreciation rate lower than that envisaged by the
    statute can be applied only in accordance with requirements of the statute.”

  3. The Committee notes the management’s observations that it is a standard practice in case of leases
    made by Government that normally they are initially made for 30 years and thereafter they are
    renewed for a further period of 30 years. Having regard to the terms of the lease and the use of the
    leasehold land (i.e, office and staff colony), it seems that at the inception of the lease, the company
    intends to renew the lease for a further period of 30 years at the expiry of the initial period of 30
  4. The Committee notes that neither Schedule XIV to the Companies Act, 1956 (the ‘Act’) nor the
    main sections, viz., sections 205 and 350 of the Act state that the rates specified in Schedule XIV are
    applicable only to the assets constructed on freehold land.
    The Committee is of the view that the rates specified in Schedule XIV to the Act are equally
    applicable for assets constructed on leasehold land, subject to the considerations stated in paragraph
    12 below.
  5. From the above, the Committee is of the view that the management should estimate the useful
    lives of the relevant assets constructed on the leasehold land on the basis of considerations mentioned
    in paragraph 9 above. Thus, the useful life will be the expected period of the lease of the land,
    including the expected period of extension which is reasonably certain at the inception of the lease.
    The depreciation rate should be worked out on that basis. If the rate so worked out is lower than the
    rate specified in Schedule XIV to the Act, the rate specified in Schedule XIV to the Act should be
    adopted. A lower rate can be adopted only if permitted by the Central Government in accordance with
    the provisions of the Act.

D. Opinion

  1. On the basis of the above, the Committee is of the opinion that depreciation rate for buildings,
    etc., constructed on leasehold land should be determined in the manner stated in paragraph 12