H I

SHIVAJI UNIVERSITY, KOLHAPUR

CENTRE FOR DISTANCE EDUCATION

B. Com. Part-III

Advanced Accountancy
(Auditing & Taxation)

Semester-V : Paper-II (DSE-A2)

Semester-VI : Paper-IV (DSE-A4)

K (From Academic Year 2021-22 onwards)

J
Copyright © Registrar,
Shivaji University,
Kolhapur. (Maharashtra)
First Edition 2022

Prescribed for B. Com. Part-III

All rights reserved. No part of this work may be reproduced in any form by mimeography
or any other means without permission in writing from the Shivaji University, Kolhapur
(MS)

Copies : 500

Published by:
Dr. V. N. Shinde
Ag. Registrar,
Shivaji University,
Kolhapur-416 004.

Printed by :
Shri. B. P. Patil
Superintendent,
Shivaji University Press,
Kolhapur-416 004

ISBN- 978-93-92887-30-7

H Further information about the Centre for Distance Education & Shivaji University may be
obtained from the University Office at Vidyanagar, Kolhapur-416 004, India.

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 Centre for Distance Education
Shivaji University, Kolhapur
n ADVISORY COMMITTEE n

Prof. (Dr.) D. T. Shirke Prof. (Dr.) S. S. Mahajan

Honourable Vice Chancellor, I/c. Dean, Faculty of Commerce and
Shivaji University, Kolhapur Management, Shivaji University, Kolhapur

Prof. (Dr.) P. S. Patil Prin. (Dr.) Smt. M. V. Gulavani

Honourable Pro-Vice Chancellor, I/c. Dean, Faculty of Inter-disciplinary
Shivaji University, Kolhapur Studies, Shivaji University, Kolhapur

Prof. (Dr.) M. M. Salunkhe Prin. (Dr.) R. G. Kulkarni

Former Vice-Chancellor, I/c. Dean, Faculty of Humanities,
Yashwantrao Chavan Maharashtra Open Shivaji University, Kolhapur
University, Nashik.
Dr. V. N. Shinde
Prof. (Dr.) K. S. Rangappa Ag. Registrar,
Former Vice Chancellor, Shivaji University, Kolhapur
University of Mysore
Shri. G. R. Palase
Prof. P. Prakash I/c. Director, Board of Examinations and
Additional Secretary, Valuation, Shivaji University, Kolhapur
Distance Education Bureau,
University Grants Commission, New-Delhi. Shri. A. B. Chougule
I/c. Finance and Accounts Officer,
Prof. (Dr.) Cima Yeole Shivaji University, Kolhapur
Git Govind, Flat No. 2,
1139 Sykes Extension, Prof. (Dr.) D. K. More
Kolhapur-416001 (Member Secretary) Director,
Centre for Distance Education,
Prof. (Dr.) R. K. Kamat Shivaji University, Kolhapur.
I/c. Dean, Faculty of Science and
Technology, Shivaji University, Kolhapur

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 n B. O. S. MEMBERS OF ACCOUNTANCY n
Chairman- Prof. (Dr.) Shrikrishna S. Mahajan
I/c Dean & HOD
Department of Commerce & Management,
Shivaji University, Kolhapur

l Dr. V. A. Patil l Dr. Ashok Ramchandra Shinde

D. R. K. College of Commerce, Kolhapur Yashwantrao Chavan Arts and Commerce
College, Urun-Islampur, Dist. - Sangli
l Dr. A. D. Jadhav
Chh. Shahu Institute of Business Education l Prof. (Dr.) Muralidhar Ananda
& Research, (CSIBER), Kolhapur Lokhande,
Department of Commerce, Dr. Babasaheb
l Dr. J. G. Mulani Ambedkar Marathwada University,
Kai. Malati Vasantdada Patil Kanya Aurangabad-431004.
Mahavidyalaya, Islampur, Dist. Sangli
l Dr. Ramchandra Dadu Patil
l Dr. P. M. Herekar B. V. D. U. Institute of Management and
Devchand College, Arjunnagar, Entrepreneurship Department,
Dist. Kolhapur Navi Mumbai
l Dr. Smt. Madhuri Shinde l Dr. Kedar Vijay Marulkar
G. K. G. Kanya Mahavidyalaya, Jaysingpur,
Department of Commerce & Management,
Dist. Kolhapur
Shivaji University, Kolhapur-416004
l Dr. Gurunath Jotiba Fagare
l CA Dr. Aditya Arvind Sontakke
Smt. Gangabai Khivraj Ghodawat Kanya
Pillai HOC Institute of Management Studies
Mahavidyalaya, Jaysingpur, Dist. Kolhapur
and Research, Rasayani, Dist. Raigad.
l Dr. Vijay Annaso Mane
l Mustafa Inayathusen Lakadawala
Shri Venkatesh Mahavidyalaya, Ichalkaranji,
Plot No. 38/E, Shivadarshan Co-op.
Dist. Kolhapur
Housing Society, 1st Floor, Flat No. B-10,
Nagala Park Kolhapur-416003.

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 Preface
We assure that this SIM will be helpful to the students of B. Com. III on distance
mode, for their academic endevour. In the entire gamut of accountancy, the elements
like audit and taxation are of prime importance. The present study material introduces
the basic concepts as well as some practical applications of audit and taxation to the
students. The first section (Sem. V) starts with basic concepts, nature and scope of
audit through unit 1. The 2nd unit describes audit of specific items in financial statements.
This provides practical approach of audit. Unit 3 describes the provisions of company
audit. 4th unit explains various types of reports and also includes special audit. The
second section (Sem. VI) is devoted to taxation. In 1st unit of 2nd section, basic
concepts and definitions about income tax have been elaborated. The second unit
focusses on provisions of the Income Tax Act, 1961 about exemptions and deductions.
The third unit elaborates various heads of income and also illustrates computation of
total income and tax liability. This units gives practical approach towards computation
of income and tax liability. The fourth units briefly introduces the GST (Goods and
Service Tax) to the students.

In this books we the unit writers and editorial board have taken reasonable care
to give maximum theoretical and practical knowledge to the students. Hope it will
enable the students to get the adequate knowledge.

We are thankful to Hon. Vice-Chancellor Prof. Dr. D. T. Shirke, Hon. Pro-Vice-

Chancellor Prof. P. S. Patil, Director Dr. D. K. More all the members of the Board of
Studies, unit writers and the authorities of Centre for Distance and Online Education,
Shivaji University, Kolhapur for the support.

n Editors n

Dr. K. V. Marulkar Prof. Dr. S. S. Mahajan

Department of Commerce Department of Commerce
and Management, and Management,
Shivaji University, Kolhapur Shivaji University, Kolhapur

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Centre for Distance Education Advanced Accountancy
Shivaji University, Paper II and IV : B. Com. III
Kolhapur.
Writing Team

Unit No. Unit No.

Author's Sem. V Sem. VI

Dr. S. S. Mahajan 1 -
Department of Commerce and Management,
Shivaji University, Kolhapur

Dr. N. L. Kadam 2 -
Jaysingpur College, Jaysingpur

Dr. K. V. Marulkar 3 -
Department of Commerce and Management,
Shivaji University, Kolhapur

Shri. S. V. Bacche 4 -
Mahavir College, Kolhapur

Dr. A. G. Suryavanshi - 1
The New College, Kolhapur

Dr. P. V. Mohite - 2
Arts & Commerce College, Ashta

Smt. Chandrabhaga Patil - 3

Chh. Shahaji Mahavidyalaya, Kolhapur

Dr. Aditya Sontakke - 4

Panvel, Mumbai

n Editors n

Dr. K. V. Marulkar Prof. Dr. S. S. Mahajan

Department of Commerce Department of Commerce
and Management, and Management,
Shivaji University, Kolhapur Shivaji University, Kolhapur

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 B. Com Part-III
Semester V and VI
ADVANCED ACCOUNTANCY PAPER II AND IV

INDEX

Unit Page
Topic
No. No.

Semester-V

1 Nature and Scope of Audit 1

2 Audit of Specific Items in Financial Statements 28

3 Company Audit 77

4 Special Audit and Audit Report 99

Semester-VI

1 Basic Concepts 121

2 Exemptions and Deductions from total income 158

3 Heads of Income, Computation of total income and tax liability 171

4 Basics of GST 324

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Each Unit begins with the section 'Objectives' -

Objectives are directive and indicative of :

1. What has been presented in the Unit and

2. What is expected from you

3. What you are expected to know pertaining to the specific

Unit once you have completed working on the Unit.

The self check exercises with possible answers will help you to
understand the Unit in the right perspective. Go through the possible
answer only after you write your answers. These exercises are not
to be submitted to us for evaluation. These are provided to you as
Study Tools to help keep you in the right track as you study the
Unit.

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 Unit-1
Nature and Scope of Audit

Structure of Unit
1.0 Objectives
1.1 Introduction
1.2 Presentation of Subject Matter
1.2.1 Meaning of Audit
1.2.2 Nature and Scope of Audit
1.2.3 Objectives of Audit
1.2.4 Relationship of Audit with other disciplines
1.2.5 Difference between Audit and Investigation
1.2.6 Basic Principles of Governing Audit (AAS-1)
1.2.7 Statutory Audit
1.2.8 Internal Audit
1.2.9 Cost Audit
1.2.10 Tax Audit
1.2.11 Management Audit
1.2.12 Concept of Vouching
1.2.13 Verification and Valuation
1.3 Summary
1.4 Terms to Remember
1.5 Answers to Check your progress
1.6 Exercise
1.7 Reference for further study

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1.0 Objectives:
1. To understand the basic concept of audit and its nature and scope.
2. To distinguish between audit and investigation.
3. To understand the basic principles of governing audit (AAS-1).
4. To explain the concepts related to audit such as statutory audit, internal audit,
cost audit, tax audit, management audit, concept of vouching, verification and
valuation.

1.1 Introduction:
When the size of organization increases, the owner and other stakeholders may
not aware of the true and fair view of their business. So, the financial statements
represents all accounts of the organization should have true and fair view. To
understand this matter, any such organization want to appoint the auditor to examine
whether their financial statements reveals true and fair view. Audit in the present
form came into existence after the Industrial Revolution during the 18th century
when age of large scale production commenced. The organization of business was
limited to sole proprietor activities, however, after the Industrial Revolution, due to
large scale production, scope of business organization enhanced and many
stakeholders involved especially investors. Such stakeholders are interested to know
what happen with their resources involved in the specific business organization,
hence, audit become important. In new forms of organization like a company, owners
(shareholders) and management (board of directors and managers) are different.
Here, the management who is handling capital and accounts of a company. It is not
possible to every shareholder to check the accounts of the company. So they appoint
a person, on their behalf, who will check the accounts, here is a need of auditor and
auditing by him. Luca Pacialo who first published his treatise on double entry system
of book-keeping for first time in 1494, he described the duties and responsibilities of
an auditor.
1.2.1 Meaning of Audit:
At the beginning, let us see the meaning of audit. The word "audit" is derived
from the Latin word "audire" which means "to hear". As the changes took place in
duties and responsibilities of auditor, the change in the meaning of audit came and
hence, various definitions of audit are given by distinct authors, thinkers and
organizations which we are going to see in this section.
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 According to Spicer and Pegler, an audit is 'such an examination of the books,
accounts and vouchers of a business, as will enable the auditor to satisfy himself that
the Balance Sheet is properly drawn up, so as give a true and fair view of the state of
affairs of the business, and whether the Profit and Loss Account gives a true and fair
view of the profit earned or loss suffered for the financial period, according to the
best of his information and the explanations given to him and as shown by books,
and if not, in what respects he is not satisfied."
L. R. Dicksee has defined an audit in the words "An audit is an examination of
accounting records undertaken with a view to establish whether they correctly and
completely reflect the transactions to which they puport to relate. In some instance it
may be necessary to ascertain whether the transactions are supported by proper
authority."
As per the opinion of F. R. M. de Paula, the term "Audit denotes something
much wider, namely, the examination of a balance sheet and profit and loss account
prepared by others. As a result of his examination of the books, accounts, vouchers
etc. and of his inquiries, the auditor must satisfy himself that such balance sheet and
profit and loss account are properly drawn up so as to exhibit true and fair view of
the state of affairs and of the earnings of a particular concern."
The Institute of Chartered Accountants of India has said about auditing that "It
is a systematic and independent examination of data, statements, records, operations
and performances (financial or otherwise) of an enterprise for a stated purpose. In
any auditing situation, the auditor perceives and recognizes the propositions before
him for examination, collects evidence, evaluates the same and on this basis
formulates his judgment which is communicated through his audit report."
According to Montegomery, "Auditing is a systematic examination of books and
records of a business or other organization, in order to ascertain or verify, and to
report upon, the facts regarding its financial operations and results thereof."
J. R. Batliboi has defined auditing as "an intelligent and a critical scrutiny of the
books of account of a business with the documents and vouchers from which they are
written up, for the purpose of ascertaining whether the working results for a
particular period, as shown by the Profit and Loss Account, as also the exact
financial condition of that business, as reflected in the balance sheet are truely
determined and presented by those responsible for their compilation."
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 On the basis of analysis of all the definitions of auditing we can come to the
conclusion that the auditing has the following characteristics:
1. It is a systematic and independent examination of financial data
2. It ensures the correctness of Trading, Profit and Loss Account and Balance
Sheet which makes a verification of true and fair view presented in financial
statements.
3. An examination of books of accounts with motive is to detect errors and frauds
in the books of accounts and financial statement.
4. An intelligent and a critical scrutiny of the books of account.
5. Through process of audit, an auditor collect the evidences, vouchers for
transactions.
6. Auditor express an opinion on the quality of financial statements after ensuring
the compliance of financial statements with the accounting standards.
7. Auditing concludes with audit report.
We can conclude on the basis of above definitions and characteristics of
auditing that the audit means a critical and intelligent examination of facts-financial
or otherwise, to give in the form of certificate or report an attestation, an expert
opinion or an expert advice.
1.2.2 Nature of Audit:
Auditing is the examination of books, accounts and vouchers of the business.
This examination means to watch, to observe, to study, to think about it, to compare,
to analyze and so on.
1. It is examination of books. Then questions comes which books. Here, books of
accounts i.e. both primary books and secondary books. In the present days these
books include loose leaf, bound books as well as digital books.
2. An examination of accounts is also a part of auditing. Auditing includes
examination of all types of accounts i.e. personal accounts and impersonal (real
and nominal) accounts.
3. Auditing includes an examination of vouchers for cash transactions and trading
(or credit) transactions. Such vouchers are considered as a documentary
evidence which supports an entry recorded into all books.

4
4. True and fair view is confirmed by an audit. The financial statements which are
presented they have true and fair view is required to be satisfied.
5. Profit or Loss must be pertaining to the concerned accounting period. For this
purpose, the compliance of specific accounting principles and accounting
standards is needed.
6. Auditors’ satisfaction depends upon few things such as information whichever
required, explanations regarding transactions and availing books for auditing.
7. Manual accounting is done the auditing is also on the same way. Now
accounting is made through digital tools, similarly auditing is consequently
becoming digital gradually.
1.2.3 Scope of Audit:
The scope of audit is determined by the auditor having regard to following: (a)
Terms of the Audit Engagement, (b) Requirement of Relevant Statute and (c)
Pronouncements of the ICAI. However, the terms of engagement cannot supersede
the requirements of statute or pronouncements of ICAI.
According to ICAI, the following points are merit considerations as far as scope
of audit is concerned:
1. Audit should cover the examination of all aspects of an entity relevant to
financial statements being audited.
2. To form an opinion on the financial statements, the auditor should be reasonably
satisfied as to whether the information contained in the underlying accounting
records and other source data is reliable and sufficient as the basis for the
preparation of the financial statements.
3. In forming his opinion, the auditor should also decide whether the relevant
information is properly disclosed in the financial statements subject to statutory
requirements, where applicable.
4. The auditor assesses the reliability and sufficiency of the information contained
in the underlying accounting records and other source data by:
(a) making a study and evaluation of accounting systems and internal controls
and

5
 (b) carrying out such other tests, enquires and other verification procedures of
accounting transactions and account balances as he considers appropriate in
the particular circumstances.
5. The auditor determines whether the relevant information is properly disclosed in
the financial statements by:
(a) comparing the financial statements with the underlying accounting records
and other source data to see whether they properly summarize the
transactions and events recorded therein; and
(b) considering the judgments that management has made in preparing the
financial statements accordingly, the auditor assess the selection and
consistent application of accounting policies, the manner in which the
information has been classified, and the adequacy of disclosure.
6. The auditor is not expected to perform duties which fall outside the scope of his
competence. For example, the professional skill required of an auditor does not
include that of a technical expert for determining physical condition of certain
assets.
7. Constraints on the scope of the audit of financial statements that imair the
auditor's ability to express an unqualified opinion on such financial statement
should be set out in his report, and a qualified opinion or disclaimer of opinion
should be expressed as appropriate.
1.2.4 Objectives of Auditing:
As per SA 200 "Overall Objectives of the Independent Auditor", in conducting
an audit of financial statements, the overall objectives of the auditor are:
(a) To obtain reasonable assurance about whether the financial statements as a
whole are free from material misstatement; and
(b) To report on the financial statements, and communicate as required by the SAs,
in accordance with the auditor's findings.
1.2.5 Relationship of Audit with other disciplines:
As business works in its environment, the accountant and auditor should take
into account all areas in business environment. Auditing is nothing but examination
of all books, accounts and financial statements in respect of true and fair view of
financial condition. Here, we can see the relationship of audit with other disciplines
6
such as accounting, economics, law, mathematics and statistics, financial
management, computer information system and behavioural science.
1. Accounting:
Auditor has to examine all books, accounts and vouchers so he must know about
accounting rules, accounting principles and accounting standards also. He should be
aware of the accounting them to evaluate financial statements with considering their
compliances.
Figure-1.1 Relationship of Audit with other disciplines

ACCOUNTING

MATHEMATICS
&
BEHAVIOURAL STATISTICS
SCIENCE

AUDITING
ECONOMICS
FINANCIAL
MANAGEMENT

COMPUTER
LAW
INFORMATION
SYSTEM

2. Economics:
While examining books of accounts, auditor requires knowledge regarding
business and economic environment which has impact on their clients. Auditor
should take into account the issues which affect on the process of auditing.
3. Mathematics and Statistics:
Auditor handles always financial data and examines and verifies the amount that
is shown in financial statements. The measurement is one of the important functions
of accounting; hence, it requires knowledge of calculation procedure involved in
7
computing various items. Auditor should have knowledge of statistical sampling for
making meaningful conclusion.
4. Law
Legal environment always influences accounting and auditing framework. Audit
of a business concern should in compliance with provisions of a law. Therefore, an
auditor should have sound knowledge of laws to understand how the respective client
affects. How the client is benefited or loosing
5. Computer Information System
Now accounting is maintained with computer softwares, hence, the record is in
the form of information system. Auditor should be able to conduct audit in an
effective way by computer systems. The digitization of accounting significantly leads
to the digitization of auditing also.
6. Financial Management
Financial management is important area of management. Auditor should have
knowledge of financial tools and techniques for understanding and evaluating the
financial statements in a better way.
7. Behavioural Science
Auditor has to deal with many people for conducting the audit efficiently. He
has to understand and study the behaviour of the people and then he can handle the
situations.
1.2.6 Basic Principles of Governing Audit (AAS-1):
This Auditing and Assurance Standard was the first standard on auditing issued
by the Institute. This Standard describes the basic principles which govern the
auditor’s professional responsibilities and which should be complied with whenever
an audit is carried out. An audit is the independent examination of financial
information of any entity, whether profit oriented or not, and irrespective of its size
or legal form, when such an examination is conducted with a view to expressing an
opinion thereon. Other Auditing and Assurance Standards to be issued by the
Institute (taken in other unit) will elaborate on the principles set out herein to give
guidance on auditing procedures and reporting practices. Compliance with the basic
principles requires the application of auditing procedures and reporting practices
appropriate to the particular circumstances.

8
 These principles are, namely, integrity, objectivity and independence,
confidentiality, skills and competence, work performed by others, documentation,
planning, audit evidence, accounting system and internal control, and, finally, audit
conclusions and reporting.
1. Integrity, Objectivity and Independence:
The auditor should be straightforward, honest and sincere in his approach to his
professional work. He must be fair and must not allow prejudice or bias to override
his objectivity. He should maintain an impartial attitude and both be and appear to be
free of any interest which might be regarded, whatever its actual effect, as being
incompatible with integrity and objectivity.
2. Confidentiality:
The auditor should respect the confidentiality of information acquired in the
course of his work and should not disclose any such information to a third party
without specific authority or unless there is a legal or professional duty to disclose.
3. Skills and Competence:
The audit should be performed and the report should be prepared with due
professional care by persons who have adequate training, experience and competence
in auditing. The auditor requires specialized skills and competence which are
acquired through a combination of general education, technical knowledge obtained
through study and formal courses concluded by a qualifying examination recognized
for this purpose and practical experience under proper supervision. In addition, the
auditor requires a continuing awareness of developments including pronouncements
of ICAI on accounting and auditing matters, and relevant regulations and statutory
requirements.
4. Work Performed by Others:
When the auditor delegates work to assistants or uses work performed by other
auditors and experts, he will continue to be responsible for forming and expressing
his opinion on the financial information. However, he will be entitled to rely on work
performed by others, provided he exercises adequate skill and care and is not aware
of any reason to believe that he should not have so relied. In the case of any
independent statutory appointment to perform the work on which the auditor has to
rely in forming his opinion, such as in the case of the work of branch auditors
appointed under the Companies Act, 1956, the auditor’s report should expressly state

9
the fact of such reliance. The auditor should carefully direct, supervise and review
work delegated to assistants. The auditor should obtain reasonable assurance that
work performed by other auditors or experts is adequate for his purpose.
5. Documentation:
The auditor should document matters which are important in providing evidence
that the audit was carried out in accordance with the basic principles.
6. Planning:
The auditor should plan his work to enable him to conduct an effective audit in
an efficient and timely manner. Plans should be based on a knowledge of the client’s
business. Plans should be made to cover, among other things:
(a) acquiring knowledge of the client’s accounting system, policies and internal
control procedures;
(b) establishing the expected degree of reliance to be placed on internal control;
(c) determining and programming the nature, timing, and extent of the audit
procedures to be performed; and
(d) coordinating the work to be performed.
Plans should be further developed and revised as necessary during the course of
the audit.
7. Audit Evidence:
The auditor should obtain sufficient appropriate audit evidence through the
performance of compliance and substantive procedures to enable him to draw
reasonable conclusions there from on which to base his opinion on the financial
information. Compliance procedures are tests designed to obtain reasonable
assurance that those internal controls on which audit reliance is to be placed are in
effect. Substantive procedures are designed to obtain evidence as to the
completeness, accuracy and validity of the data produced by the accounting system.
They are of two types:
a) tests of details of transactions and balances;
b) analysis of significant ratios and trends including the resulting enquiry of
unusual fluctuations and items.

10
8. Accounting System and Internal Control:
Management is responsible for maintaining an adequate accounting system
incorporating various internal controls to the extent appropriate to the size and nature
of the business. The auditor should reasonably assure himself that the accounting
system is adequate and that all the accounting information which should be recorded
has in fact been recorded. Internal controls normally contribute to such assurance.
The auditor should gain an understanding of the accounting system and related
internal controls and should study and evaluate the operation of those internal
controls upon which he wishes to rely in determining the nature, timing and extent of
other audit procedures. Where the auditor concludes that he can rely on certain
internal controls, his substantive procedures would normally be less extensive than
would otherwise be required and may also differ as to their nature and timing.
9. Audit Conclusions and Reporting
The auditor should review and assess the conclusions drawn from the audit
evidence obtained and from his knowledge of business of the entity as the basis for
the expression of his opinion on the financial information. This review and
assessment involves forming an overall conclusion as to whether:
(a) the financial information has been prepared using acceptable accounting
policies, which have been consistently applied;
(b) the financial information complies with relevant regulations and statutory
requirements;
(c) there is adequate disclosure of all material matters relevant to the proper
presentation of the financial information, subject to statutory requirements,
where applicable.
The audit report should contain a clear written expression of opinion on the
financial information and if the form or content of the report is laid down in or
prescribed under any agreement or statute or regulation, the audit report should
comply with such requirements. An unqualified opinion indicates the auditor’s
satisfaction in all material respects with the matters dealt with in paragraph 21 or as
may be laid down or prescribed under the relevant agreement or statute or regulation,
as the case may be.

11
 When a qualified opinion, adverse opinion or a disclaimer of opinion is to be
given or reservation of opinion on any matter is to be made, the audit report should
state the reasons therefor.
(Effective Date: This Auditing and Assurance Standard becomes operative for
all audits relating to accounting periods beginning on or after April 1, 1985).
Check Your Progress-1
(A) Choose the appropriate alternative from given alternatives below the statement:
1) Principle of Independence is the elementary principle of auditing which
refers to the following ...........
(a) The work of auditing should be based on the related evidences and
should be done in an unbiased manner.
(b) Auditor should examine material transactions as well as probable
frauds and errors in much greater depth.
(c) The work of auditing should be separate and independent from work of
accounting. Accounts should be examined in an independent and
unbiased manner, in the audit.
(d) Client should provide the auditor with all available records, evidences
and explanations. The auditor should also declare the result of his
examination in clear and unambiguous manner.
2) The scope of audit is determined by the auditor having no regard to which
following point?:
(a) Relation with client
(b) Terms of the Audit Engagement,
(c) Requirement of Relevant Statute and
(d) Pronouncements of the ICAI.
(B) State whether the following statement is true or false:
1) Audit is not an intelligent and a critical scrutiny of the books of account, it
is simple verification of transactions.
2) Audit should cover the examination of all aspects of an entity relevant to
financial statements being audited.

12
 3) The auditor should determine whether relevant information is disclosed in
financial statements.
1.2.7 Difference between Audit and Investigation:
Sometime students have impression that auditing and investigation are one and
the same. There is lot of difference between them. Now we will try to understand
what is the difference between audit an investigation.
Sr. Audit Investigation
No.
1 Audit is a systematic and Investigation is a process of searching
independent examination of data, enquiry into the profit-earning
statements, records, operations and capacity or the financial position of a
performances (financial or concern or to find out the extent of
otherwise) of an enterprise for a the fraud if there is any suspicion
stated purpose. about it and so on.
2 Audit is conducted on behalf of Investigation is carried out on behalf
owners i.e. shareholders or of outsiders. Such outsiders may be
proprietor etc. potential buyer of the business or
banker or money lenders to know the
earning capacity or the financial
position of the firm. Sometime on
behalf of owner also it can be carried
out when they suspect any fraud.
Sometime it is carried out by the
Government in the interest of
shareholders or at the instance of the
court.
3 According to Companies law, audit Investigation is not compulsory.
is compulsory.
4. It once audit is done, accounts are Investigation may be conducted even
not again audited. The exception is though accounts are already audited.
only of special audit.
5. The audit of accounts is done for a Investigation may cover a period of

13
 year or six months. over three to seven years.
6. The accounts are audited with a Investigation is conducted with a
view to ascertaining whether or not particular object in view for e.g.- to
the Profit and Loss Account and know the financial position of the
Balance sheet are drawn up as per concern or its earning capacity etc.
law and they exhibit a true and fair
view of the state of affairs of a
business.
7. Audit is a kind of test checking. Investigation is a thorough
examination of the books of accounts
for a particular year or a number of
years.
8. Audit includes an examination of Investigation is not only an
the books of accounts of a business. examination of accounts but it is also
an inquiry into other factors affecting
the business such as the extent of
fraud, who committed it or the causes
of the fall in the profits.
9. The report of auditor is sent to the The report of the investigator is sent
managing director/chairman of the to the party which has appointed him.
company who put it before the
shareholders.
10. The report of the auditor is The report of the investigator is in
stereotyped except when he detail and refers to (a) the instructions
mentions the points on which he is given to him, (b) the method of
not satisfied with regard to the approach, (c) the work carried out,
accounts of the client. (d) the documents relied upon, and
(e) his findings and often his
recommendations to the client.
11. The auditor is concerned with The investigator is not concerned
accounting policies adopted by the with accounting policies followed by
concern and he states the fact about the firm.
it.

14
1.2.8 Statutory Audit:
When the audit is conducted under the statute, it is called statutory audit. The
internal audit is helpful to the statutory audit. Both the internal auditor and the
statutory auditor are interested to check an authenticity of the accounts. The internal
auditor reviews the operations and performs such functions as evaluation,
compliance, verification and ensures that policies, procedures, rules and other type of
controls of the business are carried out efficiently. The statutory auditor accepts some
of the detailed checking made by the internal auditor. However, the area of
cooperation between internal auditor and statutory auditor is somewhat limited as the
statutory auditor has a responsibility under law to various authorities, while the
internal auditor is responsible only to the management.
The statutory auditor has to carry out his duties in accordance with standard
accounting and auditing practices and provisions of law which govern the
organization. Before accepting the assignment of checking of accounts and other
documents carried out by internal auditor, the statutory auditor must undertake such
test checks necessary to find out the effectiveness of internal audit. Statutory audit is
an independent audit made by an auditor as per the provisions of statute or laws. It is
compulsory by law. The statutory auditor is appointed by shareholders. Statutory
auditor should have specific qualification like Chartered Accountant as stipulated by
various laws. He has to report whether the balance sheet and the profit and loss
account of a company have been drawn up in conformity with law and whether they
show true and fair view of the state of affairs of the company. The statutory auditor
has identical duty of detecting errors and frauds, if any. He conducts audit on
applying test checks, however, internal auditor has to check all the transactions.
Statutory audit is carried out for the satisfaction of shareholders. Statutory auditor
has right to attend a meeting of shareholders. He is periodic, usually for a year.
Elements of Statutory Audit:
1. Statutory audit is obligatory in case of business houses incorporated under the
Companies Act and other acts.
2. Statutory audit can be carried out only by those who are qualified for
appointment as per the provision of the Companies Act and other acts.

15
3. The rights, duties, responsibilities and liabilities of auditors are governed by the
provisions of law.
4. The auditor is independent of management.
5. The statutory auditor is concerned with the legality and validity of the
transactions of business. His audit work is based on the financial statement
prepared by the business.
1.2.9 Internal Audit:
Internal audit is a critical examination of functioning of various operations of
the firm including its internal check. By internal audit process, the firm wants to test
accuracy, completeness, reliability and timeliness of accounting information and to
report for remedial actions.
It is defined that “Internal audit is the independent appraisal of activity within an
organization for the review of accounting, financial and other business practices as a
protective and constructive arm of management. It is a type of control which
functions by measuring and evaluating the effectiveness of other types of control.”
According to Howard F. Stettler, “Internal auditing is an independent appraisal
activity within an organisation for the review of operations as a service to
management.”
Walter B. Meigs says “... internal auditing consists of continuous, critical review
of financial and operating activities by a staff of auditors functioning as full-time
salaried employees.”
1.2.10 Cost Audit:
Cost audit is not popular in India. For time being a few selected industries
follow cost audit.
R. W. Dobson defines “Cost audit is the verification of the correctness of cost
accounts and of the adherence to the cost accountancy plan’. CIMA has defined cost
audit as “the verification of the correctness of cost accounts had of the adherence to
the cost accounting plan.” Cost auditor plays a role of an advisor in this respect. Cost
auditor has to form a judgment as to whether the size and channels of expenditure are
fit to yield best results and optimum returns from expenditure are expected. Section
233 B of the companies Act deals with cost audit. This section empowers central
Government to order the audit of cost accounts in respect of such companies.

16
The following are the purposes of cost audit:
1. To verify the arithmetical accuracy of cost accountancy entries in the books of
accounts
2. To find out whether the cost accounts have been properly maintained according
to the principles of costing employed in the industry concerned
3. To verify the cost statements are properly drawn up as per the records and that
they represent a true and fair view of the cost of production and marketing.
4. To assist the organization and government in fixation of proper prices.
5. To ensure that information presents to the management is reliable.
6. To assist the government in calculating taxes and taking decision regarding
grant of tariff protection to a specific industry.
7. To help in defecting inefficiencies that a rise in the utilisation of scarce
resources.
8. To make sure that cost accounting records are correct and cost accounting
principles have been property followed.
Cost auditor prepare the programme of cost audit in the light of requirements
such as (a) disclosure requirements under cost audit (report) rules, (b) manufacturing
process, (c) product/ range specifications, (d) cost accounting system, (e) marketing/
distribution channels, (f) internal control system, and (g) knowledge about company/
organizational structure.
A details cost audit programme also includes (a) review of entire cost
accounting system, (b) arithmetical accuracy of cost records, and (c) evaluation of
operational efficiency etc.
1.2.11 Tax Audit:
Tax audit means the audit applicable under Section 44AB of Income Tax Act.
Tax audit is applicable to the concerns whose turnover during the financial year
crosses Rs. 1 crore (in case of trading/ manufacturing) or Rs. 60 Lakh (in case of
professional). The tax audit report is to be given by an accountant as defined in the
Income Tax Act. Accountant means Chartered Accountant within the meaning of the
Chartered Accountants Act. The tax auditor has to submit (a) tax audit report and (b)

17
statement of particulars. These forms are given in Rule 6G of Income Tax Rules such
as Form No. 3CA, 3CB, 3CC, 3CD.
1.2.12 Management Audit:
The statutory auditor does not go into detail to see whether the policies laid
down by the management are properly carried out or not: whether any improvement
for maximizing profit or to eliminate waste is done; and whether decentralization or
centralization has been done. Internal audit is different than statutory audit. The
management audit is nothing but expansion of internal audit. Management is an
independent appraisal for taking the review of control of managerial functions in
order to ensure compliance with the organizational goals, policies and procedures.
According to William P. Leonard, Management Audit is “a comprehensive and
constructive examination of an organizational structure of a company, institution or
branch of government, or of any component thereof, such as a division or
department, and its plans and objectives, it means of operations, and its use of human
and physical facilities.”
Leslie R. Howard defines Management Audit as “Management audit is an
investigation of a business from the higher level downward in order to ascertain
whether sound management prevails throughout, thus facilitating the most effective
relationship with the outside world and the most efficient organization and smooth
running of internal organization.”
Taylor and Perry defines it as “Management Auditing is a method to evaluate
the efficiency of management at all levels throughout the organization, or more
specifically, it comprises the investigation of a business by an independent body
from the highest executive level downwards, in order to ascertain whether sound
management prevails throughout, and to report as to its efficiency or otherwise, with
recommendations to ensure its effectiveness where such is not the case”.
With considering all above definitions, we can say management audit is an
examination, review and appraisal of the various policies and actions of the
management. The statutory auditor examines the historical records of the past
performance while the management auditor appraises and reviews of the past as well
as looks to the future. Management auditor reports the performance of the
management during the particular period and suggests ways and means to achieve
the objectives in future, if they have not already been reached.

18
The various areas (Prasad, 1981) covered by management audit are as given below:
“1. Marketing Function
(a) Market survey, sales forecast, and sales and distribution policy.
(b) Sales planning, based on market research or survey, keeping in view
production policy and capacity.
(c) Policy for sales promotion or advertising.
(d) Product pricing policy, discount and credit policy.
(e) Organization of various channels of sales and distribution.
2. Production Management
(a) Production planning and its co-ordination with production.
(b) Utilization of capacity, best use for idle or surplus capacity.
(c) Organization for tools, maintenance, and repairs.
(d) Specifications and standards for materials and operative time, machine as
well as manual. Improvement of production methods and development,
designing and testing of new products and production methods.
(e) Research.
(f) Value analysis.
(g) Job evaluation.
(h) Cost reduction.
3. Inventory control
(a) Purchase organization and procedure, operating of provisioning drill, e.g.
determination of order levels, safely balance and optimum order size.
(b) Storage procedure, cost of inventory carrying and inventory turnover.
(c) Issue routine.
(d) Slow moving and obsolete items, inventory turnover.
(e) Valuation of stock and work-in-progress.

19
4. Personnel administration (now Human resource management)
(a) Procedure for recruitment, promotion, transfer, and training, time and costs-
personnel shortages, oversupplies, layoffs, overtime etc.
(b) Absenteeism and sickness, recruitment times and costs, action taken to
reduce them.
(c) Methods for wage payment and incentives, wage and salary administration.
(d) Labour turnover: methods adopted to analyze and action taken to reduce
rate of labour turnover.
(e) Accidents: preventive measures for safety.
(f) Welfare measures.
(g) Productivity of labour, performance norms
(h) Discipline and morale, union-management co-operation, collective
bargaining, participative involvement etc.
5. Financial Control
(a) Setting and operation of budgetary system of control: report of variances.
(b) Internal audit including cost audit.
(c) Financial reports and financial ratios: rendering analysis and interpretation.
(d) Scrutiny of financial proposals: investment plans and project decisions
(e) Delegation of financial powers.
6. General
(a) Delegation of authority.
(b) Flow of information and
(c) Levels of decision making.”
Check your progress-2:
(A) Choose the appropriate alternative from given alternatives below the statement:
1) As compared to audit, investigation is carried out .....................
(a) on behalf of owners
(b) on behalf of outsiders
20
 (c) to send report to the chairman
(d) to examination of accounts, books etc.
2) ...................is a comprehensive and constructive examination of an
organizational structure of a company, institution or branch of government,
or of any component thereof, such as a division or department, and its plans
and objectives, it means of operations, and its use of human and physical
facilities.
(a) Internal audit
(b) Statutory audit
(c) Management audit
(d) Cost audit
(B) State whether the following statement is true or false:
1) Investigation is compulsory.
2) Audit is a kind of test checking.
3) The audit which is done by employees continuously is called statutory
audit.
1.2.12 Vouching:
A voucher is documentary evidence in support of a transaction recorded in the
books of accounts. The process of establishing the accuracy and authenticity of
entries in the books of accounts is called vouching.
Ronald A. Irish defines vouching as “a technical term, which refers to the
inspection by the auditor of documentary evidence supporting and substantiating a
transaction.”
According to Taylor and Perry, “vouching is an examination of the evidence
offered in substantiation of the entries in the books, including such examination the
proof, so far as possible, that no entries have been omitted from the books.”
F. R. M. de Paula opined that “vouching does not mean merely the inspection of
receipts with the cash book, but includes the examination of receipts with the
transactions of the business, together with documentary and other evidence of
sufficient validity to satisfy an auditor that such transactions are in order, have been
properly authorized and are correctly recorded in the books.”
21
On the basis of above definitions we can say that following are the primary objects of
vouching:
(a) Vouching authenticates the correctness of transactions
(b) It examines the entries in the books with receipts, invoices, bills, agreements and
copies of correspondence, true extracts of minute books, opinion of experts.
(c) It authenticates the transactions.
In addition to the above objects, some other objects of vouching are there which can
be seen as follows:
1) Vouching confirms the transaction represented by the voucher pertains to the
accounting period.
2) Confirmation of purchases and sales disclosed by the vouchers with client’s
actual normal business.
3) Testing arithmetical accuracy of all vouchers and records accordingly.
4) Proper distinction between capital and revenue items.
Vouching is main part of auditing. It is nothing but backbone of auditing. The auditor
has to do vouching with proper care and intelligence. Following should be the
protocol for vouching for any auditor:
1) Deciding in advance what is to be proved.
2) Concluding that the fact to be proved is material.
3) Collecting evidence within the prescribed time limit.
4) Deciding that evidence collected is valid or invalid.
5) Drafting audit report based on the facts.
1.2.13 Verification and Valuation:
In the process of audit, auditor should make verification and valuation of assets
and liabilities. Verification means ‘providing the truth’ or ‘confirmation’. First of all
we will try to understand the meaning of verification by the following definitions.

22
 Irish says “verification means the auditor must satisfy himself by physical
inspection or by suitable documentary evidence that the asset exist, that they are
owned by the client, that all assets are recorded, that they are properly valued
according to accepted accounting principles, and that they are in the custody of a
proper party.”
According to Spicer and Pegler, “the verification of assets implies an inquiry
into the value, ownership and title, existence and possessions, and the presence of
any charge on the assets.”
Alverstone C. J. said “It is the duty of the auditor to verify the existence of
assets stated in the balance sheet and he will be liable for any damage suffered by the
client if he fails in his duty...”
The verification of assets involves the issues such as (a) comparison of the
ledger accounts with the balance sheet, (b) verifying existence of asset on the date of
balance sheet, (c) satisfying that they are free from any charge or mortgage, (d)
verifying their proper value and (e) assets are acquired for the business.
The true and fair view of financial statements depends upon the value of assets
and liabilities shown in the balance sheet. The accuracy of the balance sheet and
estimated profits of a firm depends upon the correct valuation of the assets and
liabilities. Such valuation is made by mostly the proprietors or officials of the firm.
The auditor generally rely upon the certificates given by competent persons such as
valuers, surveyors etc. He should write so in his audit report. Off course, he cannot
guarantee the correctness of the valuation of assets. The compliance of provisions in
accounting standards should be taken into consideration by an auditor for the purpose
of valuation of assets.

1.3 Summary:
Audit is a systematic and independent examination of data, statements, records,
operations and performances of an enterprise for a stated purpose. The auditor
perceives and recognizes the propositions before him for examination, collects
evidence, evaluates the same and on this basis formulates his judgment which is
communicated through his audit report. The elementary principles of auditing are: (a)
Principle of Independence, (b) Principle of Objectivity, (c) Principle of full
disclosure and (d) Principle of Materiality. There are some other principles of
auditing such as Integrity, Confidentiality, Skill and Competence, reliance on work
performed by others and documentation.
23
 The objectives of auditing are (1) to obtain reasonable assurance about whether
the financial statements as a whole are free from material misstatement and (2) To
report on the financial statements, and communicate as required by the SAs, in
accordance with the auditor's findings. Independence implies acting without any fear
or favour. Unless and until the independence of auditor is maintained properly,
auditor cannot perform his duties rightly.
The scope of audit has been described in this unit. One of the important concepts
used in accounting and auditing is 'true and fair view'. This unit has highlighted this
concept in lucid manner. Auditing and Assurance Standard-1 is entitled as "Basic
Principles of Governing Audit" which describes the basic principles which govern
the auditor’s professional responsibilities and which should be complied with
whenever an audit is carried out.
As far as the difference between audit and investigation is concerned, a lot of
difference is there which we have observed in the last part of this unit. If simply we
see meaning of these two concepts, we can refer the difference between them. Audit
is a systematic and independent examination of data, statements, records, operations
and performances (financial or otherwise) of an enterprise for a stated purpose.
Investigation is a process of searching enquiry into the profit-earning capacity or the
financial position of a concern or to find out the extent of the fraud if there is any
suspicion about it and so on.
This unit covers concepts of statutory audit and internal audit on one hand and
cost audit, management audit and tax audit on the other hand. Statutory audit is an
independent audit made by an auditor as per the provisions of statute or laws. It is
compulsory by law. Internal audit is done by the employees of the organization on
continuous basis. An audit governed under section 44AB of Income Tax Act. Cost
audit is the verification of the correctness of cost accounts and of the adherence to
the cost accountancy plan. Management audit is an investigation of a business from
the higher level downward in order to ascertain whether sound management prevails
throughout, thus facilitating the most effective relationship with the outside world
and the most efficient organization and smooth running of internal organization.
Vouching is a backbone of auditing. It is an examination of the evidence offered
in substantiation of the entries in the books, including such examination the proof, so
far as possible, that no entries have been omitted from the books. In the process of

24
audit, auditor should satisfied with the verification and valuation of assets and
liabilities so as to confirm true and fair view of financial statements.

1.4 Terms to Remember

1. Audit: Audit is a systematic and independent examination of data, statements,
records, operations and performances of an enterprise for a stated purpose. The
auditor perceives and recognizes the propositions before him for examination,
collects evidence, evaluates the same and on this basis formulates his judgment
which is communicated through his audit report.
2. True and Fair View: Accounts are true and fair when the financial
performance shown by financial statements is true and fair. It is auditor's prime
duty to verify whether financial statements represent true and fair view.
3. Window dressing: It is an act of showing accounts a much better than the
actual condition.
4. Independence of Auditor: Independence implies acting without any fear or
favour. Unless and until the independence of auditor is maintained properly,
auditor cannot perform his duties rightly.
5. Investigation: It is a process of searching enquiry into the profit-earning
capacity or the financial position of a concern or to find out the extent of the
fraud if there is any suspicion about it and so on
6. Statutory Audit: When the audit is conducted under the statute, it is called
statutory audit.
7. Internal Audit: Independent appraisal activity within an organisation for the
review of operations as a service to management.
8. Tax Audit: An audit governed under section 44AB of Income Tax Act.
9. Cost Audit: Verification of the correctness of cost accounts and of the
adherence to the cost accounting plan.
10. Management Audit: An audit implemented to identity problems or significant
weaknesses in the organisation and to repair the problem area.
11. Vouching: Vouching is an examination of the evidence offered in substantiation
of the entries in the books, including such examination the proof, so far as
possible, that no entries have been omitted from the books.

25
12. Verification: the verification of assets implies an inquiry into the value,
ownership and title, existence and possessions, and the presence of any charge
on the assets.
13. Valuation: It is estimation of value of assets and liabilities. Valuation of assets
is the process of determining a fair market value of assets.

1.5 Answers to Check your progress

Check Your Progress-1
(A) 1) - (c), 2) - (a)
(B) 1) False, 2) True, 3) True
Check Your Progress-2
(A) 1) - (b), 2) - (c)
(B) 1) False, 2) True, 3) False

1.6 Exercise:
1) What is audit? Describe the scope of audit.
2) Explain the basic principles governing an audit according to Auditing and
Assurance Standard-1.
3) Distinguish between audit and investigation.
4) How do you relate audit with other disciplines?
5) What is the difference between internal audit and statutory audit?
6) Write short notes on:
(a) True and Fair View.
(b) Independence of auditor.
(c) Investigation.
(d) Management Audit
(e) Cost Audit

26
1.7 Reference for further study:
1. Tondon, B. N., S. Sudharsanam and S. Sundharabahu, Handbook of Practical
Auditing, S. Chand and Compay Ltd., New Delhi, Edition and Reprint 1997.
2. Aruna Jha, Student’s Guide to Auditing & Assurance, Taxmann Publications
Pvt. Ltd., New Rohtak Road, New Delhi.
3. S. D. Sharma, Auditing Principles & Practice, Taxmann Publications Pvt. Ltd.,
New Rohtak Road, New Delhi.
4. Anand G. Srinivasan, Auditing, Taxmann Publications Pvt. Ltd., New Rohtak
Road, New Delhi.
5. S. K. Basu, Fundamentals of Auditing, Pearson India, 2009.
6. O. Ray Whittington and Kurt Pany, Principles of Auditing,
7. Contemporary Auditing: Kamal Gupta
8. ICSI, Fundamentals of Accounting and Auditing, The Institute of Company
Secretaries of India, New Delhi.
9. Companies Act 2013
10. The Institute of Chartered Accountants of India, http://www.icai.org
11. Government of India, Website of Ministry of Corporate Affairs,
http://www.mca.gov.in/
12. N. K. Prasad, Principles and Practice of Cost Accounting, Book Syndicate Pvt.
Ltd., Calcutta, Sixth Edition, 1981.

27
 Unit-2
Audit of Specific Items in Financial Statements

Structure of Unit
2.0 Objectives
2.1 Introduction
2.2 Audit of Specific Items in Financial Statements
2.2.1 Audit of Specific Items in Profit & Account
2.2.2 Audit of Specific Items in Balance Sheet
2.3 Summary
2.4 Terms to Remember
2.5 Answers to check your progress
2.6 Exercise
2.7 References for Further Study

2.0 Objectives
After studying this unit you will be able to:
1. Understand how to conduct practical audit of final accounts.
2. Explain audit of sale of products and services as well as various items of income
and expenses.
3. Explain audit of assets and liabilities.
4. Find relationship between theory of audit and practical points to be considered
while auditing.

2.1 Introduction
In the first unit we studied introductory part of the audit such as meaning,
nature, principles, types of audit etc. In this unit we will study how to audit important
items from financial statements.
As we know, the term ‘financial Statements’ mainly refers to Profit and Loss
Account and Balance Sheet. Profit and Loss Account shows operational result and
28
efficiency of an enterprise for a particular period of time, generally, a financial year
and Balance Sheet shows financial strength or position of an enterprise on a
particular day. These statements are prepared as per the provisions of applicable
laws, taking into account the type of business organisation.
An Auditor needs to assess occurrence, authenticity, completeness, existence
and appearance of items appearing in financial statements. The auditor has to gather
necessary information regarding the postings made in the financial statements and
verify all the records, so as to make his opinion on the financial statements,
confirming to the truth and fairness of operational result and financial strength of an
enterprise and to prepare audit report.
Before starting with audit of items in financial statements, it would be better to
understand first the financial statements and the items appearing in these statements.
a) Profit and Loss Statement - As we know, profit and loss statement includes
items of income and expenditure pertaining to a particular period i.e. the
accounting period or a financial year. Income generated by way of sale of goods
and services is the main operating source of income. In addition, an organisation
may have other operating or other sources of income. On the other hand,
purchases are the prime expenditure. In addition to this, an enterprise incurs
several other expenses to perform its regular business operations. All items
appearing in profit and loss statement are revenue items. Therefore, this
statement is also termed as revenue statement.
b) Balance Sheet - The Balance Sheet is another prominent statement. It shows
financial strength of an enterprise on a particular date. It includes capital and
liabilities at one side and property and assets on the other.
Tests of Audit of items in Financial Statements- The auditor examine the items
in the financial statements on the following viewpoints.
a) Occurrence: The items appearing in the financial statements should have
occurred during the audit period.
b) Authenticity: The items recorded in the statements must be related to the
enterprise and should be authentic.
c) Completeness: All items appearing in the financial statements were recorded
and disclosed at right time. Also, the required notes to the items are accompanied to
the financial statements.
29
 d) Existence: The items appearing in the statements were existed on the date of
the statement, possessed by and related to the enterprise.
e) Measurement or Valuation: The items in the statements are recorded
accurately with their appropriate amounts.
f) Disclosure: The items in the financial statements have been classified and
presented properly in the financial statements as per applicable accounting standards.
Check your progress - A
State whether the following statements are true or false.
1. Profit and loss statement includes items of income and expenditure pertaining to
a financial year.
2. Balance Sheet shows financial strength of an enterprise on a particular date.
3. The items appearing in the financial statements should have occurred during the
period of audit.
4. The items appearing in the financial statements must be related to the enterprise
and should be authentic.
5. All items appearing in the financial statements should have recorded and
disclosed during the period under audit with required notes.
6. The auditor should verify that items appearing in the statements were existed on
the date of the statement, possessed by and related to the enterprise.
7. The auditor should verify that the items in the statements are recorded
accurately with their appropriate amounts.
8. The auditor should check that the items in the financial statements have been
presented as per applicable accounting standards.

2.2 Audit of Specific Items in Financial Statements

Before starting actual work of checking of records, an auditor should -
• Study the nature and size of the business.
• Study the concerned Acts and provisions applicable to the business.
• System of accounting and its computerisation and
• Examine the internal control system relating to the concerned item.

30
2.2.1. Audit of Specific Items in Profit & Loss Account
2.2.1.1. Audit of Items of Incomes
I. Sale of Products and Services-
Audit Procedure - In this respect an auditor,
a) needs to identify the control system of sales in order to determine how strong
and reliable it is. If it finds strong enough, the auditor can apply test checking
instead of routine checking to reduce his work.
b) should examine the related customer purchase orders, invoices and customer
statements.
c) is to go for analysis of sales trends and category wise sales.
d) needs to know the sales prices of the products or services over the year, monthly
average sales, price per product or service, discount policy, etc.
In addition to this, auditor has to confirm with the basic tests relating to sales
transaction.
A) Occurrence - In order to check the occurrence of the transaction, auditor should
perform the following procedure.
a. Check whether a single sales invoice is recorded twice or a cancelled sales
invoice is recorded.
b. Check whether any bogus customer and sales have been recorded.
c. Check whether goods are delivered without consent and agreement of the
customer.
d. Check whether unearned revenue is recorded as earned.
e. Check whether any doubt exists about collectability.
f. Review sequence of sales invoices and journal entries to ensure for unusual
transactions.
g. Vouch all supporting documents.
h. Calculate the ratio of sales return to sales and compare it with previous year
and note down the reason for increase / decrease.
i. Check the sales return with sales invoice, challan, credit note, stock
register, reversal of tax, etc.
31
B) Completeness - In order to check the completeness of the transactions, auditor
should perform the following procedure.
a. Auditor is to see whether all sales are recorded and there is no
understatement or overstatement.
b. He is to see that revenues are recognised in the current accounting period
and sales were not tampered at the end of the period.
c. The auditor is to see “credit notes” issued after the accounting period.
Sometimes fictitious sales are recorded at the end of the year to show the
achievement of target and it is cancelled during the beginning of the next
year. In order to detect such transactions, auditor has to verify delivery
challan received and credit notes issued during post year end period. He has
to check documents such as delivery challan of the goods sold, entries in
the sales journal, quantity of goods dispatched as per stock records and the
tax effects of the same.
d. Trace a few transactions from commencement to its completion.
C) Measurement - Auditor has to see that all the sales are accurately measured as
per applicable accounting standards and correctly recorded i.e. journalized,
summarized and posted and the value of such transactions were reasonable.
D) Authenticity- The auditor has to see whether sales transactions were properly
authorized.
E) Disclosure - Auditor has to ensure whether the following disclosures as required
under Ind AS compliant Schedule III to Companies Act, 2013 have been made.
a. Whether the sales of each class of goods has been disclosed properly.
b. Whether revenue is disclosed separately in respect of sale of products and
services and other operating revenues.
c. Whether brokerage and discount on sales, other than the usual trade
discount has been disclosed.
d. Whether the transactions with related parties are disclosed properly.
In nutshell, an auditor needs to perform following tasks.
1. Checking of approved sales orders,
2. Checking amendment in the sales order and its approval,
32
3. Checking terms and conditions of sales orders,
4. Checking whether all invoices have been raised correctly;
5. Checking that quantity and rates in the sales order are matching with the
invoice,
6. Checking whether tax rate and its application is correct,
7. Checking that the delivery challan are prepared as per invoices and are checked
and signed by stores authority,
8. Checking whether all the materials are dispatched in good condition
9. Checking whether any damage is notified to the buyer or any rejections and
returns,
10. Checking returns inward have been received properly in the stores and the credit
has been raised for the same and
11. Checking GST charged, collected and its reverse credit are recorded properly
12. Checking whether sales register, stores register / stock book have been
maintained correctly with all the sales entries.
II. Interest Income
The income earned by sources other than core business operations is generally
classified as other income. Interest is one of them. The enterprise invests its excess
funds in fixed deposits, loans, mutual funds, etc. Under Ind AS it is recognised on
time basis at the predetermined rate. The amount of investment, period for which it is
outstanding and the rate of interest are the basis of audit of interest income. The
auditor has to follow the following process to verify interest income.
a. Obtain the list of investment- The investment may be in fixed deposits, loans
given, shares, debentures or any other securities.
b. Study the terms of investment- date of investment, date of maturity, duration for
which it is outstanding, rate of interest, method of calculation and charging of
interest i.e. daily, fortnightly, monthly quarterly, half yearly or annually.
c. Verify the accuracy of calculation of interest – It can be traced out by
multiplying the deposit amount with the applicable rate of interest and duration
of outstanding during the audit period.

33
d. Confirm Existence – If the investments are still outstanding as at the date of
statements, auditor is to obtain confirmation certificate from the respective bank
or financial institution.
e. Confirm Interest Amount- Obtain a confirmation of interest income and verify
the interest income with the calculation shared by the enterprise. The auditor can
obtain a copy of TDS certificate pertaining to interest and reconcile it with the
calculation shared by client.
f. Ensure Compliance of Disclosure- The auditor has to see whether the interest
income is properly disclosed by complying with required accounting standards
viz. AS-5, AS-9 (Ind AS 18), AS 22 (Ind AS 12).
III. Rental Income
Rent is earned on letting any asset. Generally, rent is recovered on monthly
basis. There must be an agreement of letting the assets. Auditor is to assess the
agreement in order to understand the conditions of agreement like the period of
agreement, amount of rent, periodicity of payment, the responsibility of the parties
regarding cost of repairs, maintenance of the asset, the escalation clause, the rate of
escalation and its periodicity etc. Accordingly, the auditor has to verify and confirm
the occurrence, authenticity, periodicity, compliance in relation to the accounting
standards and other laws, completeness and disclosure of transactions relating to
receipt of rent during the audit period.
In the audit of Rental Income, the auditor has to confirm-
A) Occurrence - The amount of rent is earned during the period of audit.
B) Completeness - The amount of rent earned was properly recorded and there is no
understatement or overstatement.
C) Measurement - It has been measured as per the applicable accounting standards.
D) Authenticity- In order to confirm authenticity of rental income, the auditor can
examine the agreement of rent and confirmation from the tenant.
IV. Dividend Income
Dividend is earned on the amount invested by the enterprise in the shares of
other companies. It is recognised in the statement of profit and loss of an enterprise
only when,
(i) the right is established to the enterprise to receive payment of the dividend,
34
(ii) the economic benefits associated with the dividend flow to the enterprise and
(iii) the amount of the dividend can be measured reliably.
Audit procedures- In the audit of dividend income, the auditor is to confirm-
A) Occurrence- the amount of dividend is earned during the audit period.
B) Completeness- the amount of dividend earned was properly recorded and there
is no understatement or overstatement.
C) Measurement- It has been measured as per the applicable accounting standards.
D) Existence and Authenticity- The auditor is to confirm that the investment in
shares was existed during the audit period. He is to calculate the amount of
dividend considering the number of shares, amount of investment, the rate of
dividend declared and confirm it with the amount received as dividend with the
help of dividend warrants and other correspondence from the respective
company.
V. Net Gain/Loss on Sale of Investments
Gain or loss on sale of investment is the difference between the redemption
price and carrying value of the investments.
Audit procedures- In the audit of Gain/ Loss on Sale of Investments etc, the
auditor is to confirm-
A) Occurrence- the investments are sold during the period of audit.
B) Completeness- the amount of gain / loss was properly recorded and there is no
understatement or overstatement.
C) Measurement- It has been measured as per the applicable accounting standards.
D) Authenticity- The auditor is to obtain the statement and trace the gain or loss as
recorded in the books of account with that reflected in the statement.
E) Presentation and Disclosure- the auditor is to see that the gain or loss is
recorded in the statement of profit and loss properly and disclosures pertaining
to income have been appropriately complied with.
Check your progress - B
State whether the following statements are true or false.

35
1. To check the completeness, an auditor needs not to trace transactions from
commencement to its completion.
2. The auditor is to see whether all sales are recorded or not.
3. To check income from investment, it is not necessary to obtain complete list of
investments.
4. While checking rental income an auditor should assess agreement with the
tenant.
5. While checking income from dividend, an auditor should check the list of
debentures purchased by the enterprise.
6. To verify net gain or loss from sale of investment, an auditor should make actual
calculation.
2.2.1.2. Audit of Items of Expenses
I. Purchases
The process of purchases begins with issuing purchase order and ends with
receipt of goods and its payment. The process of purchase involves following
activities.
Pre-purchase activities-
a) Collection of requisitions and determination of goods to be purchased,
b) Formation of purchase committee and conducting its meetings,
c) Inviting quotations/ tenders,
d) Preparation of comparative statement and short listing the supplier/s,
e) Preparation and issue of purchase order to short listed supplier/s.
Post-purchase activities
f) Receipt and inspection of goods,
g) Verification of purchases with purchase order, purchase invoice and delivery
challan,
h) Preparation of goods received note,
i) Rejection of (damaged/poor-quality) goods and issue of debit note pertaining to
the price of goods rejected,

36
j) Passing order for payment and making payment for goods accepted.
Audit Procedure
1) Auditor is to check how the process of procurement of goods is performed at an
enterprise. He is to identify the control point and internal control system in
action for purchases. Generally, it is authorised to an officer to purchase goods
up to certain limit. If the volume and amount of purchase order exceeds the
limit, the quotations/tenders are invited and purchase committee deals with the
further procedure of purchases.
2) Auditor is to check purchase procedure thoroughly in order to judge how
internal control system is effective. If he finds internal control system effective,
he can apply test-checking method of audit. He is to check purchase order,
supplier’s invoice, delivery challan, goods inward register, stock book, purchase
register, inspection report, acceptance and rejection reports of goods, debit note
issued for goods rejected.
3) The auditor is to go for analysis of trends of purchase. The auditor needs to
know the price of goods purchased over the year, monthly average, discount
policy of the suppliers, etc.
4) The purchase invoice received should be the “Original” copy and should be in
the name of auditee. In addition to this, auditor is to confirm with the basic tests
relating to purchases.
A) Occurrence:
a. Check whether the goods purchased are actually received during audit
period.
b. Check whether a single purchase invoice is recorded twice or a cancelled
purchase invoice is recorded.
c. Check in detail whether any bogus purchases have been recorded.
d. Review sequence of purchase invoices and journal entries to ensure for
unusual transactions.
e. Compare purchases returns of the current year with that of last year and
note down the reasons for increase / decrease.

37
B) Completeness:
a. See whether all purchases are recorded and there is no understatement or
overstatement.
b. See that purchases were not tampered.
c. See Debit Notes issued to trace out fictitious purchases. He can see delivery
challan, invoices, stock book entries and reverse GST effects of the same.
d. Trace a few transactions from commencement to its completion.
C) Measurement:
a) See that all the purchases are accurately measured as per applicable
accounting standards and correctly recorded.
b) Ensure purchases are not understated/ overstated.
D) Authenticity:
a) See whether purchase transactions were properly authorized,
b) Check the values of such transactions were reasonable.
E) Disclosure: Auditor is to ensure whether the following disclosures as required
under Ind AS compliant Schedule III to Companies Act, 2013 have been made:
a. Whether special discount on purchases other than the usual trade discount
has been disclosed.
b. Whether the transactions with related parties are disclosed properly.
II. Other Expenses
An enterprise incurs much expenditure like Interest expense, Rent, Repairs to
Building and Machinery, Insurance, Taxes, Travelling Expenses, and Miscellaneous
Expenses that are essential and incidental to running of business operations. The
auditor while auditing such expenditures needs to confirm-
A) Occurrence – confirm recorded expenditure was actually incurred during the
audit period.
B) Completeness - The expenditure pertaining to the period have been recorded
appropriately and there in no understatement or overstatement.
C) Measurement - The expenditure has been measured appropriately.

38
D) Authenticity - The expenditure is in certain limit and if it is in excess,
appropriate procedure has been followed. See that the expenditure incurred is
authentic and it is spent by applying certain procedure laid down. Analyse the
monthly trends for expenses. verify that -
a. the expenditure pertained to audit period.
b. the expenditure qualified as a revenue and not capital expenditure;
c. the expenditure is supported with valid documents like travel tickets,
insurance policy, third party invoice, etc;
d. the expenditure has been classified under the correct head of expense;
e. the expenditure was authorised as per the delegation of authority;
f. the expenditure relates to business and it is not personal.
In addition to these, auditor needs to consider special facts attached to each of
the expenses. Special points that are to be considered by the auditor are discussed
below.
i. Interest Expenses - Auditor should confirm amount of debts, applicable interest
rates, due dates, period, interest paid, interest outstanding etc.
ii. Rent - Auditor should check agreement of rent and confirm whether the
agreement is in the name of the enterprise and whether the rent expense pertains
to premises is used for running the business operations of the enterprise,
monthly amount of rent, increase or decrease in rent etc.
iii. Insurance - Auditor should go through all insurance policies taken by the client
in order to know their validity period, policy amount and premium on it,
periodicity of payment of premium, due date, mode of payment, prepaid amount
etc.
iv. Taxes -Auditor should know the taxes applicable to the client, basis of charging
tax, provisions applicable etc. Verify the tax amount by actual calculation and
vouch the payment.
v. Repair to Building and Plant and Machinery - Auditor should get details of
repairs- causes of repairs, types of repairs, the system adopted to carry out
repairs, tools and consumables used for repairs and authentication of the same
and reasonableness of expenses.

39
vi. Travelling Expenses - Auditor should examine the need of travel, the person
travelled, the place of designation, its authentication, mode (Road, Rail, Air,
Sea) and class of seat (I, II or economy / corporate / AC etc.), time and distance
of travel.
vii. Miscellaneous Expenses – The auditor should follow the common points
discussed above.
III. Depreciation
As per the accrual concept of accounting, cost of an asset is proportionally
charged to the period over which the asset is expected to be used. This proportionate
amount is called as ‘depreciation’. It is significant part of expenses and has direct
impact on the profit / loss of the enterprise. Hence, auditor needs to verify and ensure
that such expenditure is appropriate, accurately calculated and has been accounted as
per applicable provisions of laws and as per generally accepted accounting
principles.
Auditor needs to consider the following traits while auditing depreciation
i. The accounting policy related to depreciation.
ii. The policy for charging depreciation is as per the provisions of Companies Act
and applicable accounting standards.
iii. Whether the depreciation has been calculated after making adjustment of
residual value from the cost of the assets.
iv. Whether depreciation and amortisation charges are valid.
v. Whether depreciation and amortisation charges are accurately calculated.
vi. Whether all depreciation and amortisation charges are recorded in the
appropriate period.
vii. Whether the parts (components) of each item of property, that are to be
depreciated separately has been properly identified.
viii. Whether the most appropriate depreciation method has been used for each asset
considering the nature of the asset.
The audit procedure -
A) Completeness - Depreciation expenses pertaining to the period have been
recorded appropriately and there in no understatement/ overstatement.
40
B) Measurement - Depreciation expenses have been measured appropriately
C) Occurrence- Recorded depreciation expenses were actually incurred during the
period
D) Presentation and disclosure - Required disclosures for depreciation have been
appropriately made
Check your progress – C
State the following statements are true or false
1. Making payment for purchase of goods is the first step in the process of
purchase.
2. It is not the duty of the auditor to check recorded expenditures are actually
incurred during the period of audit.
3. The provisions of Companies Act 2013 and concerned standards are not
applicable for the depreciation of fixed assets of public limited company.
4. While auditing expenses on interest, an auditor has no right to take confirmation
from concerned parties.
5. While checking insurance premium, it is not necessary to check insurance
policies.
6. While checking travelling expenses, it is not the business of the auditor to verify
need and reason of travelling.
2.2.2. Audit of Specific Items in Balance Sheet
2.2.2.1. Items of Capital and Liabilities
I. Share Capital
Public limited companies raise its capital through issue of shares. Capital of a
company is classified as-
a) Authorised Capital or Nominal capital : It is the sum stated in the
memorandum as the capital of the company with which it is registered. It is the
maximum amount of capital to be raise by issuing shares.
b) Issued Capital : Issued capital is that part of authorised capital which is
offered by the company for subscription.

41
 c) Subscribed Capital : It is that part of issued capital which is subscribed by
the public. It also includes the shares allotted for consideration other than cash.
d) Called Capital : It is that part of subscribed capital which is called upon by
the company for payment from the shareholders.
e) Paid up Capital : It is that part of called up capital which is actually received
by the company
The shares can be issued at par or at premium. In case a company has issued
shares at a premium, the auditor needs to verify whether the premium received on
shares, has been transferred to a “securities premium account” and whether the
application of any amount out of the said account is only for the purposes mentioned.
As per section 53 of the Companies Act, 2013, a company shall not issue shares
at a discount, except in the case of an issue of sweat equity. The auditor needs to
verify that the company has not issued any of its shares at a discount
Issue of Sweat Equity Shares - According to section 54 of the Companies Act,
2013, the “Sweat Equity Shares” means equity shares issued by the company to its
employees or directors at a discount or for consideration other than cash for
providing know-how, making available intellectual property rights, value additions,
by whatever name called. The auditor needs to verify that the Sweat Equity Shares
issued by the company are of a class of shares already issued and following
conditions have been complied with-
(a) the issue is authorised by a special resolution passed by the company;
(b) not less than one year has, at the date of such issue, elapsed since the date on
which the company had commenced business; and
(c) where the equity shares of the company are listed on a recognised stock
exchange, the sweat equity shares are issued in accordance with the regulations
made by the Securities and Exchange Board and if they are not so listed, the
sweat equity shares are issued in accordance with such rules as may be
prescribed.
(d) the resolution specifies the number of shares, the current market price,
consideration, if any, and the class or classes of directors or employees to whom
such equity shares are to be issued.

42
 The rights, limitations, restrictions and provisions applicable to equity shares
shall be applicable to the sweat equity shares. The auditor also needs to verify
whether the fresh issue of shares was a rights issue or a preferential issue and
whether the relevant requirements for issue of share capital as per provisions of
Companies Act, 2013 have been complied with.
In addition to this, the auditor is to assess-
i. balance at the beginning of the audit period, changes during the audit period and
balance at the end of the audit period,
ii. Rights of shareholders, preferences and restrictions.
iii. Shares held by the holding company, subsidiaries of the holding company and
associates of the holding company
iv. Shareholder holding more than 5% shares (Aggregate number and class of
shares).
v. Shares allotted as fully paid up pursuant to contract(s) without payment being
received in cash
vi. Shares allotted as fully paid up by way of bonus shares
vii. shares bought back
If there is no change in share capital, obtain a written confirmation form the
Company Secretary in this regard. In case there is any change in share capital during
audit period, obtain the certified copies of relevant resolutions passed at the meetings
of board of directors and shareholders authorising the increase / decrease in
authorised and paid up share capital. Also, obtain and verify copies of forms filed
with Ministry of Corporate Affairs and with Reserve Bank of India (in case of
Foreign Direct Investment by a Non- resident shareholder) and verify the number of
securities issued along with the issue price.
In case there was increase in authorised share capital, verify whether the
Company has accurately calculated the fee and stamp duty payable to Ministry of
Corporate Affairs and obtain a copy of the receipt in support of the payment made.
Reduction of Capital - For verifying reduction of capital, the auditor needs to
undertake following procedures:
a) Verify that the Articles of Association authorises reduction of capital,

43
b) Verify that the meeting of the shareholder held to pass the special resolution was
convened and the proposal was circulated in advance among all the
shareholders,
c) Examine the order of the Tribunal confirming the reduction and verify that a
copy of the order and the minutes have been registered and filed with the
Registrar of Companies,
d) Inspect the Registrar’s Certificate as regards to reduction of capital,
e) Vouch the accounting entries recorded to reduce the capital and to write down
the assets by reference to the resolution of shareholders and other documentary
evidence; also check whether the requirements of Schedule III, Part I have been
complied with,
f) Confirm whether the revaluation of assets has been properly disclosed in the
Balance Sheet,
g) Verify the adjustment made in the members’ accounts in the Register of
Members and confirm that either the paid-up amount shown on the old share
certificates have been altered or new certificates have been issued in lieu of the
old and the old ones have been cancelled;
h) Confirm that the words “and reduced”, if required by the order of the Tribunal,
have been added to the name of the company in the Balance Sheet.
i) Verify that the Memorandum of Association of the company has been suitably
amended.
II. Reserve and Surplus and Provisions
i. Reserves - Reserves are amounts appropriated out of free profits. Reserves
are segregated as revenue or capital reserves. Revenue reserves represent profits that
are available for distribution as dividend. If a company appropriates revenue profit
for creation of ‘Asset Replacement Reserve’ with the objective to use it for a capital
purpose, such a reserve shall also be a capital reserve. A capital reserve, generally,
can be utilised for writing down fictitious assets, losses and issuing bonus shares.
Capital Reserve is not utilised for distribution as dividend.
ii. Provisions- The provisions are amounts charged against revenue to provide
for a renewal or diminution in the value of assets or liabilities or a disputed claim.
Provisions are charged to the Profit and Loss Account.

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The auditor is to undertake following procedure for auditing reserves and surplus.
a) Tally the opening balance of reserves and surplus to the previous year’s audited
financial statements.
b) Verify the addition or utilisation of reserve in current year.
c) Verify the resolution passed by the board of directors regarding declaration of
dividend, adjustment related to dividend payment and the dividend distribution
tax.
d) Confirm withdrawal from securities premium account is only for the following
purposes.
(i) issue of fully paid bonus shares,
(ii) writing off of preliminary expenses,
(iii) writing off of expenses / commission / brokerage on issue of shares or
debentures,
(iv) payment of premium payable on redemption of redeemable preference
shares / debentures or purchase of own shares under section 68.
Ensure whether the disclosure required as per Ind AS have been complied with.
See whether the company has disclosed the balance at the beginning, changes in
accounting policy, transfer to retained earnings, any changes and balance at the end
of reporting period
III. Borrowings
Borrowings are third party obligations of an enterprise. It may be short- term or
long-term. The auditor is to verify all borrowings on the balance sheet date are valid
claims by third parties. He should,
- Review board minutes for approval of new borrowings and significant debt
commitments.
- See that details of loans recorded agree with the loan agreement.
- Verify that borrowing limits imposed by agreements are not exceeded.
- See that overdrafts and loans agree with confirmation certificates obtained.
- See that details of leases and hire purchase creditors recorded agree with
underlying agreement.

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- Examine trust deed for terms and dates of redemption, borrowing restrictions
and compliance with covenants.
- When debt is retired, ensure that a discharge is received on assets securing the
debt.
- see that all borrowings have been accounted for in the books of the company on
a timely basis.
- Obtain a schedule of short-term and long-term borrowing showing beginning
and ending balances and repayments during the year.
- Verify evidences of debts like minutes of the board, contracts, bank accounts,
records of cash disbursements and other documents. Check totals and
calculations.
- Review debt activity for a few days before and after end of the audit period to
determine if there are unrecorded liabilities at year-end and the transaction is
recorded in the correct period.
- Obtain a confirmation for the amounts owed to each or selected lenders
- Check that the liability is recorded at the correct amount.
- Confirm that the accounting policies and methods of recording debt are
appropriate and applied consistently
- Check that borrowings have been presented, classified and disclosed in the
financial statements in accordance with the requirements of Companies Act,
2013 and applicable Indian GAAP.
- Confirm whether the following items are properly recorded, classified, and/or
disclosed.
a. Debt owed to related parties.
b. Debt callable by the creditor (e.g., due to loan covenant violations).
c. Short-term obligations expected to be refinanced.
d. Discounts or premiums and related amortization.
e. Unconditional purchase obligations.
- If enforcement of the provisions has been waived by the lender, obtain
confirmation of the waiver from the lender.

46
- Examine the relevant details of interest rates, due dates and terms of redemption
or conversion to ensure completeness and accuracy.
- See that instalments of long-term loans falling due within the next twelve
months have been disclosed in the financial statements and verify the
correctness of the amount of such instalments.
- Review debt for related parties’ transactions or borrowings from major
shareholders.
- Examine the debt agreements for provisions relating to default and ensure
disclosure thereof in the financial statements.
- Examine whether the requirements of the applicable statutes have been
complied with including disclosure of the same to the extent mandated and
considered necessary for proper understanding of the user of financial
statements.
- Verify that the amount borrowed is within the borrowing powers of an
enterprise.
- Verify that the company has not breached the restrictions laid down by Section
180 of the Companies Act 2013, on the borrowings of the company.
- Examine the purpose for which the amount is borrowed and the amount is not
used against the interest of an enterprise.
- Where the enterprise has accepted deposits, examine whether the directives
issued by the Reserve Bank of India or other appropriate authority have been
complied with.
- Ensure whether the following disclosures as required under Ind AS are made
regarding each amount disclosed as ‘long term borrowings’.
a. Sub-classification as secured and unsecured.
b. For secured borrowings, nature of security separately in each case.
c. Where loans are guaranteed by directors or others, whether the company
has disclosed the aggregate amount of such loans under each head.
d. Terms of repayment. It should include the period of maturity, number and
amount of instalments due, applicable interest rate and other significant
relevant terms (if any).

47
 e. Default in repayment of borrowing and / or interest on the balance sheet
date.
IV. Trade Payables (Creditors)
Trade payables are the short-term financial obligations created in the regular
operations of the business of an enterprise such as e.g. amount payable to suppliers
for credit purchases of goods and services.
To audit accounts payable, auditor must check –
1. The terms of payments.
2. The accounts payable turnover ratio
3. Is there any practice followed to increase net income by not recording payables?
4. The validity of transactions relating to accounts payable. Most commonly, an
auditor can check the validity of a transaction by reaching out to vendors and
suppliers to get a confirmation request.
5. Payable balance is properly disclosed in financial statements.
6. The enterprise is disclosed a mandatory letter from management attesting that all
financial statements fully represent accounts payable and purchases.
V. Other Current Liabilities
Current liabilities mean all liabilities of an enterprise that are to be settled within
a period of accounting year. It also includes the instalments due on the long-term
loans in the current fiscal year.
The auditor shall obtain a certificate from the management that all current
liabilities that had accrued till the close of the accounting year are carefully
accounted for by complying with the required accounting procedure.
The auditor should ask for a list of all current liabilities from a responsible
officer with classification as per the nature.
He should check the cash book to confirm that they have been paid off by the
time of audit. He should compare current liabilities of the current year with that of
the previous year to identify deviations, if any and ask for clarification.
He should obtain confirmation from all significant creditors regarding balance
of the liability. Any deviation in the balance as per the statement and the
confirmation letter obtained should be asked for clarification.
48
 The auditor should confirm that the disclosures required in respect of current
liabilities have been complied with.
Check your progress - D
State whether the following statements are true or false
1. According to Section 52 of the Companies Act 2013, if any company issued
shares at premium, the amount of premium should be transferred to Securities
Premium Account.
2. A limited company has a freedom of recording any amount as reserves to make
the balance sheet tally.
3. An auditor should ensure that all borrowings are approved by the board of
directors in their meetings.
4. To confirm the validity of trade payables it is not necessary to get confirmation
from the suppliers.
5. The auditor should confirm that the disclosures required in respect of current
liabilities have been compiled with.
2.2.2.2 Audit of Assets
I. Fixed Assets
Assets of a permanent or a semi-permanent nature, which are held not for resale
but for use within the business with a view to earning profits and the benefits
whereof is expected to last for more than one year and acquiring a benefit of
continuing nature are called fixed assets. Fixed assets are long-term investments and
are essential for performing the day-to-day operations of the business enterprise.
They are divided as tangible and intangible assets.
a) Tangible Assets - The assets which have physical existence are called tangible
assets, e.g. Land and Building, Plant and Machinery, Furniture and Fixtures, Office
Equipments, Electric Installations, Vehicles etc.
The audit procedure for auditing tangible fixed assets is as under.
i. The auditor is to obtain proper information about controls and accounting
system pertaining to fixed assets.
ii. The auditor is to review the internal control system relating to fixed assets

49
iii. The auditor should see that for each fixed asset, the records are maintained
properly.
iv. The auditor should verify physically the assets and check disposal of fixed
assets and treatment of low value assets.
v. The auditor should see that fixed assets have been properly used for meeting the
objectives of the enterprise.
vi. The auditor should verify the calculation and allocation of depreciation,
disposals, repairs and maintenance charges, etc.
vii. The auditor is to verify that all the assets appear in the balance sheet.
viii. Check opening balances of the fixed assets from schedule of fixed assets, ledger
or register balances.
ix. Verify acquisition of new fixed assets and improvements in the existing ones
with reference to supporting documents.
x. Check self-constructed fixed assets, improvements and capital work-in-progress
with reference to the supporting documents
xi. Examine expenses on Repairs and maintenance have not been included therein.
xii. Examine whether low value fixed assets have been written off or fully
depreciated in the year of acquisition / construction in accordance with
applicable regulatory requirements.
xiii. If fixed assets are destroyed, scrapped or sold, examine that-
a. the appropriate procedures have been properly followed;
b. appropriation of consideration amongst various assets sold is proper where
several assets have been sold for a consolidated consideration.
c. the profit or loss on sale of assets have been properly disclosed in the profit
and loss account.
d. obtain a certificate from the management that all assets scrapped, destroyed
or sold have been properly recorded in the books.
xiv. verify the ownership of assets by examining title deeds.
xv. verify that the assets are held in the name of the client and it is properly
documented there for.

50
xvi. Ensure that the valuation of assets and disclosure in the financial statements are
consistently followed and they are in accordance with the generally accepted
accounting principles.
xvii. Verify that the enterprise has charged depreciation on all its fixed assets. Also
check the calculations of depreciation and the total depreciation arrived at
should be compared with that of the preceding years to identify reasons for
variations.
xviii. Examine whether the depreciation charge is adequate keeping in view the
generally accepted accounting principles for depreciation or Income Tax Rules.
xix. For assets revalued, examine scientific/technical appraisals and consider
acceptance.
xx. see that all expenses of capital expenditure such as expenses incurred to bring
assts to the place of erection, erection charges, octroi / GST on the value of
assets, wages paid on construction of building, etc. are added to the concerned
assets
xxi. See that spare parts, stand-by equipments and servicing equipments are
recognised as property, when they meet the definition of capital expenditure.
Otherwise, such items are classified as inventory.
xxii. See that Items of property, plant and equipments acquired for environmental
safety, although not directly increasing the future economic benefits to an
enterprise are to be consider as the assets of the enterprise.
xxiii. Where several assets have been purchased for a consolidated price, examine
the method by which the consideration has been apportioned to various assets.
xxiv. If valuation has been done on the basis of an expert valuation, examine whether
the same appears reasonable.
xxv. If an enterprise owns assets jointly with others (otherwise than as a partner in a
firm) examine the relevant documents such as title deeds, agreements etc., in
order to ascertain the extent of the enterprise share in such assets.
xxvi. Examine whether any of the tangible asset has been impaired. If so, examine
whether the provisions of AS 28 has been applied.
Rights and Obligations - The auditor is to see that the enterprise has valid legal
ownership rights over the fixed assets claimed to be held by the enterprise and
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recorded in the financial statements. If the enterprise has created any charge on its
assets, the auditor is to see whether such charge was created in the interest of an
enterprise. If the enterprise has given fixed asset as security for any borrowings and
the original title deeds are not available with the enterprise, the auditor should
request the enterprise’s management for obtaining a confirmation from the respective
lenders that they are holding the original title deeds of immoveable property as
security. In addition, the auditor should also verify the register of charges, available
with the enterprise to assess the PPE that has been given as security to any third
parties.
Presentation and Disclosure - Required disclosures for tangible fixed assets
have been appropriately made. Auditor is to see whether all items of fixed assets
have been classified appropriately. For each fixed asset, whether the enterprise has
disclosed a reconciliation of the gross and net carrying amounts at the beginning and
end of the reporting period showing separately:
• Opening balance
• Additions
• Acquisitions through business combinations
• Disposals
• Disposals through demergers
• Other adjustments
• Closing balance of gross carrying amount
For each fixed asset, whether the enterprise has disclosed:
• Opening accumulated depreciation
• Depreciation for the year
• Deduction / other adjustments for depreciation
• Closing accumulated depreciation
b) Intangible Assets
An Intangible Asset is an identifiable without physical substance, held for use in
the production or supply of goods or services, for rental to others, or for
administrative purposes. Enterprises frequently expend resources or incur liabilities
on the acquisition, development, maintenance or enhancement of intangible
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resources such as scientific or technical knowledge, design and implementation of
new processes or systems, licenses, intellectual property, market knowledge and
trademarks (including brand names and publishing titles). Common examples of
items covered by these broad headings are computer software, patents, copyrights,
motion picture films, customer lists, mortgage servicing rights, fishing licenses,
import quotas, franchises, customer or supplier relationships, customer loyalty,
market share and marketing rights. Goodwill is another example of an item of
intangible nature which either arises on acquisition or is internally generated.
If an item covered does not meet the definition of an intangible asset,
expenditure to acquire it or generate it internally is recognised as an expense when it
is incurred. However, if the item is acquired in a business combination, it forms part
of the goodwill recognised at the date of the amalgamation. The physical substance
containing an intangible asset, though tangible in nature, is commonly treated as a
part of the intangible asset contained in or on it. In some cases, an asset may
incorporate both intangible and tangible elements that are, in practice, inseparable.
In determining whether such an asset should be treated under AS 10 / Ind AS-
16- Accounting for Fixed Assets, or as an intangible asset, judgement is required to
assess as to which element is predominant. For example, computer software for a
computer controlled machine tool that cannot operate without that specific software
is an integral part of the related hardware and it is treated as a fixed asset. The same
applies to the operating system of a computer. Where the software is not an integral
part of the related hardware, computer software is treated as an intangible asset. As
per AS-26 and Ind AS- 38, internally generated goodwill is not recognized as an
asset because it is not an identifiable resource controlled by the enterprise that can be
measured reliably at cost.
Existence- the auditor should verify that, such intangible asset is in active use in
the operations of the enterprise. If any intangible asset is not in active use, deletion
should have been recorded in the books of account post approvals by the enterprise’s
management and amortization charge should have ceased to be charged beyond the
date of deletion.
Completeness- the auditor should verify that,
- additions to Intangible assets during the period under audit have been recorded
appropriately in the financial statements.

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- the movement in the Intangible assets schedule i.e. Opening +Additions -
Deletions= Closing Balance and tally the closing balance to the books of
account the enterprise.
- the arithmetical accuracy of the movement in intangible asset schedule, tally the
opening balances to the audited financial statements of the previous year. For
additions during the period under audit, obtain a listing of all additions from the
management and undertake the following procedures.
• Verify if the additions have been approved by appropriate personnel of the
enterprise and is in pursuant to approval by the board of directors.
• Verify if proper internal processes and procedures like inviting competitive
quotations/ floating tenders etc. were followed prior to finalizing the vendor for
procuring item of intangible assets.
• For all material additions, verify if such expenditure meets the criterion for
recognition of an intangible asset. An intangible asset shall be recognised if,
and only if:
• the said asset is identifiable;
• the enterprise controls the asset i.e. the enterprise has the power to obtain the
future economic benefits flowing from the underlying resource and to restrict
the access of others to those benefits;
• it is probable that future economic benefits associated with the asset will flow to
the enterprise;
• the cost of the item can be measured reliably.
To assess whether an internally generated intangible asset meets the criteria for
recognition, an enterprise classifies the generation of the asset into a research phase
and a development phase.
Research phase - No intangible asset arising from research shall be recognised.
Development phase- An intangible asset arising from development shall be
recognised if, and only if, an enterprise can demonstrate all of the following:
• the technical feasibility of completing the intangible asset so that it will be
available for use or sale;
• its intention to complete the intangible asset and use or sell it;

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• its ability to use or sell the intangible asset;
In relation to deletions to intangible assets,
• understand from the management the reason and rationale for deletion
• obtain discard note authorising discard of the asset from its active use.
• verify the process followed for sale of discarded asset – inviting competitive
quotes, tenders and the basis of calculation of sales proceeds.
• verify that the management has accurately recorded the deletion of intangible
asset (original cost and accumulated amortization up to the date of disposal) and
the resultant gain/ loss on discard in the enterprise’s books of account.
Valuation- Intangible assets have been valued appropriately as per generally
accepted accounting policies and practices. The value of intangible assets may
diminish due to efflux of time, use and/ or obsolescence. The diminution of the value
represents an item of cost to the enterprise for earning revenue during a given period.
Unless this cost in the form of amortization is charged to the accounts, the profit or
loss would not be correctly ascertained and the values of intangible asset would be
shown at higher amounts. The auditor should,
• verify that the enterprise has charged amortization on all intangible assets,
• verify that the amortization method used reflects the pattern in which the asset’s
future economic benefits are expected to be consumed by the enterprise.
• The auditor should also verify if the management has undertaken an impairment
assessment to determine whether an intangible asset is impaired. For the purpose, the
auditor needs to verify if the enterprise has applied Ind AS 36, Impairment of Assets
for determining the manner of reviewing the carrying amount of its intangible asset,
determining the recoverable amount of the asset to determine impairment loss, if any.
Rights and Obligations- The enterprise has valid legal ownership rights over the
intangible assets claimed to be held by the enterprise and recorded in the financial
statements. The auditor should also verify that all invoices/ purchase contracts are in
the name of the enterprise that entitles legal title of ownership to the respective
enterprise.
Presentation and Disclosures- Required disclosures for intangible assets have
been appropriately made. Ensure whether the following disclosures as required under
Ind AS compliant Schedule III to Companies Act, 2013 have been made.
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• For Goodwill, whether the enterprise has disclosed a reconciliation of the gross
and net carrying amounts at the beginning and end of the reporting period
showing separately, Opening balance, Additions, Disposals, Impairments and
Other adjustments.
Whether all items of intangible assets have been classified as,
• Brands/trademarks
• Computer software
• Mastheads and publishing titles
• Mining rights
• Copyrights, and patents and other intellectual property rights, services and
operating rights
• Recipes, formulae, models, designs and prototypes
• Licenses and franchise
• Others (specifying nature)
For each class of Intangible assets, whether the enterprise has disclosed a
reconciliation of the gross and net carrying amounts at the beginning and end of the
reporting period showing separately,
• Opening balance of gross carrying amount
• Additions
• Acquisitions through business combinations
• Disposals
• Disposals through demergers
• Other adjustments
• Borrowing costs capitalized
• Closing balance of gross carrying amount
For each class of intangible assets, whether the enterprise has disclosed,
• Opening accumulated amortization
• Charge for the year

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• Deduction / other adjustments for amortization
• Closing accumulated amortization
For each class of intangible assets, whether the enterprise has disclosed,
• Opening accumulated impairment losses
• Impairment losses
• Impairment reversals
• Closing accumulated impairment losses
II. Loans and Advances
Loans and advances are current assets similar to trade receivables. While loans
could be understood to mean money advanced to other parties whereas, advances
include amounts recoverable either in cash or in kind or for value to be received, e.g.,
rates, taxes and insurance paid in advance/ prepaid. Other current assets primarily
include accrued interest on loans/ fixed deposits held, balances with statutory/
government authorities etc. outstanding incomes such as rent receivable, unclaimed
dividend, etc.
The audit procedures to be undertaken while auditing loans and advances and
other current assets-
Existence- Establish the existence of loans and advances and other current assets
as at the end of period of audit. In case of loans and advances, direct confirmation
procedures, similar to those performed for ‘’Accounts receivable’’ are undertaken
with the only difference that of direct confirmations, in addition to the principal
amount, interest received / receivable, if any, as per the agreed terms between the
parties, may also be included as part of the balance to be confirmed.
Completeness- Loans and advances and other current assets have been
recognized in the financial statements properly.
• Obtain a list of all advances and other current assets and compare them with
balances in the ledger.
• Inspect loan agreements and acknowledgements of parties in respect of
outstanding loans.
• A loan or an advance, if material, can be granted only if authorised by the
Memorandum and Articles of Association in the case of Company.
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• It should confirm that the loans advanced were within the capacity of persons
who had advanced the same, directors in the case of a company, partners in the
case of a firm and trustees in the case of a trust.
• Inspect the minutes of meeting of board of directors to confirm if all material
loans and advances were approved by the board of directors.
• Verify that the loan has been acknowledged by the party and, in addition,
inspect if any security has been deposited against due repayment of the loan.
• Ascertain if loans are being recovered regularly as per agreed instalments.
• Related party loans and advances- If there are any related party loans and
advances, review whether they were properly authorized and the value of such
transactions were reasonable and recoverable.
• In relation to balances with statutory authorities like service tax / VAT/ excise
input credit, verify the balances by applying applicable rate to sales and
purchases. If found any variance with, reasons for variance should be requested
from client for clarification. Further, the auditor should obtain copies of returns
filed like excise returns / GST returns etc. and verify whether the amount
recorded as per books of account tallies with the claim made with the
authorities.
Valuation- Loans and advances and other current asset balances should be
valued appropriately.
• Auditor should review the process followed by the enterprise to derive an
allowance for doubtful accounts. Also consider the consistency of the method
used in the last year, and determine whether the method is appropriate.
• Obtain the ageing report of loans and advances. It is to split as not currently due,
30 days old, 30-60 days old, 60-180 days old, 180-365 days old and more than
365 days old. Also, obtain the list of loans and advances under litigation and
compare with previous year.
• Scrutinize the analysis and identify those loans and advances that appear
doubtful. Discuss with management their reasons, if any of these loans and
advances is not included in the provision for bad recoverable. Perform further
testing where any disputes exist. Reach a final conclusion regarding the
adequacy of the bad and doubtful loans/ advances provision.

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• Assess bad loans written-off. Prepare schedule of movements on Bad loans and
written offs. See that the transaction shave been approved by an appropriate
authority.
• Check that the restatement of foreign currency loans and advances / other
current assets has been done properly.
Presentation and Disclosure- Required disclosures for loans and advances and
other current assets have been appropriately made. Ensure whether the following
disclosures as required under Ind AS have been made.
Whether loans have been classified as security deposits, loans to related parties
and other loans with nature,
Whether all the above loans have been further sub-classified as,
Secured and considered good
Unsecured but considered good and
Doubtful
Whether bad debts written and doubtful loans have been disclosed separately
under the relevant heads i.e. loans due from-
Director of the company
Director of the company jointly with other persons
Officer of the company
Officer of the company jointly with other persons
Firm in which director is a partner
Private Company in which director is a director or a member
III. Trade Receivables
Trade receivables are often referred to as debtors or account receivables. These
are monies which are owed to an enterprise by a customer. The account receivable is
a sale made on credit to a customer. It is important to carry out compliance
procedures in the sales audit as part of the debtors’ audit. It is to ensure that the
system for receivables has the following features.
• Only bonafide sales lead to receivables.
• All such sales are made to approve customers.
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• All such sales are recorded.
• Once recorded, the debts can only be eliminated by receipt of cash or on the
authority of a responsible official.
• Debts are collected promptly.
• Balances are regularly reviewed.
• A proper system of follow up exists and if necessary, adequate provision for bad
debts is made.
The audit procedures to be undertaken while auditing trade receivables is as
under
Existence-To assess the existence of trade receivables as at the end of the year,
• Check whether there are controls in place to ensure that sales invoices cannot be
recorded more than once and are automatically recorded in the general ledger
from the original invoice.
• Ensure that trade receivables ledger reconciles to general ledger.
• Calculate the receivable report, aging report to verify that the total traced to the
general ledger is correct.
• See whether realization is recorded invoicewise or not. If not, check that money
received from debtors is adjusted chronologically invoicewise and on FIFO
basis i.e. previous bill is adjusted first. If realization is made on account, verify
if the Company has obtained confirmations from debtors.
Confirmation with the Customers - The auditor, with the consent of the
enterprise under audit, is to contact customers directly and ask them to confirm the
unpaid amounts at the end of the audit period. There may be situations where the
management of the enterprise requests the auditor not to seek confirmation from
certain trade receivables. In such cases, the auditor should consider whether there are
valid grounds for such a request. The form of requesting confirmation may be either
‘positive’ or ‘negative’.
In case of positive form, the customers are asked to confirm whether the
outstanding balance is correct or not, whereas, in case of negative form, the
customers are requested to respond only if they disagree with the balance shown. The
use of the positive form is preferable if individual account balances are relatively
large, the internal controls are weak, there found substantial number of accounts in
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dispute, or inaccuracies or irregularities. The negative form is useful when internal
controls are effective, a large number of small balances are involved and when the
auditor has no reason to believe that the trade receivables are unlikely to respond.
The method of selection of the trade receivables to be circularised should not be
revealed to the enterprise until the trial balance of the trade receivables’ ledger is
handed over to the auditor. A list of trade receivables selected for confirmation
should be given to the enterprise for preparing request letters for confirmation. The
auditor should maintain strict control to ensure the correctness and proper despatch
of request letters or the auditor may request the enterprise to provide duly authorised
confirmation letters and s/he may fill in the names, addresses and the amounts
relating to trade receivables selected by him and mail the letters directly. It should be
ensured that confirmations as well as any undelivered letters are returned to the
auditor and not to the client. Any discrepancies revealed by the confirmations
received, the enterprise should be asked to investigate and reconcile the
discrepancies. In addition, the auditor should also consider what further tests he can
carry out in order to satisfy himself as to the correctness of the amount of trade
receivables taken as a whole.
If no reply is received, the auditor should perform additional testing regarding
the balances. This may include-
Agreeing the balance to cash received,
Agreeing the detail of the respective balance to the customer’s remittance
advice,
Preparing a detailed analysis of the balance, ensuring it consists of identifiable
transactions and confirming that these revenue transactions were actually occurred,
If there are any related party receivables, review them for recovery, as well as
whether they were properly authorized and the value of such transactions were
reasonable and at arm’s length.
Check that receivables for other than sales or services are not included in the
list. Review a trend line of sales and accounts receivable to see if there are any
unusual trends. Also, measure the average collection period. Make inquiries about
reasons for changes in trends from the management and document the same in audit
work papers.

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 Completeness- Trade receivable balances are supposed to be recorded correctly
in the financial statements. The auditor needs to satisfy himself of correct and proper
cut-offs. Without a correct cut-off, sales could be understated or overstated, hence,
the need to perform the following cut off tests.
• For the invoices issued during the last week closer to the cut-off date, the goods
should have been dispatched and not lying with the enterprise and included in
closing stock;
• All good dispatched prior to the year-end have been invoiced and included in
debtors;
• No goods dispatched after the year- end have been invoiced and included in
debtors for the period under audit.
Test invoices listed in receivable report- Select few invoices from the accounts
receivable ageing report and compare them with supporting documents to see if they
were billed with the correct amounts, to the correct customers and on the correct
dates.
Match invoices to dispatch log- Match invoice dates to the shipment dates for
those items in the dispatch log, to see if sales are being recorded in the correct
accounting period. This can include an examination of invoices issued subsequent to
the period being audited, to see if they should have been included in the period under
audit.
Assess bill and hold sales- It is known as “bill and hold” procedure. If there is a
situation where the enterprise is billing customers for sales despite still retaining the
goods on-site, examine supporting documentation to determine whether a sale has
actually taken place.
Review receiving log- Review the receiving log to see if the enterprise has
recorded a very large amount of customer returns after the audit period, which would
suggest that the enterprise may have shipped more goods near the end of the audit
period, than the customers had authorized. Study the system of giving discounts and
check-
- Whether the same is being given as per the policy,
- Whether cash discount is given on the basis of date of realization of cheque or
on the basis of date of receipt of cheque. If it is on the basis of date of receipt of
cheques, verify that the cheque has been realized within a reasonable time.
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 Review credit memos- Review the credit memos issued during the audit period
to see if they were properly authorized, whether they were issued in the correct
period and whether they indicate other problems. Also, review credit memos issued
after the period being audited, to see if they relate to transactions from within the
audit period. Where any deduction has been made against a bill, check the reason and
correspondence for the same.
Valuation- Trade receivable balances have been valued appropriately. The
auditor is to assess the allowance for doubtful accounts. Review the process followed
by the enterprise to derive an allowance for doubtful accounts. This will include a
consistency comparison with the method used in the last year, and a determination of
whether the method is appropriate for the underlying business environment.
Obtain the ageing report of accounts receivable and split as not currently due, 30
days old, 30-60 days old, 60- 180 days old, 180- 365 days old and more than 365
days old. Also, obtain the list of debtors under litigation and compare them with that
in previous year.
Scrutinize and identify the debts which appear doubtful, discuss with
management about their reasons, if any of these debts are not included in the
provision for bad debts, perform further testing where any disputes exist, find the
adequacy of the bad debts provision.
Assess bad debt write offs- Prepare schedule of movements on Bad Debts –
Provision Accounts and Debts written off and compare the proportion of bad debt to
sales for the current year in comparison to prior years, to see if the current expense
appears reasonable. Also check that write-offs have been approved by an appropriate
authority.
Presentation and Disclosure- Required disclosures for trade receivables have
been appropriately made. Check that the confirmation of foreign currency trade
receivables has been done properly. Determine that the accounting policies and
procedures related to accounts receivables are appropriate and are applied
consistently according to GAAPs. Validate that the enterprise presents and discloses
its accounts receivable balances in the balance sheet and its accompanying notes
properly.
Verify that the split between more than 6 months and less than 6 months has
been done from the due date instead of sales invoice date. Check classification of
amount due is properly disclosed as,
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• Secured, considered good
• Unsecured, considered good
• Doubtful
Verify that proper disclosure of amounts due from the following parties has been
made:
• By directors
• By other officers of the company
• By any of them either severally
• By jointly with any other person
• By firms
• By private companies respectively in which any director is a partner or director
or member.
Note down the transactions with parties under section 189 of Companies Act,
2013 and ensure that the same is reported properly in CARO.
IV. Inventories
Inventories are a form of current asset held for sale in the ordinary course of
business or for consumption in the production of goods / service for sale. As per AS
2- ‘Valuation of Inventories’ and IND AS 2- ‘Inventories’’, inventory is valued at
lower of cost and net realisable value. This general principle applies to valuation of
all inventories except inventories of the following to which special considerations
apply.
(a) Work-in-progress arising under construction contracts, including directly related
service contracts (refer Accounting Standard (AS) 7, “Construction Contracts”),
(b) Shares, debentures and other financial instruments held as inventory (refer AS
2- ‘Valuation of Inventories’ and IND AS 2- ‘Inventories’) and
(c) Inventories of livestock, agricultural and forest products, and mineral oils, ores
and gases to the extent that they are measured at net realisable value in
accordance with well-established practices in those industries (refer AS 2-
‘Valuation of Inventories’) and biological assets as defined under IND AS 41-
‘’Agriculture’’ and part of exclusions under IND AS 2- ‘Inventories’’.

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 The inventories referred to in (c) above are measured at net realisable value at
different stages of production. This occurs, for example, when agricultural crops
have been harvested or mineral oils, ores and gases have been extracted and sale is
assured under a forward contract or a Government guarantee, or when a homogenous
market exists and there is a negligible risk/ uncertainty of failure to sell. Such
inventories are accordingly, excluded from the scope.
Work in Progress- Ascertain how the various stages of production/ value add are
measured and estimates are made, understand the basis for such estimates. Ascertain
what elements of cost are included and the basis of inclusion. Ensure that the
overheads included have been determined based on normal costs and appear
reasonable in relation to the information disclosed in the draft financial statements.
Consistency-There should be consistency in the basis of valuation of inventory
and that of work-in-progress. If it is changed during the period under audit, it should
be disclosed how it has affected the financial statements of the enterprise.
The audit procedures required to be undertaken while auditing ‘inventories’ and
work-in-progress-
Existence-To establish the existence of inventories and work-in-progress as on
the date of year ending -
- Review client’s plan for performing inventory and work-in-progress count.
- Ensure that consigned goods have been segregated.
- Evidence of appropriate supervision for those performing count should be
examined.
- Personally perform test counts to verify that,
• the employees are adhering to the agreed plan.
• all items are properly tagged.
• proper amounts are shown on tags.
• tags and summary sheets are controlled and reconciled.
• reconciliation of test counts with tags and summary sheets and discrepancies
noted, if any are summarized and agreed with client personnel.
- Stay alert and cautious about empty boxes, etc. and obsolete items.

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- Establish cut off by documenting last receiving reports and shipping documents
for the period.
- Ensure exclusion of third party stock and damaged or obsolete stock.
- Ensure the accounting of all stock sheets.
- Investigating any significant difference between the physical stock and the stock
records.
Further, the auditor should ask the client personnel to sign all stock count sheets
and also agree the variances observed, if any to avoid any conflicts of opinion at the
time of reporting. When control risk is high and/or client uses periodic system,
inventory count should be undertaken at end of the period. If client uses perpetual
system, inventory may be counted at interim dates. Confirm or investigate public
warehouse inventory of client and also, any inventory of client lying with a third
party.
Completeness- Only the inventories held by enterprise have been recorded in the
financial statements and do not include any inventories that belong to third parties
but does include inventories owned by the enterprise and lying with a third party.
Perform analytical procedures-
— Compute inventory turnover ratio
— Perform vertical analysis
— Compare budgetary expectations vis-à-vis actual
Examine weights and measures.
Perform purchase and sales cut-off tests. Trace shipping documents (bills of
lading and receiving reports, warehouse records, and inventory records) to
accounting records immediately before and after year-end. Perform tests for omitted
transactions and tests for invalid transactions with respect to tagged inventory.
• Verify the clerical and arithmetical accuracy of inventory listings.
• Reconcile physical inventory amounts with perpetual records.
• Reconcile physical counts with general ledger control totals.
Rights and Obligations- The enterprise has valid legal ownership rights over the
inventories claimed to be held by the enterprise and recorded in the financial
statements
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 Vouch recorded purchases to underlying documentation (purchase requisition,
purchase order, receiving report, vendor invoice, and cancelled check or payment
file).
Evaluate the consigned goods- Examine client correspondence, sales and
receivables records, purchase documents.
• Determine existence of collateral agreements
• Review consignment agreements
• Review material purchase commitment agreements
• Examine invoices for evidence of ownership
• In case of inventory held by third party, the auditor should insist on obtaining
declaration from the third party confirming that the items of inventory belong to the
enterprise and are being held by such third party on behalf of and for the benefit of
the enterprise under audit.
Valuation- Inventories have been valued appropriately and as per generally
accepted accounting policies and practises. Inventory may be value by using “first in
first out (FIFO)” “last in first out (LIFO),” or a weighted average system.
Presentation and Disclosure- Required disclosures for inventories have been
appropriately made. Ensure whether the following disclosures as required under Ind
AS compliant Schedule III to Companies Act, 2013 have been made.
• Whether mode of valuation has been stated separately for each class of
inventory
• Whether inventory has been classified as,
— Raw materials
— Work-in-progress
— Finished goods
— Stock-in-trade (goods acquired for trading)
— Stores and spares
— Loose tools
— Others (specifying nature)

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• Whether goods-in-transit have been disclosed separately under each sub-head of
inventory
V. Cash and Cash Equivalents
Cash and cash equivalent in the form of cash in hand, stamps in hand, balances
with bank in various accounts, cheques in hand, etc. represent the most liquid assets
of an enterprise. Utmost professional scepticism needs to be exercised while auditing
such balances.
Existence- Establish the existence of cash and cash equivalent balances as at the
end of the period.
Completeness- Cash and cash equivalent balances have been recorded in the
financial statements as required to record.
Verification of cash balances are to be checked by surprise without giving notice
of the auditor’s visit either to the client or to his staff. If there are more than one cash
balances, all of them should be checked simultaneously, as far as practicable. It is
desirable for the cashier to be present while cash is being counted and he should be
made to sign the statement of the cash balance counted. If the auditor is unable to
check the cash balance on the date of the Balance Sheet, he should arrange with his
client for all the cash balance to be banked and where this cannot conveniently be
done on the evening of the close of the financial year.
The practice should also be adopted in the case of balance at the factory, depot
or branch where cash cannot be checked at the close of the year. In case this is not
possible, the auditor should verify the receipts and payments of cash up to the date he
counts the cash. This should be done soon after the cash balances have been counted.
The Cash Book of the day on which the balance is verified should be signed by the
auditor to indicate the stage at which the cash balance was checked. If any cheques
or drafts are included in cash balance, the total thereof should be disclosed.
If there is any rough Cash Book or details of daily balance are separately kept,
the auditor should test entries from the rough Cash Book with those in the Cash Book
to prove that entries in the Cash Book are correct. If the auditor finds any slip, chit or
(I owe you) I.O.U.s in respect of temporary advances paid to the employees included
as part of the cash balance he should have them initialled by a responsible official
and debited to Appropriate Accounts.

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 The auditor should also perform a cash sensitivity analysis by compiling a
summary of total cash receipts and payments each month and analyse the trends to
see if there is variations in any specific month and request explanations from the
management. The auditor needs to obtain bank reconciliation statements for all bank
accounts maintained. The auditor should request the client to provide Bank
Reconciliation Statement signed by the accountant and approved by the authorised
official so that he is able to assign responsibility in case of any errors.
Verification of Bank Reconciliation Statement shall perform the following-
• Tally the balance as per books to the trial balance
• Tally the balance as per bank to the bank statement
• Checking of all material reconciling items and should verify if the cheques
issued have subsequently been cleared by bank. For all cases where cheques
have become stale i.e. 3 months or more has lapsed since the issue date, the
same should not appear in the BRS and should have instead been clubbed under
liabilities.
• Cheques deposited but not credited by bank, verify if the balances were credited
by bank subsequently.
• For any instances related to cheques not cleared beyond reasonable time, the
auditor should seek explanations from the management and in case such
explanations are found to be unsatisfactory, the auditor should verify of the
revenue recognition related to such parties was in order and as per the normal
revenue recognition accounting policy.
• For Amounts / Charges debited / credited by bank but not accounted for; auditor
should request for bank statements and tally the same. If the amounts are found
to be material, the auditor should insist the management to record adjustments
for the same in its books of account or else, the auditor should qualify his
opinion with respect to cash and cash equivalents
For confirmation of cash and cash equivalents, following procedure is to be
followed.
• Ask for confirmation certificate from bank to confirm the balances held in all
bank accounts.

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• Ask the client to investigate and reconcile the discrepancies, if any and have
written explanations from the banks on any unresolved queries.
• In remote situations were no reply is received, the auditor should perform
additional testing regarding the balances.
Valuation- Cash and cash equivalent balances have been valued appropriately.
In addition to the procedures performed above, the auditor should ensure that all
bank accounts holding foreign currency have been restated at the closing exchange
rates.
Presentation and Disclosure- Required disclosures for cash and cash equivalents
have been appropriately made. Ensure whether the following disclosures as required
under Ind AS compliant Schedule III to Companies Act, 2013 have been made:
• Cash and cash equivalents shall be classified as-
(a) Balances with banks;
(b) Cheques, drafts on hand;
(c) Cash on hand;
(d) Others (specifying nature)
• Earmarked balances with banks shall be separately stated.
• Balances with banks to the extent held as margin money or security against the
borrowings, guarantees, other commitments shall be disclosed separately.
• Bank deposits with more than 12 months’ maturity shall be disclosed separately.
VI. Provisions and Contingent Liabilities
Provisions are amounts charged against revenue to provide for a -
(i) known liability, the amount whereof cannot be determined with substantial
accuracy or
(ii) claim which is disputed.
A provision is recognised when-
(i) an enterprise has a current legal obligation as a result of a past event;
(ii) it is probable that an outflow of resources will be required to settle the
obligation; and

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(iii) a reliable estimate can be made of the amount of the obligation. If the above
conditions are not met, no provision is recognised.
Contingent Liability -The contingent liability is the probable liability which may
or may not occur depending upon happening or non-happening of an event in future.
It is not wholly within the control of the enterprise. These liabilities do not meet the
recognition criteria.
a) It is a present obligation but is not recognized because it is not likely that will be
required to settle,
b) The amount of the obligation cannot be measured with sufficient reliability.
c) In a general sense, all provisions are contingent because they are uncertain. The
term ‘contingent’ is used for liabilities and assets that are not recognized
because their existence will be confirmed only by the occurrence or non-
occurrence of one or more uncertain future events.
The audit procedures required to be undertaken while auditing provisions and
contingent liabilities:
Existence - Establish the existence of provisions as at the end period under
audit.
Completeness- Provisions that were supposed to be recorded have been
recognized in the financial statements.
Valuation- Provision balances have been valued appropriately.
Audit Procedure to be followed-
• Obtain a list of all provisions and compare them with balances in the ledger.
• Inspect the appointment agreement with employees to understand the
enterprise’s commitment towards defined benefits,
• Inspect agreement with customers to assess warranty commitments, any legal
and other claims on the enterprise.
• Obtain from the management the original working and the basis for each of the
provisions made and verify whether the same is complete and accurate.
Presentation and Disclosure- Required disclosures for provisions have been
appropriately made. Ensure whether the following disclosures as required under Ind
AS compliant Schedule III to Companies Act, 2013 have been made.
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• Whether current and non- current portions have been split for provision for
employee benefits and others (specifying nature)
• Whether for each class of provision, disclosure has been made for-
• The carrying amount at the beginning and end of the period,
• Additional provisions made in the period, including increases to existing
provisions,
• Amounts used during the period,
• Unused amounts reversed during the period and
• A brief description of the nature of the obligation and the expected timing of any
resulting outflows of economic benefits.
If the possibility of settlement of contingent liabilities is less, see whether
disclosure has been made for each class of contingent liability at the end of the
reporting period. It should disclose-
• an estimate of its financial effect,
• an indication of the uncertainties relating to the amount or timing of any outflow
and
• the possibility of any reimbursement.
Whether Contingent liabilities have been classified as-
• Claims against the company not acknowledged as debts;
• Guarantees;
• Other money for which the enterprise is contingently liable.
• Whether the amount of any guarantees given by the enterprise on behalf of
directors or other officers of the enterprise has been stated and where
practicable, the general nature of each such contingent liability, if material has
also been specified.
Check your progress - E
State whether the following statements are true or false.
1. In respect of fixed assets, auditor should check self constructed assets,
improvements and capital work-in-progress.

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2. An auditor should verify that intangible assets are in active use in the operations
of the enterprise.
3. It is the duty of the auditor to inspect loan agreements and acknowledgements
of parties while auditing loans and advances.
4. While checking trade receivables, auditor can rely fully on the amounts
mentioned in the balance sheet without confirming its authenticity and accuracy.
5. In general, there should be consistency in the basis of valuation of inventories
and work-in-progress.
6. Bank Reconciliation Statement is prepared to confirm cash balance and bank
balance as per cash book and bank pass book.
7. As the contingent liabilities not affect the total of the balance sheets, it is not the
duty of the auditor to verify the contingent liabilities.

2.3 Summary
In this unit we studied how to audit important items from financial statements.
Auditor needs to assess occurrence, authenticity, completeness, existence and
appearance of items appearing in financial statements which are called as Tests of
Audit.
Before starting actual work of checking of records, an auditor should study the
nature and size of the business, the concerned Acts, system of accounting and its
computerisation and the internal control system.
While conducting audit of Specific Items in Profit & Loss Account, an auditor
should verify carefully the Sale of Products and Services, Interest Income, Rental
Income, Dividend Income and Net gain/loss on sale of Investments from income side
and Purchases, Depreciation, Interest expense, Rent, Repair to building, Repair to
Machinery, Insurance, Taxes, Travelling Expenses, Miscellaneous Expenses from
expenses side.
It is the duty of the auditor to audit each and every item of balance sheet. The
auditor should audit Share Capital, Reserve & Surplus, Long Term Borrowings,
Trade Payables (creditors), Provisions, Short Term Borrowings and Other Current
Liabilities considering every aspect.
The auditor should also examine the assets, Land and Buildings, Plant and
Equipment, Furniture and Fixtures, Goodwill, Brand, Trademarks, Computer
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Software, Loans and Advances, Trade Receivables, Inventories, Cash and Cash
Equivalents, Other Current Assets and Contingent Liabilities carefully with all
supportive evidences.
2.4 Terms to Remember
1. Financial Statements - Financial Statements refers to Profit and Loss Account
and Balance Sheet.
2. Test of Audit of items in Financial Statements –
a) Occurrence – This test verifies the items appearing in the financial
statements have actually occurred during the period of audit and are related
with the enterprise.
b) Authenticity: This test examines the items recorded in the statements are
related to the enterprise and authentic.
c) Completeness: This test assesses all items appearing in the financial
statements were recorded and disclosed at right time. Also, the required
notes to the items are accompanied to the financial statements.
d) Existence: This test verifies the items appearing in the statements were
existed on the date of the statement, possessed by and related to the
enterprise.
e) Measurement or Valuation: This test checks the items in the statements are
recorded accurately with their appropriate amounts.
f) Disclosure: This test reveals the items in the financial statements have been
classified and presented properly in the financial statements as per
applicable accounting standards.

2.5 Answers to check your progress

Check your progress – A –
Answers – All the statements are true.
Check your progress – B
Answers-1. false 2. true 3. false 4. true
5. false 6. true

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Check your progress – C
Answers – All the statements are false.
Check your progress – D
Answers- 1.True 2. False 3.True 4. False 5.True
Check your progress – E
Answers – 1. true 2. true 3. true 4. false
5. true 6. true 7. false

2.6 Exercise
A) Broad answer type questions
1. How will you audit Sales of Products or Services?
2. How will you audit Purchases?
3. How will you audit Share Capital?
4. How will you audit Borrowings?
5. How will you audit Tangible Fixed Assets?
6. How will you audit Intangible Fixed Assets?
7. How will you audit Trade Receivables?
B) Short answer type questions
1. How will you audit Other Expenses?
2. How will you audit Reserves and Surplus and Provisions?
3. How will you audit Trade Payables?
4. How will you audit Other Current Liabilities?
5. How will you audit Loans and Advances?
6. How will you audit Inventories?
7. How will you audit Cash and Cash Equivalents?
C) Write short notes
1. Tests of Audit items in Financial Statements
2. Audit of Interest Income
3. Audit of Rental Income

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 4. Audit of dividend
5. Audit of Net Gain or Loss on sale of Investments
6. Audit of Depreciation
7. Audit of Contingent Liabilities.
2.7 References for Further Study
• Kamal Gupta – Contemporary Auditing – Tata McGraw-Hill Publishing
Company Ltd., New Delhi.
• F. Clive de Paula – The Principles of Auditing – Sir Isaac Pitman & Sons Ltd.
London.
• S. V. Ghatalia (Indian Edition) - Spicer & Pegler’s Practical Auditing by Walter
W. Bigg – Allied Publishers Private Ltd., New Delhi.
• B. N. Tandon - A Handbook of Practical Auditing – S. Chand & Co., New
Delhi.
• B. N. Tandon, S. Sudharsanam, S. Sundharabahu - A Handbook of Practical
Auditing – S. Chand & Co.Ltd., New Delhi.
• Jagdish Prakash – Auditing Principles, Practices and Problems – Kalyani
Publishers, New Delhi.
• V. H. Kishnadwala, N. H. Kisnadwalla, M. V. Shetti - Auditing Principles and
Practice – Sultan Chand & Sons, New Delhi.
• Dr. P. M. Herekar – Auditing – Ajab Publications, Kolhapur.
• Ravinder Kumar, Virender Sharma - Auditing Principles and Practice – PHI
Learning Private Limited, Delhi.

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 Unit-3
Company Audit

Structure of Unit
3.0 Objectives
3.1 Introduction
3.2 Presentation of Subject Matter
3.2.1 Auditor’s Eligibility, Qualifications and Disqualifications of Auditor
3.2.2 Appointment of Auditor
3.2.3 Removal and Resignation of Auditor
3.2.4 Remuneration of Auditor
3.2.5 Powers and Duties of Auditor
3.2.6 Branch Audit and Joint Audit
3.2.7 Reporting Requirements under the Companies Act, 2013 including CARO
3.3 Summary
3.4 Key words
3.5 Check your progress
3.6 Questions for Self-Study
3.7 References for Further Reading

3.0 Objectives:
After studying this unit, students shall be able to-

Understand the provisions of the companies act relating to audit

Understand the reporting requirement under the companies act

3.1 Introduction :
Companies Act 2013 has given various provisions regarding audit of companies.
Sections 139 to 148 of the Companies Act deal with audit of companies. Therefore, it

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is important to understand these provisions in order to know the details about
company audit. Section 128 to 138 give the details about ‘Accounts’ of the
companies while the sections 139 to 148 give the details of ‘Audit’ of companies.
Eligibility, qualification, disqualification, powers and duties of auditor are mentioned
in these sections. Similarly provisions relating to appointment, remuneration and
removal of company auditor are also given in these sections.

3.2 Presentation of Subject Matter

3.2.1 Auditor’s Eligibility, Qualifications and Disqualifications of Auditor
Eligibility and Qualification : Section 141 (1) & (2) of the Act prescribed the
following eligibility and qualifications of auditor :-
i. Only a Chartered Accountant (individual) or a firm where majority of partners
practicing in India are Chartered Accountants can be appointed as auditor.
ii. Where a firm including a limited liability partnership (LLP) is appointed as an
auditor of a company, only the partners who are chartered accountants shall be
authorized to act and sign on behalf of the firm
Disqualifications of Auditor
Section 141 (3) of the Act read with Rule 10 prescribed the following persons
shall not be eligible for appointment as an auditor of the company:
• A body corporate, except LLP;
• An officer or employee of the company;
• Any partner/employee of officer or employee of company;
• A person who himself or his relative/partner is holding any security or interest in
the company, or any company which is its holding, subsidiary, associate;
• A person whose relative is holding security or interest not exceeding Rs. one
Lac face value in companies as mentioned above. Provided that this condition be
also applicable in the case of a company not having share capital or other
securities, wherever relevant. Provided further that in the event of acquiring any
security or interest by a relative, above the threshold limit i.e. Rs. one lac, the
corrective action to maintain the limits (Rs. one lac) shall be taken by the auditor
within 60 days of such acquisition or interest;

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• A person who or whose relative or partner is indebted to the company or its
subsidiary or its holding or associate company or a subsidiary of such holding
company, in excess of rupees five lakh shall not be eligible for appointment;
• A person who or whose relative or partner has given a guarantee or provided
any security in connection with the indebtedness of any third person to the
company, or its subsidiary, or its holding or associate company or a subsidiary
of such holding company, in excess of one lakh rupees shall not be eligible for
appointment;
• A person or a firm who, whether directly or indirectly, has “business
relationship” with the company, or its subsidiary, or its holding or associate
company; The term “business relationship” shall be construed as any transaction
entered into for a commercial purpose, except – (i) commercial transactions
which are in the nature of professional services permitted to be rendered by an
auditor or audit firm under the Act and the Chartered Accountants Act, 1949 and
the rules or the regulations made under those Acts; (ii) commercial transactions
which are in the ordinary course of business of the company at arm’s length
price - like sale of products or services to the auditor, as customer, in the
ordinary course of business, by companies engaged in the business of
telecommunications, airlines, hospitals, hotels and such other similar businesses.
• A person whose relative is a director or is in the employment of the company as
a director or key managerial personnel; 6 Audit and Auditors
• A person who is in full time employment elsewhere;
• Person who is auditor of more than 20 companies;
• A person who has been convicted by a court of an offence involving fraud and a
period of ten years has not elapsed from the date of such conviction;
• Any person whose subsidiary or associate company or any other form of entity,
is engaged as on the date of appointment in consulting and specialized services
as provided in section 144.
According to section 141 (4) where a person appointed as an auditor of a
company incurs any of the disqualifications mentioned as above after his
appointment, he shall vacate his office as such auditor and such vacation shall be
deemed to be a casual vacancy in the office of the auditor

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3.2.2 Appointment of Auditor
Appointment of Auditor of Companies in General : In terms of section
139(1) of the Companies Act, 2013 read with rule 3 of Companies (Audit and
Auditors) Rules, 2014 every company shall at the first annual general meeting,
appoint an individual or a firm as an auditor who shall hold office from the
conclusion of that meeting till the conclusion of its sixth annual general meeting
(AGM) and thereafter till the conclusion of every sixth meeting and the manner and
procedure of selection of auditors by the members of the company at such meeting
shall be such as prescribed under
Before considering the appointment of auditor, the Audit Committee or the
Board, as the case may be, shall consider any pending proceeding relating to
professional matters of conduct against the proposed auditor before the ICAI or any
competent authority or any Court. Further they may call for such other information
from the proposed auditor as it may deem fit. Where a company is required to
constitute the Audit Committee, the committee shall recommend the name of an
individual or a firm as auditor to the Board for consideration and in other cases, the
Board shall consider and recommend an individual or a firm as auditor to the
members in the AGM for appointment. If the Board agrees with the recommendation
of the Audit Committee, it shall further recommend the appointment of auditor to the
members in the AGM otherwise, it shall refer back the recommendation to the
committee for reconsideration citing reasons for such disagreement. Thereafter if the
Audit Committee decides not to reconsider its original recommendation, then Board
shall record reasons for its disagreement with the Audit committee and send its own
recommendation for consideration of the members in the AGM and if the Board
agrees with the recommendations of the Audit Committee, it shall place the matter
for consideration by members in the AGM.
The auditor appointed in the AGM meeting shall hold office from the
conclusion of that meeting till the conclusion of the sixth annual general meeting,
with the meeting wherein such appointment has been made being counted as the first
meeting. Such appointment shall be subject to ratification in every AGM till the sixth
AGM by way of passing of an ordinary resolution. If the appointment is not ratified
by the members of the company, the Board of Directors shall appoint another
individual or firm as its auditor or auditors after following the procedure laid down in

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this behalf under the Act. Section 139(6) of the Act stipulated that first Auditor of the
Company other than Government Company, shall be appointed by the Board within
30 days of its date of registration and in case of failure to do so by Board of
Directors, the members shall be informed and they shall appoint the same within 90
days form incorporation, who shall hold office till conclusion of first annual general
meeting.
As per second proviso of section 139(1) read with rule 4 stipulated that written
consent of the auditor must be taken before appointment. The auditor appointed shall
submit a certificate that: (a) the individual/firm is eligible for appointment and is not
disqualified for appointment under the Act, the Chartered Accountants Act, 1949 and
the rules or regulations made thereunder;
(b) the proposed appointment is as per the term provided under the Act;
(c) the proposed appointment is within the limits laid down by or under the
authority of the Act;
(d) the list of proceedings against the auditor or audit firm or any partner of the
audit firm pending with respect to professional matters of conduct, as disclosed
in the certificate, is true and correct. Certificate shall also indicate whether the
auditor satisfies the criteria provided in section 141 of the Act
Appointment of Auditor in Companies in case of Government Companies
:The appointment of auditor in Government company or government controlled
(directly/indirectly) company shall be held in accordance with the following
provisions:
The First auditor shall be appointed by the Comptroller and Auditor General
within 60 days from the date of incorporation and in case of failure to do so, the
Board shall appoint auditor within next 30 days and on failure to do so by Board of
Directors, it shall inform the members, who shall appoint the auditor within 60 days
at an extraordinary general meeting (EGM), such auditor shall hold office till
conclusion of first Annual General Meeting.
In case of subsequent auditor for existing government companies, the
Comptroller & Auditor General shall appoint the auditor within a period of 180 days
from the commencement of the financial year and the auditor so appointed shall hold
his position till the conclusion of the Annual General Meeting.

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 In the case of a company whose accounts are subject to audit by an auditor
appointed by the Comptroller and Auditor-General of India, be filled by the
Comptroller and Auditor-General of India within thirty days. In case the Comptroller
and Auditor-General of India does not fill the vacancy within the said period, the
Board of Directors shall fill the vacancy within next thirty days. The Act also
provides that in case the Company has an Audit Committee, then all appointments of
Auditor including filling of casual vacancy, shall be made after taking into account
the recommendations of the Committee.
3.2.3 Removal and Resignation of Auditor
Removal of Auditor : The auditor appointed under section 139 may be
removed from his office before the expiry of the term only by
(i) Obtaining the prior approval of the Central Government by filling an application
in form ADT-2 within 30 days of resolution passed by the Board
(ii) Holding the general meeting within sixty days of receipt of approval of the
Central Government for passing the special resolution.
(iii) Giving a reasonable opportunity of being heard.
Resignation of Auditor : The auditor who has resigned from the company shall
file a statement in Form ADT-3 indicating the reasons and other facts as may be
relevant with regard to his resignation as follows:
(i) In case of other than Government Company, the auditor shall within 30 days
from the date of resignation, file such statement to the company and the
registrar.
(ii) In case of Government Company or government controlled company, auditor
shall within 30 days from the resignation, file such statement to the company
and the Registrar and also file the statement with the Comptroller and Auditor
General of India (CAG). The onus to file such statement containing relevant
facts and reasons for resignation is on the resigning auditor and any
contravention of sub clause (2) is punishable with monetary fine which could be
minimum Rs. 50,000 and maximum Rs. 5 lakh.

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3.2.4 Remuneration of Auditor
Section 142 of the Act prescribed that the remuneration of the auditor of a
company shall be fixed in its general meeting or in such manner as may be
determined therein. Board may fix remuneration of the first auditor appointed by it.
The remuneration will be in addition to the out of pocket expensed incurred by the
auditor in connection with the audit of the company and any remuneration paid to
him for any other service rendered by him at the request of the company
3.2.5 Powers and Duties of Auditor
3.2.5.1 Powers of an Auditor:
Section 143(1) provided that Every auditor can access at all times to the books
of accounts, vouchers and seek such information and explanation from the company
and enquire such matters as he considers necessary, including the matters specified in
sub-Clauses (a) to (f). It is the duty of every auditor to make proper enquiry
regarding these matters, besides other matters and if he is satisfied, it is not necessary
to disclose this fact in his report. However, on enquiry, if he finds some adverse
features, it is his duty to report the same. Specific enquiries to be made by the auditor
under this sub-Section are as under:
a) Loans and Advances made by the Company Auditor shall inquire into
“whether loans and advances made by the company on the basis of security have
been properly secured and whether the terms on which they have been made are not
prejudicial to the interest of the company or its members.” It is applicable to all loans
and advances made on the basis of security. The auditor should verify that the
security held against the loans and advances made by the company are legally
enforceable and also ascertain the valuation of securities to see whether the loan is
fully secured or partly secured.
b) Transactions represented by book entries Auditor is required to inquire
“whether the transactions of the company which are represented merely by book
entries are not prejudicial to the interests of the company”. He should verify the all
book entry transactions and determine whether such transactions have actually taken
place and are not prejudicial to the interest of the company.
c) Sale of investments Auditor should inquire, “whether so much of the assets of
the company (except an investment company or a banking company) as consists of
shares, debentures and other securities, have been sold at a price less than that at

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which they were purchased by the company”. Auditor must verify the cases where
securities are sold at a price less than their cost of acquisition and if he finds that
such sale is bona fide Audit and Auditors 11 and the price realised is considered to
be reasonable, having regards to the circumstances of each case, no further reporting
is required.
d) Loans and Advances shown as deposits Auditor must verify “whether loans
and advances made by the company have been shown as deposits”. The auditor must
inquire in respect of all the deposits shown by the company and satisfy himself that
the loans and advances have not been shown as deposits.
e) Charging of Personal expenses to revenue account Auditor should inquire as
to “whether personal expenses have been charged to revenue account”. Auditor must
ensure that no personal expenses of directors and officers of the company have been
charged to revenue account.
f) Allotment of shares for cash Auditor should inquire as to “whether cash has
actually been received in respect of shares stated to have been allotted for cash and if
no cash has actually been so received, whether the position as stated in the account
books and balance sheet is correct, regular and not misleading”. In this connection,
auditor must ensure in respect of shares allotted in cash by the company that cash has
actually been received in respect of such allotment by the company. He should verify
and report the cases where cash was not received and that the position, as stated in
books of accounts and balance sheet, is correct, regular and not misleading. Auditor
will have access to books of accounts and vouchers, not only to those kept at
registered office of the company but also to those kept at any other place. Such
access shall be available at all times. Also, auditor of a holding company shall have
access to the books of all of its subsidiary companies for the purpose of consolidation
of financial statements of holding company and its subsidiaries.
3.2.5.2 Duties of an Auditor:
The duties of an auditor have been laid down by the Companies Act, 2013,
provided in Section 143. The Act explains the duties in a simplified manner,
although the list given is not exhaustive.
Prepare Audit Report
• An audit report, in simple terms, is an appraisal of a business’s financial
position. The auditor is responsible for preparing an audit report based on the

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 financial statements of the company. The books of accounts so examined by him
should be maintained in accordance with the relevant laws.
• He must ensure that the financial statements comply with the relevant provisions
of the Companies Act 2013, relevant Accounting Standards etc.
• In addition to this, it is imperative that he ensures that the entity’s financial
statements depict a true and fair view of the company’s financial position.
Form an Opinion : Positive of Negative:
The auditor’s report has a high degree of assurance and reliability because it
contains the auditor’s opinion on the financial statements. Where the auditor feels
that the statements do not depict a true and fair view of the financial position of the
business, he is also entitled to form an adverse opinion on the same. Additionally,
where he finds that he is dissatisfied with the information provided and finds that he
cannot express a proper opinion on the statements, he will issue a disclaimer of
opinion. A disclaimer of opinion basically indicates that due to the lack of
information available, the financial status of the entity cannot be determined.
However, it is to be noted that the reasons for such negative opinion is also to be
specified in the report.
Make Inquiries
One of the auditor’s important duties is to make inquiries, as and when he finds
it necessary. A few of the inquiries include:-
• Whether loans and advances made on the basis of security are properly secured
and the terms relating to the same are fair
• Whether any personal expenses (expenses not associated with the business) are
charged to the Revenue Account
• Where loans and advances are made, they are shown as deposits. d. Whether the
financial statements comply with the relevant accounting standards
Assist in Branch Audit:
Where the auditor is the branch auditor and not the auditor of the company, he
will lend assistance in the completion of the branch audit. He shall prepare a report
based on the accounts of the branch as examined by him and then send it across to
the company auditor. The company auditor will then incorporate this report into the
main audit report of the company. In addition to this, on request, if he wishes to, he
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may provide excerpts of his working papers to the company auditor to aid in the
audit.
Comply All Auditing Standards:
The Auditing Standards are issued by the Central Government in consultation
with the National Financial Reporting Authority. These standards aid the auditor in
performing his audit duties with relevant ease and accuracy. It is the duty of the
auditor to comply with the standards while performing his duties as this increases his
efficiency comparatively.
Report Fraud, if any:
Generally, in the course of performing his duties, the auditor may have certain
suspicions with regard to fraud that’s taking place within the company, certain
situations where the financial statements and the figures contained therein don’t quite
add up. When he finds himself to be in such situations, he will have to report the
matter to the Central Government immediately and in the manner prescribed by the
Act.
Professional Ethics and Code of Conduct :
The auditor, being a professional, must adhere to the Code of Ethics and the
Code of Professional Conduct. Part of this involves confidentiality and due care in
the performance of his duties. Another important requisite is professional scepticism.
In simple words, the auditor must have a questioning mind, must be alert to possible
mishaps, errors and frauds in the financial statements.
Assistance in Investigation:
In the case where the company is under the scope of an investigation, it is the
duty of the auditor to provide assistance to the officers as required for the same.
Hence, it can be seen that the duties of the auditor are pretty diverse, it has an all-
round and far-reaching impact. The level of assurance provided by a set of audited
financial statements is comparatively far higher as compared to regular unaudited
financial statements.
3.2.6 Branch Audit and Joint Audit
Branch Audit : Accounts of branch office can be audited by :
1. The company’s auditor; or

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2. Any other person, qualified to be and appointed as an auditor as per the
provisions of the Act as branch auditor; or
3. In case of foreign branch, by the company’s auditor or by an accountant or a
competent person appointed in accordance with the prevailing laws of the
foreign country.
The branch auditor shall prepare a report on the accounts of the branch
examined by him and the company’s auditor shall deal with such report in his audit
report in a manner as he considers necessary.
Duties and powers of the company’s auditor with reference to the audit of the
branch and the branch auditor.:
1. The duties and powers of the company’s auditor with reference to the audit of
the branch and the branch auditor, if any, shall be as contained in sub-sections
(1) to (4) of section 143 i.e. right of access to books of accounts, ensure about
the mandatory books of accounts maintained, prepare auditors’ report and state
the reasons of qualification in report, if any etc .
2. The branch auditor shall submit his report to the company’s auditor.
3. The provisions of sub-section (12) of section 143 read with rule 12 hereunder
regarding reporting of fraud by the auditor shall also extend to such branch
auditor to the extent it relates to the concerned branch.
Joint Audit : A joint audit is an audit of financial statements of an entity by two
or more auditors appointed with the objective of issuing the audit report. Such
auditors are described as joint auditors. The engagement partner and other key
members of the engagement team from each of the joint auditors shall be involved in
planning the audit. The joint auditors shall jointly establish an overall audit strategy
that sets the scope, timing and direction of the audit, and that guides the development
of the audit plan. Prior to the commencement of the audit, the joint auditors shall
discuss and develop a joint audit plan. In developing the joint audit plan, the joint
auditors shall:
a. Identify division of audit areas and common audit areas amongst the joint
auditors that define the scope of the work of each joint auditor;
b. Ascertain the reporting objectives of the engagement to plan the timing of the
audit and the nature of the communications required;

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c. Consider and communicate among all joint auditors the factors that, in their
professional judgment, are significant in directing the engagement team’s
efforts;
d. Consider the results of preliminary engagement activities and, where applicable,
whether knowledge gained on other or similar engagements performed earlier
by the respective engagement partner(s) for the entity is relevant.
e. Ascertain the nature, timing and extent of resources necessary to perform the
engagement.
At this stage, risks of material misstatement need to be considered and assessed
by each of the joint auditors and shall be communicated to other joint auditors, and
documented, whether pertaining to the overall financial statements level or to the
area of allocation among the other joint auditors. The joint auditors shall discuss and
document the nature, timing, and the extent of the audit procedures for common and
specific allotted areas of audit to be performed by each of the joint auditors and the
same shall be communicated to those charged with governance. The joint auditors
shall obtain common engagement letter and common management representation
letter. After identification and allocation of work among the joint auditors, the work
allocation document shall be signed by all the joint auditors and the same shall be
communicated to those charged with governance of the entity.
Responsibility and Co-ordination among Joint Auditors : In respect of audit
work divided among the joint auditors, each joint auditor shall be responsible only
for the work allocated to such joint auditor including proper execution of the audit
procedures. All the joint auditors shall be jointly and severally responsible for:
a. the audit work which is not divided among the joint auditors and is carried out
by all joint auditors;
b. decisions taken by all the joint auditors under audit planning in respect of
common audit areas concerning the nature, timing and extent of the audit
procedures to be performed by each of the joint auditors.
c. matters which are brought to the notice of the joint auditors by any one of them
and on which there is an agreement among the joint auditors;
d. examining that the financial statements of the entity comply with the
requirements of the relevant statutes;

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e. presentation and disclosure of the financial statements as required by the
applicable financial reporting framework;
f. ensuring that the audit report complies with the requirements of the relevant
statutes, the applicable Standards on Auditing and the other relevant
pronouncements issued by ICAI.
Where, in the course of the audit, a joint auditor comes across matters which are
relevant to the areas of responsibility of other joint auditors and which deserve their
attention, or which require disclosure or require discussion with, or application of
judgment by other joint auditors, the said joint auditor shall communicate the same to
all the other joint auditors in writing prior to the completion of the audit.
Standard on Auditing (SA) 299 (Revised) : It shall be the responsibility of each
joint auditor to determine the nature, timing and extent of audit procedures to be
applied in relation to the areas of work allocated to said joint auditor. It is the
individual responsibility of each joint auditor to study and evaluate the prevailing
system of internal control and assessment of risk relating to the areas of work
allocated to said joint auditor.
3.2.7 Reporting Requirements under the Companies Act, 2013 including
CARO
Section 143 (2) prescribed that auditor shall make a report to the members of the
company on the accounts examined by him and on every financial statement which is
required to be laid in the general meeting of the company. The Audit report should
take into consideration the provisions of this Act, the Accounting and Auditing
standards and matters which are required under this Act or rules made there under or
under any order made u/s 143(11). The Audit report should state that to the best of
his information and knowledge, the said accounts and financial statements give a true
and fair view of the state of the company’s affair as at the end of the financial year
and the profit or loss and the cash flow for the year and such other matters as may be
prescribed. Section 143 (3) laid down that auditor’s report shall also state other
details which are as under:
(a) whether he has sought and obtained all the information and explanations which
were necessary and if not, the details thereof and the effect of such information
on the financial statements;

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(b) whether, in his opinion, proper books of account as required by law have been
kept by the company and proper returns adequate for the purposes of his audit
have been received from branches not visited by him;
(c) whether the branch audit report prepared by a person other than the company’s
auditor has been sent to him;
(d) whether the company’s balance sheet and profit and loss account dealt with in
the report are in agreement with the books of account and returns;
(e) whether, in his opinion, the financial statements comply with the accounting
standards;
(f) the observations or comments of the auditors on financial transactions or matters
which have any adverse effect on the functioning of the company;
(g) whether any director is disqualified from being appointed as director under
section 164 (2);
(h) any qualification, reservation or adverse remark relating to the maintenance of
accounts and other matters connected therewith;
(i) whether the company has adequate internal financial controls system in place
and the operating effectiveness of such controls;
(j) Rule 11 prescribed that Auditor’s Report shall also include their views and
comments on the following matters, namely:- (i) whether the company has
disclosed the impact, if any, Audit and Auditors 13 of pending litigations on its
financial position in its financial statement; (ii) whether the company has made
provision, as required under any law or accounting standards, for material
foreseeable losses, if any, on long term contracts including derivative contracts;
(iii) whether there has been any delay in transferring amounts, required to be
transferred, to the Investor Education and Protection Fund by the company. The
auditor is required to provide the reasons, where any of the matters required to
be included in the Audit Report under this Clause is answered in negative or
with a qualification. {Section 143 (4)}
An auditor conducts an independent examination of the accounting information
presented by the business and issues a report there on. An auditor’s report is the
formal statement of the auditor’s opinion of the financial statements after conducting
an audit. Audit opinions are classified as follows:

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1. Unqualified opinion : This opinion states that the financial statements present
fairly, in all material respects, the financial position, results of operations, and
cash flows of the entity, in conformity with generally accepted accounting
principles.
2. Qualified opinion : A qualified opinion states that, except for the effects of the
matter(s) to which the qualification relates, the financial statements present
fairly, in all material respects, the financial position, results of operations, and
cash flows of the entity, in conformity with generally accepted accounting
principles.
3. Adverse opinion : This opinion states that the financial statements do not
present fairly the financial position, results of operations, and cash flows of the
entity, in conformity with generally accepted accounting principles.
4. Disclaimer of opinion : A disclaimer of opinion states that the auditor does not
express opinion on the financial statements. A disclaimer of opinion is rendered
when the auditor has not performed an audit sufficient in scope to form an
opinion.
The typical unqualified (or clean) opinion has three paragraphs. The first
paragraph indicates the financial statements that have been audited and states that
these statements are the responsibility of the company’s management. This paragraph
indicates that the auditors have the responsibility to express an opinion on these
statements based on the audit or to disclaim an opinion.
The second paragraph indicates that the audit has been conducted in accordance
with generally accepted auditing standards. Auditing standards define the required
level of audit quality. These standards are classified as to “general standards,” “field
work standards,” and “reporting standards.” The paragraph goes on to state that these
standards require the audit or to plan and perform the audit to obtain reasonable
assurance that the financial statements are free of material misstatement. The second
paragraph also includes a brief description of what is included in an audit. Further,
following description should be given as per the sequence.

Heading Brief of contents

Title Title should mention that it is an ‘Auditor’s Report’.
Addressee Should mention clearly as to whom the report is being given to.

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 For example ‘Members’ / Shareholders of …..Ltd.
Management’s It should be clearly mentioned that it is the Management’s
Responsibility for responsibility to Prepare the Financial Statements of the
Financial company and auditors duty is to give his opinion on these
Statements statement.
Mention that responsibility of the Auditor is to express an
Auditor’s
unbiased opinion on the financial statements and issue an audit
Responsibility
report.
Should mention the overall impression obtained from the audit
Opinion of financial statements of the organisation where audit is
conducted.
Basis of the State the basis on which the opinion as reported has been
Opinion achieved. Facts of the basis should be mentioned.
If any other reporting responsibility exists, the same should be
Other Reporting
mentioned.
Responsibility
For example Report on Legal or Regulatory requirements
The auditor shall sign the audit report. In case of firm of
Signature of the auditors, working partner has to sing the report. The seal and
Auditor membership number shall also be part of the report just below
the signature.
Place of Signature The city in which audit report is signed.
Date of Audit
Date on which the audit report is signed.
Report

The third paragraph gives an opinion on the statements - that they are in
conformity with GAAP. In certain circumstances, an unqualified opinion on the
financial statements may require that the auditor add an explanatory paragraph after
the opinion paragraph. In this paragraph, the auditor may express agreement with a
departure from a designated principle, describe a material uncertainty, describe a
change in accounting principle, or express doubt as to the ability of the entity to
continue as a going concern. An explanatory paragraph may also be added to
emphasize a matter.
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 Audit Report is a document used by the Auditors to express their opinion on the
financial statements they have audited. Auditors' opinion is that financial statements
give (or not give) true and fair view at a specific date
For any enterprise, the audit report is a key deliverable which shows the end
results of the entire audit process. The users of financial statements like Investors,
Lenders, Customers, and others base their decisions and plans on audit reports of any
enterprise. An audit report is always critical to influencing the perceived value of any
financial statement’s audit.
The auditor should be careful in issuing the audit report as there is are a large
number of people placing reliance on such report and taking decisions accordingly.
The report should be issued by being unbiased and objective in discharging the
functions.
Reporting Requirements under the Companies Audit Report Order (CARO)
Ministry of Corporate Affairs (MCA) notifies Companies (Auditor’s Report)
Order, 2020 (CARO 2020) which is applicable for audit of financial statements of
eligible companies for the financial years commencing on or after the 1st April,
2020. The auditor is required to report under this order for all class or classes of
companies, except for exempted companies, on the matters specified in the CARO
2016.
Companies (Auditor’s Report) Order, 2020 shall be made applicable from the
financial year 2020- 2021 instead of from 2019-2020 notified earlier. CARO, 2020
shall be applicable to all those companies on which CARO, 2016 was applicable.
These companies are as follows:
Every Public Company and Foreign Company as defined in Section 2(42) of the
Companies Act,2013 except Banking company , Insurance company, Company
licensed to operate under section 8 of the Companies Act,2013, One Person
Company, Small company (Companies with Paid up capital less than or equal to Rs.
50 Lakhs and Last reported turnover less than or equal to Rs. 2 Crores), Private
limited company, not being a subsidiary or holding company of a public company.
Following 21 clauses have to be reported under CARO, 2020.
i) Reporting requirements on:
Property, Plant, Equipment and intangible assets only.

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 Revaluation of Property, Plant, Equipment including rights of use assets or
intangible assets.
ii) Proceedings under the Benami Transactions (Prohibition) Act, 1988 and
disclosure in financial statements.
iii) Physical verification of inventory at reasonable interval by management and the
Opinion of the auditor on the coverage and procedure of such verification.
iv) The material discrepancies of 10% or more noticed if any.
v) Compliances if company was sanctioned working capital limits in excess of five
crore rupees or more from banks or financial institutions.
vi) Reporting requirements of investments in or providing of any guarantee or
security or granting any loans or advances to companies, firms, Limited
Liability Partnerships or any other parties.
vii) Reporting requirement on the compliances of provisions of section 185 and 186
of the companies Act, 2013 in respect of loans, investments, guarantees and
security.
viii) Reporting of compliances with RBI directives and the provisions the Companies
Act with respect to deposits or deemed deposits.
ix) Reporting requirements of Maintenance of Cost Record.
x) Reporting requirement on statutory dues.
xi) Reporting requirements with respect to transactions not recorded in the books of
account surrendered or disclosed as income in the income tax proceedings.
xii) Reporting requirements on Default in repayment of loans or other borrowing or
interest thereon, Declared as will defaulter by bank / financial institution / other
lender, Utilization of term loan for the purposes for which term loan has been
raised, Fund raised on short term basis have been used for loan term purposes,
Funds taken by the company to meet obligation if its subsidiaries, associates or
joint ventures, Loans raised on the pledge of securities held in its subsidiaries,
associates, joint ventures.
xiii) Reporting requirement on Utilization of money raised by way of IPO or further
public offer for the purposes for which money has been raised, Preferential
allotment or private equity placement of shares or fully or partly convertible
debentures and compliance of section 42 of Companies Act, 2013.
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xiv) Reporting requirement on Notice of fraud by / on the company, Report u/s
143(12) filed by the auditors in Form ADT-4, Treatment by auditor of whistle-
blower complaints received during the year by the company
xv) Reporting requirements on Net Owned Funds to Deposits of Nidhi Company in
the ratio of 1:20 and maintaining of 10% unencumbered terms deposits as per
Nidhi Rules 2014 and for default in the payment of interest on deposits or
repayments thereof for any period.
xvi) Reporting requirements on transaction with related parties
xvii)Reporting requirements on non-cash transaction with director or person
connected with him
xviii) Reporting requirement of Registration u/s 45IA of the Reserve Bank of India
Act, 1934, NBFC activities without valid certificate of registration, Fulfilling the
criteria of Core Investment Company (CIC), Number of CICs which are part of
group
xix) Reporting on cash losses and reporting on resignation of the statutory auditors
xx) Reporting on uncertainty of company capable of meeting its liabilities
xxi) Reporting requirements on transfer of unspent CSR amount to Fund specified in
Schedule VII Reporting requirements on qualifications or adverse remarks by
the auditors in the CARO reports of companies included in the consolidated
financial statements
CARO 2020 comes with more details and disclosures and obviously, more
compliance would be called for at the end of the company. The Chief Financial
Officer being an internal person in the company, has the responsibility towards
presenting the financial statements truly and fairly which are subsequently audited by
the statutory auditors of the Company. Obviously, the financial statements need to
comply with adhering the mandated accounting standards and also ensuring the
disclosure which are called for including disclosure of significant accounting policies
of the company in the financial statements. Therefore the Chief Financial Officer has
a greater responsibility to ensure the required increased disclosure as per CARO
2020 along with required compliance.

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3.3 Summary
This unit describes some of the important aspects in audit of companies. It
describes about eligibility, qualifications and disqualifications of auditor. The
provisions of the Companies Act, 2013 relating to appointment of auditor have also
been discussed in the act. The appointment is closely associated with the aspects like
remuneration and removal and as such these provisions are also mentioned. Powers
and duties are the two sides of a coin which auditor has to consider in the course of
audit. These are discussed at length in this unit. The provisions regarding reporting
requirement and particularly the recent announcement in Company’s Audit Report
Order, 2020 (CARO) are also important to be known before an auditis started. Thus,
this unit focusses on the important aspect about company audit. An auditor as well as
a company must have knowledge of these provisions as auditor and management of
the company have to report on the various aspects associated with these provisions.

3.4 Key words :

Audit, Appointment, Removal, Eligibility, Qualification, Disqualification,
Remuneration, Reporting, Financial Statements

3.5 Check your progress

A) Choose the correct alternative from the alternatives given below
i) An auditor of a company is appointed in …………….
a) Board Meeting c) Annual General Meeting
b) Creditors Meeting d) All of the above
ii) Auditor of a company is disqualified if he/she is……………………
a) Indebted to the company c) is aofficer of employee
b) Is a partner of any director of company d) all of the above
iii) Powers and duties of auditor are mentioned in …………of companies act.
a) Section 143 c) Section 142
b) Section 149 d) Section 226
iv) Companies Audit Report Order (CARO), 2020 replaces……………
a) CARO, 2016 b) CARO, 1956
c) CARO, 2013 d) CARO, 1991
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 v) Audit report of a company is addressed to …………..
a) The shareholders b) the Board of Director
c) the Chairman d) the Company Secretary
B) State whether the following statements are true or false
i) Audit is done only for detection of frauds and errors in accounts and
financial statements.
ii) Remuneration of auditor is decided by the board of directors of the
company.
iii) Once appointed, the auditor can not be removed from his office.
iv) Companies Audit Report Order (CARO) is mostly applicable to the
manufacturing companies.
v) The scope of branch audit is restricted to the branch only.
vi) Liability of joint auditors is limited to the work done by respective auditor.

3.6 Questions for Self-Study

1. Explain the provisions of appointment of an auditor of a company.
2. Explain the qualifications, disqualifications and eligibility of company auditor.
3. Discuss the provisions about remuneration and removal of auditor.
4. What are the duties and powers of a company auditor?
5. Explain the applicability of Companies Audit Report Order (CARO), 2020.
6. What are the points to be reported under CARO, 2020?
7. Explain the scope of joint audit and branch audit.
8. Explain the contents and features of an audit report.
9. Explain the types of audit report. What are contents of audit report?
Answers to check you progress:
A) i.c, ii.d, iii.a, iv.a, v.a
B) i.False, ii. False, iii.False, iv. True, v. True, vi. False

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3.7 References for Further Reading
Auditing and Assurance : CA Tapan Jindal, Bharat Publications, 18th Edition, 2016
Auditing and Assurance : CA Surabhi Bansal, Bestword Publications, 24th Edition,
2020
Systematic Approach to Auditing and Assurance : CA Kamal Garg, Bharat
Publications, 2019
Standards on Auditing : CA Sekar and CA Prasanth, PadhukaPrakashan, 2020
Practical Auditing : B N Tandon, Sudharshanam, Sudharabahu, S.Chand
Publications, 2017
Advanced Auditing : Study Material Issued by the Institute of Chartered Accountants
of India
www.icai.org.
www.taxguru.com
www.accountingedu.org
www.pwc.com
www.accountingtools.com
www.coursera.org


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 Unit-4
Special Audit & Audit Report

Structure of Unit
4.1 Introduction of Special Audit
4.2 Presentation of subject matter
4.2.1 The Need for Special Audit
4.2.2 Scope of Special Audit
4.2.3 Special Auditor
4.2.4 Audit of Bank
4.2.5 Audit of Insurance Company
4.2.6 Audit of Charitable Trust
4.2.7 Audit of Hotel
4.2.8 Audit of Hospitals
4.3 Introduction of Audit Report
4.4 Presentation of subject matter
4.4.1 Elements of Audit Report
4.4.2 Auditors Opinion
4.4.3 Clean Opinion
4.4.4 Qualified Opinion
4.4.5 Adverse Opinion
4.4.6 Disclaimer of Opinion
4.5 Summary
4.6 Terms to Remember
4.7 Answer to check your progress
4.8 Exercise
4.9 Reference for Further Study
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 4. SPECIAL AUDIT
Objectives :-
Understand the concept of Special Audit & Audit Report
Explain the different entities audit which are covered under Special Audit.
Explain elements of Audit Report & types of Audit Report.
4.2.1 An audit other than the annual audit of accounts of the company required to be
carried at under of the Companies Act 2013 special circumstances, is known as
Special Audit. Section 233 A empowers the Central Government in certain
cases, to call for a ‘special audit’ of a company. It can be seen that this type of
audit is mainly initiated by a third party, like a Government agency or the tax
authority. Special audit is mostly needed when some abnormal behavior is
suspected within the organization.

The Need For Special Audit:-
Special audit is mostly needed when some abnormal behavior is suspected
within the organization. Mostly, they are called when it is suspected that the laws and
regulations have been overlooked pertaining to finance, or financial management
within the organization. However, they are not only restricted to cases pertaining to
fraud.
It can also be conducted when there is other institutional violation are observed
include pertaining to duties, authorization, internal controls procedures or
responsibilities of the senior management etc. In the same manner special audit can
also be related to corporate governance or bankruptcy.
4.2.2 Scope of Special audit:-
As mentioned earlier it can be seen that a special audit is conducted out of
routine, with a specific or a routine purpose. However, these special purposes are
quite varied in nature, and the overall outcomes based out of those special audits.

Compliance Audit :-
This is mainly conducted when there is a need to examine whether depend upon
the purpose for which it is carried out. The policies and procedure to be followed are
in respect with internal and regulatory standard.

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Construction Audit :-
This analyzes the costs that occur for a given construction project. In the same
manner, this also tracks down actual amount that is paid to the contractor, suppliers
and other reimbursements that take place in this regard.

Information System Audit :-
Information system audit is mainly conducted when there is a need to review the
overall control present in software development. Additionally, it also involves a
review of control regarding software development, data processing and the overall
access to the computer system.

Investigative Audit :-
Investigative audit takes places when there is need to find details of a specific
event or an incident within the company that was suspicious.

Tax Audit :-
This audit is mainly initiated to analyze the overall tax returns that are submitted
by an individual or a business entity. The main rationale is to see if the paid tax is
actually valid and correct as per the prevailing tax regulations.
4.2.3 Special Auditor :-

Powers and Duties of Special Auditor :-
The auditor so appointed shall have the same powers and duties in the of the
Companies Act 2013 of special audits as the statutory auditor of a company has
under section 227, except for the fact that he must report to the Central Government
in place of the members of the company.
The Audit may be conducted either by the company auditor or a Chartered
Accountant who may or may not be engaged in practice, appointed by the Central
Government section u/s 233(1) and (2) of the Companies Act 2013.

Report :-
On receipt of the report, the Central Government may take necessary action
under companies Act 2013 or any other laws.
If no action is taken within four months from the receipt of the report the Central
Government must send a complete copy of the report or the relevant extract from it

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and direct the copy or extract among the members or to led it in the general meeting
(section 233A (6) of the Companies Act 2013)

Remuneration and its Recovery:-
The expenses incidental to a special audit, including the remuneration of the
special auditor are fixed by the Central Government.
If the company default in making the payment the amount can be recovered
from the company as arrears of a land revenue (section 233A (6) of the Companies
Act 2013)
4.2.4 AUDIT OF BANK:-
A bank audit is a routine procedure designed to review the services of financial
institutions to ensure that they are in compliance with the laws and industry
standards. Its purpose is to discover if the institution’s financial activities are
accurate, legitimate, and complete. It's primary goal is to provide an independent
evaluation of the systems, findings are generated, and auditors recommend corrective
actions that the bank needs to take. Auditor will begin his work by carrying out a
thorough verification of the assets and liabilities of the banking company. Points to
which he must pay his special attention in the performance of this work with regard
to each individual asset and liability are discussed below: -
1. Cash in hand / with other banks :-
Auditor will verify cash in hand or bullion by actually the cash & the bullion
counting or weighing. He will compare and tally the balance with the Cash Book, the
Day Book. Balances with the State Bank or other bank shall be verified &
reconciliation statement's for explaining the discrepancies.
2. Investments :-
Auditor shall obtain a list of the investments of the bank. He shall verify these
investments at the close of the year by carrying out an actual inspection of the scripts
or other documentary evidences available with the bank. He must take utmost care to
see that the same investments are not shown to him twice and also that they are
valued as per regulations.

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3. Advances, Overdrafts, Loans and Cash Credits :-
Auditor shall obtain a schedule of all loans, advances, cash credits and
overdrafts etc from the bank and then proceed to verify them with the balances of
respective ledger's. The totals will be compared and checked up with the respective
total accounts maintained in the general ledger.
The responsibilities of the auditor with regards to the verification of loans and
advances etc are very heavy. He will have to pay special attention with regard to the
different kinds of advances such as: a) Advances against government securities; b)
Advances against stock in trade; c) Advances against properties; d) Advances against
Life insurance policies; e) Advances against fixed deposits; f) Advances against
bullion.
4. Bills Discounted and Purchased :-
Auditor will verify bills discounted and purchased as recorded in the books with
those which are in the actual possession of the bank. He must see that the limits fixed
by the Board of Directors have not been exceeded and that the total of the Bills
Discounted Ledger agrees with the balance of the control account in the General
Ledger. He will examine the date of maturity of each bill in order to verify the
amount of overdue bills.
5. Contra Accounts :-
Usually, they relate to the following types of accounts (a) Bills for collection (b)
acceptances, guarantees, and letters of credit etc, opened on behalf of the customers.
These items appear on both sides of the balance sheet as they constitute both the
assets and liabilities of the bank.
6. Branch adjustments :-
This item discloses the combined effect of the differences in the inter-branch
balances. Auditor shall verify this item from the certificates of balances received
from branches preparing reconciliation statement.
7. Other Assets :-
Other assets of the bank shall include premises, furniture and fixtures, stock of
stationary, interest accrued on investments etc. Auditor shall examine the title deeds
or any other type of documentary evidence in order to ascertain that the assets of the

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bank, on the date of the Balance Sheet, do exist in the name of the bank and that they
have been properly valued.
8. Other Liabilities:-
Important items which usually appear on the liabilities side of the Balance Sheet
of a bank are the customer’s deposits, borrowings from other banks or agents etc,
bills payable, branch adjustments, liabilities for outstanding expenses and contingent
liabilities etc. Auditor will try to check-up the understatement or overstatement of
liabilities.
4.2.5 AUDIT OF INSURANCE COMPANY:-
The Insurance auditors shall examine policy and liability procedures, risk
valuation, tax documents, and various other financial record of insurance. It is to
ensure that proper insurance rates and premiums are implemented and regulators
laws are being followed by insurance companies. Claims and commission are also
the core areas to verify during the course of insurance audits. In Addition to these
responsibilities, insurance auditors might be expected to maintain quality control
between insurance companies and policyholders.
1. Vouch the premiums received with the copies of insurance policies, cover notes
or premium receipts.
2. Interest and dividends are to be checked.
3. The Claims paid or payable by the company to be checked.
4. Commission payments should be vouched.
5. Management Expenses should be examined.
6. All the reinsurance in detail should be checked.
7. Scrutinize carefully the outstanding branch and agency balances to determine
that they are recoverable.
8. All the investments made and cash balanced should be verified.
9. She that the sufficient amount has been set aside as reserve for unexpired risks.
10. Make sure that all the contingent liabilities are ascertained and provided for.
11. Make sure that the code of conduct has been duly observed as it is required to be
observed by the insurance companies in India.

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12. She that the annual accounts of insurer have been prepared in accordance with
the prescribed forms and regulaions.
4.2.6 AUDIT OF CHARITABLE TRUST :-
A charitable society is performing its operation for rendering social services. Its
main sources of revenue are donations and legacies. The objective of audit of this
type of society is to ensure that its revenue is being utilized for the purpose for which
the society has been established and it is being operated in conformity with its rules
and regulations.
The auditor should pay attention to the following points, while auditing the
accounts of a charitable institution:
1. Study of the constitution:-
Studying the constitution under which the charitable institution has been set up.
It may be registered as a society under the Societies Registration Act, 1860, as a
company limited by guarantee or as a trust. It the charitable Institution is a public
trust, then the provision of the state legislation, if any, affecting its accounts and
audit should be taken into account.
2. Examination of activities:-
Verifying whether the institution is being managed in the manner completed by
the law under which it has been set up.
3. Review of internal control system:-
The internal control system regarding the cash receipts and cash disbursement
should be reviewed.
4. Inspection of the minute book:-
The auditor should inspect the minute book of the meetings of the Managing
Committee and identify the resolutions having bearing on accounts and audit.
5. Interest and dividend:-
Interest and dividend from the deposits and investment should be checked with
the relevant vouchers. In addition to that, the interest on such deposits and dividend,
either ex-dividend or cum- dividend should be checked to see whether these are
recorded properly in the books of accounts.

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6. Rent and other income from house property:-
Rent and other income from house properties of the institution should be
checked with the help of counterfoils of receipts and other relevant documents.
7. Receipts from charity show etc.:-
Receipts from charity shows or other special function should be checked with
the counterpart of the tickets sold, statement of cash collection and entries in the cash
book.
8. Distinction between capital and revenue expenditure:-
The auditor should see that proper distinction has been made in the accounts
between capital expenditure and revenue expenditure.
9. Grants made by the institution:-
Grants made by the institution constitute the major expenses of the institution.
So, the auditor should pay special attention to check these payments. The auditor
should ensure himself that all grants have been made for admissible purpose and they
are properly authorized.
10. Purchase and sale of assets and investments:-
Purchase and sale of movable as well as immovable properties and investments
should be verified with the help of relevant documents. The auditor should assure
himself about their existence through physical verification at a particular point of
time.
11. Verification of assets and liabilities:-
The auditor should verify all assets and liabilities with the help of relevant
documents. He would confirm about their physical existence either through physical
verification or through confirmation from the concerned parties.
12. Utilization of fund:-
In this type of organization, different types of funds are created for certain
specific purposes. The auditor should ensure the proper utilization of these funds for
the purpose specified is being done.
13. Taxability of income:-
The auditor should see whether the income of the institution is exempt from
income tax according to the provisions of section 11 of the Income Tax Act, 1961,
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and if so, whether refund of income tax deducted at source (TDS) from interest
income, if any, has been claimed from the tax authority.
14. True and fair view:-
The auditor should examine the financial statement and see whether they give a
true and fair view of the surplus or deficit and of the state of affair of the institution.
4.2.7 AUDIT OF HOTEL:-
The business of running a hotel is very much dissimilar to running of any other
organizations. It is a service-oriented business and may have some element of
production of foodstuff and sales thereof. However, this business is characterized by
handling of liquid cash, stocking and providing a large variety of items, keeping
watch on customers to ensure that satisfactory services being provided to them, etc.
In view of these, following matters should be considered by the auditor in auditing
hotel businesses:
1. Internal control:-
The internal control system of the hotel should be reviewed first. The auditor
should ensure himself that effective internal control is in operation and for this
purpose, he should evaluate the following:
a. Effectiveness of arrangement regarding receipts and disbursement of cash.
b. Purchase procedure and stocking of various commodities and provisions.
c. Billing procedure for the customers.
2. Cash collection :-
Control of cash assumes great importance in any hotel. The auditor should
reconcile the total sales reported with the total bills issued. Billing may be done room
– wise as well as customer wise. The auditor should see that there exists numerical
control over the bills which are included in the total.
3. Stocks:-
The stock in any hotel is both portable and saleable particularly the food and
beverage stock. It is, therefore, extremely important that all movements and transfer
of such stocks should be properly documented. Control over stocks can be imposed
from the point of two directions-

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 a. Control over movements: The area where stocks are kept should be locked
under the supervision of the departmental manager. The auditor should see
that the movements of goods in or out of the store take place only after
proper authorization and recording.
b. Control over valuation: Although valuation of stocks is made by the experts
appointed by the management, it is important that the auditor satisfies
himself that the amount included for such stocks are reasonable. The
auditor can also attend at the physical stocktaking and check certain pricing
calculations.
4. Fixed assets :-
The accounting of fixed assets is likely to differ from hotel to hotel. Certain
hotels may consider its utensils as a stock item while others may treat it as fixed
assets. A comprehensive definition of the stock should be there and the auditor
should see whether the same has been clearly followed or not. Regarding auditing of
fixed assets, the auditor should ensure that –
a. All the fixed assets are physically verified and properly valued at the end of
the accounting period, and
b. Adequate provisions have been made for depreciation on all fixed assets for
the accounting year.
5. Compliance with statutory provisions:-
A number of statutory provisions are required to be complied with in running a
hotel business. All types of hotels are governed by various rules and regulations by
different authorities, which include the following:
a. Foreign exchange regulatory authority: In Large hotels, it is very common
to have facility of exchanging foreign currency into Indian Rupees. There
are provisions for foreign exchange transactions.
b. Department of tourism: The Department of Tourism also prescribes various
conditions to be fulfilled by the hotels.
c. Local authority: Approval of the local authority and license are required for
running hotel business. The auditor should see that various applicable
regulation and conditions are duly complied with by the hotel.

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6. Dealings with travelling agents :-
It is very common that the hotels get their booking through travel agents or other
booking agencies. The auditor should ensure that money is recovered from travel
agents as per the terms of credit allowed. Commission, if any, paid to travel agents
should be checked by reference to the agreement on that behalf.
7. Vouching the receipts and expenses :-
The auditor should vouch all receipts and expenses with reference to the entries
in the cash book with the help of documentary evidence. He should pay special
attention to the following points:
a. Consumption shown in various physical stock accounts may be traced to
customer’s bill on a sampling basis, whether practicable to ensure that all
issues have been billed or accounted for.
b. All Payments made to foreign collaborator, if any, are in accordance with
the terms of agreement.
c. Expenses and receipts may be compared with the figures of the previous
year having regard to the average occupancy of visitors and changes in the
rates.
d. Special receipts on account of letting out of the auditorium space and other
spaces for shops and for special exhibitions, etc. should be verified with
reference to the respective agreements.
e. Customer’s ledger should be examined on a sample basis but in depth to
check that all charges that should be made to the customers are in fact
made.
f. Proper reserves are required to be maintained for redecoration and
renovation of building and other structural facilities.
8. Other Points :-
In addition to the above important points regarding the working of the hotel, the
auditor should also take into consideration the following points:
a. Taxability of Income: The auditor should check the assessment of tax
aspect of the hotel in order to verify whether the tax return is submitted by
the hotel on a regular basis along with the amount of tax.

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 b. Deposit of sales and entertainment tax: The auditor should examine
whether the sales and entertainment tax collected by the hotel is duly
deposited to the proper authorities within the prescribed time limit.
c. True and fair view: The auditor should also see whether the financial
statements give a true and fair view of the profit or loss and of the balance
sheet of the hotel for the accounting period.
4.2.8 AUDIT OF HOSPITALS :-
The hospital are usually established with the fund provided by the government,
local authorities, municipalities and similar other type of funds. On the basis of
ownership, hospitals can be government hospital or private hospital or a joint venture
of public – private partnership. As the nature of activities of a hospital is totally
different from that of other organization or institutions, the audit programmed to be
followed for conducting audit of these types of organization will also differ.
1. Legal Status:-
The auditor should see relevant documents to ascertain the legal status of the
hospital. He should examine the constitution of the management and provisions
affecting annual accounts for consideration of auditing technique to be used.
2. Inspection of the minute book:-
If there is a managing committee or a governing body, the auditor should go
through the minutes of their meetings in order to note the decision concerning
financial matters, especially, engagement of staff, acquisition and sale of fixed assets
and investments, delegation of authority regarding expenditure, etc. and to see that
the resolutions affecting accounts have been duly complied with.
3. Internal check system:-
The auditor should examine the internal check as regards to the issue and
receipts of stores, linen, apparatus, clothing, instruments, etc. so as to ensure that
purchase has been properly recorded in the stock register and that issues have been
made only against proper authorization.
4. Examination of activities:-
The activities of the hospital should be identified and the auditor should ensure
himself that all the activities as decided to be undertaken are being actually
performed by the hospital.
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5. Cash Collection:-
The auditor should check the cash collections as entered in the cash book, with
the receipt counterfoils and other evidence. He should also check the bill registers of
patients to see that the bills have been correctly prepared.
6. Free bed facility: -
He should see that bills have been issued to all patients from whom any amount
was recoverable according to the rules of the hospital. He should also ensure that free
bed facilities were extended to the patients only in terms of hospital regulation.
7. Income from property and investments:-
The auditor should refer to the properties and investment registers to see that all
income that should have been recovered by way of rent from properties, dividend
and interest on securities, etc. have been collected.
8. Legacies and donations :-
He should also ascertain that legacies and donations received for a specific
purpose have been so utilized.
9. Grants received:-
The auditor should verify that the grants received, if any, have been duly
accounted for. He should also ensure that the refund in respect of taxes deducted has
been claimed.
10. Income from other sources:-
The auditor should verify the income of the hospital from any other sources,
with reference to the source of income, e.g., X- rays lab, blood testing lab, etc.
11. Distinction between capital and revenue expenditure:-
The auditor should see that proper distinction has been made in the accounts
between capital expenditure and revenue expenditure.
12. Purchase and sale of assets:-
Purchase and sale of movable as well as immovable properties Should be
verified with the help of relevant documents.
The auditor should assure himself about their existence through physical
verification at a particular point of time.

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13. Vouching of expenses:-
The auditor should vouch all the expenses including the capital expenditure. He
should verify that the capital expenditure has been incurred only with the prior
sanction of the Managing Committee.
14. Depreciation on fixed assets:-
He should see that depreciation at appropriate rates has been written off against
all the fixed assets.
15. Verification of assets and liabilities:-
The auditor should see that all fixed assets have been acquired under proper
authority and that proper registers are maintained to record their particulars. He
should also confirm about their physical existence either through physical
verification or through confirmation from the concerned parties.
16. Stock-in-trade:-
The auditor should obtain inventories of stocks and stores at the end of the year
and check a percentage of them physically. He should also verify stock register in
respect of stock and stores such as medicines, test tubes, cleaning materials, etc. and
see that the management has carried out a periodical inspection of all such store
items.
17. Taxability of income:-
The auditor should see whether the income of the hospital is exempt from
income tax according to the provision of the Income Tax Act, 1961, and if so,
whether refund of TDS, if any, has been claimed from the tax authority.
18. True and Fair view:-
The auditor should examine the financial statement and see whether they give a
true and fair view of the financial results as well as of the financial position of the
hospital.

Multiple Choice Questions:-
1. Which of the following item does not form a part of liability side of balance
sheet of bank:
a. Customer’s deposits
b. Borrowing from another bank
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 c. Advances against properties
d. Bills payable
2. Auditor should pay attention towards different kinds of advances:
a. Advances against Government Securities
b. Advances against Stock – in- trade
c. Advances against Life Policies
d. All of the above
3. Contra account relates to following type of account:
a. Bill for collection
b. Acceptance, guarantees and letter of credit
c. Only b
d. Both a and b
4. Main source of revenue of Charitable Trust are
a. Donations
b. Legacies
c. Both a and b
d. Only a
5. On the basis of ownership, types of hospital can be:
a. Government hospital
b. Joint venture of public or private partnership
c. Private hospital
d. All of the above
4.3 AUDIT REPORT :-
The audit report is the report that contains the auditor’s opinion which is issued
by independent auditor after their examination on the entity’s financial statement,
and related reports. Those including financial statement, management account,
management report or other report like compliant report.

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4.3.1 Elements of Audit Report:-
As prescribed in Standard on Auditing -700, the auditor’s report includes the
following basic elements, ordinary in the following layouts:
1. Title :- The auditor’s report should have an appropriate title.
2. Addressee :- Generally, the auditor’s report is addressed to the authority
appointing the auditor.
3. Opening or introductory paragraph :- The report should include a statement
that the financial statement is the responsibility of the management of the entity
and a statement that the responsibility of the auditor is to express an opinion on
the financial statement based on the audit. In short, the opening paragraph shall
include-
a. Identification of the financial statements audited, and
b. a statement of the responsibility of the entity’s management and
responsibility of the auditor.
4. Scope paragraph:- The auditor’s report should describe the scope of the audit
by stating that the audit was conducted in accordance with auditing standards
accepted in India. The report should include a statement that the audit was
planned and performed to obtain reasonable assurance whether the financial
statement is free from material misstatement. In short, the scoping paragraph
shall include:
a. a reference of the auditing standards generally accepted in India, and
b. a description of the work performed by the auditor.
5. Opinion paragraph:- The opinion paragraph of the auditor’s report should
clearly indicate the financial reporting framework used to prepare the financial
statements and state the auditor’s opinion as to whether the financial statement
give a true and fair view in accordance with that financial reporting framework.
In addition to an opinion on true and fair view, the auditor’s report may need to
include an opinion as to whether the financial statement comply with other
requirement specified by relevant statutes or law. In short, the opinion paragraph
shall include-
a. a reference to the financial reporting framework used to prepare the
financial statement, and
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 b. An expression of opinion on the financial statements.
6. Date of the report:- The date of report informs the reader that the auditor has
considered the effect on the financial statements and on the report of the events
and transactions of which the auditor became aware and that occurred up to that
date.
7. Place of signature:- The report should name specific location, which is
ordinarily the city where the audit report is signed.
8. Auditor’s signature:- The report should be signed by the auditor in his personal
name along with the membership number assigned by the Institute. Where the
firm is appointed as the auditor, the report should be signed also in the personal
name of the auditor and in the name of the audit firm.
4.3.2 Auditors Opinion :-
4.3.2.1 Clean Opinion:-
An unqualified opinion is considered a clean report. This is type of report that
auditors give most often. This is also the type of report that most companies expect
to receive. An unqualified opinion doesn’t include any disclaimer about any clauses
or the audit process. This type of a report indicates that the auditors are satisfied with
the company’s financial reporting. The auditor believes that the company’s
operations are in good compliances with governance principle and applicable laws.
The company, the auditors, the investors and public perceive such report to be free
from material misstatement.
4.3.2.2 Qualified opinion: -
When an auditor isn’t confident about any specific process or transaction that
prevents them from issuing an unqualified or clean report .The auditor may choose to
issue a qualified opinion. Investors don’t find qualified opinion acceptable, as they
project a negative opinion about a company’s financial status.
The auditor shall express a qualified opinion when:
I. The auditor having obtained sufficient appropriate audit evidence, concludes
that misstatements, individually or in the aggregate, are material but not
pervasive to the financial statement; or
II. The auditor is unable to obtain sufficient appropriate audit evidence on which to
base the opinion, but the auditor concludes that the possible effects on the
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 financial statement of undetected misstatements, if any, could be material but
not pervasive.
4.3.2.3 Adverse opinion :-
Auditors who discover a high level of material misstatement or irregularities
know that this creates a situation in which investors and government will mistrust the
company’s financial reports.
The auditor shall express an adverse opinion when the auditor, having obtained
sufficient appropriate audit evidence, concludes that misstatements, individually or in
the aggregate, are both material and pervasive to the financial statement.
Auditors adverse opinion is a big red flag. An adverse audit report usually
indicates that financial report contains gross misstatement and have potential for
fraud.
Auditors use all type of qualified report to alert the public as to the transparency,
reliability and accountability of companies.
4.3.2.4 Disclaimer of opinion :-
When an auditor issues a disclaimer of opinion report , it means that they are
distancing themselves from providing any opinion at all related to the financial
statement, one of the reasons that auditor may issue a disclaimer of opinion is
because they felt that the company limited their ability to conduct a thorough auditor
they couldn’t get satisfactory explanation for their questions.
The auditor shall disclaim an opinion when the auditor is unable to obtain
sufficient appropriate audit evidence on which to base the opinion, and the auditor
concludes that the possible effects on the financial statements of undetected
misstatements, if any, could be both material and pervasive.
The auditor shall disclaim an opinion when, in extremely rare circumstances
involving multiple uncertainties, the auditor concludes that, not withstanding having
obtained sufficient appropriate audit evidence regarding each of the individual
uncertainties it is not possible to form an opinion on the financial statement due to
the potential interaction of the uncertainties and their possible cumulative effect on
the financial statement.

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Multiple choice question:-
6. Which Standard of Auditing prescribes element of audit report:
a. 700
b. 701
c. 375
d. 301
7. Clean opinion may also known as:
a. Adverse opinion
b. Unqualified opinion
c. Qualified opinion
d. Disclaimer of opinion
8. Auditors report is addressed to whom:
a. Management
b. Authority appointing the auditor
c. Third parties
d. Board of Directors
9. There are how many types of auditor’s opinion:
a. 3
b. 4
c. 5
d. 6
10. Which audit opinion indicates big red flag:
a. Qualified opinion
b. Clean opinion
c. Adverse opinion
d. Disclaimer of opinion

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4.4 Summary :-
Therefore, it can be seen that special audits are mainly conducted in order to
investigate a special cause or to justify something that is not normal within the
organization.
The main reasoning behind such an audit is to ensure that the overall functioning
within the organization is normal, and there are no productivity losses involved.
This greatly helps them to be able to identify relevant area of improvement,
where they are able to trace weak link and ensure that they are able to trace weak
links and ensure that they are corrected for optimal performance within the
organization.
The Purpose of an audit is to enhance the degree of confidence of intended users
of the financial statement. The aforesaid purpose is achieved by the expression of an
independent reporting by the auditor.
The objectives of the auditor is to form an opinion on the financial statement
based on an evaluation of the conclusion drawn from the audit evidence obtained and
to express clearly the opinion through a written report. The auditor shall modify the
opinion in the auditor’s report when the auditor concludes that, based on the audit
evidence obtained, the financial statement as whole are not free from material
misstatement; or the auditor is unable to obtain sufficient appropriate audit evidence
to conclude that the financial statements as a whole are free from material
misstatement.
4.5 Terms to Remember :-
· Legacies – Gift that someone leaves to charitable organization in their/his will.
· Constitution- The basic principle and laws
· Legitimate – Confirming to the law or to rules
· Admissible- Acceptable or valid
· Delegation of authority- Process of transferring responsibility for a task to
another
· Bankruptcy – unable to repay their outstanding debts

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4.6 Answers of Multiple-choice question :-
1. c
2. d
3. d
4. c
5. d
6. a
7. b
8. b
9. b
10. c
4.7 Exercise :-
1. Draft an audit programme for examining the accounts of either a hotel or a
hospital.
2. Prepare an audit programme of any one of the following two organizations-
a. Bank
b. Insurance Company
3. What are the special points the auditor has to consider in conducting audit in the
following institutions?
a. Charitable Trust
4. What are the elements of the audit report?
5. What is meant by auditor’s report?
6. What is a qualified report?
7. How many types of audit report may be submitted by a company auditor and in
what circumstances? – Discuss briefly.

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4.8 Reference for Further Study :-

Auditing and Assurance by Sanjib Kumar Basu

Auditing and Assurance, Institute of Chartered Accountants of India

Practical Auditing : B. N. Tandon, S. Chand Publications, 2017.

Advanced Auditing : Study material issued by the ICAI.

www.icai.org


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 Unit-1
Basic Concepts

Structure of Unit
1.0 Objectives
1.1 Introduction
1.2 Presentation of subject matter
1.2.1 Income Tax in India
1.2.1.1 Meaning of Income Tax
1.2.1.2 Basis of charge
1.2.1.3 Rates of Tax
1.2.1.4 Surcharge on Income Tax
1.2.1.5 Practical Illustrations
1.2.2 Basic concepts
1.2.2.1 Concept of Previous year
1.2.2.2 Assessment year
1.2.2.3 Person
1.2.2.4 Income
1.2.2.5 Assessee
1.2.3 Residential status and taxability
1.2.3.1 Meaning of Residential status
1.2.3.2 Determination of Residential status and tax liability of individual
and HUF
1.2.3.3 Determination of Residential status of firms and companies
1.2.3.4 Terms to Remember
1.3 Summary
1.4 Answer to check your progress
1.5 Exercise
1.6 Further readings and References

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1.0 Objectives
After reading this unit you should be able;
1. To understand the basic introduction of income tax.
2. To know the basic concepts of income tax.
3. To understand Residential status and taxability of an individual and HUF.
4. To determine Residential status of firms and companies

1.1 Introduction
Most of the people while discussing about income; they talk on various issues
related to tax. It raises the question in the mind about what is tax? Let we understand
the meaning of word “Tax”. Many people are unaware about the structure of Tax.
Tax is levied as a financial charge by the Government on income, commodity or
activity. Generally there are two types of tax which is levied by the Government i.e.
Direct tax and Indirect tax.
Direct tax is paid by an assessee to the government directly. The tax is levied
on the income of an assessee as per rules of Income Tax Act 1961. Direct tax is a
progressive form of tax. In case of Direct tax, taxpayer should bear the burden of tax.
Direct Taxes are broadly classified as: Income Tax and Corporate Tax.
Income tax is paid by an individual or HUF or a person or taxpayer other than
companies on their income at the prescribed rate as per the tax law. While Corporate
tax is paid by the companies or businesses on their profit as per income tax law of
India.
Whereas, Indirect tax is paid by the person other than the one who utilizes the
product or service. Indirect tax includes Custom duty, Goods & Services Tax (GST)
etc. The burden of tax is shifted or shouldered to another person. In simple sense, the
whole society is the indirect tax payer to the government e.g. service tax on
restaurant bills, and movie tickets, GST on purchase or sale of goods and services
etc.

1.2 Presentation of Subject Matter

This unit is related to the important basic concepts of Income tax. It is essential
to know the terminologies like previous year, assessment year, person, assessee,

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income, residential status etc. This is the base to compute taxable income from
salary, business, profession etc as per Income Tax Act 1961.
1.2.1 Income Tax in India
Income tax was introduced in India for the first time by Sir James Wilson in
1860 in order to meet the losses sustained by the Government on account of the
Military Mutiny of 1857. After that there were several amendments were made in it
from time to time in the year 1886, 1918 and in the year 1922 onwards also as per the
requirement of tax policy. The Government of India appointed the Direct Taxes
Administration Enquiry Committee who submitted its report in 1956. In consultation
with the Ministry of Law finally the Income Tax Act, 1961 was passed. The Income
Tax Act 1961 has been brought into force with 1 April 1962. It applies to the whole
of India including Jammu and Kashmir.
Income-tax law in India:
The following important components are included in income tax law in India:
1. Income tax Act
2. Income tax rules
3. Annual Finance Act
4. Circulars, notifications etc
5. Legal decision of courts.
1. Income tax Act:
Income Tax Act was passed in 1961 and brought into force on 1st April, 1962 in
India. This Act includes 1 to 298 sections and XIV Schedules. The sections may
include sub sections with clauses and /or sub clauses.
2. Income-tax Rules:
The Central Board of Direct Taxes (CBDT) is the authority who looks after the
administration of direct taxes. The CBDT frames rules on time to time for smooth
functioning of Income Tax Act. These rules are collectively called Income-tax Rules,
1962. Rules may include sub rules, provisions and explanations.
3. Annual Finance Act:
Every year the budget is presented by the Finance Minister of the Government
of Indiato the Parliament. Once the Finance Bill is approved by the Parliament and
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gets the assent of the President of India, it becomes the Finance Act. It contains four
parts which specifies:
Part I : the rates of tax applicable for current assessment year.
Part II : rates at which tax is deductibles at source for the current financial year.
Part III : Rates for computation of income tax
Part IV: rules for computing net agriculture income
4. Circulars and Notifications:
The CBDT issues circulars and notifications to sort out the specific problems
and to clears the doubts regarding the scope and meaning of the provisions. These
circulars are mainly issued for the guidance of the officers and /or assessee.
5. Legal Decisions of Court:
The legal decisions laid by the Supreme Court and High court, are compulsory
to all and strictly implemented in the various states of the country.
1.2.1.1 Meaning of Income Tax
Income tax is the basic and major source of revenue to the government. Such
revenue is generated by the government from individuals and companies from their
income and profits as per the prescribed rate of tax. The collected tax revenue
reutilizes and spend on providing amenities to the society by incurring expenses on
the government projects like infrastructure, education, health-care, roads, defense
etc.
Income tax is compulsory to the person who lies under the categories of income
rates under Income Tax Act, 1961. It is mandatory to the taxpayer to pay tax
annually by filing the specific income tax returns (ITRs). As per Article 265 in the
Constitution of India, the Central and state government levy and collect direct or
indirect tax from the society.
1.2.1.2 Basis of Charge(Section 4)
Income-tax Act, 1961 section 4 provides following basis of charge:
i) AS per Annual Finance Act, Tax shall be charged at the prescribed rates for
the year.
ii) The charge is on every person specified under section 2(31);

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iii) Tax is chargeable on the total earnings during the previous year and not the
assessment year.(The sections 172, 174, 174A, 175 and176 have certain
exceptions.);
iv) Tax shall be levied as per the provisions included in Income Tax Act.
1.2.1.3 Rates of Tax
The Income Tax Act, 1961 lays down the following rates of tax in case of an
individual, Hindu Undivided Family, Association of Persons, Body of individuals,
Artificial Judicial Person, Senior citizen, Firm, LLP, Local authority, Co-operative
society, Company etc.
1. Individual/ Hindu Undivided Family (HUF)/ Association of Persons
(AOP)/ Body of Individuals (BOI)/ Artificial Juridical Person
(i) Income upto Rs. 2,50,000 NIL
(ii) Rs. 2,50,000 -Rs. 5,00,000 5%
(iii) Rs.5,00,000 ---Rs 10,00,000 20%
(iv) More than Rs.10,00,000 30%

2. For senior citizens (being resident individuals of the age of 60 years or more
but less than 80 years)
(i) Income upto Rs. 3,00,000 NIL
(ii) Rs. 3,00,000 ------Rs.5,00,000 5%
(iii) Rs.5,00,000------Rs.10,00,000 20%
(iv) Income more than Rs.10,00,000 30%

3. For resident individuals of the age of 80 years or more at any time during
the previous year
(i) Income Upto Rs. 5,00,000 NIL
(ii) Rs. 5,00,000--------Rs. 10,00,000 20%
(iv) More than Rs. 10,00,000 30%

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4. For Firm/LLP/Local Authority
1 Firm/LLP On the whole of the total income30%
2 Local authority On the whole of the total income30%

5. Co-operative society
(i) Income upto Rs. 10,000 10% of the total income
(ii) Rs.10,000-----Rs. 20,000 20%
(iii) Income More than Rs. 20,000 30%

6. Company
i) Domestic Company ( Total Turnover / Gross Receipts in the 25% of the
P.Y. 2017-18 is less than /equal to Rs.400 Crores total income
i) Other Domestic Company 30%
iii) Foreign Company( Other than domestic company) 40%
Specific Tax Rates for certain Income as per Income Tax Act, 1961 Finance
(No. 2) Act, 2019.
S.No. Section Income Rate of
Tax
(a) 112 Long term capital gains (other than LTCG taxable as 20%
per section 112A)
(b) 112A Long term capital gains on transfer of – @10%
• Equity share in a company On more
• Unit of an equity oriented fund than Rs.1
lakh
• Unit of business trust Long
Condition for availing the benefit of this concessional Term
rate is Securities Transaction tax should have been paid– Capital
Gain
In case of Capital Asset Time of payment of
STT

126
 Equity shares in a both at the time
company
Unit of equity oriented at the time of transfer
fund or unit of business
trust
Note: i) LTCG upto Rs 1 lakh is exempt.
ii) LTCG exceeding Rs. 1 lakh is taxable
@10%.
(c) 111A Short-term capital gains on transfer of – 15%
• Equity shares in a company
• Unit of an equity oriented fund
• Unit of business trust
The conditions for availing the benefit of this
concessional rate are –
(i) the transaction of sale of such equity share or unit
should be entered into on or after 1.10.2004; and
(ii) such transaction should be chargeable to securities
transaction tax.
(d) 115BB Winnings from 30%
• Lotteries;
• Cross word puzzles;
• Races including horse races;
• Card games and other games of any sort;
• Gambling or betting of any form or nature
(e) 115BBDA Income by way of dividend exceeding Rs. 10 lakhs in 10%
aggregate other than a person in domestic company, a
fund or institution or trust or any university or other
educational institution or any hospital or other
medical institution or a trust or institutions who is

127
 resident in India @10% The taxation of dividend
income in excess Rs.10 lakh shall be on gross basis it
means no deduction in respect of any expenditure or
allowance or set-off of loss shall be allowed to the
assessee in computing the income by way of
dividends.
(f) 115BBE Unexplained money, investment, expenditure, etc. 60%
deemed as income under section 68 or section 69 or
section 69A or section 69B or section 69C or section
(i) 69D plus surcharge @25% of tax. Thus, the
effective rate of tax (including surcharge @25% of tax
and cess @4% of tax and surcharge) is 78%.
(ii) exemption or allowance or expenditure shall be
allowed
(iii) no set off of any loss shall be allowable against
income brought to tax under Section 68 or 69 or 69A
or 69B or 69C or 69D.
(Source: Finance Act, 2019)
1.2.1.4 Surcharge on Income Tax:
An assessee or a taxpayer has to pay surcharge levied on the amount of income
tax in the prescribed rate of income tax. It is an additional charge payable on income
tax. It is an excessive burden of tax on the taxpayers, if he is having his total income
in the following range as stated below in the table during the financial year. As a
result, there are different rates of surcharge applicable to different taxpayers under
the Income Tax Act, 1961 under section 111A or section 112 or section 112A

128
 Rate of Surcharge for the Assessment Year 2020-21
i) Individual/HUF/AOP/BOI/Artificial juridical person
Range of Rs. 50 Lakhs Rs. 1 Crore Rs. 2 Crores Rs. 5 crores Exceeding Rs.
Income to Rs. 1 to Rs. 2 to Rs. 5 to Rs. 10 10 Crores
Crore Crores Crores Crores
Surcharge 10% 15% 25% 37% 37%

Note: The enhanced surcharge of 25% & 37%, as the case may be, is not levied,
from income chargeable to tax under sections 111A, 112A and 115AD. Hence, the
maximum rate of surcharge on tax payable on such incomes shall be 15%.
Sr.No. Assessee Income Surcharge

ii) Firm/Limited Liability Total income exceeds over

Partnership/Local Rs.1 Crore 12%
Authorities/Co-operative
societies
iii) a) Domestic Company Exceeds Rs. 1 Crore and 7%
less than or equal to Rs.10
Crores

Total income exceeds over 12%

Rs.10 Crores
b) Foreign Company Exceeds Rs. 1 Crore and 2%
less than or equal to Rs.10
Crores

Total income exceeds over 5%

Rs.10 Crores

a) Rebate ( Section 87A) :

It is tax relief to the tax payer in 5% tax slab u/s.87A. If an individual is having
his total income not exceed over Rs. 5 lakhs, he will get rebate of Rs. 12500 or tax

129
payable on total income whichever is less. It is not applicable whose income exceed
over Rs.5 lakhs to 5 Crores.
b) Health & Education Cess on Income Tax: It is additional surcharge as health
and education cess4% of income tax plus surcharge, if applicable.
c) Marginal Relief:
A marginal relief will be provided to such tax payers having a total income more
than the amount exceed, the income tax is payable (including surcharge)

Total income Surcharge Excess Tax Payable and

payable at Marginal Relief
%age of
income tax
i) Exceeds Rs.50 lakhs but 10% Excess tax payable = Tax
below or equal to Rs.1 payable including
Crore surcharge 10% on total
income tax payable -
(less)Tax payable on total
income Rs.50 lakhs
Marginal Relief = Excess
Individual/
tax payable -(less) excess
HUF/AOP/
income over Rs. 50 lakhs
BOI/Artific
ial ii) Exceeds Rs.1 Crore but 15% Excess tax payable = Tax
juridical less than or equal to payable including
person Rs.2 Crore surcharge 15% on total
income tax payable -
(less)Tax payable on total
income Rs.1 Crore +
(add)10% surcharge
Marginal Relief = Excess
tax payable -(less) excess
income over Rs. 1 Crore.
iii) Exceed Rs. 2 Crores and 25% Excess tax payable = Tax
less than or equal to payable including
130
 Rs.5 Crore surcharge 25% on total
income tax payable -
(less)Tax payable on total
income Rs. 2 Crore +
(add)15% surcharge
Marginal Relief = Excess
tax payable -(less) excess
income over Rs. 2 Crore.
iv) Exceeds Rs. 5 Crores 37% Excess tax payable = Tax
payable including
surcharge 37% on total
income tax payable -
(less)Tax payable on total
income Rs.5 Crore + (add)
25% surcharge
Marginal Relief = Excess
tax payable -(less) excess
income over Rs. 5 Crore
Firm/Limite exceeds Rs. 1 crore 12% Marginal Relief = Excess
d Liability tax payable -(less) excess
Partnership/ income over Rs. 1 Crore
Local
Authority/C
o-operative
society
Domestic i) exceeds Rs. 1 crore but 7% Marginal Relief = Excess
Company does not exceed Rs. 10 tax payable -(less) excess
crore, income over Rs. 1 Crore.
ii)Exceeds Rs.10 Crore 12% Marginal Relief = Excess
tax payable -(less) excess
income over Rs. 10 Crore.
Foreign i) exceed over Rs.1 Crore 2% Marginal Relief = Excess
butis lower or equal to Rs. tax payable -(less) excess

131
company 10 Crore income over Rs. 1 Crore.
ii) exceeds Rs. 10 crore 5% Marginal Relief = Excess
tax payable -(less) excess
income over Rs. 10 Crore.

1.2.1.5 Practical Illustrations

Illustration 1
Mr. Sharma has a total income of Rs.14,00,000 from his salary for the
financial year 2019-20.
Solution: Tax liability for Rs 14,00,000
For First Income Upto Rs. 2,50,000 - Nil
For Next Rs. 2,50,000 to Rs. 5,00,000 @ 5% of Rs. 2,50,000 Rs. 12,500
For Next Rs. 5,00,000 to Rs. 10,00,000 @ 20% of Rs. 5,00,000 Rs. 1,00,000
Balance Rs. 14,00,000 – Rs. 10,0000 = @30 % of Rs. 4,00,000 Rs. 1,20,000
excess over Rs. 4,00,000
Rs.10,00,000
Total Tax Rs. 2,32,500

Mr. Sharma has tax liability for the A.Y. 2020-21 of Rs. 2,32,500
Illustration 2
Mr. Sachin is of 44 years. In the assessment year 2020-21 he has income from
his salary and other sources of Rs. 50,75,000. He also has fixed deposit in bank and
got interest as income. There is no any cess in this case.
Compute his tax liability of Mr. Sachin for the A.Y.
Solution:
Computation of tax liability of Mr. Sachin for the A.Y.2020-21
Tax payable including surcharge on total income Rs. 50,75,000
Rs. 2,50,000 - Rs.5,00,000 @ 5% 12,500
Rs.5,00,000 - Rs.10,00,000 @20% 1,00,000

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 Rs.10,00,000 - Rs.50,75,000 @30% 12,22,500
Total 13,35,000
Add: Surcharge @ 10% 1,33,500 14,68,500
Tax payable on total income of Rs. 50 lakhs 13,12,500
(12,500 + 1,00,000 + 12,00,000)
Excess tax payable (14,68,500 -13,12,500) 1,56,000
Marginal Relief (Rs.1,56,000 – 75,000) Excess 81,000
amt. of income over 50 lakhs
Tax payable (14,68,500 – 81,000) 13,87,500

Illustration 3
Mr. Sunil, age 53, has total income of Rs. 1,00,50,000 from his salary and other
bank interest on investments in fixed assets. Compute the tax liability of Mr.
Sunil for the Assessment Year 2020-21. Ignore cess.
Solution : Computation of tax liability of Mr. Sunil for the A.Y. 2020-21
Tax payable including surcharge on total income Rs.
1,00,50,000
Rs. 2,50,000 - Rs.5,00,000 @ 5% 12,500
Rs.5,00,000 - Rs.10,00,000@20% 1,00,000
Rs.10,00,000 - Rs.1,00,50,000 @30% 27,15,000
Total 28,27,500
Add: Surcharge @ 15% x 2827500 4,24,125 32,51,625
Tax payable on total income of Rs. 01 crore 30,93,750
(12,500 + 1,00,000 + 27,00,000 +2,81,250 i.e.
surcharge 10% upto 1 crore )
Excess tax payable (32,51,625 – 30,93,750) 1,57,875
Marginal Relief (Rs. 1,57,875 – 50,000) Excess 1,07,875
amt. of income over 1 crore
Tax payable (32,51,625 – 1,07,875) 31,43,750

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Illustration:4
Mrs. Neha, age 57, is having her total income of Rs. 2,00,50,000 including her
salary, interest on Fixed deposits and House property during 2019-20. Compute the
tax liability of Mrs. Neha by ignoring cess for the Assessment Year 2020-21.
Computation of tax liability of Mr. Sunil for the A.Y.2020-21
Tax payable including surcharge on total income Rs.
2,00,50,000
Rs. 2,50,000 - Rs.5,00,000 @ 5% 12,500
Rs.5,00,000 - Rs.10,00,000@20% 1,00,000
Rs.10,00,000 - Rs.2,00,50,000 @30% 57,15,000
Total 58,27,500
Add: Surcharge @ 25% x 58,27,500 14,56,875 72,84,375
Tax payable on total income of Rs. 02 crore (12,500
+ 1,00,000 + 57,00,000 + 8,71,875 i.e. surcharge 6,68,475
15% upto 2 crore )
Excess tax payable (72,84,375 – 6,68,475) 6,61,519
Marginal Relief (Rs. 6,61,519 – 50,000) Excess amt. 6,11,519
of income over 1 crore
Tax payable (72,84,375 – 6,11,519) 66,72,856

Illustration 5
Compute the tax liability by ignoring cess of Mrs. Shahane, age 44, having total
income of Rs. 5,00,75,000 from his salary, interest on fixed deposit and other source
like house property for the Assessment Year 2020-21.
Solution:
Computation of tax liability of Mrs. Shahane for the A.Y. 2020-21

134
 Tax payable including surcharge on total income Rs.
5,00,75,000
Rs. 2,50,000 -Rs.5,00,000 @ 5% 12,500
Rs.5,00,000 -Rs.10,00,000@20% 1,00,000
Rs.10,00,000 -Rs.50,07,5000 @30% 1,47,22,500
Total 1,48,35,000
Add: Surcharge @ 37% x 1,48,35,000 54,88,950 2,03,23,950
Tax payable on total income of Rs. 05 crore (12,500
+ 1,00,000 + 1,47,00,000 + 37,03,125 i.e. surcharge 18,51,625
25% upto 5 crore)
Excess tax payable (2,03,23,950 – 18,51,625) 1,84,72,325
Marginal Relief (Rs. 1,84,72,325 – 75,000) Excess 1,83,97,325
amt. of income over 1 crore
Tax payable (2,03,23,950 – 1,83,97,325) 19,26,625

1.2.2 Basic Concepts

It is necessary to understand the basic concepts of income tax to know the scope
of income tax. The following are the main basic concepts used in Income Tax:
1.2.2.1 Previous year[Section 2 (34) and 3]
“Previous Year” means the Financial Year immediately preceding the
Assessment Year. The income earned by the assessee is taxable in the next year.
Hence, the year in which income earned by an assessee is known as Previous year.
and the tax on which the income is assessed is called as Assessment year. The
present Previous Year 2019-20 and its Assessment Year is 2020-2021.
From the assessment year 1989-90 onwards, all assessees are required to follow
financial year (i.e. April 1st of one year to March 31st of next year) as previous year.
The uniform previous year has to be followed for all sources of income.
In case of the Previous Year for newly established business from the date of
setting up of the business to the end of the Financial Year in which business was set
up. e.g. X Ltd. started business on 1.11.2015 So for X Ltd. Previous Year will be
considered as 1.11.2015 to 31.3.2016.
135
1.2.2.2 Assessment year [Section 2 (9)]
“Assessment year” means the period of twelve months commencing on 1st April
every year. Thus it is normally period beginning from 1st April of every year and
ending on 31st March of the next year. Income of previous year of an assessee is
taxed during the following assessment year at the rates prescribed by the relevant
Finance Act. The present Assessment Year is 2020-2021 relating to Previous Year
2019-2020.
1.2.2.3 Person [Section 2(31)]
Income-tax is charged in respect of the total income of the previous year of
every person. Hence, it is important to know the definition ‘person’. As per section
2(31). Person includes:
i) An individual
A natural human being, i.e. male, female, minor or a person of sound or unsound
mind.
ii) A Hindu undivided family
It consists of all persons lineally descended from a common ancestor and
includes their wives and unmarried daughters.
iii) A Company
Section 2(17) defines the term ‘company’ to mean:
(a) any Indian company, or
(b) any body corporate incorporated by or under the laws of a country outside India
i.e. a foreign company, or
(c) any institution, association or body which is or was assessable or was assessed
as a company for any assessment year under the Indian Income Tax Act, 1922 or
which is or was assessable or was assessed under this Act as a company for any
assessment year commencing on or before the 1st day of April, 1970, or
(d) any institution, association or body, whether incorporated or not and whether
Indian or non-Indian, which is declared by general or special order of the Board
to be a company only for such assessment year or assessment years (whether
commencing before the first day of April, 1971 or, on or after that date), as may
be specified in the declaration.

136
iv) A Firm
A firm includes a partnership firm whether registered or not and shall include a
Limited Liability Partnership as defined under Partnership Act, 1932.
v) An Association of Person (AOP) or a body of individuals whether
incorporated or not
The difference between Association of persons and body of individuals is that
whereas an association implies a voluntary getting together for a definite purpose, a
body of individuals would be just a body without an intention to get-together.
Moreover, the members of body of individuals can be individuals only whereas the
members of an association of persons can be individual or non-individuals (i.e.
artificial persons).
vi) A local authority
It means a municipal committee, district board, body of port commissioners, or
other authority legally entitled to or entrusted by the Government with the control
and management of a Municipal or local fund.
vii) Every artificial, juridical person, not falling within any of the above
categories
This is a residuary clause. If the assessee does not fall in any of the first six
categories, he is assessed under this clause. Generally, a statutory corporation, deity
or charitable institution or an endowment for charitable or religious purposes falls
under artificial juridical person.
1.2.2.4 Income [section 2(24)]
Every person is always in search of monetary return in the regular form. This is
received in the form of cash or kind, receipt or accrual basis, legal or illegal,
temporary or permanent, lump sum or installments, gifts etc. As per the Income Tax
Act 1961, a person who do not earns or receive income on regular basis is not
considered as income for tax. The casual income as Winnings from lotteries,
crossword puzzles etc are not Income. The Income Tax Act does not have a positive
definition of the term, 'Income':
Income [Section 2(24)] includes:
1. Profits or gains of business or profession.
2. Dividend.
137
3. Voluntary Contribution received by a Charitable / Religious Trust or University
/ Education Institution or Hospital.
4. Value of perquisite or profit in lieu of salary taxable u/s 17 and special
allowance or benefit. Specifically granted either to meet personal expenses or
for performance of duties of an office or an employment of profit.
5. Export incentives, like Duty Drawback, Cash Compensatory Support, Sale of
licenses etc.
6. Interest, salary, bonus, commission or remuneration earned by a partner of a
Firm from such Firm.
7. Capital Gains chargeable u/s 45.
8. Profits and gains from the business of banking carried on by a cooperative
society with its members.
9. Winnings from lotteries, crossword puzzles, races including horse races, card
games and other games of any sort or from gambling or betting of any form or
nature whatsoever.
10. Deemed income u/s 41 or 59.
11. Sums received by an assessee from his employers towards welfare fund
contributions such as Provident Fund, Superannuation Fund etc.
12. Amount received under Key man Insurance Policy including bonus thereon.
13. Amount received under agreement for (a) not carrying out activity in relation to
any business, or (b) not sharing any knowhow, patent, copyright etc.
14. City Compensatory Allowance/ Dearness allowance
15. Benefit or Perquisite to a Director:
16. Any Benefit or perquisite to a Representative Assessee;
17. Any sum chargeable under section 28, 41 and 59 :
18. Gift received for an amount exceeding ` 50,000 in clause (vii) or clause (vii a)
of sub-section (2) of Section 56.

138
1.3.2 Agriculture Income: Sec. 2(1A)
Agricultural income is defined under section 2(1A) of the Income-tax Act. As
per section 2(1A), agricultural income generally means:
(a) Any rent or revenue derived from land which is situated in India and is used for
agricultural purposes.
(b) Any income derived from such land by agriculture operations including
processing of agricultural produce so as to render it fit for the market or sale of
such produce.
(c) Any income attributable to a farm house subject to satisfaction of certain
conditions specified in this regard in section 2(1A).
Any income derived from saplings or seedlings grown in a nursery shall be
deemed to be agricultural income. As per section 10(1), agricultural income earned
by the taxpayer in India is exempt from tax.
Most of the following incomes are not considered as agriculture incomes:
Incomes from-
i) Mining royalties, stone quarries.
ii) Sale of earth or brick making
iii) Poultry & Dairy
iv) Forest trees, bamboo etc.
v) Fisheries etc,
vi) Managerial remuneration from agriculture farm
vii) Dividend from agriculture business or company
viii) Irrigation water supply
1.2.2.5 Assessee [Section 2(7)]
1. In simple language, every tax payer is an assessee. However, the word assessee
has been defined in Section 2(7) of the Act according to which assessee means a
person by whom any tax or any other sum of money (i.e. interest, penalty etc.) is
payable under the Act and includes:
2. Every person in respect of whom any proceeding under this Act has been taken
for the assessment of his income or assessment of fringe benefits or of the
139
 income of any other person in respect of which he is assessable or to determine
the loss sustained by him or by such other person or to determine the amount of
refund due to him or to such other person.
3. Every person who is deemed to be an assessee under any provision of this Act.
4. Every person who is deemed to be an assessee in default under any provision of
this Act. Accordingly, assessee is a person by whom tax or any other sum is
payable under the Act.
5. The expression “other sum of money” includes fine, interest, penalty and tax or
person to whom any refund of tax etc. is due under the Act or if any proceeding
under the Act has been taken against any person, he is also an assessee.
CHECK YOUR PROGRESS-I
Q.1. A) Fill in the blanks:
1. Income tax was introduced in India for the first time by ---------------in 1860 in
order to meet the losses sustained by the Government on account of the Military
Mutiny of 1857.
2. The Income Tax Act 1961 has been brought into force with effect from-----------
----.
3. Every year the budget is presented by the ------------------of the Government of
India to the Parliament.
4. ------------ is the basic and major source of revenue to the government.
5. “Previous Year” means the ----------------immediately preceding the Assessment
Year.
6. The year in which income earned by an assessee is known as--------------.
7. The year on which the income is assessed is called as --------------.
8. Income-tax is charged in respect of the ------------ of the previous year of every
person.
Q.1 B) State whether True or False:
1. Income Tax Act includes 1 to 298 sections and XIV Schedules.
2. Rules may not include sub rules, provisions and explanations.
3. Section 2(7) defines the term ‘company’.
140
4. The charge is on every person specified under section 2(31).
5. “Previous Year” means the Financial Year immediately preceding the next
Assessment Year.
6. It is mandatory to the taxpayer to pay tax annually by filing the specific income
tax returns.
7. The year on which the income is assessed is called as Previous year.
1.2.3 Residential Status and taxability
The income tax liability of any assessee depends upon their residential status.
The income earned in outside India by an assessee is also considered for
determination of taxability. Therefore, the resident of an assessee is the basis for
understanding the taxability of an assessee.
The residential status is classified as under: On the basis of residence, all the
assesses are classified into two classes :

Person
Individual & company, firm,
HUF BOI, AOP etc

Resident Non Resident

Resident Non Resident

Resident and Resident and Non

ordinarily Ordinarily Resident
Resident( ROR) (RNOR)

(a) Resident of India (ROI)

(ROI). – [For individuals and HUFs]
This is also sub classified into two i.e –
i) Resident and Ordinary Resident (ROR)
ii) Resident and Non Ordinary Resident( RNOR)

141
(b) Non-Resident of India (NRI).
There are separate rules are followed for determining the residential status of an
individual, HUF, Firms, Association of Persons (AOP), Local authorities and
Artificial persons
1.2.3.1 Residential Status of an Individual [Section. 6 (1)]
A) Resident:
An individual is resident in India if he satisfies any one of the following two
basic conditions and not satisfies the additional conditions:
I) Basic Conditions:
i. He has been in India for 182 days or more in the relevant previous year or
ii. He has been in India for 60 days or more during the relevant previous year and
for 365 days or more during 4 years immediately preceding the previous year.
Condition number (ii) has following exceptions:
Condition (ii) above is not applicable in following cases (means in following
cases a person shall be resident of India only when he is in India for 182 days or
more in the previous year):
a. If Indian Citizen leaves in India during the previous year for employment
outside India or as a member of crew of an Indian Ship
b. If Indian citizen or person of Indian origin visits India during previous year
II) Additional Conditions:
a) Resident and Ordinary Resident Section 6(6):
An individual is to become Resident and Ordinary Resident if he satisfies both
the conditions given below: ‐
1. He should have been resident in India at least 2 out of 10 previous years,
immediately preceding to the previous year.
2. He should have been in India for a period amounting to 729 days or more in 7
years proceeding to the previous year.
b) Resident but Non-Ordinary Resident:
If an individual or assessee does not satisfy any one of the above mentioned
conditions or both his Residential Status will be Resident but Not Ordinary Resident.
142
B) Non resident [Section 2 (3)]:
If the basic condition under section 6(1) is not fulfilled by an individual or
assessee, he is to be a Non resident of India during the previous year.
Other points:
• Residential status is determined for every year separately
• India includes territorial waters of India.
• Employment includes self-employment
• In computing the period of 180 days, the day of entry into India and the day of
exit from India shall be included.
• Person of Indian origin is a person who himself or any of his parents or any of
his grandparents was born in undivided India before 15th August 1947.
Easy Rules for determining residence of an individual
• Resident (R): who satisfies at least 1 basic condition
• Resident and Ordinary Resident (ROR): Who satisfies at least 1 basic + both
the additional conditions
• Resident but Not Ordinary Resident (RNOR): Who satisfies at least 1 basic +
Either none (or one) of the additional
• Not Resident (NR): who does not satisfy any of the basic
1.2.3.2 Determination of Residential Status of Hindu Undivided Family (HUF) –
Sec 6(2)
A) Resident:
A HUF is said to be resident in India-
i) when during that year control and management is situated wholly or partly in
India.
ii) Control and management lies at the place where decision regarding the affairs of
the HUF taken.

143
a) Resident and Ordinarily Resident:
A resident HUF is said to be resident and ordinarily resident in India if the karta
of the HUF satisfies both the following conditions:
i) He has been resident in India for at least 2 out of 10 previous years immediately
preceding the relevant previous year
And
ii) He has been in India for 730 days or more during 7 previous years immediately
preceding the relevant previous year.
b) Resident but Not Ordinary Resident:
If the karta of HUF does not satisfy any or both of the above conditions number
(i) & (ii), then HUF shall be resident but not ordinarily resident in India.
B) Non-Resident [Section 2(30)]
It will be non-resident in India if no part of the control and management of
affairs is situated in India.
Easy rules for determination of residential status of a HUF
Resident: Control and management of the affairs is located wholly in India or partly
in India and partly outside India.
ROR: Karta satisfies both the additional conditions, HUF is as ROR
RNOR: Karta satisfies both or one of the additional conditions, HUF as RNOR.
Non-Resident: Control and management of the affairs of a HUF is located outside
India.

1.2.3.3 Determination of Residential Status of Firms, AOP, BOI etc – Sec 6(2),
6(4)
i) A Firm, AOP, BOI etc is said to be resident in India when during that year
control and management is situated wholly or partly in India. In other words it
will be non-resident in India if no part of the control and management of affairs
is situated in India.
ii) Control and management lies at the place where decision regarding the affairs of
the firms etc are taken.

144
1.2.3.4 Determination of Residential Status of Companies – Sec 6(3)
1) Indian Company:
A company is said to be resident in India in any previous year-
i) It should be an Indian Company (always resident in India)
ii) control and management of its affairs wholly in India.
2) Foreign Company
When Foreign Company is resident in India-
Residential status of a foreign company depends upon place of effective management
“POEM”.
It is cleared that a person is (1) a Resident whose POEM of the business is
situated wholly in India.
It means if control and management of its affairs is situated wholly in India
during relevant previous year i.e. if all the board meetings of the foreign company is
held in India, then it shall be resident.
Non Resident [Section 2(30)]:
Above conditions are not fulfill by any company, it is treated as non-resident. or
whose control and management of affairs is partly located outside India, is treated as
Non Resident Company.
It means a Person is Non-Resident if POEM of the business is situated wholly
or partly outside India.
1.3.2.5 Scope of Total Income/ Incidence of Tax/ Tax Libility [Sec 5)
The Scope of total income is according to residential status of assessee.
1. Resident in India/ ordinarily resident in India [Section 5 (1)]
A person is assessable to tax in respect of income which-
i. is received or deemed to be received in India, even in outside India by
him or on his behalf or
ii. accrues or arises or deemed to accrue or arise to him in India, even in
outside India or
iii. accrues or arises to him outside India

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2. Resident but not ordinarily resident in India [Section 5 (1)]
A person is assessable to tax in respect of income which-
i. is received or deemed to be received in India, even in outside India by him or on
his behalf or
ii. accrues or arises or deemed to accrue or arise to him in India, even in outside
India or
iii. accrues or arises to him outside India from a business controlled in or profession
set up in India.
3. Non-resident in India [Section 5(2)]
A person is assessable to tax in respect of income which-
i. is received or deemed to be received in India, even in outside India by him or
on his behalf or
ii. accrues or arises or deemed to accrue or arise to him in India, even in outside
India
Other points:
• Received in India means first receipt in India. If an income is received first
outside India and then subsequently remitted to India, it shall be treated as
received outside India.
• Past untaxed profits shall not be considered to be income of the current year in
any case.
Illustration 6
Mr. J. Willam comes to India for 100 days every year. Determine his residential
status for the assessment year 2020-21.
Solution:
Mr. J. Willams residential status can be determined as:
Step 1: He resides in India 100 days in F.Y. 2019-2020. It means in the last 4
preceding year his total stay in India =100 days x 4 years= 400 days.
As he satisfies 2nd condition of the basic conditions, he is a resident in India.

146
Step 2: His total stay in India in last 7 years preceding F.Y. 2019-20 = 100 x 7 =
700 days., he satisfies the 2nd condition of the additional conditions, It means, he is
Not-Ordinarily Resident (NOR) in India.
Therefore Mr. J. Willam is the resident but Not Ordinarily Resident (NOR)for A.Y.
2020-21,
Illustration 7
Mahesh, an Indian citizen, leaves India on 25nd September 2019 for the first
time, to work as an employee of a company in Australia. Determine his residential
status for A.Y. 2020-21.
Solution: Mahesh’s stay in India during the F.Y. 2019-20,
= 30 (April) + 31 (May) + 30 (June) + 31 (July) + 31 (August) + 25
(September) =178 days and is leaving India for joining his company in Australia.
Here, 2nd condition of basic condition is not applicable to Mahesh.
Even though, He never fulfils the 1st condition of basic conditions also.
As a result, he is the Non-Resident in India for the A.Y. 2020-21
Illustration 8:
Mr. Suraj came to India for the first time on 15th July 2019 and he left India on
03rd March 2020.
Determine his residential status for the AY 2020-21.
Solution: Mr. Suraj stays in India during the financial year i.e. P.Y 2019-20 (From
15th July to 03rd March) =17+31+30+31+30+31+31+29+03 =233 days.
He satisfies the condition of stay in India 182 days or more.
Thus, Mr. Suraj is a resident in India for the AY 2020-21.
Illustration 9
Mrs. James, a US citizen but of Indian origin, comes to India for the first time
during the previous year 2015-16. Since then she is coming every year on a visit to
India for some days as shown below:
Years 2015-16 2016-17 2017-18 2018-19 2019-20
Stay in India 70 65 84 187 67
(days)
Determine her residential status for the assessment year 2020-21.
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Solution: As She is an Indian Origin the basic condition 2 is not applied.
She came India in the previous including 2019-20.
The 1st basic condition is that she has to stay 182 days or more in the P.Y.2019-20.
The other additional conditions are applicable who has become resident in the
relevant previous year. Mrs. James stays only 67 days and never 182 days or more in
the P.Y. 2019-20 as condition.
Hence, She is Non Resident for the assessment year 2020-21.
Tax liability on the basis of Residential Status
Where tax incidence arises in case of Resident or Resident but Non-Resident
Resident & not (NR)
Ordinarily Ordinarily
Resident( ROR) Resident (only
Individual or
HUF)(RNOR)
Income received in India (Whether TAXABLE TAXABLE TAXABLE
accrued in or outside India)
Income deemed to be received in TAXABLE TAXABLE TAXABLE
India (Whether accrued in or outside
India)
Income accruing or arising in India TAXABLE TAXABLE TAXABLE
(Whether received in India or outside
India)
Income deemed to accrue or arise in TAXABLE TAXABLE TAXABLE
India (Whether received in India or
outside India)
Income received and accrued outside TAXABLE TAXABLE NOT
India from a business controlled or a TAXABLE
profession set up in India
Income received and accrued outside TAXABLE NOT NOT
India from a business controlled from TAXABLE TAXABLE
outside India or a profession set up

148
outside India

Income earned and received outside NOT TAXABLE NOT NOT

India but later on remitted to India TAXABLE TAXABLE
(whether tax incidence arises at the
time of remittance)
(ROR- Resident/Ordinary Resident of India, RNOR- Resident but not Ordinarily
Resident, NR- Non Resident )
Explanation:
1. Income received or deemed to be received in India [Sec 7)
a) Income received in India:
Any income which is received in India is liable to tax in India, whether the
person receiving income is resident or non- resident. ‘Received in India’ means first
receipt.
Income deemed to be received in India: Following incomes shall be deemed to be
received in India even in the absence of actual receipt:
i. Contribution by employer to recognized provident fund in excess of 12% of
salary of employee
ii. Interest credited to RPF in excess of 9.5%
iii. Transferred balance from unrecognized PF to RPF
iv. Contribution by Government/Employer to notified pension scheme
Dividend Income (Sec 8 )
Dividends from Indian company shall always be deemed to accrue or arise in
India. However, as per Sec 10(34), such dividend is exempt in the hands of
shareholder.
Income deemed to accrue or arise in India (Sec 9)
Following income shall be deemed to accrue or arise in India:
i. Income from any property, asset or source of income in India
ii. Income from the transfer of any capital asset situated in India

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iii. Any income from salary if it is payable for services rendered in India
iv. Salary (not allowances) payable by the government of India to an Indian citizen
for services rendered outside India
v. Interest payable by-
a. Government or
b. Resident in India if money is used by the borrower for the purpose of
business or profession or earning any income from any source in India or
c. Non-resident in India if money is used by the borrower for the purpose of
business or profession in India
vi. Royalty payable by
a. Government or
b. Resident in India if services are utilized for the purpose of business or
profession or earning any income from any source in India or
c. Non-resident in India if services are utilized for the purpose of business or
profession or earning any income from any source in India
vii. Fees for technical services payable by
a. Government or
b. Resident in India it services are utilized for the purpose of business or
profession or earning any income from any source in India or
c. Non-resident in India it services are utilized for the purpose of business or
profession or earning any income from any source in India
viii. Income from a business connection in India
Any income which arises, directly or indirectly, from any activity or a business
connection in India is deemed to be earned in India. If all business activities are not
carried out in India, then only such part of income, as is reasonably attributable to the
operations carried out in India, is taxable. E.g business connection includes-
i. branch office in India,
ii. agent of non-resident entering into contracts,
iii. Subsidiary in India

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iv. maintaining stocks etc
However in case of non-resident, following shall not be treated as business
connection in India:
i. Purchase of goods in India for purpose of exports
ii. Collection of news and views for transmission outside India by non-resident
who is engaged in the business of running news agency or of publishing
newspapers, magazines or journals
iii. Shooting of films in India if
a. In case of individual – he is not a citizen of India
b. In case of Firm – none of the partner is citizen or resident of India
c. In case of company – none of the shareholder is citizen or resident of India
Illustration 10:
Following are the summary of the incomes of Mr. Raju for the previous year
2019-2020.
a) Income earned in India but received in London Rs. 15,000
b) Income earned in London in the earlier years but brought during the year of Rs.
40,000
c) Income from Bank of Maharashtra as interest on deposits Rs. 10,000
d) He earned income from his business at US which is controlled from Canada Rs.
25,500.
e) Income from House property in Japan received in India Rs. 9,000
Compute his taxable income for the A.Y. 2020-2021 by determining Mr. Raju is
-a) Resident (ii) Not Ordinarily Resident (iii) Non-Resident
Solution:
Computational Taxable Income of Mr. Raju for the A.Y. 2020-21
Income Resident ( R) Not Ordinarily Non Resident
Resident (ROR) (NR)
a) Income earned in India
but received in London

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(Earned in India) 15,000 15,000 15,000
b)Income earned in
London in the earlier Nil Nil Nil
years but brought during
the year of Rs. 40,000
( No earning this year)
c)Income from Bank of 10,000 10,000 10,000
Maharashtra as interest
on deposits
(Accrued in India)
d)He earned income from 25,500 Nil Nil
his business at US which
is controlled from
Canada
( Foreign Income)
e)Income from House 9,000 9,000 9,000
property in Japan
received in India
( Received in India)
Total 59,500 34,000 34,000

CHECK YOUR PROGRESS-II

Q.1.A) Fill in the Blanks:
1. The income tax liability of any assessee depends upon their -------------
2. The residential status is classified into ----------- classes.
3. -------------- lies at the place where decision regarding the affairs of the HUF
taken.
4. AOP Stands for…………………
5. ---------------is determined for every year separately.

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Q.1B) Match the following:
Resident Section
a) Resident and Ordinary Resident Section i) Sec 6 (2)
b) Non-resident ii) [Section 2(30)]
c) HUF iii) Sec 6 (3)
d) Non-Resident iv) [Section 2 (3)]
e) Residential Status of Companies v) 6 (6)
1.2.3.6 Terms to Remember
1. Income Every person is always in search of monetary return in the regular form.
2. Person Income-tax is charged in respect of the total income of the previous year
of every person.
3. Assessee : every tax payer is an assessee.
4. Assessment year : “Assessment year” means the period of twelve months
commencing on 1st April every year.
5. Previous year: Previous year means the financial year immediately preceding
the assessment year.
6. Residential Status:
The income tax liability of any assessee depends upon their residential status.

1.3 Summary
Tax is revenue to the government, generally used for public utility. In India,
Income tax was introduced for the first time in 1860 by Sir James Wilson in order to
meet the losses sustained by the Government on account of the Military Mutiny of
1857. The Income Tax Act 1961 has been brought into force with 1 April 1962. Tax
is the financial charge levied by the Government on income, commodity or activity
of a person under certain conditions prescribed by Finance Act every year. Every
person has to pay income tax on the basis of tax rates given under Income Tax Act,
1961. Generally, there are two types of tax which is levied by the Government i.e.
Direct tax and Indirect tax. The income tax law in India consists of the components
as Income tax Acts, Income tax rules, Finance Act, Circulars, notifications, and
Legal decision of courts. Income Tax is levied on the total income of the previous

153
year of every person. The main basic concepts used in Income Tax are Income,
Agriculture Income, Person, Assessee, Assessment year, Previous year.
The income tax liability of any assessee depends upon their residential status.
The residential status is classified as under: On the basis of residence, all the assesses
are classified into two classes as Resident of India(ROI). This is also sub classified
into two i.e- i) Resident and Ordinary Resident ii) Resident and not Ordinary
Resident, Non-Resident of India (NRI).

1.4 Answer to check your progress

CHECK YOUR PROGRESS-I
Q.1. A) 1. Sir James Wilson, 2. 1st April 1962,
3. Finance Minister, 4. Income tax,
5. Financial Year, 6. Previous year,
7. Assessment year, 8. total income.
B) 1. True, 2. False, 3. False, 4. True, 5. False, 6. True, 7. False
CHECK YOUR PROGRESS-II
Q.1.A) 1. residential status, 2. two,
3. Control and management 4. Association of Person,
5. Residential status
Q.1.B) a) –v, b) –iv, c)- i, d) –ii e)- iii

1.5 Exercise
Short Questions:.
1. Explain the following basic concepts:
a) Income,
b) Agriculture Income,
c) Person,
d) Assessee,
e) Assessment year,
f) Previous year,
154
2. Explain the types of residential status with conditions and exceptions.
3. Explain the scope of total income or incident of tax.
4. Write note on : Residential status
5. Ms. Shambhavi has a total income of Rs. 13, 00,000 from his salary for the
financial year 2019-20. Compute tax liability of Ms. Shambhavi for the A.Y.
2020-21.
6. Mr. Ram is of 43 years. In the assessment year 2020-21 he has income from his
salary and other sources of Rs. 51,00,000. He also has fixed deposit in bank and
got interest as income. There is no any cess in this case.
Compute his tax liability of Mr. Sachin for the A.Y.
7. Mr. Sunil, age 50, has total income of Rs. 1,01,00,000 from his salary and other
bank interest on investments in fixed assets. Compute the tax liability of Mr.
Sunil for the Assessment Year 2020-21. Ignore cess.
8. Mrs. Neha, age 40, is having her total income of Rs. 2,01,00,000 including her
salary, interest on Fixed deposits and House property during 2019-20.
Compute the tax liability of Mrs. Neha by ignoring cess for the Assessment
Year 2020-21.
9. Compute the tax liability by ignoring cess of Mrs. Sheetal, age 34, having total
income of Rs. 5,01,00,000 from his salary, interest on fixed deposit and other
source like house property for the Assessment Year 2020-21.
10. Mr. Willy comes to India for 96 days every year. Determine his residential
status for the assessment year 2020-21.
11. Mahesh, an Indian citizen, leaves India on 20th October 2019 for the first time,
to work as an employee of a company in Australia. Determine his residential
status for A.Y. 2020-21.
12. Mr. Suraj came to India for the first time on 15th July 2019 and he left India on
03rd March 2020. Determine his residential status for the AY 2020-21.
13. Mrs. Jadhav, a US citizen but of Indian origin, comes to India for the first time
during the previous year 2015-16. Since then she is coming every year on a visit
to India for some days as shown below:

155
Years 2015-16 2016-17 2017-18 2018-19 2019-20
Stay in India 70 65 84 187 67
(days)
Determine her residential status for the assessment year 2020-21.
14. Following are the summary of the incomes of Mr. Raje for the previous year
2019-2020.
a) Income earned in India but received in London Rs. 10,000
b) Income earned in London in the earlier years but brought during the year of
Rs. 30,000
c) Income from Bank of Maharashtra as interest on deposits Rs. 20,000
d) He earned income from his business at US which is controlled from Canada
Rs. 28,500.
e) Income from House property in Japan received in India Rs.7,000
Compute his taxable income for the A.Y. 2020-2021 by determining Mr. Raje is
-a) Resident (ii) Not Ordinarily Resident (iii) Non-Resident

1.6 Further readings and References

1. Income tax Department, Ministry of Finance, Government of India. [ As
Amended by Finance Act,2019] A.Y. 2019-20
2. Study Material Executive Programme, Tax Laws and Practice, Module I, paper
4 ICSI house, 22, Institutional area, lodi road, New Delhi 110 003. email
[email protected] website www.icsi.edu.
3. Study Material Executive Programme, Tax Laws and Practice, Module 3, paper
9 ICSI house, 22, Institutional area, lodi road, New Delhi 110 003. email
[email protected] website www.icsi.edu.
4. Direct Taxes, Special Group : A - Accounting Group M. Com (M 17) – Part Ii
Semester – Iii, Yashwantrao Chavan Maharashtra Open University
Dnyangangotri, Near Gangapur Dam, Nashik 422 222, Maharashtra.
5. Ajay B Agrawal's Tax Solutions, Direct Taxes Summary Notes For Nov. 2016
Examination, UG-105, Ackruti Sankul, Sadashiv Peth Pune.

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6. Tax Management And Practice, Final Study Notes, The Institute Of Cost
Accountants Of India CMA Bhawan,12, Sudder Street, Kolkata - 700 016Third
Edition : March, 2016 (as per Finance Act, 2015) Published by : Directorate of
Studies, The Institute of Cost Accountants of India (ICAI), CMA Bhawan, 12,
Sudder Street, Kolkata - 700 016.. www.icmai.in
7. Income Tax Law and Practice, Study material B.com. Vi Semester Core Course,
University of Calicut School of distance education, The njipalam, Calicut
University P.O., Malappuram, Kerala - 693 635
8. Ref Accounts Learning Portal ,VARIOUS EXAMPLES OF CALCULATION
OF INCOME TAX , Posted By G.S. Bansal, On September 12, 2012
9. CA Ajay B Agrawal, Summary Of Five Heads, Tax Implications, Tax Solutions
10. Dr. Naveen Mittal: Concept Building Approach to Income Tax Law &Practice
(AY 2020-21):
11. Dr. Naveen Mittal: Principles of Income Tax Law & Practice (AY 2020-21)
websites /Links
1. tps://www.bankbazaar.com/tax/marginal-tax-rate.html
2. http://caknowledge.in/list-incomes-exempt-income-tax/#ixzz4TOBxEogX
3. Income Tax Management.Com
4. Article on ‘Residential Status and Scope of Total Income by CA Rahul Jain,
http://taxguru.in/income-tax/residential-status-scope-total-
income.html#sthash.pSv6HEat.dpuf) Feb, 2017
5. http://financetool.in/computation-total-income-tax-liability/2019-20

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 Unit-2
Exemptions and Deductions from Total Income

Structure of Unit
2.0 Objectives
2.1 Introduction
2.2 Exempted incomes U/s 10
2.3 Deductions of chapter VI 'A' applicable to individual
2.4 Summary
2.5 Key terms
2.6 Self assessment questions
2.7 Further Readings

2.0 Objectives
After going through this unit, you should be able to -

know the meaning of exempted incomes

understand the various types of exempted incomes U/s 10

know the meaning of deductions

understand the deductions of chapter VI 'A' applicable to individual

2.1 Introduction
The income Tax is a tax on the income of a person, the meaning of the term
income is very important. But the income Tax Act, 1961 does not define the term
income Sec. 2 & 3 of the Act, however defines the terms & expressions of the word
‘income’ these are of two types – (i) Inclusive and (ii) Exhaustive the exhaustive
definition tries to explain the meaning of the term, where as the inclusive divination
gives the contents included in such term.
Generally speaking, the word Income covers receipts in the shape of money or
money’s worth which arise with certain source. However all receipts do not from the
basis of taxation under the act. For levy of Income Tax first of all the taxable income

158
of a person should be determined as per the provisions of the Act & Rules. The
Taxable income should be computed under the five heads. The total of such net
amount is called Gross total Income. There are other permissible deductions under
the act which are to be deducted from Gross Total Income. But there are some
Incomes are not included in the above income.
Exemptions available U/s 10, 10A, 10 B, 13 A & deductions under 80C to 80U
are of special nature of are allowed to certain limits.
These exemptions and deductions available under the act may be broadly be
grouped as “ –
(a) tax free Income (sec. 10,10 A,10 B &13 A)
(b) Deductions from Gross Total Incomes (Sec. 80C to 80U)
In this chapter, we are going to study exempted incomes and deductions of
chapter VI 'A' applicable to Individual.

2.2 Incomes Exempted from tax U/s 10

In the following cases, income is exempt from tax.
1. Agricultural Income [sec.10(1)]
Agricultural Income is fully exempted. However, the net agriculture income is
taken into account in income liable to tax. (for details refer pervious chapter).
2. Any sum/receipts received from Hindu Undivided family (HUF) [sec10 (2)]
Any sum/receipts received by an Individual as a member of Hindu undivided
family or out of income of estate belonging to the family is exempt from tax. Such
receipts are not chargeable to tax in the hands of an Individual member ever if
tax is not paid or payable by the receipts from a HUF are, however taxable vide sec.
64 (2).
3. Share of profit from a partnership firm [sec.10(2A)] –
Share of profit received by partners from a firm (which is assessed as firm) is
not taxable in the hands of partners. However, such share of a partner should be
computed by dividing the taxable profit of the firm in the same proportions as per the
profit sharing ratio mentioned in the partnership deed.
4. Interest received by a Non Resident – [sec. 10 (4) (4B)]
The following interest incomes are exempt from tax -
159
 (a) any income of a non resident by way of interest on notified Government
Securities (including premium on redemption of such bonds) – sec. 10 (4) (i)
(b) Income from interest standing to credit in a Non Resident (external)
Account in India, in accordance with the FEMA or a person who has been Permitted
by the RBI to maintain the a foreside account – sec. 10 4 (ii) and
(c) In the case of an, Indian citizen or a person of Indian origin who is a non
resident, National saving certificates VI & VII Issues if such certificates are
subscribed from outside thorough official channels – sec 10 4 (B)
5. Leave Travel concession to an Indian citizen – [sec 10(5)]
The exemption in respect of value of leave travel concession is available to an
Indian citizen. The value of any travel concession received by or due to an individual
from his employer for himself and his family while proceeding on leave to any place
in India is exempt. Such concession received from his present or former employer
after retirement or after termination of his service is also exempt.
The amount to be exempted should not exceed the amount of expenses actually
incurred for the purpose of such travel.
The cremation is available to an employee in respect of two journeys performed
in a black of 4 calendar years commencing from 1986. if such concession is not
availed of by him during a black of 4 calendar years, the amount received by him in
the first calendar year in the previous block of 4 years is eligible for exemption.
Here. “family” means the spouse, children, parents, brothers and sisters mainly
dependent on the Individual.
6. Death – cum retirement gratuity [sec. 10 (10)]
(a) Any gratuity received by the employees of Government or semi
Government department including the employees of a local authority, is FULLY
EXEMPT.
(b) Any gratuity received by employees Covered by the payment of Gratuity
Act 1972, is exempt to the extent that it is payable as per the provisions of that Act
being the least of the following (i) Actual Gratuity received (ii) Rs. 7,00,000 (iii) 15
days salary (7 days in the case of employees of seasonal establishment) based on
salary last drawn for each completed year of service or part there of exceeding 6
months

160
 (c) Any other gravity received by on employee from the employer of private
sector /corporations on his retirement or becoming in capacitated, or on termination
is exempt being the least of the following : -
(i) half month’s average salary for each year of Completed Service.
(ii) maximum limit Rs. 7,00,000.
(iii) Actual gratuity received.
The average salary is calculated on the basis of 10 months preceding the month
in which the gravity is paid. For this purpose salary means “Basic pay +Dearness
allowance (if the terms of employment provides) +Commission (if it is based on
percentage of turnover)
7. Retrenchment Compensation [sec.10(10B)]
Any compensation on received by a workman under the Industrial Despots Act
1947 or other Act Rules or orders or Awards at the time of his retrenchment, is
exempt to the extent of the amount calculated as per the provisions of the Industrial
Disputes act 1947 or an amount not being less than Rs. 5,00,000 as notified by the
Government whichever is less.
8. Compensation Under Bhopal Gas Leak Disaster Act [sec. 10 (10BB)]
Compensation received by an assessee under the provisions of Bhopal Gas Leak
Disaster (processions of claims) Act 1985 and any scheme framed there under, is
exempt from tax. However, any payment or Compensation received by an assessee in
connection with Bhopal Gas Leaks Disaster, to the extent he has been allowed as
deduction from his taxable income on account of any loss or damage caused to him,
will not be exempt from tax.
9. Compensation on Voluntary Retirement [sec. 10 (10C) ]
Any compensation received by an employees of a public sector company or of
any other company or local authority or an authority set up under government Act or
co-operative society or university or India institute of technology or specified
institute of management on his retirement, is exempt subject to a maximum limit of
Rs. 5,00,000 in accordance with the scheme formed there under [Rule 2 BA]. In the
case of Companies the scheme should be approved by the chief Commissioner or
Director General as the case may be. Further if such exemption has been allowed for

161
any employee for any assessment year, no exemption will be allowed again for any
other assessment year.
10. Payment from Provident Fund [sec. 10 (11)]
Provident fund scheme is a retirement benefit scheme. Any payment from a
provident fund to which provident fund Act 1925 (statutory provident fund) or any
other provident fund set up by central government and notified in the official gazette
is totally exempt from tax.
11. Sum received from life Insurance Policy [sec. 10 (12)]
Any sum received under a life insurance policy, including the sum allocated
by way of bonus on such policy, shall not be included in the total income of a
persons. The exemption is however not available in respect of such polices which
is in sec. 8- DDA (3) or under key man insurance policy.
12. Payment from an approved superannuation fund [sec. 10(13)]
The payment form this fund is exempt it is paid :-
(i) on the death of a beneficiary or
(ii) to an employee in lieu of or in Commutation of an annuity on his retirement
at or after a specified age or on his becoming incapacitated before such
retirement or
(iii) by way of refund of Contributions on the death of beneficiary or
(iv) by way of refund of contributions to an employee on his leaving the service
with which the fund is established and where the retirement and other
conditions are not applications and the interest there on.
13. House Rent Allowance : [sec. 10 (13A)] –
The house rent allowance actually received by an employee specially granted to
him by his employer to meet the expenditure incurred on rent, is exempt to the extent
of the least of the following –
(i) HRA actually received
(ii) The excess of rent paid over 10% of salary
(iii) (a) 50% of salary if the house is situated in Mumbai, Kolkata, Chennai &
Delhi (b) 40% of salary if the house is situated at any other place. “salary for this

162
propose” is equal to Basic salary +D.A. (if terms of employment provides) +
Commission (if based on Fixed percentage).
The period of occupation of the house by the assesses during the previous year
is to be taken into account for the above calculation.
14. Interest on Certain Government Securities: [sec. 10 (15)] –
The interest received from any of following securities is exempt :
(1) interest on notified Securities, bonds or certificates (2) Interest on 10%
Relief Bonds (for Individual / HUF only) (3) Interest on notified bonds / debentures
of a public sector Company (4) 12 years National saving annuity Certificates (5)
National defence Gold Bonds (6) Post office cash certificates (5 years) (7) Post office
National Saving certificates (12 years / 7 years) (8) Post office Saving Bank Account
(9) Post office Cumulative Time Deposit Rules 1981 (10) Scheme of fixed deposits
governed by Government Saving Certificates Rules (11) National defence Gold
Bonds (12) special Bearer Bonds 1991 (13) Treasury Saving Deposit Certificates (10
years) (14) Special deposit Scheme 1987 (15) Resurgent India Bonds (16) 7% Saving
Bonds 2002.
15. Educational Scholarships: [sec. 10 (16)]
Scholarship granted to meet the cost of education is exempt from tax. In order to
avail the exemption it is not necessary that the government should finance
scholarship.
16. Daily allowance of Members of Parliament
Sec. 10 (17) Clause (17) of section 10 provides exemption to Members of
parliament of state Legislature in respect of the following allowances :
(a) Daily allowance Entire amount is exempt. (b) any other allowance received
by a Member of parliament under the Members of Parliament (Constituency
allowance) Rules 1986 and (c) all other allowances (not exceeding Rs.2000 P.M.)
received by any person by reason of his Membership of any state legislature or any
Committee there of, which the Central Government may notify.
17. Awards &Rewards : [sec. 10 (17A)]
The following payment received either in cash or in kind are exempt – (a) Any
award Instituted in the public interest by the government or any other approved

163
public body (b) any reward received from the government for such purpose that are
approved in the public interest.
18. Annual Value of palace of a Ruler [sec.10(19A)]
The annual value of any one palace in the occupation of a Ruler during the
pervious year, is exempt provided such exemption was given be before the
commencement of the Constitution Act 1971.
19. Dividend of Domestic Companies [sec. (34)]
Any income by way of dividends of Indian Companies referred to in sec.115 is
exempt from tax, in the hands of recipient.
20. Income from units of Mutual Fund [sec. 10 (35)]
Any income received in respect of the units of Mutual fund specified under
clause 10 (23D) & units of UTI or specified Company are exempt from tax, in the
hands of recipients.
Other important exemptions are as under –
(i) Income of employees stats Insurance Fund [sec.10(25A)]
(ii) Income of National Minorities Development and finance corporation
[sec10(26B B)]
(iii) Subsidy form Tea Board [sec.(10 (30)]
(iv) Subsidy received by planters [sec10(31) ]
(v) Capital Gains on transfer of U/s 64 [sec.10 (33)]
(vi) Capital Gains on transfer of listed equity shares [sec.10 (36)]
(vii) Income of an International sporting event [sec.10 (39)]
(viii) Grant received by subsidiary Company from holding Company sec.10 (40)
(ix) Income of Insurance Regulatory Authority [sec. 10 (23BBC)
(x) Pension or family pension of gallantry award winners sec. 10 (18).

2.3 Deductions under Chapter VI 'A' applicable to Individual

The Chapter VI 'A' of the Income tax act provides for the deductions an assessee
can claim in Computing the total Income. It includes sec. 80C to 80U these are
explained as :-

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1. Deductions U/s 80 C –
The following are the main provisions of sec. 80C.
(i) It is available from Gross total Income.
(ii) It is available to Individual or HUF.
(iii) It is available on the basis of specified qualifying investments/contributions
etc. can be made out of taxable income
(iv) Maximum amount of deduction is Rs.1.5 Lakhs.

Computation of deductions u/s 80c –
Following are the 2 steps,
Step I – Gross Qualifying amt.
Step II – Amt. of deduction.
Step I – Gross qualifying amt. It is the aggregate of the following –
(1) Life Insurance premium.
(2) Contribution towards statutory PF and Recognized PF.
(3) Contribution towards PPF.
(4) Contribution towards approved super annuation fund.
5) Subscription to NSS VIII issue.
6) Contribution to ULIP scheme by UIT, LIC mutual fund.
7) Payment for notified annuity plan of LIC. (e.g. New Jeevan Dhara, New
Jeevan akshay.)
8) Payment in respect of non-commutable deferred annuity.
9) Subscription towards notified units of mutual Fund.
10) Contribution to notified pension fund. (set up by mutual fund or UIT)
11) Any sum deducted from salary payable to Govt. Employee for the purpose
of serving him a deferred annuity (subject to a maximum of 20% of salary)
12) Any sum paid (including accrued interest) as subscription to home loan
account scheme of National housing bank.

165
 13) Any sum paid as tuition fees to any university/college /educational
institution.
14) Any payment towards the cost of purchase or construction of residential
property (including repayment of loan taken from Govt. bank LIC,NHB
etc.)
15) Amount invested in approved debenture /equity shares (in a public co.
engaged in infrastructure, power sector, etc.)
16) Amount deposited as a term deposit for a period of 5 years or more.
17) Subscription to any notified bonds of NABARD.
Step II : Amount of deduction

The amount of deduction is calculated as,
(a) Gross qualifying amount. (step I amount.)
(b) Rs. 1,50,000 whichever is lower.
2. Deduction under Sec. 80 D – Medical Insurance Premia
(i) Taxpayer is an individual
(ii) Insurance scheme is framed by central insurance company & approved by
central government
(iii) It is essential to issue cheque of insurance premium by an assessee
(iv) Premium is paid out of income chargeable to tax.
(v) Mediclaim policy is taken on the health of Individual, this spouse,
dependent parents, dependent children.
(vi) Mediclaim policy is taken on the health of any member of the family, in
case of HUF.
Amount of deduction –
It above conditions are satisfied then the insurance premium paid or 15000
whichever is lower, is deductible (maximum amt. of Rs. 15000 increased to Rs.
20000 if the family Member consist a senior citizen).
3. Sec. 80 DD- Deduction in respect of maintenance including medical
treatment of handicapped dependent –

166
 The assesses should be either an individual or a HUF. He may have incurred
some amount for medical treatment or training or rehabilitation of handicapped
dependent or may have deposited some amount in an approved scheme by LIC or
UIT for such handicapped dependent.
The subscriber should have made nomination of either handicapped dependent
or any other person, trust to receive the payment and use it for the benefit of
handicapped dependent. The assesses can claim deduction under this section of
Rs50000 (A higher deduction of Rs 1,00,000 shall be allowed it dependent is a
person having disability ever 80%)
4. Sec. 80 DDB – Deduction in respect of medical Treatment –
The deduction is available to individual and a HUF. The assessee should have
actually incurred some expenditure on medical treatment for specified ailments. In
case of an individual the expenditure might be for himself or any dependent relative.
for HUF it can be for any Member of is Rs. 40,000 and if the patient is a senior
citizen the amount of deduction shall be Rs. 60,000 or the expenditure actually
incurred whichever is lower.
5. Sec. 80 E – Deduction in respect of Interest of loan taken for higher
educations.
The assessee should be an individual. It is available to student & not to parent.
Loan is taken from any financial institution or banking company. The deduction is
available for maximum 7 years & it is available only for amount paid by way of
interest & not for repayment of principal Loan amount.
6. Sec. 80G – Deductions in respect of Donations –
Only donations in cash qualify for the deduction. Generally the Qualifying
Amount of donations should not exceed 10% of Gross total Income after deductions
allowed under chapter VI 'A'.
Dontations to following funds / Institutions are100% deductible.
(i) National Defence fund by Central Govt.
(ii) Prime Minister National Relief fund
(iii) National foundation for communal harmony.
(iv) Any State Government Fund for providing medical relief to tried poor.

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 (v) Chief Minister's Earthquake Fund, Maharashtra.
(vi) Zilla Saksharta Samiti.
(vii) Central welfare fund of army &air force.
(viii) Andra Pradesh chief minister cyclone relief fund.
(ix) National Illness Assistant fund.
(x) National sports fund or National cultural fund.
Donations to following are 50% deductible-
(1) Any notified temple, mosque, gurudwar church or other place of workshop.
(2) Any corporation specified in sec. 10 (26BB) for promoting interest of
minority community.
(3) Any other fund or institution which satisfies conditions in 80F(5)
(4) Jawaharlal National Memorial fund
(5) Prime Minister's Drought Relief fund.
(6) Indira Gandhi Memorial Trust.
(7) Rajiv Gandhi foundation
The above deductions are available only to Individual.

2.4 Summary
Sec. 10 of Income Tax Act. 1961 enumerates income which are tax free. They
are called exempted incomes. These incomes are not included in computing the total
income of on assessee. Any income falling within only of the clauses in sec. 10 shall
be exempted. The burden of proving that of particulars item of income falls within
this section is on the assessee. Some of the important exempted are agriculture
income, receipts from HUF, share of income/ profits from firm, Gratuity etc.
In computing the total income of an assessee, certain deductions, are available
from gross total Income. Such deductions are contained in chapter VI 'A' of the Act.
And they have been specified in sec. 80C to 80U. The aggregate amount of
deductions u/s 80C to 80U cannot exceed Gross Total Income. The main purpose of
these deductions is to encourage saving of the people. Every sections in this chapter
VI A explains basis of calculations of these deductions.

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2.5 Key terms
1. Exempted Incomes : Sec. 10 of Income tax Act 1961 contains Incomes which
are tax free. These incomes are called exempted Incomes. These incomes are not
to be included in computing the total income of an assessee.
2. Deductions of Chapter VI 'A' : Chapter VI 'A' of Income Tax Act. 1961
contains certain deductions which are available to assessees. These deductions
can be claim by assesses while Computing his total Income. Chapter VI 'A'
covers sec. 80C to 80U.
3. Exemption and Deductions : Exemption covers Incomes which are not taxable
where as deductions covers incomes which are allowed to be deducted from
Gross total Income.

2.6 Self-Assessment Questions

(A) Objective Type Questions
I. Choose the correct alternative:
1. Maximum limit of exemption u/s 10(10)in respect of gratuity is …………..
(a) Rs. 2,50,000 (b) Rs. 3,50,000 (c) Rs. 5,00,000 (d) Rs. 7,00,000
2. Agriculture income is ………..
(a) fully exempted (b) fully taxable
(c) Partially taxable (d) None of the above
3. Sec. 80 DD in respect of maintenance of handicapped dependent available
to …………
(a) Individual (b) Individual & HUF only
(c) HUF (d) HUF, firm & company.
4. Medical Insurance Premium u/s 80 D available only when it is paid by –
(a) cash (b) cheques (c) DD (d) all of the above.
5. Donation to National Defence fund is ………. % deductible.
(a) 50% (b) 60 (c) 70 (d) 100
Ans. : [1. d 2. a 3. b 4. b 5. d]

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II. State True or False.
1. Section 10 of income tax Act Contains all exemption income
2. Deduction U/s 80E is in relation to donations.
3. Any Grauity received by Govt., semi Govt. employee is taxable.
4. Donations given to Prime Minister's Draught relief fund is deductible at
100% from total Income.
5. Maximum limit of deduction U/s 80C is Rs. 1,50,000.
Ans. : [1. T 2. F 3. F 4. F 5. T]
(B) Short answer questions -
1. Explain House Rent Allowance u/s 10 (13A).
2. Explain Interest on Certain Govt. Securities [sec 10 (15)]
3. Explain Medical Insurance Premium u/s 80 D.
4. Explain Deduction in respect of donations u/s 80 G.
5. Explain any 8 incomes exempted from income tax.
(c) Essay Type Questions –
1. Enumerate incomes which are totally exempt.
2. Explain briefly the provisions of the Income tax Act 1961, regarding
deductions allowable in computing the total income of the Individual.
3. Explain briefly the provisions of sec. 80C and 80 D.

2.7 Further Readings

1. Students Guide to Income Tax : Dr. Vinod singhania
Dr. Monica Singhania.
2. Income Tax Rules 1961 : Taxman publication
3. Direct Tax Laws : Dinkar Pagare
Sultanchand & sons publication
4. Income Tax Laws & Practice : Dr. Mehotra H.C.
5. Direct Tax : T. N. Manoharan


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 Unit-3
Heads of Income, Computation of total income and tax liability

Structure of Unit
3.0 Objectives
3.1 Introduction
3.2 Presentation of subject matter
3.2.1 Income from Salaries
3.2.2 Income from House Property
3.2.3 Income from Business/Profession
3.2.4 Income from Capital Gains
3.2.5 Income from Other Sources
3.2.6 Computation of Gross Total Income and Tax Liability in respect of
Individuals
3.3 Summary
3.4 Terms to Remember
3.5 Answer to check your progress
3.6 Exercise
3.7 Reference for further study

3.0 Objectives:
After studying this Unit you will able to understand the:
• To comprehend the meaning of salary, allowances, perquisites and various
retirement benefits and admissible deductions from salary income and
calculation of Income from salary
• Determine annual value of different kinds of house property and computation
from income from house property
• To comprehend the meaning of meaning of business and profession, identify
allowable and disallowed expenditure, maintenance of books and computation
of Income from business and profession

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• Identify the assets classified as a capital assets for the purpose of chargeability
under capital gain, determining short term and long term capital assets, meaning
of transfer, different exemptions available for investments of capital gain,
compute the capital gains chargeable to tax .
• Indentify the income which are chargeable to tax under the head income from
other source, admissible deductions and computation of income from other
source
• Computation of total taxable income and tax liability of an individual as per
income tax provisions.

3.1 Introduction:
In the previous chapter you have learnt different exemptions and deductions
from total Income of Individual. Person earns income from different sources. Income
tax is imposed on assessee’s total income. Section 14 of Income Tax Act 1961,
classified and taxable under particular groups or heads. These known as ‘Heads of
Income’. These heads of income grouped under five heads which are as under :
1) Income from salaries
2) Income from house property
3) Income from Business and profession
4) Capital gains
5) Income from other sources
Assessee’s income is computed under each head separately by applying
charging and Deeming provisions of the act, Income tax act providing different
permissible deductions and exemptions from gross total income.. after claiming the
deduction under chapter VI A if any, from the gross total income, we get the taxable
income of assessee.
Lets understand in detail five different heads of income and income tax
provisions for Computation of income. Person earn income different sources but all
this income are Classifies under five heads of income.

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3.2 Presentation of Subject Matter
3.2.1 Income from salaries :
The provisions relating to income under the head salaries are mentioned in
section 15, 16 and 17 in income tax act. The condition for compute income under the
head Salaries is that the relation between payer and payee of such payment should be
of An employer and employee. Salary consist of Allowances, perquisites, retirement
Benefits.
• Concept of Salary:
Meaning of salary for income tax purposes is much wider. Salary means every
Payment monetary or non -monetary made by employer to employee for Service
rendered by employee.
1) The amount received by an individual shall be treated as salary only if the
relationship between payer and payee of such payment should be of an employer
and employee .
2) Conceptually salary and wages are same there is no difference.
3) It does not matter whether the employment is full time or part time. Once the
relationship between employer and employee exists the income is to be charged
under the head ‘salaries’. If an individual receives salary from more than one
employer during previous year is taxable under the head salary
4) Salary received from former employer, present employers or prospective
employer should be clubbed and bought to charges under the head salary for
relevant previous year
5) Once salary has accrued to an employee it subsequent waiver by the employee
does not absolve him from liability to income tax.
6) If an employee surrenders his salary to the central government, the surrender
salary would be exempt while computing his taxable income.
7) If employer pay the tax which is due on salary the amount of tax paid by the
employer and salary received from employer both are taxable as salary income.
8) Voluntary payments by employer in the form of gift or perquisite are taxable
under head salary.

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• Definition of salary:
Section 17(1) of the income tax act gives an inclusive definition of salary which
includes:
a) Wages
b) Any annuity and pension
c) Gratuity
d) Fees, commission, allowances , perquisites or profit in lieu of salary
e) Any advance of salary
f) Leave Encashment
g) Any advance of salary
h) Contribution of employer to Recognized Provident Fund to the extent it is
taxable
i) The contribution made by central government or any other employer to the to
the account of an employee under notified pension scheme
j) Transferred balance in a recognized provident fund to the extent it is taxable
• Basis of Charge: U/s .15
1) As per section 15 of the Act the income from salary is chargeable to tax on ‘due'
or ‘receipt’ basis whichever is earlier.
2) where any salary, paid in advance, is chargeable in the year of payment, it
cannot be subsequently chargeable to tax in the year in which it becomes due.
3) Any arrears of salary paid or allowed to employee in the previous year by or on
behalf of employer or former employer, if not assessed to tax in any earlier
previous year then only taxable.
• Profits in lieu salary :[sec.17(3)]:
These payments are received by employee in addition to salary and wages. It
includes the following:
a) Any compensation received by an Individual from his employer or former
employer at or in connection with the termination of his employment or the
modification of the terms and conditions of employment. The termination may
be due to retirement, premature termination, and resignation or otherwise.
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b) The payment due to or received by an assessee from an unrecognised provident
fund or an unrecognised superannuation fund to the extent to which such it does
not consist of employees contributions or interest on such contribution.
c) Any sum received under key man insurance policy including the sum allocated
by way of bonus on such policy, will also be considered as profit in lieu of
salary.
d) Any amount received in lump sum or otherwise prior to employment or
employment or after cessation of employment.
e) All other payments received by an employee from his employer or former
employer except the following.
Payment of gratuity exempted under section 10(10)
Payment of House Rent Allowance exempted under section 10(13A)
Payment of commuted pension exempted under section 10(10A)
Payment of retrenchment compensation exempted under section 10(10B)
Payment from an approved superannuation fund under section 10(13)
Payment from statutory provident fund or public provident fund
Payment from recognized provident fund to the extent it is exempt under section
10(12).
• Pension:
Pension is a periodical payment made by the employer to the employee after the
retirement or death of employee as a reward for past service.
Pension is of two types: commuted and un-commuted.
Un-commuted or periodical pension: Un- commuted pension received periodically.
It is fully taxable in the hands of both government and non-government employees.
Commuted pension: Commuted pension means lump sum amount taken by
commuting the whole or part of the pension.
Exemption in respect of commuted pension [Sec.10 (10A)]:
a) For the employee of government organization, local authorities, statutory
corporations-It is fully exempt from tax hence not included in gross salary.

175
b) For other employees:- any commuted pension received is exempt from tax to the
following extent .
Gratuity received / Not received Exemption
Gratuity received Commuted value of one third of the
pension is exempted from tax.
Gratuity not received Commuted value of one half of the
pension is exempted from tax.

c) Any commuted pension received by an individual out of annuity plan of the

fund set up by LIC will be exempt.
Illustrations 1
Mr. Suresh retired on 1.10.2020 is receiving Rs. 5,000/- per month as pension.
On 1.02.2021, he commuted 60 % of his pension and received Rs. 3,00,000/- you are
require to compute his taxable pension assuming :
a) Suresh is a Government employee
b) He is a private sector employee and received gratuity also at the time of
retirement.
c) He is a private sector employee and he did not receive gratuity at the time of
retirement.
Solution:
a) Suresh is a government employee :
Uncommuted pension received (October to March ) 24,000
(5000 x 4 months ) + (40% of 5000 x 2 months )
Commuted pension received Rs. 3,00,000 Nil
Less: Exempt u/s 10(10A) - Rs. 3,00,000
Taxable pension 24,000

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b) Suresh is private sector employee and received gratuity –
Particular Amount
Uncommuted pension received (October to March ) 24,000
(5000 x 4 months ) +(40% of 5000 x 2 months )
Commuted pension received Rs. 3,00,000 1,33,333
Less: Exempt u/s 10(10A) Rs. 1,66,667

,, 
%
( x %
)

Taxable pension 1,57,333

c) Suresh is private sector employee and did not receive gratuity:

Particular Amount
Uncommuted pension received (October to March ) 24,000
(5000 x 4 months ) + (40% of 5000 x 2months )
Commuted pension received Rs. 3,00,000 50,000
Less: Exempt u/s 10(10A) Rs. 2,50,000

,, 
%
( x %
)

Taxable pension 74,000

Gratuity:
Gratuity is the payment made by the employer to the employee in appreciation
of past services rendered by employee. In short gratuity is the retirement benefit.
Exemption in respect of Gratuity [sec 10(10)]: Tax treatment of gratuity is
given below :
i) Government employees and employees of local authority: The entire amount of
gratuity received received by them is exempted from tax.
ii) Employees covered under payment of Gratuity Act, 1972- Any death-cum-
retirement gratuity is exempt from tax to the extent of least of the following;

177
 1 Gratuity actually received
2 Rs. 20,00,000
3 15 days of salary for every completed year of service or part thereof in
excess of six months
Note : 1) Salary for the purpose means basic pay and dearness allowance
2) Number of days in a month for this purpose, shall be taken as 26
iii) Other employees:
In case of employees not covered in the above two categories, gratuity received
from the employers is exempt to the extent of minimum of following.
1 Gratuity actually received
2 Rs. 20,00,000
3 Half month of average salary for every completed year of service (fraction
to be ignored)
(Based on last 10 months average salary preceeding the month of
retirement )
Note: : 1) Salary for the purpose means basic pay , dearness allowance (if terms of
employment so provide),commission (if it is based on fixed percentage of turnover)
2) Gratuity received during period of service is fully taxable
Illustrations 2
Mr. Shankar retired on 15/06/2020 after completion of 26 years 8 months
service and received gratuity of Rs. 16,00,000. His monthly basic salary at the time
of retirement was Rs. 70,000 p.m., Dearness allowance Rs. 14,000 p.m. (60% of
which for retirement benefits), Commission 1% of turnover (Turnover in last 12
months was Rs. 1,50,00,000), Bonus Rs. 30,000 p.a.
Compute his taxable gratuity assuming –
a) He is private sector employee and covered by payment of Gratuity Act, 1972
b) He is private sector employee and not covered by payment of Gratuity Act,
1972
c) He is a Government employee

178
Solution :
a) He is covered by payment of Gratuity Act,1972:-
Particular Amount Rs. Amount Rs.
Gratuity received at the time of 16,00,000
retirement
Less: Exemption u/s 10(10) 13,08,461
Least of the following
a) Statutory limit 20,00,000
b) Gratuity received 16,00,000
c) 15 days salary based on last 13,08,461
drawn salary for each
completed year of service or
part thereof in excess of 6
months



x (70,000 + 14000) x 27

15/26 x 84000 x 27
Taxable Gratuity 2,91,538

b) He is covered by payment of Gratuity Act ,1972:-

Particular Amount Rs. Amount Rs.
Gratuity received at the time of 16,00,000
retirement
Less: Exemption u/s 10(10) 11,81,700
Least of the following

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a) Statutory limit 20,00,000
b) Gratuity received 16,00,000
c) Half month’s of salary based 11,81,700
on average salary of last 10 months
preceding the month of retirement
For each completed year of service
(Note)
Taxable Gratuity 4,18,300

Note: × Average salary × year of service

(,
)(
,%
)[
, ,,
% 

Average Salary =

,,,
, ,
= = 9,09,000/10 = 90,900



1/2x 90,900 x26 = 11,81,700

C) He is Government employee:
Particular Amount Rs. Amount Rs
Gratuity received at the time of retirement 16,00,000
Less: Exemption u/s 10 (10) 16,00,000
Taxable Gratuity Nil

• Leave salary or Leave Encashment :-

Employees are allowed to take various kinds of leave during the period of
service some of these leaves is not availed by employee are allowed to be encashed
every year or accumulated for future and encashed after retirement or death as per
the rules of the organization. The payment received on account of encashment of
leave would form part of salary. Tax treatment for leave salary under section
10(10AA) are as under :

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Nature of leave encashment Status of employee Tax treatment
Received during service Government and Fully taxable, However relief
non government can be taken u/s 89
employee
Received at the time of Government Fully exempt u/s
retirement /leaving job employee 10(10AA)(i)
Received at the time of Non- Government Least of following is exempt:
retirement /leaving job employee a) Rs. 3,00,000
b) Leave salary actually
received
c) Cash equivalent of leave
standing at the credit of
employee (Based on average
salary of last 10 months)
(Maximum 30 days for
every year of service )
d) 10 month’s salary (based
on average salary of last 10
months preceding
retirement)

• Voluntary Retirement compensation ( Sec.10(10c):

Any amount of received or receivable on voluntary retirement would be taxable
as profit in lieu of salary. However it would be exempt subject to following :
Status of employee Tax treatment
Central and state government employee, Least of following is exempt :
public sector company, any other a) compensation actually received
company, local authority, cooperative b) Rs. 5,00,000
society, IIT etc
c) 3 month’s salary × completed year of
service
d) last drawn salary × remaining
months of service left

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• Retrenchment Compensation: [Sec10(10B)]:
Least of following is exempt :
a) Compensation actually received
b) Rs. 5,00,00
c) 15 days average pay × completed year of service and part thereof in excess of 6
months .
• Leave Travel Concession (LTC): [Sec.10(5)]:
Exemption is available for 2 trips in a block of 4 calendar year :
Journey performed by Exemption
Air Amount of economy class air fare by
the shortest route or amount spent
whichever is less
Any other mode:-
i) Journey performed by rail Amount of air –conditioned first class
rail fare by the shortest route or amount
spent, whichever is lower.

ii) Rail service is not available

a) And public transport does not exist An amount equal to air –conditioned
first class rail fare by the shortest route,
as if the journey had been performed by
rail,
b) But public transport exists Amount not exceeding first class or
deluxe class fare by shortest route to the
place of destination.

• National pension scheme (NPS):

Contribution made by employer to NPS account of employee is first included
under the salary, but at the time computation of total income of employee a

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deduction u/s 80CCD is available to employee for employees and employers
contribution.
• Provident funds:
Provident fund is a retirement benefit scheme. Under this scheme a certain
amount is deducted by the employer from the employee’s salary as his contribution
towards the fund. The employer also generally makes matching contribution to the
provident fund. The employees and employers contribution are invested outside in
securities. The interest earned on it is also credited to the Provident Fund Account.
At the time of retirement, the accumulated balance is given to the employee.
Following of the different types of provident funds:
1) Statutory Provident Fund (S. P. F):
These provident fund set up under Provident Fund Act, 1925. This is maintained
by the government and the semi government organizations, local authorities,
universities and recognized educational institutions.
2) Recognised Provident Fund (R.P.F.):
This is set up under the Employee’s Provident Fund Act, 1952 and is maintained
by private sector employees. These provident fund are recognized by the
commissioner of Income Tax
3) Unrecognized Provident Fund: (U. R.P.F.)
If a provident fund is not recognized by the Commissioner of Income Tax.
These fund approved by commissioner of Provident fund.
4) Public Provident Fund (P. P. F.):
The central government has established these fund under Public Provident Fund
Act, 1968. The membership of the open to every individual. Minimum contribution
to the fund Rs. 500.
Income tax Provisions for Provident Fund :
Particular R. P. F. U. R. P. F S. P. F. P. P. F.
Employees Eligible for Not eligible Eligible for Eligible for
contribution deduction u/s for deduction u/s deduction u/s
Or assesses 80 C deductions 80 C 80 C

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contribution
Employer’ s Amount in Not taxable Exempt from Employer
contribution Excess of 12 % yearly tax does not
of salary is contribute
taxable
Interest credited Amount in Not taxable Exempt from Exempt from
excess of 9.5 yearly tax tax
% p.a. is
taxable
Amount Exempt if, Employers Fully exempt Fully exempt
received on continuing contribution from tax from tax
retirement service over and interest
five years, there on is
entire balance taxable as
transferred to salary
his NPS Employees
account , contribution
on cessation of is not
employment taxable.
and get new Interest on
employment to employees
the extent of contribution
accumulated taxable as
balance in RPF income from
account other source.
transferred to
his RPF
account
maintained by
the new
employer.

184
Note: Salary for R. P. F. Basic salary, dearness allowance (if enters retirement
benefit), Fixed percentage commission on sales.
• Allowances:
Allowance is the fixed monetary amount paid by employer to employee for the
meeting particular requirements like house rent, expenses of uniform, conveyance
etc.
Various types of allowances are as under
A) Fully Taxable Allowances :
Dearness Allowance Entertainment Allowance
Overtime Allowance Fixed Medical Allowance
City Compensatory Allowance Interim Allowance
Servant Allowance Project Allowance
Tiffin/Lunch/Dinner Allowance Any other Cash Allowance
Warden Allowance Non-Practicing Allowance
Transport Allowance for to employee Washing Allowance
other than handicapped/blind, deaf and
dumb
Conveyance Allowance for personal use Conveyance Allowance (Unspent
allowance )

B) Fully Exempted Allowances :

Allowance to high court judge Allowance paid by united nations
organization
Compensatory allowance received by Allowance granted to government
Judge employee outside India.
Sumptuary Allowance to high court or
supreme court judge

185
C) Allowances which are Partly exempted :
i) House Rent Allowance [Sec. 10(13A)]:
HRA is given by employer to employee towards payment of rent for residence is
taxable under the head of salaries. It is exempt u/s 10(13A) to the extent of the least
of the following:
Metro cities (Mumbai, Delhi, Kolkata, Other places in India
Chennai)
a) Actual amount of HRA received a) Actual amount of HRA received
b) Rent paid (-) 10% of salary for the b) Rent paid (-) 10% of salary for the
relevant period relevant period
c) 50% of Salary c) 40% of Salary
Note: 1) Salary for this purpose include: Basic pay, Dearness Allowance (if enters
for retirement benefit), Commission (if it is based on fixed percentage of turnover
achieved by employer)
2) If the employee is not paying any rent or the rent paid by he is less than 10% of
salary then exemption is not available.
ii) Notified Special Allowances [Sec.10 (14)]:
Notified special allowances which are exempt either in full or up to certain limit
provided they are not in the nature of Perquisites. These allowances are of two types.
I. Allowance exempt to the extent of actual expenditure or actual amount
received whichever least. They are following. [sec.10 (14)(i)]
a) Travelling Allowance: Any allowance granted to meet the cost of travel or
tour on transfer of duty.
b) Daily Allowance: The allowance granted for the period of Journey on tour
or transfer to meet the ordinary daily charges.
c) Conveyance Allowance: Any allowance granted to meet the expenditure
incurred on conveyance in the performance of duties of an office.
d) Helper Allowance: Any allowance granted to meet the expenditure incurred
on a helper where such helper is engaged in the performance of the duties
of an office or employment of profit.

186
 e) Research Allowance: The allowance granted for encouraging the academic
research and training in educational institutions.
f) Uniform Allowance: Any allowance granted to meet the expenditure on
purchase and maintenance of uniform.
Note: An employee being an assessed that chooses the provision of section 115BAC
(alternate tax regime) would be entitled for exemption only in respect of travelling
allowance, daily allowance, conveyance allowance in above.
II. Allowances which of exempt to the extent amount received or the Limit
specified whichever is least.
Sr. Allowance Exemption limit
No
1 Special compensatory Rs. 800 or Rs.300 per month depending
Allowance (Hilly Areas) or on specified location
Snow bound area, Uncongenial Rs. 7,000 per month in Siachen area of
allowance Jammu and Kashmir
(Areas in Manipur, Arunachal
pradesh, Sikkim, U.P. , H.P.
2 Border area, Remote Locality or Amount exempt from tax varies from Rs.
Disturbed Area or Difficult 200 to Rs. 1,300 per month.
Area Allowance (Subject to
certain conditions and locations)
3 Tribal / Schedule /Agency area Rs. 200 per month
allowance in (a) Madhya
Pradesh (b) Tamil Nadu (c)
Uttar Pradesh (d) Karnataka (e)
Tripura (f) Assam (g) West
Bengal (h) Bihar (i) Orissa
4 Allowance to a employee of the Amount of exemption shall be lower of
transport business to meet his following:
personal expenditure during his a) 70% of such allowance; or
duty performed in the course of b) Rs. 10,000 per month
running of such transport from

187
 one place to another place
provided employee is not in
receipt of daily allowance
5 Children Education Allowance Up to Rs. 100 per month per child up
to a maximum of 2 children is exempt
6 Hostel Expenditure Allowance Up to Rs. 300 per month per child up
to a maximum of 2 children is exempt
7 Compensatory Field Area Rs. 2,600 per month
Allowance. If this exemption is
taken, employee cannot claim
any exemption in respect of
border area allowance
(Specified areas in specified
states.)
8 Compensatory Modified Area Rs. 1,000 per month
Allowance. If this exemption is
taken, employee cannot claim
any exemption in respect of
border area allowance(Subject
to certain conditions and
locations)
9 Counter Insurgency Allowance Rs. 3,900 per month
granted to members of Armed
Forces operating in areas away
from their permanent locations.
If this exemption is taken,
employee cannot claim any
exemption in respect of border
area allowance
10 Transport Allowance granted to Rs. 3,200 per month
an employee who is deaf and
dumb, blind or handicapped to
meet expenditure on commuting
188
 between place of residence and
place of duty
11 Underground Allowance to Rs. 800 per month
employees working in
uncongenial, unnatural climate
in underground mines
12 High Altitude Allowance Rs. 1,060 per month - for altitude of
granted to armed forces 9,000 to 15,000 feet Rs. 1,600 per month -
for altitude above 15,000 feet
13 Highly active field area Rs. 4,200 per month
allowance granted to members
of armed forces
14 Island Duty Allowance granted Rs. 3,250 per month
to members of armed forces in
Andaman and Nicobar and
Lakshadweep group of Island

Note: An employee being an assessee who opts for provision of section 115BAC
would be entitled for exemption only in respect of Transport Allowance granted to an
employee who is blind, or deaf and dumb or Orthopedically handicapped with
disability of the lower extremities of the body to the extent of Rs. 3,200 per month.
• Perquisites :-
The term perquisite indicates some extra benefits in addition to the amount that
may be legally due by way contract for service rendered. It may in cash or kind. In
modern times salary packages of employees include monetary salary and perquisites.
The term perquisite defined in under section 17(2) of Income Tax Act. Include
the following items.
a) The value of rent free accommodation
b) The value of concession rent
c) The value of any benefit or amenity granted or provided free of cost or
concessional rate if any.

189
On the basis of definition perquisites can be classified in following three ways.
I) Perquisites taxable in the case of all employees
II) Tax free Perquisites in case of all employees
III) Perquisites taxable only in the hands of all specified employees
• Perquisites taxable in the case of all employees:-
Perquisites taxable in the case of all employees and their valuation is as Under:
• Rent free or concessional Rent Accommodation:
i) If the accommodation is ‘ UNFURNISHED :-
For Government employees : The value of accommodation shall be equal to
the LICENCE FEE charged for such accommodation.
For Non- Government or other employees:-
Valuation is as under as per prescribed rate:
Population of City as Where the Where the
per 2001 census accommodation is owned accommodation is not
by employer owned by employer.
In cities having population 15% of salary in respect of Actual rent paid or
above 25 lakhs period during which the payable by the employer
accommodation is or 15% of salary
occupied by employee as whichever is lower.
reduced the rent if any,
actually paid by employee.
In cities having population 10% of salary in respect of Actual rent paid or
above 10 lakhs but does period during which the payable by the employer
not exceeding 25 lakhs accommodation is or 15% of salary
occupied by employee. as whichever is lower.
reduced the rent if any
,actually paid by
employee.
In cities having population 7.5% of salary in respect Actual rent paid or
up to 10 lakhs. of period during which the payable by the employer
accommodation is or 15% of salary
190
 occupied by employee. whichever is lower.
as reduced the rent if any,
actually paid by employee.
Accommodation in hotel ---- 24% of salary or actual
charges paid whichever is
less
Note: - Salary for the purpose of Valuation of rent free accommodation includes the
following:
1) Basic Salary
2) Dearness Allowance to the extent applicable for retirement benefit
3) Bonus fees and commission
4) Taxable allowances
5) Leave encashment of salary pertaining to the current year.
Following should not be included in salary.
1) Employer’s contributions to P.F. and Interest P.F.
2) Dearness Allowance not applicable for retirement benefit
3) Exempted Allowances
4) Value of Perquisites
5) Advance Salary
II. If the accommodation is ‘FURNISHED’:
Value of Rent free unfurnished accommodation (as per above rule) xx
Add :- Value of furniture xx
Taxable value of Rent free furnished accommodation xx
Less :- Rent amount received from employee if any xx
Taxable value of Rented furnished accommodation xx

191
Note:
1) Value of Furniture: it includes Radio sets, T.V., Refrigerator, Air conditioners
and other household appliances.
If furniture is owned by employer 10% p.a. of the cost of furniture
If furniture is not owned by the Rent /lease of furniture paid by
employer employer
2) If an accommodation is provided in a hotel is not chargeable to tax if the
following two conditions are satisfied.
i) Total period not exceeding in aggregate 15 days in previous year.
ii) Such accommodation is provided to an employee’s transfer from one place to
another.
A) Monetary obligations of the employee discharged by the employer :-
• Valuation of Free domestic Servants :
If domestic servants are engaged by the employee and the employer paid or
reimbursed to the employee for the wages of such servants the actual cost to the
employer shall be taxable in the hands of all employee.
• Valuation of perquisite in respect of gas, electric energy or water supply :
If the gas, electric energy or water connections are taken by the employee and
employer paid or reimbursed such expenses then actual expenditure of the employer
as reduced by any amount recovered from employee, is a taxable in the hand of all
employee.
• Valuation of perquisite in respect of education facility :
Children’s education fee paid or reimbursed. (Bills issued in the Name of
employee)
• Holiday home facility
• Hotel bill or club bill of employee discharged by the employer
• Income tax or Professional tax of employee paid by the Employer.

192
C) Life Insurance premium or Deferred Annuity Premium of Employee paid
by employer.
D) Specified security or sweat equity shares allotted or transferred by
employer.
E) The amount or aggregate of amounts of any contribution made –
In Recognized Provident Fund,
In NPS referred to in section 80CCD (1)
In an approved superannuation fund
By the employer to the account of employee, to the extent is Exceeds Rs. 7,
50,000. [section17 (2) (vii)}
F) Annual accretion by way of interest, dividend, or any other amount
Similar nature during the previous year to the balance at the credit of
RPF/NPS/Approved superannuation fund to the extent its relate to employer
contribution to the included in total income on account of the same having exceeded
Rs. 7,50,000.
G) Any other Fringe Benefits –
Any other amenity includes following:-
i) Interest free or concessional rate loan :
Interest free or concessional rate loan given by an employer to employee or his
family member chargeable to tax in the hand of all employees are taxable on
following basis.
1) Find out the maximum outstanding balance for each loan as on the last day of
each month.
2) Find out rate of Interest charged by State Bank of India (SBI) on the first day of
relevant previous year in respect of loan for the same purpose advanced by it.
3) Calculate interest for each month of the previous year on the outstanding
amount (mentioned in point 1) at the rate of interest (given in point 2)
4) Find Interest actually recovered if any
5) The balance amount is taxable value of perquisite (point 3-point 4)
No value would be charges as perquisite if
193
a) Loan in aggregate does not exceed Rs 20,000
b) Loan is provided for treatment of specified diseases (Rule 3A) like neurological
diseases, Cancer, AIDS, Chronic renal failure, Hemophilia (specified diseases)
ii) Use of movable assets of the employer by the employee is a Taxable
perquisite as under: 17(2)(viii) read with Rule 3(7)(vii)
Use of Laptops and Computers Nil
Movable asset other than Laptops, 10% of original cost of the asset (if asset is
computers and Motor Car owned by the employer) or actual higher
charges incurred by the employer (if asset is
taken on rent) less amount recovered from
employee.
ii) Transfer of movable assets by an employer to its employee:-
17(2)(viii) read with Rule 3(7)(viii)
The value of benefit arising to the employee from the transfer of any movable
asset owned by the employer is to be determined as under :
Asset transferred Value of perquisite
Computers, Laptop and Original cost of asset less depreciation at 50%
Electronics items (using reducing balance method) for each
completed year of usage by employer less
amount recovered from the employee
Motor Car Original cost of asset less depreciation at 20%
(using reducing balance method) for each
completed year of usage by employer
less amount recovered from the employee
Any other asset Actual cost of asset less depreciation at 10%
(on SLM basis) for each completed year of
usage by employer less amount recovered from
the employee.

194
iv) Travelling, touring and accommodation: 17(2)(viii) read with Rule 3(7)(ii)
a) Facility of travelling, touring and accommodation availed of by the
Employee or any member of his household for any holiday.
b) Perquisite value taxable in the hands of employee shall be expenditure
incurred by the employer less amount recovered from employee
c) Where such facility is maintained by the employer, the value of benefit
shall be taken to be the value at which such facilities are offered by other
agencies to the public less amounts recovered from employee.
v) Free food and non-alcoholic beverages: 17(2)(viii) read with Rule 3(7)(iii) :
a) Fully Taxable: Free meals in excess of Rs. 50 per meal less amount paid by
the employee shall be a taxable perquisite
b) Exempt from tax: Following free meals shall be exempt from tax
• Food and non-alcoholic beverages provided during working hours at office or
• Through non-transferable paid vouchers usable only at eating joints (exemption
would not be available in case of employee being an assessee, who opts for the
provisions of section115BAC) provided by an employer is not taxable, if cost to
the employer is Rs. 50or less per meal.
• Tea, Coffee or Non-Alcoholic beverages and Snacks during working hours are
tax free perquisites;
• Food in office premises during working hours in remote area or an off-shore
installation.
vi) Gift or Voucher or Coupon:- 17(2)(viii) read with Rule 3(7)(iv):
• Gifts in cash or convertible into money (like gift cheque) are fully taxable.
• Gift in kind up to Rs.5,000 in aggregate per annum would be exempt, beyond
which it full amount would be taxable It may be given an ceremonial occasion
or otherwise. The gift may be given to the employee or any his family member
by the employer.

195
vii) Credit cards: 17(2)(viii) read with Rule 3(7)(v):-
An employer gives credit card to employee or his family Member, credit card
which can be used for personal purpose also. In Such as case the membership fee
annual fees paid by the employer Will be taxed as perquisite as under
• Personal expenditure incurred by the employer in respect of credit card used by
the employee or any member of his household less amount recovered from the
employee is a taxable perquisite
• Expenses incurred for official purposes shall not be a taxable perquisite
provided complete details in respect of such expenditure are maintained by the
employer
viii) Free Recreation/ Club Facilities: 17(2)(viii) read with Rule 3(7)(vi):
• Expenditure incurred by the employer towards annual or periodical fee etc. less
amount recovered from the employee is a taxable perquisite.
• Expenses incurred on club facilities for the official purposes are exempt from
tax.
• Use of health club, sports and similar facilities provided uniformly to all
employees shall be exempt from tax.
• In case corporate membership of club fee to acquire corporate membership is
not treated as perquisite
• Tax- free Perquisites in all cases:-
A) Medical facilities: [Proviso to section 17(2)]:
Expense incurred or reimbursed by the employer for the medical treatment of
the employee or his family (spouse and children, dependent - parents, brothers and
sisters) in any of the following hospital is not chargeable to tax in the hands of the
employee:
• Hospital maintained by the employer.
• Hospital maintained by the Government or Local Authority or any other
hospital approved by Central Government
• Hospital approved by the Chief Commissioner having regard to the prescribed
guidelines for treatment of the prescribed diseases.

196
• Payment or reimbursement of Health Insurance premium of employee by
employer.
• Amount paid or reimbursed for medical treatment of employee or any family
member in outside India is tax free to the extent permitted by Reserve Bank of
India.
B) Refreshment: Any refreshment provided by employer to employees during
office hours at a place of work are tax free.
C) Subsidized lunch or dinner provided by employer at office in office hour is tax
free if cost of per meal is less than Rs. 50.
D) Training facility: Amount spent on training of employee is Tax free.
E) Free telephone including mobile phone: Telephone provided to an Employer
to an employee at his residence. Telephone or Mobile bill paid by employer is
tax free
F) Transport facilities: Transport facilities provided by an employer Engaged in
the business of carrying of passenger or goods to his employees either free of
charge or at concessional rate.
G) Employer contribution to staff group insurance scheme is fully exempt.
• Perquisites taxable on in case of ‘specified employees’:
[Section 17(2)(iii)]:
Meaning of Specified employees:
The following employees are called specified employees.
a) A director employee of a company.
b) An employee who has substantial interest in a company.
A person has a substantial interest in a company if he is a beneficial owner of
equity shares carrying 20% or more voting power in a company.
c) Employee drawing salary in excess of Rs. 50,000.
Salary for this purpose shall include all taxable monetary payments but shall not
include the value of any nonmonetary perquisite. From salary deduct entertainment
allowance if applicable and tax on employment.
Following are the taxable perquisites in case of specified Employees only.
197
A) Car facility :
The valuation of a car facility is done as under :
i) Car is owned or hired by the employer and used only for the office duties
employee :NIL
ii) If car is owned or hired by the employer and provided to the employee used
exclusively for private purpose of employee The amount spent by employer on
running and maintenance of the car during the previous including the
chauffeur’s salary ,if any shall be taken as value of perquisite. If the car is
owned by the employer, even the amount of no wear and tear of the car
calculated at 10% of the cost of the car should further added to such value.
iii) If car is owned or hired by the employer & provided to employee to be
party for private purpose and partly for office :
Exp. Of the car Small car 1600 cc or Large car of more than
By… Less engine capacity 1600 cc engine capacity
A EMPLOYEE Rs.600 p.m. Rs.900 p.m.
B EMPLOYER Rs.1800 p.m. Rs.2400 p.m.
If the chauffeur’s is also provided by the employer to run the car, the value
perquisite increased by the Rs.900 p.m.
iv) If employee owns any automotive conveyance (other than car) and running
and maintenance charges are met or reimbursed by employer : The value
will be NIL if it is used wholly for official purposes. If ‘Specified conditions’
are satisfied. But if the conveyance is used partly for official are partly for
private purpose, the actual expenditure incurred employee as reduced by Rs. 600
p.m. (or as reduced by a higher amount specified conditions) given below are
satisfied is taxable.
v) If any other conveyance like scooter/ motor cycle is provided by the employer.
The value of perquisite is the amount actually spent by the employee on the
running and maintenance of conveyance attributable to the private use being
reasonable in the opinion of the Assessing officer.
vi) If car owned by the employee, expenses incurred by employer and used for
partly official and partly personal purposes Actual expenditure incurred by
employer minus expenses pertaining to official use minus anything recovered
198
 from employee, is taxable in the hands of employee. Expenditure pertaining to
official use can be calculated as per logbook of the car. Alternatively,
expenditure pertaining to official use can be calculated at the rate of Rs. 1800
per month (1600 cc or less) / Rs. 2,400 per month (above 1600 cc) for car and
Rs. 900 per month for driver.
vii) The use of vehicle by an employee for traveling from his residence to place of
work and back shall not be perquisite at all.
B) Free Education Facilities : The value of benefit to the employee resulting from
provision of free or concessional education facilities member of his household
(i.e. spouse, children & their spouses, servants and dependents) shall be as
under.
i) Where educational institution is owned by employer: The value benefit will
be treated NIL, if the cost of education does not exceed Rs, p.m., per child. But
if the cost of education exceeds Rs.1, 000 p.m. shall be treated as the value of
perquisite.
ii) Where educational institution is not owned by the employer: The perquisite
shall be taxable for all employees on the basis of school fees reimbursed by the
employer in respect of education provided to the me of his household (i.e.
spouse, children & their spouses, parents, servant dependents) Tuition fee
chargeable to tax Scholarship given by employees children of its employee is
not assessable perquisite in the hands of employer.
C) Valuation of provision for domestic servants :
If domestic servant engaged by employer and facility of such servants provided
to the employee, it will be taxable in the hands of only specified employee. If any
amount paid by employee for such services the amount so paid shall be deducted
from the value of perquisite.
D) Free supply of Gas electricity and water :
If the gas, electric energy or water connections are taken in the name of
employer and facility of such supplies provided to employee it will be perquisite in
the hand of only specified employee. Value of such benefit determined as under
Circumstances Value of benefit
If purchased from outside & supplied to Amount paid to the supplier

199
 employee
If supplied from own source Manufacturing cost per unit incurred by
the employer
If any amount paid by employee for such services the amount so paid shall be
deducted from the value of perquisite.
• Deductions from salaries: (Section 16)
From salary income only following deductions are allowed:
• Standard Deduction: u/s .16(i)
The standard deduction of Rs. 50,000 or the amount of salary, whichever is
Lower is to be deducted from gross salary of employee.
• Entertainment Allowance: u/s. 16(ii)
Entertainment Allowance received by an employee is first added in salary
Income and there after deduction is to be made from gross salary.
However this deduction is available only to the Government Employee. The
Amount of deduction will be lower of following:-
i) 20% of basic salary
ii) Actual Entertainment Allowance received
iii) Rs. 5,000
Actual amount spent by employee towards entertainment out of the allowance
received by him is not a relevant consideration.
• Professional Tax on employment : u/s 16(iii) –
Professional Tax or Tax on Employment, levied by a State under article 276 of
The Constitution, is Allowed as Deduction.
The following points should be kept in view —
1) Deduction is available only in the year in which professional tax is paid.
2) If the professional tax is paid by the employer on behalf of an employee, it is
first Included as salary income and then the same amount is allowed as
deduction on
Account of “professional tax” from gross salary.
200
3) There is no monetary ceiling under the Income-tax Act. Under article 276 of the
Constitution, a State Government cannot impose more than Rs. 2,500 per annum
as professional tax. Under the Income-tax Act, whatever professional tax is paid
during the previous year is deductible.
• Computation of Income From Salary :
Computation of Taxable income from salary of Mr./ Mrs.….. for the Assessment
year 2021-2022 Financial year : 2020-2021. PAN:
Particulars Rs.
1) Basic Salary ( * 12)) ) XXX
2) Dearness Allowance ( * 12) XXX
3) City Compensatory Allowance ( * 12) XXX
4) Entertainment Allowance, Tiffin allowance ( * 12) XXX
5) Medical Allow,/ Servant Allow/ Other Special allowances ( * 12) XXX
6) Bonus, Commission, Fees XXX
7) Advance of Salary/Arrears of Salary / Ex. Gratia payment XXX
8) Pension or annuity, leave encashment while in service XXX
9) H.R.A.(Exempt a. H.R.A. received b. rent paid less 10% of salary c. XXX
50% of salary In Mumbai, Delhi, Kolkata & Chennai or 40% in XXX
other place whichever is less)
XXX
10) Children Education Allowance (Exempt Rs. 100 P.m. per child up to
2 children) XXX

11) Children Hostel Allowance ( Exempt Rs. 300 P.m. per child up to 2 XXX
children) XXX
12) Assesses in Transport system: Transport Allow, (exem. 70% of XXX
allow. Or Rs. 10,000 p.m. whichever is less) XXX
13) Employer’s contribution to Recognized Provident fund in excess of XXX
12% of salary
XXX
14) Interest on Provident Fund exceeding 9.5% p.a.
XXX
15) Gratuity (Less : Exempt u/s 10 (10)

201
16) Commuted value of pension (Less : Exempt u/s 10 (10A) XXX
17) Leave salary (less : exempted u/s 10 (10AA) XXX
18) Rent-free Accommodation (As per rules) XXX
19) Domestic Servants (As per rules )
20) Personal payments of employee paid by employer and Other XXX
perquisites.
XXX
GROSS SALARY
Less Deductions :
1.Standard Deduction u/s 16(i)
2. Entertainment Allowance u/s 16 (ii) [20% on Basic pay] ( If assesses is
of Govt. Servant)
3. Professional / Employment Tax u/s 16 (iii)
TAXABLE AMOUNT OF SALARY
XXX

• Illustrations :
Illustration 1
Mr. Anup an employee of Infosys ltd. Pune, gives you details of his salary for
the year ended 31/03/2021 as under :
i) Basic salary Rs. 25,000 p.m.
ii) D.A. Rs. 15,000 p.m. (considered for retirement benefit)
iii) Transport Allowance Rs. 1,500 p.m.
iv) Children Hostel Allowance Rs. 1,500 p.m. for 3 children.
v) Children Education Allowance Rs. 1,500 p.m. for 3 children.
vi) The company contributes Rs. 5,000 p m. towards his R.P.F.
vii) Rs. 14,500 was credited to his RPF as interest @14.50% p.a.
vii) He paid professional tax Rs. 2,500 during the year.

202
You are asked to compute the income from salary for the A. Y. 2021-2022 assuming
Mr. Anup has not opted for the provisions of section 115BAC.
Answer:
Computation of Income from Salary of Mr. Anup For A. Y. 2021-2022
Particular Rs. Rs.
1) Basic Salary ( Rs. 25,000 x12) 3,00,000
2) D. A. ( Rs. 15,000x12) 1,80,000
3) Transport Allowance ( Rs. 1,500x12) 18,000
4) Children Hostel Allowance :- 46,800
Amount Received ( Rs.1,500x12x3) 54,000
Less : Exemption (u/s.10(14)) (Rs. 300x12x2) -7,200
5) Children Education Allowance :- 51,600
Amount Received (Rs,1,500x12x3) 54,000
Less: Exemption (u/s.10(11)) (Rs. 100x12x2) - 2,400
6) Employer contribution to R.P.F. (Rs.5,000x12) 60,000 2,400
Less: Exemption (see Note 1) -57,600
7) Interest on RPF 14.5% 14,500 725
Less: Exempt (u/s.10(11)) [ 14500x9.5%] 13,775
Gross Salary 5,99,525
Less: Deduction u/s 16 52,500
i) Standard deduction 16(i) 50,000
ii) Professional tax 16(iii) 2,500
Taxable Income From Salary 5,47,025

Note:1) Employer Contribution to Recognized Provident Fund (RPF):

Salary for RPF Rs.
Basic Salary 3,00,000

203
 D. A. ( Applicable) 1,80,000
Salary for RPF 4,80,000
Employer’s contribution exempted up to : 12% of salary i.e Rs. 4,80,000 x 12% =
Rs. 57,600.
Illustration 2
Mr. Arjun, a GST officer from Kolhapur submits the following details for
computation of his salary income for the assessment year 2021-2022.
Particular Rs. P.a.
Basic pay 2,52,000
Dearness Allowance (forming part of salary) 54,000
House Rent Allowance 24,000
Children’s Hostel Allowance (for three children) 3,000
Entertainment Allowance 2,400
Employer’s contribution to Statutory Provident Fund @14% of Basic 42,840
salary and D. A.
Interest credited to above PF account @12% p. a. 51,120
Transport Allowance 14,400
Rent paid by Mr. Arjun for residence 36,000
Mr. Arjun has been granted a soft loan of Rs. 2,00,000. On 01-10-2020 repayable
after 5 years. The state Bank of India interest rate is 14% p.a. The interest rate on this
soft loan charged is 2% p.a.
Mr. Arjun was admitted in a Government hospital for treatment against heart trouble.
The re-imbursement received by arjun for this medical treatment was Rs.45,000.
Professional tax paid Rs. 2,500 during the year
Compute the income from salary for the A. Y. 2021-2022 assuming Mr. Arjun has
not opted for the provisions of section 115BAC.

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Answer: Computation of Income From Salary of Mr. Arjun for A. Y. 2021-2022
Particular Rs. Rs.
1) Basic pay 2,52,000
2) Dearness Allowance (forming part of salary) 54,000
3) House Rent Allowance : 18,600
Amount Actual Received
24,000
Less: Exemption u/s 10 (13A) (Note 1) 5,400
4) Children’s Hostel Allowance : Nil
Amount Actual Received 3000
Less: Exemption us u/s 10(14) (300x12x2) 7200
5) Entertainment Allowance 2,400
6) Employer’s contribution to Statutory Provident Fund Nil
(Exempt )
7) Interest credited to above PF account @12% p. a. Nil
(Exempt )
8) Transport Allowance 14,400
9) Concessional Rate loan (2,00,000 X 12%X6/12) 12,000
10) Reimbursement of medical expenditure at government Nil
hospital (Exempt)
Gross Salary 3,53,400
Less: Deductions u/s 16 54,900
i) Standard deduction u/s 16(i) 50,0000
ii) Entertainment Allowance u/s 16(ii) ( note 2) 2,400
iii) Professional Tax u/s. 16(iii) 2,500
Taxable Income From Salary 2,98,500
Note: 1) House Rent Allowance :

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 Salary for HRA Rs.
Basic Salary 2,52,000
D. A. (Applicable) 54,000
Salary for HRA 3,06,000

Exempt least of the following Rs.

1) H. R. A. received 24,000
2) Rent Paid (-) 10% of salary 5,400
[ (36,000-(3,06,000 x 10%)] 36,000-30,600=5,400
3) 40% of Salary (3,06,000 x 40%) 1,22,400
Exempted House Rent Allowance Rs. 5,400.
2) Entertainment Allowance :
Exempt least of the following Rs.
1) Actual Allowance Received 2,400
2) 20% of basic pay (2, 52,000X20%) 50,400
3) Maximum Rs. 5000 5,000
Deduction available Rs.2,400.
Illustration 3
Mr. Ravi, a Managing director of LKP ltd. Delhi, receives the following salary
and perquisite from his employer during the previous year 2020-2021.
1) Basic salary Rs. 66,000 p.a.
2) Bonus Rs. 18,000
3) D. A. Rs. 2,000 p.m. (enters into retirement benefit)
4) Commission on sales at 4 % turnover of Rs. 18,50,000
5) Advance salary of Rs. 22,000
6) Employer contribution towards recognized provident fund Rs. 18,000.
7) Interest credited in RPF Account at. 13% Rs. 13,000.
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8) A rent free furnished house in Delhi. (Rent of furnished house paid by employer
Rs. 84,000 rent of furniture Rs. 18,000.)
9) He has provided free services of a Gardner salary Rs. 4,000 p.a. free services of
cook salary is Rs. 3,600 p.a. of watch man salary Rs. 900 p.a.
10) Mr. Ravi’s 2 children are studying in the school run by the employer. The cost
of education in similar institution per student is Rs. 1,000 p.a.
11) Electricity bill paid by employer Rs. 3,000 p.a.
12) He has been provided 1800 cc car for both official and private purpose. The
Running and maintenance expenses paid by employer.
13) Company is provided free lunch during working days (in all 250 lunches Rs. 70
each)
14) He received Rs. 17,000 by way of reimbursement of the private hospital bill by
the Employer.
15) He paid life insurance premium Rs. 15,000 p.a.
16) He paid professional tax Rs. 2,500 p.a.
Compute the income from salary for the A. Y. 2021-2022 assuming he has not
opted for the provisions of section 115BAC.
Answer : Computation of Income from Salary of Mr. Raj For A. Y. 2021-2022
Particular Rs. Rs.
Basic salary 66,000
Bonus 18,000
D. A. (2,000X12) 24,000
4% commission on sales (Rs. 18,50,000X4%) 74,000
Advance salary 22,000
Employer contribution to RPF 18,000 Nil
Less: Exempt u/s 10(11)(12) (Note -1) -19,680
Interest on R.P, F. @13% 13,000 3,500
Less: Exempt u/s10 (11)(12) 9.5% -9,500
Value of rent free furnished accommodation (Note-2) 45,300
Grander salary 4,000
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Cook salary 3,600
Watchmen salary 900
Education facility (1,000 x 12X2) 24,000 Nil
Less : Exempt up to (1,000 x 12X2) 24,000
Electricity bill paid by employer 3,000
Value of motor car facility (Note -3) 28,800
Lunch facility (Rs. 50 x 250 days ) 17,500
Less: Exempt up to (Rs. 20 x 250 days ) -12,500 5,000
Reimbursement of Hospital bill 17,000
Gross Salary 3,15,100
Less: Deduction u/s 16 52,500
i) Standard deduction u/s 16(i) 50,000
ii) Professional Tax u/s 16(iii) 2,500
Taxable Income From Salary 2,62,600
Note:1) Employer Contribution to Recognized Provident Fund (RPF):
Salary for RPF Rs.
Basic Salary 66,000
D. A. ( Applicable) 24,000
4% commission 74,000
Salary for RPF 1,64,000
Employer’s contribution exempted up to: 12% of salary i.e Rs.1,64,000 x 12% =
Rs. 19,680
2) Value of Rent Free Furnished accommodation –
Accommodation is not owned by employer.
Salary for Accommodation Rs.
Basic Salary 66,000
D. A. (Applicable) 24,000
4% commission 74,000

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 Bonus 18,000
Salary for accommodation 1,82,000

Particular Rs. Rs.

Value of furnished accommodation is lower of following
a) Rent paid by employer 84,000
b) He is at Delhi So 15 % of salary (1, 82,000 x 15%) 27,300
Value of unfurnished accommodation 27,300
Add: value of furniture +18,000
Value of rent free furnished accommodation 45,300
3) Value of Motor car facility:
Situation: Car owned by employer and expenses paid by employer
Purpose: Official and private
Engine capacity (C.C.): 1,800 C.C. Above 1,600 CC
Value of Motor car: Rs. 2,400 x12 = Rs. 28,800
Illustration 4) Mr. Sachin is General Manager of a Raftar Ltd. Delhi. He has
submitted the following particulars of his income for the financial year 2020-2021.
1) Basic salary Rs. 1,10,000 p.a.
2) D. A. Rs. 2,000 p. m. (Rs. 500 p.m enters in to retirement benefit
3) Medical Allowance Rs. 500 p.m.
4) Commission on sales Rs. 20,000
5) Entertainment allowance Rs. 800 p.m.
6) Travelling Allowance for his official tour Rs. 40,000 actual expenditure on tour
Rs. 27,000
7) He was given cloth worth Rs. 2,000 by his employer free of cost.
8) He resides in the Bungalow of the company. Its fair rent is Rs. 2,000 p.m. He
pays Rs. 11,000. p.a. as a rent for the house. Furniture of Rs.60.000 is also
provided by company.
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9) A watchmen and a cook have been provided by the company who were paid Rs.
400 p.m. each
10) He had been provided with motor car of 1.8 liter engine capacity power for his
official as well as personal use. Running and maintenance expenses are born by
the company
11) Professional tax paid Rs. 2,500 p.a.
Compute his income from salary for the A. Y. 2021-2022 assuming he has not
opted for the provisions of section 115BAC
Answer: Computation of Income from Salary of Mr. Sachin For A. Y. 2021-2022
Particular Rs. Rs.
Basic Salary 1,10,000
Dearness Allowance ( Rs. 2,000 x 12) 24,000
Medical Allowance ( Rs. 5,00 x 12) 6,000
Commission 20,000
Entertainment allowance (Rs. 800 x 12) 9,600
Travelling Allowance for official use 40,000 13,000
Less: Actual expenditure exempt [u/s 10(14)] -27,000
Free cloth given by employer (exempted) Nil
Value of rented furnished accommodation (Note .1) 19,690
Watchmen Salary (Rs. 400 x 12) 4,800
Cook salary ( Rs. 400 x12) 4,800
Value of motor car facility (Note.2) 28,800
Gross Salary 2,40,690
Less: Deduction u/s 16 52,500
i) Standard deduction u/s 16(i) 50,000
ii) Professional Tax u/s 16(iii) -2,500
Taxable income from salary 1,88,190

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Note: 1) Value of concessional rent furnished accommodation –
Accommodation is owned by employer.
Salary for Accommodation Rs.
Basic Salary 1,10,000
D. A. (500X12) 6,000
Commission 20,000
Medical Allowance 6,000
Entertainment allowance 9,600
Travelling Allowance 13,000
Salary for accommodation 1,64,600

Particular Rs.
Value of furnished concessional rate accommodation :
He is at Delhi So 15% of salary (1,64,600 x15%) 24,690
Add: value of furniture (Rs.60,000 x10%) 6,000
Value of rent free furnished accommodation 30,690
Less: Amount collect from employee -11,000
Value of furnished concessional rate accommodation 19,690
2) Value of Motor car facility:
Situation: Car owned by employer and expenses paid by employer
Purpose: Official and private
Engine capacity (C.C.): 1,800 C.C. Above 1,600 CC
Value of Motor car : Rs. 2,400 x12 = Rs. 28,800
Illustration : 5) Mrs. Radhika employed as lecturer in private Institute at Pune, gives
you, her earnings during the year 2020-2021.
1) Basic pays Rs. 30,000 p. m.
2) D.A. 5,000 p. m. (enter for retirement benefit)
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3) H.R.A. 2,500 p.m.
4) Gratuity received Rs. 30,000 p.a.
5) She gets education allowance Rs.1500 p.m. per child for 2 children
6) She paid professional tax Rs. 2,500 pa
7) Employer‘s expenditure on free supply of gas, electricity and water Rs. 3000
8) She get conveyance allowance Rs. 3,400 p.a. spent Rs. 2,400.
Compute her income from salary for the A. Y. 2021-2022 assuming she has opted for
the provisions of section 115BAC.
Answer : Computation of Income from Salary of Mrs Radhika For A. Y. 2021-2022
Particular Rs.
Basic salary (30,000x12) 3,60,000
D.A. (5,000x12) 60,000
H.R. A .(2500x12) 30,000
Gratuity received (Gratuity received in employment is taxable ) 30,000
Education allowance (Rs.1500 x 2 x 12) 36,000
Free supply of gas, electricity and water 3,000
Conveyance allowance (3400-2400) 1,000
Gross Salary 5,20,000
Less: Deduction u/s 16
i) Standard deduction u/s 16(i) Nil
ii) Professional Tax u/s 16(iii) Nil
Taxable income from salary 5,20,000
Note : The following are the deductions and exemptions cannot claim by Radhika as
she opt opted for the provisions of section 115BAC.
1. The standard deduction, professional tax.
2. House Rent Allowance (HRA)
3. Children education allowance

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• Check your progress: I
A) Choose correct alternative from the given alternatives .
i) Advance salary of an employee is taxed in the year _________.
a) of receipt b) To which is becomes due
c) As decided by the employee d) As decided by the employer
ii) Any payment received by an employee from his former employer shall be
charged to tax under the head ______.
a) Salary income b) Income from other sources
c) Capital gains d) Profits and gains from Business or Profession
iii) Gratuity received by a government employee is ____________
a) Fully exempt b) Fully taxable
c) Exempt up to certain limit d) None of the above
iv) The concession available while valuing perquisites in respect of meal provided
to an employee is Rs. ________ per meal.
a) 200 b) 100 c) 25 d) 50
v) While computing perquisite in respect of interest free loan, small loans upto Rs.
______/- in the aggregate shall be ignored. (i.e. exempt).
a) 20,000 b) 25,000 c) 2,00,000 d) 2,50,000
B) Fill in the blanks.
i) Value of rent free unfurnished accommodation in the hands of private
sector employee (where accommodation is owned by the employer) is
_______% of salary where population of city is 8 lakhs.
ii) Meaning of term “Salary” is defined under section _____ of the Act.
iii) In case of Government employee the maximum deduction for entertainment
allowance Rs.
iv) Employer does not contribute to ------- provident fund
v) Un commuted pension is ________ whether received by the Government
employee or non-government employee

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3.2.2 Income from House Property :
• Introduction An Owning a house is everybody dream for this, every one saves
towards this and hopes to achieve this one day. A house property could be
home, an office, a shop, a building or some land attached to the building like a
parking lot. The Income Tax Act does not differentiate between a commercial
and residential property. All types of properties are taxed under the head
‘income from house property’ The Income from house property is computed on
the annual value basis.
• Basis of Charges (Section 22):
For computation of Annual value require to fulfill following conditions:
a) The property should consist of buildings or lands appurtenant or
(connected) thereto.
b) Assesses should be owner of property owner means legal owner and
deemed owner.
c) Property should not be occupied by the owner for his own business or
profession.
d) Property held as stock in trade etc. Annual value of house property will be
charged under the head Income from house property where it is held by
assesses as a stock in trade of a business also.
• Annual Value : (Section 23)
Annual value is the amount arrived after deducting the municipal taxes Actually paid
by the owner during the previous year from the gross Annual Value. The Gross
Annual Value of let out house property is determined by taking in to consideration
following four factors.
a) Actual Rental Value :
Actual rental value is the sum for which the property is let out. The rent
receivable of received us reduced by the amount spent by the owner on meeting the
obligations of tenant if the obligations of owner met by the tenant the rent received or
receivable is increased by the value of obligation.
b) Municipal Value :
Municipal value is the value determined by the municipal authorities for
levying municipal taxes on house property.

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c) Fair Rent :
Fair rent means rent which similar property in the same locality would fetch.
d) Standard Rent :
Standard rent is rent fixed by Rent Control Act. The land lord cannot
reasonably accept from tenant anything more than standard rent.
• Determination of Annual Value:
For computation of the annual value, house properties can be classified
in to the following types.
1) Let out property
2) Self- occupied house property
3) House property let out for part of the year and self occupied for part of the year
4) House partly self occupied for residence and partly let out
5) More than one house self occupied (Deemed let out)
6) House reserved for self occupation
Detrmination of annual value for different types of house properties as under :
• Let out property : [Section 23(1)]:
Where the property is let out for the whole year computation of Annual value
calcualte infollwing step;
Step:1. Ascertain Gross Annual Value :(GAV)
a) Findout expected rent or reasonable lettable value :
If the Rent Control Act is not applicable where hosue proprty is let out then
expected rent or reaonable lettable value is fair rent or munucipal value whichever is
more. If the Rent Control Act is applicable for the palce where hosue proprty Is let
out, then expected rent or reaonable lettable value should not exceed the Standard
Rent given under Rent Control Act.
b) Gross Annual Value :
Where the property is let out and the actual rent recevied and receivble by the
owner is in excess of the Reasonable lettable value as above the amount so received
shall be the Gross Annual Value. Where the let out property was vacant during the
whole year or part of year and owing to this vacancy the acutal rent received or
receivable by the owner in respect of there is less than the reasonable lettable value
the amount so received or receivable shall be the Gross Annual Value .

215
c) The unrealsied rent if any may be decuted from the rent received/receivable only
if the tenancy is bonafide.
Computation of Annual Value at glance :

Compare fair rent with

municipal value

Which ever is higher is Reasonable

lettable value (R. L. V.)

Compare R.L.V. with Standard Rent

If S.R. given

Lower of the two is R. L. V.

Compare resaonale lettable value with Actual

rent

If Actual rent is more than If Actual rent is less than

Reasonable lettable value Reasonable lettable value

Actual rent is
Because of vacany
Gross annual Any other reason
of property
value

Reasonable lettable
Actual Rent is the gross value is Gross annual
annual value value

216
Step II. Deduct Municipal Taxes:
Property taxes are allowable as deduction from gross annual value if it should be
actual paid by owner of property during previous year. If the local taxes born by
the tenant no deduction is to be made.
Step III. Allow deductions u/s. 24:
There are two deductions from Annual value :-
i) Standard deduction under section 24 (a) :
This is a flat deduction at the rate 30% of the net annual value of the let out
property is allowed in respect of the actual expenditure incurred for the repairs and
other incidental expenditure. This deduction allowed can be claimed irrespective of
fact whether the actual expenditure on house property is more or less than 30% of
annual value. In case of self occupied property standard deduction is not allowed as
its annual value is Nil.
ii) Interest on borrowed capital under section 24(b):
Interest payable on funds borrowed for the purpose of purchase, construction,
repairs or renewal of house property is allowed as a deduction. However, the interest
on loan taken on security of house property for any other purpose such as marriage or
medical expenses etc. is not available as deduction. Interest payable on fresh loan
taken for repay the original loan taken earlier for the house construction, purchase or
renovation is also admissible as deduction.
a) Interest for preconstruction period: Preconstruction period is the period
prior to the previous year in which property is acquired or construction is completed.
Interest for Preconstruction period is accumulated and can be claimed as
deduction over a period of 5 continuous year in equal installments, from the year of
completion of construction.
b) Interest on post construction period: Post construction period starts from
the beginning from the financial year in which construction is completed.
Illustrations : 1) From the following particulars of three let out house properties,
ascertain the annual value of each house.

217
 Properties I II III IV
a) Municipal value 1,50,000 2,00,000 2,50,000 5,50,000
b) Fair rent 2,00,000 1,50,000 2,00,000 6,00,000
c) Standard Rent N.A. N.A. N.A. 7,50,000
d) Annual rent 1,00,000 1,20,000 3,60,000 7,20,000
e) Municipal taxes paid:
By Owner 15,000 10,000 - --
By Tenant -- -- 25,000 50,000
f) Months vacant --- 3months --- ---
g) Unrealized rent --- --- 20,000 ----
Answer: Computation of Annual Value
Properties I II III IV
Gross Annual Value :
a) Municipal value 1,50,000 2,00,000 2,50,000 5,50,000
b) Fair rent 2,00,000 1,50,000 2,00,000 6,00,000
c) Higher of (a) and (b) 2,00,000 2,00,000 2,50,000 6,00,000
d) Standard Rent N.A. N.A N.A 7,50,000
e) Reasonable Lettable Value 2,00,000 2,00,000 2,50,000 6,00,000
(lower of (c) and (d) above
f) Actual rent received or 1,00,000 1,20,000 3,40,000 7,20,000
receivable (excluding unrealized
rent)
Gross Annual Value (Higher of 2,00,000 2,00,000 3,40,000 7,20,000
(e) and (f) above
Less : Vacancy period rent if ---- Nil ---- ----
any
(As short fall is not due to
vacancy alone )
2,00,000 2,00,000 3,40,000 7,20,000
Less: Municipal taxes paid by 15,000 10,000 ---- ----
owner
Annual value 1,85000 1,90,000 3,40,000 7,20,000
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• Self –occupied for Residence (SOR) : Sec. 23(2)(a)(i):
Where proprty is self occupeid for own redidecne during the whole previous
year .
Annual value of such property will be Nil if the following two condtions are
fullfilled
1) No other benefit is derived by the owner from scuch property.
2) The propety is not let out catually during any part of the year .
The benefit of Nil annual value is availabel only for up to two self occupied or
unoccupied house proprties
Dedcucions u/s 24 : Interest on loan taken for SOR property will be allowed as a
deduction as are under : (Interest include 1/5th of accumulated interest of
preconstrucion period.)
Sr. Condition Deduction Amount
No
1 Loan borrowed before 1-4-1999: Actual interest payable in
Where property has been purchased, aggregagate for one or two
constructed, reapired or rennovate with self occupied properties,
borrowed capital before 1-4-1999 subject to maximum of Rs.
30,000.
2. Loan borrowed on or after 1-4-1999: Actual interest payable in
a) Where property is acquired or aggregagate for one or two
constructed with fudns borrowed on or self occupied properties,
after 1-4-1999 and such aquition or subject to maximum of Rs.
construction is completed within 5 years 2,00,000.
from the end of the financial year in wich
the fund was borrowed .
b) Where property is repaired, renewed Actual interest payable in
with fudns borrowed on or after 1-4-1999 aggregagate for one or two
self occupied properties,
subject to maximum of
Rs.30,000

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However the total interest deduction udner (1) and (2) can not excceed Rs. 2,00,000.
Example : Manas is the owner of a hosue occupied by him throught the previos year
for his own residence Municipal valie of the property is Rs. 2,15,000, where as fair
rental value Rs. 2,25,000. The following expenses are incurred by Manas municpal
tax Rs. 21,500, insurance Rs. 2,000, interest on borrowed capital to construct the
property Rs. 1,66,000, interest on capital borrowed by mortgaging the property for
daughter’s marriage Rs. 20,000. Compute the income from house property if the
housing loan was borrowed on -
a) 01/01/1999
b) capital borrowed on 01/06/1999
Computation of income of Self occupied house property
Particualr If loan taken If loan taken
01/01/1999 01/05/1999
Gross Annual Value Nil Nil
Less :Municipal tax Nil Nil
Net Annual value Nil Nil
Less: Interest on borrowed capital -30,000 -1,66,000
House property Income -30,000 -1,66,000
• Partly Self –occupied and partly Let out :
If part of house is let out and the other part is self occupeid for residance during
the year, the annula value of self occupeid part is taken to be the NIL and the annual
value of let out portion is detremined as let out house property .
• Where hosue self occupeid for a part of the previosu year ans let out for the
part :[Section23 (3) ] :
a) If a singal unit of property is sellf occupied for part of the year and let out for
the ramaning part of the year, then the fair rent of the property for the whole
year shall be taken in to account for detrminig gross annual value.
b) The fair rent of the whole year shall be comapred with the actual rent for the let
out period and which ever is higher shall be adopted as the Gross Annual Value.

220
c) Municipal tax paid by the owner for the whole year shall be allowed as
deduction.
d) Interest for loan taken for the whole year shall be allowed as deduction.
• In case of deemed to be let out property : [Section 23(4)]:
a) In case the assesse occupies more than two properties for self occupation then
the income from any two properties, at the option of the assessee ,is treateds as
self occupied and its annual value is considered to be NIL .
b) Other self occcupied properties will be treated as “Deemed to be let out
properties".
c) In case deemed let out property ,the Municipal value or fair rent ,whichever is
higher but subject to maximum of standard rent.
d) Question of actual rent received /receivable does not areise.
e) Municipal taxes actually paid by the owner during the previosu year can be
claimed as dedcution.
f) Standard deduction and Interest on borrowed capital can be claimed as
dedcution.
• In case of Hosue property held as stock in trade (Section23(5):
a) In case property held as stock in trade and whole or any part of property
may not be let out during the whole or part of the previous year .
b) The annual value of such property shall be NIL.
c) This benefit would be available for the period up to two years from the end
of the financial year in which certificte of complition of constrcution oF
property is obtained.
• Compiosit Rent:
i) Property owner may sometimes receive rent inrespect of building as well as
other assets and for different services provided in building like furniture,
machinery, lift etc. The amount so received as known as composite rent.
ii) Tax treatment :
a) Letting out of building and letting out of other assets are inseparable
(i.e., both the lettings are composite and not separable) In this

221
 situation, entire rent is taxed under the head “Profits and gains of
business or profession” or “Income from other sources”. This rule is
applicable even if rent of both lettings is fixed separately.
(b) Letting out of building and letting out of other assets are separable
(i.e., both the lettings are separable) (e.g., letting out of bike along with
building). In this situation rent of building is taxed under the head
“Income from house property” and rent of other asset is taxed under
the head “Profits and gains of business or profession” or “Income from
other sources” (as the case many be). This rule is applicable even if the
assessee receives composite rent for the two lettings.
• Amount not Deductible (Section 25):
a) Interest on borrowings payable outside India is not deductible from annual
value if no tax has been deducted at source and person receiving such interest is
not assessed in India nor any of his representative is taxed in India.
b) i) In case the unrealsied rent already as allowed deuction ia realised
subsequenltly from the teanant shall be demmed to income from house
property in the financial year in which such rent is reeived .
ii) Section 25A(2) provides a dedcution of 30% of arrears of rent
subsequently realsied .
• Property owned by co-owners (Section 26):
i) Where property consisting of building or buildings and lands appurtenant
there to is owned by two or more persons and their respective shares are
definite and ascertainable, such persons shall not in respect of such property
be assessed as an association of persons but the share of each such person
in the income from the property as computed in accordance with sections
22 to 25 and included in his indiviaul total income of the previous year.
ii) Where such property is in the joint occupation of the owners, the annual
value of property of each co owner will be Nil and each cowner shall be
entitled to dedcution for Interest on borrowing of Rs. 30,000/2,00,000 as
the case may be. however, if the co ownres another self occupied proprty,
the aggregate interest from the co owned property and other self occupied
property can not exceed Rs. 30,000 and 2,00,000 as the case may be.

222
 iii) In case, the share of each co owner is not definite and un certainable, the
income from such house property will be assessed udner the status of
Association of persons .
• Computation of Income from house property at Glance :
1) If property is let out
Particular Rs Rs.
Gross Annual Value :
a) Municipal value xx
b) Fair rent xx
c) Higher of (a) and (b) xx
d) Standard Rent xx
e) Reasonable Lettable Value xx
(lower of (c) and (d) above
f) Actual rent received or receivable (excluding unrealized Xx
rent)
Gross Annual Value (Higher of (e) and (f) above Xx
Less : Vacancy period rent if any Xx
(As short fall is not due to vacancy alone )
Less: Municipal taxes paid by owner Xx
Net Annual Value (NAV) xx
Less: Deductions under section 24 xx
i) Standard deduction (30% of NAV) Xx
ii) Interest on housing loans Xx
Add: Arrears of rent received xx
Unrealized rent realized Xx
Less: Standard deduction 30% -xx
Add: Unrealised rent past collected xx
Income from let out house property xxx

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ii) If property is self occupied :
Particualr Rs.
Gross Annual Value Nil
Less :Municipal tax Xxx
Net Annual value Nil
Less: Interest on borrowed capital Xxx
If property acquired or Maximum
consructed with capital borrowed limit
Up to 31/03/1999 30,000
On or after 01/04/1999 2,00,000
Loss from self occupied House property Xxx

• Illustrations:
Illustration 1) Mr. Sangram has two houses in Pune. The constrcution of both these
houses got completed on 1 st July 2018. The particualrs of these houese for the year
ending 31/03/2021 are as udner :
Particualr House I House II
Municipal valuation 1,50,000 1,00,000
Fair rent 1,80,000 1,20,000
Standard rent as per Rent Control Act 1,35,000 96,000
Actual rent received 1,75,000 ----
Municipal taxes paid 10% of MV 10% of MV
Fire insuracne 15,000 17,000
Ground rent 4,000 6,000
Land revenue 3,000 2,000
Interest on loan for construction :
a) Pertaning to period prior to 1-7-2018 60,000 50,000
b) for the year ending 31/03/2021 50,000 45,000
Nature of occupation Let out for Self occupied
residence

224
Solution :Computation of Income from Hosue property of Mr.Sangram for F.Y.
2020-2021
Particular Rs Rs.
I. Property let out for residence :
Gross Annual Value :
a) Municipal value 1,50,000
b) Fair rent 1,80,000
c) Higher of (a) and (b) 1,80,000
d) Standard Rent 1,35,000
e) Reasonable Lettable Value 1,35,000
(lower of (c) and (d) above
f) Actual rent received or receivable (excluding 1,75,000
unrealized rent)
Gross Annual Value (Higher of (e) and (f) above 1,75,000
Less: Municipal taxes paid by owner 15,000
Net Annual Value (NAV) 1,60,000 1,60,000
Less: Deductions under section 24 1,10,000
i) Standard deduction (30% of NAV) 48,000
ii) Interest on housing loans
for preconstruction period (60000x1/5) 12,000
for previous year 50,000
Income from let out house property 50,000
II. Self occupied house property :
Annual value Nil
Less: Deductions under section 24
i) Interest on housing loans 55,000
For preconstruction period (50,000x1/5) 10,000
For previous year 45,000
Loss from self occupied house property -55,000
Total taxable income from house property

225
 Particualrs Amount
House I 50,000
House II -55,000
Total Income from house property -5,000

Illustration 2) Mr. Vijay owns one residential hosue at Mumbai. The hosue is
having two identical units . first unit of the house is self occupied by Mr. Vijay and
another unit is rented for Rs. 8,000 p.m. the rented unit was vacant for 2 monhts
during the year. The particualrs of the hosue for the previous year 2020-2021 are as
under:
1) Standard Rent Rs. 1,62,000 p.a
2) Municiapl valuation Rs. 1,90,000 p.a .
3) Fair Rent Rs. 1,85,000 p.a.
4) Municipal taxes paid by the Mr. Vijay 15% of municipal value
5) Light and warer charges Rs. 500 p.m.
6) Insurance charges Rs. 3,000 p.a.
7) Interest on borrowed capital Rs. 1,500 p.m.
Compute income from hosue property of Mr. Vijay for the A. Y. 2021-2022
Computation of Income from House property of Mr. Vijay for A.Y.2021-2022
Particular Rs Rs.
I. Property let out for residence (50% of total area )
Gross Annual Value :
a) Municipal value (1,90,000/2) 95,000
b) Fair rent (1,85,000/2) 92,500
c) Higher of (a) and (b) 95,000
d) Standard Rent (1,62,000/2) 81,000
e) Reasonable Lettable Value 81,000
(lower of (c) and (d) above
f) Actual rent received or receivable (8,000x12) 96,000
Gross Annual Value (Higher of (e) and (f) above 96,000

226
 Less Vacancy period rent (8000x2) 16,000
Less: Municipal taxes paid by owner (95000x15%) 14,250
Net Annual Value (NAV) 65,750 65,750
Less: Deductions under section 24
i) Standard deduction (30% of NAV) 19,725
ii) Interest on housing loans (750x12) 9,000 28,725
Income from let out house property 37,025
II. Self occupied house property (50% of total area )
Annual value Nil Nil
Less: Deductions under section 24
i) Interest on housing loans (750x12) 9,000 9,000

Loss from self occupied house property -9000

Total taxable income from house property :
Particualrs Amount
House I 37,025
House II -9,000
Total Income from house property 28,025
Illustration 3) Dilip and Suresh are co owners of a house property with equal share.
The property was constructed during the financial year 1998-1999. The propety
consists of eight identicle units and it situated at Kolhapur.
During the financial year 2020-2021, each co owner occupies one unit for
residence and the balacne of six units were let out at a rent of Rs. 12,000 per month
per unit. The municipal value of the house property is Rs. 9,00,000 and the municipal
taxes are 20% of municipal value, which were paid during the year. The other
expenses were as follows
1) Repairs Rs. 40,000 2) Insurance Rs. 15,000
3) Interest on loan taken for construcion of house Rs. 3,00,000
One of the let out units remained vacant for four months during the year.
Dilip could not occupy his unit for six months as he was transferred to Mumbai.
He does not own any other hosue .

227
Computer the ‘Income from Hosue Property’ of two brothers for the assessment year
2020-2021.
Computation of Income from House property for A. Y. 2020-2021
Particular Dilip Rs. Suresh Rs.
i)Self Occupied portion (25%)
Annual Value Nil Nil
Less: Deduction u/s 24(b)
Interest on loan taken for house construction -30,000 -30,000
(Note1)
Loss from self occupied hosue property -30,000 -30,000
ii) Let out Hosue property (75%) 1,25,850 1,25,850
(Note 2)
Total income from house property 95,850 95,850
Note 1. 300000/8 = 37,500 but restricted to maximum of Rs. 30,000 for each co
owner since the property was constructed before 01-04-1999 hence it is assumed that
loan was taken for before 1.4.1999
Note 2. Comutation of let out house property income
Particular Rs Rs.
I. Property let out for residence (75% of total area )
Gross Annual Value :
a) Municipal value (9, 00,000 x 75%) 6,75,000
b) Fair rent -
c) Higher of (a) and (b) 6,75,000
d) Actual rent received or receivable (12,000 x 12 x 6) 8,64,000
Gross Annual Value (Higher of (c) and (d) above 8,64,000
Less Vacancy period rent (12,000 x 4) 48,000
Less: Municipal taxes paid by owner (6,75,000 x 20%) 1,35,000
Net Annual Value (NAV) 6,81,000 6,81,000
Less: Deductions under section 24 4,29,300
i) Standard deduction (30% of NAV) 2,04,300

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 ii) Interest on housing loans (3,00,000 x75%) 2,25,000
Income from let out house property 2,51,700
Share of each co owner (50%) 1,25,850
Illustration 4) Mrs. Poonam has three houses , all of which are self occupied. The
particualrs of the houses for the previosu year 2020-2021 are as udner :
Particular Hosue I Hosue II Hosue III
Municipal valuation p.a. 3,00,000 3,60,000 3,30,000
Fair rent p.a . 3,50,000 3,40,000 3,75,000
Date of completion /purchase 31.03.1999 31.03.2001 1.4.2014
Municipal taxes paid during the 12% 8% 6%
year
Interest on money borrowed for -- 55,000 --
repair
Interest on loan for purcahse of --- ---- 1,75,000
property
Compute Poonam’s income from Hosue property for A.Y. 2021-2022
Solutions: Let us first calcualte the income from each hosue property assuming that
they are deemed to be let out .
Computation of Income from Hosue property of Mrs. Poonam for the A.Y.
2021-2022
Particular House I House II House III
Rs Rs Rs
Gross Annual Value :
a) Municipal value 3,00,000 3,60,000 3,30,000
b) Fair rent 3,50,000 3,40,000 3,75,000
Gross Annual Value (Higher of (a) and (b) 3,50,000 3,60,000 3,75,000
above
Less: Municipal taxes paid by owner 36,000 28,800 19,800
Net Annual Value (NAV) 3,14,000 3,31,200 3,55,200

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 Less: Deductions under section 24
i) Standard deduction (30% of NAV) 94,200 99,360 1,06,560
ii) Interest on housing loans ---- 55,000 1,75,000
Income from let out house property 2,19,800 1,76,840 73,640
Poonam can option to traeat any two of the above hosue properties are self
occupied.
Option I . Hosue I and II - Self occupied and house III –deemed to be let out.
Particualr Amount Rs.
House I self occupied Nil
House II self occupied (Interest deduciton restricted to Rs. -30,000
30,000)
House III deemed to be let out 73,640
Income from house property 43,640
Option II . House I and III - Self occupied and house II –deemed to be let out.
Particualr Amount Rs.
House I Self occupied Nil
House II deemed to be let out 1,76,840
House III Self occupied -1,75,000
Income from house property 1,840
Option III . House II and III - Self occupied and house I –deemed to be let out.
Particualr Amount Rs. Amount Rs.
House I deemed to be let out 2,19,800
House II Self occupied 30,000
(Interest deduciton restricted to Rs. 30,000)
House III Self occupied 1,75,000
Total interest deduction restricted to Rs. 2,00,000 -2,00,000
Income from house property 19,800

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Option II is most benificial, poonam should pot to treat hosue I and III as self
occupied and Hosue II as deemed to be let out.her income from house property
would be Rs.1,840 for the A.Y. 2021-2022.
Illustration 5) Mr. Milind is the owner of three houses at Aurangabad. He has
furnished the following details .
Partiuclar House A House B House C
Hosue used by tenants Residential Offcie Residential
Construction completed 1-4-1999 1-6-2006 31-03-1996
Municipal valuation 1,60,000 1,80,000 1,00,000
Annual fair rent 1,80,000 1,50,000 1,20,000
Rent per month 20,000 12,000 11,000
Repairs expenses 1,000 ---- 4,000
Renr collection charges 4,000 5,000 --
Ground rent 2000 3000 ----
Interest on loan:
1) For constrcution 1,00,000 --- ----
2) For marriage of daughter ---- 60,000 ----
3) for repaires ----- ----- 10,000
Municiapl Tax 20 % of Paid by Not paid up to Paid by
municipal valuation. Onwer year end tentant
The house C remained vacant for 4 months. Ground rent of house B . Arrears of rent
for past years colleted during previous year Rs. 1,00,000.
Compute income from house property for assessment year 2021-2022.
Solution :Statement showing income from hosue property for assessment year
2020-2021
Particular House A House B House C
Let out for Let out Let out for
residence Office residence
Gross Annual Value :
a) Municipal value 1,60,000 1,80,000 1,00,000

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 b) Fair rent 1,80,000 1,50,000 1,20,000
c) Higher of (a) and (b) 1,80,000 1,80,000 1,20,000
d) Actual rent receivable 2,40,000 1,44,000 1,32,000
Gross Annual Value (Higher of (c) and 2,40,000 1,80,000 1,32,000
(d) above ----- ----- 44,000
Less Vacancy period rent (11000x4)
house C
Less: Municipal taxes paid by owner 32,000
@20% paid by owner
Net Annual Value (NAV) 1,80,000 88,000
2,08,000
Less: Deductions under section 24
i) Standard deduction (30% of 62,400 54,000 26,400
NAV)
ii) Interest on housing loans ---- -----
- For constructions 1,00,000 ------ ----
For repairs ----- ------- 10,000
Income from let out house property 45,600 1,26,000 51,600

Total taxable income from house property:

Particualrs Amount
House A 45,600
House B 1,26,000
House C 51,600
Income from house property 2,23,200
Add: arrears of rent received 1,00,000
Less: Standard deduction 30% - (30,000) 70,000
Total Income from house property 2,93,200

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• Check your progress II:
1) Fill in the blanks .
i) The Annual value of self occupied house is --------------
ii) ------------- is the value determined by the municipal authorities for levying
municipal taxes on hosue property .
iii) The benefit of Nil value in respecct of upto ----- self occupied houe
property is avilable only to an indiviual and HUF for F.Y. 2020-2021.
iv) Standard deduction for let out hosue is ---------- of annual value.
v) If the municipal taxes paid by the tenant ----- is to be made.
3.2.3 Income from Business / Profession
Introduction :
In case asseesee carreid on any buinness or profession by him or his behlaf then
inocme from such activityes are taxable under the head Incoem from buiness and
profession.
Maximum number if assessees are assessed for tax under this head.
Buisenss : The term business defined in section 2(13) to "includes any trade,
commerce or manufacture or any adventure or concern in the nature of trade,
commerce or manufacture.”
Thus business is any activity carried out with the intention to earn profit,
whether such an activity is continuous or temporary is immaterial.
Profession : The term profession has been not defined in the Act. It means an
occupation requiring to some degree of learning . Profession requires intellectual
skill or manual skil or both. The examples are doctor , advocate, chatered acountanat,
engineers etc The term profeesion include vocations as well.[Section 2(36)]
• Method of computing taxable income :
A) Gross Sales or Gross fees as the case may be are to be taken as the base if
Receipt and Payment A/c or cash Book is given. From this Gross income expenses
which are Specifically allowed by the income tax act are deducted to arrive at taxable
income.

233
 B) If profit & loss a/c or income & expenditure a/c is given Net Profit or
(Surplus) is Taken as the base and then following adjustments are made:
i) Expenses, which are debited, to profit & loss a/c, but disallowed by the
income tax Act and either fully or partially are added back
ii) Expenses, which are not debited, to profit & loss a/c but which are allowed
by the Income Tax Act are deducted.
iii) Income that is credited to profit & loss a/c but not taxable at all or taxable
under Some different head is to be deducted.
iv) Income that is not credited to profit & loss a/c, but which is chargeable to
tax as business income is to be added.
• Basis of charge: Section 28:
Following are the income chargeable to tax under the head Profits or Gains
from Business or profession: ‐
1) Profit and Gains of any business or profession that is carried on by the
assessee at any time during the previous year.
2) Any compensation or other payment due to or received by an assessee for loss
of agency due to termination or modification of terms.
3) Income derived by a trade, professional or a similar association for specific
services performed for its members.
4) Any profit on sale of a license granted under Imports (controls) Order 1955
made under Imports & Exports (control) Act of 1947.
5) Any cash assistance (by whatever name called) received or receivable against
exports under any scheme of Government of India.
6) Any duty of customs or excise repaid or repayable as drawback to any person
against exports under the Customs and Central Excise Duty’s Drawback Rules
1971.
7) Any profit on the transfer of the Duty entitlement pass book scheme under
export import policy.
8) Any profit on the transfer of the Duty free replenishment certificate under
export import policy.

234
9) The value of any benefit or perquisite whether convertible into money or not
arising from business or exercise of a profession e.g. A gift received by the
lawyer from his client.
10) Any interest, salary, bonus, commission or remuneration due to or received
by partner of a firm from such firm.
11) Sum received or receivable in cash or in kind under an agreement for not
carrying out any activity in relation to any business or not sharing any know
how, patent, copyright, trade mark, license franchise or any other business or
commercial right of similar nature or information or technique likely to assist
the manufacture or processing of goods or provision of services.
12) Any sum received including bonus under Key man Insurance Policy.
13) Any sum received (or receivable) in cash or kind, on account of any capital asset
(other than land or goodwill or financial instrument) being demolished,
destroyed, Discarded or transferred, if the whole of the expenditure on such
capital asset has been allowed as a deduction under section 35AD.
14) Income from a speculative business.
• Deductions for expenses specifically allowed under section 30 to 43:-
Following deductions are expressly allowed as deductions while computing
income from business and profession.
1. Rent, rates, taxes, repairs and insurance of building (Section 30):
a) If premises has occupied as a tenant, rent of the premises and if he has
agreed to bear cost of repairs, such cost is allowed as deduction, provided it
is not in capital nature
b) If the business premise is self owned then the repairs, land revenue, local
taxes, insurance premium etc. are allowed as deduction. However, no
expenditure in form of capital expenditure is allowed.
2. Repairs & Insurance of machinery, Plant & Furniture (Sec.31):
Amount paid on account of repairs and insurance premium against risk of
damage in respect of machinery, plant & furniture are allowed as deduction provided
they are not of capital nature.

235
3. Depreciation u/s 32:
Under Section 32 depreciation on assets is allowed as deduction while
computing income from business or profession. To claim this deduction following
Conditions should be satisfied:
1) Assessee should be owner of the asset.
2) Asset must be used for the business.
3) Such use must be in the previous year.
Depreciation is allowed not on individual asset items, but on block of assets.
The block of assets mean a group of assets within a class of assets in respect of
which the same percentage of depreciation is prescribed. The block of assets are as
under :
1) Building
2) Plant and Machinery
3) Furniture
4) Intangible Assets acquired after March 31, 1998 such as know-how,
Patents, Trademarks, licenses, franchises or any other business or
commercial rights of similar nature.

The term plant includes ships, vehicles, books, scientific apparatus and surgical
equipments used for the business but exclude tea bushes or live stock. If any asset
falling in block of assets is acquired during the year and put to use during the
previous year for less than 180 days depreciation on such asset shall be restricted to
50% of the normal depreciation.
Additional depreciation:
It can be claimed on new plant & machinery acquired after 31st March 2005 by
an assessee. In the previous year in which it begins manufacturing or producing or
power generation and distribution.
Rate of additional depreciation: 20% of actual cost
Where an assessee, sets up an undertaking or enterprise for manufacture or
production of any article or thing, on or after the 1st day of April, 2015 in any
backward area notified by the Central Government in this behalf, in the State of
236
Andhra Pradesh or in the State of Bihar or in the State of Telangana or in the State of
West Bengal, and acquires and installs any new asset for the purposes of the said
undertaking or enterprise during the period beginning on the 1st day of April, 2015
and ending before the 31/03/2020 in the said backward area, then, there shall be
allowed a deduction of 15% and higher depreciation @35% ( instated of 20 % ) of
the actual cost of such new asset for the assessment year relevant to the previous year
in which such new asset is installed.
Therefore, if new plant and machinery acquired and installed in notified
backward areas on or After 1-4-2020, deduction under section 32 AD is not
allowable. Further additional depreciation is not allowable at higher rate of 35%.
Additional depreciation allowable at 20%, .
Unabsorbed Depreciation:
If profit for the year is not sufficient to absorb depreciation either fully or
partially, unabsorbed depreciation can be deducted from any other head of income. If
it still remains unabsorbed it can be carried forward to subsequent assessment years
to be adjusted Against future taxable income. It can be carried forward for unlimited
period.
Rate of Depreciation :
All assets are divided into four main categoreis and rate of depreciation as
prescribed by rule 5(1) are as under :
A. TANGIBLE ASSETS
I Buildings Rate of dep,
Block 1. Residential buildings other than hotels and boarding 5%
houses
Block 2. Office, factory, godown or building which not mainly 10%
used for residential purpose (cover hotels & boarding
houses & not covered in block1 & 3
Block 3. Buildings acquired on or after the 1st day of September, 40%
2002 for installing machinery and plant forming part of
water supply project or water treatment system and which
is put to use for the purpose of business of providing
infra- structure facilities

237
Block 4. Purely temporary erections such as wooden structures 40%
2 Furniture & Fittings
Block 1. Furniture and fittings including electrical fittings 10%
3. Plant & Machinery
Block 1 i) Motor car other than those used in the business of 30%
running them on hire , purchased on or after 23.08. 2019
but before the 1 April 2020 and is put to use before 1.4.
2020 15%

ii) Motor car other than those used in a business of

running them on hire, aquired or put to use on or after
1.4.1990 (other than motor cars mentioned in (i) above .
Block 2. i) Motor Taxis, Moto Lorries, Motor Buses used in a 45%
business of running them on hire, purchased on or after
23.08. 2019 but before the 31.03.2020 and is put to use
before 31.03. 2020 30%

ii) Buses, lorries and taxies used in the business of

running them on hire (other than mentioned in (i) above ).
Block 3. Moulds used in rubber and plastic goods factoreis 30%
Block 4 Aeroplanes , Aeroegines 40%
Block 5. Specified air Pollution control equipment, Water pollution 40%
control equipments, solid waste control equipment and
solid wate recycling and resocue recovery system .
Block 6. Plant and machienry used in semi- consuter industry 30%
covering all integrated circuiys.
Block 7 Life saving medical equipments 40%
Block 8 Machinery and plants purchased and installed on or after 40%
the 01.09.2002 in a water supply project or a water
treatment system and which is put to use for the purpsoe
of buiness of providng infrastructure facility .
Block 9 Oil wells 15%

238
Block 10 Renewable Energey Saving Devices (as specified ) 40%
i) Windmills and any specially designed devices which
run on wind-mills installed on or before 31.03.2014. And
any special devices including electric generators and
pumps running on wind energy installed on or before
31.03.2014.
ii) Windmills and any specially designed devices which
run on wind-mills installed on or after 1.04.2014.
Block 11 Computers including computer software 40%
Block 12 Books (annual publications or other than annual 40%
publications) owned by assessees carrying on a profession
Block 13 Books owned by assessees carrying on business running 40%
lending libraries
Block 14 Plants & Machinery (General rate ) 15%
4 Ships
Block 1 Ocean –going ships 20%
Block 2. Vessels ordinarily operating on inland waters not covered 20%
by block 3 below.
Block 3 Speed boats operating on inland water 20%
PART B. INTANGIBLE ASSETS
Know-how, patents, copyrights, trademarks, licenses, 25%
franchises or any other business or commercial rights of
similar nature

4) Expenditure on Scientific Research [U/S 35]:

Scientific Research means any activities for the expansion of knowledge in the
fields of natural or applied science including agriculture, animal husbandry or
fisheries. The following expenditure on scientific research is allowed as deduction:
a) Revenue expenditure incurred for scientific research related to assessee’s
business. Will be fully allowed. This may be the payment of any salary to the
239
 persons engaged in scientific research or purchase of materials for use in such
scientific research.
b) Capital expenditure incurred on scientific research related to assessee’s
business, will be allowed in full, however purchase of land is not allowed. No
depreciation is allowed u/s 32 in respect of such asset during the previous year
and subsequent year.
c) Contribution made to approve scientific research association or college or
university or other approved institutions for scientific research and to approve
university, college or institution for the use of scientific research is allowed.
Above may or may not be related to assessee’s business & a sum equal to
amounts paid is allowed as a deduction.
d) Contribution made to approved university, college or institution for research in
social science or statistical research is allowed. Above may or may not be
related to assessee’s business & a sum equal to amounts paid is allowed as a
deduction.
e) Any sum paid to a “National laboratory” or I.I.T. or a university or a specified
person approved by prescribed authority, to be used for scientific research under
an approved program, will be allowed deduction of the amount so paid [Sec.
35(2AA)]
f) Company engaged in business of bio-technology or manufacturing of article or
things. Not being an article or thing specified in the list of the eleventh schedule.
A deduction of a sum equal to the expenditure will be allowed. Such
expenditure should not be in the nature of cost of any land or building. For
entitle to take deduction company require to enters into agreement with
prescribed authority for co operation in such research and development.
5) Investment linked tax incentives for specified business: (Section 35AD] :
This section provides for investment linked tax deduction in respect of
following specified business:
a) Setting of and operating cold storage, transport facility for agriculture produce,
meat and meal, poultry, marine and dairy products.
b) Setting up or operating warehousing facility for agricultural produce.
c) Laying and operating a cross country natural gas pipeline.

240
d) Building or operating a hotel of two star or above category, anywhere in India.
e) Building and operating a hospital anywhere in India, at least 100 beds for
patients.
f) Developing and building a housing project under a notified scheme for
affordable housing farmed by the central government or state government.
g) Production of fertilizers in India.
Amount of deductions; 100% of capital expenditure excluding land, goodwill
and financial instruments.
6) Amortization of certain preliminary expenses under section 35 D:
Amortizations of preliminary expenses section 35D an Indian company or a
resident non-corporate taxpayer can claim deduction under section 35D in respect of
preliminary expenses. Such expenditure may be incurred before commencement of
the business or after commencement of the business in connection with extension of
an undertaking or in connection with setting up a new unit.
Amount of deduction: 1/5th of the total eligible preliminary expense is allowed
in 5 equal annual installments starting from the year in which the business
commences or unit expanded or the new unit commences production or operation.
Maximum amount eligible for deduction: In case non corporate resident
assessee at a 5% of the cost of project. In case of Indian company 5 % of the cost of
the project or capital employed whichever is higher.
7) Other deductions : [Section36]:
i) Insurance: Section 36(1) (i)‐ Premium paid to cover the risk of damage or
destruction of stocks, stores, cattle and on health of employees under the approved
scheme.
ii) Insurance Premium paid by Federal milk co‐op. society on the lives of
cattle owned by the members of a Primary Milk Co‐op, Society affiliated to it.
Section 36(1) (ia)
iii) Premium for insurance on health of employees in accordance with scheme
framed by GIC& approved by Central Government or any other insurer & approved
by the Insurance Regulatory & Development Authority (only if paid by cheque)
Section 36(1) (ib).

241
 iv) Bonus or commission paid to Employees: Section 36(1) (ii): It is allowed
as deduction So far as they are mo paid as profit or dividend.
v) Interest on borrowed capital: Section 36(1) (iii): ‐ It is allowed as
deduction.
However, interest paid by firm to its partners is allowed subject to provisions of
Sections 40(b).
vi) Discount on zero coupon bonds is deductible by issuing Company on pro
rata Basis Sec.36(1)(iiia)
vii) Contribution to recognized Provident fund or an approved super
annuation fund:
Section 36(1)(iv).Any sum paid by the assessee as an employer by way of
contribution Towards pension scheme.
viii) Contribution to Pension Scheme: Section 36(1)(iv a) Any contribution by
an employer By way of contribution towards pension scheme referred to a section
80CCD for an employee up to 10% of salary shall be allowed as deduction.
ix) Contribution to approved Gratuity Fund Section 36(1)(v): ‐ Amount
contributed to the fund which is for the exclusive benefit of the employees will be
allowed as deduction.
x) Contributions received from employees (when deposited) Section
36(1)(va): ‐ Any contribution received from employees towards any funds for the
welfare of the employees e.g. P.F. will be allowed as deduction when such
contribution is credited to employees a/c on or before the due date. It is allowed as
deduction not because it is an expenditure of the assessee. In fact, it is not at all an
expenditure of the assessee. But when this amount is deducted from salary of
employees, it is treated as an income under section 2(24)(x). Therefore, deduction is
allowed when payment is made by the due date.
xi) Animals used for the business: Section 36 (1) (vi): ‐ Deduction is allowed
when animals have died or have become permanently useless. Amount of deduction
will be difference between actual cost of the animals and amount realised if any in
respect of carcasses of the animals Deduction is allowed only if animals are used for
the purpose of business but not as stock in trade.

242
 xii) Bad debts: Section 36(1)(vii) and Section 36(2): ‐ Deduction is allowed on
this account of debts have arisen out of business transaction. It is the responsibility
of the assessee to prove to the satisfaction of income tax officer that such debts are
irrecoverable.
xiii) Expenditure for promoting family planning: Section 36(1)(ix): ‐ Only a
company can claim this deduction. Any expenditure incurred by a company to
promote family planning among its employees is allowed as deduction fully,
provided it is revenue expenditure. Any capital expenditure on this account is
allowed as deduction in 5 equal installments. If profit is not sufficient to absorb this
expenditure it can be carried forward to be set off in future. No depreciation can be
claimed under section 32 on capital assets used for promoting family planning and
allowed as deduction under section 36(1)(ix).
xiv) Any amount of security transaction tax paid during the year. 36(1)(xv
8) Residuary Expenses : [Section 37]:
Any other expenditure not covered by section 30 to 36 which is of revenue
nature will be allowed as deduction provided it is incurred exclusively for the
purpose of business or profession. e. g.
1. Embezzlement of cash.
2. Expenses on local festival such as Diwali, Muhurta etc.
3. Cash shortage found in the business at the end of the day.
4. Entertainment Expenses
5. Advertisement Expenses
6. Travelling Expenses
7. Guest House Expenses.
8. Lawful expenses related to illegal business.
9. Premium on redemption of debentures
10. Discount on issue of debentures (on pro rata basis)
Expenses Not Deductible Under Section 37
1. Donations 2. Charities
3. Gifts to relatives 4. Income tax
243
5. Wealth tax 6. Advance income tax
7. Fines and penalties for breach of any laws.
8. Personal Drawings 9. Salary to owner
10. Interest on proprietor’s capital 11. Capital expenditure
12. Purchase of an assets 13. Extension of building
14. Personal expenditure 15. Household expenses.
16. Drawings 17. Education expenses of children
18. Residential telephone bill 19. Residential electricity bill
20. Residential maintenance 21. Amount transferred to reserve
22. Personal Hotel expenses
23. R.D.D. But deduction is allowed for actual bad debts
24. Personal motor expenses 25. L.I.C. on own life.
26. Any Investments
27. Any expenses related to let out house property.
28. Expenditure on Advertisement (Section 37(2B): It is allowed as deduction.
However, as per Section 37 (2B), any expenditure incurred by an assessee
on the advertisement in any souvenir, brochure, pamphlet etc. published by
a political party will not be allowed as deduction.
29. In case of all assessee Section 40(a): Interest, royalty, fees for technical
services or any other sum chargeable to tax payable outside India without
deducting tax at source & where there is no person to be treated as an agent
of person receiving this amount.
30. Salary paid outside India without deducting tax at source
31. Any contribution to PF or any other Fund, if there is no arrangement for
TDS from any payment to be made from such Fund if it is taxable under the
head Salaries.

244
• Expenditure ExpresslyDisallowed : [Section 40]:
The following amounts are not deductable from business or profession
income :
In case of any assessee u/s 40(a):
i) Interest, royalties, fees for technical services or any other other expenses
chargeable to tax payable outside India, or in India to a non-resident on which no tax
has been paid or deducted at source. Interest, commission, brokerage, professional
fee, payments to contractors payable to resident also will not be allowed as a
deduction if income tax has not been deducted and paid before the due date of filling
of return.
ii) Income tax :Any tax levied on profits and gains on business or profession.
iii) Tax on perquisites paid by employer u/s 10 (10cc) is not deductable
iv) Section 40 (a) (iib): (a) royalty, license fee, service fee, privilege fee,
service charge or any other name whatever called if such royalty etc., is
exclusively levied on a State Government undertaking by the State
Government; or
(b) any amount which is appropriated directly or indirectly from a State
Government undertaking by the state government.
v) Section 40 (a) (iii): Salaries paid outside India or to a non-resident are not
allowed unless income tax has been paid or deducted at source.
vi) Section 40 (a) (iv) : Any contribution to a provident fund, if no arrangment
is being made for deduction of tax at source .
In case of firm u/s 40 (b): Payment of salary, bonus, commission or remuneration to
working partner of the firm, by the firm is allowed as deduction only to the following
extent: ‐
1. Loss or profit up to Rs. 1,50,000 or 90% of book profit whichever
‐
3,00,000 is more
2. On the balance of book
‐ 60% of book profit
profit

245
 Book profit means the net profit as shown in profit and loss account computed
in the manner laid down in chapter ( IV –D ) without considering the deduction for
remmuneartion as calcualte above.
Interest to any partner in excess of 12 % p.a. : Interest on capital of partners is
allowed as deduction provided it is authorized by the partnership deed & rate of
interest does not exceed 12% p.a.
• Expenses or payments not deductible in certain circumstances (Section
40A):
i) Payment to relatives and associates: Section 40A(2)
Payments made by assessee to following persons :‐
(a) Who is relative of assessee, if assessee is an individual i.e. spouse, brother, sister
or an lineal ascendant & descendant
(b) Who is director, partner, member or their relatives, if assessee is a company or a
firm or AOP or HUF
(c) Any person who is having substantial interest in business or profession of the
assessee. i.e. a person who is beneficial owner of at least 20% of equity capital
or entitled to 20% profit. If any payment is made by assessee on any account to
above mentioned persons & if in the opinion of assessing officer such payment
is excessive or unreasonable then to the extent it is unreasonable will be
disallowed.
ii) Payments exceeding Rs. 10,000 made otherwise than by a crossed cheque or
a draft Section 40A(3) & 40A (4):‐
If assesses incurs any expenditure exceeding Rs. 10,000 otherwise than by a
crossed cheque or a draft or electronic mode it shall be disallowed to the extent of
100% where the assessee incurs any expenditure in respect of which a payment or
Aggregate of payments made to a person in a day, otherwise than by an account
payee cheque drawn on a bank or account payee bank draft, exceeds ten thousand
rupees, no deduction shall be allowed in respect of such expenditure.
The monetary limit of Rs. 35,000 in the case of payment made transport
operator.

246
iii) Provision made for payment of gratuity under section 40 A (7):
No deduction shall be allowed in respect of any provision for payment of
gratuity to employees, by whatever name called.
However, the deduction shall be allowed in respect of following:
Provision made by the assessee for the purpose of payment of a sum by way of
any contribution towards an approved gratuity fund, or for the purpose of payment of
any gratuity, that has become payable during the previous year.
iv) Contributions made by employer to non‐‐statutory funds 40A(9):
No deduction shall be allowed to an assess for contribution made as an employer
to any fund other than recognized provident fund, approved superannuation fund or
approved gratuity fund.
• Deemed Income from Business or profession: Section 41
i) Recovery against any Allowance or Deduction Allowed earlier:
The amount received by the assessee in respect of a loss or expenditure
allowed as deduction in the earlier years, is deemed to be profit of the previous year
in which it is received by the assessee, whether the business or profession in respect
of which the deduction has been made is in existence in the year or not.
ii) Remission or censure of liability: The amount of liability which was
allowed as deduction in the earlier years if waived or ceased is deemed to be profit of
previous years during which it is waived by the creditor.
iii) Profit on sale of asset used for scientific research :
Where any capital asset used in scientific research is sold without having
been used for other purposes and the sale proceeds, together with the amount of
deduction allowed under section 35, exceed the amount of the capital expenditure
incurred on purchase of such asset, such surplus (i.e., sale price) or the amount of
deduction allowed, whichever is less, is chargeable to tax as business income in the
year in which the sale took place.
iv) Bad debts recovered :
Where any bad debt has been allowed as deduction under section 36(1)(vii)
and the amount subsequently recovered on such debt is greater than the difference

247
between the debt and the deduction so allowed, the excess realization is chargeable
to tax as business income of the year in which the debt is recovered.
12) Disallowance of unpaid statutory liability (Section 43B): ‐ This section is
applicable only if books are maintained on accrual basis. In the following cases,
deduction otherwise allowable under the Income‐tax Act will not be allowed unless
the amounts are actually paid by the due date for filing return of income. If these
liabilities are disallowed under section 43B in the year of provision, they will be
allowed in succeeding year or year when actually paid: ‐
1) Tax, duty, cess or fees, under any law (e.g. Sales‐tax, Excise duty, etc.)
2) Employer’s contribution to provident fund or super annuation fund or gratuity
fund or any other fund for the welfare of the employees.
3) Bonus or commission for services rendered payable to employees referred to in
section (1) (ii) & sum due in lieu of leave balance.
4) Interest on any loan or borrowing from any public financial institutions or a
State Financial Corporation or a State Industrial Investment Corporation, in
accordance with the terms and conditions of loan/borrowing agreement.
5) Interest on any term loan from a scheduled bank in accordance with the terms
and conditions of the agreement governing such loan. It should be noted that
these payments will not be allowed as deduction on accrual basis if not paid by
the due date of filing return of income even if books are kept on mercantile basis
• Other Important provision :
1. Maintenance of accounts by certain Assessees under section 44AA(1):
a) Every person carrying on legal, medical, engineering or
architectural profession or the profession of accountancy or technical
consultancy or interior decoration or any other profession as is notified by
the Board in the Official Gazette shall keep and maintain such books of
account and other documents as may enable the Assessing Officer to
compute his total income in accordance with the provisions of this Act.
(i) If their gross receipts in the profession exceed Rs. 1,50,000 in all the 3
years immediately preceding the previous year; or

248
 ii) If profession newly set up in the previous year, his gross receipts are
likely to exceed Rs. 1,50,000 in that year.
b) Every person carrying on business or profession [not being a profession
referred to in sub-section (1) above: section 44AA(2):
i) In case Individual or HUF:
Existing business or profession: In case where the income from the existing
business or profession exceeds Rs. 2,50,000 or the total sales or gross receipts
exceeds Rs. 25,00,000 any one of three year immediately preceding the accounting
year.
For Newly set up business: If his income from business or profession is likely
to exceed Rs. 2,50,000 or his total sales or receipts are likely to exceeds Rs.
25,00,000.
ii) Person other than individual and HUF:
Existing business or profession: In case where the income from the existing
business or profession exceeds Rs. 1,20,000 or the total sales or gross receipts
exceeds Rs. 10,00,000 any one of three year immediately preceding the accounting
year.
For Newly set up business : If his income from business or profession is likely
to exceed Rs. 1,20,000 or his total sales or receipts are likely to exceeds Rs.
10,00,000.
c) Where the profits and gains from the business are deemed to be the profits
and gains of the assessee under section 44AE or section 44BB or section 44BBB, as
the case may be, and the assessee has claimed his income to be lower than the profits
or gains so deemed to be the profits and gains of his business, as the case may be,
during such previous year; or
• Audit of accounts of certain persons carrying on business or profession
(Section 44AB):
The Finance Act 2020 has made amendment in the threshold limit of tax audit
under section 44AB. The tax audit limit under section 44AB is as under:
• Where the person is carrying on business shall and his total sales, turnover or
gross receipts, as the case may be, in business exceed or exceeds Rs. 1 crore in
any previous year is liable for ax audit.
249
• As per amendment made by Finance Act 2020, where the person is carrying on
business and fulfills below conditions then threshold limit for tax audit shall be
increased to Rs. 5 Crores:
(i) aggregate of all amounts received including amount received for sales, turnover
or gross receipts during the previous year, in cash, does not exceed five per cent
of the said amount; and
(ii) Aggregate of all payments made including amount incurred for expenditure, in
cash, during the previous year does not exceed five per cent of the said payment.
(c) In case the person is carrying on profession then he shall be liable for tax audit if
his gross receipts in profession exceed Rs. 50 lakh in any previous year.
• Estimated income scheme of assessment :
Where the person is carrying on the business shall and is opting for presumptive
taxation scheme under the following provisions:
i) Section 44AD: Presumptive taxation in case of business:
Under Section 44AD of presumptive taxation, small taxpayers with less than Rs.
2 crore of turnover can opt for presumptive tax scheme to declare profit of 8% of
their turnover. For availing benefit under this scheme, profits where income is
credited digitally or through the bank will be considered as 6% as against 8% for
cash receipts. If a taxpayer opts for presumptive taxation, he will not be allowed
deduction for expenses u/s 30 to 38
(ii) Section 44ADA: Presumptive taxation in case of Profession:
Presumptive income of profession shall be 50% of gross receipt (if gross receipt
of assessee does not exceed Rs. 50 lakh).
(iii) Section 44AE: Presumptive taxation in case of business of plying, hiring or
leasing goods carriages. For Heavy Goods Vehicle:
Rs. 1,000 per ton of gross vehicle weight for every month or part of a month
during which the heavy goods vehicle is owned by assessee
For Other Goods Vehicle:
Rs. 7,500 for every month or part of a month during which the goods carriage is
owned by assessee

250
• Computation of the profit and gains of business and profession :
a) When profit and loss account or Income and expenditure is given :
Computation of Income from business or profession :
Legal Status : Previous year :
Residential Status: Assessment year :
Particular Rs. Rs.
Net profit/ loss as per P& L A/c. or I/E. A/c. Xxx
Add: Disallowed expenses :
Household Expenses, Personal Expenses, Capital expenses xx
Expenditure on L I. C., Donation, Provisions &Reserve xx
Provisions for various funds & reserve xx
Proprietor Salary, Interest on capital, Drawing xx
Losses of earlier years xx
Expenses related with other heads xx
Preliminary expenses in excess of provision u/s 35D xx
100% payments in excess of Rs. 10,000 not made by crossed cheque xx
or draft
Income tax, wealth tax, STT xx
Depreciation debited to P& L not as per the income tax rule xx
Xxx
Xxx
Less: Income credited to P& L A/c. or I/E A/c
Not taxable under this head or exempt
Income from house property xx
Income from other source like Interest, dividend xx
Salary xx
Income tax refund xx
Capital gain xx
Bad debts recovered (previously disallowed as deduction ) xx
Income exempt u/s 10 xx
Xxx
251
 Xxx
Less: Depreciation as per IT rule Xxx
Income from Business or profession Xxx

B) When Receipts and payment account is given :

Computation of Income from business or profession :
Legal Status : Previous year :
Residential Status: Assessment year :
Particular Rs. Rs.
Professional Receipts ( Income )
Consultation fees xx
Professional fees xx
Visiting fees xx
Sale proceeds of medicines etc (doctor) xx
Gifts from patients or client xx
Other professional receipts xx
Examiner’s fee xx xx
Less: Allowable professional expenses
Production expenses xx
Office & administrative expenses xx
Postage, telegram, stipend xx
Finance charges xx
Subscription or membership fees for profession xx
Car expenses relating to business or profession xx
Medicines, printing and stationery xx
Depreciation as per IT rule xx
Books and journal annual publication xx
Staff salary xx xxx
Income from business or profession xxx

252
• Illustratons :
Illustration 1) Mr. Shaha has prepared following profit and loss account :
Profit and Loss Account for the year ended 31/03/2021
Particular Amount Particular Amount
Salaries 80,000 Gross profit b/d 5,03,000
Advertisement 40,000 Winning from TV show 18,500
Sundry Expenses 45,000 Interest on securities 2,000
Interest on own capital 20,000 Dividend from co- 4,000
operative society
Fire Insurance 3,000
Income Tax 7,000
Household Expenses 25,000
Bad Debts 10,000
Provision for Doubtful Debts 5,000
Repairs 4,600
Life Insurance Premium own 6,000
life
Donations 4,000
Depreciation 37,000
Net profit 2,40,900
Total Rs 5,27,500 Total Rs. 5,27,500

Additional information :
a) Salary includes Rs. 16,000 paid to proprietor’s son, studying in 8th standard.
b) Sundry expenses include Rs. 150 towards charity and Rs. 2,500 towards school
fees of the son.
c) Repairs include Rs. 1,500 for repairs carried out at the residence of Mr. Shaha
d) Depreciation as per income tax rule Rs. 35,000.
Compute his income from business for the year ending 31st March 2021.
Answer : Computation of income from business of Mr. Shaha for A.Y. 2021-2022

253
Particular Amount Amount
Profit as per profit and loss account 2,40,900
Add: Expenses disallowed :
Salary to proprietors son studying in 8th standard 16,000
Sundry expenses for charity 150
Sundry expenses for school fee of the son 2,500
Interest on own capital 20,000
Income tax 7,000
Household expenses 25,000
Provisions for doubtful debts 5,000
Repairs 1,500
Life insurance premium 6,000
Donation 4,000
Depreciation 37,000
1,24,150
3,65,050
Less :Income chargeable under other head
Winning from TV show 18,500
Interest on securities 2,000
Dividend from co-op. Society 4,000 24,500
3,40,550
Less: Depreciation as per income tax rule 35,000
Income from business 3,05,550

Illustrations : 2) From the following Income expenditure account of a Dr. Pallavi

Kulkarni, Kolhapur, compute the taxable income for the assessment year 2021-2022
Income & Expenditure Account for the year ended 31/03/2021
Particular Rs. Particular Rs.
To Salaries to Staff 3,00,000 By consultation Fees 9,50,000
To Office Expenses 1,00,000 By Visiting Fees 4,50,000

254
 To OPD Rent 2,40,000 By Salary as a Visiting 9,00,000
lecturer
To Subscription 30,000 Examiner’s Fees 20,000
To Books for Profession 60,000 Dividend from co 30,000
(Annual Publication ) operative society
To Car Expenses 1,00,000 By Rent from let out 3,60,000
house property
To Purchase Of Computers 4,50,000 By Presents from Patients 1,40,000
(10-12-2020)
To Advance Tax 2,50,000 By Prize received from 1,00,000
lion club as best member
of the year
To Donations 1,00,000 By Received a share from 2,50,000
H.U.F. income
To Personal Drawings 8,00,000
To Expenses of let out 65,000
house
To Life Insurance Premium 1,00,000
To Depreciation 50,000
To Surplus 5,55,000

32,00,000 32,00,000
Following further information is given :
1. Half of the car expenses were related to private purpose.
2. Depreciation allowable as per Income Tax rules amounted to Rs. 1, 20,000
excluding cost of computer but including depreciation on car Rs. 48,000.
3) Donation are given to Prime Minister’s Earthquake Relief Fund.

255
Answer: Computation of Income From Profession of Dr. Pallavi Kulakarni For A.
Y.2021-2022
Particular Amount Amount
Surplus as per Income & Expenditure Account 5,55,000
Add: Expenses disallowed :
Car expenses ( Personal expenses 1,00,000x1/2) 50,000
Purchase of computers 4,50,000
Advance Income Tax 2,50,000
Donations 1,00,000
Personal Drawings 8,00,000
Let out house expenses 65,000
Life Insurance Premium 1,00,000
Books 60,000
Depreciation 50,000
19,25,000
24,80,000
Less: Income not taxable under profession head and
tax free incomes
Salary 9,00,000
Dividend from co operative society 30,000
Examiner’s fees 20,000
Prize received from lions club 1,00,000
Received a share from H. U. F. 2,50,000
Rent from let out house 3,60,000 16,60,000
8,20,000
Less: Depreciation as per I. T. Rules:
Car (48,000/2) 24,000

256
 Computer (4,50,000 x 40% x 1/2) 90,000
Other Assets (1,20,000-48,000) 72,000 1,86,000
Income from Profession 6,34 ,000
Notes: 1) Purchase of computers is capital expenditure and hence not allowable.
2) Depreciation on computer @40 % p.a. charge for half year as computer
used for less than 180 days in year.
Illustration 3): Profit and Loss Account of Mr. Ravi , Mumbai for the Financial year
ended 31st March 2021.
Profit and Loss Account
Particular Rs. Particular Rs.
To Salary 2,00,000 By Gross Profit 16,00,000
To Advertise 40,000 By Interest on Securities 40,000
To General Expenses 80,000 By Rent From House 60,000
Property
To Entertainment Expense 30,000 By Bad Debts Recovered 10,000
(Previously allowed)
To Bad Debts 5,000 By Commission 60,000
To Travelling Exp. 45,000
To G.S.T. 10,000
To Interest on Capital 20,000
To Repairs 5,000
To Depreciation 30,000
To Car Purchased 3,00,000
To Car Expenses 30,000
To Donations 20,000
To Provisions For Bad 20,000
Debts
To Municipal Tax on House 10,000
To Wealth Tax 15,000

257
To Income Tax 25,000
To Net Profit 8,85,000
17,70,000
17,70,000
Adjustments:
1) Half of the repairs were on house property let out.
2) Depreciation as per Income Tax Rule Rs. 40,000
3) Advertisement includes Rs. 10, 000 were spent on Permanent signboard fixed on
the premises.
4) Donations paid to Prime Minister’s National Relief Fund.
Compute his Income from Business for the year ending 31/03/2021.
Solution : Computation of Income from Business of Mr. Ravi for A. Y. 2021-
2022
Particular Amount Amount
Profit as per profit and loss account 8,85,000
Add: Expenses disallowed :
Advertisement 10,000
Interest on capital 20,000
Repairs 2,500
Car purchased 3,00,000
Donation 20,000
Provision for bad debts 20,000
Municipal Taxes of house 10,000
Wealth Tax 15,000
Income Tax 25,000
Depreciation 30,000 4,52,500
13,37,500
Less : Income chargeable under other head
Interest on Securities 40,000

258
Rent From House Property 60,000 1,00,000
12,37,500
Less: Depreciation as per I.T. Rule 40,000
Income from Business 11,97,500

Illustration 4) Mr. Ramesh is a leading advocate at Pune. Following is the summary

of cash book for the year ended 31/03/2021. Compute his income from profession.
Receipts Amt Rs. Payments Amt. Rs.
Opening Balance 50,000 Salary to Assistance 2,50,000
Professional Fees 15,00,000 Rent of Chamber 1,80,000
Arbitration Fees 3,00,000 House Hold Expenses 8,00,000
Gifts 2,00,000 Membership Fees 60,000
Policy amount received on 20,00,000 Books For Profession 1,00,000
maturity of policy (Annual Publication )
Interest on Bank Deposit 1,50,000 Fixed Deposits in 20,00,000
Banks
Car Expenses 2,00,000
Advance Income Tax 50,000
Bonus and Gifts to Staff 2,00,000
Computer Purchase 1,00,000
Telephone Expenses 1,30,000
Closing Balance 1,30,000
42,00,000 42,00,000

Additional Information :
1) Gifts included Rs. 70,000 received from friends & relatives on family function
and balance from clients.
2) Depreciation allowable on assets as per rules amounted to Rs. 1,60,000
including Rs. 50,000 on car but excluding books purchased.
3) One fifth of car expenses are related to personal use.
4) Membership fees included Rs. 20,000 to bar council and balance to private club.

259
Solution : Computation of Income from Profession of Mr. Ramesh for A.Y.
2021-2022.
Particular Amount Amount
Rs. Rs.
Allowed Income :
Professional Fees 15,00,000
Arbitration Fees 3,00,000
Gifts 1,30,000
19,30,000
Less: Allowed Expenses :
Salary to Assistance 2,50,000
Rent of Chamber 1,80,000
Membership Fees 20,000
Car Expenses (2,00,00x4/5) 1,60,000
Telephone Expenses 1,30,000
Depreciation :
On other assets (1,60,000-50000) 1,10,000
On Car (50,000x4/5) 40,000
Books Annual Publication (1, 00,000 x 40%) 40 ,000 9,30,000
Income from Profession 10,00,000

Illustrations 5) Dr. Suresh is a renowned medical practitioner who maintains books

of account on cash basis, furnishes his Receipts and Payments Account for the
financial year 2020.2021.
Receipts Amt Rs. Payments Amt. Rs.
Balance b/d 2,80,000 Rent of Clinic 1,20,000
Consultation Fees 4,00,000 Electricity and Water 40,000
Visiting Fees 6,00,000 Purchase of 80,000
Professional Books
Loan from Bank (For 5,00,000 Household Expenses 1,58,000

260
Profession)
Pathological Tests 2,00,000 Motor Car Purchased 6,00,000
Receipts from Indoor Patient 10,00,000 Surgical Equipments 96,000
Gifts and Presents 1,00,000 Income Tax 2,00,000
Interest on Bank Deposits 4,60,000 Salary to Staff 3,00,000
Life Insurance 4,00,000
Premium
Interest on Loan 40,000
Car Expenses 3,00,000
Purchase of 8,00,000
Medicines
Balance c/d. 4,06,000
35,40,000 35,40,000

Additional Information:
1) 1/3rd of the car related to his personal use.
2) Depreciation on motor car allowable is 15%, on books 40%, and on surgical
equipments 40%.
3) Gifts and present include Rs. 60,000 from patients and Rs. 40,000 received on
birthday.
4) Closing stock of medicines amounted Rs. 1,10,000.
5) All fixed assets are purchased before 30/09/2020
Compute taxable income from profession for A.Y. 2021-2022.

261
Solution: Computation of Income from Profession of Mr. Suresh for A.Y. 2021-
2022.
Particular Amount Amount
Rs. Rs.
Allowed Income :
Consultation Fees 4,00,000
Visiting Fees 6,00,000
Pathological Tests 2,00,000
Receipts from Indoor Patient 10,00,000
Gifts and Presents (1,00,000-40,000) 60,000 22,60,000
Less: Allowed Expenses :
Rent of Clinic 1,20,000
Electricity and Water 40,000
Salary to Staff 3,00,000
Interest on Loan 40,000
Purchase of Medicines (8,00,000-1,10,000) 6,90,000
Car Expenses (3,00,000x2/3) Professional 2,00,000
purpose
Depreciation :-
On Car (6,00,000 x15%)=90000x2/3 60,000
On Surgical equipments (96,000x40%) 38,400
On Books (80,000x40%) 32,000 15,20,400
7,39,600
• Check your progress III :
1) Fill in the blanks .
i) In case of a person adopting the provisions of section 44ADA, income will be
computed on Presumptive basis, i.e., @ _________of gross receipts of the
specified profession.
ii) Section ________ deals with the provisions relating to depreciation allowance
while computing income chargeable to tax under the head “Profits and Gains of
business or profession”.

262
iii) Any interest, salary, bonus, commission or remuneration due to or received by
partner of a firm are taxable under the head -------
iv) If the asset is acquired during the previous year by the taxpayer and the same is
put to business use for less than _____ days during that year, then taxpayer can
claim depreciation at 50% of normal depreciation
v) Section _______ deals with the deductibility of expenditure incurred by the
assessee in respect of rent, rates, taxes, repairs and insurance for building under
the head “Profits and Gains of business or profession”.
3.2.4 Income from Capital Gain :
• Introduction:
Any profit or gain arising from the sale or transfer of a capital asset is
chargeable to tax under the head Capital Gains under section 45. Capital gain can be
short term or long term.
Capital gain arises when the selling price of asset is greater than purchase price
of asset.
Followings are the different concepts and provisions applicable for calculation
of capital gain.
• Capital Assets : [Section 2(14)]:
Capital asset means –
i) Any kind of property held by an assessee, whether or not in connection with his
business or profession;
ii) Any securities held by a Foreign Institutional Investor which has invested in
such securities in accordance with the regulations made under the Securities and
Exchange Board of India Act, 1992 but does not include the following:
(1) Stock in trade
Stock in trade, consumable stores or raw materials held for business or
profession.
(2) Personal effect
Personal effect means any movable property held for personal use of the
assessee or for any dependent member of his family but excludes. Jewellery,
paintings, drawings,
263
 archaeological collections, sculptures, or any other art work.
(3) Agricultural land in rural area
Agricultural land in India is not a capital asset except the following –
a. land which is situated within the jurisdiction of any Municipality (whether
known as a municipality, municipal corporation, notified area committee, town
area committee, town committee, or by any other name) or Cantonment Board
having population of 10,000 or more; or
b. in any area within the distance, measured aerially,—
Population of the Area within the aerial distance from the local
municipality or cantonment limits of such municipality or cantonment
board board is non-rural area
More than 10,000 but not
Upto 2 kilometres
exceeding 1,00,000
More than 1,00,000 but not
Upto 6 kilometres
exceeding 10,00,000
More than 10,00,000 Upto 8 kilometres

(4) Gold Bonds

Following gold bonds issued by the Central Government are not capital asset:
(i) 6.5% Gold Bond, 1977 (ii) 7% Gold Bonds, 1980; and (iii) National Defence
Gold Bond, 1980
(5) Special Bearer Bond
Special Bearer Bond, 1991 issued by the Central Government are not capital
asset.
Note: It is not necessary that the assessee should be the initial subscriber.
(6) Gold Deposit Bonds
Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999 or deposit
certificates issued under the Gold Monetization Scheme, 2015 notified by the Central
Government are capital asset.

264
• Types of Capital Assets :
Short Term Capital Asset [Sec. 2(42A]: It means capital assets held by an
assessee for not more than 36 months immediately before the date of transfer.
Long Term Capital Asset [Sec. 2(29A]: A capital asset, which is not a short-
term capital asset, is a long it is held for not -term capital asset
Exceptions: In the following cases, an asset shall be termed as a short-term
capital asset (STCA) if more than following period before the date of transfer:
12 Months 24 months
Equity or preference share in a Equity or preference share in an unlisted
company (listed in India ) company
Any security e.g. debenture, Immovable property being land or building
Government securities or both
etc. (listed in India)

A unit of an equity oriented fund

Zero-Coupon Bonds (whether quoted
or not)
Units of UTI (whether quoted or not)
Short-term capital gain (STCG) arises on transfer of short-term capital assets
(STCA) and long-term capital gain (LTCG) arises on transfer of long-term capital
assets (LTCA).
However, any gain on transfer of an asset on which depreciation is allowed as
per WDV method u/s 32(1)(ii) shall be taxable as short-term capital gain
(irrespective of their period of holding) [Sec. 50]
• Transfer: [Section 2 (47)]:
Transfer in relation to a capital asset includes:
(a) Sale, Exchange & Relinquishment of the asset;
(b) Extinguishment of any right in an asset;
(c) Compulsory acquisition of an asset under any law;
(d) Conversion of asset into stock-in-trade by the owner;

265
(e) Any transaction of immovable property u/s 53A of the Transfer of Property Act,
1882;
(f) Any transaction which has the effect of transferring or enabling the enjoyment
of any immovable property.
(g) Maturity or redemption of a zero coupon bond
• Transactions not regarded as transfer :
Following transactions are not regarded as transfer-
1. Distribution of asset in kind by a company to its shareholders at the time of
liquidation.
2. Distribution of capital asset on total or partial partition of Hindu Undivided
Family (HUF).
3. Transfer of capital asset under a gift or will or an irrecoverable trust.
4. Transfer of capital asset by a company to its wholly owned subsidiary.
5. Transfer of capital asset by a wholly owned subsidiary to its holding company.
6. Transfer of capital asset in the scheme of amalgamation.
7. Transfer of shares in an Indian company held by a foreign company under the
scheme of amalgamation of two foreign companies.
8. Transfer of capital asset in the scheme of amalgamation of banking company
with a Banking Institution.
9. Transfer a capital asset by a demerged company to resulting company.
10. Transfer of shares held in an Indian company by a demerged foreign company to
resulting foreign company.
11. Any transfer of capital asset in a business reorganization, by the predecessor co-
operative bank to the successor co-operative bank.
12. Any transfer by a shareholder, in a business reorganization, of a capital asset
being shares held by him in the predecessor co-operative bank, if the transfer is
made in consideration of allotment to him of any shares in the successor co-
operative bank.
13. Transfer or issue of shares by the resulting company, in a scheme of demerger to
the shareholders of demerged company.
266
14. Allotment of shares in amalgamated company in lieu of shares of amalgamating
company.
15. Transfer of a capital asset (being foreign currency convertible bond or Global
Depository Receipts (GDR)) by a non-resident to another non-resident.
16. Any transfer, made outside India, of a capital asset being rupee denominated
bond of an Indian company issued outside India, by a non-resident to another
non-resident.
17. Any transfer of a capital asset, being a Government Security carrying a periodic
payment of interest, made outside India through an intermediary dealing in
settlement of securities, by a non-resident to another non-resident.
18. Transfer of capital asset made by a non-resident on a recognized stock exchange
located in international financial services centre and where the consideration is
paid/ payable in foreign currency.
19. Transfer by an individual of Sovereign Gold Bond (Issued by RBI under the
sovereign Gold Bond Scheme, 2015) by way of redemption.
20. Transfer of agriculture and in India before 01/03/1970.
21. Transfer of capital asset (being work of art, manuscript, painting etc) to the
Government/University/ national museum, etc.
22. Transfer by way on conversion of bonds or debentures into shares.
23. Transfer by way of conversion of bonds into shares or debentures of any
company.
24. Transfer by way of preference shares of a company into equity shares of that
company.
25. Transfer by way of exchange of capital asset being membership of a recognized
stock exchange for shares of a company.
26. Transfer of land by a sick industrial unit which is managed by its workers’ co-
operative.
27. Transfer of capital asset by a firm to a company in case of conversion of firm
into a company.
28. Transfer of capital asset, being a membership right held by a member of a
recognized stock exchange in India.
267
29. Transfer of share by a private company/unlisted public company to a Limited
Liability Partnership (LLP), or any transfer of shares held in the company by a
shareholder, in case of conversion of company into LLP.
30. Transfer of capital asset to a company in the case of conversion of proprietary
concern into company.
31. Transfer involved in the scheme of lending of securities.
32. Transfer of capital asset in a transaction of reverse mortgage made under the
scheme notified by the Government.
• Computation of Capital gain:
Short-term Capital Gain means the gain arising on transfer of short-term capital
asset
Long-term Capital Gain means the gain arising on transfer of long-term capital
asset
Computation of Short Term Capital Gain (STCG)
Computation of capital gain of _____ for the Assessment Year ……..
Particulars Amount Amount
Sale consideration (Full value of consideration) xx
Less: Expenses on transfer xx
Net sale consideration xx
Less: i) Cost of acquisition xx
ii) Cost of improvement xx xx
Short Term Capital Gain xx
Less: Exemption u/s 54B, 54D, 54G, etc. (xx)
Taxable Short Term Capital Gain xx
Computation of Long Term Capital Gain (LTCG):
Computation of capital gain of _____ for the Assessment Year ……..
Particulars Amount Amount
Sale consideration (Full value of consideration) xx

268
 Less: Expenses on transfer xx
Net sale consideration xx
Less: i) Indexed cost of acquisition xx
ii) Indexed Cost of improvement xx xx
Short Term Capital Gain xx
Less: Exemption u/s 54, 54B, 54D, 54EC, 54F, etc. (xx)
Taxable Long Term Capital Gain xx
The meaning of terms used in the computation:
(i) Sale consideration (full value of consideration)
It refers to sale value of the asset (in form of money or money’s worth).
Consideration in installments In case, consideration is receivable in installment in
different years, the entire value of the consideration shall be taxable in the year of
transfer.
(ii) Expenses on transfer
It means any expenditure incurred wholly and exclusively in connection with
such transfer such as, brokerage or commission incurred for securing buyer, cost of
stamp and registration fee by the vendor, traveling expenses, etc. It is reduced from
sale consideration to get net sale consideration.
(iii) Cost of Acquisition [Sec. 55(2)]
Cost of acquisition includes expenditure incurred for acquiring the asset or
completing the title of the asset. For instance–
i) Sum paid for discharge of mortgage debt to clear charge over the property
(created by previous owner) is a part of cost of acquisition.
ii) Litigation expenditure incurred by a shareholder to get the shares registered in
his name will form part of cost of acquisition of shares.
(iv) Cost of Improvement [Sec. 55(1)(b)]
Cost of improvement means an expenditure incurred to increase the productive
quality of the asset. It includes all expenditures of a capital nature incurred in making
any additions or alterations to the capital asset.

269
(v) Indexed Cost of acquisition:
“Indexed cost of acquisition” means the ‘cost of acquisition’ (as discussed in
case of short term capital gain) adjusted according to the price level of the year of
sale. As per explanation to sec.48, “Indexed cost of acquisition” is an amount which
bears to the ‘cost of acquisition’ the same proportion as Cost Inflation Index for the
year in which the asset is transferred bears to the Cost Inflation Index for the first
year in which the asset was held by the assessee or for the year beginning on
1/4/2001, whichever is later.
Taxpoint:
!"#$ "% &'()*#*$*"+  ,+-. "% $/. 0.&1 "% #&2.
Indexed cost of acquisition = ,+-. "% $/. 0.&1 "% &'()*#*$*"+ "1 %"1 
3 4/*'/.5.1. *# 2&$$.1

vi) Indexed cost of improvement

“Indexed cost of improvement” means the ‘cost of improvement’ is cost
adjusted according to the price level of year of sale. As per explanation to sec. 48,
indexed cost of any improvement” is an amount, which bears to the cost of
improvement the same proportion as Cost Inflation Index for the year in which the
asset is transferred bears to the Cost Inflation Index for the year in which the
improvement to the asset took place.
!"#$ "% *671"5.6.+$  ,+-. "% $/. 0.&1 "% #&2.
Indexed cost of improvement =
,+-. "% $/. 0.&1 "% *671"5.6.+$

vii) Cost of inflation index:

Cost inflation index, in relation to a previous year, means such Index as the
Central Government may, having regard to 75% of average rise in the Consumer
Price Index (urban) for the immediately preceding previous year to such previous
year, by notification in the Official Gazette, specify, in this behalf. Cost Inflation
Index for different financial years is as follows:

Index Financial Year Index

2001-02 100 2011-12 184

2002-03 105 2012-13 200
2003-04 109 2013-14 220
2004-05 113 2014-15 240
2005-06 117 2015-16 254

270
 2006-07 122 2016-17 264
2007-08 129 2017-18 272
2008-09 137 2018-19 280
2009-10 148 2019-2020 289
2010-11 167 2020-2021 301

Notional cost of acquisition:[Section 49 (1)]

In the following certain cases the cost of acquisition is taken at notional figure.
(a) Assets received on total or partial partition of HUF
(b) Assets received under a gift or will
(c) Assets received by succession, inheritance or devolution
(d) Assets received on dissolution of a firm, BOI or AOP
(e) Assets received on liquidation of a company
(f) Assets received under a trust (whether revocable or irrevocable)
(g) On any transfer, by wholly owned Indian subsidiary company from its holding
company
(j) on any transfer, by an Indian company from its wholly owned subsidiary. Or
(k) On any transfer in the scheme of amalgamation.
(h) Asset (being a self-acquired property of a member) received by an HUF from its
member
• When the capital asset become the property of the assessee before 1-04-
2001:
Where capital asset is acquired by the assessee or the previous owner before 1st
April 2001, the cost of acquisition will be taken as the actual cost or fair market
value on 1st April, 2001, whichever is beneficial to the assessee.
However, in case of capital asset, being land or building or both, the fair market
value of such asset on 1-4-2001 shall not exceed the stamp duty value, wherever
available, of such asset as on 01-04-2001.

271
• Where a capital asset became the property of the assessee by any of the modes
specified in sec. 49(1), cost of improvement includes improvement expenditure
incurred by the previous owner.
• Exemptions in respect of Capital Gain:
Sections 54, 54B, 54D, 54EC, 54F, and of the act grant total or partial
exemptions of capital gain so computed, the Provisions of these sections are
discussed as under:
• Capital Gain on Transfer of residential house property under section 54:
Eligible Asseesee ; Individual and HUF
Conditions for claim exemption:
1) Assessee should transfer residential house property
2) It must be a long term capital asset.
3) Income from such house property is chargeable under the head income
from house property.
4) Where the amount of capital gain exceeds Rs. 2 crore: One residential
house in India Should be purchased within 1 year before or 2 years after
the date of sale/transfer. Or constructed within a period of 3 years within a
period of 3 years transfer.
Where the amount of capital gain less than Rs. 2 crore the assessee at his option
purchase 2 residential house in India within one year before or 2 years after the date
of transfer. construct 2 residential house in India within a period of 3 years after the
date of transfer.
This exemption once claimed cannot be claimed in again in any other year. For
all other years, Investment should be made in construction/ purchase of 1 residential
house only.
5) If such investment is not made before the date of filling of return of income,
then the capital gain has to be deposited under the capital gain deposit
account scheme.
Amount of exemption: Minimum of Investment in new house or amount of
capital gain.

272
 Revocation of benefits: If the newly acquired residential house is transferred
within 3 Years from the date of acquisition of new assets, then the benefit availed
earlier shall be revoked. Such revoked income shall be reduced from cost of
acquisition of new asset.
If the amount held in Capital Gains Deposit Account Scheme (1988) is
unutilized, then such amount shall be taxable as long-term capital gain in the
previous year in which the period of 3 years from the date of transfer expires.
• Capital gains on transfer of agricultural land [Section 54B] :
Eligible Assessee; Individual and HUF
Conditions for claim exemption:
1) Assessee must have transferred a capital asset being an urban agricultural land .
2) Such agricultural land must have been used by the individual or his parents or
by such HUF for agricultural purposes for at least 2 years, prior to its transfer.
3) Assessee must purchase a new land for agricultural purpose. The new land may
be in urban area or rural area.
4) If such investment is not made before the date of filling of return of income,
then the capital gain has to be deposited under the capital gain deposit account
scheme.
Amount of exemption: Minimum of Investment in new asset or amount of
capital gain
Revocation of benefits: If the newly acquired asset is transferred within 3 years
from the date of acquisition of new assets, then the benefit availed earlier shall be
revoked. Such revoked income shall be reduced from cost of acquisition of new
asset.
If the amount held in Capital Gains Deposit Account Scheme (1988) is
unutilized, then Such amount shall be taxable as long-term capital gain in the
previous year in which the period of 3 years from the date of transfer expires.
• Capital Gains on Compulsory acquisition of land and building of industrial
undertaking (Sec. 54D):
Eligible Assessee; Any assessee

273
Conditions for claim exemption:
Assessee must have transferred a capital asset being a land or building or any
right therein, forming part of an industrial undertaking. Tax point: Asset may be a
short term or long-term capital asset.
Such capital asset has been compulsorily acquired under any law for the time
being in force.
Such capital asset was used for industrial purpose by the assessee for at least 2
years prior to its transfer.
Assessee must purchase any other land or building or construct a building, for
the purpose of shifting or reestablishing the said undertaking or setting up another
industrial undertaking within 3 years from the date of transfer.
If such investment is not made before the date of filling of return of income,
then the Capital gain has to be deposited under the capital gain deposit account
scheme.
Amount of exemption: Minimum of Investment in new asset or amount of
capital gain
Revocation of benefits: If the newly acquired asset is transferred within 3 years
from the Date of acquisition of new assets, then the benefit availed earlier shall be
revoked. Such revoked income shall be reduced from cost of acquisition of new
asset.
If the amount held in Capital Gains Deposit Account Scheme (1988) is
unutilized, then such amount shall be taxable as long-term capital gain in the
previous year in which the period of 3 years from the date of transfer expires.
• Capital gains not chargeable on investment in certain bonds [Section
54EC]-
Eligible Asseesee; Any assessee
Conditions for claim exemption:
Assessee must have transferred any long-term capital asset being land or
building or both.
Such asset can also be depreciable asset

274
 The Capital gains arising from such transfer should be invested in long term
specified assets within 6 months from the date of transfer.
Long-term specified asset means specified bond redeemable after 5 years, issued
after 01-04-2018 by a) the National Highways Authority of India (NHAI);
b) The Rural Electrification Corporation Ltd.;
c) Any other bond being notified by the Central Government
Amount of exemption: Minimum of Investment in new asset or amount of
capital gain. The total limit of exemption u/s 54EC for a capital gains relating to one
financial year cannot exceed Rs. 50 lakhs.
Revocation of benefits: Earlier benefit shall be revoked if such bond is
transferred or converted into money within 5 years of its acquisition or a loan is
taken on security of the new asset within the period.
• Capital gains in case of investment in residential house [Section 54F]:
Eligible Assessee; Individual and HUF
Conditions for claim exemption: Long-term capital asset (other than
residential house property) provided on the date of transfer, taxpayer does not own
more than one residential house property (except the new asset stated below).
The taxpayer should purchase one residential house in India within a period of
one year before or two years after the date of transfer or construct the one residential
house in India within three years from the date of transfer.
If such investment is not made before the date of filling of return of income,
then the
Capital gain has to be deposited under the capital gain deposit account scheme.
The taxpayer should not purchase any other residential house within a period of
two years or construct any other house within a period of three years.
Amount of exemption: Minimum of the following:
,+5.#$6.+$ *+ $/. +.8 &##.$
× Capital gain
9.$ :&2. '"+#*-.1&$*"+

Net sale consideration = Sale consideration – Expenditure on transfer

Revocation of benefit and its treatment :

275
1. If the newly acquired residential house is transferred within 3 years after the
date of its acquisition, benefit availed earlier shall be revoked.
2. If another residential house is purchased (apart from newly acquired residential
house property) by the assessee within 2 years or constructed within 3 years
after the date of transfer of original asset, benefit availed earlier shall be
revoked.
Such revoked income (exemption) in above two points shall be taxable as long-
term capital gain in the year of revocation of condition.
3. If the amount, held in Capital Gains Deposit Account Scheme (1988), is
unutilized, benefit availed earlier shall be revoked.
Chargeable amount shall be =
>
;+)$*2*<.- &6")+$ %"1 8/*'/ =.+.%*$ @ *# &5&*2.-
?
9.$ #&2. '"+#*-.1&$*"+
× Original capital gain

• Capital Gains Accounts Scheme, 1988:

If the new asset is not acquired till the due date of submission of return of
income, then the taxpayer will have to deposit the money in ‘Capital Gains Deposit
Account’ with a nationalized bank. The proof of deposit should be submitted along
with the re-turn of income. On the basis of actual investment and the amount
deposited in the de-posit account, exemption will be given to the taxpayer.
The taxpayer is to acquire a new asset by withdrawing from the deposit account.
New asset must be acquired within specified time, provided in the relevant section.
The unutilized amount will become chargeable to tax in the previous year in
which the specified time limit expires.
• Tax on Capital Gains:
1) Short-term capital gains: are taxable at normal rates but Short term capital
gain on transfer of equity shares or units sold through Stock Exchange and
Securities transaction tax paid, it will be taxable at concessional rate 15%.
2) Long-term capital gains are taxable at special rates for each type of assessee
–
a. on sale of equity shares and units of equity oriented fun 10% over and
above Rs. 1,00,000.

276
 b. 20% on other long term capital gains.
• Illustrations :
Illustration 1) Mr. Paresh purchased a capital asset for Rs. 5,00,000 in the year
2005.06, spent Rs. 2,00,000 on its improvement during 2010-11. He sold the same
for Rs. 50,00,000 in the previous year 2020-2021. The cost of inflation index for the
financial years 2005-06, 2010-11 and 2020-2021 were 117,167 and 301 respectively.
Compute the taxable capital gains for A. Y. 2021-2022.
Answer : Computation of taxable long term Capital Gain of Mr. Paresh for A.Y.
2021-2022
Particular Amount
Sale proceeds of capital assets 50,00,000
Less: Indexed cost of acquisition
(5,00,000/117x301) -12,86,325
Less: Indexed cost of Improvement
(2,00,000/167x301) -3,60,479
Long term capital gains 33,53,196

Illustration 2) The written down value of a block of assets consisting of plants M,

N, O as on 01/04/2020 was Rs. 4,40,000. During the year the new plant P was
purchased for Rs. 1,60,000.
Compute the capital gains for A. Y. 2021-2022 if :
a) Plant M was sold for Rs. 8,00,000, the expenses on transfer being Rs. 80,000.
b) All the plants M, N, O, P were sold for Rs. 8,00,000 the expenses on sale being
Rs. 80,000.
Answer: Computation of Short –term Capital Gains for F.Y. 2020-2021
Particular Amount Amount
a) If Plant M is sold
Sale proceeds of plant M 8,00,000
Less: Cost of acquisition :
1. Written down value of entire block of plants on 4,40,000

277
 01-04-2020
2. Cost of new plant 1,60,000
3. Expenses on transfer 80,000 6,80,000
Short term capital gains 1,20,000
b)If all the plants in block are Sold :
Sale proceeds of all the plants in block are sold 8,00,000
Less: Cost of acquisition :
1. Written down value of entire block of plants on 4,40,000
01-04-2020
2. Cost of new plant 1,60,000 6,00,000
Short term capital gains 2,00,000

Illustration 3) Mr. Ganesh purchased 100 equity shares of Infosys Ltd. On 01-04-
2005 at the rate of Rs. 1,000 per share in public issue of the company by paying
security transaction tax he has sold all the shares on 01-10-2020 at the rate of Rs.
4,000 per share through a recognized stock exchange and paid brokerage Rs. 4,000
and securities transaction tax 0.02% compute his capital gain during the previous
year 2020-2021. Fair market value of shares of Infosys Ltd. On 31/01/2018 is Rs.
2,000.
Answer : Computation of taxable capital gains of Mr. Ganesh for F. Y. 2020-
2021
Particular Amount
Sale proceeds of Share ( 100 X Rs.4,000) 4,00,000
Less: Brokerage -4,000
Net sale consideration 3,96,000
Less: Cost of acquisition (100 X Rs. 2,000) -2,00,000
Long term Capital Gain 1,96,000
Note: 1) Long term capital gains exceeding Rs. 1 lakh on sale of original shares
through a recognized stock exchange and STT paid at the time of purchase and sale

278
is taxable under section 112A at a concessional rate of 10%, without indexation
benefit.
2) Cost of acquisition of equity shares acquired before 31/01/2018 is higher of :
i) Actual cost of acquisition of shares i.e. Rs. 1,000 per share
ii) Lower of –a) Fair market value of such asset Rs. 2,000 per share
b) Full value consideration Rs. 4,000 per share i.e. Rs. 2, 000
So the cost of acquisition of original share is Rs. 2,000 per share
Illustration 4) From the following information compute the taxable capital gains of
Mr. Vishal for the A. Y. 2021-2022.
Particular Amount

Capital Asset Jewellery

Acquisition in 1996-97 ------
Cost of acquisition 3,00,000
Cost of improvement in 1999-2000 30,000
Cost of improvement in 2011-2012 35,000
Fair market value on 01-04-2001 4,50,000
Sale proceeds on 01-12-2020 16,00,000
Selling expenses 40,000

Mr. Vishal has purchased a residential house costing Rs. 10,00,000 within the
specified period the cost of inflation indices for the financial years 2001-02,2011-
2012 and 2020-21 were 100,184,301 respectively. He was not owning any other
residential house on the date of sale.
Answer: Computation of taxable capital gains of Mr. Vishal for A. Y. 2021-22
Particular Amount Amount
Sale proceeds of Jewellery 16,00,000
Less: 1. Indexed cost of acquisition 13,54,500
(4,50,000\100*301)

279
 2. Indexed cost of improvement in 2011-12 57,255
(35,000/184*301)
3. Selling Expenses 14,51,755
40,000
Long- term Capital Gains 1,48,245
Less: Exempt u/s 54F 95,029
(1,48,245X10,00,000/16,00,000-40,000)
Taxable Long-term Capital Gain 53,216

Notes: i) As the fair market value of Jewellery as on 01-04-2001 is adopted as cost of

acquisition, the cost of improvement before 01-04-2001 is ignored
ii) As cost of new residential house acquired is less than the net sale proceeds
the long term capital gains arising is exempt u/s 54 proportionately .
• Check your progress IV :
1) Fill in the blanks .
i) Exemption under section 54 will be _______of the amount of capital gains
arising on transfer of eligible asset or amount invested in
purchase/construction of new residential house property
ii) The upper limit for claiming exemption under section 54 EC in a financial
year is_______
iii) The holding period for an Immovable property to consider it as a Long
Term Capital Asset is _______
iv) The holding period for Listed Equity shares and Equity Mutual Fund Units,
to consider them as Long Term Capital Asset is _______
v) The Cost Inflation Index for the year 2001 is _______
3.2.5 Income from Other Source :
• Introduction: Income from other sources is a residuary head of income under
the Income Tax in which we can consider all the different sources of income
which does not fall under other heads as Income from salary or House property
or Capital Gains or Business / profession. As per Section 56(1), any income
which is not specifically exempted & not chargeable to tax under any other

280
 heads of income, shall be chargeable under the head Income from Other
Sources.
• Types of Incomes Chargeable under the head Income from other Sources
[Section 56(2)]
Section 56(2) lays down an inclusive list of incomes taxable under this head.
These are – 1. Dividend
2. Winning from lotteries, crossword puzzles, horse races, card games, other
games of any sort of gambling, betting of any form or nature.
3. Interest on Securities
4. Income by way of letting on hire of machinery, Plant or Furniture.
5. Any sum received from employee as contribution towards staff welfare
scheme.
6. Any sum received under Keyman Insurance Policy.
7. Any sum of Money or Value of Property received without consideration or
for inadequate consideration to be subject to tax in the hands of the
recipient [ i.e. Taxability of Gift , section 56(2)(X)]
8. Interest on loan /Debenture
9. Director’s sitting Fees
10. Agricultural Income outside India.
11. Remuneration received by the Members of Parliament.
12. Insurance Commission
13. Remuneration received by a teacher for acting as an examiner.
14. Compensation or Other Payment.
15. Interest on Bank deposits.
16. Interest on undisclosed sources.
17. Gratuity received by a director.
18. Family Pension.

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• Taxability of Gift , section 56(2)(X)]:
i) For prevent the practice of receiving sum of money or the property without
consideration or for inadequate consideration, sec 56(2)(x) brings to tax any
sum of money or the value of any property received by any person without
consideration or the value of any property received for inadequate
consideration
Sr Nature of asset Particular Taxable value
No
1 Money without consideration The whole amount if the
same exceeds Rs. 50,000
2 Movable property without consideration The aggregate fair market
value of the property if it
exceeds Rs. 50,000
3 Movable property Inadequate The difference between the
consideration aggregate fair market value
of and the consideration,
such difference exceeds Rs.
50,000
4 Immovable without consideration The stamp Duty value of
property such property if it exceeds
Rs. 50,000.
5 Immovable Inadequate The difference between the
property consideration stamp duty value and the
consideration, if such
difference exceeds the
higher of Rs. 50,000 and
10% of consideration.

Receipts exempted from the applicability of section 56(2)(x):

1) From any relative on the occasion of the marriage of the individual
2) Under a will or by way of inheritance,

282
3) In contemplation of death of the payer or donor as the case may be,
4) From any local authority
5) From such class of persons
6) subject to such conditions as may be prescribed.
• Admissible deduction [Sec 57]: For computation of Taxable income under this
head, the following deduction are to be made.
1. In case of Dividend (other than u/s 115 – O) or interest on securities - Any
reasonable sum paid by way of commission or remuneration to a banker or any
other person.
2. Income consists of recovery from employees as contribution to any PF.
Superannuation fund etc. Amount of contribution remitted before the due date
under the respective Acts, in accordance with the provision of section 36(1)(va)
3. Income from letting on hire of machinery, Plant & furniture - Current Repairs to
the machinery, Plant & furniture - Insurance Premium - Depreciation /
Unabsorbed Depreciation.
4. Family Pension- - 1/3 rd of such income or Rs. 15,000 whichever is less.
5. Interest on Compensation / enhanced Compensation received – - 50% of such
interest
6. Any other expenditure not in the nature of capital expenditure incurred wholly
& exclusively for earning such income.
• Illustration:
Illustration 1) From the following particulars of Mr. Dipak, compute the income
from other source for AY 2021-22.
1) Income from Units of UTI Rs. 25,000.
2) Composite rent from letting on hire of building & Machinery Rs. 80,000
3) Ground rent received Rs. 40,000
4) Winning form lotteries (Gross) Rs. 50,000.
5) Interest on Government securities Rs. 4,000.
6) Dividend from Shares of Axis bank Ltd. Rs. 9.450.

283
7) Dividend from co-operative Society Rs. 8,000.
8) Royalty received on text book written by him Rs. 15,000
Solution: Computation of Income from Other source of Mr. Dipak for A.Y. 2021-
2022
Particulars Amount
Income from UTI 25,000
Composite rent from letting on hire of building & Machinery 80,000
Ground rent received 40,000
Winning form lotteries 50.000
Interest on Government securities 4,000
Dividend from Shares of Axis bank Ltd 9,450
Dividend from co-operative Society 8,000
Royalty received on text book 15,000
Income From other source 2,31,450

Illustration 2) From the following particulars of Mrs. Kirti Joshi, compute the
income from other source for AY 2021-2022.
1) Directors fees Received Rs. 80,000.
2) Prize won in crossword puzzles Rs. 5,000.
3) Remuneration as a working as a examiner in the university exam. Rs. 10000
4) Dividend from listed Indian company Rs. 15,000
5) Interest on government securities Rs. 4,000 (Net)
6) Interest on Fixed deposits with Bank Rs. 15,000
7) Dividend from co-operative Society Rs. 5,000.
8) Gift from Mother Rs. 20,000.
Solution : Computation of Income from other source of Mrs. Kirti Joshi for
AY. 2021-2022

284
Particulars Amount
Directors fees received 80,000
Casual Income (Prize won in crossword puzzles 5,000
Remuneration as examiner 10,000
Dividend from listed Indian company 15,000
Interest on government securities 4,000
Interest on Fixed deposit 15,000
Dividend on shares of Co-operative society 5,000
Gifts from mother Nil
Income From other source 1,34,000

• Check your progress V :

I) Fill in the blanks
1) Mrs. Aruna receives a family pension of Rs. 5000 per month. She entitled
to a standard deduction of Rs. -----------
2) The stamp duty value of immovable property received by a person without
consideration shall be charged to tax if the same will exceed ________
3) Dividend received from a foreign company is charged to tax under the
head______.
4) Mrs. Patil won a lottery. At what rate such winnings would be chargeable to
tax?
5) Income from sub-letting is taxable under the head _________
3.2.6 Computation of Gross Total Income and Tax Liability in Respect of
Individuals only
• Introduction: Individual means an human being. Income tax is levied on
assesses total income. The total income of individual is computed after making
deductions from gross total income. Gross total income is aggregate of the
income computed under different five heads.

285
• 2.6.2. Steps for calculate total taxable income:
Following steps are considered for computing total income of individual and
charge tax there
Step 1 Determination of residential status – Resident, Resident But Not
Ordinary resident , Non- resident
Step 2 Classifications of income under different heads
Step 3 Exclusion of Income not chargeable to tax
Step 4 Computation of income under each head – Salary, House Property,
Business, Capital gain, Income from other source
Step 5 Apply the clubbing provision if any
Step 6 Set- off or carry forward and set- off of losses
Step 7 Compute Gross total Income
Step 8 Deductions from Gross Total Income
Step 9 Compute Total Income
Step Application of the rates of tax on the total income
10
Total Income Rate of Tax
Up to Rs. 2,50,000 (below 60 years ) Nil
Up to Rs. 3,00,000 (60 years and above but less
than 80 year )
Up to Rs. 5,00,000 (above 80 years and resident in
India)
Rs. 2,50,001\Rs. 3,00,001, as the case may be to 5%
Rs. 5,00,000
Rs.5,00,001 to 10,00,000 20%
Above Rs. 10,00,000 30%
Step Rebate under section 87A of maximum up to Rs. 12,500 if total income
11 does not exceeds Rs. 5,00,000
Step Calculate surcharge if applicable
12
Total income (assuming that the Surcharge
286
 same does not include dividend,
LTCG u/s. 112A, and STCG u/s
111A)
More than Rs.50 lakhs and less 10% of income tax
than Rs. 1 crore
More than Rs. 1 crore and less than 15% of income tax
Rs. 2 crore
More than Rs. 2 crore and less than 25% of income tax
Rs. 5 crore
More than Rs. 5 crore 37% of income tax
Step Health and education cess at 4% on income tax and surcharge if payable
13
Total Tax Liability=Tax on total income at applicable rate+ surcharge if
applicable –Rebate u/s 87A if total income less than 5 lakh+ Education
cess
Step Examine the applicability of Alternate Minimum Tax (AMT):-
14
a) If an individual is claiming deductions under section 10 AA or under
section 35 AD or section 80JJAA, 80QQB, & 80RRB and his adjusted
total income exceeds Rs. 20 lakhs, Minimum Alternate Tax provisions
will apply
b) Compute minimum Alternate Tax @18.50% of adjusted total income
c) If AMT is more than tax computed as per normal provisions, adjusted
total income will be deemed to be total income
d) tax applicable 18.5%
e) Tax credit to be carried forward =AMT less tax computed as per
regular provision
f) If Individual or HUF s opted for section 115BAC are not liable for
MAT u/s. 115JC
Step Examine whether or not to exercise option u/s 115BAC for availing
15 concessional tax slab :-
1) The Budget 2020 introduces a new regime under section 115BAC
giving an option to individuals and HUF taxpayers to pay income tax at
287
lower rate other than income chargeable to tax at special rates Subject to
following conditions
A) Exemptions and deductions not claimable under the new tax regime
The following are the deductions and exemptions you cannot claim under
the new tax system:
1. The standard deduction, professional tax and entertainment
allowance on salaries
2. Leave Travel Allowance (LTA)
3. House Rent Allowance (HRA)
4. Other special allowance [Section10(14)]
5. Interest on housing loan on the self-occupied property or vacant
property (Section 24)
6. Chapter VI-A deduction (80C, 80D, 80E and so on) (Except Section
80CCD(2) and 80JJAA)
7. Deduction from family pension income
8. Daily allowance or constituency allowance of MPs and LMAs
9. Exemption in respect of income of minor child included in the
income of parent
10. Tax holiday for units established in SEZ
11. Additional depreciation
12. Deduction in respect of contribution to notified approved research
association, Approved Indian company for scientific research, an
national laboratory , universities
B) Total income of individual should be computed without set off any
brought loss and depreciation.
2) Time limit for exercise the option :
1) If an individual having income from business or profession exercise
the option to pay tax under section 115BAC in a previous year, then said
provision would apply for all subsequent previous years.
2) A salaried taxpayer can opt-in and opt-out every year. That means
you can choose the new tax regime in one year and choose the regular tax
regime in another year.

288
 C) Concessional Tax Rate :
Up to Rs. 2,50,000 Nil
From 2,50,001 to 5,00,000 5%
From 5,00,001 to 7,50,000 10%
From 7,50,001 to 10,00,000 15%
From 10,00,001 to 12,50,000 20%
From 12,50,001 to 15,00,000 25%
Above Rs. 15,00,000 30%
Compare the Normal tax liability with liability computed under section
115BAC and choose them one.
Step Credit for Advance tax , TDS and TCS
16
Step Tax payable / Tax refundable
17
The rate of income tax is specified in the Finance Act
• Performa Showing Computation of Total Income of Individual
Particular Rs. Rs
Income from salary xx
Income from house property xx
a) Self occupied xx
b) Let out xx
Income from business or profession xx
Capital gains xx
Income from other source xx
Gross Total Income xx
Less: Deductions under chapter VIA u/s 80C to 80 xx
U
Total Taxable Income xxx
Tax payable zxx
Less: Relief u/s 87 A if applicable -xxx
Tax Payable after relief xxx
289
 Add: Education cess xxx
Add: Surcharge if applicable xxx
Tax liability xxx
Add: Interest payable if any xx
Total Tax liability xxxx
Less: Advance tax paid xxx
Less: TDS xxx -xxxx
Total tax payable/ Refund xxxx

• Illustrations:
Illustration 1) Mrs. Priti, aged 35 years, is a chartered accountant in practice. Her
Income
And Expenditure Account for the year ended 31/03/2021 are as follow.
Expenditure Rs. Income Rs.
Salary to staff 15,50,000 Professional Fees 55,98,300
Stipend to article assistant 1,50,000 Dividend from Indian 10,524
listed company
Office Rent 12,00,000 Income from UTI 7,600
Printing and stationery 12,46,000 Honorarium received from 15,800
valuation of answer papers
Meeting seminar and 31,600 Rent received from 85,600
conference residential flat let out
Purchase of car on 80,000
01/05/2020 for office use
Repairs and maintenance 4,000
Travelling expenses 5,25,000
Municipal tax of house 3,000
property
Surplus 9,28,224
57,17,824 57,17,824

290
Other information :
1) Allowable rate of depreciation on motor car is 15%
2) Value of benefits received from clients during the course of profession is Rs.
10,500
3) Travelling expenses include Rs. 30,000 for private purpose
4) She invested an Amount of Rs. 10,000 in National Saving Certificate
5) Medical insurance premium paid in cash Rs. 10,000
6) She has paid Rs. 70,000 towards advance tax during the previous year 2020-
2021
7) TDS on dividend made by UTI Rs. 1,052 and other Indian listed company
Rs.760.
Compute the total income and tax payable of Mrs. Priti for A.Y. 2021-2022 under
normal provision and provision as per section 115BAC. Which option is beneficial to
her?
Answer: Computation of total income and tax payable of Mrs. Priti for the A.Y.
2021-2022
Particular Rs. Rs
Income from House Property ( See working Note No. 1) 57,820
Profit and gains on business and profession (See working 9,20,200
note No. 2)
Income from other source (See working note No. 3) 33,924
Gross Total Income 10,11,944
Less: Deduction under chapter VI A 10,000
Total Income 10,01,944
Total Income Rounded off 10,01,940
Tax on Total Income
Up to Rs. 2,50,000 Nil
Rs. 2,50,001 to Rs. 5,00,000 @5% (5,00,000-2,50,00 x 12,500
5%)
Rs. 5,00,001 to Rs. 10,00,000 @20% (10,00,000- 1,00,000

291
5,00,000x20%)
Rs. 10,00,000 and above @30% (10,01,940 - Rs. 582 1,13,082
10,00,000 x30%)
Add : Health and education cess @4% 4,523
Total Tax liability 1,17,605
Less: Advance tax 70,000
Less: TDS (Rs. 1052, Rs.760) 1,812
Tax payable 45,793
Tax payable (Round off ) 45,790

Computation of tax payable in accordance with provisions of section 115BAC

Particular Rs. Rs
Gross Total Income 10,11,944
Income under the head profession, house property, Income
from other source would remain the same even if she opts
for special provisions u/s 115BAC, because deductions
claimed by her under these heads is allowable even u/s
115BAC)
Less: Deductions under chapter VI-A (Not allowable if Nil
opts for section 115BAC)
Total Income 10,11,944
Total Income rounded off 10,11,940
Tax on total income
Up to Rs. 2,50,000 Nil
Rs. 2,50,00 to Rs. 5,00,000 @5% (5,00,000-2,50,000 12,500
x5%)
Rs. 5,00,000 to Rs. 7,50,000 @10% (7,50,000-5,00,000) 25,000
Rs. 7,50,000 to Rs. 10,00,000 @15% (10,00,000- 37,500
7,50,000x15%)
Rs 10,00,000 to Rs.12,50,000 @20% (10,11,944- 2,388 77,388
10,00,000x 20%)

292
Add Health and education cess @4% 3,096
Total Tax liability 80,484
Less: Advance tax 70,000
Less: TDS (Rs. 1052, Rs.760) 1,812 71,812
Tax payable 8,672
Tax payable (Round off ) 8,670

Working Notes:
1) Income from house property:
Particular Rs.
Gross Annual Value 85,600
Less: Municipal tax paid -3,000
Net Annual Value (NAV) 82,600
Less: Standard deduction @30%of NAV 24,780
Income from house property 57,820

2) Income under the head profits and gains from Business and Profession :2) 2Npre
Particular Rs. Rs.
Net profit as per Income and Expenditure account 9,28,224
Add: Expenses debited but not allowable
Personal Travelling expenses 30,000
Amount paid for purchase of car 80,000
Municipal tax of residential house 3,000 1,13,000
10,41,224
Add: Gifts from client 10,500
10,51,724
Less: Income credited but not taxable under this head
Dividend from Indian listed companies 10,524
Income from UTI 7,600
Honorarium for valuation of answer paper 15,800

293
 Rent of flat 85,600 1,19,524
9,32,200
Less: Depreciation on car 12,000
Income from profession 9,20,200
3) Computation of Income from Other Source
Particular Rs.
Dividend from Indian listed company 10,524
Income from UTI 7,600
Honorarium received from valuation of answer papers 15,800
Total 33,924

4) Health insurance paid in cash is not eligible for deduction u/s 80DF2
5) Since tax payable as per provisions of section 115BAC is lower than the tax
payable under regular provision, it would be beneficial to Priti to opts for
section 115BAC
Illustration 2) From the following details, compute the total income and tax liability
of Virat, aged 31 years, of Mumbai both as per regular provisions and as per section
115BAC of Income -tax Act, 1961 for assessment year 2021-2022
Particular Amount
Salary including DA 3,00,000
Bonus 15,000
Salary of servant provided by the employer 15,000
Rent paid by Virat for his accommodation 60,000
Bills paid by the employer for gas, electricity and water 11,000
Interest received on Fixed deposit 9,500
He received cash gift of Rs. 30,000 each from four friends 1,20,000
Rent received Rs. 3,500 per month. He paid Interest on home loan Rs. 24,000 p.a. He
paid Municipal tax paid by him for rented property Rs. 4,300 p.a.
He contributed Rs. 50,000 to Public Provident Fund during the year.

294
Answer : Computation of total income and tax payable of Mr. Virat for the A.Y.
2021-2022
Particular Rs. Rs
I. Income From Salary 2,91,000
Salary including DA 3,00,000
Bonus 15,000
Salary of servant provided by the employer 15,000
Free gas, electricity and water 11,000
3,41,000
Less: Standard deduction 50,000
2,91,000
II. Income From House Property 2,390
Gross Annual Value (Rent receivable is taken as GAV in the 42,000
absence of other information ) (Rs.3,500 X 12)
Less : Municipal taxes paid 4,300
Net Annual Value (NAV) 37,700
Less: Deductions under section 24
i) 30% of NAV 11,310
ii) Interest on loan 24,000
2,390
III. Income From Other Source 1,29,500
Interest on Fixed Deposit 9,500
Gifts received from friends ( as the aggregate amount received 1,20,000
during the year exceeds Rs. 50,000)
1,29,500
Gross Total Income 4,22,890
Less: Deductions under section 80 C (PPF) 50,000
Taxable total Income 3,72,890
Tax on total income
(3,72,890-250000)X5% 6,145
Less: Rebate under section 87A , since total income does not 6,145
exceeds Rs. 5,00,000
Tax Liability Nil

295
Computation of total income and tax payable of Mr. Virat in accordance with the
provisions of section 115BAC for the A.Y. 2021-2022
Particular Rs. Rs
I. Income From Salary 3,41,000
Salary including DA 3,00,000
Bonus 15,000
Salary of servant provided by the employer 15,000
Free gas, electricity and water 11,000
3,41,000
Less: Standard deduction Nil
3,41,000
II. Income From House Property 2,390
Gross Annual Value (Rent receivable is taken as GAV in the 42,000
absence of other information ) (Rs.3,500 X 12)
Less : Municipal taxes paid 4,300
Net Annual Value (NAV) 37,700
Less: Deductions under section 24
i) 30% of NAV 11,310
ii) Interest on loan 24,000
2,390
III. Income From Other Source 1,29,500
Interest on Fixed Deposit 9,500
Gifts received from friends ( as the aggregate amount received 1,20,000
during the year exceeds Rs. 50,000)
1,29,500
Gross Total Income 4,72,890
Less: Deductions under section 80 C (PPF) Nil
Taxable total Income 4,72,890
Tax on total income
(4,72,890-2,50,000)X5% 11,145
Less: Rebate under section 87A, since total income does not 11,145
exceeds Rs. 5,00,000
Tax Liability Nil

296
Illustration 3) From the following information compute total income of Mr. Sagar
for assessment year 2021-2022 as per regular provision of tax Act .
Particular Amount Particular Amount
Salary to Staff 3,00,000 Gross Profits 10,00,000
Salary to Proprietor 60,000 Gross Salary 4,20,000
General Expenses 50,000 Life Insurance policy 2,00,000
amount received
Interest on Capital 40,000 Commission and 20,000
Brokerage
Drawings 2,10,000 Interest on Debentures 30,000
Income Tax 38,000 Interest on Saving Bank 25,000
Accounts
Bad Debts 20,000 Interest on Fixed 35,000
Deposits
Provision for Bad Debts 30,000 Rent Received 4,80,000
Fire Insurance 5,000
Life Insurance Premium 2,04,000
Law Charges 27,000
Furniture purchased 25,000
Donations 16,000
Charity to students 17,000
GST paid 80,000
Repairs 8,000
Municipal Tax Paid 5,000
Depreciation 70,000
Net Profit 10,05,000
22,10,000 22,10,000

Additional information:
1) General expenses included Rs. 10,000 being compensation paid to an employee
on termination of his service in the interest of the business.
2) Donation were paid to Prime Minister Relief Fund

297
3) Insurance Premium on own life
4) Repairs included Rs. 2,000 for let out house property.
5) Depreciation as per Income Tax rule Rs. 90,000.
Answer: Computation of Total Income of Sagar for A.Y. 2021-2022
Particular Amount Amount Amount
I. Income From Salary 3,70,000
Gross Salary 4,20,000
Less: Standard Deduction -50,000
Net Income from Salary 3,70,000
II. Income From House Property :
Gross Annual Value (Rent Received ) 4,80,000
Less: Municipal Tax Paid -5,000
Annual Value 4,75,000
Less: Deductions u/s 24
Standard Deduction (4, 75,000X30%) 1,42,500
3,32,500 3,32,500
III. Income From Business :
Net Profit as per Profit and Loss Account 10,05,000
Add: Expenses debited but not allowed
Salary to proprietor 60,000
Interest on capital 40,000
Drawing 2,10,000
Income Tax 38,000
Life Insurance premium 2,04,000
Furniture 25,000
Donations 16,000
Charity to students 17,000
Repairs 2,000
Provision for bad debts 30,000

298
Municipal Tax Paid 5,000
Depreciation 70,000 7,17,000
17,22,000
Less: Income Taxable under other head or
exempt
Gross Salary 4,20,000
Life Insurance policy amount received 2,00,000
Interest on Debentures 30,000
Interest on Saving Bank Accounts 25,000
Interest on Fixed Deposits 35,000
Rent Received 4,80,000
11,90,000 11,90,000
5,32,000
Less: Depreciation as per IT rule 90,000
4,42,000 4,42,000

IV. Income From Other Source

Interest on Debentures 30,000
Interest on Saving Bank Accounts 25,000
Interest on Fixed Deposits 35,000 90,000
Gross Total Income 12,34,500
Less: Deductions u/s 80
Life Insurance Premium u/s 80C 2,04,000 1,50,000
Interest on Saving accounts u/s 80TTA 25,000 10,000
Donations u/s 80G 16,000 16,000
1,76,000 1,76,000
Total Taxable Income 10,58,500
Tax on Total Income
Up to Rs. 2,50,000
Rs. 2,50,001 to Rs. 5,00,000 @5% 12,500

299
(5,00,000-2,50,00x5%)
Rs. 5,00,001 to Rs. 10,00,000 @20% 1,00,000
(10,00,000-5,00,000x20%)
Rs. 10,00,000 and above @30% (10,58,500 17,550
- Rs. 10,00,0000 x30%)
Total 1,30,050
Add Health and education cess @4% 5,202
Total Tax liability 1,35,252
Less: Advance tax ----
Less: TDS ---
Tax payable 1,35,253
Tax payable (Round off ) 1,35,250
Note : 1) LIC amount received is exempt from tax u/s 10(10D)
2) Maximum allowable deduction us 80 c Rs. 1,50,000.
Illustration 4) Mr. Pranit is working in India Ltd. Pune. He has furnished the
following details of his income for the financial year 2020-2021.
1) Basic Salary Rs. 50,000 p.m.
2) D.A. 40 % of salary (Considered for retirement benefit)
3) Bonus equal to 2 months of basic salary
4) He received House Rent Allowance of Rs. 20,000 per month from the employer.
But he paid rent Rs. 25,000
5) Helper Allowance Rs. 1,000 p.m.
6) He contribute to Public provident Fund Rs. 50,000 per annum
7) Life Insurance Premium Paid Rs. 1,00,000
8) Income from business Rs. 3,50,000
9) Dividend received from listed Indian Company Rs. 15,000
10) He has self occupied at Kolhapur during the year he has paid Rs. 1,15,000 as
interest and 50,000 as principle amount on housing loan
11) Interest on Fixed deposit Rs. 50,000

300
12) The company has deducted income tax Rs. 50,000
13) Tax paid on employment Rs. 2000
Compute income and tax liability of Mr. Pranit for A.Y. 2021.2022 under regular
provision and provision u/s 115BAC. Which is beneficial to him?
Answer : Computation of total income of Mr. Pranit as per regular provisions for
A.Y.2021-2022
Particular Amount Amount Amount
I. Income From Salary
Basic Salary (Rs. 50,000X12) 6,00,000
D. A. (Rs. 6,00,000X40%) 2,40,000
Bonus (Rs. 50,000X2) 1,00,000
House Rent Allowance 24,000
Allowance Received (Rs. 20,000X12) 2,40,000
Less: Exempt (Working note .1) 2,16,000
24,000
Helper Allowance (1,000X12) 12,000
Gross Salary 9,76,000
Less: Deductions u/s 16
i)Standard Deduction 50,000
ii) Professional Tax 2,000
52,000 52,000
Income From Salary 9,24,000 9,24,000

II. Income From Business 3,50,000

III. Income From House Property

Self occupied
Annual Value Nil
Less: Interest paid on Housing Loan -1,15,000
Loss From House Property (1,15,000)

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IV) Income From Other Source
Dividend From Listed Indian company 15,000
Interest on Fixed Deposit 50,.000
65,000 65,000
v) Capital Gain Nil
Gross Total Income 12,24,000
Less: Deductions under chapter VIA
Life insurance premium (u/s 80C) 1,00,000
Principal repayment of housing loan (u/s 50,000
80C)
Public Provident Fund contribution (u/s 50,000
80C)
(Maximum allowable under section 80C) 2,00,000 -1,50,000
Total Taxable Income 10,74,000
Tax on Total Income
Up to Rs. 2,50,000 Nil
Rs. 2,50,001 to Rs. 5,00,000 @5% 12,500
(5,00,000-2,50,00x5%)
Rs. 5,00,001 to Rs. 10,00,000 @20% 1,00,000
(10,00,000-5,00,000x20%)
Rs. 10,00,000 and above @30% 22,200
(10,74,000 - Rs. 10,00,0000 x30%)
Total 1,34,700
Add Health and education cess @4% 5,388
Total Tax liability 1,40,088
Less: Advance tax ---
Less: TDS 50,000
Tax payable 90,088
Tax payable (Round off ) 90,090

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Working Notes:
1) House Rent Allowance:
Salary For Amount Exempt least of following Amount
H.R. A.
Basic 6,00,000 a) H. R. A. Received 2,40,000
D.A. 2,40,000 b) Rent paid (-) 10% of salary
Salary for H. 8,40,000 [(25,000X12)-(8,40,000X10%)]=300000- 2,16,000
R. A. 84000
c) 40% of Salary (8,40,000X40%) 3,36,000
Whichever is least is exempt i.e. 2,16,000

Computation of total income of Mr. Pranit in accordance with the provisions of

section 115BAC for A. Y.2021-2022
Particular Amount Amount Amount
I. Income From Salary
Basic Salary (Rs. 50,000x12) 6,00,000
D. A. (Rs. 6,00,000x40%) 2,40,000
Bonus (Rs. 50,000x2) 1,00,000
House Rent Allowance 2.40,000
Helper Allowance (1,000x12) 12,000
Gross Salary 11,92,000
Less: Deductions u/s 16
i) Standard Deduction ----
ii) Professional Tax ----
---- ---
Income From Salary 11,92,000 11.92,000

II. Income From Business 3,50,000

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III. Income From House Property
Self occupied
Annual Value Nil
Less: Interest paid on Housing Loan ----
Loss From House Property ------

IV) Income From Other Source

Dividend From Listed Indian company 15,000
Interest on Fixed Deposit 50,.000
65,000 65,000
V) Capital Gain Nil
Gross Total Income 16,07,000
Less: Deductions under chapter VIA ------
Total Taxable Income 16,07,000
Tax on total income
Up to Rs. 2,50,000 Nil
Rs. 2,50,00 to Rs. 5,00,000 @5% 12,500
(5,00,000-2,50,000 x5%)
Rs. 5,00,000 to Rs. 7,50,000 @10%
(7,50,000-5,00,000) 25,000
Rs. 7,50,000 to Rs. 10,00,000 @15% 37,500
(10,00,000-7,50,000 x 15%)
Rs 10,00,000 to Rs.12,50,000 @20% 50,000
(12,50,000-10,00,000x 20%)
Rs. 12,50,000 to Rs.15,00,000 @25% 62,500
(15,00,000-12,50,000 x 25%)
Rs. 15,00,000 and above (16,07,000- 32,100 2,19,600
15,00,000x30%)
Add Health and education cess @4% 8,784
Total Tax liability 2,28,384
Less: Advance tax ----

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Less: TDS 50,000 50,000
Tax payable 1,78,384
Tax payable (Round off ) 1,78,380

Note: 1) If individual opts for section 115BAC he do not avail standard deduction,
professional tax deduction, H.R.A. exemption, self occupied house interest
exemption, deductions under chapter VIA .
2) As Mr. Pranit is require to pay lower tax as per the regular provisions of the
Income Tax Act, it would be beneficial to him opt for regular provision.
Illustration 5) Following is the profit and loss account of Mrs. Tanuja for the
previous year ending 31/03/2021
Particular Amount Particular Amount
Travelling Expenses 1,50,000 Gross Profit 15,40,300
Salary to Staff 3,75,000 Long term Capital Gain 35,400
on Equity shares
Telephone and Internet 10,500 Short term Capital Gain 15,000
charges
Light Bill 60,000 Rent received 3,00,000
Provisions for Bad Debts 10,000 (Fair Rent 1,00,000,
Municipal Value
2,00,00)
Office Expenses 75,000 Dividend from listed 5,000
company
Depreciation 50,000 Directors Fees
10,000
Printing and Stationery 47,000 Lottery Income (Net) 3,50,000
Insurance 15,000
Collection Charges 5,000
GST paid 80,000
Municipal Taxes 4,500
To Net Profit 13,73,700
22,55,700 22,55,700

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Additional Information :
1) Municipal taxes are in connection with let out house.
2) Depreciation as per IT rules Rs. 55,600.
3) Collection charges Rs. 1,000 for dividend and Rs. 4,000 for house property.
4) Gross Lottery income Rs. 5,00,000. TDS made from this Rs. 1,50,000
5) LIC paid during the year Rs. 1,05,000
Compute her total income for the assessment year 2021-2022 as per regular
provision of Income Tax Act.
Answer : Computation of total income of Mrs. Tanuja as per regular provisions for
A. Y.2021-2022
Particular Amount Amount Amount
I. Income From Salary Nil
II. Income From Business
Net Profit as per Profit and Loss
Account 13,73,700
Add: Expenses debited but not allowed
Provisions for Bad Debts 10,000
Collection Charges 5,000
Depreciation 50,000
Municipal Taxes 4,500
69,500
69,500
14,43,200
Less: Income Taxable under other head or
exempt
Long term Capital Gain on Equity shares 35,400
Short term Capital Gain 15,000
Rent received 3,00,000
Dividend from listed company 5,000
Directors Fees 10,000
Lottery Income (Net) 3,50,000
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 7,15,400 7,15,400
7,27,800 7,27,800
III. Income From House Property
Gross Annual Value
a) Municipal Value 2,00,000
b) Fair Rent Value 1,00,000
c) Annual Rent Value 3,00,000
d) Annual Lettable Value 2,00,000
( Higher of (a) or(b) above)
e) Gross Annual Value 3,00,000
( Higher of (c) or (d) above)
Less: Municipal Tax Paid 4,500
Annual Value 2,95,500
Less : Deduction u/s 24
Standard deduction (2,95,500X30%) 88,650
Income From House Property 2,06,850 2,06,850
IV. Capital Gain
Long term Capital Gain on share 35,400
Exempt up to Rs. 1,00,000 -35,400 Nil
Short Term Capital Gain 15000
15,000
V. Income From Other Source
Dividend from listed company 5,000
Directors Fees 10,000
Lottery Income (Gross) 5,00,000 5,15,000
Gross Total Income 14,64,650
Less: Deductions under chapter VIA
LIC premium paid 1,05,000
Total Taxable Income 13,59,650

307
3.3. Summary
Total income of assessee has to be computed as per the different provisions of
contained in the Income – tax Act, 1961. For computation of total income first we
require to calculate five different heads Income from salary, Income from business or
profession, Income from house property, Capital gain and Income from other source
sum total of these five heads of income is called gross total income. Some person
has all heads of income but some has only few heads of income. After calculation of
gross total income deduct there from deductions under chapter VIA and then
calculate tax liability applicable rate determined in finance act.

3.4. Terms to Remember:

• Income From Salary:
Meaning of salary for income tax purposes is much wider. Salary means every
Payment monetary or non -monetary made by employer to employee for Service
rendered by employee.
Allowances : There are three types of allowances:
1. Allowances included in salary & full taxable.
2 . Allowances totally exempt from tax and not included in salary.
3. Allowances partly included in salary and partly exempted.
PERQUISITES (Section 17 (2)
Perquisites mean “any casual emolument fee or profit” attached to an office or
position in addition to salary or wages. It is a personal advantage – something that
benefits a man by going “into his own pocket”

308
1. Taxable for all Employees : 3. Tax-free Perquisites for all
1. Rent free Accommodation 2. Employees : 1, Medical facility
Accommodation at concessional rent 2. Refreshment during working hours 3.
3. Monetary obligation of employee Free meals 4. Recreation in group
discharged by employers like: 5. Transport facilities to work place and
a. Life insurance premium or deferred back 6. Training facility
Annuity Premium. 7. Goods at concession 8. Telephone bills
b. Income – tax or Profession tax (c) for connection given at residence
Hotel or club bill. (including cellular) 9. Free ratio to armed
force personal 10. Family planning
d. children’s education fee e Personal expenses of employee 11. Conveyance
conveyance exp. Car or other facilities to Judges 12. Perquisites to
f. Wages of domestic servants Govt. Employees posted abroad 13.
engaged by employers. Computer, laptops given to employee for
official or personal use. 14. Transfer of
g. Personal gas, water, electricity bills
movable asset (like car, computer or
(connection in name employee) any
electronic item) more than 10 years old
other personal bills.
without consideration 15. Accident
2. Other fringe Benefits: (a) Interest insurance premium paid by employer for
free loans or loans at concessional his own benefit 16. Value of shares or
interest (loan exceeding Rs. 20,000) debentures given free of cost or at
and not for medical for medical concession to employees. 17.
treatment of specified disease, excess Accommodation provided in hotel or
or prescribed rate over actual interest transfer of employee for not exceeding 15
rate taxable (b) Use of movable asset days
by an employee except computer &
laptops (c) transfer of movable asset 4. Taxable Perquisites only for
to an employee (d) Travelling & tour Specified Employees
(e) free food (g) Gift vouchers 1. Supply of gas, electricity k & water 2.
exceeding Rs. 5,000 (h) Credit cards Education facility to children
(i) Club expenditure. 3. Services of domestic servant provident
by employer.
4. Free transport facility to employee by
transport undertaking.

309
Meaning of “salary” for different calculations :
(A) 1. House Rent Allowance, 2. Employer’s Contribution to Recognized
Provident Fund 3. Gratuity (not being gratuity under the payment of
Gratuity Act). 4. Leave Encashment at the time of Retirement
Salary : 1 Basic salary + 2. Dearness allowance /Pay it part of salary or Computing
all retirement benefits and 3. Commission if paid as percentage of turnover achieved
by an employee)
(B) Value of Rent-Free Accommodation / Concessional House:
Salary – Basic salary + Dearness allowance / pay if part of alary OR computing all
retirement benefits +bonus + commission+ Fees+ taxable allowance and any
monetary benefit otherwise chargeable to tax.
DEDUCTIONS U/S 16 : The income chargeable under the head “salary” shall be
computed after making deduction.
1. Standard Deduction: Rs. 50,000 or actual salary whichever less
2. Entertainment Allowance : It is to be added to salary income first and then a
deduction is allowed LEAST of the following for Govt. Employees only. A Rs.
5,000 B.20% of Basic salary only. C. Entertainment allowance actually received
during the year.
3. Professional Tax: Deduction is allowed in respect of any sum paid by the
assesses on account of tax on employment.
• Income From House Property
Basis of Charges (Section 22):
For computation of Annual value require the property should consist of
buildings or lands appurtenant or (connected) thereto, Detrmination of annual value
for different different types of house properties as under :
1) Let out property
2) Self- occupied house property
3) House property let out for part of the year and self occupied for part of the year
4) House partly self occupied for residence and partly let out
5) More than one house self occupied (Deemed let out)

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6) House reserved for self occupation
Let Out property ::
Step:1. Ascertain Gross Annual Value :(GAV)
a) Actual Rental Value:
Actual rental value is the sum for which the property is let out
b) Municipal Value:
Municipal value is the value determined by the municipal authorities for levying
municipal taxes on house property.
c) Fair Rent :
Fair rent means rent which similar property in the same locality would fetch.
d) Standard Rent :
Standard rent is rent fixed by Rent Control Act. The land lord cannot reasonably
accept from tenant anything more than standard rent.
a) Findout expected rent or reasonable lettable value .:
If the Rent Control Act is not applicable : expected rent or reaonable lettable
value is fair rent or munucipal value whichever is more .
If the Rent Control Act is applicable: Expected rent or reaonable lettable value
should not exceed the Standard Rent given under Rent Control Act.
b) Gross Annual Value :
Where the property is let out and the actual rent recevied and receivble by the
owner is in excess of the Reasonable lettable value as above the amount so received
shall be the Gross Annual Value.
Where the let out property was vacant during the whole year or part of year and
owing to this vacancy the acutal rent received or receivable by the owner in respect
of there is less than the reasonable lettable value the amount so received or
receivable shall be the Gross Annual Value .
c) The unrealsied rent if any may be decuted from the rent received/ receivable
only if the tenancy is bonafide.

311
Step II. Deduct Municipal Taxes:
Actual Municipal tax paid by owner of property during previous year..
Step III. Allow deductions u/s. 24:
There are two deductions from Annual value :-
i) standard deduction under section 24(a) : This is a flat deduction at the rate
30% of the net annual value of the let out property .In case of self occupied
property standard deduction is not allowed as its annual value is Nil.
ii) Interest on borrowed capital under section 24(b): Interest payable on funds
borrowed for the purpose of purchase, construction, repairs or renewal of house
property is allowed as a deduction
a) Interest for preconstruction period:
Interest for Preconstruction period is accumulated and can be claimed as
deduction over a period of 5 continuous year in equal installments, from the year of
completion of construction.
b) Interest on post construction period: Post construction period starts from the
beginning from the financial year in which construction is completed
Self –occupied for Residence (SOR) : Sec. 23(2)(a)(i):
Annual value of such property will be Nil
Dedcucions u/s 24 : Interest on loan taken for SOR property will be allowed as a
deduction as are under
Loan borrowed before 1-4-1999: Actual interest payable in aggregagate for one or
two self occupied properties ,subject to maximum of Rs. 30,000.
Loan borrowed on or after 1-4-1999: subject to maximum of Rs. 2,00,000.
• Income From Business or Profession:
Buisenss : Includes any trade, commerce or manufacture or any adventure or
concern in the nature of trade, commerce or manufacture.
Profession : It means an occupation requiring to some degree of learning.
Profession requires intellectual skill or manual skil or both. The examples are doctor,
advocate, chatered acountanat , engineers etc The term profeesion include vocation.
Deductions for expenses specifically allowed under section 30 to 43
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 Rent, rates, taxes, repairs and insurance of building, repairs & Insurance of
machinery,
Plant & Furniture, Depreciation u/s 32, (Expenditure on Scientific Research,)
Investment linked tax incentives for specified business, Amortization of certain
preliminary expenses under section 35 D:- Amount of deduction: 1/5th of the total
eligible preliminary expense is allowed in 5 equal annual installments,
Other deductions: Insurance Premium paid to cover the risk of damage or
destruction of stocks, stores, cattle and on health of employees, Bonus or commission
paid to Employees, Interest on borrowed capital, Discount on zero coupon bonds,
Contribution to recognised Provident fund or an approved super annuation fund,
Contribution to Pension Scheme, Bad debts
Residuary Expenses :Embezzlement of cash, Expenses on local festival such as
Diwali, Muhurta etc., Cash shortage found in the business at the end of the day,
Entertainment Expenses, Advertisement Expenses, Travelling Expenses, Guest
House Expenses. Lawful expenses related to illegal business, Premium on
redemption of Debentures Discount on issue of debentures (on pro rata basis)
Expenses Not Deductible Under Section 37
1. Donations, 2. Charities, 3. Gifts to relatives, 4. Income tax, 5. Wealth tax, 6.
Advance income tax, 7. Fines and penalties for breach of any laws, 8. Personal
Drawings, 9. Salary to owner, 10. Interest on proprietor’s capital, 11. Capital
expenditure, 12. Purchase of an assets, 13. Extension of building, 14. Personal
expenditure, 15. Household expenses, 16. Drawings, 17. Education expenses of
children, 18. Residential telephone bill, 19. Residential electricity bill, 20.
Residential maintenance, 21. Amount transferred to reserve, 22. Personal Hotel
expenses, 23. R.D.D. But deduction is allowed for actual bad debts, 24. Personal
motor expenses, 25. L.I.C. on own life., 26. Any Investments, 27. Any expenses
related to let out house property. 28. Expenditure on Advertisement (Section 37(2B):
It is allowed as deduction. However, as per Section 37 (2B), any expenditure
incurred by an assessee on the advertisement in any souvenir, brochure, pamphlet
etc. published by a political party will not be allowed as deduction., 29. In case of all
assessee Section 40(a): Interest, royalty, fees for technical services or any other sum
chargeable to tax payable outside India without deducting tax at source. 30. Salary
paid outside India without deducting tax at source, 31. Any contribution to PF or any
other Fund, if there is no arrangement for TDS from any payment to be made from

313
such Fund if it is taxable. 32. Income Tax paid 33. Excess Payment of salary, bonus,
commission or remuneration to working partner of the firm, Interest in excess of
12% on capital,
Deemed Income from Business or profession:
i) Recovery against any Allowance or Deduction Allowed earlier
ii) Remission or censure of liability :
iii) Profit on sale of asset used for scientific research
iv) Bad debts recovered
v) Disallowance of unpaid statutory liability
• Capital Gain:
Types of Capital Assets :
Short Term Capital Asset [Sec. 2(42A]: It means a capital assets held by an
assessee for not more than 36 months immediately before the date of transfer
Long Term Capital Asset [Sec. 2(29A]: A capital asset, which is not a short-
term capital asset, is a long it is held for not -term capital asset
Transfer: Transfer in relation to a capital asset includes: Sale, Exchange &
Relinquishment of the asset; Extinguishment of any right in an asset;
Compulsory acquisition of an asset under any law; Conversion of asset into stock-in-
trade by the owner; Any transaction of immovable property u/s 53A of the Transfer
of Property Act, 1882; Any transaction which has the effect of transferring or
enabling the enjoyment of any immovable property, Maturity or redemption of a zero
coupon bond
Sales consideration: refers to sale value of the asset (in form of money or
money’s worth). Consideration in installments: In case, consideration is receivable
in installment in different years, the entire value of the consideration shall be taxable
in the year of transfer.
Expenses on transfer
It means any expenditure incurred wholly and exclusively in connection with
such transfer

314
Cost of Acquisition
Cost of acquisition includes expenditure incurred for acquiring the asset or
completing the title of the asset
Cost of Improvement:
Cost of improvement means an expenditure incurred to increase the productive
quality of the asset.
Indexed cost of acquisition:, “Indexed cost of acquisition” is an amount which
bears to the ‘cost of acquisition’ the same proportion as Cost Inflation Index for the
year in which the asset is transferred bears to the Cost Inflation Index for the first
year in which the asset was held by the assessee or for the year beginning on
1/4/2001, whichever is later.
Taxpoint:
!"#$ "% &'()*#*$*"+  ,+-. "% $/. 0.&1 "% #&2.
Indexed cost of acquisition = ,+-. "% $/. 0.&1 "% &'()*#*$*"+ "1 %"1 
3 4/*'/.5.1. *# 2&$$.1

Indexed cost of improvement :

“Indexed cost of improvement” means the ‘cost of improvement adjusted
according to the price level of year of sale.
!"#$ "% *671"5.6.+$  ,+-. "% $/. 0.&1 "% #&2.
Indexed cost of improvement =
,+-. "% $/. 0.&1 "% *671"5.6.+$

Cost of inflation index:

Cost inflation index, in relation to a previous year, means such Index as the
Central Government may, having regard to 75% of average rise in the Consumer
Price Index (urban) for the immediately preceding previous year to such previous
year, by notification in the Official Gazette, specify, in this behalf.
Exemptions in respect of Capital Gain:
Section Eligible Asset Asset New asset Period limit Quantity of
Asseesee transferred held for eligible for for new exemption
a exemption asset
period purchase
more
than
54 Individual Residential 24 Residential Within a one Minimum of

315
 H.U.F. House Months House year before Investment in
or 2 years new house or
after the amount of
transfer in capital gain.
case
purchase or
3 years after
transfer in
case
construction
54B Individual Agriculture 24 Agriculture Within 2 Same as
land Months land years after above
transfer
54D Any land and 24 Land and Within Same as
assessee building of Months building for 3years after above
industrial industrial transfer
undertaking undertaking
acquired by
Government
54EC Any Any long Long Specified Within 6 Same as
assessee term capital term long term months s above
asset asset
54F Individual Any long Long Residential Within a one Investment in
H.U.F. term asset term House year before the new asset
except or 2 years Divided by
residential after the Net Sale
house transfer in consideration
case into capital
purchase or gain
3 years after
transfer in
case
construction

316
• Income from Other Source :
Income from other sources is a residuary head of income under the Income Tax
in which we can consider all the different sources of income which does not fall
under other heads as Income from salary or House property or Capital Gains or
Business / profession. As per Section 56(1), any income which is not specifically
exempted & not chargeable to tax under any other heads of income, shall be
chargeable under the head Income from Other Sources
• Computation of Gross Total Income and Tax liability in respect of
Individual:
Individual means an human being. Income tax is levied on assesses total
income. The total income of individual is computed after making deductions from
gross total income. Gross total income is aggregate of the income computed under
different five heads

3.5 Answers to Check your progress:

I) A) 1)- (a), 2) – (a), 3) - (a), 4) - (d), 5) - (a)
B) 1) – 7.5% 2)- 17(1), 3) 5000, 4) Public, 5) Taxable
II) 1) Nil 2) Municpal value 3) Two 4) 30% 5) No deduction
III) (1) - 50% (2) 32 ( 3) Income from business or profession (4) 180 (5)30
IV) 1) Lower 2) 50 lakhs 3) 24 months 4)12 months 5)100
V) 1) 15,000 2) 50,000 3) Income from other source 4) 30% 5) Income from
other source

3.6 Exercise:
• Write short notes
i) Salary ii) Specified employee
iii) Perquisite iv) Types of provident fund
v) Annual Value of let out property vi) Self occupied property
vii) Standard deduction from Annual value viii) Fair rent
ix) Estimated income u/s 44AD x) Maintenance of books u/s 44AA
xi) Short term capital gain xii) Cost of inflation index
xiii) Exemptions from capital gains xiv) Income from other source

317
 xv) Computation of total income of Individual
• Illustrations :
Illustration 1) Mrs. Vanita is an employee in a company at Aurangabad. She gives
the Following information for the P. Y. 2020-2021
1) Basic salary Rs. 15,000 per month
2) Dearness allowance Rs. 9,000 per month (Rs. 3000 per month of this enters
the retirement benefits
3) Project Allowance Rs. 600 p.m.
4) Education allowance for two children at Rs. 300 per month per child.
5) She is provided by employer a motor car of 1.8 liter engine capacity for
both official and private purpose all expenses including driver salary are
met by the company.
6) Employer’s contribution to recognized provident fund is Rs. 2460 per
month
7) Interest credited to the said fund at 13% p.a. Rs. 39,000
8) House Rent Allowance Rs. 3,000 per month
9) Entertainment Allowance Rs. 9000 per month
10) During the year she paid Rs. 2,500 as professional tax and Rs. 3,600 per
month as rent for her residential house.
Compute her taxable Income from salary for A.Y. 2021-2022.
Illustration 2) Mr. Ajay is employed in Private company Parth ceramic Ltd.
Mumbai. He is a member of unrecognized provident fund. The particulars of income
for previous year 2020-2021 were as under;
i) Salary @Rs. 80,000 p.m.
ii) Dearness pay, forming part of salary for super-annuation benefits @ 20% of
salary.
iii) House Rent Allowance @Rs. 15,000 p.m.
iv) Rent paid by him Rs. 25,000 p.m.

318
v) He contributed 10% of his salary for provident fund to which employer
contributed 20% of salary
vi) He retired from service on 31st December. 2020 after 28 years and 8 months of
service. He gets Rs. 9,00,000 as accumulated balance from provident fund . It
consist of Rs. 2,00,000 as his own contribution and Rs. 1,50,000 as interest there
on. The employers contribution Rs. 3,00,000 and interest thereon Rs. 2,50,000.
vii) He also get gratuity of Rs. 17,50,000 and pension of Rs. 30,000 p.m. on
retirement. on 01-03-2021, he surrenders one half pension for a consolidate
value of Rs. 12,00,000.
Compute his taxable income from salary for A.Y. 2021-2022
Illustration 3) Find out the income from house property of Mr. Shivam for the
A.Y. 2021-2022
Particulars House I House II
Municipal Valuation 3,00,000 4,00,000
Fair Rent 3,50,000 4,80,000
Standard Rent 3,30,000 5,00,000
Annual Rent 3,60,000 ---
Period of vacancy 2 months ---
Municipal Tax (Due) 30,000 30,000
Interest on Capital Housing Loan 70,000 2,05,000
Nature of occupation Let out Self –
occupied
Housing loans for both houses are taken after 1st April, 1999 and constructions are
completed by the end of March 2000.
Answer : House I Rs. 1,40,000. House II to (2,00,000)
Illustration 4) Mr. Jay owns three houses, particulars of which are as :
Particulars House I House II House III
Municipal Valuation (M.V.) 3,60,000 4,80,000 6,00,000
Fair Rent 3,70,000 4,70,000 6,20,000
Standard Rent 3,80,000 4,65,000 6,30,000

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 Annual Rent (if the property let out 3,78,000 4,50,000 6,25,000
throughout the year )
Unrealized rent for the year 15,700 ---- ----
Period of vacancy 1 month --- ----
Municipal Taxes 10% of M.V 10% of 10% of
M.V M.V
Date of construction completed 10-04-2003 10-10- 10-05-
2002 2002
Date of loan taken for construction 16-11-1999 15-07- 02-11-
1998 1999
Interest paid on loan 1,70,000 1,53,000 1,55,000
Nature Let out Let out Let out
Answer: House I. 41,750, House II .1,38,900, House III. 2, 40,500
Illustration 5) Profit and Loss Account of Mr. Naman for the year ended on 31st
March, 2021
Particulars Amount Particulars Amount
To Salary 1,25,000 By Gross Profit 3,00,000
To General Expenses 12,500 By Commission 33,000
To Travelling Expenses 1,250 By Gifts From Friends 12,000
To Telephone 125 By Interest on F. D. 23,075
To Depreciation 25,000 By Bad Debts 10,000
recovered
To Printing and Stationery 2,500
To Furniture Purchase 15,700
To Donation to Education 10,500
Institutions
To GST paid 25,000
To R. D. D. 2,500
To Net Profit 1,58,000
3,78,075 3,78,075

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Additional Information:
1) Salary includes Rs. 12,500 paid to Mr. Naman
2) General expenses include Rs. 5,850 as gift to a friend in his marriage ceremony.
3) Depreciation allowed as per income tax rule is amounted to Rs. 22,000
4) GST include Rs. 2,500 as penalty for evasion of GST
Compute taxable income from business of Mr. Naman for the A. Y. 2021-2022
Answer: Income from Business Rs. 1, 75,475.
Illustration 6) Advocate Pawar is a leading practitioner in Kolhapur. Following is a
summery of his cash book for the year ended on 31/03/2021
Receipts Amount Payments Amount
To Opening Cash Balance 1,10,000 By Salaries 60,000
Professional Fees 7,10,000 By Rent of Chamber 90,000
To Arbitration Fees 1,90,000 By Household 1,50,000
expenses
To Gifts 1,00,000 By Membership Fees 20,000
To Agricultural Income 5,00,000 By Car Expenses 60,000
By Fixed Deposit 6,00,000
By Books 30,000
By Income Tax 20,000
By Donation PM Funds 10,000
By Closing Cash 5,70,000
Balance
16,10,000 16,10,000

Additional Information :
1) Gifts include Rs. 25,000 received from relatives and balance from clients
2) Depreciation as per income tax rules amounted to Rs. 50,000 including that on
books 100% and on car Rs. 20,000.

321
3) Half of the car is used for personal purpose.
4) Membership fees include Rs. 10,000 to bar council and balance to private club.
Compute taxable income from profession for A.Y. 2021-2022
Answer: Income from Profession Rs. 7,45,000
Illustration 7) Mr. Kamalakar Sells the following long –term capital assets on
11-01-2021
Particular Residential Gold Silver Diamonds
house
Sales consideration 3,90,000 8,10,000 2,96,000 6,40,200
Indexed cost of acquisition 70,000 1,15,000 1,78,000 4,30,000
Expenses on transfer 10,000 81,000 6,000 32,000

The due date of filling return of income for the assessment year 2021-2022 is
st
31 July 2021 for claiming exemption under section 54 and 54EC, Kamalakar
purchases the following assets –
Assets Date of Amount
acquisition Rs.
Land for constructing residential house 02/04/2021 1,00,000
Bank deposit in saving account for constructing 05/08/2021 50,000
house
Bonds of Rural Electrification Corporation (Long 05/07/2021 7,50,000
term )
Bonds of National Highways Authority of India 10/07/2021 3,05,000
(Long Term)
Find out the amount of capital gain chargeable to tax for the assessment year 2021-
2022
Answer:
Particular Residential Gold Silver Diamonds
house
Capital gain chargeable to Nil 6,14,000 1,12,000 1,78,200
tax

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Illustration 8) Mr. Pradeep is senior residential individual submits the following
information for A.Y.2021-2022
Particulars Amount Particulars Amount
Staff Salary 6,30,000 Gross Profits 22,60,000
Drawing for household 4,00,000 Rent from house 4,80,000
expenses property
Life Insurance Premium 65,000 Interest on fixed 70,000
paid deposit with banks
Contribution to P.P.F. 10,000 Profit from firm 15,000
Depreciation on assets 90,000 Gold coin received 46,000
from friend
Advertisement 25,000
Printing and stationery 30,000
Interest on loan 40,000
Net Profit 15,81,000
28,71,000 28,71,000
Additional information:
1) Interest on loan related to personal loan
2) Depreciation as per income tax rule Rs. 1,10,000
3) Value of gold coin given in the profit and loss account is cost of gold coins
purchased by friend in 1998. Fair market value of gold coin on the day of gift
Rs. 1,40,000, Compute total taxable income for A.Y. 2021-2022
Answer : (Income from house property Rs. 3,36,000, Income from business Rs.
14,65,000, Income from Other source Rs. 2,10,000, Gross Total Income Rs.
20,11,000, Deductions under chapter VIA Rs. 1,25,000, , Net Income Rs. 18,86,000)
3.7. Reference for further study:
1) Dr .Singhania, V. K., & Dr. Singhania, M. (2020-2021). Student's Guide to
Income Tax Including GST. Delhi: Taxmann Publications (P). Ltd.
2) (ICAI Knowledge portal)
3) Dr. Singhania & Dr. Singhania, 2019-2020.

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 Unit-4
Basics of GST

Structure of Unit
4.0 Objectives
4.1 Introduction
4.2 Presentation of Subject Matter
4.2.1 Meaning of GST
4.2.2 Features of GST
4.2.3 Benefits of GST
4.2.4 Need of GST
4.2.5 Constitutional Provisions of GST
4.2.6 Levy and Collection of GST
4.2.7 Introduction to CGST, SGST, IGST, UTGST
4.3 Summary
4.4 Terms to Remember
4.5 Answers to Check Your Progress
4.6 Exercise
4.7 Reference for Further Study

4.0 Objectives:
After studying this unit the students should be able to:
• Understand the concept of Indirect-taxes
• Define and explain the important features of GST and its need
• Explain the framework, benefits and challenges in implementing GST

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4.1 Introduction:
GST is the biggest reform for indirect taxes in India in the post independence
period. It simplified indirect taxation, reduced tax complexities, removed the
cascading effect and led to one nation and one tax regime in India. Experts believe
that GST will have a huge positive impact on business and change the way the
economy functions. In this chapter we shall have a brief introduction on new GST
regime introduced in India since July, 2017. Before we are introduced to the system
of GST in India let us know the concepts of Direct and Indirect taxes.

Concept of Direct and Indirect Taxes:

A tax may be defined as a fee charged by a government on a product, income or
an activity. It is a pecuniary burden laid upon individuals or property owners to
support the Government, a payment exacted by legislative authority. A tax "is not a
voluntary payment or donation, but an enforced contribution, exacted pursuant to
legislative authority".
Taxes are broadly classified into direct and indirect taxes.
i) Direct Taxes: If a tax is levied directly on an individual or an organization it
is called direct tax. A direct tax is a kind of charge, which is imposed directly on the
taxpayer and paid directly to the Government by the persons (juristic or natural) on
whom it is imposed. An incidence of direct tax cannot be shifted by the taxpayer to
someone else. The burden of such tax is borne by the payer of tax himself. An
important direct tax imposed in India is income tax.
ii) Indirect Taxes: If tax is levied on the price of a good or service, then it is
indirect tax. The person paying the indirect tax passes on the incidence of tax to
some other person. He collects the tax from his customer on sale of goods and
services and remits it to the government. The ultimate burden of such tax falls on the
final consumer of such goods and services. If the taxpayer (such as a manufacturer
or provider of service or seller of goods) is just a conduit and at every stage the tax-
incidence is passed on till it finally reaches the consumer, who really bears the brunt
of it, such tax is indirect tax. An indirect tax is one that can be shifted by the taxpayer
to someone else.
Indirect taxes are also called consumption taxes, they are regressive in nature
because they are not based on the principle of ability to pay. All the consumers,
including the economically challenged bear the brunt of the indirect taxes equally.

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 Indirect taxes are levied on consumption, expenditure, privilege, or right but not
on income or property. Hitherto, a number of indirect taxes were levied in India,
namely, excise duty, customs duty, service tax, central sales tax (CST), value added
tax (VAT), entry tax, purchase tax, entertainment tax, tax on lottery, betting and
gambling, luxury tax, tax on advertisements, etc.
However, indirect taxation in India has witnessed a paradigm shift on July 01,
2017 with the introduction of a unified indirect tax regime wherein a large number
of Central and State indirect taxes have been subsumed into a single tax – Goods and
Services Tax (GST). The introduction of GST is a very significant step in the field of
indirect tax reforms in India.

Distinction between Direct and Indirect Taxes:

Point of
Direct Taxes Indirect Taxes
Distinction
Incidence of tax The person paying tax to The person paying the tax to the
the Government directly Government collects the same
bears the incidence of tax from the ultimate consumer. Thus,
incidence of the tax is shifted to
the other person.
Nature Progressive in nature – high Regressive in nature - All the
rate of taxes for people consumers equally bear the
having higher ability burden, irrespective of their ability
to pay. to pay.

Burden Burden of tax borne by the Burden of tax shifted by the payer
payer of tax himself. to his customer in the distribution
chain.

Features of Indirect-taxes:
i) A major source of revenue: Indirect taxes are an important source of tax
revenues for Governments all over the world and continue to grow as more and more
countries are moving to consumption oriented tax regimes. In India, indirect taxes
contribute more than 50% of the total tax revenues of Central and State
Governments.
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 ii) Tax on commodities and services: It is levied on commodities at the time of
manufacture or purchase or sale or import/export thereof. Hence, it is also known as
commodity taxation. It is also levied on provision of services.
iii) Shifting of burden: In the indirect taxes the tax burden is shifted by the tax
payer to his customer. The tax is collected through the selling price of goods and
services and remitted to the tax department of the government. Price of goods and
services serves as vehicle for indirect taxes. For example, GST paid by the supplier
of the goods is recovered from the buyer by including the tax in the cost of the
commodity.
iv) No direct pinch to tax payers: Since, value of indirect taxes is generally
inbuilt in the price of the commodity or service, most of the time the tax payer pays
the tax without actually knowing that he is paying tax to the Government. Thus, tax
payer does not perceive a direct pinch while paying indirect taxes. Through the
purchase and consumption of various goods and services in our day to day life we are
regularly paying several indirect taxes to the government treasury.
v) Inflationary: As indirect taxation directly affects the prices of commodities
and services a rise in indirect taxes leads to inflationary trend.
vi) Wider tax base: Unlike direct taxes, the indirect taxes have a wide tax base.
Majority of the products or services are subject to indirect taxes with low thresholds.
Hence every person in a nation is indirect tax-payee. Therefore, it is rightly said that
there are two things certain in human life namely, death and taxes.
vii) Promotes social welfare: High taxes are imposed on the consumption of
harmful products (also known as ‘sin goods’) such as alcoholic products, tobacco
products etc. This not only curtails their consumption but also enables the State to
collect substantial revenue. Thus indirect taxes indirectly promote social welfare.
viii) Regressive in nature: Generally, the indirect taxes are regressive in nature.
The rich and the poor have to pay the same rate of indirect taxes on certain
commodities of mass consumption. This may lead to further increase the income
disparities between the rich and the poor.

Evolution of GST in India:

France was the first country to implement GST in the year 1954. Within 62
years of its advent, about 160 countries across the world have adopted GST because
this tax has the capacity to raise revenue in most transparent and natural manner.
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 i) Kelkar Task Force 2004 : The Finance Ministry of Government of India set
up a Task Force under the chairmanship Mr.Vijay Kelkar in 2004 on the
implementation of Fiscal Responsibility and Budget Management. It made
recommendations to bring about a radical transformation of the Indian Tax System. It
disagreed with the existing approach of the government to reduce government
expenditure to achieve the fiscal consolidation. It has advised to go for a Revenue-
led Approach which focuses on enhancing the revenues instead of compressing the
expenditure. It went further to suggest that the Government should enhance capital
expenditure in order to counterbalance the contraction effects of fiscal consolidation.
The Goods and Service Tax is an outcome of the recommendations of the Task Force
under the chairmanship of Mr. Vijay Kelkar. In India the draft of Goods and Service
Tax ( GST) was presented in the parliament in August, 2009.
ii) Initiative of NDA Government: Subsequently, the then Union Finance
Minister, Shri P. Chidambaram announced that GST would be introduced from April
1, 2010. Since then, GST missed several deadlines and continued to be shrouded by
the clouds of uncertainty. The talks of ushering in GST, however, gained momentum
in the year 2014 when the NDA Government tabled the Constitution. (122nd
Amendment) Bill, 2014 on GST in the Parliament on 19th December, 2014. The Lok
Sabha passed the Bill on 6th May, 2015 and Rajya Sabha on 3rd August, 2016.
Subsequent to ratification of the Bill by more than 50% of the States, Constitution.
(122nd Amendment) Bill, 2014 received the assent of the President on 8th September,
2016 and became Constitution (101st Amendment) Act, 2016, which paved the way
for introduction of GST in India. In the following year, on 27th March, 2017, the
Central GST legislations - Central Goods and Services Tax Bill, 2017 integrates
Goods and Service Tax Bill, 2017, Union Territory Goods and Services Tax Bill,
2017 and Goods and Services Tax (Compensation to States) Bill, 2017 were
introduced in Lok Sabha. Lok Sabha passed these bills on 29th March, 2017 and with
the receipt of the President’s assent on 12th April, 2017, the Bills were enacted.
iii) State GST Laws: The enactment of the Central Acts was followed by the
enactment of the State GST laws by various State Legislatures. Telangana,
Rajasthan, Chhattisgarh, Punjab, Goa and Bihar were among the first ones to pass
their respective State GST laws GST is a path breaking indirect tax reform which
will create a common national market. GST has subsumed multiple indirect taxes
like excise duty, service tax, VAT, CST, luxury tax, entertainment tax, entry tax, etc.

328
4.2 Presentation of Subject Matter
4.2.1 Meaning of GST
GST is a single value added tax on the supply of goods and services, right from
the manufacturer to the consumer. Credits of input taxes paid at each stage will be
available in the subsequent stage of value addition, which makes GST essentially a
tax only on value addition at each stage. The final consumer will thus bear only the
GST charged by the last dealer in the supply chain, with set-off benefits at all the
previous stages.
4.2.2 Features of GST:
i) Value Added Tax: GST is a single value added tax on the supply of goods
and services levied by the government of India. Under GST, tax is levied only on the
value added at each stage in the supply chain from producer to the ultimate
consumer. For example, if a business house purchases the goods of Rs. 1,000 and
sells it for Rs. 1500 by adding Rs. 500 to the initial cost (consisting of say business
overheads Rs. 200 and Profits of Rs. 300) he will have to pay GST only on the value
addition of Rs. 500 and not on the total cost of Rs. 1500.
ii) Comprehensive: GST subsumes all the prevailing indirect taxes. Moreover,
by bringing in a unified taxation system across the country, it ensures that there is no
more arbitrariness in tax rates.
iii) Multi-stage: GST is levied at each stage in the supply chain from
manufacturer to the ultimate consumer where the transaction takes place. GST offers
comprehensive and continuous chain of tax credits from the producer’s point or
service provider’s point up to the retailer’s level or consumer’s level thereby taxing
only the value added at each stage of supply chain.
iv) Credit of GST paid on Purchases: The supplier at each stage is permitted
to avail credit of GST paid on purchase of goods and or services and can set-off this
credit against the GST payable on supply of goods and services to be made by him.
Thus only the final consumer bears the GST charged by the last supplier in the
supply chain, with set-off benefits at all previous stages.
v) Destination based consumption: GST is collected at the point of
consumption. The tax authority with appropriate jurisdiction in the place where the
goods / services are finally consumed will collect the tax. For example let us say that
the cotton garments are shipped from Gujarat to Maharashtra. Gujarat is producer
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state and Maharashtra is the consumer state. Tax revenue under GST shall be
collected by GST authorities in Maharashtra.
vi) No Cascading Effect: Since only the value added at each stage is taxed
under GST, there is no tax or cascading of taxes under GST system. GST does not
differentiate between goods and services and thus the two are taxed at a single rate.
vii) Rates of GST: Currently there are four slabs of GST on the various
categories of goods and services. They are 5%, 12%, 18% and 28%.
viii) Registration under GST: Every supplier who makes a taxable supply of
goods and / or services liable to get himself registered in the state from where he
supplies. Threshold limit (computed on all India basis) – Special category states –
Rs.10 lakhs – Other states –Rs.20 lakh. Online application for registration has to be
made within 30 days. PAN based Registration has to be done. Following persons
have to obtain registration irrespective of their threshold limit: (a) Persons making
inter-state taxable supply (b) Casual taxable persons and (c) Non-resident taxable
persons
ix) GST for sale within the state: In case the buyer and seller of goods or
service are from the same state transaction would be taxed simultaneously under
Central GST (CGST) and State GST (SGST). The Central GST and the State GST
would be levied simultaneously on every transaction of supply of goods and services
except the exempted goods and services. Further, both would be levied on the same
price or value. While the location of the supplier and the recipient within the country
is immaterial for the purpose of CGST, however, SGST would be chargeable only
when the supplier and the recipient are both located within the State.
x) GST for Inter-state Sale : Integrated Goods and Service Tax (IGST) would
be levied and collected by the Centre on inter-State supply of goods and services.
The GST on supplies in the course of Inter-State trade or commerce shall be levied
and collected by the Government of India. Such tax shall be apportioned between the
Union and the States in the manner as may be provided by the law.

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Taxes Subsumed by GST:
GST incorporates the following taxes earlier levied at the center and state
level.GST has replaced or subsumed the following taxes:

• • Service Tax
• Countervailing Duty
• Special Additional Customs Duty
Centre Level • Central Excise Duty
• Additional Excise Duty

• • Entry Tax & Octroi

• Luxury Tax
• Purchase Tax
State Level • Entertainment Tax
• Sales Tax
• Lottery/Betting/Gambling Taxx

Taxes not to be subsumed by GST in India are:

● Basic Customs Duty ● Export Duty ● Toll Tax ● Road and Passenger Tax ●
Electricity Duty ● Stamp Duty ● Property Tax
Note:
1. Alcoholic beverages for human consumption are proposed to be kept out of the
purview of GST
2. GST on petroleum products would be levied from a notified date to be
recommended by the GST Council

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Illustrations explaining the working of GST:

SGST paid = Rs.10 State SGST SGST paid = Rs.10

@ 10% (Rs. 30 – Rs. 20 Input tax credit)

SGST paid Rs.10

( Rs. 20 – Rs. 10 Input tax credit)

Spinning Mill Textile Mill Garment Producer Consumer

A B C

CGST paid Rs.10

(Rs. 20 – Rs. 10 Input tax credit)

CGST paid = Rs.10 Centre CGST CGST paid = Rs.10

@ 10% (Rs. 30 – Rs. 20 Input tax credit)

Tax Invoice A Tax Invoice B Tax Invoice C

Rs. Rs. Rs.
Cost of Goods 100 200 300
SGST @ 10% 10 20 30
CGST @ 10% 10 20 30
Total 120 240 360

As shown in the above diagram when a spinning mill at Ichalkaranji sells yarn
of Rs. 100 to a textile mill in Mumbai it collects GST of 20 % on sale of Rs. 100 i.e.
Rs.20 from the textile mill of which CGST @ 10% ( i.e. Rs. 10) is remitted to the
central govt. and SGST @10% ( i.e. Rs. 10) is remitted to the Maharashtra state govt.
When the textile mill manufactures the cloth from the yarn and sells it to garment
manufacturer in Kolhapur at Rs. 200 ( i.e. Cost of yarn Rs. 100 plus value added Rs.
100 , consisting of its manufacturing expenses plus profit ) it charges GST of 20% of
sale of Rs. 200 i.e. Rs. 40 and from Garment Manufacturer of which it remits CGST
@10% Rs. 20 to the central govt. and SGST @ 10% i.e. Rs. 20 to the Maharashtra
State Govt. In the third stage of transaction when the Garment producer in Kolhapur
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manufactures dresses from the cloth and sell those to the final consumer in Kolhapur
at Rs. 300 (i.e. Cost of cloth Rs. 200 plus value added Rs. 100, consisting of its
manufacturing expenses plus profit ) it charges GST of 20% of sale of Rs. 300 i.e.
Rs.60 and from Garment Manufacturer of which it remits CGST @10% Rs. 30 to
the central govt. and SGST @ 10% i.e. Rs.30 to the Maharashtra State Govt.

4.2.3 The benefits of GST: can be summarized as under:

A) For business and industry
i) Easy compliance: A robust and comprehensive IT system would be the
foundation of the GST regime in India. Therefore, all tax payer services such as
registrations, returns, payments, etc. would be available to the taxpayers online,
which would make compliance easy and transparent.
ii) Uniformity of tax rates and structures: GST will ensure that indirect tax
rates and structures are common across the country, thereby increasing certainty and
2 ease of doing business. In other words, GST would make doing business in the
country tax neutral, irrespective of the choice of place of doing business.
iii) Removal of cascading: A system of seamless tax-credits throughout the
value-chain, and across boundaries of States, would ensure that there is minimal
cascading of taxes. This would reduce hidden costs of doing business.
iv) Improved competitiveness: Reduction in transaction costs of doing business
would eventually lead to an improved competitiveness for the trade and industry.
v) Gain to manufacturers and exporters: The subsuming of major Central and
State taxes in GST, complete and comprehensive set-off of input goods and services
and phasing out of Central Sales Tax (CST) would reduce the cost of locally
manufactured goods and services. This will increase the competitiveness of Indian
goods and services in the international market and give boost to Indian exports. The
uniformity in tax rates and procedures across the country will also go a long way in
reducing the compliance cost.
B) For Central and State Governments
i) Simple and easy to administer: Multiple indirect taxes at the Central and
State levels are being replaced by GST. Backed with a robust end-to-end IT system,
GST would be simpler and easier to administer than all other indirect taxes of the
Centre and State levied so far.

333
 ii) Better controls on leakage: GST will result in better tax compliance due to a
robust IT infrastructure. Due to the seamless transfer of input tax credit from one
stage to another in the chain of value addition, there is an inbuilt mechanism in the
design of GST that would incentivize tax compliance by traders.
iii) Higher revenue efficiency: GST is expected to decrease the cost of
collection of tax revenues of the 3 Government, and will therefore, lead to higher
revenue efficiency.
C) For the consumer
i) Single and transparent tax proportionate to the value of goods and
services: Due to multiple indirect taxes being levied by the Centre and State, with
incomplete or no input tax credits available at progressive stages of value addition,
the cost of most goods and services in the country today are laden with many hidden
taxes. Under GST, there would be only one tax from the manufacturer to the
consumer, leading to transparency of taxes paid to the final consumer.
ii) Relief in overall tax burden: Because of efficiency gains and prevention of
leakages, the overall tax burden on most commodities will come down, which will
benefit consumers.

4.2.4 Need of GST :

The prevailing value added tax system had several deficiencies which were
cured by the GST. These deficiencies were as under:
i) Multi-tax Regime : In the earlier indirect tax regime, a manufacturer of
excisable goods charged excise duty and value added tax (VAT) on intra-State sale
of goods. However, the VAT dealer on his subsequent intra- State sale of goods
charged VAT (as per prevalent VAT rate as applicable in the respective State) on
value comprising of (basic value + excise duty charged by manufacturer + profit by
dealer). Further, in respect of tax on services, service tax was payable on all
‘services’ other than the Negative list of services or otherwise exempted.
ii) Deficiencies and Diversities in Indirect taxes: The earlier indirect tax
framework in India suffered from various shortcomings. Under the earlier indirect
tax structure, the various indirect taxes being levied were not necessarily mutually
exclusive.

334
To illustrate, when the goods were manufactured and sold, both central excise duty
(CENVAT) and State- Level VAT were levied. Though CENVAT and State- Level
VAT were essentially value added taxes, set off of one against the credit of another
was not possible as CENVAT was a central levy and State-Level VAT was a State
levy.
Moreover, CENVAT was applicable only at manufacturing level and not at
distribution levels. The erstwhile sales tax regime in India was a combination of
origin based (Central Sales Tax) and destination based multipoint system of taxation
(State-Level VAT).
Service tax was also a value added tax and credit across the service tax and the
central excise duty was integrated at the central level.
Despite the introduction of the principle of taxation of value added in India - at
the Central level in the form of CENVAT and at the State level in the form of State
VAT - its application remained piecemeal and fragmented on account of the several
reasons:
4.2.5 Constitutional Provisions of GST:
The new regime for GST was given effect through the GST (101st Amendment)
Act, 2016 . As the GST is a single tax that replaces multiple other indirect taxes, both
the Centre and the States had to give up their exclusive powers to levy different
indirect taxes. Through the GST Amendment, the Centre lost out on its power to levy
taxes such as excise duty, while the States could no longer levy entry tax, VAT etc.
As the GST is a tax that is to be levied concurrently by the Centre and the
States, a GST Council was established under Article 279A of the Constitution. The
GST Council is headed by the Union Finance Minister. The other members of this
body include the Union Minister of State for Finance, and the Finance Ministers of
all the State Governments. The GST Council was envisaged to facilitate collective
decision-making between the Centre and the States, for all matters concerning the
GST, including the rate of GST applicable on different goods and services.
As the GST is implemented through a process of collective decision-making,
both the Centre and the States have lost out on their autonomy to unilaterally
determine their indirect tax policies. This is reflected in clause (9) of Article 279A,
which lays down the voting pattern that shall be adhered to before any
recommendation of the GST Council is ratified.

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 Under the voting pattern, the Centre’s vote shall have a weightage of one-third
of the total votes cast, which effectively gives it a veto over all decisions that may be
put to vote before the Council. While the State Governments can also collectively
exercise a veto, no individual State Government can exercise a veto over any
decision of the Council. But the significant point here is that the Centre’s veto power
allows it to block any proposal moved before the GST Council, even if all the State
Governments unanimously approve of the same. This veto power also has
implications for the present crisis, which I shall address in the concluding sections of
this piece.
Another significant aspect to note here is that the State Governments ceded their
autonomy to independently frame their tax policies because they were assured of full
compensation from the Centre, for revenue losses that may arise under the GST. This
is reflected in Section 18 of the GST Amendment, which states that – “Parliament
shall, by law, on the recommendation of the Goods and Services Tax Council,
provide for compensation to the States for loss of revenue arising on account of
implementation of the goods and services tax for a period of five years”
Interestingly, although Section 18 was part of the Constitutional Amendment
Bill, it did not amend any provision of the Constitution. But it mandated Parliament
to pass a law that would lay down a framework under which States would receive
compensation for 5 years from the date of GST implementation (1st July 2017).
As Thomas Issac (Finance Minister of Kerala) points out, the assurance of
compensation was one of the main foundations on which the States agreed to the
GST in the first place, and ceded their autonomy to frame their tax policies
independently. If this assurance of compensation was not mandated by law, States
may not have agreed to the GST in the first place. In furtherance of the mandate
given under Section 18 of the GST Amendment, Parliament enacted the GST
(Compensation to States) Act, 2017 (‘the Compensation Act’). This legislation forms
the root of the present controversy, as the Centre’s arguments to deny payment of
compensation is based on its provisions which is discussed in the compensation act.
4.2.5.1 The Compensation Act
The Preamble of the Compensation Act clearly states that the statute aims to
provide “compensation to the States for the loss of revenue arising on account
of implementation of the goods and services tax in pursuance of the provisions of the
Constitution (One Hundred and First Amendment) Act, 2016”. The statute lays down

336
the manner in which the compensation is to be paid for the first 5 years of the
implementation of the GST (i.e. the transition period). Under Section 3 and Section 7
of the Compensation Act, the percentage of annual revenue growth of a State has
been projected to be 14%. Under Section 7, if the annual revenue growth of a State is
less than 14%, the State is entitled to receive compensation under the statute.
The compensation that is to be paid is the shortfall in the revenue growth. For
instance, if the annual revenue growth of Maharashtra after GST implementation is
4%, it shall be compensated for the balance 10% – which is the shortfall. On the
other hand, if the revenue growth of Tamil Nadu is 12%, it shall be compensated for
the balance 2%. Under Section 9, the Centre has been granted the power to levy a
GST Compensation Cess, which shall generate the funds required to compensate the
States. The proceeds of this Cess have to be transferred to the GST Compensation
Fund, from which the States shall be compensated for their revenue shortfall. Now,
Section 10(2) of the Compensation Act states that “All amounts payable to the States
under section 7 shall be paid out of the [GST Compensation] Fund”.
4.2.5.2 The Centre’s arguments and its discontents
As of today, the amount present in the GST Compensation Fund is insufficient
to cover the revenue shortfall of the States. The Centre has been unable to collect the
amount of Cess that is required to meet the revenue shortfall of the States. In this
scenario, the Centre has taken benefit of Section 10(2) of the Compensation Act to
argue that it has no further obligation to pay compensation to the States.
Through a Policy Paper issued by the Ministry of Finance (available here), the
Centre has referred to Section 10(2) to contend that in case the amount present in the
GST Compensation Fund is insufficient to fulfil the revenue shortfall of the States, it
has no further obligation to compensate the States by tapping into other sources of
funds. The Centre has argued that by virtue of Section 10(2), it has no obligation to
compensate the States through the Consolidated Fund of India, or through any other
source of finance.
But, at the same time, the Policy Paper also acknowledges that the Centre has an
obligation to compensate the States for the entire shortfall of projected revenue, that
arises by virtue of implementation of GST. Moreover, the Policy Paper accepts that
this mandate cannot be evaded on account of an ‘Act of God’, such as the Covid-19
pandemic. The Policy Paper also refers to a legal opinion given to the Ministry of
Finance by Attorney General K.K. Venugopal. In his legal opinion, K.K. Venugopal

337
mentions that the Centre has an obligation to pay the full amount of compensation,
even if there is a shortage in the amount available in the GST Compensation Fund.
This highlights an inherent contradiction in the arguments of the Centre. On the
one hand, the Centre states that it has no obligation to compensate the States by
tapping funds from other sources if there is a shortfall in the amount present in the
GST Compensation Fund. But, simultaneously, the Centre is also acknowledging that
it has an obligation to pay the full amount of compensation to the States, even if there
is a shortage in the GST Compensation Fund. The Policy Paper itself accepts that
there is no provision in the GST Amendment or in the Compensation Act, which
exempts the Centre from paying compensation, on account of an ‘Act of God’. This
is a mutually contradictory argument – as if the obligation to pay compensation is
absolute, the Centre cannot then renege on its legal mandate.
Moreover, Section 10(2) of the Compensation Act does not bar the Centre from
tapping into other sources of funds to compensate the States. Section 10(2) only
states that all amounts payable to the States under Section 7 of the statute shall be out
of the GST Compensation Fund, and does not in any way state that if there is a
shortfall, the Centre can evade its primary obligation to the States. In this scenario,
Section 10(2) should also be read in conjunction with Section 18 of the GST
Amendment, and the Preamble of the Compensation Act. Both Section 18 and the
Preamble unambiguously mention that States are entitled to compensation for the
loss of revenue, which arises on account of GST implementation.
Also, as discussed above, the constitutional bargain which cements the GST is
based on the Centre’s obligation to compensate the States for the shortfall in revenue.
If the Centre would not have assured compensation to the States, the States would
never have consented to the GST Amendment, by limiting their taxation powers.
Hence, if the true spirit behind Section 18 of the GST Amendment is taken into
account, it can be argued that the Centre has an absolute obligation to compensate the
States without exception – even if the amount present in the GST Compensation
Fund is insufficient.
Another argument made by the Ministry of Finance in the Policy Paper is with
reference to Section 10(1) of the Compensation Act. Under Section 10(1), the
inflows to the GST Compensation Fund are to be made from the GST Compensation
Cess, and any other sources as may be recommended by the GST Council. The GST
Council can hence decide to tap the shortage and compensate the States through any

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other source of finance, such as the Consolidated Fund of India. But this is exactly
where the design flaw in the GST Council’s functioning begins to hurt the States
4.2.6 Levy and Collection of GST :

Levy and Collection

Intra State Supply :

Basis of charge as per respective Inter State Supply :
SGST Act, 2017/ UTGST Act, 2017 Basis of charge as per respective
(Most of the provisions are same IGST Act, 2017
as CGST Act, 2017)

4.2.6.1 Levy and collection as per CGST Act, 2017

U/s 9(1) of CGST Act, 2017 there shall be levied a tax
• Called the Central Goods and Services Tax(CGST);
• On all the intra-state supplies of goods or services or both, except on supply of
alcoholic liquor for human consumption;
• On the value determined u/s 15; and
• At such a rate (maximum 20%,) as notified by the Central Government on
recommendation of GST Council; and z Collected in such a manner as may be
prescribed; and
• Shall be paid by the taxable person.
(b) U/s 9(2) of CGST Act 2017, the CGST of following supply shall be levied with
the effect from such date as notified by the Central Government on
recommendation of GST Council

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• Petroleum crude
• High speed diesel
• Motor spirit (commonly known as petrol)
• Natural gas
• Aviation turbine fuel
(c) U/s 9(3), CGST is to be paid on reverse charge basis by the recipient on notified
goods/ services or both (liability to pay tax by the recipient of supply of goods /
services rather than supplier of goods/ services under forward charge)
(d) U/s 9(4), CGST on taxable supply of goods/ services to registered supplier from
unregistered supplier is to be paid on reverse charge basis by the recipient.
(e) U/s 9(5), E-Commerce operator is liable to pay CGST on notified intra-state
supplies.
4.2.6.2 Levy and collection as per IGST Act, 2017
(a) U/s 5(1) of IGST Act, 2017 there shall be levied a tax
• Called the Integrated Goods and Services Tax (IGST);
• On all the inter-state supplies of goods or services or both, except on supply
of alcoholic liquor for human consumption;
• On the value determined u/s 15 of CGST Act, 2017; and
• At such a rate (maximum 40%,) as notified by the Central Government on
recommendation of GST Council; and
• Collected in such a manner as may be prescribed; and
• Shall be paid by the taxable person. Provided further that IGST will be
imposed on goods/ services imported into India.
(b) U/s 5(2) of IGST Act, 2017, the CGST of following supply shall be levied with
the effect from such date as notified by the Central Government on
recommendation of GST Council
• Petroleum crude
• High speed diesel
• Motor spirit (commonly known as petrol)
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 • Natural gas
• Aviation turbine fuel
(c) U/s 5(3), IGST is to be paid on reverse charge basis by the recipient on notified
goods/ services or both (liability to pay tax by the recipient of supply of goods /
services rather than supplier of goods/ services under forward charge).
(d) U/s 5(4), IGST on taxable inter-state supply of goods/ services to registered
supplier from unregistered supplier (agriculturist) is to be paid on reverse charge
basis by the recipient.
(e) U/s 5(5), E-Commerce operator is liable to pay CGST on notified inter-state
supplies

4.2.7 Introduction to CGST, SGST, IGST, UTGST

i) Dual GST
India has adopted a dual GST system, which was imposed concurrently by the
Centre and States as CGST & SGST. Center has the power of tax intra-state sales
and states are empowered to tax services. Now GST has extend to all over the India.
ii) CGST/SGST/UTGST/IGST;-
GST is a destination based tax applicable on all transactions involving supply of
goods and services for a consideration subject to exceptions thereof. GST in India
comprises of Central Goods and Service Tax (CGST) – levied and collected by
Central Government, State Goods and Service Tax (SGST) – levied and collected by
State Governments/Union Territories with State Legislatures and Union Territory
Goods and Service Tax. (UTGST)-levied and collected by Union Territories without
State Legislatures, on intra-State supplies of taxable goods and/or services. (IGST)-
Inter-State supplies of taxable goods and/or services are subject to Integrated Goods
and Service Tax. IGST is approximately the sum total of CGST and SGST/UTGST
and is levied by Centre on all inter-State supplies.
iii) Legislative Framework:
There is single legislation – CGST Act, 2017 – for levying CGST. Similarly,
Union Territories without State legislatures [Andaman and Nicobar Islands,
Lakshadweep, Dadra and Nagar Haveli, Daman and Diu and Chandigarh] are
governed by UTGST Act, 2017 for levying UTGST. States and Union territories
with their own legislatures [Delhi and Puducherry] have their own GST
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legislation for levying SGST. Though there are multiple SGST legislations, the basic
features of law, such as chargeability, definition of taxable event and taxable person,
classification and valuation of goods and services, procedure for collection and levy
of tax and the like are uniform in all the SGST legislations, as far as feasible. This is
necessary to preserve the essence of dual GST.

Challenges in implementing GST:

While the desirability of the reform was undoubted, making a transition to GST
involved not only considerable work but also formidable challenges.
i) Understanding between Center and States: Unlike in many other countries
where GST is a centralized tax, in India it is to be executed by both central and state
governments, according to the proposals. This implies that both the structure and
administration of the levy had to emerge after detailed negotiations and bargaining
between the centre, 29 states and the two Union Territories with legislatures. Given
the sharp differences in the structure of the economy and sales tax revenue (as a ratio
of gross state domestic product, or GSDP) across states, the interests of the states did
not always coincide. Hence considerable effort was needed to persuade them to adopt
a uniform or even a broadly harmonized structure and administrative system for the
tax.
ii) Information Technology Platform: For ensuring seamless input tax credit,
they had agreed on a mechanism wherein the tax levied at the stage of inter-state sale
was to be collected and pooled separately and transferred to the destination state
through a clearing house. They had also established the GST Network (GSTN), a
special purpose vehicle with equity contributions from the technology partner
(NSDL), and central and state governments to erect the information technology (IT)
platform to administer GST.
iii) Issue of compensation for the loss of revenue: The 13th Finance
Commission’s recommendation that states should levy “flawless” GST to be eligible
to receive compensation for any loss of revenue put the entire negotiation process on
the back burner. The problem was compounded by the central government’s refusal
to pay compensation for the loss of revenue arising from the reduction in central
sales tax (CST). CST is the sales tax levied on inter-state transactions. The tax which
was levied at 4% by the exporting state was reduced to 2% in 2007 in preparation for
the introduction of GST. The central government had agreed to pay compensation for
the loss of revenue to the states until 2010, when the GST was to be implemented.
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When the central government refused to compensate the states after 2010, a huge
trust deficit was created and the entire negotiation process virtually broke down. The
new finance minister has promised to clear the backlog of dues to the states and the
states have resumed the negotiation process. The finance minister has also
announced that the Constitution Amendment Bill will be placed in the winter session
of Parliament. These developments bode well.
iv) Contentious issues and negotiation process: There are a number of issues
on which negotiations are necessary to reach a consensus between the centre and the
states and among the states themselves. The first issue relates to the inclusion of
taxes within the ambit of GST. The bone of contention relates to inclusion of
purchase taxes on foodgrain, taxes on motor spirit and high-speed diesel (GSD), and
octroi or entry tax in lieu thereof. The foodgrain surplus states have been levying the
purchase tax, the burden of which is exported to non-residents. The states were
reluctant to bring motor spirit and high speed diesel within the ambit as presently the
tax is levied at a floor rate of 20% and the states derive about 35% of their sales tax
collections from these petroleum products.
v) Determination of Revenue Neutral Rate: Another issue to be decided is the
rates of central and state GSTs to be levied. It was expected that the tax rates would
be revenue neutral. This implies that in the short term, there would not be any
revenue loss or gain, but over time the revenue productivity is expected to increase
due to better compliance of the tax and increased productivity of the economy.
However, estimation of revenue-neutral rate required consensus on the exemption
list, number of tax rates to be levied and the list of goods and services to be included
in different rate categories. Revenue-neutral rates had to be estimated for the centre
and for each of the states. Furthermore, when there was a preference for two rates—
one for essential goods and services consumed by common people and another
general rate—the estimation of revenue-neutral rates becomes further complicated.
vi) Setting up of an administrative system: Another area where a lot of work
is needed is the setting up of an administrative system for GST and working out the
transitional arrangements. Ideally, from the viewpoint of reducing compliance cost, a
unified administration would be desirable. However, that is not likely to happen as
each state would like to control the administration of its GST. In this situation,
harmonization of administrative processes with uniform systems, forms and
procedures would be necessary. This would also require additional training of tax

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collectors in the administration and enforcement of the tax. Equally important is the
dissemination of information about the tax to taxpayers.
Check Your Progress
A) Objective Type Questions:
Select the correct alternative:
1. Which of the following taxes have been subsumed in GST?
(a) Central Sales Tax (b) Central Excise Duty
(c) VAT (d) All of the above
2. Which of the following has not been subsumed in GST?
(a) Central Sales Tax (b) Central Excise Duty
(c) VAT (d) Income Tax
3. Inter-State supplies of taxable goods and/or services are subject to:
(a) CGST (b) SGST (c) IGST (d) UGST
B) Stat true or false:
1. GST is a direct-tax
2. Stamp duty is subsumed by GST.
3. GST is a value added tax.
4. The first draft of Goods and Service Tax ( GST) was presented in the
parliament in August, 2009
5. GST Bill were enacted on 12th April, 2017.

4.3 Summary :
This unit introduces the concept of GST to the students. The basics of GST like
meaning, definition, features, benefits and need of GST are elaborated in this unit.
Importantly, this unit also covers the constitutional provisions of GST as well as levy
and collection of GST. The terms like CGST, SGST, IGST and UTGST have been
discussed in this unit. Interestingly, although Section 18 was part of the
Constitutional Amendment Bill, it did not amend any provision of the Constitution.
But it mandated Parliament to pass a law that would lay down a framework under
which States would receive compensation for 5 years from the date of GST
implementation (1st July 2017).

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4.4 Terms to Remember :
GST : Goods and Services Tax
SGST : State Goods and Services Tax
CGST : Central Goods and Services Tax
IGST : Integrated Goods and Services Tax
UTGST : Union Territory Goods and Services Tax
Intra State Trade : Trade within the same state.
Inter State Trade : Trade between the two different states

4.5 Answers to Check Your Progress :

A) 1-d, 2- d, 3 -
B) 1- False, 2- False, 3- True, 4- True, 5- True

4.6 Exercises :
1. Differentiate between direct and indirect taxes.
2. Enumerate different types of direct and indirect taxes.
3. Explain the salient features of indirect taxes.
4. Explain the meaning and features of GST.
5. Which taxes have been subsumed by GST?
6. What are the benefits of GST to industry and business?
7. What are the benefits of GST to central and stage governments?
8. Explain in brief the framework of GST introduced in India.
9. Explain the evolution of GST in India.
10. What were the major challenges in the introduction of GST in India?

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4.7 Reference for Further reading:
Datey, V. S. : Goods and Services Tax, Taxmann.
Acharjee, M. : Goods and Service Tax.
Singhania and Singhania, : Student Guide to Income Tax including GST, Taxmann.
Chatterjee T. B. and Sony V. : Goods and Services Tax, Book Corporation.
Banger and Banger : Goods and Services Tax, Aadhya Prakashani.

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