Chargeability of gifts made to HUF u/s 56 of IT Act

In this article  as made an attempt to distinguish between the exemption benefits granted to Individual or HUF  on gift received by them, although both of them are covered by the Act under the same section i.e. 56(2)(vii), leaving other categories of assessees e.g. AOP and BOI  which are not covered altogether under this section.

Taxation Entries

This article is helping hand for those students who feel problem in taxation entries. Experts and others are requested to correct me or give their valuable feedback.

Taxation and accounting are the soul of the accounting profession. To become a good accounting professional, a sound correlation between tax and accounts is required. Practically, it has been seen that students feel difficulty in passing the entries of taxation. Problem not arises because of lack of knowledge but due to lack of conceptual clarity. Confusion arises while reversing the entries of Tax Payments (Advance tax, Self assessment tax, TDS recoverable etc.) and Tax Provision. An attempt has been made to clear the concepts of students. Let us discuss point to point these entries.

TDS on Salary

SECTION 192 : DEDUCTION OF TAX FROM SALARY

SECTION 192(1): Tax to be deducted at average of income-tax

The total tax to be deducted, on the estimated income of the employee for the relevant financial year, is divided by the number of months of his employment during that financial year. The amount so arrived at is the monthly deduction of tax at source. No tax will, however, be required to be deducted at source in any case unless the estimated salary income including the value of perquisites, exceeds the maximum amount which is chargeable to income-tax.

Combined Application of AS 11 & AS 16

This article deals with the combined application of AS 11 and AS 16. This article defines a situation in which the exchange difference shall be treated as both borrowing cost as per AS 16 and exchange difference as per AS 11.

In simple words the exchange difference shall be bifurcated into ‘interest portion’ (to be accounted for as per AS 16) and ‘exchange gain/loss’(to be charged to P&L as per AS 11).

Paragraph 4(e) of AS 16 deals with capitalization of interest portion of exchange difference arising from foreign currency borrowings.

VAT on BOT contracts - A view point

The concept of Public-Private partnership in  infrastructural  development has given rise to the concepts of BOT contracts. BOT contract means Build-Operatre-Transfer, i.e. the contractor is given a contract to build some infrastructure out of his own funds and thereafter he is given right to operate such infrastructure and recover his cost of funds and profits therefrom for a certain period and thereafter the  infrastructure is transferred to the Government.

Defination of Corpus Fund in practical view

Definition of Corpus Fund

1.  The term ‘corpus’ is often confused and misunderstood. The literal meaning of the term ‘corpus’ is the main part/organ of a body. The term ‘corpus’ also denotes the sum and substance of an issue/entity. From a layman’s point of view a corpus fund should be understood as the capital of the organization ; the funds generated and kept for the existence and sustenance of the organization.

10 Steps for Restructuring Risk Management Function

“Don't judge each day by the harvest you reap but by the seeds that you plant. “ – By Robert Louis Stevenson

Last decade altered the risk profile of the world. Look it from any lens - financial, technological, political, legal, reputation or physical – risks have increased for all organizations. The business rewards are higher of organizations who effectively manage risks.

Previous year’s Deloitte study on governance, risk and compliance showed that financial institutions with highly developed risk management function showed 23% better financial performance than their peers with skin-deep risk management functions. A strong risk and ethics culture facilitates more reliable reporting of financial and non-financial performance indicators thereby improves management functioning and strategic risk management. It improves staff engagement levels and enhances relationships with investors, regulators, customers, and other external parties.

These results indicate that the effort on developing risk management functions is worthwhile. Hence, to leverage the benefits companies need to restructure risk management function. I am sharing some ideas on the steps needed to restructure risk management functions.

1.   Get the right team on board

Selecting key risk management personnel is the single most important factor for an organization to form an effective risk management function. Risk managers must have technical expertise, business knowledge, emotional intelligence, psychological strength and strong personal values. Reason being risk managers are the charioteers of the organization. The CEO and management lead the organization to unchartered territories to win the battles in the markets. The risk managers ensure the safety of the senior management and organization. Their role requires them to constantly face adversity, be change agents, knowledge managers and principled role models. Hence, getting the right risk managers is crucial for success of the organization.

Neglecting this aspect can cause heavy damages to the organization. Risk managers have access to sensitive information. Hence, without the emotional intelligence and personal values, they can easily become deviant. Without the psychological strength to face adversity and strong consciousness, they may not inform various risks to senior management to save their own skin. Lastly, as risks are dramatically changing, without the technical expertise and knowledge, they may lead the management astray.

2.  Modify organization structure

At the global level, there is ongoing debate on the organization structure of risk management functions. Companies are focusing on integrating governance, risk management and compliance (GRC) functions. As per the KPMG Convergence report, 50% of the respondent organizations were spending 5% of annual revenue on GRC. However, interestingly cost is not the driver for integrations. As per the report – “44 percent cite overall business complexity, followed by a desire to reduce organizational risk exposure (37 percent) and improve corporate performance (32 percent).” This indicates that risk management organization structure has an impact on financial performance of the organization.

The first step as I have mentioned before, is to appoint a Chief Risk Officer (CRO) reporting to the CEO. However, the single step itself will not give substantial benefits. The function needs to cover strategic, tactical, operational, financial, reputational, political, legal and other risks. It should have a specialized team of business ethics managers, fraud investigators, internal auditors, compliance officers, information security personnel, physical security managers etc. The reporting lines need to be clear, and the control must not be with business heads. In case of global organizations, there should be matrix reporting to integrate with global initiatives.

3.   Clean up the mess

Charles Darwin had said – “It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change”. Since we base our identity on what we have done in the past, it is difficult to let go. However, it is difficult to run fast with old baggage. Elephants don’t dance; hence, we need to bring flexibility in the risk management organization. The first thing to do after getting the team and structure in place is to get rid of the redundant people, processes and technology.

This might sound harsh and ruthless; however, it is a necessity for making an agile organization. However, we need to stop adding organizational resources trying to inspire employees that avoid and inhibit change or processes and technology that is not giving adequate returns. Simply put, clean up the previous mess otherwise it will keep resurfacing and the new team will continuously spend time fire-fighting old issues. Do this by identifying all the facts, halting ongoing violations and preventing their reoccurrence in the future.

4.   Evaluate risk exposures

Dynamically changing internal and external risk landscape of organizations increases the risk exposures. Frequently, companies fail to identify emerging risks, as they have no previous exposures to it. For example, few companies still don’t have social media risks management plan or policy within the organization. The senior management dabbles in social media, and without guidelines, significant reputation risks exist.

Recent incidents have shown black swan incidents can trigger major disasters. However, organizations frequently calculate each risk exposure separately, rather than seeing the correlation between risks and assessing the collective impact.

Additionally, regulatory risks change due to multitude of new reforms, policies, and acts issued across countries. For example, the recently released UK Foreign Corrupt Practices Act affects all the subsidiary companies working in other geographies. Hence, compliance and legal functions need to evaluate the risk exposures on an ongoing basis.

Similarly, with new business strategies, strategic and operational risks change. Hence, before formulating a risk management strategy, it is important to identify various risk exposures.

5.   Assess various frameworks

While frameworks are not an end in itself, they do provide the means to achieve a desired state of risk management. Various frameworks of enterprise risk management (COSO:2004, ISO 31000, AN 4360:1999, OCEG Redbook 2.0 etc.) ensure a good starting point towards rebuilding the function. Depending on the industry, an organization can choose from a variety of frameworks (information security, data protection, and banking)  to model the risk management function.

Take care to customize the framework guidelines according to the organization requirements. Choose the best fit and/or combine a couple of them to form a best fit. Sometimes the mindset is that implementing a framework is only useful when certification is required to enhance business. However, this approach is incorrect.  

Risk managers can also use frameworks to benchmark the maturity level of the risk management function. Frameworks generally depict t best practices, hence provide a good roadmap for improving the function.

6.  Higher external consultants

Sometimes it is a good idea to hire external consultants, especially when revamping the function. The challenge of restructuring risk management function is that there is a high level of wariness amongst stakeholders if things have gone wrong before. The old risks management team may be viewed skeptically and the new risk managers don’t have the political and operational knowledge to be effective. They are also scared of giving the not so rosy picture to senior management as they haven’t had the time to develop strong relationships with them. This leaves all parties concerned attempting to wade through muddy waters.

External consultants besides have excellent technical knowledge are less involved in the politics of the organization. Hence, they are more independent and confident in presenting the bare facts. They are unlikely to face retaliation from business teams, as they are not part of the organization. Secondly, since they look at the scenario with fresh eyes they see the bigger picture better. Hence, it benefits the organization to smoothen the path of restructuring by seeking additional help and advice.

7.   Develop risk management strategy

I have written previously on criticality of forming a risk management strategy and I reiterate the importance here. Risk management functions are taking bottom up approach when presenting annual plans to senior management. For example, if the organization is having a balance scorecard performance appraisal system, the annual plan may be nothing more than the consolidation of balance scorecards.

This approach doesn’t give a strategic advantage to the organization. The business strategy and risk strategy are running parallel with major disconnect.

Risk managers need to prepare an annual strategy along with a long-term strategy for 3-5 years. The risk strategy has to be aligned and derived from the business strategy. Use strategy maps to monitor the performance of the strategy and revise it accordingly.

8.   Leverage technology

Putting experienced boots on the ground without relevant technology doesn’t give incremental returns on investment. Investing in GRC software adds value to the function and business. The Economist Intelligence Unit report “Too Big to Fail” states that 51% of the financial institutions participating in the survey increased investment in technology.

Secondly it says – “Just 40% of respondents say that their firm is effective at collecting, standardizing and storing data. Insufficient data is also seen as one of the key barriers to effective risk management after regulatory uncertainty and poor communication between departments.” Hence, efficient and effective risk management requires timely and relevant information and analysis for effective decision-making. Without technology, risk managers provide outdated qualitative information to management. It results in reactive rather than proactive risk management. Business intelligence tools – SAP Business Objects, IBM Cognos, etc. – give risk dashboards for business executive users. As data is apolitical, the dashboards help in accurate decision-making.

Moreover, the focus now is on building a risk and ethics culture within the organization. Traditionally formal classroom training programs were used. However, these have proved to be majorly ineffective as users fail to apply the concepts after leaving the classroom and revert to old habits within a few weeks. Studies have shown that employees are easily influenced when they participate in the process and have a continuous stream of information. Therefore, applying concepts of collective intelligence is beneficial. Organizations can have internal social networking sites, blogs and knowledge management systems. These allow employees to share knowledge, concerns and take ownership for managing their own department’s risks.

9.  Get business teams commitment

Sell, sell, and sell. Do as much internal selling as possible to get buy-in from the business teams. Get business executives talking about risk management through social networking sites, blogs, senior management messages, group discussions, step one meetings etc. Create a common language across the organization.

Studies have shown that people respond more strongly to risks – “when the consequences of those risks are available to them, such as from memory, from imagination, and from mass media. For example, if they witness a news item about a house fire, they are more likely to avoid the kind of behavior that they believe started the fire.” Hence, the more information business executives have regarding various risks the less prone they will be to taking unnecessary risks. Let them be the owners of transforming the risk culture within the organization. Risk managers just need to provide the guiding light.

10.   Formulate audit committee/ risk committee

In India, 90% of the companies are unlisted or privately held companies. The corporate governance norms of listed public companies do not apply to them. Hence, quite a few do not have focus on risk committees or formulate an audit committee. This becomes tricky situation as sometimes the private companies CEOs are managing bigger turnovers than listed companies are. If they have a team of technocrats running the business, the focus on risk management is limited. The problem becomes bigger in case of global organizations with subsidiaries in various geographies.

In such a scenario, it is a good idea to form risk and audit committees. The members may be board members and senior risk managers from other locations, if the organization is unwilling to have external members. The idea behind is that other locations senior managers will look at the information independently and share best practices at global level.

The board of directors and senior management though cannot delegate their risk oversight role completely do get better sources of information. As this keeps the internal teams on their toes, as they know that there are other risk experts looking at their work.

Closing thoughts

To progress, one has to change. Risk managers need to tackle the challenge of evolving risks hence need to transform rapidly. Their ability to adapt and transform themselves directly correlates to the organizations ability to manage risks. During change, a team is fragile and needs constant nourishment.  Hence, senior management support is needed for the change, not only by providing the budgets but also protecting their nascent growth.

References:

1. The convergence challenge Global survey into the integration of governance, risk and compliance February 2010 KPMG INTERNATIONAL

TDS on supply of eggs

High court of Madras in case of Mani Muthusamy v. Personal assistant to the Collector (Mad):

Facts:

The assessee was a supplier of eggs. He entered into a contract with the competent authority of State Government for the supply of eggs to certain Noon Meal Centers in the State and the supply of eggs had been made in accordance with the specifications contained in the contract.

According to the assessing officer the tax is required to be deducted at source U/S 194 C by contending the present contract is an indivisible contract for supply of a tailor-made product involving not only cost of goods but also value of service, transportation, handling / breakage, inventory management etc. Therefore, it is submitted that composite contract involving supply of goods and labour, is definitely a works contract.

Held:

Yes, Tax is required to be deducted under section 194C. 

Some highlights of cases referred relating to Section 194C about Law laid down by the Hon’ble Supreme Court on Subject “Contract for Sale or For Work and Labour”

In the case of Sentine Rolling Shutter & Engg. co. (P.) Ltd:

The distinction between a contract for sale or contract for work and labour has been pointed out  by this court in a number of decisions and some tests have also been indicated, but it is necessary to point out that these tests are not exhaustive and do not lay down any rigid or inflexible rule applicable alike to all transactions. They merely focus on one or the other aspect of the transaction and afford some guidance in determining the question, but basically and primarily, whether a particular contract is one for sale of goods or for work and labour depends upon the main object of the parties gathered from the terms of the contract, the circumstances of the transaction and the custom of the trade.

In the case of Anandam Viswanathan:

The primary difference between a contact for work or service and a contract for sale is that in the former there is in a person performing or rendering service, no property in the thing produced as a whole, notwithstanding that a part or even the whole of the material used by him may have been his property. Where the finished product supplied to a particular customer is not a commercial commodity in the sense that it cannot be sold in the market to any other person, the transaction is only a work contract.

In the case of Hindustan Aeronautics Ltd:

It is well settled that the difference between contract of service and contract for sale of goods, is that in the former, there is in the person performing work or rendering service no property in the thing produced as a whole notwithstanding that a part or even the whole of materials used by him had been his property. In the case of contract for sale, the thing produced as a whole has individual existence as the sole property of the party who produced it some time before delivery and the property therein passed only under the contract relating thereto to the other party for price. It is necessary, therefore, in every case for the courts to find out whether in essence there was any agreement to work for a stipulated consideration. If that was so, it would not be a sale because even if some sale may be extracted that would not affect the true position. Merely showing in the bill or invoices, it was contended on behalf of the appellant, the value of materials used in the job would not render the contract as one of sale. The nature and type of the transactions are important and determinative factors. What is necessary to find out, in our opinion, is the dominant object.

Therefore, based on the law laid down by Hon’ble Supreme Court, what is required to be seen is the nature and type of transaction, which are determinative factors and it is necessary to find out what is the dominant object of the said contract.

In the case of Anandam Viswanathan:

Where the finished product supplied to a particular customer is not a commercial commodity in the sense that it cannot be sold in the market to any other person, the transaction is only a works contract.

Kone Elevators (India) Ltd:

It can be treated as well settled that there is no standard Formula by which one can distinguish a contract for sale from a works contract. The question is largely one of fact depending upon the terms of the contract including the nature of the obligations to be discharged there under and the surrounding circumstances. If the intention is to transfer for a price in which the transferee had no previous property, then the contract is a contract for sale. Ultimately, the true effect of an accretion made pursuant to a contract has to be judge not by artificial rule but from the intention of parties to the contract. In a contract of sale, the main object is the transfer of property and delivery of possession of the property, whereas the main object in a contract for work is not the transfer of the property but it is one for work and labour. Another test often to be applied is: when and how the property of the dealer in such a transaction passes to the customer: is it by transfer at the time of delivery of the finished article or by accession during the procession of work on fusion to the movable property of the customer. If it is the former, it is sale; if it is the latter, it is a works contract.

The predominant object of the contract, the circumstances of the case and the custom of the trade provide a guide in deciding whether transaction is a sale or a works contract. Essentially, the question is of interpretation of the contract. It is settled law that substance and not the form of the contract is material in determining the question as to whether a particular given contract is a contract for sale of goods or is a works contract.

In the case of Hindustan Shipyard Ltd v. State of A.P. :

If the thing to be delivered has any individual existence before the delivery as the sole property of the party who is to deliver it, then it is a sale. If the bulk of material used in construction belongs to manufacturer who sells the end products for a price, then it is a strong pointer to the conclusion that the contract is in the substance one for the sale of goods and not one for labour. However, the test is not decisive. It is not the bulk of the material alone but the relative importance of the material qua the work, skill and labour of the payee which also has to seen. If the major component of the end product is the material consumed in producing the chattel to be delivered and skill and labour are employed for converting the main components into the end products, the skill and labour are only incidentally used; the delivery of the end product by the seller to the buyer would constitute a sale. On the other hand, if the main object of the contract is to avail the skill and labour of the seller though some material or components may be incidentally used during the process of the end product being brought into existence by the investment of skill and labour of the supplier, the transaction would be a contract for work and labour.