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Tax Problems- III
BY Jagadish Agrawal
More examples of tax-related problems created by the tax officers misinterpreting the law.
Tax Audit and Certification of Tax Return:
Sec. 96(3) of the Income Tax Act states that in case a person, other than the employees of the firm concerned, prepares or helps in preparing tax return and other documents required for tax return to be filed by the firm and for this service s/he receives some remuneration, he or she has to certify as follows:
That s/he has examined the accounts maintained as per the provisions of Section 81 of the Act, and that the statement or the return states the true and accurate position of the related circumstances.
The Section does not mean to say that a taxpayer must get its tax return and documents attached with the tax return examined by a qualified person. It is upto the taxpayer whether to engage a qualified person for this purpose or not.
Section 81(1) has given power to the IRD that it can make it compulsory to audit the accounts and records maintained by a person as per this section and also the followings:
a. All records and documents necessary to explain the information provided or to be provided in tax return and in other documents to be filed with IRD or Inland Revenue Office (IRO).
b. All documents and records that help to determine the actual tax liability of the person.
c. All documents and records that prove the validity of the expenses shown in the books.
Thus, neither of these sections make it compulsory, directly or indirectly, for a qualified person to audit the return filed by a taxpayer.
The tax return form No. Dr. 3-02-03-60 prescribed by the IRD has made it mandatory for an auditor with a PAN number to certify the tax return. The above analysis shows that such a requirement is imposed without any legal authority.
If the IRD thinks that the tax audit and the certification of a tax return by a qualified person is necessary, under certain circumstances, it should get a suitable provision incorporated in Section 96.
Wrong Use of Input-Output Norms:
The Customs Act has allowed, under certain circumstances, duty drawback facility to export oriented manufacturing units or bonded warehouses. The amount of duty draw back is calculated on the basis of the customs duty and other duties paid (exclusive of VAT) on the import of main raw materials and subsidiary raw materials (except packing materials) used for the production of finished goods for export only. The customs office must have a record of the finished goods exported, but the office has to depend on the declaration made by the manufacturing unit for the raw materials and subsidiary raw materials required for the production of the exported finished goods. The Customs Act, duly amended by the Finance Ordinance, has a provision that the unit, while applying for the refund of the duty draw-back, has to furnish a copy of the statement showing the input-output ratio set for a similar unit by the Department of Industry. This input-output ratio is based on an average of the input-output ratios of all similar industrial units and also on the average of the data supplied by different industrial units at different times. It never means that a unit has to produce goods using the set input-output ratio and also the same recipe. The actual consumption may differ according to the conditions of the plant, working environment, as well as the technique and recipe used. The production units are usually changing the technique and recipe according to the market test, demand and result of research and development. These new techniques, recipes, etc. are the hidden treasure of the unit and can be undeclared even before government officers. So, the actual consumption, in most of the cases, differs from the estimated or budgeted consumption, though the volume of difference may vary from one unit to another. If anyone is showing the accounts exactly as per the norms, it means manipulation of the figures.
While making VAT or income tax assessments, the tax officers in most cases reject the actual figures of consumption on the grounds that the figures of consumption is higher than the set ratio. It means that they lay emphasis on the use of estimated (deemed) figures of consumption for actual consumption. It is against the generally accepted accounting standards under which estimations are allowed only in case the actual figures are not available.
The tax officers are generally quoting Section 7 (2)(b) as a reason for such assessment. But, the Sub-section simply says that any amount received from the disposal of an inventory should be included in the assessable income. Section 7 is not talking about deemed disposal. Chapter 7 with the heading: “Quantification, Allocation, and Characterisation of Amounts” is also silent about such deemed disposal. Section 142 of the Income Tax Act is very much clear that other regulations cannot be used in the matter of income tax.
The contention of the tax officers shall be rightly applicable if Section 15 of the Income Tax Act had said that the production cost of a product should include the cost of raw materials and subsidiary raw materials only as per the norms fixed by the Department of Industry. But, it has not specified that.
Also the Revenue Tribunals has rejected such contentions of the tax officers so many times, but the tax officers are neither accepting the decision nor are they going to the Supreme Court for a final interpretation.
Capitalisation of Interest Expenses:
In one case, a tax officer rejected interest to be allowed as expenses on the grounds that it belonged to a period before the commencement of production, and thus it should be capitalised. Section 14 of the Income Tax Act has the following provision:
Interest paid or payable on borrowed capital is deductible expense under the following conditions:
The amount borrowed should have been utilised for business during the income year. But if the borrowed capital has not been put to use during the income year the interest paid or payable is not allowed to be deducted as expenditure.
Again, suppose the loan amount is allowed to be used by the owners for their personal purpose, the interest on the portion of the loan utilised by the owners is not deductible.
If the loan is borrowed for the purchase of an asset, the asset must have been put to use during the income year.
In conditions other than those described above, the debt obligation should have been created for the income generation from the business.
In the case under discussion, the person had taken a bridge gap loan for the project, not for a specific asset, for which it has incurred the expenses. The loan was utilised during the year by paying the amount to the supplier of various machines, all the assets purchased out of the loan have duly been installed and used for production during the year and the loan was taken for income generation. Not only one but all the three conditions as stated in the Section are rightly followed.
Let us see what the International Accounting Standard 23 (IAS) related to Borrowing Cost says about interest cost.
As per the IAS, the benchmark treatment of borrowing cost is to recognise the cost as an expense in the period in which they are incurred. But, the alternative treatment allows these to be capitalised in the cost of assets under certain conditions. The conditions are: that the cost should be directly attributable to the acquisition, construction or production of a qualified asset. When an enterprise borrows funds specifically for the purpose of obtaining a particular qualifying asset, the borrowing costs that directly relate to that qualifying asset can be readily identified. The capitalisation of borrowing cost should be commenced when expenditures for the asset are being incurred and ceases when substantially all the activities necessary to prepare the qualifying asset for its intended use are complete.
Thus, the contention of the tax officer in this case is neither supported by the Income Tax Act nor by the IAS.
(Agrawal is practicing Chartered Accountant)
Company Law’s
Anti-Labour Provision
A recent verdict of the Supreme Court has put a large number of Nepali workers in the organised sector out of the purview of the labour laws, due to serious lapse in the Nepali legal framework.
The verdict is related to a case of a security officer employed by a consortium of international contractors in the civil works of the mid-Marsyangdi hydropower project. He was sacked by the employer on the charge of misbehaviour.
The sacked security officer first approached the Labour Office in Pokhara, which immediately asked the employer to reinstate him. The employers filed a writ in the Supreme Court arguing that the Labour Office had no jurisdiction over the labour matters relating to the contract workers in their firm, formed for the temporary contract for the construction of the project. Meanwhile, the Labour Office directly wrote to the Nepal Electricity Authority asking it to pay money to the worker for the period he was put out of work, and to deduct the amount from the money the Authority was to pay to the civil works contractor and to ensure the reinstatement of the sacked security officer. Then the international contractor filed another writ in the Supreme Court, with the same argument. The contractor also claimed that the Labour Office was acting unilaterally and arbitrarily.
In its final verdict, the Supreme Court said that the Labour Office has jurisdiction only over matters that are under the purview of the Labour Act, and that the Labour Act is not applicable in case of a firm that is not “incorporated” (sic) in Nepal. The international contractor in this case was a consortium formed abroad by a joint venture agreement among the three partner companies incorporated in their respective countries and thus the Supreme Court said that it could not be regarded as any establishment (factory, organisation, institution firm or their group) established in Nepal, which is the prerequisite for the applicability of the Labour Act.
Thus the Apex Court quashed the decision of the Labour Office and upheld the sacking as it was carried out as per the conditions of the employment contract, which was based in turn on the agreement signed by the consortium of the contractors and the Nepal Electricity Authority.
The Supreme Court Justices who handed down this verdict were not happy while handing down this verdict on January 4, 2005 , say the lawyers who were present at the court. In fact they made efforts searching for ways to give a verdict in favour of the worker. But a blunder committed by the drafters of the present Companies Act constrained the learned Justices.
The earlier Companies Act that was replaced by the present one had a provision (Section 138) that made it compulsory for any foreign company to be registered in Nepal before it could do any business in Nepal . Once registered as per the Companies Act, the company automatically becomes established in Nepal and comes under the purview of the Labour Act. It could register either a subsidiary company or a branch or a liaison office or a project office (the last with a fixed duration). But that provision is just omitted in the existing Companies Act. While this did not stop foreign companies from operating in Nepal , it also paved the way for them to operate here without “incorporating” themselves. For example, the regulations governing the economic administration (related to awarding contracts for construction works by the government) allow foreign companies to take contracts for various construction works and work here. Though they have to be registered as taxpayers and obtain permission to conduct specific construction activities, this matter is governed by a separate law, which does not make them an establishment, as defined in the labour law of Nepal. Thus the labour law cannot have jurisdiction over such establishments. The Companies Act does not require them to be incorporated or established in Nepal , while the labour law says that its provisions are applicable only in factories, organisations, institutions, companies and firms or their groups established in Nepal as per the prevailing laws.
The effect of the lapse is not only in labour matters. This also makes it difficult to bring such foreign companies into the country’s tax net. This way, the government is losing a lot in terms of personal income tax from the employees of such companies working here as well as from the rent and other payments that such companies make here.
by Nubiz Reporter
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