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TaxTMI 
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The Finance Act, 1986-Explanatory Notes on the provisions relating to direct taxes
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....he Gift-tax Act, 1958; (vii) omitted section 6A of the Gift-tax Act, 1958; and (viii) amended section 4 of the Companies (Profits) Surtax Act, 1964. PROVISIONS IN BRIEF 3. The provisions in the Finance Act, 1986, in the sphere of direct taxes relate of the following matters:- (i) Prescribing the rates of income-tax on incomes liable to tax for the assessment year 1986-87; the rates at which income-tax will be deductible at source during the financial year 1986-87 from interest (including interest on securities), dividends, salaries, insurance commission, winnings from lotteries and crossword puzzles, horse races and other categories of income liable to such deduction under the Income-tax Act; rates for computation of "advance tax" and charging of income-tax on current incomes in certain cases for the financial year 1986-87. (ii) Abolition of surcharge on companies with immediate effect. (iii) Amendment of the Income-tax Act, 1961, with a view to granting relief to salaried taxpayers; exempting notional income from one self-occupied property; removing the disparity in the matter of liability to income-tax as between an employee getting house rent allowance and another provid....
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....omes liable to tax for the assessment year 1986-87. 4.1 In respect of incomes of all categories of tax-payers (corporate as well as non-corporate) liable to tax for the assessment year 1986-87, the rates of income-tax (including surcharge thereon) have been specified in Part I of the First Schedule to the Finance Act. These rates are the same as those laid down in Part III of the First Schedule to the Finance Act, 1985, for the purposes of computation of "advance tax", deduction of tax at source from "Salaries" and retirement annuities payable to partners of registered firms engaged in specified professions, and computation of tax payable in certain cases during the financial year 1985-86. 4.2 The Finance Act, 1985, had allowed companies required to pay advance tax during the financial year 1985-86 to make a deposit with the Industrial Development Bank of India in lieu of the surcharge payable by them. The Finance Act, 1986, has accordingly made a provision that where a company has made a deposit during the financial year 1985-86 with the Industrial Development Bank of India under the Companies Deposits (Surcharge on Income-tax) Scheme, 1985, framed by the Central Government unde....
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....es during the financial year 1986-87. 6. The rates for deduction of tax at source from "Salaries" in the case of individuals during the financial year 1986-87 and also for computation of "advance tax" payable during the year in the case of all categories of taxpayers have been specified in Part III of the First Schedule to the Finance Act. These rates are also applicable for deduction of tax at source during the financial year 1986-87 from retirement annuities payable to partners of registered firms engaged in certain professions (such as, chartered accountants, solicitors, lawyers, etc), and for charging income-tax during the financial year 1986-87 on current incomes in cases where accelerated assessments have to be made, e.g., provisional assessment of shipping profits arising in India to non-residents, assessment of persons leaving India for good during the financial year 1986-87, assessment of persons who are likely to transfer property to avoid tax, where an order has to be passed in a case of search and seizure for calculating the amount of tax on the estimated undisclosed income, etc. (iv) Rates of tax applicable to individuals, Hindu undivided families, unregistered firms....
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....employer to his employee to meet expenditure actually incurred on payment of rent for residential accommodation is exempt to such extent, not exceeding Rs. 400 per month, as may be prescribed by rules, having regard to the area or place in which such accommodation is situated. With a view to removing the disparity to the extent possible in the matter of liability to income-tax as between an employee getting house rent allowance and another provided with rent-free accommodation by the employer, the Finance Act has omitted the above ceiling of Rs. 400 per month. Consequently rule 2A of the Income-tax Rules, 1962, is being amended by a notification which is expected to be issued shortly. Under the proposed amendment, clause (d) of rule 2A and clause (iii) of the Explanation to the said rule will be omitted. Further, clause (c) of rule 2A will provide the limit of one-half of the amount of salary in the case of an assessee who is in receipt of house rent allowance in respect of a residential accommodation occupied by him which is situated at Bombay, Calcutta, Delhi or Madras and the limit of two-fifth of the amount of salary in respect of the accommodation situated at other places. Thi....
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.... parts during the previous year. The annual value of the entire property will be first determined as if it is let. Out of the above, the annual value of the self-occupied portion will be de ducted for the full year. Further, for the let out portion, the proportionate annual value for the period during which that part was self-occupied is to be excluded. The balance will be the tax able annual value. (c) If the property is let during any part of the previous year. The annual value will be determined as if the property had been let. Out of the above, the proportionate value for the period for which it is self-occupied will be excluded and the balance will be the taxable annual value. 13.4 Where more than one house property is in the occupation of the owner for his residence in respect of which the assessee may specify one of such properties, the annual value shall be determined in the same manner as discussed at (a), (b) and (c) of para 13.3. In respect of the remaining properties, the annual value will be determined as if such house or houses had been let. 13.5 As a consequential amendment, section 23(2A) has been omitted. 13.6 Section 23(3) which has been substituted provides....
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....g, including an article or thing of low priority specified in the Eleventh Schedule to the Income-tax Act for eight initial assessment years (10 years in the case of a co-operative society). 15.2 For the purposes of the above mentioned tax concessions, a "small scale industrial undertaking" has been defined as an industrial undertaking in which the aggregate value of the machinery and plant installed, as on the last day of the previous year, does not exceed Rs. 20 lakhs. With a view to promoting the growth of the small scale sector, the limit of investment in a small scale industrial undertaking was increased from Rs. 20 lakhs to Rs. 35 lakhs by the Department of Industrial Development, vide their Notification dated 18th March, 1985. In view of the increase in the aforesaid qualifying monetary limit, the Finance Act has amended sections 32A and 80HHA of the Income-tax Act to provide that an industrial undertaking will be regarded as a small scale industrial undertaking if the aggregate value of the machinery and plant (other than tools, jigs, dies and moulds) installed therein, as on the last day of any previous year ending after the 17th March, 1985, does not exceed Rs. 35 lakhs.....
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....years. [Section 7(a)(i), (b) & (c) of the Finance Act] (viii) Substitution of the provisions relating to investment allowance by an investment deposit account scheme. 17.1 The 1985-86 Budget had initiated a process of reform of the corporation tax. It had been announced that the scope for further reform would be examined, along two alternative lines as under:- (i) A further reduction in the rate of tax by 5 per cent. for the next year and withdrawal of surcharge and surtax in the third year along with withdrawal of the investment allowance in the phased manner; or (ii) retention of the investment allowance with no further cut in rates. 17.2 An open debate was invited on the relative merits of these alternatives before taking any decision. On a consideration of the related issues, the surcharge on the companies has been abolished with immediate effect and it has not been postponed to the third year, as envisaged earlier as per para 5.12 of the LTFP. Keeping in view, the interest of revenue, the surtax has been discontinued with effect from the assessment year 1988-89. The scheme of investment allowance has been replaced by a new scheme of investment deposit account. 17.3 One....
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....as per section 32AB(2) means business or profession other than the business of construction, manufacture or production of any article or thing specified in the list in the Eleventh Schedule (in case it is not a small scale industrial undertaking) and the business of leasing or hiring of machinery or plant to an industrial undertaking other than a small scale industrial undertaking engaged in the business of low priority items as specified in the list in the Eleventh Schedule. It may be clarified that the business of construction is an eligible business for the purposes of this provision. (b) In order to encourage a more productive use of capital leading to a low-cost economy, the benefits under the new investment deposit scheme shall be available only if there are profits in the eligible business or profession whereas the benefit of investment allowance is available even if there is no such profit, because the deduction is linked merely to the cost of the plant and machinery. (c) The acquisition of a ship or an aircraft or installation of plant and machinery, as the case may be, during the previous year is a condition precedent for availing of the benefit of the existing investme....
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....in a case where separate accounts in respect of such business or profession are maintained, an amount arrived at after deducting an amount equal to the depreciation computed in accordance with the provision of section 32(1) of the Income-tax Act from the amount of profits computed in accordance with the requirements of Parts II and III of the Sixth Schedule to the Companies Act, 1956, as increased by an amount equal to the depreciation, if any, debited in the audited profit and loss account. This implies that the profit has to computed, taking into account only the depreciation for the current year, as admissible under the Income-tax Act. Further, Part II of the Sixth Schedule to the Companies Act lays down the requirements as to profit and loss account. These requirements, as per the provisions of section 32AB(3) of the Income-tax Act, will be applicable in the cases of corporate as well as non-corporate assessees. 17.5 The requirements as per Part II of the Sixth Schedule to the Companies Act, include the following:- (i) The profit and loss account shall be so made out as clearly to disclose the result of the working of the company during the period covered by the account and s....
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....quantum of arrears of depreciation computed should be disclosed by way of a note. (ix) The amount of interest on debentures and other fixed loans, the charge for income-tax and other Indian taxation on profits, etc., should be disclosed. (x) The expenditure incurred on consumption of stores and spare parts, power and fuel, rent, repairs, salaries, wages and bonus, contribution to provident fund, etc., may be shown separately for each item. 17.6 The definitions as per Part III of the Sixth Schedule to the Companies Act are as under:- (i) The term provision means any amount written off or retained by way of providing for depreciation, renewals or diminution in value of asset or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy. (ii) The expression "reserve" shall not include any amount written off or retained by way of providing for depreciation, renewal or diminution in value of the assets or retained by way of providing for any known liability. (iii) The expression "capital reserve" shall not include any amount regarded as free for distribution through the profit and loss account. (iv) The expression "reve....
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....e in respect of any amount utilised for the purchase of a computer installed even in office premises, deduction will be admissible. (g) The term "computer" does not include calculation machines and calculating devices. (h) For getting the benefit under this provision, the deposit in the Development Bank or the purchase of any new ship, plant, etc., should be out of income from the eligible business or profession. There is an underlying reason for this pre-condition. As mentioned in the Long Term Fiscal Policy (Para. 5.14) since the benefit of investment allowance is related to the cost of plant and machinery irrespective of how it is financed, such a benefit had created a distortion in the profitability of companies depending on the extent to which they were able to find the resources internally or through borrowings to acquire the new ship, plant, etc. That being so, under the Investment Deposit Scheme, deduction will be admissible only if the deposit is made or the ship, plant, etc., is acquired out of income chargeable to tax under the head "Profits and gains of business or profession". 17.7 As provided in section 32AB(10), no deduction shall be allowed under section 32AB(1) ....
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....t is an accepted accounting principle that where an asset is acquired out of borrowed funds, the interest paid or payable on such funds constitutes the cost of borrowing and not the cost of the asset acquired with those funds. It is for this reason that as per the clear guidelines issued by the Institute of Chartered Accountants of India, the interest on moneys which are specifically borrowed for the purchase of a fixed asset may be capitalised only relating to the period prior to the asset coming into production, i.e., relating to the erection stage of the asset. However, once the production starts, no interest on borrowings for the purchase of such assets should be capitalised. In spite of these clear guidelines, as also the consistent view of the Department in this matter, some tax-payers had adopted a contrary stance and had capitalised such interest. The first decision in favour of this stance had been rendered on May 13, 1974, in the case of CIT v. J.K. Cotton Spinning and Weaving Mills Ltd. ([1975] 98 ITR 153. This decision as well as the subsequent decisions were contrary to the legislative intent. Hence, in order to enable the Government to collect the tax legitimately due....
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....structs a residential house. The exemption of capital gains is restricted to the amount of such gains utilised for the purchase or construction of the new residential house. Where the amount of capital gains is greater than the cost of the house so purchased or constructed, the balance amount of the capital gains is charged to tax. If, however, the amount of capital gains is equal to or less than the cost of the residential house so purchased or constructed, the amount of capital gains is totally exempted from income-tax. The process of selling or purchasing a residential house either to or from a private source or a Government agency or a co-operative society involves steps which in most cases require a longer time frame than one year. The assessees, therefore, would experience difficulty in complying with the time-limit of one year for purchasing a new house after the date of transfer of the residential house. Hence, by amending this provision, the period of one year has been extended to two years. Where the transfer is by way of compulsory acquisition and the compensation awarded is enhanced by any court, tribunal or other authority, the period of one year after the date of rece....
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....er cent. of the paid-up share capital is held by the Central Government or by any State Government or Governments or partly by the Central Government and partly by one or more State Governments and includes a company which is a subsidiary of a Government company. The holding of fifty-one per cent. or more of shares (equity or even preference shares carrying no voting rights) by the Central and/or any State Government-and not municipal and other local authorities or public corporations-makes a company, a Government company. 22.2 The amendment will be applicable for the assessment year 1987-88 and subsequent years. [Section 12 of the Finance Act] 23.1 Modification of the provisions relating to deduction in respect of long-term capital gains in the case of non-corporate tax payers. Under the provisions of section 80T read with Schedule XII to the Income-tax Act, in respect of long-term capital gains in the case of non-corporate tax-payers, an initial deduction of Rs. 5,000 is admissible and, in addition, a further deduction is admissible, depending upon whether the capital gains relate to buildings or lands or any rights therein on the one hand and other assets on the other, as a....
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....r hotel business. Under the existing provisions of section 80K of the Income-tax Act, any dividends paid by a company out of profits in respect of which the company is entitled to a deduction under section 80J are exempt from income-tax in the hands of the shareholders. However, the dividends distributed out of profits derived from industrial undertakings, hotels and ships which, respectively, went into production or started functioning or were put to use after 31st March, 1976, are not entitled to the aforesaid tax exemption. With a view to withdrawing concessions which are no longer relevant, the Finance Act has deleted section 80K of the Income-tax Act. As a consequential measure, sub-section (2) of section 80L, sub-section (2) of section 80M, clause (xxiv) of sub-section (1) of section 80VVA and sub-section (3) of section 197 of the Income-tax Act, have been deleted and amendment made in section 80A(3). 25.2 These amendments will take effect from 1st April, 1987, and will apply in relation to the assessment year 1987-88 and subsequent years. [Sections 19, 20(b), 21, 39(a)(i), (b)(ii) and (c)(ii) of the Finance Act] 26.1 Deduction in respect of compensation for termination o....
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....sting provisions of section 194B of the Income-tax Act, any person responsible for paying to any other person any income by way of winnings from lotteries or crossword puzzles in excess of Rs. 1,000 is required to deduct income-tax on such payments at the rates in force. By an amendment, the aforesaid limit has been raised from Rs. 1,000 to Rs. 5,000. This amendment takes effect from 1-6-1986. [Section 30 of the Finance Act] 29. Winnings from horse races. As per the provisions of section 194BB of the Income-tax Act, a book-maker or a licencee for horse races in any race course or for arranging any wagering or betting in any race course responsible for paying to any person any income by way of winnings from any horse race in excess of Rs. 2,500 is required to deduct income-tax on such payments at the rates in force. The Finance Act has raised the aforesaid limit from Rs. 2,500 to Rs. 5,000. [Section 31 of the Finance Act] 30.1 Modification of the definition of the expression "person responsible for paying" for the purpose of deduction of tax at source from long-term capital gains in the case of a non-resident Indian. Under the provisions of section 195 of the Income-tax Act,....
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....set [in the application under section 19(5) of the FERA or in the suitable form] that the asset sold by him is a capital asset and no stock-in-trade. Also that the capital asset was held by him for more than 36 months. In order to facilitate verification of this kind of statement, hereafter, when a foreign exchange asset is initially purchased by a non-resident Indian, a declaration may be obtained from him that the same is acquired as capital asset and not as stock-in-trade. 30.3 The amendment is effective from 1st June, 1986. [Section 32 of the Finance Act] (xiii) Provision of a flat rate of tax on winnings from lotteries, crossword puzzles, races, including horse races, etc. 31.1 Under the existing provisions, any income by way of 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 is chargeable to tax under the head "Income from other sources" along with the other income of an assessee. By inserting a new section 115BB in the Income-tax Act, it has been provided that any income of a casual and non-recurring nature of the type referred to above, shall be ....
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....a tax-payer, being the owner of horses maintained by him for running in horse races, the amount of loss incurred in the activity of owning or maintaining such race horses in any assessment year shall not be set off against income, if any, from any other source and shall be allowed to be carried forward to the four assessment years next following the assessment year for which such loss was first computed for being set off against income, if any, from the same activity. 32.2 These amendments will apply in relation to the assessment year 1987-88 and subsequent years. [Section 16 of the Finance Act] (xv) Modification relating to limit of deduction in respect of rent paid. 33.1 Under the provisions of section 80GG of the Income-tax Act, any expenditure incurred by an assessee, other than those covered under section 10(13A) of the Income-tax Act, in excess of 10 per cent. of his total income towards payment of rent is allowed as deduction in computing his total income. The amount of deduction is subject to a ceiling of Rs. 400 per month or 15 per cent. of his total income of the year whichever is less. With a view to liberalising the provisions of this section, by an amendment broug....
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.... rate of tax on royalty might result in inflating fees for technical services. Hence a uniform rate of tax of forty per cent. for both royalty and technical services fees was prescribed. It may appear to be ironical that with the passage of time, the lower rate of tax at 20 per cent. applicable to lump sum payments for supply of technical know-how abroad has given rise to the problems which had been apprehended relating to royalty vis-a-vis fees for technical services. It has been found that the foreign collaborators tend to take more by way of lump sum which attracts lower rate of tax than by way of royalty and in some cases payments for grant of licence for use in India of technical process are camouflaged as lump sum payments abroad. This is also not in the interest of absorption and adaptation of imported technology. An agreement for transfer of technology in India is more conducive, when compared to an agreement for lump sum payment, to self-reliance in our industrial production. Further, the differential rates of tax have been found to be open to abuse and have also given rise to litigation. Hence, by an amendment of section 115A of the Income-tax Act, the tax rate on lump su....
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....of a business premises, the nature of business/profession, the details regarding the account books, bank accounts and stock-in-trade, etc. 35.2 The new section 272AA provides for penalty extending up to Rs. 1,000 for failure to comply with the provisions of section 133B. 35.3 These provisions are effective from 13th May, 1986. [Sections 27 and 35 of the Finance Act] (xviii) Measures for raising resources for the public sector. 36.1 Under the existing provisions of section 80L of the Income-tax Act, interest on such debentures issued by any co-operative society (including a co-operative land mortgage bank or a co-operative land development bank) or any other institution or authority, as notified by the Central Government is allowed as a deduction within specified limits. Under the provisions of section 193 of the Income-tax Act, no tax is deductible at the time of payment of any interest on such debenture. 36.2 With a view to tapping rural savings for the benefit of public sector, section 80L(1)(ii) of the Income-tax Act has been amended so as to include also the interest on debentures issued by a public sector company as an item qualifying for deduction. With a view to avoid....
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....iate authority' within the prescribed period. To begin with, it is proposed to issue a notification making this provision applicable to metropolitan cites and to transactions of the value of Rs. 10 lakhs and above. 37.4 The cases coming under this Chapter will not involve deprivation of property or any rights therein but will only imply a restriction on the contractual rights of the parties. This restriction is just, fair and reasonable having regard to the object sought to be achieved. 37.5 It is a known fact that proliferation of black money is evident in the transfer of immovable properties. As mentioned in the LTFP (para. 5.30), one way of tackling the problem of tax evasion is to confer on the Government the pre-emptive right to acquire any immovable property undergoing a transfer for consideration above a certain value. The assumption of the powers by the Central Government to purchase immovable properties in certain cases of transfer thus has the object of including the transferors and the transferees to declare the full amount of consideration in the agreement for transfer. 37.6 On receipt of the statement by each of the parties to such transfers as are within the purvie....
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....provisions, free from all encumbrances. 37.8 As per section 269UK, no person entering into an agreement for the transfer of immovable property in respect of which a statement has been furnished, shall revoke or alter such an agreement for transfer of such property unless the appropriate authority has not made an order for purchase of the said property by the Central Government under section 269UD and the period specified for making such order has expired or the order of the appropriate authority stands abrogated under the provisions of section 269UH. Any transfer of any immovable property in contravention of these provisions shall be void. 37.9 As per a further condition under section 269UL, a registering officer under the Registration Act, 1908, has been barred from registering any document purporting to transfer any immovable property, exceeding the value prescribed unless the appropriate authority certifies that it has no objection to such a transfer. Further no person shall do anything or omit to do anything which will have the effect of transfer of any immovable property unless the appropriate authority certifies that it has no objection to such a transfer. 37.10 As per sec....
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....eys or other assets not disclosed by the transferee for the purposes of income-tax or wealth-tax. 38.2 As mentioned in the LTFP (para. 5.29) these provisions have not proved to be effective and have generated a great deal of litigation, etc. Further, it is essential to find ways in which taxpayers could be induced to disclose the true value of their properties. In order to achieve this purpose, the new Chapter XXC conferring on the Central Government a pre-emptive right to purchase an immovable property has been inserted in the Income-tax Act and at the same time by a new section 269RR, it has been provided that the provisions of Chapter XXA of the Income-tax shall not apply to or in relation to the transfer of any immovable property made after the 30th day of September, 1986. 38.3 As a consequential measure, section 276AA of the Income-tax Act providing for punishment with rigorous imprisonment up to two years and also for liability to fine for failure to comply without reasonable cause or excuse with the provisions of section 269AB or with any direction issued under sub-section (5) of section 269-I of the Income-tax Act has been omitted with effect from 1-10-1986. [Sections 3....
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.... and subsequent years. 40.3 Certain representations had been received by the CBDT mentioning that it was not clear as to whether the exemption was available under the above provisions in respect of moneys or assets which were not brought into the country at the time when the person returned to India but were brought before or after the person's return. It has been clarified by the CBDT as per Circular No. 411 (F. No. 317/5/85-WT dated 26-2-1985*) that the moneys which are deposited in the Non-Resident (External) Account shall continue to qualify for exemption under the Wealth-tax Act even after the person returns to the country and the moneys in the above account are converted into any other assets. In response to further representations, a clarificatory amendment has been made by the Finance Act by inserting Explanation 2 in clause (xxxiii) of section 5(1) of the Wealth-tax Act. This explanation clarifies that the moneys standing to the credit of a person in a Non-Resident (External) Account in any bank in India in accordance with the Foreign Exchange Regulation Act, 1973, on the date of his return shall be deemed to be moneys brought by him into India for the purposes of the sai....
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....sections 18 and 19 and Schedule to the Gift-tax Act. 41.3 These amendments will apply in relation to the assessment year 1987-88 and subsequent years. [Sections 41, 44, 45 & 46 of the Finance Act] 42.1 Withdrawal of exemptions in respect of certain gifts. Under the provisions of section 5(1)(iiia) of the Gift-tax Act, gift of National Defence Gold Bonds, 1980, not exceeding the value of such bonds for an aggregate weight of 5 kg. of gold in any previous year is exempt. These Bonds matured in 1980 and hence there is no likelihood of gift of such bonds now. This provision has thus become redundant and hence has been deleted by the Finance Act. 42.2 As per clause (vi) of sub-section (1) of section 5 of the Gift-tax Act, gifts for charitable purpose (other than gifts to an institution or fund to which section 80G of the Income-tax Act applies) are exempt, subject to a limit of Rs. 100 for each gift and Rs. 500 in the aggregate to the same donee within the same previous year. The gifts for charitable purpose to institutions or funds covered by section 80G of the Income-tax Act are separately exempt under clause (v) of sub-section (1) of section 5 of the Gift-tax Act. This exemptio....
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....r regarding the bona fide nature of gifts in relation to carrying on of business has given rise to litigation and interpretations by the courts which were not in conformity with the legislative intent. For example, even gift of 25 per cent. of the share of a senior partner to a young lawyer partner has been held to be exempt, under this clause. (V.O. Markose v. CGT [1975] 98 ITR 504). Even otherwise, this provision does not appear to serve any purpose and hence it has been deleted, keeping in view the higher exemption limit now provided. 42.6 Under clause (xvi) of sub-section (1) of section 5 of the Gift-tax Act, gift to any person up to a maximum of rupees five hundred in any previous year is exempt. This clause was inserted with effect from 1-4-1985. With the enhancement of the basic exemption limit as per the Finance Act, this exemption will cease to have any purpose and hence the provision has been deleted. 42.7 Consequent upon the deletion of the aforesaid provisions, certain consequential amendments have also been made. 42.8 The amendments at paras 43.1 to 43.7 above, will be applicable in relation to the assessment year 1987-88 and subsequent years. [Section 42(a), (b) ....