With roughly 4 months left for May 2016 exams, it is high time the students taking up the exams to start their preparations. Direct taxes are arguably the most voluminous of all papers. And In Direct Taxes, Profits and Gains from Business and Professions seem to be one of the most important areas.
Here I have taken up an important Section which is covered in 'Profits and Gains from Business and Profession' which would be useful for May 2016 aspirants - Section 35 that deals with expenditure on scientific research which is one of examiner's favourite area.
With a view to encourage investment in scientific research in the country, Section 35 as introduced which provided for tax benefits on expenditure towards scientific research.
What type of expenditure the Section covers
For broader understanding, the expenditure, which is deductible u/s 35, can be divided into 2:
A. In house research
1. Revenue expenditure
2. Capital expenditure
3. Expenditure on approved in house research
B. Payment to outsiders
1. Contribution to approved research association
2. Contribution to approved national laboratory etc.
3. Contribution to Indian scientific research company
Let us discuss in detail one by one.
(i) Revenue expenditure related to business [Section 35(2)]
As per Section 35(1), any revenue expenditure laid out or expended on scientific research related to the business is deductible.
Where any revenue expenditure has been incurred before the commencement of the business on payment of any salary to an employee engaged in such scientific research (perquisites paid to employees is not covered) or on the purchase of materials used in such scientific research, the aggregate of the expenditure so laid out or expended within the 3 years immediately preceding the commencement of the business shall, be allowed in the previous year in which the business is commenced.
But it should be certified by the prescribed authority to have been laid out or expended on such scientific research.
(ii) Capital expenditure related to business [Section 35(2)]
If capital expenditure incurred on scientific research related to business, the whole of such capital expenditure incurred shall be deducted.
But no deduction shall be admissible in respect of expenditure incurred on the acquisition of any land.
Where any capital expenditure has been incurred before the commencement of the business, the aggregate of the expenditure so incurred within 3 years immediately preceding the commencement of the business shall be allowed in the previous year in which the business is commenced. But no deduction shall be admissible in respect of expenditure incurred on the acquisition of any land.
(iii) Expenditure on in house research and development -Section 35(2AB)
Where a COMPANY engaged in the business of bio-technology or in any business of manufacture or production of any article or thing, (except Eleventh Schedule article) incurs any expenditure on scientific research (not being expenditure in the nature of cost of any land or building) on in-house research and development facility as approved by the prescribed authority, then, there shall be allowed a deduction of a sum equal 200% of the expenditure so incurred.
- This deduction is only for COMPANIES specified above.
- Cost of BUILDING is eligible for 100% deduction u/s 35(2)
A. (i) Contribution to outsiders: Section 35(1)(ii)/(iii)
An approved research association which has as its object the undertaking of scientific research
175% of actual expenditure
An approved university, college or other institution to be used for scientific research
175% of actual expenditure
An approved research association which has as its object the undertaking of research in social science or statistical research
125% of actual expenditure
An approved university, college or other institution to be used for research in social science or statistical research
125% of actual expenditure
The deduction, to which the assessee is entitled in respect of any sum paid to a research association, university, college or other institution, shall not be denied merely on the ground that, subsequent to the payment of such sum, the approval granted to the association, university, college or other institution has been withdrawn.
B. (ii) Contribution to National Laboratory, IIT etc. [Section 35(2AA)]
- Where the assessee pays any sum to
- A National Laboratory or
- A University or
- An Indian Institute of Technology or
- A specified person as approved
with a specific direction that the said sum shall be used for scientific research undertaken under a programme approved in this behalf by the prescribed authority, then—
(a) there shall be allowed a deduction of a sum equal to 200% of the sum so paid ; and
(b) no deduction in respect of such sum shall be allowed under any other provision of this Act.
Note: The deduction, to which the assessee is entitled in respect of any sum paid to above institutions, shall not be denied merely on the ground that, subsequent to the payment of such sum, the approval granted to such institution has been withdrawn.
B. (iii) Contribution to a company to be used by such company for scientific research [Section 35(1)(iia)]
An amount equal to 125% of any sum paid to a company to be used by it for scientific research:
Provided that such payee company—
- is registered in India,
- has as its main object the scientific research and development,
- is approved by the prescribed authority, and
- fulfills such other conditions as may be prescribed.
An important thing to be kept in mind here is that if a taxpayer is allowed deduction u/s 35(1)(iia), the payee company referred to in the same section shall not claim any weighted deduction of 200% u/s 35(2AB) (Section 35(2AB) has already been discussed). But such payee company can claim deduction to the extent of 100% of the sum-spent u/s 35(1).
What happens when asset purchased for scientific research is sold ?
Let me explain the provisions with an illustration.
Harvard Limited a manufacturing company purchases a machine on 01 March 2005 for Rs.5,00,000 for its lab to make improvements in its quality of manufacturing.
Since the scientific research is related to its business, Rs. 5,00,000 is deductible u/s 35(2).
Lets assume that the research is ceased in 2014 and machine is brought into business-proper on 01 November 2014. Market value of machine is Rs. 2,30,000. Depreciated value of block on 01st April 2014 is Rs.10,00,000. This machine is sold for Rs. 1,90,000 04th April 2015.
Then, tax treatment is as under:
Opening WDV on 01 April 2014
Add: Scientific equipment brought into business proper (500000 -500000), since full value was allowed in 2005
Less: Depreciation at 15% on 1000000
Closing WDV on 31 March 2015
Less: Sale proceeds of scientific equipment
Less: Depreciation at 15% on 660000
Closing WDV on 31 March 2016
Hence no capital gain as block exists.
If in the above example, the machine was NOT USED for any other purpose but was sold for Rs. 1,90,000, tax treatment is as under:
Less: Indexed cost of acquisition
Long term capital loss
Deemed income u/s 41(3)##
## As per Section 41(3), if capital asset used in scientific research is sold, without having been used for other purposes, and the proceeds of the sale together with the total amount of the deductions made under section 35 exceed the amount of the capital expenditure, the excess or the amount of the deductions so made, whichever is the less, shall be chargeable to income-tax as income of the business or profession of the previous year in which the sale took place.
In other words, if capital asset used in scientific research is sold, without having been used for other purposes, the following is taxed u/s 41(3):
- Surplus i.e. sale proceeds or
- Deduction allowed earlier u/s 35,
whichever is lower.
Excess of sale price over cost/indexed cost is taxed as capital gains (deficiency shall be capital loss).
That is the reason as to why in the above illustration Rs. 190000 was taxed u/s 41(3), being lower of Rs.190000 (sale proceeds) and Rs.500000 (deduction allowed earlier).
Carry forward and Set off of deficiency:
If deduction u/s 35 relating to capital expenditure is not fully allowed due to absence/ inadequacy of profits, it shall be carried forward for unlimited years and set off in any subsequent year. Business loss already brought forward will have precedence over this deficiency.
What happens when there is amalgamation?
Where, in a scheme of amalgamation, the amalgamating company transfers to the amalgamated company (being an Indian company) any asset representing expenditure of a capital nature on scientific research, the provisions of Section 35 shall apply to the amalgamated company as they would have applied to the amalgamating company had the latter not transferred the asset.
SECTION 35(1)(ii) OF THE INCOME-TAX ACT, 1961 – SCIENTIFIC RESEARCH EXPENDITURE – APPROVED SCIENTIFIC RESEARCH ASSOCIATIONS/INSTITUTIONS
CIRCULAR NO.778,DATED 20-8-1999
1. The Finance Act, 1999, has made amendment in section 35(1) of the Income-tax Act, 1961, by which the approval under section 35(1)(ii) and section 35(1)(iii) of the Income-tax Act shall be granted by the Central Government instead of prescribed authority [Director General of Income-tax (Exemption), in concurrence with Secretary, Department of Scientific and Industrial Research]. Subsequently consequential changes have also been made in rule 6 of the Income-tax Rules, 1962 and Form 3CF vide Gazette Notification dated 25-6-1999.
2. It has been now decided that henceforth, the following procedure shall be adopted for dealing with the pending as well as fresh applications for approval under section 35(1)(ii) and 35(1)(iii) of the Income-tax Act, 1961:
|(i)||Fresh application for approval under section 35(1)(ii) and 35(1)(iii) for assessment year 2000-2001 onwards shall be filed in Form 3CF with Central Government.|
|(ii)||All applications pending with DGIT(E) as on 25-6-1999, i.e., the date of Gazette Notification of amendment of rule 6 of the Income-tax Rules, 1962, for approval under section 35(1)(ii) and 35(1)(iii) pertaining to assessment year 2000-2001 or subsequent year shall stand transferred to Central Government.|
|(iii)||DGIT(E) in concurrence with Secretary, Department of Scientific and Industrial Research shall continue to be the prescribed authority for approval of cases under section 35(1)(ii) and 35(1)(iii) pertaining to assessment year 1999-2000 or any earlier year.|
|(iv)||Approval already granted by the prescribed authority under pre-amended section 35(1)(ii) and 35(1)(iii) for assessment year 2000-2001 or any subsequent year, prior to 25-6-1999, i.e., the date of Gazette of amendment of rule 6 of the Income-tax Rules, 1962, shall continue be valid and no further notification or approval from Central Government shall be required in such cases for those assessment years.|