The Hindu Business Line : Be prepared at the threshold

ACCOUNTING has always dictated the rules relating to tax incidence. Over the years, this proposition has encountered several hurdles, particularly in matters dealing with accounting method. While Section 145 of the Act deals with the "method of accounting", the nuts and bolts of this has been spelt out in various court decisions on the subject.

Entries in the books of accounts have no relevance in deciding tax liability. But judicial thinking on the subject has been divided. The method of accounting plays a significant role in deciding the point at which fringe benefit tax (FBT) is payable. As discussed in these columns, FBT is basically a tax which has relevance to the trial balance and not necessarily the profit and loss (P&L) account. Scanning the items both in the balance-sheet and P&L account is necessary to decide the type of payments which are exigible to FBT.

Advance payment and FBT

FAQ No. 18 of Circular No. 8/2005 deals with the question of advance payment and FBT liability.

Whether FBT would apply to payment of advance towards expenses to be incurred in the future?

Answer: "FBT would be payable in the year in which the expenditure is incurred. Therefore, FBT would not be payable on payment of advance towards expenses to be incurred in the future."

During the course of business, advance payments towards various expenses, such as travelling, advertisement, insurance, and so on, have to be made and these are parked under the head `Loans and Advances' in the balance-sheet. These would be reversed to the expenses account in the following year. When is FBT payable on such advances? Is it at the time of making the advance or during the incurring of the expenditure? Section 115WC(2) dealing with the concept of deemed fringe benefits has fastened the liability at the time of incurring the expenditure.

Legally, an expenditure is incurred as and when the liability arises and the same is captured in the accounting system. To elaborate, the expense in question has to be backed by invoice or related evidence to book it as an expense. At the time of advance, there is no definite liability giving rise to the expenditure. This is a fairly settled issue both in accounting and tax law.

Therefore, the FAQ on the subject speaks of liability not at the time of advance but on incurring of expense. It is important to track advances which are part of `loans and advances' and ensure that the liability is crystallised and FBT thereon paid whenever these accounts are reversed as expenses in the following year. At times, advance may be paid in instalments and that will not alter this decision of capturing the expenses at the time of incurring the same.

This naturally leads to the questions: Can some planning mechanism be devised to treat certain expenses as advances for a fairly long time, thereby postponing the incidence of FBT? Will an account classification alone decide the liability for FBT?

Capitalisation of expenses

Accountancy pronouncements have mandated that for a new venture, all expenses, including revenue, are to be treated as pre-production and capitalised up to the date of commercial production. At times, expenses are capitalised and amortised over a period of time based on certain defined criteria.

The I-T law on the subject deals with expenses differently. An expenditure is allowed as a deduction when it is incurred during the previous year unless the statute recognises a spread over — such as in Section 35D (on preliminary expenses), Section 35DD (amortisation of expenditure in case of amalgamation) and Section 35DDA (amortisation under voluntary retirement scheme).

In the world of accounting, amortisation is an accepted concept depending on the type of expenditure.

This does not necessarily mean that this is blessed under the I-T law. Capitalisation of expenses and its implications on FBT are dealt with in FAQ No. 19:

"... Where the expenses are capitalised and amortised over a period, whether FBT will be payable over the whole of the amount capitalised or restricted to the amount amortised during the year?"

Answer: "FBT is payable in the year in which the expenditure is incurred irrespective of whether the expenditure is capitalised or not. However, the same expenditure will not be liable to FBT again in the year in which it is amortised and charged to profit."

Since the principles of FBT cover incurring of expenditure, it does not really matter if the expense is capitalised or not. Once expenditure is incurred, though capitalised in books, it does lead to an illogical situation of paying tax on expenditure that is treated as a fixed asset.

But then one is used to the dictum `Logic and taxation do not go together.' Hence the reiteration that FBT is trial-balance based — as it captures even expenses forming part of fixed assets — and not P&L-account based. Tracking expenses forming part of fixed assets is of paramount importance for determining the correct liability towards FBT.

Housekeeping and data capturing are essential prerequisites in the context of FBT. One has to maintain records compartment-wise, such as a) direct reimbursements; b) deemed fringe benefits forming part of profit and loss account; c) advance payments with FBT implications; and d) expenses capitalised.

Unless this segregation is captured at the source, there will be confusion at the time of assessment proceedings. It is better to be prepared at the threshold than search for information at a later stage.

(The author is a Chennai-based chartered accountant.)

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