The Hindu Business Line : Two streams of assessments

UNDER the Income-Tax Act, certain types of expenses are not allowed as a deduction on the ground that they may constitute personal expenses incurred by the assessee. There has been much litigation on what constitutes business expense and what makes up personal expense. The problem is especially acute in the assessment of partnership firms, where the firm may incur expenses ostensibly constituting personal expenses of the partner. Often, personal expenses — such as 20 per cent for petrol, 25 per cent on travel, and so on — are decided on ad hoc basis.

The basis of disallowance has roots in Section 37 of the I-T Act, which places an embargo on allowing any expense that is personal in nature. In the case of corporate assessees, it has been held that the question of disallowance of expenditure on the ground of personal use by the directors will not arise. This principle was laid down in Dinesh Mills Ltd vs CIT (2002 254 ITR 673, Gujarat). Disallowance of expenses in the normal computation has special significance in the context of the fringe benefit tax (FBT). This issue has been addressed in FAQ No. 35 of Circular No. 8/2005 issued by the Central Board of Direct Taxes (CBDT).

FAQ No. 35

FAQ 35: "Whether expenses disallowed under Section 37 of the I-T Act on the plea that the expenses are personal in nature would also be liable to FBT?"

Answer: "Section 37 of the Income-Tax Act provides that any expenditure laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head `profits and gains of business or profession'. Accordingly, any expenditure that is incurred for personal purposes is not allowable as deduction.

"Sub-section (2) of Section 115WB provides for a levy on fringe benefits estimated on a presumptive basis using certain expenses as a measure. To the extent the expenses incurred by the employer are personal in nature and have, therefore, been disallowed under Section 37 of the Income-tax Act, such disallowance would not be liable to FBT."

The circular proceeds on the basis that to avoid double taxation, expenses disallowed as personal in nature will not be liable to the FBT. But this does not address the question: What if the assessee files an appeal against the so-called disallowance relating to the personal expenses? The appellate authority may decide in favour of the assessee. In such a case, will the differential FBT be payable by the assessee? If so, when?

Moreover, it make take two-three years for the appellate authority to come to a decision. How does one go back and revise the FBT returns and pay the tax differential?

The whole issue becomes complicated because the normal income-tax assessment is an independent process and is completely delinked from FBT assessment. Both operate independently.

One is not clear if different assessing officers would be dealing with these assessments. Herein lies the issue of implementation and harmonisation of the process of assessments. At times, expenses disallowed as personal may travel through appellate forums and be decided by the Supreme Court. This will leave FBT assessments in a state of uncertainty and may require frequent modifications depending on the appellate orders.

Since the FBT is essentially a tax on various forms of expenses, assessments under it should have been interwoven and interlinked with income-tax assessments. Only this can ensure correlation of issues and easier settlement of disputes. In operating the FBT separately, the lawmakers have created an unnecessary divide which will result in more complications and additional administration costs for monitoring two streams of assessments.

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

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