The Hindu Business Line : Tax implications of insurance compensation

Mr A is an individual carrying on business. His stock and machinery were damaged and destroyed in a fire accident. The value of stock lost (totally damaged) was Rs 6,50,000. A certain portion of the machinery could be salvaged. The opening written-down value (WDV) of the block as on April 1, 2005, was Rs 10,80,000. During the process of safeguarding machinery and in the fire-fighting operations, Mr A lost his gold chain and a diamond ring, which he had purchased in April 2002 for Rs 1,20,000. The market value of these two items as on the date of the fire accident was Rs 1,80,000.

Mr A received the following amounts from the insurance company: i) towards loss of stock, Rs 4,80,000; ii) towards damage of machinery, Rs 6,00,000; iii) towards gold chain and diamond ring, Rs 1,80,000. You are requested to briefly comment on the tax treatment of the above three items under the provisions of the Income-tax Act, 1961.

The tax consequences in the case of Mr A carrying on business and whose stock, machinery and gold chain destroyed by fire are shown in the Table. The assessee can claim the value of stock destroyed by fire as revenue loss, eligible for deduction while computing income under the head business.

The assessee has received insurance compensation in respect of the machinery destroyed by fire. It has been stated that a certain portion of the machinery was salvaged. The insurance compensation received will go to reduce the block value and any replacement of machinery before the end of the previous year will increase the block value, resulting in no tax implication to the assessee. If the entire block is destroyed and compensation is received there will be short-term capital loss of Rs 4.80 lakh. Since the question does not say anything about fresh addition of assets after obtaining insurance compensation, only short-term capital loss could be computed.

In respect of gold chain and diamond ring it may be noted that these are capital assets. Hence, the excess of consideration received over the cost of acquisition is chargeable to tax as capital gain. Since it is stated that the gold chain and ring were purchased in April 2002 and the fire accident had taken place in the financial year 2005-06, the assessee is eligible for indexation benefit. Since the computation of income is not required to be made, the taxability or otherwise of the compensation is only narrated.

Income of previous year

Briefly discuss about the exceptions to the rule that income of an assessee for a previous year will be charged to tax in the subsequent assessment year.

Exceptions to the rule that income of an assessee for a previous year will be charged to tax in the subsequent assessment year:

Shipping business of non-resident — as contained in Section 172;

Persons leaving India with no intention of returning to India — as per Section 172;

Association of persons (AOP) or body of individuals (BOI) or artificial juridical person formed for particular purpose — as per Section 174A;

Persons likely to transfer property to avoid tax - as per Section 175; and

Discontinued business or profession — as per Section 176(3A).

True or false

Discuss whether the following statements are true or false, as per the provisions of the Central Sales-tax Act:

Definition of `sales tax law' includes `value-added tax law': False.

The term `works contract' has not been defined: True.

For the penultimate sale to be deemed as a sale in the course of export, it is possible only if a declaration in prescribed form is furnished by the dealer selling goods: False. The dealer claiming penultimate sale must obtain Form H declaration from the exporter.

The applicable rate of tax where undeclared goods are sold in an inter-State sale to a registered dealer, if the purchase of such goods is not covered in dealer's registration certificate, is 4 per cent or the State sales tax rate, whichever is lower: False. In the case of inter-State sale of undeclared goods to a registered dealer in respect of goods which is not covered by registration certificate it is 10 per cent or the rate of appropriate state - whichever is higher.

Transfer of goods on payment of hire charges, without transfer of property in the goods, will still constitute sale: True. Sale includes transfer of property in goods in hire purchase/instalment system.

Multiple chioce

i) `Crossing the Customs frontiers of India' means crossing the limits of the area of Customs station in which imported or exported, goods are ordinarily kept: a) after clearance by customs authorities; c) before clearance by customs authorities; d) before being loaded into the ship or carrier; e) none of the above.

The answer is (b).

ii) For any trade, commerce, manufacture, etc. to be treated as `business': a) profit or gain should accrue from such trade, commerce, etc. in all years; b) profit or gain should accrue from such trade, commerce, etc. c) after at least first five years; d) profit or gain need not accrue from such trade, commerce, etc.; e) none of the above.

The answer is (c).

iii) The burden of proving that transfer of goods is otherwise than by way of sale, lies on: a) dealer who claims exemption; b) assessing authority who alleges that it is a taxable sale; c) the carrier who moves the goods; d) None of the above.

The answer is (a).

iv) Amendment of certificate of registration can be made (a) only upon an application made by the assessee; b) by the assessing authority suo motu; c) on an application from assessee, or by the assessing authority suo motu on information received from any other source; d) none of the above.

The answer is (c).

(v) Inter-state sale of stationery to the following class of dealer is liable to tax at the normal rate of 4 per cent or the State Government rate, whichever is lower: a) government department issuing Form D; b) manufacturing company issuing Form C; c) any dealer, provided appropriate form is obtained; d) none of the above.

The answer is (c).

Short notes

Write short notes on the following, with reference to the provisions of the CST Act: a) sale price; b) sale to personnel, consular or diplomatic agent of any foreign diplomatic mission; c) difference between a sale for export and sale in the course of export.

a) As per Section 2(h), sale price means the amount payable to a dealer as consideration for the sale of any goods. It includes any sum charged for anything done in respect of the goods sold by the seller before delivery thereof to the buyer. However, the following sums shall be deducted from the sale price:

Cash discounts allowed to the buyer according to the prevailing trade practice.

Cost of freight or delivery or the cost of installation, provided such costs are separately charged.

A sale price is equal to the valuable consideration payable to the seller in terms of the agreement of sale plus any sum charged for anything done in respect of the goods sold less cash discounts allowed and the cost of freight or delivery charges separately charged.

b) As per Section 6(3), sale to any official or personnel of any consular or diplomatic agent of any foreign diplomatic mission is exempt on sale of such goods, which is notified by the Central Government by notification in the Official Gazette. The notification may also contain such other conditions for the purpose of exempting such sale transaction from the levy of tax.

c) A sale shall be deemed to take place in the course of export if such sale or purchase either occasions such export or is effected by transfer of documents of title to the goods, after the goods have crossed the Customs frontiers of India. Also, any last sale or purchase of goods preceding the export of those goods outside the territory of India shall also be deemed to be in the course of export, if such last sale or purchase was for the purpose of complying with the agreement or order, relating to such export.

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