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Vol 2
 Foreword
In the rapidly changing economic scenario, where the economic transactions are happening across
the borders and becoming more and more complex by the day, the tax authorities are required
to keep themselves updated on the important developments in various trades and industries. The
latest information on the cutting-edge developments in various sectors of economy are a must for
the tax investigators. Therefore, a need was felt to revise the write-ups on various important, as well
as upcoming sectors of economy, as a lot of changes have occurred since the existing ‘Manual on
Techniques of Investigation’ was last released in the year 2002.
Two volumes (i.e. Volume 1 and 2) of the Manual have already been revised. Volume 3 and 4 of this
Manual have also been updated now.
Volume 3 covers twenty industries and trade, encompassing conventional manufacturing, hospitality
and services industry. The impact of introduction of GST and GST related tax evasion has been
discussed in relevant chapters. The use of Tally and ERP software for tax evasion has also been
explained with examples in the chapter ‘Engineering Industry’. Further, tax-related issues arising in
Joint Ventures with foreign multi-national corporations and foreign manufacturers, the TP issues,
analysis of segment wise performance have also been discussed in the chapter ‘Automobile Industry’.
The tonnage scheme and the issues involved in international shipping companies have been
incorporated in the Chapter on ‘Shipping Industry’.
Volume 4 contains write-up on ten sectors of industry and economy including multi-national
corporations, information technology companies, e-Commerce, broadcasting and television industry,
event management & advertisement industry. The contemporary tax related challenges pertaining to
these sectors of industry have been discussed in a nuanced manner.
I would like to reiterate my special appreciation for the efforts of all the members of the Committee
and other officers associated with the enormous task of updating and writing this Manual. I hope
that these Volumes shall be able to meet the expectations of all the stakeholders and would act as a
guiding light while conducting tax-related investigations.

New Delhi
Dated: 09/09/2019 (Pramod Chandra Mody)
Chairman and Member (Investigation)[i/c]
Central Board of Direct Taxes

[ v ]
 Preface
The Board had constituted a Committee on 27.11.2017 to review and update the departmental
publication of “Techniques of Investigation Manual” (Vol. 1 to 5) 2002. The Committee had decided
to bring the manual in seven volumes. The first two volumes had introductory and general chapters
whereas the rest of the volumes would cover specific business/ industry wise write-ups. The work
involved re-writing the existing chapters incorporating the changes undergone in last sixteen
years and also including many new chapters. The Volume 1 & 2 was presented to the Chairman,
CBDT in the month of December, 2018. The Volume 1 had dealt with general issues arising in tax
administration, investigation & examination of accounts for the purpose of drafting good assessment
orders etc. However, all the topics of Volume 2 were new covering TP&IT issues, Black Money Act,
PMLA, GST, Investigation of undisclosed foreign assets, Accommodation entries, Penny stock & shell
companies, Digital Evidence and Forensic, Bitcoins & Cryptocurrencies, NCLT, Commodity, Money
and Currency Market etc.
The Committee has great pleasure in now bringing out the Volume 3 of the Manual. This volume
incorporates write-up on twenty industries and trade, identical with the second volume of 2001
edition, except that topic ‘Computer Training Institutes’ has been excluded. As the computer training
has now become part of basic curriculum and the essential features of this sector is already part of
‘Educational & Coaching Institutes’, this separate write up has been done away with.
As the basic concepts and process of the industries have not undergone change, we have Utilised the
material available in the earlier volume. At the same time there is value addition to them taking into
account the new processes and the new issues in avoiding or evading the taxes. Most of the topics
have been revised incorporating the refinements undergone in old methods and incorporating the
changes in the statute and the procedures. The recent judicial pronouncements on the relevant topics
have also been incorporated.
In the chapter ‘Engineering Industry’ the impact of GST has been discussed in detail, incorporating
the accounts to be maintained and various returns to be filed under GST. Further, use of Tally and
ERP software for tax evasion has also been discussed in detail and explained with examples. The
GST related tax evasion having impact on income has been discussed in the chapter ‘Handloom and
Powerloom’. The ‘e-way billing’ pursuant to GST and coordination with the GST authorities in this
regard has been included in the ‘Road Transport’. The scope of the topic ‘Hosiery Industry’ has been
widened by including all kinds of fabric, in place of only woollen fabric discussed in earlier volume.
The concept of benchmarking of various ratios of the industry as a whole vis-a-vis those of Indian
manufactures, JV with foreign MNC and foreign manufactures has been discussed in the chapter
‘Automobile Industry’. Further, the TP issues in automobile sector, investigation of AMP and analysis

[ vii ]
of segment wise performance has also been discussed. In the ‘Power and Energy’ sector; the recent
trends, key challenges of the sector and various taxation issues have been discussed in great detail.
The issues of applicability of MAT as well as international taxation and TP issues have also been
dwelt upon in this chapter.
The tonnage scheme and the issues involved in international shipping companies have been
incorporated in ‘Shipping Industry’. Similarly, the profession of Sports professionals and Painters,
Sculptors & Fine Artists has been included in ‘Other Professions’. The manipulation of computerized
accounts in the case of standalone restaurants detected in the course of search and surveys has been
supplemented in ‘Hospitality Industry’. In the chapter on ‘Charitable Trusts and Institutions’ the recent
changes in the nature of charitable activity and the various issues involved in the registration and
assessment of Trusts are discussed in great detail. The issues pertaining to trusts and societies, which
run the educations institutes, have been focussed upon in the chapter ‘Educational and Coaching
Institutes’.
We hope that the material compiled in this volume will provide necessary guidance and help to the
Officers and will be a reference point for times to come. The Committee acknowledges the effort of
all the officers who have contributed and made value addition for compilation of this Volume. We are
thankful to the Editorial Board for going painstakingly through the write-ups and for their valuable
inputs.

N.P. Sinha
Chairman of the Committee

[ viii ]
 Acknowledgments
CONTRIBUTORS TO VOLUME 3

Shri Binay K. Jha Chief Commissioner of Income-Tax, Ludhiana

Shri A.D. Mehrotra Chief Commissioner of Income-Tax, Ahmedabad
Shri K.K. Singh Chief Commissioner of Income-Tax (OSD), Mumbai
Mrs. Lekha Kumar Pr Commissioner of Income-Tax-11, Mumbai
Shri Rakesh Mishra Pr Commissioner of Income-Tax-13, Mumbai
Shri Yogesh Pandey Pr Commissioner of Income-Tax, Bangalore
Shri Anand Kumar Pr Director of Income-Tax (Inv.), Mumbai
Shri Rajiv Nabar Pr Commissioner of Income-Tax, Surat
Shri Rajkumar Lachhiramka Pr Commissioner of Income-Tax, Ahmedabad
Shri R.K. Sinha Commissioner of Income-Tax (A), Ahmedabad
Shri Pratap Singh CIT (TDS), Mumbai
Shri Debashish Chanda Commissioner of Income-Tax (A), Mumbai
Shri Vivek Wadekar Commissioner of Income-Tax (A), Ahmedabad
Shri Sreenivas Bidari Commissioner of Income-Tax (A), Ahmedabad
Shri Sanjeev Shankar DIT (I&CI), Pune
Shri M. Rathinasamy ADG (Vig), Chennai
Shri Jasdeep Singh CIT (TP), Chennai
Shri L.K.S. Dehiya CIT (DRP)-1, Mumbai
Shri N.K. Chand CIT (TP)-1, Mumbai
Shri V. Vivekanandan CIT (TP)-3, Mumbai
Shri S.C. Tiwari CIT (DRP)-1, Mumbai
Shri Ajit K. Srivastava CIT (A)-17, Mumbai
Shri Antony Pariath Addl. CIT, Ahmedabad
Shri Arvind Sontakke JCIT, Ahmedabad
Shri Santosh Kumar Karnani Addl. CIT, Ahmedabad
Shri Mahesh Jiwade Addl. CIT, Ahmedabad

[ ix ]
Shri Rahul Kumar Addl. CIT, Ahmedabad
Shri Anil Dhaka Addl. CIT, Ahmedabad
Shri Vipul Agrawal Addl. Commissioner of Income-Tax, Delhi
Shri Sambit Mishra Addl. CIT (TP) Mumbai
Shri Ramapriya Raghavan Addl. CIT (TP) Mumbai
Shri Mukund M. Chate Addl CIT (TP), Mumbai
Shri Lovish Kumar Addl. CIT (I&C), Mumbai
Shri Shiddaramappa Addl. CIT R-20(3), Mumbai
Kappatanvar
Shri J. Saravanan Addl. CIT-28(3), Mumbai
Shri D.V. Singh Addl CIT 12(3), Mumbai
Shri J.X. Peter JCIT (TP), Chennai
Mohd. Mustafa JCIT (TP), Chennai
Shri K.N. Dhandapani JCIT, Bangalore
Shri Manish Kasodekar DCIT (HQ) to CCIT 7, Mumbai
Shri Drop Singh Meena DDIT (Inv.), Ahmedabad
Smt. Nayana Krishn Kumar DCIT, Ahmedabad
Shri Rajiv Garg DCIT (TP) Mumbai
Shri Bhagwati Charan DCIT 5(2)(1), Mumbai
Shri P. Saikrishna ACIT 2(3)(1), Mumbai

[ x ]
 Committee for Review and Updating of Manual
of
Techniques of Investigation
for Assessment

Sr. No. Name Designation Station Position

1 Shri Vinodanand Jha Chief CIT (Since Retired) Mumbai Chairman

2 Shri N.P. Sinha Chief CIT Mumbai Chairman

3 Shri K.K. Vyawahare DGIT (Inv.) Mumbai Member

4 Shri A.D. Mehrotra Chief CIT Ahmedabad Member

5 Shri Harish Kumar DGIT (Inv.) New Delhi Member

6 Shri Nilimesh Baruah Chief CIT (Since Retired) New Delhi Member

7 Shri Pravin Kumar Pr. DIT (Inv.) Hyderabad Member

8 Shri Alok Johri Pr. DIT (Inv.) Raipur Member

9 Shri Yogendra PCIT Mumbai Member

Choudhary Secretary

10 Shri Sunil Kumar Singh CIT (Inv.) CBDT Member

[ xi ]
Editorial Board for Volume 3
Shri N.P. Sinha
CCIT(C)-2, Mumbai

Shri K.K. Vyawahare

DGIT(Inv.), Mumbai

Shri C.S. Gulati

CIT(A)-1, Mumbai

Shri Rajeshwar Yadav

CIT(A)-47, Mumbai

Shri L.K.S. Dehiya

CIT(DRP)-1, Mumbai

Shri Ajit K. Srivastava

CIT(A)-17, Mumbai

Shri Kumar Sanjay

CIT(A), Mumbai

Shri Sunil K. Jha

CIT(DRP)-2, Mumbai

Shri Vivek Anand Perampurna

Addl CIT, CR-7, Mumbai

[ xii ]
 Committee for Selection of Key Phrases/
Key Words for Index of Volume 3

Shri Adarsh Kumar Modi CIT (TDS), Pune Chairman

Shri Amit Bobde JCIT (TP)-2, Pune Member

Shri Sudhanshu Shekhar JCIT (Range-5), Pune Member

[ xiii ]
 Foreword v
 Preface vii

 Acknowledgments ix

 Committee xi
 Editorial Board xii

 Committee for Selection of Key Phrases/ Key Words for Index of Volume 3 xiii

1. Engineering Industry 1

2. Cotton Textile Industry 23

3. Handloom and Powerloom 39

4. Process House 49

5. Hosiery Industry 57

6. Woollen Mills 69

7. Woollen Carpet Industry 79

8. Packaging Industry 89

9. Automobile Industry 99

10. Bicycle Industry 113

11. Power and Energy 117

12. Ship Breaking Industry 139

13. Road Transport 165

[ xv ]
14. Shipping Industry 175

15. Medical Profession & Nursing Homes 191

16. Other Professions 201

17. Hospitality Industry 213

18. Travel and Tour Industry 221

19. Charitable Trusts and Institutions 231

20. Educational & Coaching Institutes 247

Index 269

[ xvi ]
 Chapter

1
Engineering Industry

1.  INTRODUCTION
1.1 According to Webster’s dictionary (1961
Edition), the word ‘Industry’ means (i) systematic
labour especially for the creation of value, (ii) a
department or branch of craft, art, business or
manufacture, a division of productive and profit-
making labour especially one that employs a
large personnel and capital in manufacturing,
and (iii) a group of productive or profit making
enterprises or organisations that have a similar
technological structure of production and that
produce or supply technically substitutable a. NAS National Accounts of Statistics:
goods, services or sources of income. This compiled and published by Central
definition has been referred to by the Hon’ble Statistics Organisations
Supreme Court in the case of Harakchand b. IIP Index of Industrial Product: prepared by
Ratanchand Banthia vs. Union of India 1969 Department of Industries (Govt. of India)
(SCC) 166.
c. ASI Annual Survey of Industries:
1.2 Industrial Sector: Industrial sector Governmental Survey
consists of five sub-sectors as under:
d. RBI Bulletins Published by Reserve
a. Procurement and processing of raw Bank of India after survey of Industries.
material
e. CMIE Surveys of different Industrial
b. Manufacturing and production sectors published by Centre for Monitoring
c. Mining and quarrying Indian Economy.
d. Electricity, energy, gas and water supply 1.4 Production Process: It is necessary for
an AO to have an overview of the production
e. Engineering Industry
process, for being able to make basic judgments
1.3  Source of Output/ Value Added Data: of the various claims being made before him. For
There are five distinct sources of output/ value- this, he must have information on the following
added data of the industrial sector: points:

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Techniques of Investigation for Assessment Vol. 3

a. Product types, varieties o. Electric wire and cable producing machines

b. Manufacturing process p. Machines used for production of bolts,
c. Number and levels of workers involved in nuts, rivets and washers
manufacture q. Jute, textile and netting machinery
d. Input-output ratios r. Batteries manufacturing machines
e. Capital investment per unit of production s. Railway coaches and wagons
of main items manufacturing machinery
f. Physical measures/ value of output,
t. Mechanical pumps machinery
installed capacity and its utilisation, etc.
g. Type/ level of technology/ automation. u. Earth moving machinery
h. Profitability ratios. v. Harvester machinery
w. Bright steel bars and shafting machinery
2.  ENGINEERING INDUSTRY
x. Steel melting works machinery
2.1  Engineering Industry has a very wide reach
y. Steel rolling mills machinery
and coverage in terms of the variety of products,
the level of technology, the size/ capacity, z. Household goods manufacturing machines
geographic dispersal, and levels of employment aa. Power-driven pumps
potential. Some of the main products of this
Industry are: The National Industrial Classification Code 1998
(NIC) gives descriptive classification of groups,
a. Electric motors class, sub-class of engineering Industries. This
b. Automobile and auto parts manufacturing is available in the market, under Central Excise
machines Classification/ Valuation publications. Basically,
the Engineering enterprises are classified as
c. Hand tools manufacturing machines
Heavy engineering enterprises and Light
d. Mathematical instruments engineering enterprises.
e. Locomotive machineries 2.2  Heavy Engineering Enterprises: Heavy
f. Machinery related with ships and aircrafts engineering enterprises are basically industries
producing machines, heavy vehicles, motors,
g. Bicycles, motorbikes and auto cycles etc. For example, Larson and Toubro, Bharat
h. Auto Rickshaws, tempos etc. Heavy Electricals Ltd., Hindustan Aeronautical
Ltd., Bharat Engineering Works, Hindustan
i. Boilers and steam generating plants
Machine tools. These are capital intensive, their
j. Steam engines, turbine and internal ownership patterns vary and their gestation
combustion engines periods are large. They can be in Public or
k. Electrical machines and appliances Private sector.
manufacturing machines 2.3 Light Engineering Enterprises: Light
l. Tele-communication equipment machinery engineering enterprises are mainly those industries
which produce common consumer/ engineering
m. Radio and electronic equipment machinery goods, with or without sophisticated technology.
n. T.V., A.C, refrigerator, wireless, mobile These can be industries producing marketable
phone manufacturing machines products with independent manufacturing units,

2
 Engineering Industry

or ancillary industries dependent upon other big b. Industries using tin plates, tin bars,
industries manufacturing engineering machinery, galvanized plates, & iron sheets.
goods, etc. Some examples of these are: c. Industries using nonferrous metal and
a. Watch manufacturing units alloys.
b. Rerolling units d. Industries using copper, zinc and lead.
c. Steel rods and sheets manufacturing units e. Metal products industries, like producer of
wire nails, nuts, bolts, spanners, utensils,
d. Metal Box industry razor blades, wire ropes.
e. Container manufacturing units f. Non-electrical machinery industries which
f. Bucket producers produce machines for mining, cotton
textile, jute mills, sugar mills, cement, pulp
g. Hurricane lanterns manufacturers and paper, earth movers, tractors, machine
h. Stove manufacturers tools, typewriters, calculators, sewing
machines, ball bearings, compressors,
i. Cycle and automobiles parts manufacturers batteries etc.
j. Bearing manufacturers g. Industries which manufacture electric
k. Small pumps producers machinery, appliances, instruments etc.,
switch gear and control gear, transformers,
l. Hand set pump producers electric fan, electric lamp, electric motor,
m. Diesel oil engine manufacturers electric wires and cables.
n. Sheet metal parts manufacturers h. Electronic industries which include
manufacturers of radio sets, photo camera,
o. Rubber based industries X-rays machine, sonography machine,
p. Plastic components manufacturers T.V. sets, mobile phone sets, wireless,
transmitters, computer and related
q. Small industrial machinery and parts equipments.
manufacturers
i. Transport equipment manufacturing
industry, which includes the automobiles
3.  MANUFACTURING PROCESS
industry-cars, trucks, three wheelers, two
3.1 Raw Materials: Engineering industries wheelers, buses, motorcycles, cycles and
include a large number of industries, producing their equipments and parts.
a variety of goods. The exact raw material used j. Other industries, manufacturing items like
by a particular industry will depend upon the watches and clocks, house service meters,
finished goods it is producing and the technology scientific instruments, surgical instruments,
it is using. Therefore, it is necessary to ascertain asbestos brake lining, grinding wheels etc.
the particulars of the raw materials being used
The basic raw materials and components are
and the source of their supply in a given case.
procured from definite sources which might be
A broad classification of the engineering a steel plant, an aluminum plant or other large
industries, in terms of their finished products can plants making various grades of metals. At times
be as under: these raw materials are procured from open
a. Industries using basic metals, alloys and market from traders. The quantity details of the
steel products. consumption of raw material and its opening

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Techniques of Investigation for Assessment Vol. 3

and closing Stock can be available if records a. Split-Phase: Owing to their high starting
are maintained methodically. The range of currents, split-phase motors are generally
wastage and process losses in a particular type used for loads of low inertia and frequent
of Light Engineering Industry can be determined starting. Where a higher starting current
and compared with other units in the same can be tolerated, motors of the higher
line of business using similar raw material and torque rating can be used.
technology. b. Capacitor-Start Induction-Run: These
motors, having higher starting torques
3.2 Manufacturing: It is essential for an AO to
and low starting currents than split-phase
have full knowledge of the manufacturing process
motors, are more suitable for loads of
in a given case. Without this, he will not be able
higher inertia and more frequent starting.
to judge the reasonableness of the production
results, yield, burning losses, shortages and c. Capacitor-Start Capacitor-Run: These
the input: output ratio. Some of the heavy motors have characteristics similar to
engineering Industries involve complicated capacitor-start induction-run motors, but
are useful when greater degree of quietness
manufacturing process. Similarly, some light
or a higher efficiency and power factor are
engineering industries may also have complex
desired.
activities of manufacturing. There would not be
a common manufacturing process because of d. Capacitor-Start and Run: These motors
the varieties of the industries and their products. are useful where low starting torques are
However, some steps of manufacturing process acceptable. They are also generally quieter
than split-start induction-run motors.
may be common. An Assessing Officer will have
to comprehend full details of manufacturing e. Shaded-Pole: These motors are suitable
process in a given case. While going through for all applications where only very low
the whole process one has to be clear about the starting torque is required and motor
technology and quality of machinery used by the efficiency is unimportant.
assessee. If a manufacturing unit employs latest f. Universal: These motors are series-wound
technology using sophisticated manufacturing or compensated series-wound, which may
process, it would be able to process the raw be operated either on direct current or single-
material and consumables in a more efficient phase alternating current at approximately the
way giving better production in terms of quantity same speed and out-put, and are suitable for
as well as quality, as compared to a unit which applications where speeding up on light loads
employs a labour-intensive, out dated technology is desirable. In these motors, it is possible to
or older technology. The exact manufacturing get gradually high speed. Therefore, they are
process will vary from industry to industry. An suitable for domestic mixers, grinder juicers,
overview of the manufacturing process in some sewing machines, domestic mono-block
pumps etc.
of the major engineering industries is given in
succeeding paragraphs. Capacitor-start Induction-Run, and Capacitor-
Start Capacitor-Run motors are mainly used by
4.  ELECTRIC MOTORS the cottage industries, for domestic mono-block
pumps, domestic grinders, washing machines,
4.1  Electrical motors can be either of DC type air conditioners, exhaust fans, bore-well
or AC type. The AC motors can also be either pumps, cooking Chula, water cooler, air cooler,
single phase or three phase. Single phase AC refrigerator, etc.. Due to such wide applications,
motors can again be of several different types, there is big market of these motors. Indian
depending upon their usage, as under: Standard specifications for single phase small AC

4
 Engineering Industry

and Universal Electric Motors IS: 996–1964 have l. Fixing insulation paper in slot of stator.
been issued by Indian Standard Institution. Testing m. Inserting coil in stator slots.
guide lines, 7572–1974 are also published by the
ISI. Separate publications are also published by n. Winding coil connection.
the ISI for special purpose motors. o. Winding pre-heating at 120 C in oven for
4.2  There are three main types of 3-Phase 1 hr.
motors, viz.-Squirrel Cage Induction Motors, p. Winding high voltage insulation test.
Slipring Electric Motors, Synchronous Electric
Motors. These have their own advantages and q. Winding varnishing.
disadvantages. Industries select the motors as r. Varnish curing in oven at required
per their applications/ sustainability. SSI Units temperature.
manufacture mostly upto to 10 HP motors. s. Fixing bearings on shaft.
Motors below 10 HP are mainly in Squirrel cage
only. The Squirrel cage motor has two main t. Assembling the motor.
parts, i.e. stator and rotor. These are made from u. Routine or type testing of motor.
laminations (stampings). The stator has 24 to
v. Terminal connections.
36 slots. Depending upon the requirements of
speed of motor, manufacturers wind the stators w. Colour processing
with enameled copper wire. These motors are x. Registration and labeling.
made of copper bars threaded through slots in
a laminated rotor core, with their ends short-
5.  CENTRAL AIR CONDITIONING
circuited with short ring. Some manufacturers
PLANTS
use aluminum die cast rotor. Generally, most
of the SSI units procure these die cast from Central air conditioning plants comprise of
lamination manufacturer or get these made on compressors, condensers, air-handling units,
job basis from die cast industries. water chillers and cooling towers. It also
includes pumps, gauges, ducts, and cables. The
4.3  The various stages involved in manufacture compressors used in vapour compression plants
of motors can be listed as under: are of three types:
a. Casting enclosures of motor with the help a. Reciprocating Compressor.
of patterns.
b. Screw Compressor.
b. Machining of motor body.
c. Centrifugal Compressor.
c. Machining of motor side cover. All or some of these parts may be manufactured
d. Machining of motor shaft. in-house, and remaining purchased from outside
sources for assembling.
e. Machining of motor shaft-rotor.
f. Grinding of motor shaft-rotor. 6.  BATTERIES
g. Drilling all parts of enclosures. Battery is a power generating device which
converts stored chemical energy into work
h. Binding stator lamination on press.
of an electrical nature. There can be Primary
i. Fixing of stator inside body on press. batteries (which are not rechargeable, and are
used in electronic equipments); and, Secondary
j. Winding coil from super enameled wire.
Batteries (which are electrically rechargeable,
k. Cutting the insulation paper. eg., Lead Oxide and Nickel Cadmium).

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Techniques of Investigation for Assessment Vol. 3

7.  BEARING INDUSTRY CNC version machines are being imported, and
work on 3-axis control. Now-a-days “zero error”
7.1  Bearing industry has grown up substantially
gear motors are being manufactured which need
in Saurashtra, North India and Bangalore region.
higher kinematics.
Bearings facilitate the relative motion of metal
surfaces in contact, with limited consumption of
energy. This lowers the friction and thereby the 9.  CONTROL OF VARIOUS
energy required. The roller bearings consist of GOVERNMENT DEPARTMENTS
an inner ring, an outer ring, a cage, and rolling 9.1  Various engineering industries come
elements. Roller bearings are divided according under the statutory control of various different
to the type of the roller as under: departments, e.g., GST, Pollution Control,
a. Taper Roller Bearings Factory Inspector, Industries, Labour, Consumer,
Weights & Measures, Electricity Boards, Fire
b. Cylindrical Roller Bearing safety, etc. Besides, they have dealings with
c. Needle Roller Bearings banks and financial institutions.
d. Spherical Roller Bearings 9.2  Information furnished to these departments
7.2 Roller bearings are different from ball can be a good source for the AO. For example, an
bearings. Ball bearings have higher limiting industrial gas producing unit might be disclosing
speeds than roller bearings. Manufacturing of a lower yield ratio in its books, whereas in the
bearings comprises of following stages: project report submitted to the Pollution Control
Department or Energy Department or District
a. Inner recess Industry Centre, it might disclose the actual yield.
b. Outer recess The yield factor is part of Form 3CD, both for
trading and manufacturing concerns. This can
c. Rollers
be cross-checked with various other sources or
d. Cages technical journals and project reports pertaining
e. Assembly, and to the specific Industry. Burning loss can be
compared with the average burning loss from
f. Technical inspection
reputed journals. Scrap generated is also closely
Inner recess involves face grinding, large outer- related to the consumption process as the scrap
grinding, bore-grinding, side-cut rough grinding, is generated in the production process. Many
side-cut finish grinding, track rough/ finished industries do not report the scrap or contend
grinding, dimensional and visual assembly. At that these have no value. This may need further
the time of final assembly, a technical inspection investigation.
is made to check the bore and outer dimensions;
the height of Taper roller bearing; the radial 9.3 Similarly, information given to banks
run of outer race with reference to stationary may be materially different from that given in
inner race; and, the perfection of contact angle the books of accounts. The industries regularly
between rolling elements and the recess. hypothecate the stock for procuring working
capital or fixed assets. This is an important
source for ascertaining the stock at a particular
8.  GEARS point of time and the stock so ascertained can be
Earlier most of the gear manufacturing machines matched with the stock as per books. This may
were based on conventional technology but now result in detection of undisclosed production or
gear engineering and gear motors manufacturers out-of-books sale, particularly when detailed
have switched over to CNC versions. The latest stock statement is provided to the Bank.

6
 Engineering Industry

9.4  Electricity consumed: Engineering industries (iii) Shops and Commercial Establishments
consume substantial electricity. It has come to Act (of respective States)
light in many cases that the day-wise electricity (iv) Contract Labour (Regulation and
consumption figure varies abruptly with respect Abolition) Act, 1970
to corresponding production figures. This may
happen where books are back-dated and are (v) Inter-State Migrant Workmen (Regulation
also pointers to out-of-books production and of Employment and Conditions of
sale. This aspect should be closely scrutinised, Service) Act, 1979
which may yield substantial results in certain (vi) Weekly Holiday Act, 1942
industries like casting, blast furnaces etc.
(vii) National and Festival Holidays Act (of
9.5  Industrial Laws Applicable to respective States) 1963
Engineering Industries: Engineering
(viii) The Plantation Labour Act, 1951
industries are subject to several important
industrial legislations relating to safety, labour (ix) The Mines Act, 1952
welfare, consumer welfare, quality control, etc. (x) The Dock Workers (Safety, Health &
Sometimes actions under these laws by the Welfare) Act, 1986
concerned departments can give important clues
to the Assessing Officer. Some of these central e. Laws Relating to Equality and
laws are as under: Empowerment of Women

a. Laws Relating to Industrial Relations (i) Equal Remuneration Act, 1976

(i) Industrial Disputes Act, 1947 (ii) Maternity Benefits Act, 1961

(ii) Trade Unions Act, 1926 f. Prohibitive Labour Laws

b. Laws Relating to Wages (i) Bonded Labour System (Abolition),

Act, 1976
(i) Minimum Wages Act, 1948
(ii) Child Labour (Prohibition &
(ii) Payment of Wages Act, 1936 Regulation) Act, 1986
(iii) Payment of Bonus Act, 1965 (iii) The Beedi and Cigar Workers
c. Laws Relating to Social Security (Conditions of Employment) Act, 1966
(i) Employees’ Provident Funds and (iv) The Sexual Harassment at the
Miscellaneous Provisions Act, 1952 Workplace (Prevention, Prohibition
(ii) Employees’ State Insurance Act, 1948 and Redressal) Act, 2013

(iii) Labour Welfare Fund Act (of respective g. Laws Relating to Employment and
States) Training

(iv) Payment of Gratuity Act, 1972 (i) Apprentices Act, 1961

(v) Employee’s Compensation Act, 1923 (ii) Employment Exchanges (Compulsory

Notification of Vacancies) Act, 1959
d. Laws Relating to Working Hours,
Conditions of Services and Employment 9.6  Most of these laws have a direct relevance
for the assessment proceedings. For example,
(i) Factories Act, 1948 Factories Act 1948 imposes certain obligations
(ii) Industrial Employment (Standing and responsibilities on the occupier of factory.
Orders) Act, 1946 As per Section 7 of this Act occupier shall, at

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Techniques of Investigation for Assessment Vol. 3

least 15 days before he begins to occupy or use a. Building and Other Construction
any premises as a factory, send to the Chief Workers (Regulation of Employment and
Inspector a written notice containing name and Conditions of Service) Act 1996;
situation of factory, name and addresses of
b. Contract Labour (Regulation and
occupier and owner of the premises, nature of the
Abolition) Act 1970;
manufacturing process carried on in the factory,
total rated horse power installed in premises, c. Equal Remuneration Act 1976;
name of the manager of the factory, number of
d. Inter-State Migrant Workmen (Regulation
workers likely to be employed, average number of
of Employment and Conditions of Service)
workers per day employed and other particulars.
Act 1979;
This information submitted to the competent
authority is relevant for assessment proceeding. e. Mines Act 1952;
There may be a situation that factory has already
f. Minimum Wages Act 1948;
been started but return of income is filed later
concealing the date of start of manufacturing g. Payment of Wages Act 1936;
process or completion of project or installation of h. Sales Promotion Employees (Conditions
plants etc. The actual date of start of operation of Service) Act 1976; and
can be ascertained for the purpose of deduction
u/s 10 or u/s 80I, which is often in dispute. An i. Working Journalists and Other Newspaper
AO can find out the date of actual installation of Employees (Conditions of Service) and
the plant and machinery, where there is dispute Miscellaneous Provisions Act 1955,
about claim of depreciation. Again, u/s 62 of (collectively referred to as the Specified Labour
the Factories Act 1948 manager of the factory Laws).
has to maintain register of adult workers, which
can be scrutinised to check the correctness of The 5 (five) types of combined registers required
the claims of expenditure on salary or wages. to be maintained under the Specified Labour
U/s 110 of Factories Act, the manager, occupiers Laws, include:
or owners of the factory have to submit returns a. Employee Register;
periodically to the concerned authority, which
b. Wage Register;
can be a source of information for the AO.
The registers maintained also throws light on c. Register of Loan/ Recoveries;
the items in the closing stock, besides the use d. Attendance Register; and
of raw material etc. in the production process.
Similarly, information submitted under the e. Register of Rest Days/ Leave account of
Payment of Bonus Act, Payment of Gratuity Act, employees/ Leave with Wages.
and Employees Provident Funds Act 1952, can The format of employee register contains different
become important source for an AO. entries, e.g. Employee Code, Name, Surname,
Gender, Father’s/ Spouse Name, Date of Birth,
9.7  The Ministry of Labour and Employment,
Nationality, Education Level, Date of Joining,
Government of India has notified the Ease of
Designation, Address, Type of Employment,
Compliance to Maintain Registers under various Mobile, UAN,PAN,ESIC, IP, AADHAAR, Bank
Specified Labour Laws Rules 2017 (Ease of A/c Number Bank etc. All these information may
Compliance Rules). The Ease of Compliance come in handy in ascertaining actual labour/
Rules enables an employer to maintain 5 (five) employee expenses. Labour charges/ employee
types of combined registers under the following expenses are substantial in manufacturing/
labour laws: construction industries. One should verify the

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 Engineering Industry

muster rolls/ wage register and other related the goods to the end comsumer at Rs. 700. The
registers maintained under Factories Act, Labour tax to be paid @ 10% is Rs. 70. but since he has
laws etc. Corresponding compliance with PF/ already paid Rs. 60, he needs to pay only Rs
ESIC Act also needs to be verified to ensure that 10/- extra. The total tax levied, therefore, comes
no bogus amounts are claimed. to Rs 40+10+10+10= 70/-.
10.3 There are 3 taxes applicable under this
10.  GOODS & SERVICES TAX system: CGST, SGST & IGST.
10.1  Goods & Services Tax Law in India is a a. CGST: Collected by the Central
comprehensive, multi-stage, destination- Government on an intra-state sale (eg:
based tax that is levied on every value within Maharashtra)
addition. In simple words, Goods and Service
Tax (GST) is an indirect tax levied on the supply b. SGST: Collected by the State Government
of goods and services. This law has replaced on an intra-state sale (eg: within
many indirect tax laws that previously existed Maharashtra)
in India. GST is one indirect tax for the c. IGST: Collected by the Central
entire country. GST is an Indirect Tax which Government for inter-state sale (eg: from
has replaced many Indirect Taxes in India. The Maharashtra to Tamil Nadu)
Goods and Service Tax Act was passed in the
Parliament on 29th March 2017. The Act came In most cases, the tax structure under the new
into effect on 1st July 2017. regime will be as follows:

10.2  Under the GST regime, the tax is levied New Old
Transaction
at every point of sale. GST is applicable on Regime Regime
each value addition to the product. GST has VAT + Revenue will be
thus removed the cascading effect as the tax is Central shared equally
Sale within CGST +
Excise/ between the
calculated only on the value-addition at each the State SGST
Service Centre and the
stage of the transfer of ownership. For example tax State
a manufacturer who makes bearings buys steel
There will only
and other consumables. Assume that the cost be one type of
of raw material is Rs. 400 including tax @10% Central tax (central) in
of Rs. 40. The value of the input materials Sales case of inter-state
increases as the bearing is manufactured.The Sale to
IGST
Tax + sales. The Centre
manufacturer then sells it to the wholeseller for another State Excise/ will then share
Service the IGST revenue
Rs. 500 with a margin of Rs. 100. The tax @
Tax based on the
10% comes to 50 but since he has already paid destination of
Rs 40 on input items, therefore, he is required goods.
to pay only Rs. 10 extra. The wholeseller packs
required number of bearings in packs and labels 10.4  The following is the list of indirect taxes in
it with further addition of value after which he the pre-GST regime which has been replaced by
sells it to the retailer. Let us assume that he sells CGST, SGST, and IGST:
the goods to retailer at Rs. 600. He has to pay a. Central Excise Duty
tax @ 10% at Rs. 60 but since he has already
paid tax of Rs. 50, therefore, he needs to pay b. Duties of Excise
only Rs. 10 extra. The retailer may package the c. Additional Duties of Excise
bearings in smaller quantities as per orders and
also invests in the marketing and promotion of d. Additional Duties of Customs
the product thus increasing its value. He may sell e. Special Additional Duty of Customs

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Techniques of Investigation for Assessment Vol. 3

f. Cess GSTR 2: Information relating to inward

supplies of products and services
g. State VAT
by registered taxable recipients.
h. Central Sales Tax The return due date will be the 15th
i. Purchase Tax day of the following month.
j. Luxury Tax GSTR 2A: Information relating to auto-drafted
k. Entertainment Tax supplies from GSTR 1 or GSTR 5
l. Entry Tax to the recipient.

m. Taxes on advertisements GSTR 3: This is a monthly return based

on the finalisation of information
n. Taxes on lotteries, betting, and gambling relating to outward supplies as
However, the chargeability of CST for Inter-state well as inward supplies in addition
purchase at a concessional rate of 2%, by issue to the payment of tax amount by
and utilisation of C-Form is still prevalent for registered taxable persons. The
certain Non-GST goods such as: return due date will be the 20th day
a. Petroleum crude; of the following month.
b. High-speed diesel; GSTR 3A: Notice to return defaulter under
Section 46 of the Central GST Act,
c. Motor spirit (commonly known as petrol); 2017.
d. Natural gas; GSTR 4: Quarterly return for registered
e. Aviation turbine fuel; and individuals who have selected the
composition levy by composition
f. Alcoholic liquor for human consumption suppliers. The return due date will
in respect of following transactions only: be the 18th day of the month next to
quarter.
a. Resale
GSTR 4A:
Auto-drafted information for
b. Use in manufacturing or processing
registered individuals who have
c. Use in the telecommunication network or in chosen the composition levy.
mining or in the generation or distribution
GSTR 5: Return for NRI taxable individuals
of electricity or any other power
by NRI taxable individuals. The
10.5  GST has a number of returns that must be return due date will be the 20th day
filed electronically via the GST Network portal. of the following month.
Here is a list of returns applicable under GST: GSTR 5A: Information relating to the supply of
GSTR 1:
Information regarding outward database access, online information,
supplies of commodities or services or retrieval service by an individual
by registered taxable suppliers. The located outside the country
return due date will be the 10th day of made to non-taxable individuals
the following month. in India.
GSTR 1A: Information relating to auto-drafted GSTR 6: Return for Input Service Distributor
supplies of commodities or services. by Input Service Distributor. The
The return due date will be the 15th return due date will be the 13th day
day of the following month. of the following month.

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 Engineering Industry

GSTR 6A: Information relating to auto-drafted a. The following records are mandatorily to
supplies from GSTR 1 or GSTR 5 be maintained by each & every registered
to Input Service Distributors. dealer in relation to all businesses and
GSTR 7: Return for Tax Deducted at Source all business locations–specific for that
by the tax deductor. The return location. The same can be maintained in
due date will be the 10th day of the electronic format.
following month.
(i) production or manufacture of goods;
GSTR 7A: Tax Deducted at Source Certificate.
(ii) inward and outward supply of goods or
GSTR 8: Statement for Tax Collected at services or both;
Source by the tax collector or
e-commerce operator. The return (iii) stock of goods;
due date will be the 10th day of the
(iv) input tax credit availed;
following month.
GSTR 9: GST Annual return by registered (v) output tax payable and paid;
taxable persons. The return due (vi) goods or services imported or exported or
date will be the 31st of December of
the following financial year. (vii) supplies attracting payment of tax on
reverse charge along with relevant
GSTR 9A:
Simplified annual return by
compounding taxable individuals documents, including invoices, bills of
registered under Section 8. supply, delivery challans, credit notes,
debit notes, receipt vouchers, payment
GSTR 10: GST final return by taxable
vouchers, refund vouchers and
individual whose registration is
either cancelled or surrendered. e-way bills.
The return due date will be within (viii) accounts of stock in respect of each
three month from the date on which commodity received and supplied by
the registration was cancelled or him, and such account shall contain
the date on which the cancellation
particulars of the opening balance,
order was issued, whichever is later.
receipt, supply, goods lost, stolen,
GSTR 11: GST inward supplies statement for destroyed, written off or disposed of by
(Universal Identification Number)
way of gift or free samples and balance
UIN by individuals having UIN
and claiming a refund. The return of stock including raw materials, finished
due date will be the 28th day of the goods, scrap and wastage thereof.
month after the month for which b. Every registered person shall keep and
the statement was filed. maintain a separate account of advances
ITC-1A: GST ITC mismatch report. received, paid and adjustments made
10.6 Accounts & Other Records that thereto.
needs to be Maintained under GST c. Every registered person, other than a
The provisions with regards to maintenance of person paying tax under Section 10, shall
Books of accounts and other related documents keep and maintain an account, containing
are contained in Section 35 & 36 of the CGST the details of tax payable (including tax
Act & Chapter VII (Rule 56, 57 & 58) of the payable in accordance with the provisions
CGST Rules, 2017. of sub-section (3) and sub-section (4) of

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Techniques of Investigation for Assessment Vol. 3

Section 9 of the Act), tax collected and h. Every registered person manufacturing
paid, input tax, input tax credit claimed, goods shall maintain monthly production
together with a register of tax invoice, accounts, showing the quantitative details
credit note, debit note, delivery challan of raw materials or services used in the
issued or received during any tax period. manufacture and quantitative details of
the goods so manufactured including the
d. Every registered person shall keep the waste and by products thereof.
particulars of:
i. Every registered person supplying services
(i) Names and complete addresses of shall maintain the accounts showing the
suppliers from whom he has received quantitative details of goods used in the
the goods or services; provision of each service, details of input
(ii) Names and complete addresses of the services Utilised and the services supplied.
persons to whom he has supplied the j. Every registered person executing works
goods or services; contract shall keep separate accounts for
(iii) The complete addresses of the premises each works contract showing
where the goods are stored by him, (i) The names and addresses of the
including goods stored during transit persons on whose behalf the works
along with the particulars of the stock contract is executed;
stored therein. (ii) Description, value and quantity
e. If any taxable goods are found to be stored (wherever applicable) of goods or
at any place(s) other than those declared services received for the execution of
under sub-rule(6) without the cover of any works contract;
valid documents, the proper officer shall (iii) Description, value and quantity
determine the amount of tax payable on (wherever applicable) of goods or
such goods as if such goods have been services Utilised in the execution of
supplied by the registered person. each works contract;
f. Every registered person shall keep the (iv) The details of payment received in
books of account at the principal place respect of each works contract; and
of business and at every related place(s) (v) The names and addresses of suppliers
of business mentioned in his certificate from whom he has received goods or
of registration and such books of account services.
shall include any electronic form of data
k. Every owner or operator of warehouse
stored on any electronic device.
or godown or any other place used for
g. Any entry in registers, accounts and storage of goods and every transporter,
documents shall not be erased, effaced irrespective of whether he is a registered
or overwritten, and all incorrect entries person or not, shall maintain records of the
shall be scored out under attestation and consigner, consignee and other relevant
thereafter correct entry shall be recorded, details of the goods in such manner as
and where the registers and other may be prescribed.
documents are maintained electronically, l. Any person engaged in the business of
a log of every entry edited or deleted transporting goods shall maintain
shall be maintained. records of goods transported, delivered

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 Engineering Industry

and goods stored in transit by him along 11.  EXAMINATION OF

with GSTIN of the registered consignor MANUFACTURING-CUM-TRADING
and consignee for each of his branches. ACCOUNTS
m. Every owner or operator of a 11.1 Purchases: One of the most important
warehouse or godown shall maintain aspect in investigation is to look into the
books of accounts with respect to the purchases. Inflation of purchases is a common
mode of tax evasion. There are instances where
period for which particular goods remain
purchases are either found to be bogus in
in the warehouse, including the particulars
nature or are inflated. Income-tax Act allows for
relating to dispatch, movement, receipt, adjustments to be made in respect of purchases
and disposal of such goods. made from related parties as defined u/s 40A(2)
n. The records under these rules may be (b) of the Act. However, in case of non related
maintained in electronic form and the parties one needs to be circumspect. The rates
record so maintained shall be authenticated of various items used in engineering industries
by means of a digital signature. are verifiable from different journals mentioning
the prices. Different type of assessee use
o. Accounts maintained by the registered different documents and registers for purchases,
person together with all invoices, bills of for example:
supply, credit and debit notes, and delivery a. Purchase invoice, purchase bills, proforma
challans relating to stocks, deliveries, invoice.
inward supply and outward supply shall
b. Delivery challans.
be preserved for the period as provided in
Section 36 of the Act and shall be kept at c. Bill of transportation
every related place of business mentioned d. Slip of measurement/ weighment
in the certificate of registration i.e 6 years
e. Octroi bill or cess charging bill of municipal
from end of financial year.
corporation
10.7 Books/ Records Required to be f. Unloading expense voucher
Maintained: The engineering industries
coming under the purview of Section 44 AA of g. Gate pass slip
the IT Act, are required to maintain the records h. Inward register
prescribed under that provision, in addition to i. Purchase register
the records under the GST as mentioned above.
j. Stock register
The records maintained under GST laws will
be immensely helpful for income-tax purpose. k. Store register
Where these concerns are corporate bodies, Common and general methods of inflation of
records prescribed under the Companies Act are purchases have been discussed in the Chapters
also required to be maintained. The industries relating to Trading Account, and Manufacturing
to which Cost Accounting/ Audit rules are Account, in Volume-I.
applicable u/s 209 of the Companies Act, are 11.2 Production Account: Examination
obliged to maintain cost audit records. Details of Manufacturing/ Production account is of
regarding statutory audits under the Companies paramount importance in these cases. For this,
Act, Cost Audit, and special audit have already co-relation of quantity records of consumption of
been discussed in Volume-I. raw materials and production of finished goods,

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 Techniques of Investigation for Assessment Vol. 3

and the knowledge of the input: output ratios of 11.3 Wastage in Production Account:
the particular industry, is essential. It is useful to There are visible as well as invisible wastage in
first examine following details before taking up engineering industry, which have a direct impact
serious investigation work: on gross profit. In order to find out the wastage,
quantitative details have to be obtained and
a. Licensed/ Registered/ Installed capacity of
examined with reference to the quantity of raw
the unit
materials consumed and quantity of finished
b. Type and quality of finished goods and goods and by-product produced. The normal
main by-products per centages of loss due to shortage/ wastage,
c. Production capacity Utilised by the varies from industry to industry and also
assessee depends upon the type of raw materials and
technology used. Industry norms of wastage are
d. Capacity enhanced by installation of new
usually available from trade bodies, Government
machineries
authorities, etc. Many times, assessees try to
e. Level of technology being employed present their accounts in such a way that over-
f. Purchase of new machinery all wastage in terms of percentage will conform
to industry norms. However, if month wise or
g. Age of Plant and Machinery and technology
fortnightly accounts are prepared, an entirely
h. Actual production shown by the assessee different picture may emerge. Therefore, the AO
i. Reasons for variation of production vis-á- should test-check the production register and
vis the installed capacity work out percentage of wastage on particular
dates. If such per centages tally with overall final
j. Shortage and wastage shown by the
result disclosed by assessee and wastage are not
assessee
apparently on higher side, the book result cannot
k. Standard or norms fixed by Trade be easily doubted but where test-check shows
Association, Government authorities or abnormal variations in wastage percentage
available in project reports of the assessee of different periods, this may require detailed
or financial institutions examination.
l. Time taken in one complete production 11.4  Wastage Pattern in Various
cycle. Industries: In engineering industry wastage
It may be useful to cross verify the quantity pattern is not uniform but varies from unit to
particulars appearing in the inward register and unit, industry to industry, product to product
Stock register with the corresponding entries in and plant to plant. In an older unit, having older
first part of production register, and thereafter technology, wastage may be high. If at the out-
with the production of the finished goods in set it appears that wastage is on higher side, the
same register. Input-output ratios can be worked AO can investigate the accounts with reference
out for selected periods, i.e., months, fortnights, to normal standards or some comparable cases.
weeks, etc.., on random basis and compared If cases are not available for comparison and
with industry norms. Any abnormal variations standard is not found applicable, one can always
may require detailed examination. There may go by test-check of input and output ratio on
be some difficulty in working out input-output a few random dates of production which may
ratios where the units of measurement of the bring out wastage ratios different from those
input are different from those of the output. In disclosed by the assessee in the final statements
these cases, standard conversion factors have to of account. If records of wastage are not kept
be applied. on a day-to-day or weekly or fortnightly basis,

14
 Engineering Industry

then the production records may not be reliable. (i) Stampings for stator and for rotor.
Different types of wastage/ losses incurred in (Stampings are made out of dynamo
the production process in some engineering grade electrical steel lamination sheets.
industries are discussed below: The purpose of the stamping is to carry
the electromagnetic flux).
a. Steel Re-rolling Mills: In steel rolling
mills and re-rolling mills two types of (ii) Enamel covered copper wires are used
wastage are shown i.e. burning loss, and, in the windings of stators and rotors. The
melting loss. Burning loss is invisible loss wires carry the input current to induce the
whereas melting loss is visible loss. The electromagnetic flux.
burning process can be through coal-fired (iii) Copper bars and end rings or aluminum
or oil-fired furnaces. Studies reveal that, for rotors (other than wound rotors).
in case of oil-fired furnaces, the normal
burning loss is between 2% to 2.5%. In (iv) Steel round bars for making shaft.
case of coal-fired furnace, burning loss can (v) Castings for enclosure of the motor and
be from 4% to 5%. If an assessee claims an for other parts.
excessive burning loss then examination of
the entire manufacturing process, input: (vi) Ball bearings used for smooth running of
output ratio, quality of raw materials, rate the rotor. Bush bearings are often used in
of raw materials, as also study of other small motors.
comparable cases has to be made. (vii) Insulation materials such as papers,
b. Auto-parts Manufacturers: Due to varnish, etc..
a large number of units manufacturing (viii) Hardware, paints and small components.
different type of pistons, rings and auto
A study reveals that total wastage in the
parts, it is difficult to have standard pattern
manufacturing of motors ranges from 4.3
of this industry. In most of the cases raw
to 5.2%.
material is purchased by weight whereas
goods are produced and sold in numbers. 11.5  Manufacturing Account:
Therefore it is difficult to have a quantity- a. The general issues relating to examination
wise correlation between purchases and of manufacturing account have been
sales. As regards wastage one has to go discussed in the chapter relating to
into details of day-to-day production. The “Manufacturing Account”, in Volume-I.
products of auto parts manufacturers,
are normally of standard specifications, b. In the engineering industry manufacturing
and variation is only in respect of sizes. expenses include expenses on raw
Therefore, input and output ratios can not materials, consumables, power and
be abnormal. In these industries, burning fuel, wages and salary of factory, repairs
loss or process loss may also be there. and maintenance, deprecation and
other overhead expenses. While going
c. Electric Motors: While investigating through the manufacturing account, the
the case of electric motor manufacturers it AO must verify the input:output ratios
has to be kept in mind that electric motors of main raw materials, power and fuel
vary from motors of small fractional horse vis-à-vis the production of individual
power to special purpose giant motors. products. The AO has also to compare
The cost of production of electric motors actual physical consumption per unit of
comprises of: production with reference to standards

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Techniques of Investigation for Assessment Vol. 3

available in literature, & studies of trade b. Many assessees value their raw material
associations etc. At times assessees claim on the basis of purchase bills of 15th to
correct expenditure on power and fuel but 30th March. Often direct expenses like
understate the productions. Therefore, transportation, duties, cess, fees, Octroi,
suppression of production can be detected unloading charges, are not included in the
by applying standard input-output ratios. value of closing Stock of raw materials. This
is contrary to Supreme Court judgment in
c. The AO must distinguish between direct
CIT vs. British Paints (India) Ltd. (1991)
labour cost on production and indirect
188 ITR 44 (SC).
employee cost on production. He should
also verify total man days of direct labour c. In one case, the assessee had valued
employed during the year and average finished goods on the basis of last sale
number of workers employed for the year. bill dt. 24th March, as no sale was affected
Thereafter, he has to examine direct labour thereafter. While investigating the case, the
cost per unit of production. This will give a AO found considerable difference between
clue as to whether wages and salaries have the sale price of 24th March and the sale bill
been inflated. of 1st April.
d. Manufacturing expenses also include: d. Often goods-in-transit, and/ or goods
sent for approval, are not included in the
(i) Stores and Spares expenses
inventory of closing stock.
(ii) Maintenance and Repair
e. It is always useful to compare the Stock
(iii) Outside Contract Repair Charges statement furnished by the assessee to
(iv) Purchase of Miscellaneous items financial institutions and banks. If Stock
statement given to the bank differs from
It is easy to inflate expenditure under above Stock declared in books, the difference in
heads by creating self made vouchers. A scrutiny stock can be added to the closing Stock as
of such vouchers may show that the signatures suppression of closing stock. This issue has
appearing on revenue stamps for payment are now been settled by the Supreme Court of
of the same persons. India in the case of Ghasiram Agrawal vs.
11.6  Closing Stock: CIT 201 ITR Page 192 while dismissing the
SLP of the assessee against the judgment
More often than not, the auditors mention
of Hon’ble Gauhati High Court.
that the closing stock is valued on the basis of
feedback provided by management. As a rule the f. Consignment Sales present another area
closing stock is valued either at the historical cost of suppression of closing Stock. Some
or market value as per practice adopted by the assessees do not include the goods sent to
assessee. It may be worthwhile to verify certain consignee in their closing Stock.
items of closing stock as regards its historical cost g. Some other malpractices for undervaluation
or market value by looking into instances of sale of closing Stock are as under:
of such items in the closing months of the year.
Important features to be borne in mind are: h. Undervaluation of Stock by fixing up
predetermined GP rate, and showing the
a. Value of closing stock, in most cases, is balancing figure as closing Stock.
shown in an ambiguous fashion. It is very
common to exclude or undervalue the i. Undervaluation of Stock by mis-referring
work-in-progress. the purchase bills

16
 Engineering Industry

(i) Undervaluation of Stock on the basis of of invoices. If that is there then invoices must
purchase bills but without including direct be reconciled with figure of sales. Than, the AO
expenses can prepare a price-profile of that product and
thereafter tally it with the sale proceeds made to
(ii) Undervaluation of Stock by referring to
the various parties.
some sale bills of month of March, but
not of 31st March 12.  TAX AUDIT AND COST AUDIT
(iii) Undervaluation of Stock on the basis REPORTS
of market price by referring to under- The revised Form 3CD for Tax Audit Reports
invoiced sale bills of last week of March contains important data including financial ratios
(iv) Undervaluation of Stock by taking and quantity data of production/ consumption
average purchase cost etc. These audit reports can be an important
tool in the hands of AO investigating the case
(v) Undervaluation of Stock on the basis of
of a manufacturing concern. The issues arising
non-genuine purchases of March
from these audit reports have been discussed
(vi) Undervaluation of Stock of work-in- in the Chapters relating to “Tax Audit Reports”
progress or unfinished goods and “Making Quality Assessments” in Volume-I.
(vii) Undervaluation of Stock of semifinished Similarly, where cost audit rules apply to a
goods concern, Cost Audit Reports can be examined
by the AO. This subject has been discussed in
11.7  Under Invoicing of Sales: Suppression the Chapter titled “Cost Audit”, in Volume-I.
of sales is often resorted in various manners. Recourse can also be taken to special audit u/s
There may be cases of outright understatement 142(2A) in appropriate cases.
of sale price in bills and collecting a part in cash
outside the books. Under invoicing can also 13.  USE OF TALLY SOFTWARE FOR
be done through intermediary arrangements. DETECTING TAX EVASION
Goods are sold directly to the ultimate purchaser
13.1 Income-tax is always levied on surplus
but documents are prepared to show sales
income. Surplus income is the one where receipts
through a chain of intermediaries. The sale are higher than expenses. More is this difference,
made to the real purchaser at the end of the more is the tax liability. Hence, any tax evader
chain is invoiced at real market rate. All these would always like to bridge the difference between
intermediaries are legally constituted and the receipts and the expenses. Hence, the tax
most of them file their returns of income. But evader would either suppress his actual receipts
in this arrangement premium or profit is split- or inflate its actual expenses. Inflation of expenses
up at various stages to reduce the incidence is carried out by mostly by following ways:
of tax. In some cases of under-invoicing, some
a. Bogus Purchases
assessees issue Debit Memo or Debit Note in
later period after close of the accounting year to b. Bogus Sub-contract expenses
misappropriate the respective amounts. While c. Bogus commission expenses.
verifying sale bills, the AO has to examine the
d. Over-invoicing of expenses.
system adopted for preparing the invoices and
recording the figure of sales in accounts. It must Common tendency of the assessee is to bring
be verified whether manufacturer has a system back the money generated through tax evasion
for writing sales figure in terms of both quantity into the normal books. This is reflected in the
and value for each type of product by grouping books in the following forms:

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Techniques of Investigation for Assessment Vol. 3

a. Share Application Money b. A mere look at it shows more than average

consumption in two months-May and
b. Securities Premium
June.
c. Unsecured Loan
c. Further enquiries revealed that the
13.2  It is advisable to concentrate on the purchases were made from one of the
software used for accounting purpose. The most associate concerns of the assessee for
common software used for Accounting purpose which no supporting documents were
is “TALLY”. Now-a-days in big organisations, available with the assessee.
ERP is used for accounting purpose. Although
d. Bogus purchases admitted.
ERP cannot be brought for verification during
assessment stage, Tally can always be brought
on for verification of accounts in the office itself. EXAMPLE B
The advantages of operating Tally at office are:
a. Rather than relying on the data submitted
by the assessee at the Macro level, one
can go to the micro level and analyze the
accounts.
b. One can study the patterns of expenses
over the years and also over the months
in a year.
c. The patterns of various expenses can also be
analyzed over all the products/ projects of the
assessee. a. The above ledger shows the labour charges
d. The abnormality can be visually seen and incurred for 3 months.
then further probed into. b. Since the project was completed in June,
no more expenses debited after June.
13.3  Examples of Bogus Purchases found
through Tally c. However, June month showed abnormal
expenses.
EXAMPLE A d. Next step was to go into details of June
expenses. Next screen shot shows June
expenses details.

a. The above ledger shows the consumption

of cement over one year.

18
 Engineering Industry

e. By looking into these details, one cannot

make up as to what would be bogus
expenses, if any.
f. Solution is to look into these details in
Columnar format, where all entry details
are provided.
g. Next screen shot is that of columnar entry
details of these June expenses.

a. The above screen shot shows the

commission ledger in the books of the
assessee for one year.
b. It can be noticed that in the month of
March, the assessee has debited extra-
ordinary commission expenses of Rs. 5.90
crore.
c. Further verification showed that out of
these 5.90 crore, Rs. 5.89 crore were paid
h. If one looks carefully at these entries, to one party, viz. M/s QST Ltd.
one could make out that against some d. The assessee was cornered and lots
of the entries, no voucher numbers were of questions were asked regarding the
mentioned. services provided by the said concern.
i. These entries can be picked up for further e. Finally admitted the bogus commission
verification. entry.
j. Next step is the verification of the bank
accounts of these concerns. 14.  USE OF ERP FOR DETECTION OF
k. There would invariably be cash withdrawals TAX EVASION
immediately after the cheque deposits into
these accounts. 14.1  Basic Concept of ERP
l. Proves the bogus sub-contract expenses. ERP stands for “enterprise resource planning”. It
is a business management software which uses
EXAMPLE C system of integrated applications to manage
the business. It contains many modules. Each
Key is to again take the ledger of respective
ERP module is mostly focused on one area
head of expenses from tally. Then verify it of business processes, such as Purchase or
across the different years and in a year, across marketing. Common ERP modules include
the various months. Make general enquiries those for product planning, material purchasing,
through Google about the existence and inventory control, distribution, accounting,
credentials of concerns to whom commission marketing, finance and HR. All modules are
was paid. The assessee won’t admit easily the interconnected and they are shared by all the
bogus commission entries since it is a service departments in the organisation in order to
and one cannot value it. smooth the flow of data across the organisation.

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Techniques of Investigation for Assessment Vol. 3

14.2  ERP Operations i. Based on this data, Payment Vouchers

(“PV”) are prepared by the Accounts
There are different departments within the
Department.
company. The departments which would be
relevant for income-tax investigation purpose j. PV is then printed and forwarded to internal
are as follows: auditor. After this, the PV is again sent to
a. Production Planning Department/ Design Accounts Department for preparation of
Department banking voucher and cheque which get
printed through system.
b. Purchase Department
c. Stores Department 14.4  Example A
d. Accounts Department a. Alongwith the Normal ERP Modules, a
separate module was installed.
14.3  Basic Flow of Operations
b. This Separate Software Module named
a. The Design Department prepares drawing as “SPO System” was programmed to
for all the individual processes/ components generate a separate series of GIN bearing
and accordingly, raises Bill of Material code 99.
(BOM) for each individual component so
designed for the project. c. A separate log-in id was created to access
this module and which was known only to
b. Based on the BOM, the Material Requisition the single person who used to make entries
(“MR”) or Purchase Requisition (“PR”) is into this module.
communicated by the Production Planning
d. The salient features of this separate
Department.
software module-SPO System-was that it
c. Once this MR/ PR is received by the contained 3 different functions-Purchase
Purchase department, a Purchase Order Generation, GIN generation and
Order(“PO”) is generated by Purchase Bill Passing Purchase Voucher Generation-
Department. in a single module.
d. The supplier then sends the material e. In a normal course, one Department or
alongwith the Delivery Challan, where it is user of one module cannot access the
received by the Stores Department. other module. However this module
contained all the three different and
e. The Stores Department then prepares
crucial functionalities in order to facilitate
Goods Receipt Note (GRN)/ Goods
manipulations.
Receipts-cum-Inspection Note (GRIN)/
Goods Inward Note (GIN). f. The SPO System was linked neither to the
Purchase Department nor to the Stores
f. GIN/ GRIN is then handed over to Quality Department. However, it was linked to the
Control Department for inspection in case Accounts Department, so that the Payment
of raw material or component Voucher numbers printessd on the PVs
g. The GIN alongwith the Tax Invoice, could be in continuation of all other PVs.
Challans and supporting documents are g. The Purchase Department was asked
sent to Accounts Department for payment. to show the Purchase Orders of some
h. After entering the GIN, all the details of suspicious dealers.
that particular GIN gets populated on the h. It was told that the Purchase Orders of
Accounts Module screen. those dealers were not available with them.

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 Engineering Industry

i. It was checked and then realised that all separate operation In purchase department
such Purchase Orders and GINs bear the such codes were known as buyer codes
code 99. and were to be operated with passwords.
j. These GINs were gathered separately c. One separate code, ‘code 70’ was allotted
and then confronted to the Software for corporate functions and known as
development department head who ‘corporate code’.
confessed that they were prepared using d. Code 70 was not known to other persons
separate module. in any other department.
k. Traced for last 8 years. Total bogus e. All the procedure related to purchases of
purchases were 157 Crores. material through this code was handled by
only one person in accounts division who
14.5  Example B is close to M.D.
a. A Purchase Officer was entrusted upon to f. While generating GRIR, the documents
generate the Purchase Orders within ERP needed for this were not available and
System, for which no material was to be procedure beyond this was blocked for
received. this code. This delinked its connection
b. All such Purchase orders were generated with stores and manufacturing but had
using the log-in id “FA1”. connection only with accounts.
c. These purchases were recorded for the g. After understanding the procedure of
material to be used in site offices and never purchase and issue of materials, list of all
for the factory office of the assessee. the buyer codes was obtained through
Systems Division.
d. When the ERP System was analyzed, it
was found that there were certain Purchase h. Corporate code 70 was shortlisted as
Orders for which no PR was raised. suspicious which got strengthened by the
fact that nobody knew about functions
e. Normally all POs are backed by PRs; only of that code, which was buyer code and
in exceptional cases, POs are not backed should have been normally operated by
by PRs. purchase department personnel.
f. All such POs were segregated. It was then i. A query was run on CLARITY to generate
realized that a particular log-in id and a a report of parties from whom purchases
particular dealer appears with unusual from this code were done.
frequency for such POs.
j. A query generated a report of 28 parties
g. This fact was confronted to the user who from F.Y. 2007–08 onwards totaling to
has entered these POs who then spilled the 12.70 Crs.
beans. The total bogus purchases for block
period were 150 Crores. k. Simultaneously, we verified the suspicious
parties in the BRIEF in purchase module of
14.6  Example C CLARITY. Purchases of these parties were
also done through corporate code 70.
a. “C” was using ERP system known as
l. GRIR report was generated, which showed
CLARITY.
no documents of delivery challan, weight
b. Separate codes were allotted by Systems slip, transport slip were available on the
Division of C for each officer working on fields in GRIR page.

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Techniques of Investigation for Assessment Vol. 3

m. A query generated a report of 28 parties from 14.7  Gist of Above Cases

F.Y. 2007–08 onwards totalling to 12.70 Crs.
If one already has certain data about the bogus
n. Simultaneously, we verified the suspicious dealers, identify their Purchase Orders and
parties in the BRIEF in purchase module of GRNs separately. Then it will be important
CLARITY. Purchases of these parties were
to locate common grounds in these Purchase
also done through corporate code 70.
Orders. After locating the common thread, it will
o. GRIR report was generated, which showed be required to be applied for all the years and
no documents of delivery challan, weight for all the purchases. If no ready-made data is
slip, transport slip were available on the available then it will be important to just check
fields in GRIR page. the normal procedure and find the missing link
p. On searching his computer thoroughly, in the operations for certain purchases. Most
all the Excel sheets of generation and importantly, one must always look out for the
application of cash for last three years were difference in the Stores Data and Accounts Data.
found which was admitted by Directors. As a standard practice, the bogus purchases are
q. Purchases from similar parties were never entered in the Stores Module of the ERP,
verified for earlier years on the stored data but are always entered in the Accounts module.
base in server. On confrontation, assessee Then run the query on the System to find out the
admitted of bogus purchases in earlier difference between Stores Data and Accounts
years also. Data. This will give desired result.

22
 Chapter

2
Cotton Textile Industry

1.  INTRODUCTION
The cotton textile industry is one of the oldest
industries in India. In the 18th Century, the
famous ‘muslin’ manufactured at Dacca were
exported to Europe. Thus, this industry has a
very important place in the national economy. It
not only contributes substantially to the state and
national exchequers but also brings in a large
amount of foreign exchange by way of export.
The industry gives employment to large number
of people, particularly in Maharashtra, Gujarat
and Tamilnadu, where the bulk of the textile mills then processed into cotton fibre. For unit weight
of the country are located. The manufacture of of fibre, about 1.6 units of seeds are produced.
textiles involves different stages of processing The seeds are about 15% of the value of the
through the various units of a textile mill. crop and are pressed to make oil and used as
ruminant animal feed. The cottonseed price
2.  GINNING in April 2018 was in range of Rs. 1200 to
Rs. 1300 per quintal. Cottonseed and Cottonseed
2.1  The cotton gin is where cotton fiber is
separated from the cotton seed. Ginning is the hulls are good source of protein and serve as
process of separating the cotton seeds from raw an excellent source of feed for the livestock. The
cotton or ‘kapas’, in order to get the lint (cotton cottonseed meal after being dried can be used
in a fluffy state). The process is done in ginning as a dry organic fertilizer. The seed oil extracted
factories which purchase ‘kapas’ and convert it from the kernels, after being refined, serves as a
into lint and seeds. In this process, the cotton is good edible and nutritious food. It is also used in
vacuumed into tubes that carry it to a dryer to the production of shortening and margarine. The
reduce moisture and improve the fiber quality. fine quality oil extracted from cottonseed during
Then it runs through cleaning equipment to the extraction process is also used in cosmetics,
remove leaf trash, sticks and other foreign matter. such as moisturizing lotions and bath soaps. The
2.2 The cotton boll is a protective fruit and yield of cotton seed vis-a-vis the raw cotton after
when the plant is grown commercially, it is the ginning process may be analyzed to find the
stripped from the seed by ginning and the lint is inconsistency in purchases.

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Techniques of Investigation for Assessment Vol. 3

2.3 There are two kinds of ginning-roller 5.  COTTON PRESSING

ginning and saw ginning. Roller ginning is 5.1 In some ginning factories, there is also a
also of two kinds-single and double. The latter Pressing section. After ginning, the lint obtained
produces a superior quality of ‘lint’. is in a fluffy state. It is pressed and packed in this
section. If the ginning factory has no Pressing
3.  ROLLER GINNING section, the lint is taken to a pressing factory,
Roller ginning of ‘kapas’ is carried out manually. where it is pressed and packed into bales, against
The kapas is also taken to the ‘opener’ or fixed pressing charges per bale.
‘jhamba’ manually. This removes the impurities. 5.2  The device usually adopted by the Pressing
It is then taken to the roller machines. Labourers factory to reduce its profit is to inflate the
put the ‘kapas’ into the rolling machine by quantity of iron hoops and hessian purchased
hand. These machines separate cotton from and Utilised for baling. Quantitative details of
cotton seeds. The ginned cotton is carried in these two articles should be obtained and the
loose bales to the godown, where it is stored for reasonableness of the consumption checked with
processing. reference to the bales packed. Usually, a fixed
quantity of iron hoops and hessian is required
4.  SAW GINNING for each bale pressed and packed. The expenses
on stores and wages should also be examined
4.1 Saw ginning came into use only about
thoroughly, and ratio analysis may be done to
25 years back and is popular particularly with
find inconsistency in the books.
the textile mills of Mumbai. In this process the
services of the ‘opener’ i.e. ‘jhamba’, which
removes impurities, are dispensed with, as it 6.  TYPES OF PRESSES
has an automatic ‘opener’. The raw ‘kapas’ is Generally, there are three types of presses in use.
sucked through the pipe into the saw machine. These are:
It is then fed into the ‘opener’ which removes
a. Double press
dust, and other impurities mixed in the ‘kapas’.
This ‘opener’ or ‘jhamba’ automatically opens b. Single press, and
the ‘kapas’. The ‘kapas’ is then fed into the c. Common press
machine which separates cotton from cotton
seeds. Cotton seeds are automatically separated The Presses are run either by steam from a coal-
to one side, while the lint is sucked into the fired furnace or by electricity. The difference in
perforated pipes where it is cleared of impurities. these three types of Presses is that the double
The cleared cotton is then put into bags. These Press has the maximum capacity, while the
bags are stocked in godown and later transferred single Press has less capacity and the common
to the pressing section. Press has the minimum capacity.
4.2  The saw ginning process gives more refined
cotton, as it entails cleaning at two places. This, 7.  PURCHASES OF RAW COTTON
however, gives a lesser yield because, apart from The purchases may be either directly from
impurities, some lint is also left on ‘binolas’. The cotton growers or from dealers/ brokers in raw
yield and shortage depends on quality of cotton cotton. The purchase rate of ‘kapas’ depends
and type of machine. However, labour expenses upon its quality. The purchases of raw cotton
are lower in this process because of automation. from dealers and through brokers are generally
Saw ginning is now losing ground because of the verifiable, whereas purchases made from
excessive loss involved in the process. growers are usually not capable of proper

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 Cotton Textile Industry

verification. However, daily market reports are rate paid for ‘kapas’ purchased from the market
available in major cotton centres and it may be or in auction. If the rate for cash purchases is
useful to compare the purchase rates of a few higher, it may indicate inflation of purchases.
selected items as shown by the assessee with the
market rates given in those reports. 9.  PURCHASES THROUGH SUSPENSE
ACCOUNTS
8.  CASH PURCHASES 9.1 Such purchases are usually supported
8.1 Since most of the purchases are from by ‘bought notes’ issued by the owners of
cultivators, there may not be satisfactory ginning factories. At times, when money is
evidence to prove all the purchases. It is usual drawn for making purchases from growers, a
to inflate ‘kapas’ purchases, both in terms of ‘suspense account’ is opened. It is necessary
quantity and value. Where the cotton traders or that purchases financed through ‘suspense
the spinning and weaving mills themselves own account’, are scrutinised properly for detecting
a ginning factory, the chances of making such any inflation of purchases. In some cases the
inflation are more. For instance, in one case, the value of purchases exceeds the money taken
partners of a firm running a textile mill owned to the ‘suspense account’ for financing such
certain lands on which cotton was grown. In their purchases. If this is noticed, it will be necessary
personal accounts, they showed large credits to inquire as to how such purchases have been
for sales of raw cotton or ‘kapas’ to a ginning financed. In the absence of a proper explanation,
factory in support of such purchases. The books the presumption would be that the purchases
of the ginning factory correspondingly showed have been inflated or have been made out of
large quantities of ‘kapas’ purchases from these undisclosed sources.
partners at the highest market rate. However, 9.2  A rough and ready method of determining
on close scrutiny, it was found that the quantity the extent of inflation of such purchases is to
shown was much higher than could have been deduct from the value of the goods purchased the
obtained from the area of land owned by them, money passed through the ‘suspense account’
even at the highest yield for cotton recorded less the travelling, lodging and boarding expenses
by the District Agricultural Officer. An inference of the employees. The dates of purchases made
could, therefore be drawn that either fictitious from the purchase centres by the employees and
sales had been entered, in order to bring into the dates on which funds were withdrawn from
books undisclosed income of these partners, or the ‘suspense account’ should also be carefully
they had purchased ‘kapas’ from agriculturists looked into. The mode of taking money by
outside the books, and had recorded only the employees to the purchase centres should then
sales, thus bringing their undisclosed income be verified for detecting any manipulation of
into books of account surreptitiously. purchases. Location of purchases made from the
8.2  Similarly, when the disclosed output of lint place of vendor and that of the assessee is also
is poor and/ or the wastage excessive, a possible vital to be looked into so as to inquire about the
reason can be that the ‘kapas’ purchased was movement of cash from one place to another.
of an inferior quality, in which case the average 9.3 Sometimes, claims are made that the
purchase rate ought to be less than in other funds withdrawn by the employees through
similar cases. the ‘suspense account’ have not been Utilised
8.3 Where there are both cash and credit fully and these are deposited back in the books
purchases, the rates paid for cash purchases from of accounts. Such claims should be thoroughly
agriculturists should ordinarily be less than the checked with reference to the purchase and

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Techniques of Investigation for Assessment Vol. 3

stock registers. The time lag between the dates of location of vendors and the assessee, trend
withdrawals and the dates of bringing the money analysis of turnover, background of assessee in
back into the books would help to establish past, etc needs to be duly considered.
whether the funds advanced have been Utilised
for purchases or for some other purposes. The 11.  OUTPUT FROM GINNING
day book should also be scrutinized for finding FACTORIES
out any cash deficit, as the funds withdrawn for
purchases are usually adjusted in the books at 11.1  While examining the accounts of a ginning
assessee’s convenience. factory, it is always necessary to judge the
reasonableness of the output of lint and seeds
9.4 At times, funds are withdrawn from the with reference to the quantity of ‘kapas’ ginned.
books for financing purchases from growers, and The yield in processing of raw cotton into lint
bank drafts are purchased. Such bank drafts are depends upon the quality of the raw cotton and
encashed at the purchasing centres for payments the type of machines used. The normal yield
to growers. It would be necessary to verify the and the shortages are as under:
withdrawal of the money for purchasing the
drafts and the dates of encashment of the bank Process Type Yield Shortage
drafts at the purchasing centres. Such dates can Saw Long staple
32% to 34% 1.5% to 2.5%
be correlated with the dates of purchases made ginning quality
at the purchasing centres, the ‘bought notes’, Roller
Desi kapas 36% 1.5%
and the day book. The stock register can also be ginning
checked up with reference to the dates of such 11.2  Studies conducted by Ahmedabad
purchases. Textile Industry’s Research Association, (ATIRA)
for improving ginning technology reveal the
10.  SCRUTINY OF PURCHASES following:
The rates of the purchases made directly from the When Indian cottons are compared with foreign
growers should be compared with the purchases cottons, Indian cottons are comparable or even
made through brokers/ dealers in raw cotton. It is superior than foreign cottons in fibre length,
necessary that the purchases made directly from fineness and strength. In foreign countries
the growers should be carefully enquired into for mechanical harvesting is adopted and trash
detecting any inflation. Apart from inquiring into content is 20 to 25%. This is 7 to 8% in most
the sources of funds and the dates of purchases, of the Indian kapas material. The trash content
the stock register and the day book should also after ginning process, is not more than 2 to 3%
be scrutinised. A complete tally of the movement in foreign cotton bales while in Indian bales, it is
of stock purchased, processed/ consumed and
4 to 6%. Average trash content in Indian cotton
sold to the consumers be checked. Yield ratio of
bales is 6 to 7% and the maximum level is 15%
the industry at the prevailing point of time also
inspite of the manual harvesting system.
needs to be considered to catch any anamolies
or inconsistencies in the books. This may also 11.3  If cleaning machines at ginning,
invite any instances/ reasons for rejecting the post-ginning cleaner (to remove seed-coat
books and determining the industry profit rates fragments), and pneumatic cotton conveying
to be the income of the assessee. Nonetheless, system are adopted, contaminants in cotton
a fair and practical approach may be adopted can be reduced thereby improving the cotton
in exercising and adopting such rate of profit quality. Enquiries can be made to find out
once books are rejected and overall facts and whether such ‘modernisation’ has been carried
circumstances like industrial profit margin, out. Accordingly, cotton realisation percentage

26
 Cotton Textile Industry

may be verified from the books of accounts. types of cottons/ fibre to spinning. Nowadays,
In case the yield and shortages are abnormal, the knowledge and practice of hand sampling
the accounts should be scrutinised for detecting of classier cotton is supplemented with the
possible manipulation of purchases. physical properties measured by sophisticated
instruments. Once raw material has been brought
SPINNING MILLS and is ready for use, its processing starts with the
help of machines and the men on the floor.
12.  SPINNING PROCESS
12.5  Mixing: The basic objective here is to
12.1  Spinning is the mechanical process mix the different types of cotton together to
of converting cotton into yarn suitable for take advantage of the desirable characteristics
manufacture of cloth or other cotton fabrics. of each component in the mix. By a judicious
12.2 An important parameter in spinning blend of the different varieties, the mixing cost
process is ‘count’ by which the quality of yarn is could be kept at a minimum and consistency in
determined. The count of the yarn depends on yarn quality between the seasons can also be
its weight. Yarn of 840 yards is called a ‘hank’. maintained. Mixing for open end spinning may
If one hank of yarn weighs one pound, then contain virgin cotton and waste (like comber
count of that yarn is 1. If 40 hanks of yarn weigh nails, flat strips, roving ends, droppings, sliver
one pound, then the count of that yarn is 40. bits and lap bits).
The higher the count, the finer will be the yarn. 12.6  Usually, a purchase register which records
12.3  Raw Material: With development of all the purchases with the details of quality, and
technology, now in addition to cotton, jute and variety, weight and ex-mill cost of each bale is
also other man-made fibres such as viscose and maintained. An Issue Register is maintained for
polyester are used as raw material either singly issue of raw material to the mixing department.
or in combination so as to manufacture mixed Yet another register is maintained for insurance
fabrics such as terry cot. The factors which make purposes for arriving at the stock on hand at a
fibres suitable for textiles are length, strength, particular time with the details of storage place.
pliability, diameter, abrasion, resistance and 12.7  Usually, mills adopt moving average cost
power of cohesion etc. Besides, fibres must be or lot-wise cost method for arriving at the value
pleasant to touch, absorbent to the extent that of the Issues and the stock on hand. As the mills
they can be dyed, comfortable to wear and maintain lot wise register on the basis of their
washable by some method. Not all the desirable arrivals, it is easy to identify each lot and arrive
properties are available in any one fibre. Cotton at the cost of each lot (usually a lot contains 55
is a natural fibre which is still considered as one fully pressed bales). The closing stock also is
of the most suitable textile fibres. maintained at cost on the basis of the cost of
12.4  As the raw material constitutes about 55 each lot.
per cent of the total cost of yarn, and about 50
per cent of the total cost of cloth, raw material 13.  BLOW ROOM
procurement plays a significant part in textile 13.1  The essential functions of the blow room
industry. Apart from being proficient in finalising are to:
deals at the right time to take advantage of
a. open the cotton into loose mass;
the market, one must be adept in selecting the
right cotton to suit the end use and must have b. clean the cotton by removing the trash,
intimate knowledge of the amenability of various seeds, leaves etc.; and

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Techniques of Investigation for Assessment Vol. 3

c. deliver the cotton in the form of a reasonably 15.  PREPARATORY PROCESS

uniform sheet rolled into the form of a All subsequent processes after carding are for
lap which facilitates easy handling in the the following objectives:
subsequent process.
a. To lay the fibres parallel which will facilitate
13.2  The cotton bales are opened in the ‘bale drafting and yield uniform yarn;
breaker’ in which hard compressed slabs of
cotton are broken into a fluffy state. Thereafter, b. To achieve uniformity in weight per unit
different types of cotton which have been mixed length by the necessary processes; and
in calculated proportions to obtain the particular c. To attenuate or draft the sliver into thinner
quality or count of yarn are put in the ‘opener’. strands at stages to achieve the desired
Here, the mixing is done. The mixed cotton is ultimate yarn count.
then folded into a sheet form called ‘lap’. For
processing man-made fibre, there is a provision
16.  COMBING
to bypass the beating points.
16.1  This operation is an optional one. Usually
13.3  The laps produced are designed to have
yarns are produced in carded form (without
a pre-determined weight per yard. Hence all
going through this process) or in combed form.
the laps should have the same weight within
Previously, foreign cotton needed for production
allowable tolerance. Any serious deviation in
of fine yarns such as 80, 100 and 120 used to
lap weights will result in variation in yarn count
be combed but now even Indian cotton is also
which is undesirable. The mills maintain a lap
combed. This is an expensive process. It reduces
register indicating the production of laps and
the output of yarn from cotton. Hence, it is gone
their weights
through only if the selling price is remunerative.
Usually other raw materials are not combed.
14.  CARDING
16.2 The fibres are combed by means of a
14.1  The maxim “to card well is to spin well” rotating cylinder, having a number of pins. The
emphasises the importance of this process. sliver obtained from Carding department are
The function of this process is to open the lap, passed through pairs of drafting rollers. This helps
separate the fibre, remove the impurities and in parallelisation of fibres. The resultant sheet of
short fibres in the lap. This is done by subjecting fibres is wound on a spool (sliver lap). Six such
the fibres to the action of a large number of sliver laps are passed through a series of pairs
metallic wire points. Here, the end product is of drafting rollers. This helps in parallelisation of
delivered in the continuous form of a ‘sliver’ fibres and six sliver laps fed are combined into
(resembling thin ropes of cotton) deposited into one ribbon lap. This ribbon lap is next fed into
a vertical container namely sliver can for feeding another machine, where the sheet of fibre is
the next process viz. drawing/ combing. The gripped firmly between a pair of nippers, over
important parameters in this are the flat speed which the combing cylinder passes, removing
and the allied settings as the removal of short the short fibres of less than a preset length. The
fibres is dependent upon these factors. sliver is coiled in vertical cans for feeding the
next process-drawing.
14.2 Usually the mills maintain a register
of production of sliver cans by each carding
17.  DRAWING
machine. For producing quality yarn, it is
necessary to periodically grind the metallic wire This process passes multiple carding sliver
and flat tops. through a series of pairs of rollers, moving

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 Cotton Textile Industry

at progressively increasing surface speeds. is wound around a slim bobbin. The amount
This helps in parallelisation of fibres, removal of twist put and the speeds in spinning play a
of hooks, regularisation of weight per unit significant role in the manufacturing cost.
length. Normally, two passages of drawings are
employed but depending upon the requirements 20.  OPEN END SPINNING
of the end product, use of three passages is also
adopted. 20.1  This is a new development for production
of yarn by replacing speed frame and ring frame
department. Here, the drawing sliver is separated
18.  SPEED FRAMES into single fibres by means of a saw toothed or
18.1 The sliver received from the Drawing pinned roller called ‘opening roller’ and thrown
department is passed between pairs of rollers. on the circumference of a rotor rotating at a
The object of this process is to reduce the draw high speed of over 50,000 rpm. The fibres are
frame sliver to a size suitable for final spinning deposited on the collecting groove forming a
by employing necessary drafts. The strands thus fibrous ribbon which is then doffed at the yarn
produced are given a slight twist by the machine forming point, and is collected on a tube to form
to obtain cohesive strength. The resultant a cheese.
material, called roving, is wound on a plastic
20.2  The advantage of open-end spinning is the
bobbin.
huge production as well as use of comber waste
18.2  The conventional systems used either two and flat strips along with virgin cotton, thereby
or three pairs of speed frames called slubber, inter substantially reducing the manufacturing cost.
and roving where the drawing sliver was drafted
in stages. However, with the development of 21.  COTTON INPUT AND OUTPUT
apron drafting systems it is possible to employ
high drafts both in speed frame and ring frame. The cotton fed into the blow room undergoes
Hence, modern spinning sequence uses only various processes. In each stage, loss of material
one stage of roving generally called can-inter, takes place in the form of waste. This waste
thereby reducing process costs. varies from mill to mill because of the machinery
conditions, the quality of cotton, and the end
19.  RING FRAMES product. Coarser counts are produced with
cheaper variety of cotton. Hence waste is higher
This is the final stage of process in which the
compared to fine counts that are produced with
raw material is converted into yarn. Depending
superior cotton. In the output statement for
upon the count to be spun, drafts are employed
spinning, only the salable waste is considered for
and the delivered strand is imparted necessary
twist. The amount of twist to be put is decided calculating the invisible loss. The usable waste
by the quality of cotton and the end use of the collected is normally reused, in which case it
yarn. Yarn meant for warp in fabrics is generally need not be considered. Otherwise, it should be.
twisted more because it has to withstand a lot of Wherever yarn is conditioned for improving its
stress and strain in further processes whereas yarn quality, weight gain takes place and the invisible
meant for knitting or hosiery for manufacture of loss comes down. For monitoring and controlling
banians etc. is generally soft spun with less twist of wastes the waste collected is analysed, and
necessary to get soft feel and fullness in knitted percentage of waste at various stages is calculated
garments. Finally, the twisted strand called yarn variety-wise.

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Techniques of Investigation for Assessment Vol. 3

22.  POINTS FOR INVESTIGATION their villages along with amounts paid to them.
Thereafter, details of the persons from whom
22.1 The P&L account of the spinning mills
such purported cotton purchase was made in
shows:
cash, were called for from Revenue Authorities
a. Direct cost: Value of cotton consumed, about their land-holding/ farm produce data etc.
wages, stores consumed, fuel power. as also their names were checked from Electoral
b. Indirect cost: Salary, interest, repairs and register which was updated in view of impending
renewals, commission, transport and other state legislature elections. The enquiries revealed
administrative expenses. as under:

c. Other issues to be looked into–Govt a. From the analysis of land revenue records,
incentives such as capital/ interest subsidies, it came out that out of a total of 1602
tax saver schemes, income/ loss in Future URD purchase parties verified in the land
Contracts. records, 963 persons didn’t possess land in
the respective villages.
d. Genuineness of claim of additional
depreciation b. On analysis of the electoral data it emerged
that out of 794 URD purchase entries
22.2 Cotton Purchases: Usually cotton is whose electoral records were retrieved, 484
purchased on contract basis and a contract names were non-existent in the respective
book is maintained showing the serial number villages which the assessee had recorded
of the contract, the date of the contract, the against their names in its books of account.
names and addresses of the parties concerned,
the quality and quantity of cotton contracted, Thus, in percentage terms it turned out that
and the rates and period of delivery, etc. It is a 60% of the purchase parties were non-verifiable
common practice that certain percentage known from the land records as well as electoral records
as ‘cut’ is secreted out of the Purchase account of the respective villages. Accordingly, these
and pocketed by the Directors. An investigator parties were actual cultivators or not could
has to look into the market indicators and not be established and hence, proportionate
various parameters in the cotton market such as disallowance was suggested and substantial
reduction in supply of yarn. amount was proposed to be added u/s 40A(3)
on this count.
22.2.1 Case Study: In one search case of
Saurashtra region, it was found that around 22.3 Wages: Wages have a direct relation to
Rs. 1300 crores of URD cash purchases of cotton the quantity of yarn produced. While checking
was made over a period of 6–7 years from 2 expenses on wages, figures of earlier years may
parties, who in turn had claimed to have made be compared with the relevant year in relation
purchases from farmers/ cultivators. Further it to production and abnormal variations, if any,
was found that assessee had claimed all these be properly scrutinised. Generally, the textile
cash purchases exceeding Rs 20,000 as business industry is in the process of modernization, which
expenses in light of the provisions of Section results in reducing the manpower and wages.
40A(3) r. w. Rule 6DD(e). It is noteworthy that The AO may see if expenses on installation of
Rule 6DD(e) grants immunity from the provisions sophisticated machineries are commensurate
of Section 40A(3) only if cash payments in excess with the reduction in wage bill.
of Rs 20,000 are made to the cultivator, grower 22.4  Stores Consumed: The expenses
or producer for the purchase of agricultural on stores, and on fuel and power have a
produce. On enquiry, the said parties merely direct bearing on the cotton consumed. The
informed names of numerous persons and reasonableness of these expenses should,

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 Cotton Textile Industry

therefore, be examined with reference to the was found that the Directors used to collect extra
quantum of cotton consumed. The figures for money on sale of waste, scraps and to inflate
one year may also be compared with those of wages account and as a result, cash more than
earlier years, in comparable cases. Where the Rs. 2 crores was seized. To unearth this practice,
component of stores consumption in the cost of only search or survey will be useful. Scrap sale
production is high, it may be necessary to obtain of such waste needs to be examined with the
comparative details of the quantity and value of industry standards and the output/ yield ratio of
certain selected items of stores consumed for the assessee generally achieved over the years. If
different accounting years, as this will reveal the quantum claimed is relatively excessive, one
the items in which there has been a substantial needs to probe further into the matter.
increase. A pursuit of the purchases of such 22.8 Final Output: Yarn realisation is
stores may result in detection of inflation in generally between 80 to 88 per cent of the cotton
those items. In one particular mill’s case, stores used and in the case of open-end spinning, the
purchases were inflated. On investigation, it was percentage range is 70 to 75 per cent.
noticed that no purchase was actually made. The
Internal Auditor managed to get bogus vouchers 22.9  Repairs and Renewals: During
for purchase of stores. in modernisation process of textile mills
replacements mostly of full items of machinery
22.5 Sales: In a spinning mill, the main item take place. These replacements are capital in
of sales are yarn and cotton waste. Generally, character. However, often the assessees claim
the yarn produced is subject to excise duty and that the expenditure as revenue. In this effort
as such there is control over production and the following propositions are conveniently
dispatches by the Central Excise authorities. forgotten:
However, while assessing a spinning mill, it is
necessary to verify and reconcile the quantities of a. Machinery does not cease to be machinery
yarn produced, with those sold and dispatched. merely because it has to be used in
In some cases, verification of the dispatches of conjunction with one or more machines.
yarn, recorded in the ‘gate pass book’ revealed Nor does it cease to be machinery merely
double numbers in the gate passes showing because it is, for instance, installed as part
dispatches of additional bales without being of a manufacturing or industrial plant.
brought in the books. Sometimes, it is also
b. “Broadly speaking, outlay is deemed to be
found that the mills have sold yarn at rates which
capital when is made for the initiation of a
are less than the prevailing market rates. It is,
therefore, necessary to compare the selling rates business, for extension of a business, or for
of the quality of yarn sold on particular dates a substantial replacement of equipment.”
with the prevailing market price. (Lord Sands)

22.6 Wastage: In this industry, invisible 22.9.1 The arguments against holding such

wastage is normally between 1.5 to 2.5 per expenditure as revenue are many:
cent. In the case of use of method of Comber, a. The new machinery will lose its character
invisible wastage may be a little more. Post- as a capital asset consequent to the artificial
industrial waste is the material left over from the allowance of the cost incurred on it as a
production. The material can be cutting leftovers, revenue expenditure. This violates the
roll ends, overproduction and rejected fabrics. definition of ‘capital asset’ in Section 2(14)
22.7 Sale of Waste, Scraps, etc.: In a and of ‘block of assets’ given in Section
leading textile group, during search operations, it 2(11).

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Techniques of Investigation for Assessment Vol. 3

b. It leads to an unacceptable situation where investigation, it was found that it was a bogus
a revenue item is created either by an purchase.
admixture of capital and revenue assets
or only revenue assets (when all the old 22.10 Modvat/ GST Credit: In one case, it
machineries are replaced). was noticed that the MODVAT credit taken was
credited to stores purchase account. But when
c. A capital asset does not get expended on
revenue account either at the time of its stores consumption was accounted in the P&L
acquisition or in the course of production. Account, the stores consumed were valued
at cost including excise duty. Thus, the stores
d. Section 43A mandates that exchange consumed was shown at an inflated figure.
rate fluctuation on making the payments Hence, it is always better to analyse modvat
relating to an asset acquired outside India (now GST) credit and to find out whether it is
should be adjusted in the actual cost of
properly accounted in the P&L Account.
the asset as per Section 43(1) of the Act. If
the cost of the asset is allowed as revenue 22.11 Additional Depreciation: During
expenditure, the exchange rate fluctuation scrutiny proceedings in a case, it was found
has to be treated as capital expenditure, that certain notices issued to the transporters,
resulting in an abnormal situation wherein
supposedly involved in transport of new
part of the value of the machinery is
machinery purchased, had returned unserved.
revenue and the other capital. This cannot
It was also observed that, in some cases, the
be logical.
transport challans were not complete and
e. The Income-tax Act, the Accounting seemed to be spurious, i.e. in same handwriting
Standards of the ICAI, the decisions of the on challans issued by different transporters,
Supreme Court and lastly the commercially irregular serial numbers, etc. The directors of
prudent policies adopted by the assessees the entities, from whom assessee had claimed to
themselves while computing the profits have purchased the machineries, were examined
and declaring dividends, do not envisage on oath wherein they admitted that they had sold
a situation where final salable product
second hand machineries to assessee company
is manufactured by a mixture of capital
but they had attempted to show the same as new
and revenue assets or by revenue assets
machinery at the behest of the assessee. The
themselves.
assessee on being confronted with the said facts,
22.9.2  While faced with this situation the AO admitted that the machineries were not new but
should not confine himself to the legal aspects rather were second hand and therefore the claim
alone. In fact, success depends largely on of additional depreciation was disallowed in the
marshaling the facts and bringing them out in Assessment proceedings.
the order. The particular machinery may be
inspected, its functions studied and the AO may
come to a conclusion whether such replacement 23.  WEAVING MILLS
is capital or revenue. After drawing a proper 23.1 The Warping Process: Many cotton
conclusion, assessment order may be passed textile mills weave the yarn spun by them into
citing appropriate case laws. cotton fabrics. Weaving consists in converting
22.9.3  The purchase bills for machineries may the yarn into fabric. The yarn supplied to
also be analysed. In a case, one machinery was weaving mills is in cones of weights of 1.5 to 2
said to have been purchased from a place which Kgs. To construct a fabric, this yarn needs to be
is not known for textile machinery. On further converted from cone to sheet form.

32
 Cotton Textile Industry

23.2 The cloth to be woven has two major b. the insertion of the weft or the cross thread,
components of yarn called the warp (the known as picking; and
lengthwise yarn) and the weft (the breadth wise c. the striking of each weft thread into its
yarn). A part of the cones from the spinning appointed position in the fabric, known as
Section is sent to the pirn-winding department beat up.
to make pirns which go to the weaving shed for
making the weft yarn. The conversion of cloth
demands the warp ends to be prepared in sheet 26.  CLOTH VARIETIES
form by arranging the cones in a creel. As many The cloth produced is divided mainly into
as 650 to 800 ends are taken from the creel and four categories viz. coarse, medium, fine and
wound on to a beam. This is called warping. superfine. The output of medium and coarse
Electronic sensors are provided to detect yarn cotton fabrics ranges from 40 to 50 yards per
breaks during the process for rectification. loom per shift, whereas the output of fine and
superfine cotton fabrics vary from 32 to 40
24.  SIZING yards per loom per shift, although the output
varies according to the quality of cotton used.
To overcome the strain of warp ends during Generally the production of coarse cloth works
cloth formation on the loom, the yarn is given out to about 2.7 yards, medium about 4.8 yards,
a protective coating, called sizing. Sizing is done fine about 5.2 yards and superfine about 8.5.
by applying starch-based adhesives to the yarn yards per pound of yarn consumed. Where there
in sheet from, with proper drying arrangements. is defect in the manufacture, the defective cloth
The width of fabric determines the number of is sold separately as seconds, rejects, rags, and
warp ends to be sized. The beams are arranged chindies.
one behind the other in tandem to deliver the
designated warp ends of the fabric to be sized. 27.  BOOKS MAINTAINED
The sheet of warp ends are immersed in the size
mix and squeezed to remove excess material and The design of the texture, the width, the weave
and the pattern of the cloth are all determined by
taken over a series of hot cylinders for uniform
the weaving master before weaving commences
drying. In this process, called ‘size retention’,
on the loom. The cotton fabric emerging from
the warp yarn gains weight. The size retention
the looms is called gray cloth. Each weaver
is about 40 per cent of the sizing materials
is paid on the basis of the gray cloth woven
used. The mill is expected to maintain a sizing by him, which as it comes out of the loom is
register and a waste register which record the immediately recorded in a ‘pick production
weight of the sized yarn and the wastage. book’, weaver wise. This is the initial record
in the factory, for cloth production. In most
25.  FORMATION OF CLOTH factories pieces handled by weavers are also
The beams of sized warp yarn are then transferred weighed and the weight recorded, in addition to
to the loom shed for weaving. This final stage of other particulars, weaver wise, and loom wise, in
a production account termed ‘kanta register’.
weaving consists of three steps:
Thereafter the gray cloth is transferred to the
a. the division of the warped yarn and folding department where it is actually measured
lifting/ lowering of its strands, so that the mechanically or manually, rejecting defective
weft or cross thread may be interwoven pieces. The correct yardage or meter length
or interlaced between them, known as is then recorded in the ‘output book’ from
shedding; which the daily production report is prepared,

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Techniques of Investigation for Assessment Vol. 3

showing quality wise manufacture of all cotton = Production as per

fabrics. This corresponds to the daily production Adjusted production RG 1 (now GST) (+)
statement in the spinning section. If the cloth is to as per RG 1 (now closing stock of cloth
be marketed in its gray condition, it is subjected GST) register in process (-)opening
to calendering, stamping, packing and baling. stock of cloth in process
In most of the mills, the gray cloth is subjected Opening stock of
to further processes before marketing. These yarn in the =a
weaving shed
include bleaching, dyeing, printing, mercerising
and ‘sanforising’. Thereafter, the pieces are Yarn issued to
=b
weaving
folded and sent to the stamping department
where the trade mark is stamped on each piece. Closing stock of
yarn in the =c
weaving shed
28.  TAX INVESTIGATION
Actual yarn
= (a + b)–c
28.1 Production: It is necessary to reconcile consumption
the production of cloth with the consumption This actual consumption is then to be compared
of yarn and the consumption of sizing material. with the standard consumption.
The sizing retention is usually about 40 per cent
Standard consumption = adjusted production
of the quantity of sizing material consumed. On
as per RG-1(now GST) register x standard yarn
this basis, the yarn consumed can be worked out
consumption per yard
as under:
28.3 Where quantitative details of the sizing
Weight of sized yarn =a materials issued are not available the test should
Add: Weight of wastage produced in be to see whether the ‘output statement’ reveals
=b
sizing any sizing retention at all. Normally the total on
Less: Weight of unsized yarn =c the right hand side of the above table should be
more than the total in the left hand side, and the
Difference, being size given to warp = d = a + b-c
excess represents the size retention. If no gain
Percentage difference = (d x 100)/ c = m due to size retention is recorded, it may indicate
Less: Size retained at 40% of d/c x 100 = 40 d/ c inflation of yarn issued or suppression of cloth
Net weight of yarn in cloth = m - 40 d/ c produced or manipulations in the closing stock
in the process.
Add: Weight of weft yarn produced
=n
in weaving
28.4 A quantitative tally should be made
Yarn consumed in cloth produced = m - 40 d/ c + n showing the cloth produced, issued and sold.
This can easily be found out from the Central
This figure of yarn consumed i.e. (m - 40d/ c +
Excise records. The output of cloth can also be
n) should then be compared with the actual yarn
checked with reference to average production
consumed. If there is a variation the reasons
per loom or the production per pound of yarn
have to be enquired into.
consumed on the basis of the average given
28.2  Another method of reconciling the yarn earlier. But this is only a rough check and if wide
shown as issued for weaving and the cloth deviations come to light a deeper probe may be
manufactured is as under: required.

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 Cotton Textile Industry

28.5 The following records/ registers are is suitable for multi-coloured garments. The
generally maintained and need scrutiny: spinning mills supply yarn on paper cones. For
dyeing, the grey yarn is first wound on steel
a. Sizing register
cones, and is then dyed. It is then dried in the
b. Waste register dryer, and re-wound on paper cones. The dyed
c. Weaver wise production book, and Kanta or the grey yarn is then knitted on circular knitting
register machines. If the cloth has been knitted on dyed
yarn, it is washed and calendered (pressed).
d. Daily production report Output book In case the cloth has been knitted from grey
The following verifications should be done for a yarn, the knitted cloth is sent for dyeing. Some
meaningful investigation: overseas buyers insist upon the manufacturers to
dye the yarn before converting into fabric. The
a. Reconciling of cloth with reference to yarn
latest development in dyeing is the introduction
and sizing material consumed.
of computerised dyeing machines which ensures
b. Quantitative tally of cloth issued and sold dyeing in correct shades. The bleached and dyed
should be verified from Central Excise fabric is then subjected to steam calendering,
Register. Overall production should be a process in which the fabric is passed over
checked with the Average production per hot rollers to remove wrinkles. Nowadays,
loom or per pound of yarn consumed. compacting machines are steadily replacing the
calendering machines. These machines ensure
29.  KNITTING INDUSTRY uniform width of the fabric and also minimise
Knitting: Hosiery goods are manufactured in shrinkage. The processed cloth is then cut into
various parts of the country. Tirupur in Tamilnadu the required sizes and shapes. Stitching and
is the major centre of this industry. The town is labeling make the goods ready for dispatch.
known the world over for hosiery manufacture 30.3 In cotton hosiery, knitting is done on
and exports. circular knitting machines. Most of these
machines are imported. The machines imported
30.  MANUFACTURING PROCESS from Germany & Italy are expensive and
produce cloth of finer quality. The machines
30.1 In cotton hosiery, cotton yarn is the
imported from Korea, Taiwan, China are
main raw material. The cotton yarn is supplied
by various spinning mills. Cotton of long cheaper but the cloth manufactured by these
staple is imported from America and Egypt to machines is not of very fine quality. The price
manufacture super fine cotton yarn. The yarn of the imported circular knitting machine varies
comes in various counts. Usually, single count of between 15 lakhs to 80 lakh depending upon
yarn of 8 to 60 is used for manufacturing T-shirts, the extent of computerization and other facilities
undergarments, ladies garments, nighties, sports available in the machine. The quality of the
wear, etc. The double count yarn is used for fabric depends upon the various factors like the
manufacturing collars, cotton sweaters, etc. quality of raw material, type of the machine used
Double count yarn is considered finer than the for manufacturing and the skill of the labour.
single cotton yarn e.g. yarn of 2/ 60 count is finer 30.4 The units which undertake all the
than the yarn of 1/ 30 count. manufacturing processes are known as
30.2 The spinning mills supply either the grey composite units. A majority of the manufacturers
yarn or the dyed yarn. Grey yarn is suitable of hosiery goods prefer to outsource the various
for single colour garments and the dyed yarn processing.

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Techniques of Investigation for Assessment Vol. 3

30.5 There is a significant difference in the 31.3  In export units, separate sheets of work-
business outlook of export units and the in-progress are maintained for each order.
units which manufacture goods for domestic Normally, it takes about 40 days (in the case of a
consumption. The export units are customer- unit outsourcing the processing) for export units
oriented. They first procure orders from overseas to execute the orders. The AO can check the
buyers and get samples approved, and then order sheets. Many exporters indicate, for easy
start procuring the raw materials. The domestic identification, the export order number in the
manufacturers manufacture goods according bills received from processors. Crosschecking of
to local fashion, in standard sizes and patterns. bills with the export orders will bring to light the
Their procurement of raw materials does not malpractices attempted in this regard. Analysis
depend on orders. of purchase and expense vouchers for February
and March with reference to the export order
31.  EXAMINATION OF ACCOUNTS would be useful.

31.1 Inflation of Expenses: A widespread 31.4  In the case of the manufacturers of goods

practice for suppressing income is to inflate the for domestic consumption, the manufacturing
expenses on fabrication charges, bleaching and process takes only 15 days as the approval of
buyers are not required at every stage. The
dyeing charges, stitching charges etc. A diligent
summer months are the peak season for the
analysis of input-output ratio may help the AO
hosiery goods in India. Production of hosiery
to find out the extent of inflation of expenses.
goods peaks in the months of February and
Whenever goods are taken out for processing or
March. The assessee is likely to have substantial
goods are received back from processing, delivery work-in-progress as on 31st March. A low closing
notes are prepared either by manufacturer or stock of work-in-progress or finished goods may
by the person who does the processing. The require scrutiny.
scrutiny of delivery notes would be useful to
ascertain whether the assessee had got the 31.5 Most of the hosiery goods are sold on
goods processed. Processing charges like dyeing consignment. Suppression of the stock of goods
with the consignees is often resorted to by the
charges vary depending upon the specifications.
manufacturers. The AO would do well to check
As there are no uniform rates the AO may find
the account statements from the consignees.
it difficult to analyse the dyeing charges. Rest of
Comparison of purchase of raw materials made
the processing charges have uniform rates and it
during the last quarter of the previous year
would not be difficult to examine the correctness (January-March) with the output achieved would
of the claim. be very useful in ascertaining the correctness of
31.2  Suppression of Closing Stock: Units, the closing stock.
other than composite units, send goods for 31.6  Suppression in Sale of Waste:
processing. At any point of time, some goods Wastage arises at each manufacturing stage
will be with the processors. The manufacturers starting from the wastage of cones, the wastage
often do not take into account the goods in at knitting stage (wastage of gray fabric), the
process in the closing stock. Method of valuation wastage when the dyeing or printing are not
of closing stock should be consistently adopted properly done. In the semi finished stage,
by the assessee in accordance with the generally improper cutting and stitching produce wastage.
accepted accounting policies and should not Rejected pieces cannot be sold. In the case of
be inconsistent with the law unless otherwise a composite manufacturer, the AO can fix the
provided. sale of wastage at 1 to 2 per cent of the total

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 Cotton Textile Industry

turnover of the manufactured goods. Invariably, 31.8 The assessees may generally go for tax
the assessee may sell the waste and contend that planning in such industry as there are various
the same is recycled. This needs to be properly allowances in the form of additional depreciation
examined with various factors or otherwise the u/s. 32, investment allowances u/s. 32A/ 32AC/
scrap sales earned in cash would go unnoticed.
32AD, deduction u/s. 80JJAA in respect of
31.7  The manufactures who out-source employment of new employees. Proper analysis
activities such as dyeing etc. realise the cost of the of the compliance of the conditions stipulated
rejects from the processors. The AO may verify
therein should be closely examined to avoid
whether the cost recovered from the processors is
properly accounted for. There would also be sale any mischief and to see that the intent of the
of waste. This aspect also has to be examined. legislature is not overstepped.

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Techniques of Investigation for Assessment Vol. 3

ANNEXURE - 1

GINNING PROCESS
RAW COTTON/ LOOSE BAGS
GINNING MACHINE
REMOVAL OF SEEDS/ OTHER IMPURITIES
COMPRESSED BALES OF C COTTON

SPINNING PROCESS
COMPRESSED BALES OF COTTON
LOOSE COTTON
MIXING UNIT
BLOW ROOM
LAP
CARDING UNIT
SLIVER
DRAWING (PROCESSED SLIVER)
SIMPLEX (ROVING)
SPINNING (YARN)
YARN

PACKING OF YARN
YARN [SINGLE YARN/ DOUBLE YARN]
CONE WINDING
CONE
YARN
PACKING OF YARN
YARN [SINGLE YARN/ DOUBLE YARN]
CONE WINDING
CONE

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 Chapter

3
Handloom and Powerloom

1.  HANDLOOM
1.1  Introduction: Industry Profile, Market
Size, Major Players
1.1.1 The Textile industry occupies a unique
place in our country. The Indian textiles industry,
currently estimated at around US$ 150 billion,
is expected to reach US$ 250 billion by 2019.
India’s textiles industry contributed seven per
cent of the industry output (in value terms) of
India in 2017–18. It contributed two per cent
to the GDP of India and employs more than
is mainly technology driven and uses various
45 million people in 2017–18. The sector
machinery and equipments of production. The
contributed 15 per cent to the export earnings
of India in 2017–18 and is the second largest unorganized sector which forms the dominant
employment generator after agriculture. India’s part of this industry, is labor intensive. The hand
overall textile exports during FY 2017–18 stood loom and power loom industries are mainly
at US$ 39.2 billion. under the unorganized Sector. The Handloom
Export Promotion Council (HEPC) is a statutory
(^Source: https:/www.ibef.org/industry/textiles. body constituted under the Ministry of Textiles,
aspx)
Government of India, to promote the export of
1.1.2 India’s textile sector comprises of four all handlooms products such as fabrics, home
important segments viz.: furnishings, carpets and floor coverings. HEPC
a. Modern textile mills was constituted in 1965 with 65 members, and
its present membership is about 2,000.
b. Independent Power looms
1.2  Role of Hand Loom Sector
c. Handlooms and
1.2.1 The Handloom Sector plays a very
d. Garments sector important role in the country’s economy. It is
It can also be classified into ‘organized and one of the largest economic activities providing
unorganized sector’. The handloom and direct employment to over 65 lakhs persons
power loom industries fall in the category of engaged in weaving and allied activities. As a
‘unorganized sector’. The organized sector result of effective Government intervention

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Techniques of Investigation for Assessment Vol. 3

through financial assistance and implementation 1.2.5 Handloom cloth is woven on looms

of various developmental and welfare schemes, worked by manual labour. It is a cottage industry
this Sector has been able to withstand and the looms are set-up even in the houses of the
competition from the power loom and mill weavers. The middle man plays a vital role here.
sectors. This sector contributes nearly 19% of The usual practice in this trade is that, the master
the total cloth produced in the country and also weaver employs several weavers. Yarn is supplied
adds substantially to export earnings. Handloom by the master weaver and the cloth woven by the
is unparalleled in its flexibility and versatility, weaver is taken back, and wages paid.
permitting experimentation and encouraging 1.3  Key Markets and Export Destinations
innovations. The strength of Handloom lies
in the introducing innovative designs, which The export of handloom products from India stood
cannot be replicated by the Power loom sector. at US$ 357.53 million in Financial Year 2016–
Thus, Handloom forms a part of the heritage of 17. In 2016–17, the US was the major importer
India and exemplifies the richness and diversity of Indian handloom products, with estimated
of our country and the artistry of the weavers. purchases of US$ 100.08 million, followed by
the Italy, UK and UAE at US$ 19.65 million, US$
1.2.2  Though the machine age and 18.45 and US$ 18.18 million, respectively. Spain,
mechanization sounded the death knell to Germany, France, Netherland, Australia, Japan,
Indian excellence in the field of cotton fabrics, Sweden, South Africa, Greece Thailand, Chile,
the handloom Industry has displayed innate Sri Lanka, Belgium, Canada, Denmark and
resilience and has survived the onslaught of Norway are some other key export destinations.
the more efficiently organized mill industry and During 2016–17, export of fabrics stood at US$
the decentralized powerloom industry. The 25.77 million, floor coverings stood at US$
handloom industry has passed through many 129.88 million, clothing accessories stood at
vicissitudes in its long checkered career and has US$ 20.27 million, and made-ups stood at US$
managed to exist and has been playing its role in 181.61 million.
the national economy.
1.4  State Wise Production of Handloom
1.2.3 A spectacular range of hand loom and
silks is created by weavers across the country,
from the Madras checks and Kanchipuram
weaves of Tamil Nadu to Pashmina and
Shahtoosh of J&K, from the ‘tie-and-dyes’ of
Gujarat and Rajasthan to the ‘eri and muga
silks’ of Assam.
1.2.4  Handlooms constitute a vital sector of the
village economy next only to agriculture. The
number of handlooms in the country is estimated
to be 3.8 millions scattered over the entire length
and breadth of the country. 4.3 million people
are directly involved in handloom production.
Handloom industry is the 2nd largest employment
provider in rural India after agriculture. 85%
of world’s capacity in handloom production is
in India. India produces 1000 crore worth of
handloom goods.

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 Handloom and Powerloom

2.  POWERLOOM 2.1.5 The process of liberalization opened-

up Textile Sector to potential entrants. Besides
2.1  Introduction eliminating the system of licensing, the Textile
2.1.1 Powerloom accounts for nearly 60% of Sector was removed from the list of ‘reservation’
fabrics and, because it is mechanized, works for the small scale industries. In 2000, a new
nearly 10 times faster than handloom. Costs textile policy was announced by the Government
differ, but the gap is massive: handloom can cost of India, with an aim of modernizing the textile
Rs 500/ meter to create, while the same fabric industry so as to meet the global competition and
could be woven on a powerloom for Rs 30/ implemented in a time bound manner with the
meter. The average investment in a powerloom technology up-gradation fund scheme covering
industry could be Rs. 15,000 which is three times all manufacturing sectors of the textile industry.
that of handloom. The policy relaxed the restrictions on foreign
investment, foreign technology and foreign
2.1.2  India manufactures 5% of cloth through
organized sector, 20% of through handloom equipment to make the domestic industry more
sector, 15% through printing sector and 60% efficient and competitive.
through decentralized powerlooms sector. The 2.1.6  Besides the textile mills, cloth is
decentralized Power Loom sector is the life also manufactured by smaller units called
line of Indian Textile Industries. 2.43 million of ‘powerlooms’ using indigenous looms run
powerlooms weaving 19000 million meters of by power. The powerloom factories generally
fabric provide employment to 7 million workers. purchase yarn from spinning mills and weave
The industries now produce wide range of fabric, various types of cotton fabrics. The powerloom
dyed fabric, cotton fabric, various mix of cotton, weaving industry has undergone major changes
synthetic and other fabrics. The country exports in terms of modernization of machinery and
to the tune of Rs. 44,000 million worth of goods
technological upgradation of the process of
to other countries like USA, France, Germany,
manufacture.
UAE, Hong Kong, etc.
2.1.3 Most of the power loom units are 3.  BUSINESS OPERATION/
concentrated into ‘Semi urban or Rural area’. PROCESSES IN TEXTILE INDUSTRY
Among all, Maharashtra has the highest number
of power looms (8 lakh units), Tamilnadu is 3.1  India’s textile industry comprises mostly
second (5 lakh units), Gujarat ranks at third small-scale, non-integrated spinning, weaving,
(4 to 4.5 lakh units). The city namely Bhiwandi finishing, and apparel-making enterprises. The
situated 50kms from Mumbai is key textile Centre figure below depicts the overall value chain and
of Western India and has 1/ 3rd of country’s total the number and type of units within the industry.
power looms and turnover of around Rs. 10,000
crore annually.
2.1.4 The earlier powerlooms were shuttle
based which were slow. Now-a-days faster
looms without shuttles are used. We have 45%
of world powerloom capacity. However, in this
industry we suffer from (i) obsolete technology,
(ii) low value addition, (iii) unskilled labour and
(iv) power shortage.

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Techniques of Investigation for Assessment Vol. 3

3.2 The various processes involved in the c. Weaving: ‘Weaving’ is an ancient textile

textile industry beginning from cotton fiber to art and craft that involves placing two
final garment is shown in the flow chart: threads or yarn made of fiber into a wrap
a. Ginning: ‘Ginning’ is a process of cleaning and weft of a loom and turning them into
the cotton fiber of impurities like cotton cloth. The yarn for weaving is of two kinds
seeds, dust, grime etc. and straitening the namely, (i) wrap yarn and (i) weft yarn.
cotton fiber, which is then pressed into bales Wrap yarn means the yarn running length-
and sent to spinning mills. wise in the cloth, and the transverse threads
in the cloth are called weft. The wrap yarn
b. Spinning: ‘Spinning’ is the process of
creating yarn (or thread, rope, cable) from should be stronger than weft yarn so as to
various raw fiber materials. Several fibers withstand the stress and strain of shuttle
are twisted together to bind them into a movement at the time of weaving. This
strong, long yarn. Characteristics of the cloth can be plain (in one color or a simple
yarn vary based on the material used, fiber pattern), or it can be woven in decorative
length and alignment, quantity of fiber or artistic designs, including tapestries. The
used and degreeof twist. Various types of following chart shows the steps in weaving
looms are used like shuttle, air jet, water process:
jet, rapier, projectile, dobby, jacquard
and circular. Spinning involves a lot of
processes which is given below:

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 Handloom and Powerloom

d. Processing of Cloth: The steps involved desired textile product. This includes fiber, yarn,
in processing of cloth is depicted in the fabric or garment. Some type of batch dyeing
flow chart below: machines can function at temperatures only up
to 1000oC. For example cotton, rayon, nylon,
wool, etc. can be dyed at 1000oC or lower
temperatures, while polyester and some other
synthetic fibers are dyed at 1000o Centigrade
or even higher temperatures. There are three
general types of batch dyeing machines which:
a. where there is circulation of fabric,
b. where the dye bath gets circulated while
the material that is being dyed remains
stationary,
c. where both the bath and materialto be
dyed gets circulated. Examples of dyeing
machines that utilizes batch dyeing process
are Beck, Jet, Jigs, Beam Package dyeing
machines, etc.
3.4  Garment Manufacturing: The Garment
manufacturers are primarily engaged in the
design, cutting and sewing of garments from
fabric. Design and patterning is now done on
‘CAD’ and ‘CAM’ software. Some manufacturers
are either contractors or sub-contractors, which
generally manufacture apparel from materials
owned by other firms. Some manufacturers are
vertically integrated, producing the textiles from
which, they make garments, or even operating
3.3 Textile Dyeing: In selecting the method of
retail outlets too.
textile dyeing, the type of process used depends
on several factors that include type of material 3.5  The production of various types of fabrics is
like, fiber, yarn, fabric, fabric construction, depicted in the pie diagram below:
garment, generic type of fibers, quality standards Total Production of Various Types of Fabrics
used in the dyed fabric, sizes of the dye lots,
etc. Batch Dyeing Process is the most popular
and common method used for dyeing of textile
materials. Batch dyeing is also sometimes
referred to as Exhaust dyeing. This is because
in this process, the dye gets slowly transferred
from a comparatively large volume dye bath
to the substrate or material that is to be dyed.
The time taken is also longer. The dye is meant
to ‘exhaust’ from dye bath to the substrate. In
batch processes, textile substrates can be easily
dyed at any stage of their assembly into the

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Techniques of Investigation for Assessment Vol. 3

4.  TAX EVASION AND ACTION TO BE disclosed all the production which he gets done
TAKEN BY THE INVESTIGATION through the other weavers employed for the
OFFICER/ ASSESSING OFFICER purchase.
Tax evasion is a complex problem. Investigation
of tax evasion is a challenging task requiring 4.2  Bogus/ Inflated Purchases
imagination, intuition, skill, aptitude and 4.2.1  Since more than 60% of the finished
experience. Techniques of tax evasion become product cost consists of principal raw material
more and more complex as methods of detection i.e. cotton which is purchased in cash through
become sophisticated. The various issues that farmers who generally do not maintain books of
need to be examined & verified to detect tax accounts or file returns. Hence, it is a common
evasion are enumerated here-in-under. tendency of the assessee to show purchases at
a higher price and overcast purchases. Cotton
4.1  Profit Ratios Association of India (CAI) is soon going to
launch a ‘CAI trader mobile app’ for the benefit
4.1.1 The AO should compare the gross
of all its members who deal in cotton trade. The
profit ratios of assesses having similar nature
app would help cotton traders with fresh market
of business to check the correctness of profits.
data about prices and arrival. In addition to data
It is seen that industries of similar nature are
of BSE and MCX rates, the app will also give live
concentrated in specific regions. For example,
data of USD/ INR exchange rate and ICE cotton
in Saurashtra region there are many ginning
futures price. The officers can also make use of
industries. Similarly power loom weaving
such app to understand the general pricings and
industries are found in Bhiwandi and Surat and
to evaluate the justification of the profits shown
knitting industry is based at Coimbatore (TN).
in the books.
The books of accounts of the assessee which do
not reflect the true state of affairs and incorrect 4.2.2 Some of the manufacturers mix art silk
GP and NP are shown by way of under reporting yarn or blended yarns with cotton yarn and
of quantity of stocks and over reporting of sell the product. Art silk yarn is obtained by
manufacturing cost. The AO should verify the getting import licenses. These Licenses are sold
stock and the expenses claimed by the assessee. at premium and regular rackets flourish in the
sale of this quota. In such cases, the production
4.1.2 There should be reconciliation of raw
and sale account would be sham, there being no
material consumed and finished product
production or sale, the art silk licenses having
produced. Further in case of power loom, to
been sold. Wherever an assessee is found to
operate the same, permission from the Textile
have purchased a license, his account should be
Commissioner is needed. All power loom
taken up for intensive scrutiny. As the upcountry
units are under the supervision of GST officer merchants purchase the licenses after payment
of particular area. They are required to keep a of the premium, the enquiry should be to find
register showing particulars of owner, location out whether the manufacturer has utilised the
of factory, total number of looms, number of license by:
looms working on non cotton fabrics, name
and address of master weaver. Similarly in case a. Importing the yarn and paying for it,
of master weaver the GST range office has to b. Clearing the yarn,
maintain a register showing name and address
c. Transporting the same to his place of
of master weaver, license number, location of
manufacture, and
work premises etc. The AO may go through
this register to see whether a master weaver has d. Utilizing the same in the business.

44
 Handloom and Powerloom

Liaison with the Controller of Import and Export, 4.6  Price Inflation
Customs etc. would be helpful. Expenditure Some dealers purchase at discounted prices,
account also should be scrutinized to see whether finished products from the co-operatives and
any ‘bogus expenditure’ is claimed. other handloom producer and resale them
when the market conditions are favourable
4.3  Bogus/ Inflated Job Work Charges after inflating purchase price. Payment made
The job work is mostly done in the unorganized as advances to cooperative societies and lorry
sector and payments are made in cash through receipts/ transport receipts are to be reconciled
labourers who do not file returns hence there for proper date of booking the purchase.
is common tendency to inflate the job work
charges. There have been several instances of 4.7  Transfer Pricing
bogus job work payments. The investigation Multinational players in the industry transfer the
officers should verify the same. Beside GST is goods at lower cost to their related/ associated
applicable to minimum turnover of Rs. 20 lacs concerns located outside India. The transfer
so many of those parties doing job work do not pricing provisions although are applicable on
file return. Thus the scope for inflating the job such transactions, such company portray the
work expenses is high. The AO should examine price quoted by the other company in the same
the job work register, register of goods inward segment and justify the prices charged by them.
and outward and other circumstantial factors Further, transfer pricing being a subjective issue
including place from which job work is carried also casts additional burden on the revenue to
out, mode and source of payment to job work, justify their stand. Therefore, proper verification
etc. Also, in order to increase the expenses the with documentation is required to be done by
manufacturers book bogus or inflated job work Transfer pricing officer to stand the test of further
expenses to related parties. The AO should litigation.
minutely examine these expenses.
4.8  Capital Expenses Claimed
4.4  Over Booking Wages and as Revenue
Commission Payments
As explained earlier, organized sector in the
In some cases, wages and commission are textile industry are technology driven considering
inflated and huge advances are shown to be the variety of machines engaged in the process.
pending from the weavers. But, on examination In major expansion or updation carried out by
these are found not to be true. Thus, where huge them the capital outlay is often shown as repairs
advances are shown contrary to normal practice, and maintenance and claimed as revenue
expense. Therefore, proper verification with
examination of weavers to whom such advances
documentation is required to be done in this
are made will be essential.
regard.

4.5  Stock Transfer

4.9  Under Invoicing/ Suppression
Where business is carried out through branches of Sale
at various places, it is necessary to see that branch 4.9.1 As regards ‘suppression of sales’,
accounts have been reconciled with head office. it would be necessary to verify the sales with
The transfer of stock from head office to branch reference to the railway and road bookings.
office should be invariably checked to verify the It would be useful to take contemporaneous
same and outgoing from the branch office. extracts from railways stations and transport

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Techniques of Investigation for Assessment Vol. 3

companies as some cloth bales are booked into possession the ledger account and prepare
by the master weaver against self address and an inventory which in time should be compared
railway receipts is usually sent to their agents with the consumption and production shown in
stationed at various locations. The agents take the weaver’s accounts.
money from purchasers and clear RR through
4.10.2  The cloth manufactured can be arrived
bank and then sale bales. Very often such sales
at both in terms of weight and in terms of yards
for which invoices are fabricated in different
or meters. In a particular area there will be
name are omitted from the books. Therefore, in
standard output of cloth either in terms of yards
respect of consignments sent by rail or road from
the station where production Centre is situated if or in terms of meters with reference to every 1
such extracts are taken and checked suppression Kg. of yarn consumed. Thus, if the output of a
can be unearthed. Registers of transporters particular type of cloth is not upto the standard
should also be checked to find inflation in production shown in the accepted cases, it
purchases. would be necessary to subject the accounts to
a thorough scrutiny. The details regarding the
4.9.2  Sometimes, inferior or substandard
estimates of fabric from khadi, wool and silk,
quality of production is shown as sold, whereas
can be collected from the O/o Khadi and Village
production is of standard quality. This practice is
Industries Commission, Wool Development
resorted to pocket the excess sale proceeds.
Board and Central Silk Board respectively.
4.9.3  Common method of under booking sales
is through offering heavy discounts generally 4.11  Wastage
named as “seconds”/ “quality defect”. However,
Wastage is inherent in the different processes,
in reality the same is sold at retail counter in
therefore, its cost should be charged to the good
cash at full price. During the course of stock
units produced. The calculation of the cost of the
taking/ manufacture process, verification of
finished product per unit for each cost centre is
such defective pieces as a percentage of total
worked out after taking account of the wastage
production to be compared on year to year basis
multipliers for the respective cost Centres. The
for any major fluctuation.
waste multipliers are calculated to determine the
quantity of raw materials required to produce
4.10  Yield
one unit of the finished product. In the case of
4.10.1  The yield of the products from various spinning activity, a waste multiplier is also known
type of looms varies depending on the type as the ‘Yarn Equivalent Factor’ (YEF). The
of the weaves and the mix of yarns used. In a formula used for its calculation for a cost centre
typical case, the master weaver keeps a ledger is as follows:
account for such weavers showing the quantity
100 - Total waste% (Upto and including the
of yarn supplied the quantity of cloth taken
waste% at that cost centre)
back and wages paid. The consumption of
yarn and the production of cloth in such cases, 100 - Total waste% in all cost Centres.
as recorded in the assessee’s book should,
It may be noted that the total waste percentage
therefore, be compared with the consumption
in the above formula has to be based upon the
and production shown in the weaver’s accounts.
input of the first cost centre. The calculation of
Where such ledger account is not produced,
the waste multiplier is illustrated below:
the only way to get at the information is to take
resort to action under Section 133A and take Mixing: 30s

46
 Handloom and Powerloom

Cost Centres Actual Waste % 6.1.1  Billing higher quantity of goods: A

particular finished product of say a shirt costing
(i) Mixing and Blow Room 6.00 Rs. 1200/- is billed as two shirts costing Rs.
(ii) Carding 7.60 600/-. Accordingly, they can claim twice the
(iii) Pre-comb Drawing 0.80 expenditure of related costs and reduce the profit
(iv) Combing 10.10
6.1.2  Using the same invoice three times:
(v) Post-comb Drawing 0.50
saree traders often use the same set of invoices
(vi) Inter-roving 0.50
to ship goods to other state. The reason why
(vii) Ring-spinning 2.50
the same invoice is used is unknown but it is
28.00
customary that the invoice is used three times
Thus, for carding cost centre the waste and accordingly sales are under booked.
multiplier is 6.1.3  Simultaneous use of kacchha and pakka
= 100 - (6 00 + 7.60) = 1.2 invoice which are destroyed if tax authorities do
100 - 28 not check truck on the way is also a common
trend in the industry.
If the per kg cost of yarn produced upto the
‘carding’ process is ‘x’ (before taking account 6.1.4  Unlike goods moving by trucks, which
of the wastages), the final per kg. cost of yarn are stopped on the way, there are virtually no
produced upto the “carding” process can be checks in case of railways, making it easier to
determined by multiplying ‘x’ 1 with the waste evade taxes.
“multiplier” for that process i.e. 1:2. 6.1.5  The traders have started dispatching
goods by railway instead of roads as movements
5.  CONCESSION GIVEN BY of goods by trucks involve e-Bills (GST).
GOVERNMENT
6.1.6  The investigation officers should verify
In recent years many primary cooperative these aspects. Beside GST is applicable to minimum
societies have been formed at various production turnover of Rs. 20 lacs so many of those parties
Centres and there is an apex body regulating the doing job work do not file return. Thus the scope
primary cooperative societies. Thus, Section for inflating the job work expenses is high. To plug
80P comes into operation in such cases and this problem the reverse charge mechanism has
the income from this mostly gets deducted. The been introduced in GST wherein the buyer from
Department has, therefore, to deal with both unregistered dealers pays tax on the goods and
manufacturers and merchants. The merchants services rendered by the job workers. However,
may be either wholesalers or retailers. New the same was deferred by Government.
issues like purchase of looms, their claim of
depreciation, subsidy etc. needs to be verified. 6.2 Under the ‘GST regime’ and even under
previous excise regime the classification of
output goods is done by manufacturer in such a
6.  GST RELATED TAX EVASION
way that it attracts the lowest rate of indirect tax.
6.1  As recently reported in the press the players For example, under GST regime synthetic yarn
of the garment industry employ the following and man-made fibre is taxable @ 18% & 12%
innovative techniques of tax evasion of GST due whereas output fabric is taxable at lower rate
to differential GST rates based on price, type of of 5%. Hence the finished product is wrongly
yarn, exemption given and structured faults of classified by the manufacturer and the rate
GST schemes. applied is much lower than at the price it is sold.

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Techniques of Investigation for Assessment Vol. 3

The investigation/ AO officer should check-up and other assesses in the same line of business.
the type of goods manufactured. Unusual ratio should be examined and such
case be taken up for survey.
6.3  Products sold below Rs. 1000/- should be
thoroughly verified. Further, bills made below 7.7 Repairs and Maintenance Expenses
Rs. 50,000/- are not subject to e-way bill. Special should be verified keeping in mind the various
verification of bills or parties to whom repetitive case laws as to whether the same is capital or
bills of below Rs. 50,000/- are sent should also revenue expense.
be made and if possible cross verification should 7.8  In case of 1st year of assessee or Capital
be done. expansion, the AO should examine the source
of increase in capital by way of Share Issue/
7.  CHECK LIST FOR AO’S AND Unsecured loans. Also in case of share premium
SAMPLE QUESTIONNAIRE the basis of premium calculation needs to
verified, keeping in mind the provisions of Sec.
7.1  Purchase of cotton (URD) purchases 56(2)(x) of the I.T. Act.
should be verified vis-a-vis MCX prices on
7.9  Any wastage out of production activity
that date. Upcoming trading app may also be
should be factored properly with the yield ratio
relevant for this purpose.
and general industrial trends and business
7.2  Installed capacity details of unit should be practices. Many a times, wastages are recycled
called for and should be verified vis-á-vis actual or sold in scrap. Relevant measures to check this
production figures. The difference is clear indicator aspect should be taken by the officer.
of suppression of sales. Electricity consumption, 7.10  The Income-tax Act provides various
factory registers, engineer certificate, stock benefits in the form of additional depreciation,
records, GST records etc can be relevant pointers investment allowances, profit linked deductions,
to check the production carried out. employment linked deductions. It should be
7.3  The AO should call for loan details and properly examined whether the claims of the
Project Report submitted to Bank u/s. 133(6) of assessee are genuine and necessary conditions
have been complied with or not.
the I.T. Act to verify the projected production and
sales figures submitted to the bank which should 7.11  Considering the industrial profit
be match with actual production figures. In case margin, trend analysis and the overall market
of high variation the same should be examined of this industry, the Officer should examine
thoroughly. the records minutely to check whether there is
any suppression in the profits offered to tax by
7.4  Related party sales should be verified inflating the expenses or reducing the sales or
for pricing. Similarly related party purchases/ closing stock valuation.
expenses claimed like job-work, commission etc
7.12  Instances of showing higher profits in
are also inflated or are bogus. The AO should books and claiming deductions in Income-tax
verify the genuineness of these expenses. can also prevail in order to show rosy picture
7.5  Sales show under invoicing or unreported in books and simultaneously, also avoiding any
sales. The AO should call for Transport Receipts, tax implications as this helps the assessee to
Railways Receipts, export Receipts and verify even avail higher finance assistance from banks,
accordingly. NBFC or any other financial institutions. The
Officer should also monitor such transactions
7.6  AO should compare Gross Profit Ratio, and check the genuineness thereof to avoid any
electricity consumption, lower/ wages charges, defaults of payments to such finance lending
job-work charge with that of previous years companies/ banks as well.

48
 Chapter

4
Process House

1.  INTRODUCTION
1.1 A process house is an institution where
colouring and finishing work is executed on
gray cloth with the help of machines. It is Chapter an - 4
important limb of the textile industry. The
PROCESS HOUSE
demand for synthetic fabrics has gone up in
Introduction
India due to increase in population, direct and
indirect exports, durability
1.1 A and
process low
house is ancost of the
institution where colouring and finishing work is executed on
gray cloth with the help of machines. It is an important limb of the textile industry. The
fabrics, besides several other favourable factors
demand for synthetic fabrics has gone up in India due to increase in population, direct and
as compared to cotton fabrics.durability and low cost of the fabrics, besides several other favourable
indirect exports,
factors as compared to cotton fabrics.
1.2  Textile manufacturing is a major industry.
It is based on the1.2conversion
Textile manufacturing
of fiberisinto
a major the Itcomplexities
yarnindustry. is based on ofthe theconversion
finishing and colouration
of fiber into yarn and yarn into fabric. These are then dyed or printed and fabricated
and yarn into fabric. These are then dyed or processes to the production
into clothes. Different types of fibers are used to produce yarn. Cotton remains the most
of wide ranges of
printed and fabricated into fiber.
important natural clothes.
There Different
are many variable products. Thereatremains
processes available the spinningaandlarge industry that
types of fibers arefabric-forming
used to produce stages coupled
yarn.with uses of
the complexities
Cotton hand techniques
the finishing to achieve the same
and colouration
processes to the production of wide ranges of products. There remains a large industry that
remains the mostuses important natural fiber. There results. Any fabric, may it be a Saree, Dress,
hand techniques to achieve the same results. Any fabric, may it be a Saree, Dress,
are many variable processes available at the Suiting,
Suiting, Shirting is made up of yarn and has to typically Shirting
pass through is made
following process:up of yarn and has to
spinning and fabric-forming stages coupled with typically pass through following process:

Dyeing and Cutting and

Yarn Printing Packing

Grey Value
Addittion

1.3  Yarn is the basic raw material for preparing 1.4  The yarn is then used by the weavers who
1.3 Yarn is the basic
any fabric. Yarns are manufactured from variousraw material for preparingweave the
any fabric. Yarnsyarn into various
are manufactured from types of fabrics.
various natural and manmade fibres originating from cotton, viscose, POY and so on. These
natural and manmade fibres
fibres passes originating
through
The process
fromlike twisting,
various processes
of weaving is carried out through
texturising, heating etc. and are
cotton, viscose, POY and into
manufactured sovarious
on. grades,
Thesedenierfibres Looms. Looms may be traditional Indian looms
quality etc.
passes through various
1.4 Theprocesses
yarn is then usedlike bytwisting,
the weavers who or weave
high the endyarntechnologies
into various typeslike
of rapier, water jet,
texturising, heating etc.Theand
fabrics. process areof manufactured electronic
weaving is carried out through Looms. jacquard
Looms may be and so on. The cost of a
traditional
Indian looms or high end technologies like rapier,typical water jet, loom
electronicmay
jacquardrange anywhere between
and so on.
into various grades, denier quality etc.
The cost of a typical loom may range anywhere between Rs 0.50 Lakhs to Rs 150.00 Lakhs
and the industry may be categorised from cottage industry to large scale industry depending
on the number and types of looms.
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1.5 In all these processes the most complicated process is dyeing and printing. Grey
fabrics, which are the coarse or raw fabrics, passes through various process of cleaning,
softening, shortages, elongation and dyeing, printing, heat setting and so on. This part of
textile processing is the most capital intensive part of the chain and uses the maximum
Techniques of Investigation for Assessment Vol. 3

Rs 0.50 Lakhs to Rs 150.00 Lakhs and the depending upon the requirements of user like
industry may be categorised from cottage suit, saree, scarf, burka, duppata and so on. The
industry to large scale industry depending on the ready fabric is now sent for value addition. Value
number and types of looms. addition may of various kinds like stitching of
1.5  In all these processes the most complicated laces, stones, embroidery, garmenting, foiling
process is dyeing and printing. Grey fabrics, and so on.
which are the coarse or raw fabrics, passes 1.7 After the completion of the above stages,
through various process of cleaning, softening, the fabric are then polished, packed, branded
shortages, elongation and dyeing, printing, heat and despatched to various wholesalers spread
setting and so on. This part of textile processing throughout India and across globe through
is the most capital intensive part of the chain various means viz. road, railway and sea ways.
and uses the maximum number of raw materials 1.8 Out of the above processes, Process
and machineries in the process, transforming the Houses are the biggest value addition chain
raw fabric into finished and ready to wear fabric. and deploy maximum number of machines,
Typically such units are called as process house. processes, employees, raw materials and so on.
1.6 After the dyeing, printing and processing The complete flow chart of production process
of fabric, the fabric are cut into various size can be summarised as below:
Grey Fabric Purchase

Grey Inspection

Drumming Color Chemical U Tube / Long Tube

Store

Stenter (H. Set.) Stenter (H. Set.)

Purchase
Department
Scouring Scouring (Jet)

Stenter (H. Set.) Bleaching

CWR Soflina Stenter

Stenter (Drying)

Dyeing (Then)

Stenter (Heat Setting)

Folding

Padding

Padding Dyed Finish Padding Print

Loop 1. Designing Printing

2. Tracing
3. Engraving /
Washing Rotary Rotary / flat bed
Exposing Printing
4. Sampling
Stenter (Finish)
Loop
Color Chemical
Sanforsing (Zero-Zero) Store-Color
Dispenser Washing

Selvedge Cutter
Handprint, Stenter (Finish)
Sachin
Folding Dispatch
Sanforsing (Zero-Zero)

Selvedge Cutter

Folding Dispatch

Dispatch

1.9 The production flow chart depicted supra, clearly show that there are number of
processes involved in the dyeing and printing of fabrics. The whole process is a very
50

70
 Process House

1.9  The production flow chart depicted supra, investment in a process house. It is very difficult
clearly show that there are number of processes to detect such ON Money paid conclusively,
involved in the dyeing and printing of fabrics. The except in search or survey actions, where some
whole process is a very complicated production incriminating documents may be found. But in
method and not a line production. A piece of course of assessment also the valuation derived
fabric may go more than once through the same by the bankers for providing term loan to the
production process. The process may elongate assessee is a very important factor in deriving
the fabric, shorten the fabric and change the the value of land. In process house almost all
colour of fabric, width of fabric or weight of the units take Bank Loans for availing benefits
fabric. From the view of tax investigation, the of subsidy available under TUF (Textile Up
complicated production method and not a line production. A piece of fabric may go more
understanding of process house may be divided
than once through the same production process. The process may elongate the fabric, shorten
gradation Fund) and other state government
intoandcapital
the fabric change theexpenses,
colour of fabric, production expenses
width of fabric or weight andthe viewscheme.
of fabric. From
of tax investigation, the understanding of process house may be divided into capital expenses,
production
expenses andprocesses as depicted below:
production production processes as depicted below: 2.3 Building: A major part of unaccounted
Understanding money may be Utilised in construction cost of
Process House the building in order to avoid payment of indirect
taxes like VAT, Excise, Service Tax (Now merged
Capital into GST). Such evasions may be generally
Expenses identified through the Valuers or obtaining
of engineers report or putting some standard
Revenue construction rates on the constructed area which
Expenses may vary from Rs. 600 per sq. ft. to Rs. 1200
per sq. ft. depending on quality of construction,
Production foundation laid etc.
Process
2.4  Temporary Sheds: A process house
raises temporary or permanent sheds from time
2.
2. Capital Expenses:
CAPITAL EXPENSES to time for purpose of storage of raw material
2.1 The capital expenses of a Process House consist of following major heads:
and establishing some ancillary machineries.
2.1 The
 Land capital expenses of a Process House
Generally such sheds are not accounted for
consist
 Buildingof following major heads:
 Temporary Sheds properly in the books of accounts. To avoid
a. Plant
Land
and Machinery indirect taxes on materials, low rates item are
 Software
b. Building shown to be used more in comparison of high
The above CAPEX are very important from tax perspective and contain some common
verification points and some industry specific issues. rate items. Also cost of such sheds may be inflated
c. Temporary Sheds to reduce the profitability of the company. Many
2.2 Involvement of ON Money in Land: In India it is a very common practice to pay
cash overd. Plant and Machinery
and above the recorded price for purchase of immovable property. Land forms aa times cost of such sheds are also debited to
major part of investment in a process house. It is very difficult to detect such ON Money paid
repairs and maintenance expenses for reducing
e. Software
conclusively, except in search or survey actions, where some incriminating documents may
be found. But in course of assessment also the valuation derived by the bankers for providing the profits.
term loan to the assessee is a very important factor in deriving the value of land. In process
The above CAPEX are very important from
house almost all the units take Bank Loans for availing benefits of subsidy available under 2.5 Plant & Machinery: A process house
TUFtax(Textileperspective and
Up gradation Fund) and othercontain
state governmentsome
scheme. common
uses various types of Plant & Machinery,
verification points and some industry specific
which ranges from small to large, portable to
issues. 71 immovable, mechanical to complex electronical,
2.2  Involvement of Money in Land: In India second hand to tailor made machines. Such
it is a very common practice to pay cash over heterogeneous mixture of non-standardised
and above the recorded price for purchase of machines lead to a situation where finding out
immovable property. Land forms a major part of the cost of machineries, number of machineries

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Techniques of Investigation for Assessment Vol. 3

installed etc. becomes practically near to 3.  REVENUE EXPENSES

impossible. But one important aspect is the use 3.1 No Standard Recipe: In a process
of second hand machineries. In many cases, house various quality of fabrics are processed
second hand machineries are bought at high and in multiple methods. There may be wide
cost to claim extra depreciation. variation in usage of colour, chemical, power,
2.6 Software: A process house may use various gas and other raw materials in processing of
various types of fabrics. So, it is very difficult
type of software used in designing, R&D, Quality
to assume in such circumstances as to the
control, Process control and accounting. The
actual consumption of stock, but then also
accounting packages may be local accounting
analysis of various qualities produced by the
software or high end SAP. Generally the costs
process house, its historical costing and current
of such software are accounted in books of
years cost incurred vis-a-vis the job charges
accounts. But the analysis of such cost throws a
collected, may throw a light on actual expenses.
light on what type of software the assessee has Comparison of financial data with cost records
purchased. Many a times, some software may be can be quite helpful in this regards.
found to be purchased which are used in cloud
computing, external hard disk and so on, which 3.2  Stock Register Not Maintained: Most
may be an important source of information for of the process houses maintains proper stock
tax matters. of the inward and outward quantity of fabric
produced in the process house. At the same
2.7 Subsidy: Textile sector receives various time most of the process house do not maintain
subsidies in form of capital subsidy or revenue proper records of raw materials consumed
subsidy, under TUFS, State schemes, Electricity in the complete production process and the
schemes and so on. Various assessee may use same results into a big black hole for assessing
various accounting policies in respect of timing, officer to determine actual consumption of raw
quantum and nature of such receipts. It may be materials. Verification of secondary records/
treated directly as a capital grant and not passed books maintained by process house may be
through Profit and Loss account; it may be helpful in such circumstances.
reduced from the cost of machines or it may be 3.3  Inflated Expenses: Both the above
straight forward taken into revenue account. It scenarios cumulatively provide a very
may be booked at time of finalisation of amount conducive environment for any process house
or receipt of amount or on fulfilment of all the to inflate the expenses in form of raw materials.
conditions of subsidy compliances up to the As it is virtually not possible to calculate exact
prescribed period of time. It is very important consumption of raw materials, many a time cash
to note that any accounting policy must be in purchases or bogus purchases are resorted for
line with the ICDS guidelines. Now, due to the inflating expenses. Verification of Indirect tax
amendment in the definition of Section 2(24) records of suppliers and process house may lead
(xviii) of the Act, assistance in the form of to identification of black sheep in the books of
subsidy by whatever name called is invariably to accounts.
be treated as income unless otherwise provided 3.4  High Employee Turnover: Textile is one
in said section. Thus, the major dispute which of the biggest employers in MSME segment in
arose earlier regarding revenue or capital subsidy India. The majority of employees are unskilled
gets resolved and settled. and uneducated. Due to lack of awareness,

52
 Process House

the labourers keep moving from one factory 4.  PRODUCTION PROCESS
to another after collecting their wages daily, 4.1  As discussed the fabric process unlike any
weekly or monthly and there is a huge turnover line process of manufacturing, moves in a very
of employees in any process house. This huge complex way with over-lapping processes and
turnover allows the process houses to show basically comprises of various permutation
more man days of work done by any worker, and combinations of complex processes, not
who have left the job and inflate the salary and providing any audit trails during assessment.
wages expenses. But after the demonetisation Nevertheless the following points may be useful
and recent instruction of Labour ministry, most for assessment.
of the labours are to be paid their wages or
4.2  Energy Consumption & Job Bill: All the
salary by cheque only. Under such condition machinery used in process house is working on
cash payments to labourers may be an area to energy. The energy may be in form of electricity,
be focussed upon. gas or solar. It is the gospel truth that if the
machineries will run more, the power consumed
3.5  GST—The Game Changer will be more and the job work billed must be
3.5.1  Before GST regime, the suppliers were more. So, a judicious analysis of the energy
covered under Vat or Excise. In both the laws consumed and sales made may be helpful.
there was no live monitoring on the existence or 4.3  Production Capacity of Few Standard
genuinity of the suppliers. The black sheep were Machines: There are machines like Boilers,
identified at a much later stage when the indirect stenter, drum etc. which are invariably used for
tax authorities were discovering that some processing of any fabrics. Production capacity of
suppliers were bogus and were not depositing such machines and cross matching of productions
the indirect taxes. Due to passage of time, such machine-wise, to the extent available, may be of
cases were handled by the Department under great help for the assessment.
provisions of Section 147/ 148, which were
quite litigative and time consuming. Now due 4.4  Shortage and Elongation: During
to advent of GST the AO can check the inward process a fabric may be shortened or elongated
credit register of the assessee and find which from the original size and length, which may
suppliers are depositing GST against invoices increase or decrease the invoicing of the process
raised. This simple litmus test may filter majority house. A smart analysis of various types of
of suppliers, who are genuine and let the AO fabrics processed and nature of the fabrics may
concentrate on other suppliers who are not give very good results.
registered under GST or not depositing taxes 4.5 Wastages and TCS: Any process house
regularly. may show more wastage to inflate the cost of
3.5.2  Further, the advent of e-way bill will be of production. Such inflation may be identified
great evidentiary value as the same will leave an by historical data of the same assessee by
online trail of movement of goods and make it comparing the historical data of wastages. Most
virtually impossible for generating fake invoices of the scrap sold by the process house is liable
etc. A cross matching of income-tax return with for TCS. Analysis of TCS collected in earlier
GST returns and e-way bills generated will result years in amount nature of scrap sold may be of
in segregating the bogus supplies from the actual great help.
one. A comparison of GST paid by various peer 4.6  SOP of the Process House: With the
units may also throw a light on the integrity of advent of technologies, most of the process
the accounts of the assessee. houses have started using ERP, in which almost

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Techniques of Investigation for Assessment Vol. 3

the complete production processes are captured may be helpful to curb the practice of putting
in computerised software. Understanding of the small expenses to reduce the profit.
standard operating process of various units vis-
5.5 Credit of Indirect Taxes on Capital
a-vis the financial data may be the game changer
Goods: Till date, the process houses were
in some cases.
not able to take credit of Indirect taxes paid
on various capital expenditures. Under GST,
5.  IMPACT OF GST they will be able to take credit on such capital
5.1 Supply chain of Textile Industry is loaded expenditure other than immovable property.
with input and output across geographical Taking of such credit will increase the profits of
and product boundaries to reach the ultimate assessee, which may be ascertained.
consumer. Most of industry, being SSI, use
5.6  Seamless Credit of All Indirect Taxes:
‘Composition Scheme’. Numerous transactions
in the textiles industry flow from the unorganized As of now various taxes such as service tax,
to the organized sector and vice versa. Where octroi, VAT, entry tax etc. were included in the
regular/ registered taxpayer purchases goods cost of the assessee, as credit was not allowed
from ‘composition scheme’ taxpayers, they are against Excise of such taxes. But now the credit
not eligible for Input Tax Credit, thus breaking for such taxes will be allowed and this will
the CENVAT Credit chain. Input Tax credit paid increase the profits of the assessee.
on the previous transaction is included in the 5.7 An important effect of GST would be to
cost of the product, making the product costly. improve compliance. The value chain under the
5.2  This breakage of chain also leads to a great GST will be fully traceable. As a result, ITC claims
impact on direct taxes; due to non-linkage of will have to be backed by full information chain
buying and selling data. The breakage of trail of purchases and sales. Improved compliance
of input and output produces grave challenge will automatically lead to higher revenues.
before the assessing officer to determine actual
5.8  So, it is evident that the process houses are
consumption in value and quantity. Also it leads
a very complex form of production units with a
to transactions not recorded in books as no
trail is left behind. However, after the advent heterogeneous type of machineries and process
of GST, sweeping changes have been brought. which give space for various tax leakages with
The major changes which will be important for very little or no audit trails. Finding out specific
assessment proceedings are discussed below. faults or cases of tax evasion, calls for innovative
methods and deep data analytics on part of the
5.3  E-way Bill: A very novice concept of e-way assessing or investigating authorities.
bill has been brought in the GST. It mandates
every movement of goods to be recorded online
on almost real time basis. Matching of such data 6.  VERIFICATION OF MAJOR
with books will be of great help in determining INPUT WITH REGARDS TO
the actual sales and purchase of the assessee. PROCESS HOUSES

5.4 Reverse Charge Mechanism: In GST 6.1  In a manufacturing operation based

regime, any person having turnover of more on chemical process, consumption of inputs
than Rs. 20 Lakhs has to mandatorily take provides a major area for investigation. In process
registration under GST. For small suppliers, the houses, quantity of inputs is predetermined at
person taking the service has to pay GST on every stage of processing. The AO must know
reverse charges. A micro analysis of payment the proportion of each input necessary to obtain
made under such reverse charge mechanism the product at each stage. These ratios can be

54
 Process House

used as standard to compare the actual in a f. In appropriate cases actual production

given case. The Ahmedabad Textile Industrial of intermediary processes must be
Research Association (ATIRA) prepares a report compared with the capacity of the various
on a cost-wise and region-wise comparison of manufacturing segments so as to ensure
inputs, productivity and damages in processing that the end product of one segment has
activities. been fully put through the succeeding
segments and the final product obtained
6.2 The consumption pattern of chemicals,
has been fully accounted for. The point
colour, other material, water, steam, power and
to be noted here is that where the final
wages and salary in each manufacturing stage
segment has a higher capacity it is always
of process house are available in the report of
possible to use that capacity to process
the ATIRA and in the norms published by four
intermediary processed clothes purchased
textile associations (ATIRA, BTRA, NITRA and
outside the books of accounts.
SITRA).
6.3 The AO may examine the reasons for 7.  CLUES FROM DETECTED CASES
variation between actual consumption and
the standard prescribed by ATIRA taking into 7.1 In the case of a process house, the AO
account efficiencies at each stage of processing. suspected excess consumption of colour and
The internal records maintained by the chemicals, shown at Rs. 3.8/- meter of cloth
manufacturer must be studied closely to trace compared to Rs. 2.74 in preceding year.
the destination of consumption and output of The AO detected bogus purchases of colour
the batch concerned. The quantity and value of and chemicals of Rs. 56 lakhs, as also bogus
inputs may be verified as under: processing charges in fictitious names.
a. Ascertain the quantity of batch wise 7.2 In another case the assessee reported a
production. shortage of 2.29% of cloth during processing.
The Industry norms of shrinkage in processing
b. Convert actual production as percentage of were much lower. The assessee also claimed
installed capacity and examine the reasons purchase of processed cloth for trading. These
for shortfall in production compared to purchases were found to be bogus. It turned out
installed capacity. It will be necessary to that the production claimed as shortage was
take into account addition to production shown as purchases for trading (Rs. 41.65 lakhs).
capacity during the year of account and in
the preceding year. 7.3  Often a part of the production is not recorded
in books of account. However, the assessees
c. Loss due to shrinkage may be examined try to maintain ratio of consumption of various
with reference to norms of shrinkage. inputs to production. Where full production
Similarly, loss of production capacity may is not recorded in books, consumption of the
be critically examined. Any abnormal corresponding quantities of inputs is also not
reasons for low production/ loss of capacity/ recorded to avoid detection.
idle time must merit special attention.
7.4  In a search case, it was found that the
d. Co-relate production with the norms of assessee had a generating set. In the books the
consumption of water/ steam/ power and use of generating set for running the plant was
wages/ salary etc. shown for a brief period. The plant was shown
e. Reconcile the quantity of production with as running one shift on power drawn from
sales. Electricity Board. In fact, it was being run in two

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Techniques of Investigation for Assessment Vol. 3

shifts. A register was seized which contained This arrangement suited B also. B had to account
details of day to day generation of power and for investment in only Y quantity that was much
consumption of diesel. With a view to maintain less than the actual investment made in quantity
the ratio of consumption of power to production, X, and the processing charges payable on that.
the assessee ran the second shift exclusively on In such a case, verification of the purchases,
generator set. The corresponding expenses on particularly those for which payments were either
diesel were not recorded in the books. A rough not made within a reasonable time or shown to
cash book seized from a director of the company have been made in cash, will help.
showed that the actual purchases of coal and
chemicals were far in excess of the purchases 7.6  Understatement of processing charges is
shown in the regular books. prevalent in this line. During a search, it was
found that though the assessee was in receipt of
7.5 Processing houses usually do job work as
processing charges @ Rs. 3.5 to 4.5 per meter
well. They receive raw-material, i.e. gray cloth,
of cloth (as indicated in the seized records), it
from their customers and, after processing it,
return the processed cloth to them. A novel disclosed only a rate of Rs. 2 to 2.5. It is useful
method of tax evasion was found in one case. to compare the processing charges shown as
The processing house A received X quantity received by the assessee with that shown by
of gray cloth for processing from a party B and other concerns. Particularly, the receipts shown
returned the same quantity to B after processing. by the public sector units will provide a good
In its records, however, it showed the quantity indicator.
as Y, which was only a small fraction of X. The 7.7 Understatement of sale is resorted to
quantity Y was shown as purchased from a depress income and to evade Duty. Excise Duty
fictitious party. It raised a bill for sale of Y in
is chargeable on sale price of cloth. Action u/s
the name of B. Thus, the processing charge that
132 in a case led to detection of understatement
was received from B for processing quantity X
of sale price by Rs. 6 crores. In another case,
was shown as received as sale price of quantity
understatement of sale price by about Rs. 2 crores
Y. Thus, A depressed its profits. The receipt
on account of processing charge was recorded was admitted by the assessee. It is advisable to
in A’s accounts as sale proceeds. However, correlate quality-wise details of production and
A also debited its accounts for purchases of sale of fabric with the sale price of similar quality
corresponding quantity of gray cloth. Of course, admitted by other manufacturers during the
A must have incurred some unrecorded expenses same period. If significant difference is noticed,
on consumption of chemicals, coal, power, etc. it may call for deeper investigation.

56
 Chapter

5
Hosiery Industry

1.  INTRODUCTION
1.1 The history of textiles and garments in
India dates back to around 3000 BC, as there
is archaeological evidence of a cotton textile
industry at Mohenjo-Daro in the Indus Valley.
The diversity of fibers found in India, complex
weaving on its manual but state-of-art looms
and its organic dyes attracted buyers from all
over the world for centuries. However, the British
colonization of India and its industrial policies
destroyed this innovative eco-system.
1.2 The modern hosiery industry in India prompted the entrepreneurs to enter the global
came into existence with the setting up of a unit market. The production of good quality cotton in
in Khidderpore, Kolkata in the year 1893 and our country, particularly in Punjab, is a plus point
has played a significant role in the industrial for boosting export of cotton garments. With the
development since then. The hosiery industry advent of the liberalized policies, modern and
reached its peak during the Second world war efficient machinery and equipments are being
which become an important landmark in its added to hosiery industry for the production of
evolution. After the end of the War the hosiery quality items commensurate to the expectations
industry began to expand rapidly. Ludhiana, of the global customers. Presently, export of
Tirupur, Surat, Delhi, Mumbai and Bangalore woollen, cotton and acrylic knitwear, fabrics and
are presently the key Centres propelling constant readymade garments from the country is the
growth to this industry. Numerous items of major source of earning foreign exchange.
daily use made of woollen, synthetic, acrylic
and cotton yarns are manufactured in these 1.3 India’s hosiery and woollen industry has
cities for domestic and global markets. Due to come a long way from being a cottage industry
ever increasing population in the country, the predominantly catering to the local community.
domestic market for hosiery and knitwear items It has now entered a new era in which the
has always been the most important segment. industry is able to meet international standards
Supplies to defence and paramilitary forces also through constant innovation of techniques,
play an important role in growth of this industry. styles, textures and colours. All wool and
The broad and well developed manufacturing blended fabrics, cardigans, pullovers, mufflers,
and technological base in this industry has always shawls, socks, gloves, garments, blankets are

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being exported to various countries like the b. Silk: India is also the second largest
U.K., the USA, Canada, France, Italy, Germany, producer of silk and contributes about
Kyrgistan, Ukraine, Kazakhstan, Saudi Arabia 18 per cent to the total world raw silk
and Hong Kong. India’s wool and woollen production.
goods exports registered a spectacular growth in c. Wool: India has the 3rd largest sheep
the last few years.
population in the world, having 6.15
1.4 At present, the Indian textile industry crores sheep, producing 45 million kg of
is second largest after China, in terms of raw wool, and accounting for 3.1 per cent
spindleage, and has share of 23% of the world’s of total world wool production. India ranks
spindle capacity. It has been estimated that the 6th amongst clean wool producer countries
Indian textile industry contributes about 11 per and 9th amongst greasy wool producers.
cent to industrial production, 14 per cent to the
d. Man-Made Fibres: India is the fourth
manufacturing sector, 4 per cent to the GDP
largest in synthetic fibres/ yarns globally.
and 12 per cent to the country’s total export
earnings. It is estimated to be providing direct e. Jute: India is the largest producer and
employment to over 35 million people, being second largest exporter of jute goods.
the second largest provider of employment 1.6 The Indian textile industry is, however,
after agriculture. Besides, another 54.85 million pre-dominantly cotton-based with 70 per cent
people are engaged in its allied activities. The of the raw material consumed being cotton. It
fundamental strength of this industry flows from comprises of four major sectors, namely:
its strong production base of wide range of
fibres/ yarns from natural fibres like cotton, jute, a. The Mill Made, also called the organised
silk and wool to synthetic/ man-made fibres like sector;
polyester, viscose, nylon and acrylic. b. The Handloom and Power Loom sector
both being classified as decentralised
1.5  The strong multi-fibre base of the industry sectors;
in India could be understood by highlighting the
following important positions reckoned by this c. The Hosiery; and
industry across globe: d. The Garment sector.
a. Cotton: India is second largest cotton and 1.7  The composition of textile Industry in India
cellulosic fibres producing country in the and its structure could be understood from the
world. following diagram:

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2.  HOSIERY INDUSTRY 1902–03. Ludhiana which was a very small

town, received significant migration from
Hosiery industry refers to the manufacture of
Pakistan after partition. People here started
garments made out of cotton, woollen or man-
the knitting industry by using flat machines.
made yarn. The word ‘hosiery’ is derived from
Presently, there are about 14000 hosiery units
the word ‘hose’ appearing in hose top. (Hose
in the city and it is the major town for small
top is a cylindrical garment worn on the leg
scale industrial units in Punjab and also the
below the knee and above the ankle.) Hosiery
largest town of Punjab for industrial activities.
items manufactured in India are pullovers,
cardigans, under-garments, woollen vests, 3.1.1 Ludhiana has full-fledged infrastructure
trousers, mufflers, hose tops, stockings, shirts, for a successful industrial hub. About four or
sport wears, jackets, scarves, skirts, frocks, tops, five lakh labour has migrated to Ludhiana
baby blankets, bloomers, night suits, etc. from States outside the Punjab particularly
from Bihar, Jharkhand and Uttar Pradesh. The
estimated value of hosiery production in the year
3.  TEXTILE CENTRES
2016 was Rs. 15000 crore. The direct export
As per a report published in 2013 by the India of hosiery goods from Ludhiana is estimated
Brand Equity Foundation, India is the world’s at about 30% of the production. About 4 lakh
second largest producer of textile and garments. persons are directly or indirectly employed in the
Although the textile Industry has a Pan-India hosiery industry at Ludhiana alone.
presence, Ludhiana in Punjab and Tirupur in
3.2 Tirupur Textile Centre: Tirupur is a
Tamilnadu are the most prominent amongst
small town in Coimbatore district of Tamil Nadu.
the textile centres of India. Other centres are
Traditionally, Tirupur is famous for its cotton
Bombay, Kolkata, Delhi, Surat, Ahmedabad,
market and cotton ginning factories. Though
Jetpur, Saharanpur, Kanpur, Varanasi, Jaipur
cotton trading and ginning operations have
and Indore. The cotton hosiery industry is mostly
shrunk, Tirupur is still a very popular market for
concentrated in Ludhiana, Tirupur, Kolkata,
un-ginned cotton. The origin of hosiery industry
Kanpur, Varanasi and around Delhi. The woollen
in Tirupur may be traced back to the early 1930s.
hosiery Industry is thriving in Ludhiana and
It is believed that the first hosiery factory with
synthetic hosiery industries are concentrated in
hand operated machines was setup in 1935.
Bombay and Delhi, whereas in Jetpur, a small
For more than 30 years, the hosiery industry in
town in Saurashtra region of Gujarat, a majority
Tirupur was producing mainly grey and bleached
of the units cater to the Cotton Saree Printing,
banians (vests). In the late sixties, the industry
having supply base to a variety of consumers
slowly diversified towards manufacture of other
in India and also from African subcontinent for
inner garments. In the seventies, export of small
printed cloth named as “khanga” and “kitange”.
quantities of banians and other inner garments
A brief description of the two most prominent
were made from Tirupur. In the early eighties,
centres, Ludhiana and Tirupur, are given below:
export of knitwear, mainly basic T-shirts, were
3.1  Ludhiana Textile Centre: Ludhiana is made in small quantities. Export of other items
the main centre for production of hosiery items of knitwear gained momentum from 1985
in India and is also known as the ‘Manchester onwards. In the late eighties, knitwear industry
of India’. The hosiery industry was established diversified very quickly and took up manufacture
at Ludhiana in the early 20th century with the and export of knitwear. Besides knitwear, now
setting up of a socks manufacturing unit in knitted fabrics are also exported from Tirupur.

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4.  KNITWEAR SECTOR e. Knitwear can also be piece knitted like

4.1 Indian knitting industry has emerged as a sweaters and socks thus eliminating cutting
premier supplier of value added items earning and sewing.
high foreign exchange. This industry has adapted Because of these advantages, the usage of
itself to suit to the changing market conditions knitted fabrics ranges from hosiery, underwear,
globally. Fashion designers from all over the sweaters, slacks, suits, coats to rugs and other
world find Indian fabrics the perfect complement home-furnishings. At present, the knitting
to their style. Knitwear sector in India grabs major Industry meets an estimated 45% of the clothing
chunk of its share in the country’s textile exports. needs in developed countries like USA, Europe
Exports of knitwear items from India have made
and Japan.
strides and occupied 50% share of its total
readymade garments exports. Indian knitwear is 4.4  Knitting consists of constructing a fabric on
now being sold to almost every country in the needles by inter-looping one or more yarns. It
world. may be done by hand or machine. The basis of
a knitted fabric is the loop or stitch by setting up
4.2  In simple terms, knitting refers to
a loop on a needle and drawing a strand through
manufacturing of fabric with the help of
needles. Before knitting started, the fabric was it to make a second loop. A chain of loops, each
manufactured by weaving. The fabric thus drawn through the other forms a knitted fabric.
manufactured was called woven fabric. The 4.5 The construction of knitted fabric is
popularity of knitting has increased tremendously evaluated by the number of stitches or loops.
in recent years because of the increased versatility When the interlocking loops run lengthwise,
of the technique, the adaptability of many new each row is called a wale. When the loop runs
man-made fibres, and because of the growth in across the fabric each row is called a course. The
demand for wrinkle free, stretchable, snug-fitting quality of the needle effects the quality of the
fabrics, particularly in the greatly expanding
fabric. If the thickness of the loop varies from
areas of sportswear and other casual garments.
needle to needle the stitches vary in width. If all
4.3  Because of its looped structure, the knitted other parameters remain constant the fabric with
garments have the following advantages over more wales in it will be more rigid and stable in
the woven garments: width, but a fabric with more courses in it will be
more rigid and stable in length.
a. Price of a knitted garment is lesser than
that of a woven garment, since yarn to
fabric conversion is simpler and faster. 5.  CLASSIFICATION OF KNITTED
FABRICS
b. Knitted garments are more comfortable
than woven garments because of their There are two broad categories of knitted fabrics.
flexibility and stretch ability. a. Weft knit fabrics, where one continuous
c. Knitted garments are more suitable for yarn forms courses across the fabric, and
leisure and sports activities.
b. Warp knit fabrics, where a series of yarns
d. Knitted garments are light weight, soft touch form wales in the lengthwise direction of
and have excellent wrinkle resistance. the fabric.

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5.1 Weft Knitting: There are three stitches in 5.4  The Rib Stitch fabrics have alternating
weft knitting-Plain knit stitch, Purl stitch, and Rib rows of purl and plain stitches so that the
stitch which are discussed below. front and back of the fabric look alike. In a rib
machine, one set of needles pulls the loops to
5.2  The Plain Knit Stitch is a basic knit.
the front and the other set pulls the loops to the
This basic knit can be produced in flat knit or in
back of the fabric. Each set of needles alternately
tubular (circular) form. The flat knit is also called
draws loops in its own direction, depending on
the jersey stitch. The knitting is done with a row
the width of the rib desired. Ribs have excellent
of latch or bearded needles arranged in linear
width wise elasticity and are often used in
position on a cylinder. All the needles are evenly
underwears, socks, wristbands of sleeves and
spaced side by side and are moved by cams,
waist bands of garments.
which act on the needle butts. The spacing of
the needles is referred to as the gauge or cut. 5.5  Warp Knitting: In warp knitting, each
It usually refers to the number of needles per 1 needle loops its own thread. The needles
½ inch e.g. if a machine has 8 needles per inch produce parallel rows of loops simultaneously
the gauge of that machine would be 12. In cases that are interlocked in a zigzag pattern. The
where needles are adjustable, gauge refers to stitches on the face of the fabric appear vertically
the number of needles per inch. The plain knit at an angle and the stitches on the back appear
is made by needles intermeshing, loops drawn horizontally. The warp knits are very popular and
to one side of the fabric. Although there is a are appreciated for their smoothness, possible
technical face and technical back to the plain sheerness, wrinkle and shrink resistance, strength
knit, either side may be used as the face. The and abrasion resistance. Products ranging from
plain knit produces a relatively lightweight fabric hairnets to rugs may be manufactured by warp-
compared to the thicker fabrics produced by knitting depending upon the machine and the
the other stitches. It has high rate of production technique employed. There are many types of
and is inexpensive. It is useful for variation in warp knitting machines but those mainly used
designs by pattern devices. These variations are Tricot and Raschel machines.
include stripes, multi-coloured patterns, textured
surfaces produced by raised designs and pile
6.  MACHINERY USED
effects. Horizontal stripes can be knitted by
using different coloured yarns/ textured yarns 6.1  Normally, three types of machines are used
on different feeders or by setting certain feeds to in hosiery knitting. These are round knitting
knit a looser stitch. Multi-coloured designs called machines, flat knitting machine and circular
Intartia can also be created through the use of knitting machines. The size of the machine is
highly specialized single bed machines. known by its gauge. The gauge refers to the
total number of needles in 1 inch. The higher
5.3  The Purl Stitch is also called the links-
the gauge of the machine, the finer the cloth it
and-links stitch. It is made on flat bed or circular
manufactures.
machines by using needles that have hooks on
both ends, to alternately draw loops to the front 6.2  The round knitting machines are circular in
of the fabric in one course and to the back in the shape and are used to manufacture socks and
next course. The fabric looks the same on both gloves. These machines may be hand operated
the sides and resembles the back of the plain or power operated. The socks and gloves
knit. It is often used in children’s wear. manufactured by hand operated machines are

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of coarse quality whereas the power operated high pressure fabric dyeing and microprocessor-
machine manufactures finer quality socks and controlled piece dyeing, pole drying equipment,
gloves. tubular calendering and stentering machines,
colour matching and colour fastness testing
6.3 The flat knitting machines are flat and
equipment, etc. These machines, though quite
square in shape because of which they are called
expensive, have increased the production many
flat knitting machines. The flat knitting machines
times and have also substantially reduced
may be either hand operated or power operated.
wastage and rejections.
The hand operated flat knitting machine is of 4
gauge to 14 gauge whereas the power operated
flat knitting machine is of 8 gauge to 14 gauge. 7.  RAW MATERIALS
These machines are used for manufacturing 7.1 The basic raw materials used for the
sweaters, cardigans etc. Flat machine may also manufacture of hosiery products could be put
be computerized to get a particular design. under following four categories:
6.4  The circular knitting machine is one in a. Animal Fibre: Animal fibre is the first
which the yarn is fed through ‘yarn feeders. The among them. These fibres include sheep
bed of the machine moves whereas the feeders wool, angora wool, lamb’s wool, mohair,
and cams move to assist in the knitting process. etc. These yarns are supplied by spinning
These machines knit cloth in tubular form. This mills located at Ludhiana and Amritsar.
machine is used to knit various yarns like cotton, Some of these mills supply dyed woollen
acrylic, polyester, nylon and their blends.
yarn wound on cones. Others supply grey
6.5 In the last decade, the machinery used yarn in the form of hanks that is separately
in the hosiery and knitwear has undergone dyed in dyeing houses. Some yarns
a sea change. Since the industry is highly like Cashmere yarn and Pashmina yarn
labour intensive, locally manufactured and and also yarns of finer quality and some
fabricated machinery and equipment suited to blended yarns are imported. Woollen
the capabilities of the lesser educated workforce yarns of various counts, mainly 2/ 32, 2/
are being used by the industry in almost all the 48, 3/ 11, 1/ 28 and 1/ 22 counts, are used
operations involved in the manufacturing of for manufacturing.
low-end hosiery products right from the dyeing
b. Seeds Fibre: The second type of raw
of yarn to stitching and packaging. However,
materials is seeds fibre like cotton. The
more recently, the units that have diversified
cotton yarn is obtained from various
their manufacturing activities from the low-end
spinning mills located in Punjab, Gujarat
products to high value-added fashion garments,
and other parts of the country. The
have added the computerized/ motorized
spinning mills supply grey or dyed cotton
flat bed/ circular knitting machines, jacquard
yarn of different counts wound on cones.
machines, modern stitching machines like flat,
The main counts used in the manufacture
chain and lock stitch machine, computerized
of cotton knitwear are 10s, 20s, 24s, 30s,
embroidery heads alongwith other gadgets
34s and 40s.
and equipments. Similarly, ancillary supporting
units like dyeing and finishing houses have also c. Man-Made Fibres: The third category of
updated themselves with the latest version of raw materials are man-made fibres. These
machinery and equipment in soft flow dyeing, are polyester, nylon, viscose, acrylic,

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etc. In this category polyester, nylon and 8.2  In the case of woollen yarn, if one pound of
acrylic are the yarns mainly used for the yarn is drawn to make yarn of 560 yards length,
manufacture of knitwear either in pure the resultant thickness of the yarn will represent 1
form or in blended form. This yarn is count. If the yarn of 1 count is further drawn out
manufactured by various large-scale units. to make yarn of 32 times 560 yards i.e. about
10 Km, the yarn produced will have count of 1/
d. Blended Yarn: The fourth category is
32. In the case of man-made fibres, the thickness
blended yarn. The synthetic fibres are also
is measured in terms of deniers. If one gm of
blended with animal as well as cellulose
fibre is drawn to a length of 9000 meters, the
fibres to give them strength and durability.
resultant thickness of the yarn will represent 1
The main blends available in the market
denier. If one gm of fibre is drawn to 100 meters
are polyester-cotton, polyester-viscose,
yarn, the yarn would be of 90 deniers and so on.
wool-acrylic in different blends. Apart from
Therefore, in the case of woollen yarn and the
the blending of the synthetic fibres, artificial
cotton yarn, the higher the count of the yarn, the
silk is also blended either with wool or
finer the yarn will be. However, in case of man-
cotton to prepare yarn for manufacturing
made fibres, the lower the denier of the fibre, the
high fashion knitwear. finer the yarn will be.
7.2 In addition to the above, certain other
materials like buttons, zips, fasteners, sewing 9.  MANUFACTURING PROCESSES IN
threads, embroidery threads, lining materials, WOOLLEN HOSIERY
tapes, laces, labels, size stickers and pipings are
9.1 The basic raw material used in woollen
also used in the production of knitwear.
hosiery is woollen yarn, which is obtained from
greasy wool, mainly imported from Australia,
8.  YARN COUNT New Zealand and South Africa. There are no
8.1 There is a fixed relationship between the restrictions on the import of wool. Any person
weight of the original quantity of fiber and having Exporter/ Importer Code Number from
the length of the yarn produced from that raw RBI can import wool. India produces about 45
material. This relationship indicates the thickness million kg wool annually. However, it is not fit for
of the yarn and is designated by a number apparel production because of its poor quality. It
called the yarn count. The measurement of this is mainly used in blankets and carpets.
relationship differs in cotton yarn and woollen 9.2 The greasy wool is first of all scoured,
yarn. In the case of cotton yarn, if one pound carded and combed in a combing mill. There are
of fiber is drawn to make 840 yards of yarn, the 70 combing mills of various sizes in India mostly
resultant thickness represents 1 count. If the yarn located in Ludhiana. Some combing mills are
is drawn out further, so that one pound makes also located in places like Kolkata, Bhilwara,
twice 840 yards, the resultant count will be 2. Mumbai and Vadodara. After combing, the
If one pound of fiber is drawn out to make 32 greasy wool gets converted into wool top. The
times 840 yards i.e. about 15 Kms long yarn, the wool top is spun into yarn in a spinning mill. A
resultant count will be 32 or 32s i.e. 32 single. If multiplicity of processes is involved in combing
two yarns of 32 count are twisted around each and spinning but these are not discussed here
other, the result will be 2/ 32 and so on. The in detail. Only a few units have composite
purpose of twisting around two yarns is to make manufacturing facilities of combing, spinning,
the yarn stronger. dyeing and fabrication.

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9.3  For the woollen industry, yarn constitutes the the AO should go through this Hand Book
main raw material. The quality of yarn depends to have an idea of the input-output norms
upon various factors like its composition, count, stipulated by the DGFT for the products of the
knots, twist per inch, breaking strength etc. hosiery Industry. In case there is any substantial
Mainly yarn of 1/ 16, 2/ 20, 2/ 28, 2/ 32 count is variation in consumption shown by the assessee
used for manufacture of sweaters and cardigans. and the consumption indicated in these norms,
The yarn having 1/ 16, 1/ 28, 1/ 32, 1/ 42, 1/ the AO should investigate the case thoroughly to
44, 1/ 48, 1/ 54, 1/ 56, 1/ 64, 2/ 30, 2/ 40, 2/ find out the reasons for the same.
42, 2/ 44, 2/ 48, 2/ 52, 2/ 64 count is used for
10.2  For the purpose of investigations, the units
manufacturing shawls. For blankets, the yarn
engaged in hosiery industry can be classified as
having single count of 2 ½ to 10 is used. The
follows:
fineness of the woollen yarn can also be known
from its micron. Wool of 18 micron is considered a. Units engaged in exports.
as the finest. Wool having 18 to 24 microns is
b. Units catering to defence and other
used in shawls whereas wool having 24 to 30
government requirements.
micron is used in hosiery.
c. Units catering to the internal civil
9.4  Yarn is obtained by a garment manufacturer
requirements.
from a spinning mill. The yarn passes through
many processes before the final garment is There is no doubt about the fact that some units
manufactured. First of all panels of the garment would deal in more than one type of goods, but
are knitted on flat knitting machines. Then they broadly speaking, the units fall into one of the
are checked and mended. The panels are then above three categories. Their modus operandi
washed and steam-pressed after which the panels and the points of investigation involved in the
are cut according to the desired sizes. After doing above three categories are briefly discussed here
embroidery work, if any, the panels are stitched under.
together. Then the cups and necks are linked
with the help of linking machines. After stitching 10.3  Manufacture for Exports
buttons and fitting zips, the garment is washed
10.3.1  For export of knitwear, there is no need
or dry cleaned. Then the garment is inspected
to obtain license for export as it does not fall in
manually for any possible defect. After steam
the list of restricted items. An exporter is primarily
processing, the garment is ready for dispatch.
required to register himself with the concerned
export promotion council (EPC) like the Wool
10.  POTENTIAL ISSUES FOR
& Woollens Export Promotion Council, and
INVESTIGATION
the Apparel Export Promotion Council. The
10.1 The Director General of Foreign Trade concerned EPC allots a Code Number to its
(DGFT) makes studies on input-output analysis members. The Customs authorities will not allow
in respect of various items from time to time the exporter to export goods unless the exporter
after making detailed studies. The Ministry is having Export Code Number. This number
of Commerce publishes a ‘Hand Book for is required to be filled in the shipping bill and
Procedure’ in which the details of input-output other documents. This number is also required
norms for various industries are given. This Hand to be mentioned in various foreign exchange
Book is available in any office of the DGFT. declarations form like GR and PP forms. The
While investigating the case of a manufacturer, Registration Cum Membership Certificate issued

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 Hosiery Industry

by the concerned EPC helps the exporters to foreign exchange credited to the exporter’s
obtain incentives like cash assistance, duty draw account
back and replenishment licenses.
d. Have a close look into the sale of visible
10.3.2 An export invoice is required to be wastage and make a proper analysis of
prepared by the exporter both in terms of the same. Scrap is generated in various
quantity and weight. Even the tare weight is manufacturing processes like cutting, and
mentioned therein. The AO, while examining tailoring. It should be seen whether the
the accounts, should work out the quantity of assessee has shown any sale proceeds of
raw material embedded in the sale and tally it the waste material.
with the quantitative details of consumption,
e. Examine the accounts of the assessee to
production etc. filed by the assessee.
find out the fabrication and other expenses
10.3.3 The exports are to be made in bulk. paid to its sister concerns. The charges
While examining the accounts, the AO should paid by the assessee to its sister concerns
look into the investment in purchases of different may be lower than the market rates and
raw materials and payment of different expenses this way, the assessee may have inflated
like wages, electricity, job charges etc. The source its export income eligible for benefits and
of generation of funds for making payment have suppressed the domestic income of
of these expenses by the assessee should be the sister concerns.
thoroughly examined. The assessee might
have introduced its own unaccounted money f. The hosiery industry is a seasonal industry.
in the guise of loans, advances, etc. for making Usually, the manufacturing activity is
payments for various expenses, more so easily in at its peak from the month of August to
the cases of purchases of raw materials as those November. There is sharp fluctuation
are often purchased from the farmers or brokers. of labour employed in the peak season
Similarly, there could be a case of artificially and in the off season. With the higher
inflating expenses by way of introducing bogus employment of labour in the peak season,
intermediaries for purchases of raw materials. the requirement for the machinery also
goes up. The AO should see whether the
10.3.4 Further to the above, the following machinery required for the peak season
measures could be helpful to ascertain whether manufacturing is duly reflected in the
there is a case of suppression of income: account books or not.
a. Work out the G.P rate in respect of export g. Consumption of electricity may also be
sales and domestic sales separately and try examined for the peak season and normal
to find out the reasons, in case there is a season so as to have an idea if there is
substantial variation in the two G.P. rates. any suppression of productions during the
b. Obtain bill-wise details of sales and various peak season.
benefits received in order to see whether
h. Usually expenses such as payment to
all the benefits have been reflected in the
labour become very low during non-
books of account or not.
production/ very less production during
c. Verify independently from the bankers of non-peak seasons. Hence, the month-wise
the exporters, the details of convertible pattern of expenses may be examined

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so as to ascertain whether there is a case operated flat knitting machines are used for
of excessive and non-genuine claim of manufacturing jerseys.
expenses during the months of non-peak
period. 10.4.4  Most of the units manufacturing hosiery
goods for defence forces do not maintain
10.4  Supplies to Defence and Other quantitative details. They usually do not maintain
Government Departments any consumption or production records. Even
if they maintain such records, they deny to be
10.4.1 Earlier all the purchases made by the maintaining such details. In such a situation,
defence forces were centralized with the Director an important point for investigation is the gross
General of Supplies and Disposals. However, profit rate shown by the assessee. The gross
to avoid delay in making procurements, the profit rate shown in a particular year should
three wings of the Defence-the army, the navy be compared with the rates shown in the past
and the air force-have been authorized to make and the rates shown by similar manufacturers.
purchases from the market. The purchases by
If the rate of gross profit shown by the assessee
the Army are made through the Director General
is lower, efforts should be made to find out the
of Ordinance Services whereas the Naval Head
reasons for the same.
Quarters and the Air Force Head Quarters make
purchases for Navy and Air Force respectively. 10.4.5  The AO should obtain copies of all the
Although, the Army has also its own factories contracts executed by the assessee during the
to produce hosiery goods, it purchases various year. As discussed earlier, the contract orders
hosiery items from the market also. give the details of raw materials to be used in
10.4.2 For making purchases, the concerned the production of a particular item. The gross
wing of the Defence floats tenders. The tenders weight of the final product and the weight of
include such information as the quantity, the raw material to be used is specified in these
price, duration of the contract etc. Besides, the documents. Therefore, the consumption of
manufacturer is required to supply the goods as yarn required for manufacture of various items
per specifications stipulated by the concerned supplied by the assessee can be worked out.
department. These include such details as the 10.4.6  The disclosed consumption of yarn can
weight and size of the product, the details of be checked from the figures of opening stock,
yarn used. These departments lift the supplies purchases and closing stock shown in the books
after getting the goods inspected through of account. In case, the consumption shown by
various sources like the laboratory of the Textile the assessee is on the higher side, the reasons
Committee and Quality Marketing Centre. for it may be investigated. It is possible that the
Mostly, yarn made out of pure wool or blended assessee may have inflated the purchases in
with nylon or nylon and viscose is used for
the books. Besides, the consumption of other
defence supplies.
materials like buttons and zips should be looked
10.4.3 The manufacturers of defence goods into. The wastage shown by the assessee at
use circular knitting machine, or flat knitting various stages like knitting, cutting, tailoring may
machines. Hand-operated round knitting also be examined. The nature of the penalties,
machines are used for manufacturing socks and if any, levied on the assessee for breach of
the power operated circular knitting machines warranty should be ascertained and examined
are used for manufacturing vests. The hand- from tax angle.

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 Hosiery Industry

10.5  Units Catering to Other introduced bogus purchase bills in the name of
Domestic Requirements non-existing parties.
10.5.1 Apart from the issues relating to 10.5.4 The purchases made by the assessee
suppression of production, inflation of expenses in the month of March or at the fag end of the
etc. discussed previously in these cases, wastage season should be examined to see that these are
is another item that should engage the AO’s either accounted for in production or in closing
attention. He should enquire into the extent stock. The valuation of closing stock should
of wastage generated at different stages of be checked to ensure that the stock is valued
production. The extent of wastage depends on properly keeping in view the purchase rates of
the item being manufactured and the level of the last purchase bills. Usually, the production
technology. It would be worthwhile to visit the in the woollen hosiery units continues up to
factory premises of the assessee to have an idea the month of November or December. The
of various processes involved in manufacturing. purchases of needles made in the last part of
Nowadays, the manufacturers are using the manufacturing season should be verified
sophisticated computerized knitting machines. to ensure that the unconsumed needles are
These machines are efficient. They generate very duly shown in the closing stock. Further, the
low wastage. The assessee might be claiming AO should verify whether the material sent by
wastage on the basis of wastage shown in earlier the assessee for combing, spinning, dyeing,
years. fabrication during the year but not received back
10.5.2 The AO should also compare the GP till 31st March has been duly shown in the closing
rate shown in a particular year with that shown stock. The copies of the stock statements given
in the earlier years. He should also compare by the assessee to the bank during the year for
the GP rate shown by the assessee with that availing cash credit (hypothecation) facilities
shown by other persons in the same trade. In should be called for directly from the bank. The
case there is significant variation, the reasons stock hypothecated to the bank may be more
may be investigated. The assessee might than the stock appearing in the assessee’s books
have suppressed production or debited bogus indicating unaccounted investment made in
expenses in the books. stock.
10.5.3  The AO may also verify the genuineness 10.5.5 Most of the hosiery manufacturers
of some of the purchases. However, the AO make payments to the workers on piece-rate
should carefully select the purchases in respect basis to optimize their production. However, in
of which investigation is to be made. He may the books of accounts, they show the payments
examine the purchases made by the assessee to the workers on monthly lump sum basis. The
in the month of March. Any suspicious looking thumb impressions and the signatures of the
purchase bill should be investigated. The AO workers appearing in the wages register/ muster
may also investigate the purchases made by roll may be examined. These signatures and
the assessee ostensibly against credit but the thumb impressions may be similar as, usually,
payment in respect of which has been made these registers are prepared afterwards. In case
subsequently through cash on various dates. of such a situation, the possibility of invoking
Further, the purchases made during the year the provisions contained in Section 145 may
the in respect of which payment has not been be examined. In case the assessee has got any
made at all during the year, may also be picked particular work done on piece-rate basis, the
up for investigation. The assessee might have total quantity of the production may be worked

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out on the basis of the charges paid for the work of fictitious individuals for amounts below Rs.
during the year. The figure of production thus 20000/-. Till these drafts are encashed, they are
arrived at may be checked with the number of transferred from one party to another merely
pieces accounted for in the sale and the closing through delivery. Ultimately, these drafts reach
stock. the commission agents/ brokers who make
10.5.6 In the hosiery trade, most of the payments of these drafts by deducting brokerage.
spinners make substantial cash sale of yarn. The brokers get these drafts credited in their
The cash sales of yarn made by the spinners bank accounts or some benami accounts. Such
are undoubtedly the unaccounted purchases unaccounted sales may not possibly be detected
of the hosiery manufacturers. To unearth such through the normal enquiry process. To unearth
purchases, the possibility of conducting surveys such unaccounted sales, surveys under Section
under Section 133A during the peak season 133A may be necessary.
(August to November) may be examined.
10.5.7 The proceeds of the hosiery products 10.5.8 The AO may also collect information
sold outside the books of accounts are generally from the GST Department about the cases of
received through bank drafts. These drafts tax evasion detected by them so as to verify
are not likely to be crossed or made account whether there could be a case of tax evasion
payee. They are generally purchased in favour from income-tax perspective.

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 Chapter

6
Woollen Mills

1.  INTRODUCTION
1.1 Wool is the animal fibre forming the
protective covering or fleece, of sheep or of other
hairy mammals, such as goats and camels. The
woollen industry mostly uses wool obtained from
sheep. Wool is a versatile fabric and is composed
of a protein called ‘keratin’. Wool is characterized
by waviness with up to 12 waves per centimetre
in fine fibres and 2 or less in coarser fibres. It
also has scales on its surface which traps air
and provides insulation from heat and cold. For
obtaining raw wool, shearing of sheep is done per sheep in India is only 0.9 Kg. as against the
from time to time. Different parts of the sheep’s world average of 2.4 Kg. Of the total Indian wool
body provide different quality of wool. The wool production, about 85% is carpet grade wool,
from the shoulders and the sides of the sheep 5% apparel grade and remaining 10% coarse
is considered superior and is called ‘first fleece’. grade wool for making rough blankets etc. A
The first wool sheared from a six to eight months small quantity of specialty fibre is obtained from
old lamb is also called ‘lamb’s wool’ and it is of Pashmina goats and Angora rabbits also. Since
very fine quality. The wool from the head, chest, the domestic produce of wool is not adequate,
belly and shanks of a sheep is not very fine. the Indian woollen industry is dependent on
Sometimes pelts of slaughtered sheep are also imported raw material. The woollen industry
treated to loosen the fibre, yielding an inferior in the country is broadly divided & scattered
type called ‘pulled wool’. Australia, China, USA, between the organized and decentralized sectors.
New Zealand, Argentina, South Africa, Uruguay, The organized sector consists of Composite
Kazakhstan etc. are the main wool producing mills; Combing units; Worsted and Non-
countries in the world while India leads in the Worsted spinning units; Knitwear and Woven
production of the coarser wool, also known as Garments units; and Machine-Made Carpets
carpet wool. manufacturing units. The un-organised sector
1.2 India has the 3rd largest sheep population consists of Hosiery and knitting; Power-looms;
in the world, having 65.07 million sheep, Hand-knotted carpets, Druggets, Namadahs
producing 43.50 million kg of raw wool in units and other independent Dyeing, Process
2017–18. However, the average annual yield houses as well as the woollen handloom sector.

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In India, wool industry is concentrated in Punjab, b. In 2017–18 India imported raw wool from
Haryana, Rajasthan, Uttar Pradesh, Maharashtra the following wool producing countries:
and Gujarat. Punjab alone accounts for about
35 per cent of wool production units, followed Table 2
by Maharashtra and Rajasthan. S. No. Country Qty. in Tonnes
1.3  India exports various woollen products like 1 Australia 14079.488
tops, yarn, fabrics, ready-made garments and 2 China 10513.462
carpets. Carpet enjoys the maximum share of
total exports. The aggregate export of woollen 3 New Zealand 9157.914
items from wool tops to finished products like 4 Saudi Arab 4918.388
textiles, clothing, blankets and carpets is currently 5 Pakistan 4690.367
estimated around app. Rs. 11484 Crores in FY
2017–18. 6 Syria 4501.574
Source: DGCI&S, Calcutta
2.  INDUSTRY STATISTICS c. The details of year-wise, quantity-wise
a. The major wool producing States in the and value-wise import of raw wool are as
country are: under:

Table 1 Table 3
(Qty. in’ 000 kg.) Qty. Value
Year
Wool Production (in Million Kgs.) (Rs. in Crores)
S. No. States
2017–18 2010–11 94.77 1434.65
1 Rajasthan 13924.19
2 Jammu & Kashmir 7411 2011–12 76.29 1876.87
3 Karnataka 4392 2012–13 77.16 1801.90
4 Telangana 4800
2013–14 89.60 1967.72
5 Gujarat 2267
6 Himachal Pradesh 1500 2014–15 96.53 2125.74
7 Maharashtra 1418 2015–16 97.83 2016.12
8 Uttarakhand 558
2016–17 87.15 1894.26
9 Uttar Pradesh 1404
10 Andhra Pradesh 793 2017–18 79.95 1884.59
Source: Animal Husbandry Deptt., Ministry of Agri. Source: DGCI&S, Calcutta

d. The item-wise Statement of Indian Woollen Exports are as under:

Table 4
(Rs. Crores)
Woollen Yarn, Ready Made Carpet
Year Total
Fabrics, Made ups Garments (Excluding Silk) Handmade
2013–14 684.70 1888.60 6255.83 8829.21
2014–15 1234.61 1901.76 8301.56 11437.90
2015–16 1284.91 1724.86 9421.75 12431.52
2016–17 1180.24 1443.26 9956.63 12580.13
2017–18 1197.86 1089.97 9196.99 11484.82
Source: DGCI&S, Kolkata

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 Woollen Mills

e. The main destination of Indian exports of 3.  GRADING OF WOOL

Woollen Yarn, Fabrics, Made Ups are as
3.1 The grading of wool is very crucial
under:
determinant of its price and demand. It is not
Table 5 to be confused with other classifications of
Value in Crores wool. The Finer (smaller diameter) wools are
S. No. Country associated with more expensive, lighter weight
(2017–18)
1 Italy 261.86 fabrics, while the coarser-fibered wools (larger
2 United Kingdom 193.90 diameter) are used in bulkier sweaters, blankets,
and carpets. There are three systems of wool
3 Japan 122.69
grading which are commonly used:
4 Korea RP 106.83
5 USA 48.50
a. The American or Blood system;
6 Bangladesh 36.39 b. The English or Spinning Count system;
and
Source: DGCI&S, Calcutta
c. The Micron system.
f. The main destination of Indian exports of
Carpets, excluding Silk, is as below: 3.1.1 The American Blood Grade System was
developed in the early 1800s and originally
Table 6 represented the amount of fine-wool Merino
Value in Crores genetics (Spanish origin) present in the native
S. No. Country
(2017–18)
coarse-wool sheep. The American Blood
1 USA 4716.61 Grade System now no longer refers to breeding
2 Germany 905.50 background but now represents a broad
3 Australia 362.62 description of fiber diameter. The English system
4 U.A.E. 183.28 of grading wool uses a measurement called the
5 Netherland 179.79 “spinning count” and is based on the number
of “hanks” of yarn which could be spun from
6 Italy 164.46
one pound of clean wool on the equipment
7 France 153.88
available at the time the system was developed.
Source: DGCI&S, Calcutta Finer wools have more individual fibers per unit
g. In 2017–18 the major destination of Indian of weight. Consequently, more hanks of yarn
exports of Readymade Garments Wool can be spun from fine wool than coarse wool
was as under: (one hank is 560 yards). Increased emphasis
on an exact and highly descriptive method of
Table 7 describing wool grade has produced a measuring
S. No. Country Value in Crores system in which individual fibers are accurately
1 USA 233.81 measured in terms of microns. Nowadays the
2 United Arab 105.59 standard method of measuring wool fibres is
3 United Kingdom 103.74 by a microprojection technique in which short
4 Tanzania 95.58 longitudinal sections of the fibres are projected
5 France 64.44 onto a screen at 500-fold magnification. As
6 Canada 49.35 the wool gets coarser, it becomes necessary to
7 Germany 46.38 measure significantly more fibres to ensure a
high degree of accuracy. Wool that grades in
Source: DGCI&S, Calcutta

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Techniques of Investigation for Assessment Vol. 3

the 62s spinning count requires about 3,000 average fibre diameter only and they can be
fibre measurements, while 50s spinning count used interchangeably as shown in the table
wool requires taking more than 6,000 fibre below, but the micron system is the system used
measurements to ensure acceptable accuracy. internationally and is preferred by wool buyers
All the three systems above are measures of and manufacturers:
Table 8
American or English or Spinning Microns
Type of Wool
Blood Grade Count Grade (Average Fibre Diameter)
Fine Fine Finer than 80s Under 17.70
Fine Fine 80s 17.70 - 19.14
Fine Fine 70s 19.15 - 20.59
Fine Fine 64s 20.60 - 22.04
Medium 1/ 2 Blood 62s 22.05 - 23.49
Medium 1/ 2 Blood 60s 23.50 - 24.94
Medium 3/ 8 Blood 58s 24.95 - 26.39
Medium 3/ 8 Blood 56s 26.40 - 27.84
Medium 1/ 4 Blood 54s 27.85 - 29.29
Medium 1/ 4 Blood 50s 29.30 - 30.99
Coarse Low 1/ 4 Blood 48s 31.00 - 32.69
Coarse Low 1/ 4 Blood 46s 32.70 - 34.39
Coarse Common 44s 34.40 - 36.19
Very Coarse Braid 40s 36.20 - 38.09
Very Coarse Braid 36s 38.10 - 40.20
Very Coarse Braid Coarser than 36s Over 40.20

3.2  The following method of grading of Indian 4.  CLASSIFICATION OF WOOL

wool is also followed in India:
4.1  Wool is also classified in terms of its other
Table 9 characteristics e.g. sorting fleeces into various
Sl. Mean Fibre Diameter
lines according to fineness, length, strength,
Type of Wool yield, color, and style. Fine wools are about 4 to
No. (in Microns)
North India superior 7.5 centimetres long and the extremely coarse
1. ≤ 30
clothing white fibres may be as much as 30 centimetres in
North India clothing length. The soft and fine wool fibres are suitable
2. 30 - 42
white for garments and clothing whereas coarse fibres
3. North India rug white 43 - 46 are used for making carpets. In India wool is also
classed as per the season of clipping, the breed
4. North India carpet type ≥ 46 of sheep, the colour of wool and the ‘scoured
South India blanket yield’ per centage. The percentage yield of clean
5. 43 - 46
type scoured wool (greasy wool minus its grease, wax,
South India tannery sweat, dirt and plant material) is the product
6. ≥ 46
type which gets to be processed by the manufacturer.

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 Woollen Mills

As much of the greasy weight consists of these 5.  MANUFACTURING PROCESS

impurities, the proportion must be known so After shearing and grading/ sorting, the
that the price per kilogram in the greasy wool manufacturing process of woollen yarn can be
that will correspond with the clean-scoured cost divided into following stages:
can be fixed. The higher the yield, or the greater
the percentage of pure wool in the consignment, a. Scouring: The greasy wool contains
the natural oils of sheep, dust, and other
the higher the greasy value will be.
impurities that are picked up by the sheep
4.2  Woollen yarn also gets classified in three or from the bushes and plants where they
categories on account of its length and fineness had been grazing. Before the greasy wool
as under: is washed, it is passed through a machine
called the wool duster or wool opener. In
a. Woollen Yarn: Woollen yarn is
this machine, thick knots in the raw wool
manufactured from shorter stapled wool.
are opened. This machine consists of
The woollen yarn is quite loosely spun
cylindrical drums that have pins on their
with little twist and the fibres are also not
outer surface. When the raw wool rolls
very parallel. The woollen fabrics have alongwith the drums, the pins separate
a soft fuzzy surface. Tweeds, Shetland, the thick knots from the wool. The knots
Cashmere are the examples of woollen and other undesirable materials such as
fabrics. The woollen fabrics made from this dust fall down through an opening and
kind of yarn are warmer than the worsted the remaining wool is delivered out from
fabrics but they are not as durable though where it is collected. To further remove
woollen yarn is generally less expensive the impurities, the first process involved
than the worsted yarn. is the scouring or washing. The scouring
b. Worsted Yarn: Worsted yarn is machine consists of chambers which are
manufactured from longer stapled wool. In equipped with automatic rakes, which stir
the wool. The first few chambers of the
worsted yarn, the fibres are laid as parallel
machine use water, detergents and a mild
as possible and the yarn is also smooth with
solution of soda ash to remove the grease
relatively high twist. Gabardine, Whipcord
and dust from the raw wool. A temperature
Serge, Worsted Cheviot, Tropical Worsted
of 70 degree Celsius is maintained in these
and Bed Ford Cord are examples of
chambers using steam from a boiler. The
worsted fabrics.
last chamber contains clean water, in which
c. Shoddy Yarn: To meet the increasing wool coming out of the earlier chambers is
demand of wool and in view of the limited washed. It also has rollers to squeeze out
supply of new wool, worsted fibres have to the water. After scouring, the wool is passed
be recovered from old clothing, rags and through the dryer for drying. However, it
other such waste in wool manufacturing. is not dried fully and a 12 to 16 per cent
This wool is known as ‘shoddy wool’. moisture is left in the wool to condition
The shoddy wool sector provides cheaper it for subsequent handling. The chemical
clothes. Besides, the hardier shoddy process used to remove vegetable matter
fibres obtained from good original stock from wool is referred to as Carbonising.
blended with new wool from lamb etc. add b. Carding or Combing: After drying, the
durability to the soft new wool. wool is passed through various carding

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machines for carding or combing. These c. Spinning: In the spinning process, the
are two related techniques for preparing ‘wool top’ is spun into yarn. The wool
wool fibres for making either woollen or top slivers obtained are first of all passed
worsted threads respectively. In the case of through gill boxes and rubbing frames.
woollen yarn, the main objective of carding These machines have several pairs of
is to individualize the fibre by passing the rollers, each revolving at a progressively
wool fibre through various rollers covered faster speed. This action pulls the staple
with fine wire teeth. The wool fibres are lengthwise and makes the sliver thinner.
brushed and individualized by wires. The sliver is also given a little twist in this
Some dirt and foreign matter are also process. The drawing out and twisting
removed at this stage. Since the woollen continues till the fibre is about the diameter
yarn should be somewhat rough and fuzzy, of a pencil lead. After these processes, the
it is not necessary to make the fibre too fibre is placed in the spinning frames where
parallel to each other. One sliver of wool it passes through a series of rollers running
is placed diagonally overlapping another at successively higher speeds. The fibre
sliver by use of an oscillating device which is ultimately drawn out to the yarn of the
provides a fuzzy surface to the yarn. After desired size. After passing through spinning
this process, the woollen slivers go directly frames, the yarn goes to the winders for
to the spinning operations. However, in the winding on cones. Now the yarn is ready
case of worsted yarn, the essential purpose to be used by the fabric manufacturers.
of the combing is to make the fibre as d. Weaving: Next, the wool yarn is woven
parallel as possible. Combing is a technique into fabric. Wool manufacturers use two
whereby wool fibres are passed through a basic weaves: the plain weave and the
series of straight, metal teeth in order to twill. Woollen yarns are made into fabric
lay the fibres parallel to one another. The using a plain weave (rarely a twill), which
fibres are then placed together in a long produces a fabric of a somewhat looser
line (‘combed sliver’), which is used to spin weave and a soft surface (due to napping)
a smooth, even thread. In this process, with little or no luster. The napping often
long fibres are separated from shorter conceals flaws in construction. The Worsted
ones (‘noils’) and tangles are removed. At yarns can create fine fabrics with exquisite
the same time, practically all remaining patterns using a twill weave. The result is a
foreign matter is removed from the fibres. more tightly woven, smooth fabric.
In general, combed fibres are cleaner,
finer, stronger and more lustrous than e. Finishing: After weaving, both worsteds
carded ones. Most of the combing units in and Woollens undergo a series of finishing
the country are located at Ludhiana and procedures including: fulling (immersing
Amritsar. However, some combing units the fabric in water to make the fibers
are also located in the states of Haryana, interlock); crabbing (permanently setting
Maharashtra, Rajasthan, West Bengal, etc. the interlock); decating (shrink-proofing);
The Wool combing capacity of the units and, occasionally, dyeing. Although wool
is around 30 million kg per year. After fibers can be dyed before the carding
scouring and carding/ combing, the wool process, dyeing can also be done after the
obtained is referred to as ‘wool top’.. wool has been woven into fabric.

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 Woollen Mills

6.  IMPORTANCE OF WOOL TESTING in the consignment. The mean fibre diameter
represents the average thickness of the fibre in
6.1  Since 1930, the International Wool Textile
microns (micro-metres). The vegetable matter
Organisation (IWTO) is the recognized global
base is the amount of vegetable matter present
authority for standards in the wool textile industry
in the greasy wool. After combing, the comber
and for protecting the interests of the parties
also issues similar certificate to the importer
in the global wool trade. Since international
on the basis of actual combing results. Usually,
trading of wool requires clear specifications
there is no variation in the actual results and the
of the quantity and quality of the wool and all
anticipated results shown in the certificate issued
parties to the trade need to be assured that these
by concerned wool testing authority. In India
specifications have been achieved, the IWTO
the Central Wool Development Board (CWDB),
Test Certificates are essential to the wool trade.
Jodhpur has its wool testing laboratories at
IWTO issues licenses to various test houses
various locations. The Indian Institute of Carpet
to issue IWTO certificates. The Test Houses
Technology also has a laboratory at Bhadohi,
licensed by IWTO are further accredited by their
Uttar Pradesh for the Carpet and Textile Industry.
national standardization bodies and the relevant
The Central Sheep and Wool Research Institute,
tests are carried out in strict compliance with
Tonk, Rajasthan also has testing laboratories.
IWTO test methods and regulations. Through
Wool testing is also done by the Textile Testing
this process, buyers and sellers can use IWTO
Lab of the Wool Research Association, Thane.
certificates with confidence. In addition, IWTO
Certificates are backed by the IWTO Arbitration
Rules that outline the rights and responsibilities 7.  POSSIBLE LINES OF
of all concerned, including those of the testing INVESTIGATION FOR
authority. ASSESSING OFFICERS

6.2  The Test Houses and similar Authorities are 7.1  The assessing officer should keep in mind
the ones which issue a certificate to the supplier that except for carpet wool, most of other raw
regarding the probable results expected from wool used in India is imported. A wool trader
a particular lot of the wool consignment. The imports the wool and supplies it to the wool
major wool testing authorities in the world are agent who further sells it to the spinner. The
Australian Wool Testing Authority Ltd, Australia; rest of the value-chain for wool consisting of the
SGS Wool Testing Services, New Zealand stages of dyeing, weaving, fabric processing and
and Wool Testing Bureau, South Africa. The end-product manufacturing remains the same as
requisite certificate is issued by them on the that of cotton. The only minor difference is that
basis of samples taken from the lot of the wool wool fibre is only ring spun not rotor spun.
being dispatched by the supplier. The certificate 7.2 The carpet industry in India mainly
gives such details as the wool base, mean fibre produces three types of carpets-tufted, knotted
diameter, vegetable matter base and clean weight and woven carpets-all of which are hand-woven.
of the consignment. Clean weight represents the Carpets are predominantly produced from
quantity of wool top, noils, shoddy and burrs wool though other materials such as cotton,
likely to be obtained from the consignment of polyester and viscose are also used in various
the greasy wool after the combing process. This blends. The value chain of the carpet industry is
also includes the amount of moisture contained unique in the sense that it centres around carpet
in the wool. The wool base is the weight of dry manufacturers who typically have the in-house
wool (excluding moisture) likely to be contained facility for finishing and dyeing as well. They

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can be involved in any part of the value chain, Top and Noil that can be combed from a greasy lot.
directly or indirectly. They buy the wool fibre The Indian combers also issues similar certificate
from agents who in turn procure it either from to the importer after actual combing. Usually, the
domestic wool growers or through imports. The results found on actual combing are marginally
manufacturers subsequently get the wool spun better than the results shown in the certificate
and dyed on job work basis. A similar process is issued by the wool testing authority concerned.
followed for non-woollen yarn which is bought In case there is substantial variation between the
directly from their manufacturers or from their results, the reasons should be enquired into. It
yarn agents. The yarn thus produced is sent by is likely that cheaper and inferior quality wool
the carpet manufacturers through contractors might have been blended with the imported
who act as master weavers. They get the yarn wool. The assessing officer may go through the
woven from the weavers on job work basis. The correspondence between the comber and the
woven carpet is finished in the in-house facility of importer to find out the reasons for the variation.
the carpet manufacturers or through job work as The correspondence of the importer with the
applicable. The finished product thus produced supplier may also be gone through as, usually,
is either sold to buying agents, domestic buyers the importer lodges the claim for compensation
or exported. The buying agents further sell the with the foreign supplier, through its indenting
finished goods directly in the domestic market agent, in case there is any substantial variation
or export it. between the expected results as shown in the
certificate issued by the Wool Testing Authority
7.3  The first step involved in the investigation
and the actual results. In case the assessee has
of accounts in the case of a woollen mill is the
not lodged any claim for compensation, the
verification of the consumption-yield ratio. The
genuineness of the claim of low recovery of wool
yield should be seen at two stages-at the stage of
top from the greasy wool shown by the assessee
conversion of wool top from greasy wool, and at
becomes all the more doubtful.
the stage of the conversion of wool top into yarn.
As far as conversion from greasy wool to wool 7.5 For verifying the yield of wool top from
top is concerned, there is no fixed ratio of yield the scoured wool or the yield of yarn from wool
since it depends upon the quality of the greasy top, it will be worthwhile to compare the results
wool. Usually, the wastage at this stage varies shown by the assessee with the input-output
between 30 to 40 per cent although it may go up norms for various industries prescribed by the
to 70 per cent if the quality of the wool is inferior. Director General of Foreign Trade. The assessing
7.4  Before dispatch, most of the consignments officer should go through these norms. In case,
of greasy wool sent by foreign suppliers are tested there is any substantial variation between the
by the wool testing authority of the concerned yield shown by the assessee and the input-output
country. All these authorities issue a certificate norms prescribed by the DGFT, the assessing
called ‘IWTO Combined Certificate’. This officer should thoroughly investigate the case
certificate contains details of the mean staple for detecting possible bogus purchases, inflated
length, mean diameter of the fibre, dry weight expenses or suppressed sales. The Input-Output
of the fibre free from all impurities (also called Table, Commodity by Commodity Matrix, 2007–
wool base) and the vegetable matters base. The 08 prepared by the CSO, MOSPI, Government
IWTO Schlumberger Dry (Top & Noil Yield) is a of India (2013) indicates the following per
commercial yield which predicts the amount of centages of inputs in woollen textile products:

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 Woollen Mills

Table 10 7.5.2 Similar breakup is available for the

(In Per cent) relative share of Non-textile inputs (Goods) and
Structure of Woollen Carpet Non-Textile inputs (Services).
Inputs Textiles Weaving
7.6 The woollen industry has to pay Goods
Textile inputs 45.1 42.2
and Services Tax on wool top and on wool yarn.
Non-textile inputs
(goods)
19.5 19.9 These rates would need to be checked as the
Non-textile inputs
GST Council changes the rates from time to
33.9 36.7 time. The combing mills, spinning & weaving
(services)
Total Non-textile mills have to maintain certain statutory registers.
53.4 56.6
inputs The Register of Goods Produced contain the
Non-textile inputs day to day details of quantity manufactured and
1.4 1.2
(not shown) cleared from the factory. Similarly, the other
Total 100 100 mandatory registers like the Input Tax Credit
Availed, Output Tax Liability, Output Tax Paid,
7.5.1  Details of relative shares of inputs from the
Input Tax Credit Availed, Sales Register, Stock
textile sector to produce textile sector outputs are
Register and Purchase Register can be examined
shown in Table XI. Textile products are produced
to find and correlate the amount of GST paid and
out of textile inputs in different mixes and blends
total quantity of wool top or yarn manufactured.
and at different stages of value added.
The register also gives information regarding
Table 11 the raw material used in manufacture of various
(In Per cent) goods. The registers also give such information
Woollen Carpet as the opening balance, quantity of raw material
Product
Textiles Weaving purchased, visible wastage, invisible wastage,
Jute 0.01 3.74 closing balance of raw material, etc.
Cotton 10.74 0.40 7.7 The assessing officer should prepare a
Khadi, cotton month-wise consumption-yield ratio chart on the
textiles 0.35 1.08 basis of the information available in the registers
(handlooms)
mentioned earlier. In case the yield shown by
Cotton textiles 2.58 4.16 the assessee for some months is substantially
Woollen textiles 17.85 7.69 lower than the yield shown in other months, the
Silk textiles 0.20 0.46 assessing officer should investigate the reasons
for the same. The assessee might have introduced
Art silk, synthetic
6.10 10.73 bogus purchase bills or might have shown excess
fibre textiles
Jute, Hemp, wastage in the months in which the yield shown
1.11 3.26 is significantly lower. It will also be worthwhile
mesta textiles
Carpet weaving 0.25 0.01 to compare the figures of stock appearing at the
end of each month with the stock shown by the
Readymade
4.29 2.30 assessee in the stock statements given to the bank
garments
Miscellaneous for the corresponding months. This exercise may
1.43 6.61
textile products reveal any unaccounted stock hypothecated by
Synthetic fibres, the assessee to the bank.
0.21 1.73
resin
7.8 The greasy wool contains natural oils of
Total 45.12 42.17
sheep. After scouring, the oils are removed from

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Techniques of Investigation for Assessment Vol. 3

the wool. In the case of scouring and combing in a Firm so that the fact of the imposition of
units, it should be kept in mind that the cleaning the penalty does not come to the notice of the
the fleece removes ‘wool grease’. This is a fatty Revenue. It would be worthwhile to go through
substance which is purified to make Lanolin the vouchers relating to the custom clearing
(yolk), a by-product which is extensively used in agents as they make the payment on account
pharmaceutical and cosmetic industries. Most of of custom duty or the penalty to the Customs
the combing plants have installed machinery for on behalf of the assessee. Penalties cannot be
extraction of grease from the oils removed from allowed as deduction. Besides, the penalties
the greasy wool. The assessing officer should find may reveal the modus operandi adopted by
out whether such grease has been accounted for the assessee for earning unaccounted profits.
in the books of accounts by the comber or not. The assessee might be importing fine quality
7.9 The valuation of closing stock also needs wool under the garb of rags or inferior quality
to be checked carefully. Sometimes, the customs wool and making unaccounted investment on
duty on the raw material is not included in the purchases outside the books of account.
value of closing stock resulting in undervaluation
of closing stock. The duty paid by the assessee on 7.11 The assessing officers should be aware
imported raw material constitutes an important of the various Government initiatives taken in
element in the total cost of the goods and, this sector from time to time. The Government
accordingly, requires to be added to the value Departments are a good source of information
of imported raw material. Further the assessing for the assessing officers. The ‘Central Wool
officer should also verify whether the material Development Board’ (CWDB), Jodhpur, under
sent by the assessee for combing or dyeing the administrative control of Ministry of Textiles
during the year but not received back till 31st has been formed to develop the domestic wool
March, has been included in the closing stock textiles industry by undertaking various support
or not. programme. It also has a ‘Market Information
7.10  The assessing officer should also Network’ which publishes fortnightly raw wool
check whether the Customs/ GST authorities and woollen yarn prices in respect of various
have imposed any penalty on the assessee. woollen articles. It also gives information about
Sometimes, the assessee debits the penalty to the arrival and sale of raw wool in various
the purchase account without showing the same mandies in the country. There is also the ‘Wool
as penalty. The assessee may even debit the & Woollen Export Promotion Council’ which
penalty to the capital account of the partners promotes woollen exports.

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 Chapter

7
Woollen Carpet Industry

1.  INTRODUCTION
1.1 The important carpet producing centre
in India are Mirzapur, Bhadohi, Gopiganj,
Khamaria and Agra in Uttar Pradesh, Srinagar
in Jammu and Kashmir; Amritsar in Punjab;
Panipat in Haryana; Jaipur and Bikaner in
Rajasthan; Gwalior in Madhya Pradesh, Eluru
and Warangal in Andhra Pradesh; Madras and
Walajapet in Tamil Nadu and Obra in Bihar.
The popular qualities of Bhadohi and Mirzapur
in Uttar Pradesh vary from ordinary to medium
fine; finer varieties are from Agra, Jaipur, Amritsar in which woollen warp is used. When wool is
and superior varieties come from the Kashmir. used for warp, the carpet clings to the floor and
The rough Berber and Shaggy carpets are in is considered superior. The quality of the carpet
complementary colours while the Hamadan depends upon the knots per sq. inch, which
variety is brightly coloured and heavy. The varies from 6 to 1000. Generally, it is 20 to
exquisite mulberry silk carpets are light, silky, 400. The Indian handmade woollen carpets are
glossy and woven in multiplies shades. usually made with following tools:
1.2 Indian carpets are available in different a. A loop made of wood.
sizes and lengths of pile, which may be as low as
1/ 5 of an inch as in Kashmir carpets or as high b. Chhura: It is a curved steel knife for cutting
as 7/ 8 of an inch as in the Indo-berber variety. the thread after a knot is tied.
Amongst Persian carpets the different qualities c. Panja: It is a heavy comb of iron with
are generally known as: 3/ 28, 5/ 40, 7/ 52, 8/ wooden handle for beating the waft and
56, 9/ 45, 9/ 60, 10/ 62, 10½/ 48, 11/ 55, 12/ the pile tufts.
60, 14/ 70, 16/ 80, 15/ 75. Knots per sq. inch
can be obtained by multiplying both the figures d. Kainchi: or scissors for cutting pile level.
and dividing it by 4. For example: 3/ 28 means 1.4  Generally, for hand-woven woollen carpets,
(3x28)/ 4 or 21 knots per sq. inch. machine made yarn is used but hand-spun yarn
1.3  The warp of a carpet is always of cotton or is regarded as superior to machine spun yarn.
jute except in a few special carpets like Bokhara Spring clipped wool is considered superior to

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autumn clipped wool. The former is stronger and losses at various processing stages in
and gives better results. There is also a difference the carpet industry considerably impact the
in sheep’s and lamb’s wool. profitability of such concerns.
1.5  An average weaver can make about 12000 2.3 Shortage/ Gains in Transit: As per
knots in a day. The minimum knots expected of standards fixed by International Wool Testing
a weaver are 15 per minute or 900 per hour. In Authority (IWTA), the imported wool is sold
other words lowest quality Persian carpet can be on conditioned basis. For each article of wool,
woven by a weaver at the rate of about 4 sq. ft. certain standard regains are fixed in respect of
per day, while superior quality carpets like 12/ imported wool. In the case of the carpet wool,
60 and onwards, can be woven at the rate of ½ the conditioned weight is about 16 to 17 per
sq. ft. per weaver per day. cent. Every lot is accompanied by a certificate
1.6  The above average knotting also varies with from a Conditioning House in which the moisture
different types of knots. The knots are of five content is mentioned. This is called ‘regain per
types namely, Persian, Turkish, Tufted, Tibetan centage’. It would therefore, be desirable for
or Nepali. The last three knots are on four strings the AO to go through the original vouchers
of warp instead of two, and carpets made with of imported wool and ascertain the narration
these knot are considered only half as good as about the conditioning and the weight for which
the carpet with the other knots. the price is charged. IWTA has fixed norms of
conditioning loss or regains to avoid disputes
2.  MANUFACTURING PROCESS amongst the parties making transactions across
the world. When there is a higher content of
2.1 The process of carpet manufacturing can moisture in the atmosphere, the weight of wool
be broadly divided into three stages: increases as it absorbs moisture of even 25 per
a. Manufacturing of woollen yarn from raw cent or more. However, in the case of Indian wool,
wool; the original vouchers for purchase do not indicate
the moisture content. The moisture content in the
b. Dyeing of woollen yarn in different colours
wool is normally the same as in the atmosphere.
as per requirement; and
The loss in weight on account of driage/ loss in
c. Carpet-weaving and process of finishing of transit may vary from 2 to 5 per cent.
carpet.
2.4  Willowing: The first operation in the case
The first stage, namely, manufacturing of woollen of woollen carpet yarn is ‘willowing’ or ‘zaffery’.
yarn is generally carried out separately except in During this, the wool is passed through a
some cases, where all the three stages are carried willowing machine, which removes dust, thorns
out by the same covers. Traditionally dyeing etc. from the wool. The shortage in willowing
used to be done by the manufacturing concerns varies from 5 to 8 per cent, depending upon the
themselves but these days separate dyeing units quality of wool. The waste material recovered
are established by many independent houses. is not capable of reuse and is sold as manure.
2.2  Raw Materials: The raw materials for the The assessees not having willowing machines,
woollen carpet industry comprises of imported engage labour for beating the wool to separate
raw wool, indigenous wool, both indigenous the dust, thorns etc. This operation is called
and imported man-made fibres, and imported ‘zaffery’. The loss in ‘zaffery’ may vary from 5
woollen rags. The subject of wastage, shortages to 6 per cent.

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2.5  Blending and Oiling: After willowing has during carding and spinning process varies
been completed, the process of ‘blending’ and between 6 to 10 per cent. The usable waste
‘oiling’ is performed. Different grades of wool recovered from carding and spinning operations
or other fibres are blended with the willowed is as high as 60 per cent of the total wastage
wool. For manufacture of woollen yarn, in this operation. Out of the wastage in carding
different colours and qualities of wool fibre or and spinning operations, 40 to 50 per cent is
the reprocessed yarn are blended in the desired reusable visible waste that can be reused; and
combination. This is done to reduce the cost of 10 to 20 per cent is unusable visible waste that is
yarn as also to create a mix of colours or special sold to shoddy manufactures.
effects. It also helps in the spinning process. The 2.8  Reeling, Scouring, and Dyeing
Mills maintain a Blending Register that contains Processes: The yarn is unfolded from the
particulars of recovery, wastage, and wastes bobbins and rewound into ‘hanks’. This is
delivered to the wool godown including soft, known as ‘reeling’ and is done mostly by hand,
hard, shoddy, sweepings and invisible loss, etc. for which reeling wages are paid according to
These particulars are also available along with the quantity reeled. The production by each reeler
oil (Mahua or castor oil) and the chemicals used
is noted in the Register for Reeling production.
in the ‘woollen blend card’-a card maintained The ‘count’ of yarn is a term used to express
in the Blending Section to reconcile the various the fineness of yarn, i.e., the number of hanks
results, recoveries and shortages. This card is of yarn which weigh one kg. The yarn after
submitted to the mill’s office on completion of being unfolded from bobbins and rewound
the blending process. This information if checked into hanks, is either sold in market or sent for
up, at random, will give a clear picture of the scouring and dyeing. The object of ‘scouring’
working of the mill. is to remove the oil added before spinning
2.6  Carding and Spinning: In this process, and other impurities in the wool. The loss in
the yarn is sent for carding, spinning and dyeing. scouring may vary from 12 to 15 per cent and
Carding is done by passing wool through the that there is no recovery of visible waste. A
machines where its locks are separated, and vigilant AO should carefully scrutinize the cases
the rearranged fibres come out. All out efforts of assessees who are not themselves performing
are made to open, separate and straighten the all the operations involved in spinning of yarn
individual fibres of the stock. The fibres are and manufacturing of carpets, and have instead
rearranged in different directions, crossing and formed different sister concerns for carrying on
re-crossing as much as possible. Short/ broken different operations.
fibres can be accepted. In this process there 2.8.1  Dyeing Process: In the dyeing section,
is also some invisible waste which should be there are several dyeing machines of different
compared with assessee’s previous records, as sizes in which different colours and proportionate
also with similar cases. This occurs when some weights of yarn are put together. Expenses on
fibres go into the air and fly away. Visible loss colours and chemicals should be compared with
is on account of miscellaneous impurities, still other comparable cases and the assessees earlier
left over which are removed at this stage. For record. Normally wastage or shortage in dyeing
verifying these losses, the AO can call for the should range between 2 to 3 per cent depending
records maintained in the carding section. upon the wool and yarn’s quality, and, whether
2.7  Carding and spinning are complementary the process is of machine-dyeing or hand dyeing.
processes and are done together. The bobbins The dyeing section, maintains a receipt book
are brought into a machine called ‘Mule’, on that contains information on shortages/ wastage.
which the yarn is spun. The wastage/ shortage If the claim under this head is excessive, the

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Techniques of Investigation for Assessment Vol. 3

receipt book can be examined. If dyeing is got weavers depending upon the size of carpets.
done through independent dye houses, the loss The loss in weaving process is negligible. When
in dyeing and the details of yarn dyed in terms the weavers complete weaving, they return the
of weight, colour and dyeing charges can be carpet to the manufacturing houses. At that time
cross-verified from the books of the dye houses. entries of manufactured carpet are made by the
assessee in the Bazar Register.
2.9  Weaving Process
2.9.5  Generally, the carpet manufacturer
2.9.1  After all these processes, the yarn is ready
employs the same weaver for weaving carpet,
for weaving-either by hand if the carpet is to be
year after year. These weavers may be employed
hand-knotted and hand tufted or by machines. In
as regular employees or on contract basis. The
the first case, the weavers can be either assessee’s
percentage by a particular weaver can be cross-
own full-time employees; or working full time on
contract basis; or outside weavers running their checked with the percentage wastage by the
independent weaving business. Generally, hand same weaver on earlier occasions for a carpet of
weaving is got done through weavers working the same quality. As the weavers become more
full time on contract basis for the assessee. In experienced, the wastage should come down.
Persian carpets, the weaving charges vary from The weaver can also be summoned to verify the
Rs. 200 per sq. yard to 5500/- per sq. yard. claim of shortage.

2.9.2  The processed yarn is given to weavers. 2.9.6 Most of the big mills maintain detailed
Weaving, finishing, cutting, clipping etc. is done information about the receipt of yarn, daily
in the weaving section, after which the carpet is production of carpets therefrom, quality,
ready according to the design and specification colour of yarn, weight of carpets etc. on cards
given to weavers. It is extremely difficult to have maintained in the weaving section.
an idea of wastage in this Section, as it depends
2.10 Finishing: The various finishing
upon the expertise of the weaver, his moods,
experience and the quality of supervision etc. processes such as cutting, grossing, washing,
back burring, clipping (embossing in embossed
2.9.3 Hand weaving involves following steps: carpets), binding, stretching etc. are generally
a. Issue of raw material (woollen yarn, cotton done in the premises of the manufacturing
yarn) to weavers. houses. However, in recent years, a practice of
getting the carpets washed by different units is
b. Supply of design/ map with the materials.
becoming popular.
c. Description of quality, size to be
manufactured. 2.11  The processes of manufacturing the Tufted
and Tibetan carpets are almost similar, with the
The material is issued through ‘purja’ that serves following variations:
as gate pass also. In some cases, separate gate
passes are issued. From these ‘purjas’ the issue a. Tufted: Separate looms made of pipe
register is prepared with following columns: are used. The tufting is made on cloth
and then put on the loom. After finishing
Description Design Size Quality
tufting latex, jute and the thick cloth are
2.9.4 The weavers take the raw material and used to support the tufted carpet. The
weaves the carpet as per the design given to weaving of this carpet generally takes less
them on loom-either alone or with some other time compared to Persian carpets.

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b. Tibetan: Separate looms made of girders Wastage in excess of the above require detailed
are used. The weaving process is very enquiries by the Assessing Officer.
simple and require less time compared to
Persian carpets. No knots can be found in 4.  COST ACCOUNTING AND
these carpets andweaving is generally on PROFITABILITY
contract basis/ job work basis and weaving
charges are 200–250 per sq. yard. 4.1 Apart from various shortage and wastage
discussed above, the manufacturing/ production
2.12 Netting: After the carpet has been made, expenses may also require investigation. The
‘netting’ is done with cotton net or jute net to
normal thickness (i.e. height of the yarn) of
give support to the yarn and to make a base for
carpets is 12–18 mm for handmade carpets
the carpet. Cotton net is used as base for hand-
tufted carpets and jute net is used for machine and 6–8 mm for machine made carpets. The
made ones. Liquid rubber is also used to even consumption of yarn per sq. meter depends
out the backside of carpet and to give it support upon the thickness of yarn. This varies from 1.5
and to properly hold the yarn. This special to 2.00 kg per sq. meter from handmade carpets
quality rubber called ‘latex’ is issued on licenses and is around 1 kg per sq. meter for machine
issued by the Rubber Board. Usually, 5 to 6 liters made carpets. Therefore, the proportion
of liquid rubber is consumed for every square between the total yarn consumed and the total
yard of carpet area. carpet area should be calculated with other
similar cases. In a number of cases of carpets
3.  MANUFACTURING LOSSES AND of normal thickness, the average consumption
SHORTAGES was found to be around 30 gms of yarn per
3.1 In opening and reel-making stages, the square foot. The average cost per square foot
wastage could be 1 to 1.5 per cent depending of Persian carpet depends on the cost of yarn,
upon whether this is done by machine or by hand. the consumption of yarn per sq. meter and the
The hooking loss can be between 2.5 to 5 per weaving charges. Other carpets such as tufted
cent. Further, in cutting, finishing and clipping, the etc. are cheaper and highly in demand.
process shortage may be between 4–5 per cent.
The clipping wastage is sold to ‘kabaris’ or used 4.2 The G.P. rates in these cases vary from
as shoddy. The overall shortages/ loss in various 15–25 per cent due to the highly ambulatory
processes can be between 25 to 35 per cent. In nature of this industry. These per centages are
some cases, losses of upto 40 per cent have been after excluding the credit of cash entitlements,
claimed. These require probe from primary books subsidies and incentives from the trading
and cards/ registers discussed above. account, since the amounts of these incentives
3.2  The normal wastage at different stages can go on varying every year.
be summarized as under:
5.  BANK LOANS
Willowing/ zaffery = 5 to 8%
Blending = 1 to 2% Advances are taken by the carpet manufacturer/
Oiling = Nil (in fact, oiling adds to
exporters in two stages. The first is the pre-
weight of wool) shipment stage in which they have to hypothecate
Carding, spinning & = 6 to 10% the stock to the bank. The second is the post-
reeling shipment stage of packing credit, where the
Scouring = 12 to 15%
exporting unit obtains the advance against the
Dyeing = 2 to 3%
bill drawn on the foreign buyer.

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Techniques of Investigation for Assessment Vol. 3

6.  INFLATION IN PURCHASES of wool consumed is disproportionately high. In

such cases collusion between the assessee/ its
6.1  Usually wool is purchased on contract basis.
representatives and the wool supplier may be
A ‘contract book’ is maintained showing the serial
suspected.
number of the contract, date of the contract,
names and addresses of the parties, quality and 6.3 Fictitious Purchases: Where a mill
quantity contracted, rates and period of delivery shows abnormally low profits or losses as against
etc. A receipt register is also kept showing the good profits shown by similar others in the line,
details of wool received and weighed in the there may be reasons to suspect inflation in the
factor, showing the date of weighment, contract rate and value of wool purchased or in quantity.
number, party’s name, quality, rates etc. The Such quantitative inflation would be reflected
weighed wool is given a lot number before being in the low output of yarn or large invisible
consigned to the godown. A ‘lot book’ is also wastage. These low rates can be the starting
maintained showing the lot number, quantity, point for further detailed investigation. In such
quality, date of receipt, rates, supplier’s name, cases, purchases that appear to be from dealers
weight, dates of issue and mixing. In suspected who have not much of a standing or who have
cases of tax evasion, it is necessary to obtain a not made supplies either before or after that
full list of the wool purchases showing lot-wise purchase should be selected and cross-checked.
details. Such an enquiry might reveal the bogus nature
of the item particularly, when it is pursued as
6.2  In one case, it was found that in the lot-wise to its movement, storage, payment of godown
statement a purchase of Rs. 1,50,000/- was shown rent etc.
together with the lot number but in the lot book
6.4  Suspense Purchases: In some case,
there was no entry of that particular lot number.
there is also the practice of suspense purchases.
This suggested that no such lot had actually
Under this system, the seller gives possession to
been purchased and Utilised. On enquiry, it
the buyer but retains the right to fix the price on
emerged that this amount of Rs. 1,50,000/- was
future date of his choice, after taking advance
carriage expenses. But according to the contract,
of about 50 to 60% of the current market price
wool was to be delivered with freight fully paid
of the wool sold. If the price is not fixed by the
at the assessee’s factory premises. Ultimately, it
seller before the end of the accounting year of
turned out that the amount Rs. 1,50,000/- was the buyer, the purchaser takes the rate prevailing
a transfer entry by which a similar debit in the on the last day of the accounting year and debits
account of the managing agents was squared up. the purchases account with corresponding credit
Thus a comparison of the terms of the contract to the seller. On the first day of next succeeding
and the entries in the lot book would enable year the entries are reversed until the rate is
the AO to identify fictitious or inflated items of finally fixed between the seller and the buyer.
purchases. In some cases, even the contracts This system lends itself to evasion of tax as the
were manipulated to show purchase rates assessee might make an entry showing that prices
higher than the rates at which they were actually were fixed when the market was very high. But
contracted, thereby substantially inflating the careful enquiry with the seller may show the rate
value of the wool purchased. There are also at which he actually sold the wool. It is useful to
instances where, although the average count of refer to trade journals such as “Wool intelligence
yarn spun is comparatively low, the average cost Bulletin” and “Wool and woollens of India”.

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 Woollen Carpet Industry

These contain wool purchases rates from time made to the stores consumption account, which
to time. ultimately appears in the manufacturing amount.
The following tax evasion methods have been
7.  INFLATED CLAIMS OF WASTAGE detected in some of the cases.

The loss in weight on account of driage/ loss in 9.2  In one case, a mill advanced large amounts
transit may vary from 2 to 5 per cent. The AO to sundry parties in one year. In the subsequent
can find out inflated claims of driage or loss in year, these advances were squared up by
transferring the same to the stores account,
transit in the case of imported wool by referring
for which stores bills were prepared to make it
to the original vouchers and ascertaining the
appear that the mill had purchased stores from
percentage of moisture content. The loss in
these parties. Although receipts and issues of
‘zaffery’ may vary from 5 to 6 per cent. If an stores were shown in the stock register, there
assessee is showing loss in both ‘zaffery’ and were no slips issued to the storekeeper for issue
‘willowing’, the AO must make a thorough of these stores. Besides, the stores suppliers
probe. could not be traced out.
9.3  In another case, the stores account showed
8.  INFLATION OF CHARGES purchase usually ranging from Rs. 1000/- to
Inflation of charges, particularly scouring Rs. 5000/- on various dates from various parties.
charges paid to other concerns, is a common In respect of five items however, the purchases in
malpractice. In one case, it was found that cash exceeded Rs. 15000/-. On investigation, it
the assessee was carrying on the business was found that the alleged suppliers had given
of manufacture of carpets but was not bills showing the names and address of far off
manufacturing yarn itself. It would purchase places. These bills also showed telegraphic code
raw wool from the market and give it to its and telephone number etc. On enquiry, with the
sister concern after zaffery for spinning of yarn. postal department it was found that there was no
The spun yarn was then given to another sister such telegraphic code or telephone number, nor
concern for dyeing. The dyed yarn was then was there any such dealer at the address given.
to be used for manufacture of carpets. Neither Besides, no freight charges were claimed for
the transport of the stores. The explanation was
the assessee nor the sister concern carrying
that the stores were brought by the agents of the
on spinning of yarn had shown recovery of
suppliers when they visited the mill. There was no
visible waste. Again, to inflate its expenses,
correspondence and the payments were made
the assessee had paid scouring charges to
by bearer cheques although even in respect of
both the sister concerns. Ongoing through the
cheaper items the payments had been made by
past records, it was found that, in none of the
crossed cheques. When the matter was further
earlier years, scouring charges were paid at two pursued, it was found that the bearer cheques
stages. During the year under consideration, were actually encashed over the Bank’s counter
the assessee had bumper profits and it adopted by the mills’ manager. When the manager was
this tactics to reduce its income. examined, he admitted that the money encashed
had been paid to the managing partner and that
9.  INFLATION IN STORES ACCOUNT he did not know the alleged suppliers.
9.1  Usually, purchases of stores are debited to 9.4  Where the component of stores consumption
the stores account and periodical transfers are in the cost of production is high, it would be

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Techniques of Investigation for Assessment Vol. 3

necessary to obtain comparative details of the While expenses on looms can be capitalized
quantity and value of certain selected item of for the purpose of depreciation as per rules,
stores consumed for different accounting year, the reasonableness of the expenditure on other
as this will reveal the items in which there has tools and consumable stores should be watched
been substantial increase and a further pursuit carefully. The life of the other tools is not so short
of purchases of such stores may result in the and if excessive or unreasonable expenditure on
detection of inflation in those items. tools and consumable stores is claimed, the AO
9.5 Rate of purchase of stores may also be must make a thorough probe.
inflated in collusion with suppliers. Some-
times, the suppliers may be only benamis of the 12.  PRODUCTION AND CONTROL
assessee or the concerns in which it is interested. OF GST AUTHORITIES
12.1  Under the GST Act, the woollen mills are
10.  INFLATION OF WAGES obliged to maintain records of yarn production,
This is another area in which expenses can detailed stock accounts, quantities removed from
be easily inflated. In the case of permanent the factory, gate pass particulars, description
employees, a regular muster roll is kept under of goods removed etc., in various prescribed
the Factories Act. The inflation is usually in the registers. The mills maintain such records, and
muster roll for temporary employees. In one these can be quite useful for investigations. It
case, a perusal of the muster roll for temporary is also useful to examine the Spinning Master’s
employees showed that lump sum amounts were daily production report and compare it with the
added at the end of the each week to the total of Spinning register, which records the production
the temporary wages shown in the “Temporary at the spinning point. The spinning production
wages register” and the whole amount was can then be compared with the reeling
debited to the wages account of the mill. These production which should normally be higher, as
lump sum amounts were actually withdrawn yarn gathers weight in the reeling process due
by the partners. In some cases, only thumb to moisture content, but by the time the reeled
impressions of the so-called labourers were yarn is bundled and baled, some of the moisture
taken and their whereabouts or names were not content is again lost. Therefore, the baling
available. production is more or less equal to the spinning
production.
11.  CAPITAL EXPENDITURE AS 12.2  In one case where search was conducted
REPAIRS u/s 132, it was found that the yarn production
Sometimes, capital expenses such as construction was recorded in the stock register at a figure much
of a new shed or a wing etc. are claimed as less than the daily production report submitted
revenue expenditure through this account. by the spinning master. In fact, duplicate daily
Besides, cash advances might be shown in one report statements were got prepared to support
year in the name of some sundry parties and the entries in the stock register. The actual
they would also be shown in sundry debtors production so diverted was sold through the
balance. In the subsequent year, these advances mill’s retail depot to weavers and dealers in
are squared up by transferring the same to the yarn. Therefore, in suspected cases of evasion,
repairs account on the basis of certain typed bills it is essential to gather stock and production
alleging that these persons carried out repairs details from the primary books of entry including
to the building or roads in the mill premises. original production reports.

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 Woollen Carpet Industry

13.  SUPPRESSION OF SALES authorities after which the assessee’s premises

were raided. It was then found that the advance
13.1  Suppression of sales turnover is common
of 800 dollars was mentioned only in the order
in this line of business. In the case of a carpet
form and was not entered in the regular books.
manufacturer, some special arrangements
Therefore, while scrutinizing accounts, the
were made for sales during specific periods
order forms that are usually issued at the time
which indicated a departure from the normal
of advances received from the customers or at
established procedures. It was found that it was
the time of booking should also be thoroughly
selling its products to some firms on consignment
scrutinized.
basis. The assessee had agreed to bear the
cost of freight, storage, godown and other 13.3  Very often sale of wool waste is shown at
allied charges, till the date of sale of the goods. a reduced rate. Such sale may be to persons who
Goods that could not be sold were returned to are dummies or benamidars of the assessee.
the assessee. These firms used to pledge the
goods with the bank and dispatch the amounts 14.  EXPORTS AND IMPORTS
to the assessee that would pay the interest on
the amounts advanced. The commission paid 14.1 The carpet industry in India is basically
along with other expenses as interest, godown export-oriented and its local demand is limited.
charges, freight cartage, Octroi etc. worked out With an estimated 1,00,000 looms employing
to be more than 20 per cent of the sale proceeds. about five lakhs weavers, the industry has a fairly
Enquiries revealed that these dealers were getting large production base in the country. Export
favoured treatment. The arrangement of sale on Sales is an important area of investigation in
consignment basis was found to be a method for suitable cases.
diverting a part of profits to these dealers with 14.2 Non-repatriation/ non-realization of the
whom the assessee had entered into collusive export sale proceeds is a major issue. Often
arrangement. exporters enter in collusive arrangements,
13.2  In cases of sale of carpets to tourists, often wherein the outstanding proceeds are partly
advances are received against the sale proceeds, realized and the balance proceeds are retained
but these do not find any mention in the regular abroad. Simultaneously, these amounts are
receipts. A German national visited a carpet claimed as irrecoverable bad debts. The foreign
factory where she selected a carpet for 2800 exchange so accumulated is used for personal
dollars and paid advance of 800 dollars with an expenses on visits abroad.
agreement that the remaining amount of 2000 14.3  Information relevant to income-tax
dollars would be sent as soon as the carpet was assessments can also be gathered from the offices
dispatched to Germany. In the order-form, copy of Textile Committee of Inspection, Controllers
of which was supplied to the German national, of Imports and Exports and Regional Textile
the manufacturer mentioned the advance of Commissioner functioning under the Commerce
800 dollars. However, in the invoice that was Ministry. The Textile Committee inspects the
dispatched along with other papers to the Clearing quality and quantity of the intended exports,
Agent the amount mentioned was 2000 dollars and issues a certificate regarding the fitness
only. It so happened that the carpet was lost in of the goods for export on the basis of which
transit and did not reach the destination. When Government allows incentives to the exporters.
the German national claimed damages from The Textile Commissioner’s office has useful
the insurance company, the insurance company information regarding the quality of goods
offered 2000 dollars only i.e. the sum mentioned and raw material imported, license no. and the
in the invoice. She lodged a complaint with the actual user of the goods, total production etc.,

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Techniques of Investigation for Assessment Vol. 3

Similar, information can also be obtained from imported against a REP license is a scarce one,
the Regional Controllers of Imports and Exports. the possibility of the transaction involving on-
money cannot be wholly ruled out.
14.4 The Indian woollen industry is heavily
dependent on imported raw wool and wool 14.7  Cash Incentives etc.: It is also necessary
tops. India buys raw wool mainly from Australia, to verify whether various cash incentives,
New Zealand and Japan. The AO may, in subsidies and entitlements given to exporters are
suitable cases, verify whether the importer has properly reflected in the books of accounts. These
properly Utilised the imported material for the incentives are allowed to increase the export of
purpose for which it was imported or the same carpets. The cash compensatory support in case
was sold off in the black market at premium and of carpets is paid upto even 20 per cent on the
has fabricated his production and sale accounts. FOB value.
14.5  The AO should also ensure that all cash
assistance whether due or received has been 15.  SOURCES OF INFORMATION
properly accounted for in the relevant year Some of the main trade bodies and departments
according to the system of accounting followed having technical data/ expertise on export trade
regularly by the assessee. It may be useful to are specified hereunder:
collect full information regarding payment of
a. All India Handicrafts Board.
cash assistance from the regional offices of the
Controllers of Imports and Exports to find out if b. Wool and Woollen Export Promotion
there is any discrepancy in accounting for such Council
receipts in the respective accounts. c. Institute for Carpet Technology at Bhadohi
14.6 Import Entitlements: The object of (UP)
Import Replenishment Scheme is to provide d. Regional Textile Commissioner
registered exporters import replenishment e. Textile Committee of Inspection
licenses, to import material required by them
f. Chief Controller of Imports and Exports
for manufacturing the product to be exported.
and its Regional Offices.
The rate of the replenishment license against
export is given in the import policy, which is g. Reserve Bank of India (Foreign Exchange
normally announced in the month of April each Department).
year. Such REP licenses are also transferable, h. Directorate of Enforcement (Foreign
unless they are held by Import Houses and used Exchange)
for importing OGL items for actual users. The i. Customs & Central Excise Department
AO may verify the correctness of transactions
relating to transfer of REP licenses at a particular j. All Indian Carpet Manufacturer’s
rate of premium. Where the commodity to be Association Bhadohi.

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 Chapter

8
Packaging Industry

1.  OVERVIEW
1.1  India has the world’s 5th largest Packaging
Industry. Packaging Industry is also one of the
fastest growing sectors in India, consistently
displaying a growth rate of 15–20% per annum1.
Additionally, India is fast emerging as a preferred
hub for packaging industry since the cost of
processing and packaging food in India could be
up to 40% lower than in Europe which, combined
with India’s resources of skilled labour, make it
an attractive venue for investment.
in the Indian packaging industry and will itself
1.2  Packaging activity is umbilically connected grow at a healthy CAGR of 8.9% during 2016–
to major industries like pharmaceuticals, 2021, with major contributions from the Food,
food processing, FMCG, healthcare etc. India Household Care, and Cosmetics & Toiletries
presently exports packaging materials like industries. This growth is largely driven by its low
flattened cans, printed sheets, cork & caps, cost and flexibility to suit multiple shapes and
plastic film laminates, craft paper, paper board sizes, convenience (zip-locks, plastic closures),
and packaging machinery to other countries. and low-carbon foot print on the environment
The imports into India include tinplate, coating as compared to Rigid Plastics. In addition, the
and lining compounds and others. increasing prominence of low-density flexible
packs in high protein foods is expected to drive
1.3 The value of packaging consumption in
the growth in the future.
India amounted to INR 81110 crores in 2012
which is projected to grow to INR 148860 crores 1.4 As per the FICCI-TSMG report4 the
in 20182. As per Business Wire (a Berkshire packaging industry in India is expected to reach
Hathaway Company) Indian packaging industry USD 73 billion by the fiscal year 2020. The
was predicted to see notable growth over 2016– report prepared by FICCI and Tata Strategic
2021, growing at a Compound Annual Growth Management Group (TSMG) on plastic
rate(CAGR) of 9.2% as compared to 6.2% packaging industry declares that the Indian
during 2011–20163. As per the same report packaging industry, which is valued at over USD
Flexible Packaging is the leading packing type 32 billion in FY 15–16 after growing at a CAGR

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Techniques of Investigation for Assessment Vol. 3

of 16% in the last five years, offers employment 2.  TYPES OF PACKAGING
to more than 10 lakh people across the country The packaging industry can be segregated in
through 10,000 firms. The report also mentions three broad categories, based on the nature of
that presently the Indian packaging industry packaging, the type of materials used and the
constitutes 4% of the USD 700 billion worth function or layers of packaging.
global packaging industry. Presently the per
capita packaging consumption in India is low 2.1  Based on Nature of Packaging
at 4.3 kg, compared to developed countries like
According to the nature of the material used the
Germany and Taiwan where it is 42 kg and 19 kg
Packaging industry can be broadly classified as:
respectively. Therefore, in the coming years, the
Indian packaging industry is expected to grow at a. Rigid packaging
18% per annum, wherein, flexible packaging is b. Flexible packaging
expected to grow at 25% per annum and rigid Rigid packaging would include glass, tin,
packaging to grow at 15% per annum. The aluminum sheets, wood, plastics and paper
overall packaging industry in India has a huge (corrugated boxes and carton board). Flexible
growth potential and is expected to reach USD packaging segment uses lightweight, durable
73 Billion in FY 20–21. and flexible materials like plastic films and
1.5  In common parlance, the term ‘Packaging’ aluminium foils. In the global packaging market,
connotes the wrapping material around a rigid plastic packaging gets an advantage over
consumer good and which is used to indicate, glass or metal packaging due to its weight
and design flexibility. Rigid plastic packaging
hold and protect the product. However, such
is mainly used in industries such as food and
a simplistic notion has long been discarded. In
beverage, personal care, and home care. The
the modern world of marketing, the consumer
metal packaging segment is also experiencing a
is the king and consumer satisfaction is the
drop in the demand due to shifting trends and
key. Packaging now forms a major part of consumer preferences.
advertisement and it also communicates the
product information to the consumer. Further, 2.2  Based on Materials Used for Packaging
the concepts of brand image, trade mark,
pattern, design and other intellectual properties Another categorisation can be based on the
materials used for packaging as under:
also tend to focus on Packaging to a large extent.
Packaging has veritably attained the status of an a. Glass packaging;
‘Art’ in its quest to lure the customers towards the b. Metal packaging;
particular product by playing upon their senses of
c. Polymer packaging; and
sight, smell, and touch. The marketers now also
use sound e.g. clicks or pops emanating from d. Paper packaging.
the packaging as well to push their products.
Together with the product, its price, its promotion 2.3  Based on Function on Packaging
and its placement, the packaging determines the The packaging industry can also be classified,
success of any product. It is essential to note that based on the function or layer:
even if the average manufacturer may not have a. Primary packaging;
an idea about packaging but the sales team of
the packaging industry ensures transmission of b. Secondary packaging; and
new concepts and technology. c. Tertiary packaging.

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2.3.1 The Primary packaging is the one which under challenge on account of a flourishing
comes into direct contact with the product and organized retail segment and the consumption
which does not react with the product. It is mostly of corrugated packaging has begun to rise. More
used in packaging food products like ready-to- and more new automatic plants are being setup
eat foods, beverages, snacks etc. where paper to meet the new demand for high precision boxes
or aluminium foil is laminated or metalised for with attractive graphics and large integrated
packaging purposes. production capacities. The MNCs are also
demanding corrugated boxes of international
2.3.2 The Secondary packaging is the outer
standards.
layer of primary packaging. Apart from protecting
the products, it also acts as a mode of marketing
and branding eg. carton board boxes etc. 3.3  Plastics

2.3.3 The Tertiary packaging is used for Plastics are the most commonly used packaging
bulk packaging. These are commonly used material in India also. The common plastic
for storing and transporting products, such as resins used in packaging are LLDPE (Linear
industrial chemicals, consumer durables, fruits low-density Polyethylene), HDPE (High-
and vegetables etc. The examples of tertiary density polyethylene), PP (Polypropylene),
packaging are corrugated boxes, steel drums, BOPP (Biaxially-Oriented Polypropylene),
HDPE barrels and containers etc. PET (Polyethylene terephthalate) etc. Most of
the plastic packaging is manufactured using
high precision machines. The brochures of
3.  BRIEF NOTE ABOUT SOME
plastic packaging machineries contain lots of
PACKAGING MATERIALS
information about their functions, consumption
3.1  The global pattern5 of consumption of figures and output figures. The ‘plastic packaging’
various packaging materials is displayed in the is the foundation of the consumer culture due
graphic below: to its cost to performance ratio. As can be seen
from the symbolic table below, Plastics are fast
Global segment breakup of replacing traditionally used materials in many
packaging material (%) segments:
Others
Glass5% Traditional
Product Current Trend
7% Board Material
Metal 31%
15% Milk/ Edible Oil Glass/ Metal 3/ 5 Layer Film
Flexible pouches
Packaging
20% Rigid Plastic Toiletries (Soap/ Paper/ Glass Plastic Pouches/
22% Shampoos) Films
Cement/ Fertiliser etc Jute PP/ HDPE
Woven Sack
3.2 Corrugated cardboard
3.2  Corrugated Cardboard
The prices of corrugated sheet and converted boxes in India have generally remained low due
Toothpaste Metal Lamitube
to over-capacity, manual operations and low productivity. There are nearly 4000 corrugated
The prices of corrugated sheet and converted
board and sheet plants in the country, which are highly labour intensive. The scenario is3.4  Laminated Tubes
boxes
under challenge in India
on account have generally
of a flourishing remained
organized retail low
segment and thedue
consumption of
to over-capacity,
corrugated packaging has begun to rise.manual operations
More and more new automaticand
plantslow
are beingThese
set up lamitubes, as they are now referred to,
to meet the new demand for high precision boxes with attractive
productivity. There are nearly 4000 corrugated graphics and large integrated
are multi-layered plastic tubes with a ‘barrier
production capacities. The MNCs are also demanding corrugated boxes of international
standards.
board and sheet plants in the country, which layer’ in between. The plastic layers are made of
are highly labour intensive. The scenario is polymers and the barrier layer is usually a thin
3.3 Plastics
Plastics are the most commonly used packaging material in India also. The common plastic
resins used in packaging are LLDPE (Linear low-density Polyethylene), HDPE (High-density                                                           91
polyethylene), PP (Polypropylene), BOPP (Biaxially-Oriented Polypropylene), PET
(Polyethylene terephthalate) etc. Most of the plastic packaging is manufactured using high
precision machines. The brochures of plastic packaging machineries contain lots of
information about their functions, consumption figures and output figures. The ‘plastic
Techniques of Investigation for Assessment Vol. 3

metal foil. Such lamitubes are basically used for sealing and labeling bottles, cans and boxes,
oral care products, pharmaceuticals and creams. and wrapping and aseptic packaging machinery,
Of late the metal foils have been replaced the U.S. firms mainly export filtering/ purifying,
with Ethylene Vinyl Alcohol and these plastic wrapping, aseptic packaging, form-fill-sealing
laminate structures can be coloured. Some machines and extruders.
lamitubes also come in transparent plastic with
4.2  Currently, there are an estimated 20 major
Ultra Violet blockers, if required. A few players
companies worldwide in the organized sector
have also introduced laminated tubes using the
that manufacture packaging machinery. The
recycled high-density polyethylene i.e. High-
major suppliers are Krone AG, Sidel Group,
Density Polyethylene Post Consumer Resin (PCR
Bosch Packaging Technology, KHS GmbH
HDPE) with organic polymers. In all such cases
etc. The Technology, price, delivery, and
the supplier needs to invest in suitable printing
performance standards are critical factors that
technologies also. Presently the pharma sector
determine whether packaging equipment can
and the home care products sector still depend
be sold in the Indian market. Due to intense
on aluminum foil based lamitubes whereas the
competition in the end-user market, the cost of
beauty and cosmetics industry has moved on to
equipment and low running cost remain one
the plastic barrier laminates.
of the primary factors that influence the sale of
the packaging equipment. Upgrading is another
3.5 Others
other extremely important factor in the buying
Shrink Film Packaging: Is a fast-growing decision of Indian end-users. After-sales service
trend due to its multiple benefits besides costing is also a key concern of buyers.
nearly a third of corrugated boxes. Woven
sacks have also emerged as a major Packaging 4.3  Some of the major domestic equipment
material in cement, fertilisers, agri-produce etc manufacturers supplying the market are Flex
replacing paper/ jute. The Packaging peripherals Engineering Ltd., (Noida), ITW Signode
like crowns, corks and caps are also significant India Ltd. (Hyderabad), Print Pack Machinery
components. The newer packaging materials Ltd. (Faridabad), Eagle Manufacturing Co.
are in the field of aseptic packaging, retort (Mumbai), Larsen & Toubro for various type of
packaging (a type of food packaging made from packaging machinery; Acrofil India (New Delhi),
a laminate of flexible plastic and metal foils) and S.P.M. Engineering (Bangalore), E.C. Packaging
biodegradable packaging. (Faridabad), specifically for filling and sealing
machines; S.P UltraflexSystems (Mumbai) for
4.  PACKAGING MANUFACTURING flexible packaging machines; and Multi Pack
SUPPLIERS Machines Pvt Ltd. (Hyderabad), and Primo Pack
(Ahmedabad) for pouch packing machines.
4.1 India has domestic packaging machinery Many domestic firms have established joint
manufacturers and it also imports the same. ventures with foreign companies to produce a
The Indian imports of packaging equipment variety of packaging machinery.
consist mainly of highly automated advanced
machines and systems. The major equipment
suppliers to the Indian market include Germany, 5.  PACKAGING MACHINES
Italy, Switzerland, and others including Taiwan There is a large variety in packaging machines
and the U.S. While German companies are the and the main packaging manufacturing machines
lead suppliers of machinery for filling, closing, are of the following general types6:

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 Packaging Industry

a. Accumulating and collating machines v. Form, fill and seal machines

b. Blister packs, skin packs and vacuum w. Other specialty machinery: slitters,
packaging machines perforating, laser cutters, parts attachment,
etc.
c. Bottle caps equipment, over-capping,
lidding, closing, seaming and sealing
machines 6.  MARKET SCENARIO
d. Box, case and tray forming, packing, 6.1  In 2015, Asia-Pacific Region had the largest
unpacking, closing and sealing machines market share among all regions, and is expected
e. Cartoning machines to retain its dominant position in near future
as well. This is mainly because packaging film
f. Cleaning, sterilizing, cooling and drying
manufacturers are shifting their manufacturing
machines
facilities to countries such as India and China to
g. Coding, printing, marking, stamping, and reduce their operational costs.
imprinting machines
h. Converting machines 6.2  The Indian Packaging industry, regarded as
a commodity play in the early 2000’s, has now
i. Conveyor belts, accumulating and related transformed into a value added, innovation
machines
driven and technology-based industry. Extensive
j. Feeding, orienting, placing and related use of plastics in packaging has contributed to
machines the industry’s success story, given its virtues of
k. Filling machines: handling dry, powdered, light weight, cost effectiveness and possibility of
solid, liquid, gas, or viscous products innovations.
l. Inspecting: visual, sound, metal detecting, 6.3 CRISIL Research estimates the Indian
etc.
Packaging Industry at nearly Rs. 1,290 billion
m. Label dispenser in Fiscal 2017, up 2.5% on year to year basis.
n. Orienting, unscrambling machines In packaging, the Polymer Packaging, which
is the largest segment (62% in Fiscal 2017),
o. Package filling and closing machines
increased by 3% during the year. Metal and
p. Palletizing, depalletizing, unit load Paper packaging increased by 1–2% while Glass
assembly
witnessed a decline of 1% owing to pricing
q. Product identification: labeling, marking, pressure and decline in volume on account of
etc. substitution in non-alcoholic segment. CRISIL
r. Sealing machines: heat sealer predicts Packaging Industry to grow by 7–7.7%
s. Slitting machines in Fiscal 2018 and Polymer Packaging also
to grow at 7%. The next three years are also
t. Weighing machines: check weigher, multi-
expected to show growth rates of 7–8%.
headweigher
u. Wrapping machines: stretch wrapping, 6.4  The share of various packaging materials in
shrink wrap, banding India, as per CRISIL Research, is as under:

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 predicts Packaging Industry to grow by 7-7.7% in Fiscal 2018 and Polymer Packaging also to
grow at 7%. The next three years are also expected to show growth rates of 7-8%.

6.4. The share of various packaging materials in India, as per CRISIL Research, is as
under:
Techniques of Investigation for Assessment Vol. 3

Share of packaging material in India

(in %)

Glass
0%
Metal 6%
11%

Paper
20% Polymer
63%

7.  REGULATORY FRAMEWORK 7.4 Manufacturing of flexible packaging

7.1  Indian packaging sector is loosely regulated products is open to private players and there are
124
with no specific restrictions on manufacturing and no operational restrictions on manufacturers.
sales of packaging products. Private companies However, companies manufacturing packaging
of domestic origin as well as global packaging products for food & beverage industry as well
companies currently operate in the sector. Entry as for pharmaceutical industry have to abide
of global packaging manufacturers is through by quality regulations set by the Government
acquisition of Indian companies as regulations of India e.g. Agricultural Grading & Marking
regarding transaction (acquisition/ merger/ Joint (AGMARK) Rules, Edible Oil Packaging
venture) involving a global company and Indian (Regulation) Order etc.
company are flexible.
7.5  The Food Safety Standards Authority
7.2 The Prevention of Food Adulteration
Act 1956, Plastic Waste (Management and of India (FSSAI) is revising the existing Food
Handling) Rules 2011 and Food Safety and Safety Standards (Packaging and Labelling)
Standards (Packaging and Labeling) Regulations Regulations, 2011, and it has decided that the
2011 are the three major regulations governing same would be divided into three parts, namely
food & beverage packaging in India. In addition, regulations pertaining to packaging, labelling &
manufactures also have to abide by the standards advertisement and claims. FSSAI is expected to
laid out by Bureau of Indian Standards (BIS), release the drafts soon.
notable among them being the directive
preventing usage of recycled plastic/ polymer for 7.6 Furthermore, the GST implementation
manufacturing food packaging products. has changed the environment of the industry
by converting the country into a single market
7.3 As per the existing regulatory framework,
recycled plastic based flexible packs cannot place. Also, growth in many other industries
be used in food packaging. Further all plastic due to the effects of GST will add to the growth
materials used in flexible packs (like sachets, in the Packaging Industry. Most noticeable,
pouches, vacuum packs) must confirm to sectors like FMCG and e-commerce have
quality standards as laid out by Bureau of Indian benefitted from GST implementation and are
Standards. projected to see strong growth.

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 Packaging Industry

8.  MAJOR PLAYERS IN INDIA 8.5  Uflex

Uflex manufactures BOPP, BOPET and CPP
8.1  Balmer Lawrie & Company Limited films, pouches, laminates, polyester chips,
This is a public sector enterprise and is based holographic films, coated films, etc. inks and
in Kolkata. The company is currently under the adhesives that can be used in every kind
control of Ministry of Petroleum and Natural of printing. Packaging machines are also
Gas, Government of India. The company manufactured by the company.
manufactures plain steel drums, composite
drums, lined drums, cylinders and a variety 8.6  Time Technoplast Limited
of other industrial packaging solutions. The Time Technoplast Limited is a leading producer
company has a turnover of Rs. 2762 crores and of polymer and packaging products.
is the topmost packaging company in India.
Website: www.timetechnoplast.com
Website: www.balmerlawrie.com
8.7  Flexituff International Limited
8.2  Ess Dee India The company manufactures proof bags, liner
Ess Dee India has its headquarters in Mumbai. bags, baffle bags, single loop bags etc.
The company is the largest producer of Website: www.flexituff.com
aluminum foils in Asia. Ess Dee India is also
the pioneer in the manufacturing of high-end 8.8  TCPL Packaging Limited
pharmaceutical packaging products such as
TCPL Packaging Limited is a leading producer
Child-Resistant Blister packaging and Cold Form of printed folding cartons in India. The other
Blister packaging in India. products manufactured by the company apart
Website: www.essdee.in from folding cartons include plastic cartons,
litho lamination, blister paper, printed blanks
8.3  Max India Limited and outers, shelf ready packaging, etc. It is also
one of the largest exporters of printing cartons
Max India Limited is a multi-business from India.
conglomerate and its group concern Max
Website: www.tcpl.in
Specialty Films manufactures barrier and
packaging films. This company has a production
8.9  Parekh Aluminex Limited
capacity of 52,000 tons every year.
The company is the largest manufacturer of
Website: www.maxindia.com
aluminum foil and aluminum lids containers in
the country.
8.4  Jindal Poly Films Limited
Website: www.parekhaluminex.com
Jindal Poly Films Limited manufactures
polypropylene and polyester films. It is also the 8.10  Ester Industries Limited
largest producer of PET and BOPP films in India.
The company’s manufacturing unit in located in The company is the leading producer and
Nasik, Maharashtra. supplier of polyester films and engineering plastic
compounds in the country. “Uma PET” and
Website: www.jindalpoly.com the “Estoplast” are the names of the polyester

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Techniques of Investigation for Assessment Vol. 3

films and engineering plastics respectively under 8.12  Huhtamaki PPL Flexible Packaging
which they are marketed by the company. India
Website: www.esterindustries.com Huhtamaki PPL manufactures flexible laminates,
films, specialized pouches, cartons, tube
8.11  TGI Packaging Pvt. Ltd. laminates, labels, shrink sleeves, rotogravure
cylinders, packaging machinery etc. It caters to
It is one of the India’s largest manufacturer and
customers across sectors ranging from food and
exporters of corrugated boxes.
beverages, personal care to pharmaceuticals,
Website: www.tgipackaging.in industrial products etc.

9.  PROFIT MARGINS

As per CRISIL the segment-wise financials in Packaging Industry are as under:
Operational Parameters Unit Glass Metals Polymer Paper
Industry size (2016–17) Rs. bn 86 174 794 232
Revenue Growth % - 5.7 0.0 3.3 11.0

Extent of competitiveness - Moderate Moderate to high High High

Growth over next 3 years-CAGR % 1.0 0.2 8.8 9.0

Growth in last 3 years-CAGR % 2.6 - 2.1 4.7 3.4

Financial Parameters (2016–17)

Operating Margin % 12.1 11.8 13.7 14.8
Net Margin % - 0.2 4.1 4.8 8.4

Return on capital employed (RoCE) % 5.5 9.0 9.5 22.3

Asset Turnover Times 0.6 0.9 0.8 1.3

Debt/ Equity Times 1.8 0.3 0.6 0.8
Interest coverage ratio (EBIT/
Times 1.9 6.3 3.9 5.0
Interest)

10.  INVESTIGATION TECHNIQUES in the unorganized sector, who basically convert

packaging materials or print the polyester or
10.1 General: The accounts of the
BOPP films etc. The investigation process would
manufacturers of packaging materials can
have to be differently oriented in all such cases.
be investigated like that of any capital goods
industry and the primary/ secondary users 10.2 Examination of Profit Ratios: The
of packaging products need to be separately assessing officer should examine the book
investigated. The primary users are those who results of the packaging concerns and compare
buy manufactured machines for their use. Some the same with the operational parameters and
of the users are large companies, which may financial parameters available in the industry
have their own captive units also. The secondary as given in para 9 above. These would lead to
users are essentially small-scaleconcerns, mostly possible lines of inquiry.

96
 Packaging Industry

10.3  Acquisition of Machinery: The disintegrated, to give an idea of the requirement

investment made by the primary user assessee for of raw materials. Alternatively, a test run of
the purchase & installation of various machines the production process can be carried out to
should be enquired into. Such assessee do not ascertain the average input: output ratios of
import or buy all the ancillary machines from various raw materials required for each category
the same source as these can be acquired locally of the finished product. This will also bring out
also. The purchase price of the machinery and average norms for wastage & by-products. The
installation expenditure should be enquired disclosed consumption/ production can then
into from the suppliers of such machinery. In be verified from the technical brochures of the
the case of machinery purchased from abroad, machine as given out by the manufacturers,
the documents of import, various duties paid, and logical conclusion regarding inflation of
mode of payment, channel of payment should purchases can be drawn. The Assessing Officer
be looked into. For this purpose, information may identify the various machines (model/ type
should be directly collected and verified with the and brand) being used by the assessee. From the
help of Government agencies/ Departments and website of the machine suppliers he can get the
various other organisations whose assistance/ data of raw material consumption, input output
channel is used by the assessee for the purchase ratio, cost of production of packaging material
of machinery. In nearly all such cases the which can be compared with data shown by the
services of specialists/ engineers are required for assessee. This will be helpful in identifying the
installation of machinery as per the specification issues/ cost elements which need to be examined
of the manufacturers. A direct enquiry from in depth. Thereafter, disclosed purchases of raw
the agencies providing such services, will material can be verified from the suppliers of
give information to the AO with regard to the raw material, for both, quantity and price. In
movement of the machinery from the place of the world of flexible plastic packaging a minor
manufacturers to the place of the buyer and the reduction in the micron level thickness of layers
process and date of its installation and other or quality of craft paper/ metal sheet would give
incidental activities. enormous savings to such assessees who have
large scale units. Many such machines have an
10.4 Purchases of Raw Material: A major
output counter also and records are kept by the
area of manipulation of accounts in packaging
machines for repair and service use.
units is in the purchase of raw material. The
purchases are inflated to reduce profits chargeable 10.5  In case of companies manufacturing
to tax. For proper enquiries, first the exact nature packaging products for food & beverage
& quality of the products being manufactured by industry as well as for pharmaceutical industry
the assessee with their full specifications should the Assessing Officer should examine their
be obtained. This is because the requirements of compliance vis-a-vis quality regulations set by
raw material is directly dependent on the type of Government to find out the likely bogus expense
packaging material manufactured by the assessee on material not conforming to standards.
for different kinds of products as discussed in
10.6  As per the existing regulatory framework,
the preceding paragraphs. There are differing
recycled plastic based flexible packs cannot
requirements of raw material depending upon
be used in food packaging. If the assessee has
the type & quality of the product to be packed,
claimed such material in expenses, investigation
shelf life required, sensitivity of the product to
in the same may lead to good results.
the temperature variation and humidity etc.
For this purpose, few pieces of finished goods 10.7  Similarly, if the assessee is claiming loss
of the assessee can be examined, analysed and on account of rejection of packaging materials

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Techniques of Investigation for Assessment Vol. 3

which were not confirming to quality standards properly charged to tax. For this purpose, the
as laid out by Bureau of Indian Standards/ quantitative analysis of raw material purchased
Consumer, the same should be investigated. The & consumed, wastage and finished goods
services of the laboratories of the Indian Institute produced should be made. The stock register of
of Packaging can be availed in serious cases. the assessee, should be examined. Purchase of
raw material, its distribution to various sections
10.8  Sales of Finished Products: The sales
of the workshop, semi-finished goods at various
of finished goods to various customers should
stages of the process, production & sales of
be directly verified from the data available in the
finished goods, and wastage generated, can be
books of the customers. In case of discrepancies/
checked with the help of dates recorded in the
suppression of sales, the same should be
stock register.
confronted to the assessee and adverse view may
be taken where discrepancies are not properly
explained by the assessee with reliable evidence. RESOURCE
The production, sales and closing stock figures The Indian Institute of Packaging [http://www.
should be matched material quantity-wise. iip-in.com/]. The Institute is an autonomous
10.9  In case of packaging user assesses, other body in the field of packaging and works
than a packaging company itself, if the Assessing under the administrative control of the Ministry
Officer has apprehension that out of books sales of Commerce and Industry, Government of
or purchases are being made in such a scenario India. It has its Head Quarter at Mumbai and
he can correlate the quantitative consumption Centres located at Delhi, Kolkata, Hyderabad
of packaging used in production and packaging and Chennai. It also has advanced testing
used in sales with the amount of production and laboratories like Consumer Package Laboratory,
sales. He can call for details from the suppliers Material Testing Laboratory, Optical and Barrier
of packaging about deliveries on all addresses Properties Laboratory, Chemical Laboratory
controlled by the assessee. In one case in Delhi and Transport Laboratory.
the investigation wing had called for sales made
by various packaging material suppliers to a REFERENCES
particular address (instead of sales made to a 1. 51st Annual Report of Indian Institute of Packaging
particular assessee). This exercise revealed that [www.iip-in.com]. However, the website of Packaging
the assessee used to buy unaccounted goods Industry Association of India mentions the growth rate
from various suppliers (in fake names and of 22–25% p.a. [http://piai.org/About_Packaging_
on cash basis) and such goods were naturally Sector.aspx]
transported and supplied to its address only. 2. The Future of Global Packaging to 2018, a Smithers
Pira report. [https://www.smitherspira.com]
10.10 Disposal of Wastage: Most of the 3. h t t p s : / / w w w . b u s i n e s s w i r e . c o m / n e w s /
ingredients required for the manufacture of home/20170509006321/en/Trends-Opportunities-
packaging material are valuable items. Their Indian-Packaging-Industry-2017-Analysis
cuttings, leftovers etc. carry some value, as these 4. http://ficci.in/spdocument/20690/Plastic-packaging-
can be recycled to produce the same material report.pdf
once again. Proper accounts of such wastage, 5. op. cit.
should be obtained from the assessee so that 6. Wikipedia.
income/ receipts from sales of these items is 7. Crisil Research

98
 Chapter

9
Automobile Industry

1.  OVERVIEW
1.1 Auto industry is said to be the engine of
growth in most developed countries, including
in China and India today. Indian automobile
industry which was at its nascent stage at the
beginning of the 21st century has now become a
huge industry that contributes majorly to growth
and development of Indian Economy. As per the
current statistics, the auto industry’s turnover is
estimated to be equivalent to:
a. 7.1% of overall GDP
2.  PRODUCTION TREND
b. About 26% of Industry GDP
2.1  Indian Automobile Industry has produced
c. About 49% of manufacturing GDP 25,316,044 vehicles including passenger
The industry employs 29 million people, directly vehicles, commercial vehicles, three wheelers,
and indirectly, and contributes to 13% of excise two wheelers and quadricycle in April-March
revenue for the Government. 2017. Thus, this is one of the largest economic
1.2 The auto-industry is a key employment activity of the country with players from both
generator in the OEM factory that manufactures domestic and international markets. Besides the
the vehicles, in the inbound auto component automobile manufacturing, the allied industries
and logistics industry that makes and delivers like spare parts and accessories like tyres, wheels
components & systems and the outbound are also growing.
logistics and dealer network that sells, maintains
2.2  Some quick statistics are given below. The
and distributes the cars. Every vehicle produced,
generates secondary and tertiary employment. details are available from the website of Society
The industry generates employment of 13 of Indian Automobile Manufacturers.
persons for each truck, 6 persons for each car http://www.siamindia.com/statistics.aspx?
and four persons for each three wheeler and mpgid=8&pgidtrail=15
one person for two-wheelers. It is important
to appreciate the sector’s multiplier effect on
economic activity.

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Techniques of Investigation for Assessment Vol. 3

2.2.1  Turnover of the Industry over the past years:

Gross Turnover of Automobile Manufactures in India 2009–10 to 2014–15

2.2.2  Production Trends

Category 2011–12 2012–13 2013–14 2014–15 2015–16 2016–17
Passenger Vehicles 31,46,069 32,31,058 30,87,973 32,21,419 34,65,045 37,91,540
Commercial Vehicles 9,29,136 8,32,649 6,99,035 6,98,298 7,86,692 8,10,286
Three Wheelers 8,79,289 8,39,748 8,30,108 9,49,019 9,34,104 7,83,149
Two Wheelers 1,54,27,532 1,57,44,156 1,68,83,049 1,84,89,311 1,88,30,227 1,99,29,485
Grand Total 2,03,82,026 2,06,47,611 2,15,00,165 2,33,58,047 2,40,16,068 2,53,14,460

2.2.3  Automobile Exports Trends

Category 2011–12 2012–13 2013–14 2014–15 2015–16 2016–17
Passenger Vehicles 5,08,783 5,59,414 5,96,142 6,21,341 6,53,053 7,58,830
Commercial Vehicles 92,258 80,027 77,050 86,939 1,03,124 1,08,271
Three Wheelers 3,61,753 3,03,088 3,53,392 4,07,600 4,04,441 2,71,894
Two Wheelers 19,75,111 19,56,378 20,84,000 24,57,466 24,82,876 23,39,273
Grand Total 29,37,905 28,98,907 31,10,584 35,73,346 36,43,494 34,78,268

2.2.4  Automobile Domestic Sales Trends

Category 2011–12 2012–13 2013–14 2014–15 2015–16 2016–17
Passenger Vehicles 26,29,839 26,65,015 25,03,509 26,01,236 27,89,208 30,46,727
Commercial Vehicles 8,09,499 7,93,211 6,32,851 6,14,948 6,85,704 7,14,232
Three Wheelers 5,13,281 5,38,290 4,80,085 5,32,626 5,38,208 5,11,658
Two Wheelers 1,34,09,150 1,37,97,185 1,48,06,778 1,59,75,561 1,64,55,851 1,75,89,511
Grand Total 1,73,61,769 1,77,93,701 1,84,23,223 1,97,24,371 2,04,68,971 2,18,62,128

3.  TAX ISSUES

3.1 Taxing the income of an operator in this sector has certain industry specific practices.
industry requires some specific techniques as The business in this sector can be classified into
compared with the rest of the industries as this following categories:

100
 Automobile Industry

a. An Indian owner with production and FIAT Motors, Ford India, General Motors, Honda
sales in India with or without overseas fully Cars, Hyundai Motors, Mahindra & Mahindra,
owned enterprises (Indian MNC). Maruti Suzuki Ltd, Mercedez Benz India Private
b. A Joint venture like Maruti-Suzuki with an Ltd, Renault India Pvt Ltd, Skoda Auto India
Indian partner and a foreign MNC Pvt Ltd, Toyota Kirloskars India Pvt Ltd and
c. A foreign company which has setup Volkswagen India Pvt Ltd.
manufacturing facility in India. 3.2.3 A list of key essential ratios derived
d. Spare-parts dealers who manufacture sub- from the analysis of the financials for the above
assemblies or other spare parts. companies taking into account the financial
It is always beneficial to primarily look at statements (Balance Sheet and Profit & Loss
the industry benchmarks and analyze how a Accounts) for the period F.Y 2011–12 to F.Y
particular assessee differs from them and the 2015–16 was undertaken.
implications thereon.
3.2.4  Based on the Ratio Analysis, the following
3.2  Risk Analysis through Ratio Benchmarks were identified for the sample auto
Analysis and Setting Bench Marks companies:

The share of Automotive sector in the Indian a. Turnover Ratios: Debtor Turnover
GDP is about 7.1%. However, the total share of Ratios: 6.09%; Creditor Turnover Ratio:
revenue in the form of direct taxes is quiet low 15.09%; Inventory Turnover Ratio: 12.48%;
as compared to it’s share in GDP. The Assessing COGS to Turnover Ratio: 60.58%; Turnover
officers may adopt the approach of Risk Analysis to Capital Employed Ratio: 5.33 times.
through Ratio Analysis and setting Bench Marks b. Expenses Ratio: Miscellaneous Expenses
to identify the critical areas in individual cases to Turnover Ratio: 4.3%; Interest to
for deeper scrutiny. An illustration is this respect Borrowing Ratio: 7.29%; Selling Expenses
is given below. to Turnover Ratio: 4.86%.
3.2.1  14 major automobile companies c. Others: Debt-Equity Ratio: 1.68 times;
(Passenger car segment), which comprised Marketable securities to Total Asset
of about 40% of the market share in value Ratio: 11%, Advance Tax Paid to Total
and 25% in numbers were selected, using the Tax Liability Ratio: 51.2%; Profit (EBIT)/
random sampling technique, for the purposes of Turnover Ratio: 5.1%.
Analysis. The objective was to undertake a data
As indicated above, the benchmark was derived
driven sectoral analysis of Automobile Industry,
for the sample companies on the basis of their
identify sectoral benchmarks for various revenue
financial statements for the five years. The ratios
and capital heads and compare individual
may vary when a different sample and segment
companies vis-à-vis the benchmarks to flag risks
of the Auto sector is analyzed. Ratios may also
for deeper examination by the Assessing Officers.
change depending on the age of the companies
3.2.2 Companies selected for the above and their business structure. Ratio Benchmarks
analysis were: Audi Motors India Pvt Ltd, BMW, are indicators for greater investigation.

                                                          101
 As indicated
segment of theabove, the benchmark
Auto sector was
is analyzed. derived
Ratios mayfor
alsothe sample
change companies
depending on the
on the age basis
of theof
their financial
companies andstatements for the structure.
their business five years.Ratio
The ratios may varyare
Benchmarks when a differentforsample
indicators and
greater
segment of
investigation. the Auto sector is analyzed. Ratios may also change depending on the age of the
companies and their business structure. Ratio Benchmarks are indicators for greater
investigation.
3.2.5 Risk Analysis: Company results compared to benchmarks & Risks are flagged as
under:
Techniques of Investigation for Assessment Vol. 3
3.2.5 Risk Analysis: Company results compared to benchmarks & Risks are flagged as
3.2.5  Risk under:
Analysis: Company results compared to benchmarks & Risks are flagged as under:
Inventory Turnover Ratio (BM:12.48%)
50.00%
Inventory
InventoryTurnover
TurnoverRatio
Ratio(BM:12.48%)
(BM:12.48%)
40.00%
50.00%
30.00%
40.00%
20.00%
30.00%
10.00%
20.00%
0.00%
10.00% 2011 - 12 2012 - 13 2013 - 14 2014 - 15 2015 - 16
0.00% Audi Motors BMW Mahindra and Mahindra Mercedes
2011 - 12 2012 - 13 2013 - 14 2014 - 15 2015 - 16

Audi Motors BMW Mahindra and Mahindra Mercedes

3.2.6 Tax Implications:
3.2.6 Higher
Tax Implications: Inventory
Higher TurnOver
Inventory Turn Over
ratioratio was found
was found in the
in the cases that cases
may that may
indicate overvaluation
indicate overvaluation of inventory
of inventory & fictitious
& fictitious purchases.ItItisisaa general
purchases. general trend
trendof of
thethe
Industry
Industry to keep
to keep
3.2.6 an
Taxaverage 5% to
Implications: 10% of
Higher total turnover
Inventory Turnas inventory.
Over ratio The
was above
found
an average 5% to 10% of total turnover as inventory. The above table indicates the ratio table
in the indicates
cases thatthe
may exceeding
ratio
10% in many exceeding
indicate 10% in
overvaluation
cases many cases implying
of inventory & fictitious
implying inconsistency inconsistency
purchases.
in inventory in inventory valuation
It is a general
valuation policy.
policy.trend of the Industry
to keep an average 5% to 10% of total turnover as inventory. The above table indicates the
ratio exceeding 10% in many cases implying inconsistency in inventory valuation policy.
Marketable Securities
Marketable Securities to
to Total
Total Assets
Assets Ratio(BM:11%)
Ratio (BM:11%)
60.00%
50.00% Marketable Securities to Total Assets Ratio(BM:11%)
40.00%
60.00%
30.00%
50.00%
20.00%
40.00%
10.00%
30.00%
0.00%
20.00%
-10.00% 2011 - 12 2012 - 13 2013 - 14 2014 - 15 2015 - 16
10.00%
0.00% Audi Motors General Motors FIAT Motors Hyundai Motors
-10.00% 2011 - 12 2012 - 13 2013 - 14 2014 - 15 2015 - 16

3.2.7  TaxmayImplications:
3.2.7 be Tax Higher
seen,Implications:
in one case,
AudiwhileMarketable
Higher
Motorsfor the ofSecurities
Marketable theSecurities
rest Motors
General yearFIAT toratio
toTotal
thisMotorsTotalAsset
Asset
wasHyundai
less Ratio
Ratio
than was
1%,was
Motors found
in a found
year it inin cases that
may be examined
cases highfor
was asthat as diversion
may of borrowed
be examined
48.75%, which for diversion
clearly funds
needed of to examination.
non-business
borrowed
deeper purposes. As
funds to non-business may be
purposes. Asseen, in one
case, while3.2.7
for the rest of the year this ratio
Tax Implications: Higher Marketable was less than 1%, in a year it was as high as 48.75%,
136 Securities to Total Asset Ratio was found in
which clearly
casesneeded
that maydeeper examination.
be examined for diversion of borrowed funds to non-business purposes. As

Cost
Cost of
of Goods Sold to
136
Goods Sold toTurnover
Turnover
Ratio(BM:60.58%)
Ratio (BM:60.58%)
100.00%

80.00%

60.00%

40.00%

20.00%

0.00%
2011 - 12 2012 - 13 2013 - 14 2014 - 15 2015 - 16

Audi Motors Renault India Mercedes Benz India

102 3.2.8 Tax Implications: Higher Cost of Goods Sold to Turnover Ratio was found which
may be analyzed for over invoicing. At least in two cases this ratio was as high as 90% and
above as against industry trend of 60-70%.
 Audi Motors Renault India Mercedes Benz India

3.2.8 Tax Implications: Higher Cost of Goods Sold to Turnover Ratio was found which
may be analyzed for over invoicing. At least in two cases this ratio was as high as 90% and
above as against industry trend of 60-70%. Automobile Industry

3.2.8  Tax Implications: Higher Cost of Goods Sold to Turnover Ratio was found which may be
analyzed for over invoicing. At least in two cases this ratio was as high as 90% and above as against
industry trend of 60–70%.

SellingSelling Expenses
Expenses totoTurnover
Turnover Ratio(BM:4.86%)
Ratio (BM:4.86%)
25.00%

20.00%

15.00%

10.00%

5.00%

0.00%
2011 - 12 2012 - 13 2013 - 14 2014 - 15 2015 - 16

BMW India Ford India General Motors India Renault India

3.2.9  Tax Implications: In cases

3.2.9 Tax Implications: found
In cases with
found withhigher selling
higher selling expenses
expenses to turnover
to turnover ratio, the ratio, the nature
naturebe
of expenses may of examined
expenses may from be examined
Sectionfrom37section
point37ofpoint of view.
view. TheThe normal trend
normal trend followed in the
followed in the automotive sector is to incur selling and marketing expenses ranging about 6
automotive sector is to incur selling and marketing expenses ranging about 6 to 8%, especially for
to 8%, especially for the luxury car brands.
the luxury car brands.
Depreciation137 to Fixed Asset Ratio
100.00%
Depreciation
Depreciation to Fixed
to Fixed AssetRatio
Asset Ratio
80.00%
100.00%

60.00%
80.00%

40.00%
60.00%

20.00%
40.00%

0.00%
20.00%
2011 - 12 2012 - 13 2013 - 14 2014 - 15 2015 - 16
0.00%
2011 - 12 General
2012 Motors
- 13 Skoda India
2013 - 14 Volkswagen India
2014 - 15 2015 - 16

General Motors Skoda India Volkswagen India

3.2.10 Tax Implications: Depreciation may be used as a tool for excessive tax-deferral. The
3.2.10 Tax Depreciation
Implications: to Fixed Asset Ratio may be examined by the AO for this purpose. In the year
3.2.10 Tax Implications: Depreciation may
Depreciation may be be
used used
as a toolasforaexcessive
tool for
2013 - 14, the Companies Act, 2013 was introduced and depreciation calculation was
excessive
tax-deferral. The tax-deferral. The
Depreciation
Depreciation to FixedtoAssetto Fixed Asset
Ratio mayRatio may be
be examined examined by
byofthethe AO for
AO forlife.this
thispurpose. In
purpose. the year
supposed
2013 - 14, be
the done as per
Companies Schedule
Act, 2013II was
on the basis
introduced the
anduseful
depreciation It was observedIn
calculation
the year 2013–14,
that
was
the Companies manyAct,
supposed 2013
assesses was
to betook
done asintroduced
this opportunity
per and
ScheduletoIIreduce
on thedepreciation
the book
basis calculation
profits
of the by life.
useful It waswas
depreciating supposed
up to
observed90%thatof to be done as
per Schedule IIthe
onassets
the and thereby
basis of deferring
the usefultaxation.
life. It was observed that many assesses
many assesses took this opportunity to reduce the book profits by depreciating up to 90% of took this opportunity
to reduce the book profits
the assets by depreciating
and thereby up to 90% of the assets and thereby deferring taxation..
deferring taxation.

Miscellaneous Expenses
MISCELLANEOUS EXPENSESto TOTurnover
TURNOVERRatio (BMW
RATIO (BMW India)
India)
(BM:4.3%)
MISCELLANEOUS EXPENSES(BM:4.3%)
TO TURNOVER RATIO (BMW India)
20.00% (BM:4.3%)
20.00%
15.00%
15.00%
10.00%
10.00%
5.00%
5.00%
0.00%
0.00% 2011 - 12 2012 - 13 2013 - 14 2014 - 15 2015 - 16
2011 - 12 2012 - 13 2013 - 14 2014 - 15 2015 - 16
3.2.11 Tax Implication: Higher than 5% of Miscellaneous Expenses vis-à-vis turnover
should
3.2.11 be
Taxexamined. At least
Implication: in onethan
Higher case,5%
thisofratio was as high Expenses
Miscellaneous as 18%, which needed
vis-à-vis further
turnover
examination
should be examined. At least in one case, this ratio was as high as 18%, which needed further
                                                          103
examination
 Techniques of Investigation for Assessment Vol. 3
INTEREST COST TO TOTAL DEBT RATIO
3.2.11 Tax Implication: Higher (Maruti
than 5% Suzuki India) (BM:7.29%)
of Miscellaneous Expenses vis-à-vis turnover should
be examined. 50.00%
At least in one case, this ratio was as high as 18%, which needed further examination
40.00%
30.00% INTEREST
Interest COSTto
Cost TOTotal
TOTAL Debt
DEBT RATIO
Ratio
20.00% (Maruti
(Maruti SuzukiIndia)
Suzuki India) (BM:7.29%)
(BM:7.29%)
10.00%
50.00%
0.00%
40.00%
2011 - 12 2012 - 13 2013 - 14 2014 - 15 2015 - 16
30.00%
20.00%
10.00%
0.00%
3.2.12 Tax Implication:
2011 - 12
Interest cost above 2013
2012 - 13
market
- 14
rates may be examined. 2015
2014 - 15
The- 16total
interest cost incurred by a company was found to be far above the market rate of interest. On
verification it was found that the company has debts in foreign currencies, which are
3.2.12  Tax supposedly
Implication: Interest cost above market rates may be examined. The total interest cost
repaid at such higher interest rates. The genuineness of such payments may be
incurred by afurther
company was found to be far above the market rate of interest. On verification it was
3.2.12 assessed.
Tax Implication: Interest cost above market rates may be examined. The total
found that the company
interest has debts
cost incurred in foreign
by a company currencies,
was found which
to be far above are supposedly
the market repaid
rate of interest. On at such higher
interest rates.verification
The genuineness
it was foundof that
suchthepayments
company has may beinfurther
debts foreign assessed.
currencies, which are
supposedly repaid at such higher interest rates. The genuineness of such payments may be
Advance tax payments to Total tax Liability (BM:55%)
further assessed.
Advance Tax Payments to Total Tax Liability (BM:55%)
100.00%

80.00%

60.00% Advance tax payments to Total tax Liability (BM:55%)

40.00%
100.00%
20.00%
80.00%
0.00%
60.00%
2011 - 12 2012 - 13 2013 - 14 2014 - 15 2015 - 16
40.00%
Audi Motors India FIAT India Volkswagen India Toyota Kirloskar India
20.00%

0.00%
3.2.13 Tax 3.2.13
Implication: 2011 - Lower
Tax Implication:
12 Advance
Lower2012 -Advance
13 tax tax
payments
payments
2013 - 14 toto total
total tax
2014 - tax liability
15 liability Ratio
Ratio
2015 may indicate tax
- 16 may
indicate tax deferral
deferral that may be pursued that may be
for advance pursued for advance tax monitoring purposes.
Audi Motors India FIAT tax
India monitoring
Volkswagen Indiapurposes.
Toyota Kirloskar India

3.2.13 TaxRaw Material

Implication: Consumed
Lower Advance taxtopayments
Turnover Ratio
to total tax (GENERAL
liability Ratio may
Raw Material Consumed to Turnover Ratio (General Motors)
indicate tax deferral that may be pursued forMOTORS)
advance tax monitoring purposes.
170%
165%
160%
155%
150%
145%
140%
139
135%
2011 - 12 2012 - 13 2013 - 14 2014 - 15 2015 - 16

3.2.14 Tax Implications: Higher Raw Material 139 Consumed to Turnover Ratio may indicate
fictitious purchases
3.2.14 Tax Implications: Higher Raw Material ConsumedIn
or expenses related to manufacturing. to one caseRatio
Turnover it was
mayfound
indicateto be as high as
above 150%fictitious
in successive
purchasesyears.
or expenses related to manufacturing. In one case it was found to be as
high as above 150% in successive years.

3.2.15 After the AO has compared the assessee’s financials with the industry benchmarks, he
should look in to some of the most common issues encountered in the cases of automobile
industry which are discussed hereunder.
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Warranty Provision:
 Automobile Industry

3.2.15  After the AO has compared the assessee’s 4.4 There are several components that are
financials with the industry benchmarks, he purchased by the auto manufacturer from the
should look in to some of the most common OEM vendor. These components are covered by
issues encountered in the cases of automobile warranty offered by such vendors as part of the
industry which are discussed hereunder. contract. Any expenditure on account of failure
of these components shall be first incurred by
4.  WARRANTY PROVISION the assessee and subsequently claimed from the
supplier of the failed component. This should be
4.1 The claim of expenditure in the form of written back. For these reasons, the provision
warranty provision is one of the most contentious movement account needs to be examined.
issues. The Hon’ble Supreme court in the case of
M/s Rotark Controls P Ltd ruled that this should
be allowed as deduction if the computation 5.  CLAIMING CERTAIN EXPENSES
of the warranty provision was carried out in a THAT ARE NOT RELATED TO
scientific manner. IND AS-37 recognizes the BUSINESS
warranty provision as a contingent liability and 5.1 In many cases the assessee manufacturer
provides a mechanism to compute the value of makes payments to business associates for
the warranty claims by considering the discount certain services received. This activity needs to
rates. This is akin to the valuation by an actuary be examined closely. The agreement between the
in valuing the insurance risks. Thus, the liability assessee and the person receiving the payments
of the manufacturer to provide for warranty should be examined. Some of these payments
claim is a risk that can be estimated by valid would be in the same nature for which payments
scientific methods. would be made separately to other parties. In
4.2  Therefore, the warranty provision estimates all these cases the specific activity performed
should be examined to see if there is any scientific by the person receiving the payment should be
or actuarial valuation of the liability. In addition examined. The claim of such payments made
to this, the AO should examine the accounting should be allowed only after establishing that the
method followed by the assessee. Once the services were actually rendered.
provision made in the books is allowed, then all 5.2  For this purpose, the AO may examine if the
the expenses that arise out of warranty claims associate has the expertise, manpower to render
should be debited to the provision account. The the service and whether such manpower was
unutilised provision, if any, that remains after available at the locations where such services
the warranty period shall be written back at the were delivered. All the mails and correspondences
expiry of the period. between the parties may be a good source to
4.3  In certain cases, the assessee sells additional determine if there was any service rendered. In
extended warranty. The premium received for many cases where the transactions are either
the extended warranty may be for a period of International Transactions or Specified Domestic
one or more years. The assessee should offer all Transactions, the same shall be examined by the
the amount of premium so received as income TPO. There may be other parties to whom such
in the year of actual receipt. In many cases, this payments are made that shall be examined by
is not done. The assessee may resort to offering the AO. In certain cases, acquisition of fixed
only a proportional quantum of the premium as assets like building needs to be looked into. There
income of the year and carry the balance for the have been a few instances where the assessee
remaining years. This is not to be allowed as the manufacturer makes payment to acquire fixed
assessee is claiming all the warranty provision as assets that are far in excess of the actual cost
expenditure in the year the product is sold. of asset acquired. Therefore, additions to fixed

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Techniques of Investigation for Assessment Vol. 3

assets may be examined to see if the payment be looked into carefully. In some cases, it may
made was in excess. call for disallowance, as the payment is not for
the business purpose of the assessee. In most
5.3 Some of the expenditures of this nature
cases, the TPO would also examine this as the
that were claimed but disallowed during the
assessee manufacturer provides some additional
assessment are discussed below.
services to the AE and the amount is to be
5.4  Shared Services Cost: In certain cases, recovered from the AE with due profit margin
the service provider may be carrying on some for similar business services.
activity like maintenance of server, HR services,
5.7  Certain Write Offs: In some cases, the
Market Research etc. These persons do a lot
assessee writes off certain amounts from the
of activities for themselves and purportedly for
account payables being the creditors for capital
others also. The assessee manufacturer making assets. This usually happens in the case of
payment to these service providers stating that retention money. Such occurrences may have
some of the services were shared may still have in to be examined. The assessee may reduce the
their payroll persons having technical expertise to amount of write off from the opening WDV in
carry out the same functions. All such cases of this the corresponding block of assets. As per the
nature should be examined to see whether such decision of Hon’ble Supreme Court in the case
services were actually needed by the assessee. of T.V. Sundaram Iyengar & Sons Ltd (222 ITR
The place at which such services were rendered 344 (SC)), it has been held that the amount,
should be examined. All the related documents which has been received, may be of revenue
like agreements, contracts and communications in nature at the time of the receipt even though
that show that the services were rendered and the same may be treated as capital item in the
receipts acknowledged should be examined. books of accounts. In such circumstances, the
5.5 Reimbursement of Expenditure: The AO shall examine if by the nature of such a write
reimbursement may be outbound or inbound. off, whether the amount can be considered as
In most cases, it is examined by the Transfer profit u/s 41(1) of the Act.
Pricing Officer. In a case where outbound 5.8 Remittances Abroad: All remittances
reimbursement is made to an overseas party, abroad should be reported in Form 15A. These
the AO shall examine if the other party charged forms should be examined for remittances where
the assessee on cost-to-cost basis. Wherever the no withholding of tax was made by the assessee.
assessee fails to provide necessary proof that the Full and complete details of such transactions
overseas party did in fact charge the assessee should be obtained. Details such as the person
on cost-to-cost basis, and if the assessee did not to whom such payments are made, details of any
withhold tax, the AO shall examine the issues agreement as a result of which the payments are
for possible disallowance u/s 40 (a)(i) of the Act. made, the reasons why the assessee considered
5.6  Testing and Development Charges: that no withholding of tax is required, etc. are to
The assessee manufacturer having a technology be looked into.
partner who receives royalty for the patent and 5.9  In all cases where the withholding of tax was
trademark may be making a payment to another not made as the payment was not taxable as per
party for testing and development. This needs to the DTAA between India and the tax territory
be examined. The Associated enterprise is the 1, further investigation may be needed. Efforts
owner of the patent of the product. The assessee may be taken to identify the overall holding
makes all the required payments to the AE. In company. The details of the company to which
such a case, the product development should the payment was made, such as the location,
be the primary responsibility of the AE. Any address, number of employees, qualification
expenditure by the assessee in this regard should of them, copies of board notes of the overseas

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 Automobile Industry

company and the assessee company are relevant (ii) Skilled manpower availability at less
information in this regard. If it is seen that this cost (at about 20% of cost in developed
amount was in turn immediately transferred to countries)
the ultimate holding company in another tax (iii) Free or cheap water (about 4 lakh liters
territory 2, it may call for further enquiry. For are required to make a small car),
this purpose, the AO may make a reference
via FTTR of CBDT. If the AO can establish that (iv) Cheap electricity (rates are 1.5 times
the entity to which the payment is made is a in USA, 2.4 times in France, 2.5 times
paper company and the beneficial owner is the in USA, 3.25 times in Japan and 4.4
holding company in another tax territory and all times in Germany), and
management decisions are made by the holding (v) Liberal Govt. subsidies like refund of
company, then the AO can pierce the corporate VAT, duty drawback, etc.
veil and examine whether the Tax Treaty between
With the above advantages, they could
the India and tax territory 1 shall still apply to the
make quality cars at low cost
transaction between or the treaty between India
and tax territory 2 shall apply. c. With low cost they can capture a big market
in India besides deriving maximum profit
6.  INVESTIGATING OTHER on sale in the global market. So the foreign
TRANSACTIONS car manufacturers created their subsidiary
companies in India. They:
The other transactions like Receivables/
Payables, reimbursements/ recoveries, corporate (i) Entered into agreements with their
guarantee, etc, that are common to other subsidiaries to grant technical know-
industries/ sectors. Therefore, the techniques of how, etc. for making of cars for a royalty
investigation are common. Claims like forex gain/ @ 5 to 8% of sales effected by the
loss as operating/ non-operating, customs duty subsidiary. They also collected a lump
adjustment, idle capacity adjustment, working sum fee at the time of entering into the
capital adjustment, etc., are also common to agreement.
other industries/ sectors and the techniques of (ii) Sold, at a profit, machinery and
investigation of these issues are also common. equipments required for setting up of
manufacturing plant in India.
7.  TRANSFER PRICING ISSUES IN (iii) Sold, at a profit, raw material and
AUTOMOBILE SECTOR consumables needed for manufacturing.
7.1 When the Indian economy opened for (iv) Sold, at a profit, CBU (Completely
entry of global players in early nineties, many Built Units) cars or CKD (Completely
leading global car manufacturers saw a huge Knocked Down) parts of cars, for direct
opportunity in India for the following reasons: sale or sale after assembly respectively.
a. To capture India’s growing car market. (v) Sold, at a profit, spares required for the
It has one-fifth of world population. Its sales of cars made already.
increasing middle-class population was (vi) Provided technical services to their
aspirational. Indian subsidiaries and charge more
b. India has many location advantages such than the cost.
as: (vii) Purchased the cars and spares
(i) Cheap land, manufactured in India, mostly at rates

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less than their domestic selling rates. in the form of increase in the value of brands
Sold these cars in the global market owned by the AE.
with a high margin and still capture the 7.4  So, during T.P. audit, the affairs of the Indian
global market easily because of their taxpayer and the overseas AE are required
low cost in India which gave them the to be investigated in order to make proper
competitive edge when compared to benchmarking of the reported transactions
other manufacturers who do not have and also to discover unreported transactions
subsidiaries in countries like India. and benchmark the same. The techniques of
(viii) Collected their receivables from their finding out the actual profile of the assessee and
subsidiaries in time, but did not pay investigating different transactions are discussed
within the normal credit period and hereunder.
force them to avail external loans at 7.5  Actual Profile of the Assessee: Profiles
market rate of interest. of the Indian assessees can be of several types
(ix) Granted interest-bearing loans to Indian such as licensed manufacturers, contract
subsidiaries, at rates much higher than manufacturers catering to the Group’s markets
the rates at which they get such loans, outside India, distributors, joint ventures
thereby eroding the profitability of the or technology collaborators, etc. Since the
Indian subsidiaries. benchmarked margins will be in proportion to
the grade of their profile, the assessees tend to
(x) Entered into cost contribution
camouflage their real profile and present a picture
agreements with Indian subsidiaries
of a lower profile in their T.P. study. For example,
without extending the benefits
in one case, the assessee claimed that it is merely
proportionate to their contributions.
distributing the earthmovers imported from AE
7.2  Many a times, while the foreign AEs reaped and, therefore, its margin was low. But when
profits in each one of the above transactions, the invoices were verified it came to light that
the Indian subsidiaries were not able to get even it was actually importing parts of earthmovers
5% of sales as its profit margin for the entire and only in India they were assembled and sold
manufacturing, marketing and distribution as earthmovers to the ultimate customers. This
functions carried out by them. Many a times the additional function involving additional assets
subsidiaries posted losses year after year. The and risks entitle it to a higher margin than that
above scenario is not only applicable for OEMs of of a distributor. This fact could also have been
vehicles but also for TIER-II and TIER-III suppliers. brought out by examining the expenses debited
7.3 All the ten activities listed above call for to the P&L account. The assessee ought to have
benchmarking with regard to arm’s length price debited substantial expenses towards assembling
(ALP). Most of these transactions are reported in camouflaged as sub-contract expenses or under
Form 3CEB but the transactions in receivables/ some other head of similar nature.
payables are not reported directly by most of 7.5.1 A contract manufacturer need not pay
the assessees on the ground that their main royalty for the technology supplied by the AE for
transactions in imports/ exports are reported and whom it is the contract manufacturer. If royalty
receivables/ payables are only a consequence of is paid by a contract manufacturer, it needs to
their main transactions. Yet another transaction be probed thoroughly. Similarly, the risks, such
that is not at all reported by any assesse is as inventory risk, marketing risk, etc., actually
incurring of expenses by the Indian taxpayers undertaken by an assessee, claimed to be a contract
towards Advertising, Marketing and Sales manufacturer, needs to be investigated. The higher
Promotion (AMP) that benefits the overseas AE the risk, the higher should be the margin.

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7.6  Royalty Payment: In an independent and assessees are not doing it. There could be other
uncontrolled situation, any company would be deviations from the method of computation,
ready to pay for an intellectual property right or which need to be checked.
an intangible asset if it sees a long term benefit
from the usage of the same and it is not available 7.7  Import of Machinery and Equipment
to it otherwise. In the automobile industry,
royalty payment is claimed towards royalty 7.7.1 Some assessees adopt CUP or Other
for technology, for brand name or logo, or on Method and benchmark by comparing valuation
account of both technology and brand name. made by Customs authorities. Since the focus of
The contractual terms in the royalty agreement valuation by Customs Dept. is entirely different,
need to be carefully examined. It needs to be it cannot be mechanically accepted. The issue
seen whether royalty is for patented technology becomes complex in the case of import of second
or for general technology and if it is for patented hand machinery from AEs. Some assessees
technology then whether during the relevant furnish valuation certificates given by approved
previous year the patent was still valid. (The valuers by adopting CUP or Other Method.
validity period of a registered patent is only 20 Many a time such certificates are sketchy, lacking
years). The way to examine is to undertake a credibility.
benefit analysis for both the technology and 7.7.2  By collecting details such as invoice price
the intangibles being transferred. OECD’s at the time of purchase of new machinery by
latest guidelines acknowledge this concept and the AE and the details of depreciation claimed,
stipulate that commercial rationality into such benchmarking has been done by many TPOs.
decisions of payment of royalty needs to be But the appellate authorities have not upheld
examined. such approach. The necessity for importing
7.6.1 Yet another issue in royalty could be second hand machinery and the cost of similar
the rates at which royalty is paid. A leading new asset in India are some of the factors that
automobile manufacturer was actually paying need to be gone into. Referring the valuation
5% royalty on domestic sales and 8% royalty to the Valuation Cell of the Dept. is another
on export sales. It could not substantiate the possibility.
reason for paying an additional 3% on export 7.8  Import of Raw Material: In several cases
sales when the same model car with almost the it has been found that the while the raw material
same features was sold in both domestic and is supplied from one country (as per bill of lading
export markets. Its only contention was that RBI that mentions the port of discharge), billing has
permitted a maximum royalty of 5% on domestic been done from another country which is a
sales and 8% on export sales. The assessee low tax incidence country. Those cases are fit
benchmarked the payment by combining the cases to seek, under exchange of Information,
royalty amount and the sales value and claiming details of activities and financials of the AEs.
it to be within arm’s length. When the payments Purchase bills, terms and conditions of supply
were segregated and benchmarked, it turned and payments, mode of transportation and
out that royalty payment of 8% was outside the trail of payments made are significant nodes of
arm’s length. investigation in this transaction.
7.6.2  One more issue in royalty could be the 7.9  Intra Group Services (Technical Fees,
method of computation of royalty as per the Management Fees, Warranty Cost): These
Clauses in the royalty agreement and also as per intra group services are to be examined to ensure
RBI norms. According to RBI norms, the cost that such payments are not used to shift profits
of standard bought out components should be under the garb of some service availed from AE
reduced from the base for computation. Many especially if it is situated in a low tax incidence

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Techniques of Investigation for Assessment Vol. 3

country. The service should not be in the nature 7.14  Cost Contribution Agreements: TPOs
of share-holding activities and also should not be have come across international transactions of
duplicative in nature. OECD’s revised guidelines cost contributions from the Indian jurisdiction
stipulate that MNCs have to demonstrate via where such expenses have been debited to the
documentation the benefits derived from such P&L account. However, during TP audit, the
intragroup services. assessees have not been able to substantiate the
expenses in terms of the benefits that are likely to
7.10 Import of Completely Knocked
accrue from such expenses. In the absence of any
Down and Completely Built Units: In view
such demonstration in the TP documentation,
of the lesser import duty on CKD parts, many
the value of such cost contribution arrangements
assessees prefer import of CKD parts to CBUs.
would be suspect.
The discussion under “import of raw materials”
is equally applicable for both these transactions.
8.  INVESTIGATING THE
7.11 Import of Spare Parts: While some TRANSACTION OF AMP
assessees aggregate this transaction along with
their main transaction of import of raw materials/ 8.1 Since this transaction is not at all being
CKD/ CBU, some others benchmark this reported by any assessee, TPO should first start
transaction separately by comparing segmental by looking at the figure of expenses booked
margins with that of comparables. TPOs may under the head “advertisement, marketing
try to get segmental results in all cases. While and sales promotion”. If it is substantial when
computing segmental margins, the allocation compared to the sales figure, then he needs to
keys need to be checked carefully. call for the full break-up and details of the entire
expenses.
7.12 Export of Vehicles, Components
and Spares: The approach of the assessee in 8.2  The second step is to segregate the selling
such exports is to aggregate all transactions and expenses booked under the head AMP since
conclude that since at entity level the financial it is a common practice to debit expenses like
results shown are comparable to companies sales commission, dealer commission, dealer
involved in similar line of business, exports events, promotional tours for dealers, etc, under
should also be treated at arm’s length under the head “AMP”. A thorough demarcation of
TNMM. This approach has to be thoroughly the expenses is to be made, separating selling
examined, especially when exports are to AEs expenses from the brand promotion expenses
located in low tax incidence countries. through advertising, marketing and promotion
of brand. Selling expenses can be accepted as
7.13  External Commercial In-Bound wholly incurred for the benefit of the assessee.
Loans: Determination of ALP of this transaction Generally, there is little dispute in the demarcation
is generally done by the assessees using CUP of expenses between selling expenses and others
(Comparable Uncontrolled Price) method, (brand promotion expenses).
adopting the rates of LIBOR/ EURIBOR/ PLR,
8.3 The assessees claim that the brand
whichever suits them. Comparability of the
promotion expenses cannot be treated as
inbound loan international transaction is decided
incurred for the benefit of the AE because if the
by its price that is normally expressed in terms of
brand is promoted in the local market, sales are
rate of interest at which it is available. However
also be promoted here. Hence, any increase in
as per Delhi High Court’s decision in the case of
brand value is merely incidental.
Cotton Naturals, which has been accepted by the
Department, the currency in which the loan is to 8.4 Therefore the third step is to analyze the
be repaid is the deciding factor in determining non-selling expenses. By going through the
the applicable rate. actual advertisements placed in various media,

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 Automobile Industry

the claim of the assessees that the advertisements 8.6 In one case, the agreement between the
are meant to promote sale of their products and assessee and the AE provided that the content,
not the brand of the AE can be verified. If the periodicity, etc, are to be decided only by the
advertisements were placed in global events, AE. In another case, the royalty agreement
then, certainly most of the benefits would accrue specifically provided that the Indian taxpayer
to the overseas AE and not to the Indian assessee. should take steps to popularize the brand. In yet
After analyzing the above, a fair allocation of another case, it was admitted in the financials of
brand promotion expenses can be accepted as the Indian taxpayer that it is the group’s strategy
to spend heavily during the relevant previous
incurred for the benefit of the assessee. The share
year to promote the brand. If the payments to
of brand promotion expenses incurred for the
third party advertisers are determined by the AE,
benefit the AE can be considered for adjustment. it can be deemed to be a separate international
8.5 The fourth step is trying to establish AE’s transaction and benchmarked.
control over the AMP functions of the assessee 8.7 On the basis of evidence gathered from
to establish that it is an international transaction. the above marshalling of the facts, it is likely
The following details need to be analyzed to to be clear as to who is the actual controller of
arrive at the decision whether the AMP spend the activities. It will be easy to establish if all the
was incurred by the assessee on its own or at the activities are carried out under the control and
instance of the AE: guidance of the owner of the brand, irrespective
of the fact whether the assessee is in a position
a. Contents of the advertisements and who
to reasonably benefit from such expenditure.
designed it
Once it is established that the assessee is not
b. Periodicity of release of advertisements the sole entity controlling AMP expenditure, it
and who decided it would be easy to categorize the expenditures
incurred under the guidance of the parent MNC
c. Who negotiated the price with third party
as an international transaction. Similarly, it will
advertisers
also be relevant to compare these expenses
d. Geographies in which it was released and with such expenses existing in the industry.
who decided it This can be used as an evidence to suggest that
there is a tendency to disproportionately book
e. Occasions of release of the advertisements
expenditures in the territory viz-á-viz the other
and who decided it
companies operating in the same field.
f. Agreement between the assessee and AE
8.8 Fifth step can be taken to strengthen the
with regard to advertisement or brand
rationale for AMP adjustment by finding out
promotion
the actual increase in the value of the brand
g. Group’s strategy with regard to promotion owned by the AE during the relevant financial
of its brand year. There are globally renowned brand
valuation expert agencies such as “Interbrand”
h. Agreement, if any, between the AE and the
which comes out with rankings and values of
advertiser
various reputed brands annually. There are
i. Copies of MIS reports to the AE several regional/ national level brand valuation
agencies. By gathering necessary details, the
j. Data gathered from the media campaign
actual accretion to the brand value can be
undertaken by the AE
computed. One MNC has admitted in its report
k. Studies carried out by AE on brand to the shareholders the increase in the value of
promotion brand as per “Interbrand” valuation, making the

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job of TPO easy to refer to that valuation and market were compared, the prices in export
propose the AMP adjustment. market were found to be too low. Even after
8.9  Hon’ble Delhi High Court, in Sony Ericsson considering the differences on account of duty
Mobile Communications India Pvt. Ltd. in ITA drawback, etc, applicable only to export market,
No.16/ 2014, held that quality control is the the price was still found to be low warranting an
most important element, which can mar or adjustment.
enhance brand value. Hon’ble ITAT, Madras, 9.2  If the assessee is selling to its AEs and third
in the case of M/s. Hyundai Motor India Ltd., parties in export market, analysis of margins in
in ITA NO.853/ CHNY/ 2014, 563/ CHNY/ those two segments could help in benchmarking
2015 & 842/ CHNY/ 2016 for AY 2009–10 to its margins in AE segment.
2011–12, held that “increased visibility to this 9.3 Sometimes, analyzing the performance in
trade name does contribute to increase in brand car segment and spare parts segment will reveal
valuation of the brand name.” The visibility that the high margins earned in spare parts
will happen through sale of cars carrying the sales to third parties is used to cover up the
name and logo of the brand of foreign AE and poor margins in car sales to AEs, warranting an
through advertisements. As per the International adjustment towards car segment margin.
Accounting Standard (IAS) 38, the advertising
9.4 In the case of a new heavy commercial
and selling expenses are held to be part of
vehicle manufacturer’s case, the assessee
brand-building activity related to expenses made
claimed that its loss in the initial year is due to
on behalf of the parent company being the legal
market penetration efforts in India. When the bill
owner of the IP, knowhow and technology.
of material for different models of vehicles were
8.10  In view of the above, the benefit that has called for and examined it was found that all the
accrued to the AE in the form of increase in vehicles were sold at a loss. But the percentage
brand value during the year can be attributed of loss varied from model to model and the
to the global sales (quantity and/ or value) and vehicles, which were exported to AEs, had a
global AMP expenses. The figures for the global higher percentage of loss when compared to that
sales and global AMP expenses may be obtained, of the vehicles sold in India. The assessee stood
either from the assessee or through the exchange exposed. Same modus operandi was found out
of information route, and the share of Indian in the case of a car manufacturer also.
assessee computed. An equivalent proportion in 9.5  The vital issue in analyzing the segmental
the increase in value can be directly attributed as result is that these segments are usually not
an accrued benefit to the AE on account of AMP part of the financials and they are prepared
spends of the assessee. exclusively for transfer pricing purposes.
Therefore, the allocation keys used play a vital
9.  INVESTIGATING SEGMENT-WISE role in projecting the margins as desired by the
PERFORMANCE assessee. The appropriateness of the key used
for allocation of different expenses should be
9.1  The assessees tend to present a consolidated examined meticulously.
picture of its operating margin and claim it to be
within arm’s length. But if the performance of 10.  USAGE OF EXCHANGE OF
different segments is analyzed, the real picture INFORMATION
will come out. In one case, the assessee claimed
that its overall margin was within arm’s length. Many of the details discussed above can be
The assessee was selling its car in domestic and collected by using the route of exchange of
export markets. In the domestic market it was information. e.g. financials of AE to know its
selling to third party customers. In the export margins, group expenditure for AMP, validity of
market it was selling only to AEs. When the patents registered by AEs, etc. Therefore, this
selling prices in domestic market and export route should also be Utilised fully.

112
 Chapter

10
Bicycle Industry
1.  INTRODUCTION
A very large share of the India’s total population
is based in rural areas, where the bicycle is an
important mode of transportation. It is also an
important component of urban transport as well
as a mode of transport for children. Bicycles
have a role to play in supporting the mobility
and livelihoods of the urban poor in making
public transport accessible to more people at
lesser cost and curbing harmful automobile
emissions. The growing urban population base
and rising demand for roadster bicycles from
rural population is projected to drive growth population and the rising purchasing power of
in the country’s bicycle market in the ensuing the poor in the country. The Bicycle industry is
years. India is the largest manufacturer of expected to continue to grow at an average rate
bicycles in the world after China. India produces of 8% or more per annum from the year till the
approximately 10% of the world annual bicycle year 2022.
production. The annual domestic demand of 2.  There are some unique characteristics of this
bicycles in India is approximately 17 million industry, which have a determining influence on
units out of which around 2.5 million units are the structure and the manner in which cycles are
government demand for the various welfare produced and sold:
schemes. As per a study by the National Council
for Applied Economic Research (NCAER), there a. There is a high degree of ancillarisation
were over 12 crores bicycles on the Indian roads where parts and components are sourced
in 2015, only a marginal increase over the past out to small units. Some of the big
years. However, the Bicycle industry itself has manufacturers have slowly developed
seen a growth rate of 8% per annum for the last backward integration but still large number
15 years. The future prospects of this industry of components and parts are obtained
are also considered to be bright. For an Indian, from ancillaries, some of which operate in
the first consumer durable to be purchased the informal sector.
is a wrist watch and the second most desired b. There is a strong brand identity with
consumer durable is a bicycle. Considering this respect to the assembling and marketing of
factor, demand for the standard roadster model bicycles. Four of the largest manufacturers
of bicycle is directly linked with the increase in in the country, namely Hero, Atlas, Avon

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and Tube India (TI) account for more than unit or purchased from the market. The
93% of the annual production. tubes are aligned with the components
c. The manufacturing process is divided into and fabricated in the tubular department
a number of sub-assemblies. There are a through various operations, brazed up and
large number of cycle parts and component machined to the requirement. Afterwards
manufacturing units which are involved in these two sub-assemblies are bonded
manufacture of the subassemblies. together. The bonded subassemblies are
painted and finished and sent into shed for
d. There is an exclusive distribution network final assembly of the cycle.
for bicycles wherein distributors and
b. Handle Assembly: Handle is assembled
retailers sell only bicycles and do not keep
in the processing shop, brazed up, bent
any other consumer durable in their stores.
and machined as per design specifications.
The exclusive kind of distribution channel and Then they are polished and nickel chrome
the strong brand identity makes it very difficult plated. Handle along with its small
for new entrants to penetrate this industry. Thus, components are assembled and wrapped
the structure of the industry has a strange kind in the assembly shop.
of dualism. On the one hand are the large cycle
c. Brake Assembly: Brake components,
manufacturing companies like Hero Cycles,
purchased as well as processed in the press
Atlas Cycles etc.. and on the other side of the
shop, are barreled, polished and plated as
spectrum are small or medium sized ancillary
per requirements. These are then finally
units supplying some or the other component
assembled and wrapped for dispatch.
to these companies. This implies that the large
companies involved in the manufacture of d. Pedal Assembly: Sheet metal components
complete bicycle have a stranglehold over the of the pedal are produced in the press
small scale ancillaries, which places them at a shop, these are barreled and plated. All the
great advantage in any bargain involving these components are assembled along with few
two types of players. components bought from the market and
then finally packed.
3.  Process of Manufacture: A bicycle consists
of more than 500 different components and e. Chain Wheel and Crank: Chain wheels
parts. Its manufacturing process involves several are produced from cold rolled strip through
subassemblies like frame, fork, handle, pedal, various press tools in the press shop and
mudguard, brake set, chain wheel and crank set, then polished and plated. Bought out crank
saddle, rims, hubs etc. The standard procedure forging are machined through various
is to assemble the main components on the stages and then polished and plated. Both
workshop floor and send them in batches to the are assembled, wrapped and packed finally.
main assembly shed. All the major manufacturers 4.  Main Machinery Required: The machinery
dispatch the cycles in knocked down kits which installed in any cycle manufacturing unit depends
are assembled at the retail outlets. This form of on its dependence on ancillaries for different
dispatch is necessitated by considerations the components and the degree of automation in the
transport cost. Some of the major sub-assembling manufacturing process. But a typical unit would
processes in the manufacture of a cycle can be have the following main machines:
described as follows: a. Power presses.
a. Frame and Fork: Steel tubes are usually b. MIG welding sets
procured from the market already cut to
the required sizes. Sheet metal components c. Gas brazing sets
for fork sub assemblies are produced in the d. Painting shop

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 Bicycle Industry

e. Rim rolling mill material cost debited by the manufacturing units

f. Mudguard rolling mills in the books of accounts. Ministry of Commerce,
Government of India, periodically conducts
g. Dip brazing furnaces input-output surveys of different parts of a cycle.
h. Debrassing plant Information so generated is used for various duty
exemptions available to the cycle industry. These
i. Electroplating plant
norms also take into account the likely wastage
j. Jigs and fixtures and special tools. in manufacturing different parts of a cycle. If in a
k. Some of the manufacturers have installed particular case, it is found that the raw material
robotics processors/ automatic processors used for a particular component is much more
for different subassemblies, particularly than given in norms or is shown of a quality
frame and fork sub-assembly. and nature different than that in these norms,
then the AO must check the purchases of the
5. Cost Analysis of Different Components
raw material and its utilization to manufacture
of a Bicycle: It is difficult to provide a generalised
different components of a cycle.
cost analysis of the components of a bicycle
because of the large number of models available
in the market. These models differ in size, colour, 7.  OTHER POINTS FOR INVESTIGATION
weight of the components and are manufactured 7.1 Cycle components require a high degree
to cater to different market segments of the bicycle of standardization and the norms of variation
market. Each large cycle manufacturer makes at from any given standard are provided in any
least 20 different models. But more than 70% of contract entered into by a cycle manufacturer
the demand is for the standard roadster model of with the ancillary units. Normally, an ancillary
the bicycle. Thus, the cost analysis of a standard contract is accompanied by detailed drawings
roadster model can be of great assistance to an of the component to be manufacturer specifying
AO. The attempt at providing the cost analysis of the weight of the component, and the degree
the different components is only an approximation of variation permitted in weight or machining
and it applies to the standard roadster model of that component. This primary record is of
of the bicycle. This Cost analysis should be vital importance to investigate the raw material
considered indicative and cannot be applied ipso requirement for manufacturing the components
facto to any particular company. In other words, or parts by the ancillary units. If the AO finds that
it is an average and indicative analysis of the cost the raw material debited by the ancillary units is of
of different components for general guidance of different quality than that given in the contract or
the AOs to cross-verify whether a manufacturer the quantity debited by the ancillary unit is much
is booking excessive cost with respect to specific more than warranted by the detailed drawing of
components. This analysis would be useful in the component and the standard input-output
cases where the bicycle manufacturer purchases norms of the component, then this information
some components from concerns in which its can be a good starting point for detailed inquiry
directors/ partners have substantial interest. to determine excess raw material cost debited or
to establish that the ancillary unit is showing less
6. Standard Input-Output Norms for
production and Sales in the books of accounts
Different Parts of a Bicycle: Exact input-
as compared to actual production.
output norms for different parts of a cycle
are not available. The exercise involved is 7.2  The AO must keep up-to-date with the new
complex in view of the large number of models techniques of production becoming available
of cycles available in the market. But from an in this industry. With increase in competition
investigator’s point of view, the input-output manufacturers are striving to reduce wastage of
norms provide a useful tool to verify the raw raw material and to recycle the waste generated.

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What was once considered waste material and segment is largely in informal and unstructured
sold as scrap, is finding new buyers and users. For sector and is the likely channel through
instance, in the manufacturing of chain wheel, which unrecorded production of components
the HR sheet or coil cut by press to make holes in manufactured by these ancillaries are sold.
it, was being sold as scrap and waste. But lately,
7.5  The AO assessing the cases of the directors
this scrap is being used to manufacture metallic
or partners of large cycle manufacturers must
washers for the automobile industry. Similarly,
remember that these persons exercise great
the bonding of lugs and tubes used in the frame
control over the small ancillaries which supply
sub-assembly of the bicycle was traditionally
done by using brass. But with improvement components to these concerns. The profitability,
in technology, brass is no longer required for and in most of the cases the very existence of
bonding and consequently the raw material cost these ancillary units, depends on the orders
of frame sub-assembly has come down. received from the big units. Given the unequal
power of the two players in this arrangement,
7.3 The AO must look into the nature of the issue of pay-offs to these individuals at the
plant and machinery and the likely decline in time of granting ancillary contract has to be kept
labour and production cost as a consequence
in mind. Evidence of this nature must be looked
of addition to new machinery. In most of the
for during any survey or search in these cases.
units, for instance, frame assembly is a labour
intensive process. It involves the heating of the 7.6  A recent trend in this industry has also been
frame and tubes and lugs in furnace. A frame to import readymade cycles from China and
assembly team in this method of production other South East Asian countries, and to sell
consists of six to eight labourers. With the these under local brand names after stamping of
installation of robotic assembly of frames, the local trademarks. Such an activity will normally
same task is performed by one trained person. not constitute as production of an article or thing.
Thus with the introduction of one such robotic
frame assembly unit, the labour requirement 8. CONCLUSION
and cost for assembling the frame declines to The bicycle industry had remained stagnant for a
say one-sixth to one-eighth of the original cost. long time, but the winds are changing now, a lot is
Same is the case with the fixing of spokes in the happening in the industry and in the country, due
wheel rim. The labour working on mechanised to which the market is set to grow in the future.
wheel spoke fitting apparatus are three to four The efforts made by manufacturers to grab the
times more efficient than the traditional manual market through interventions like entering into
wheel spoke fitters. Therefore, the importance joint ventures with foreign brands, revisions in the
of linking the installation of new machinery with marketing and distribution strategies, introduction
decline in some of the production cost is an of wider product portfolio and innovations like
aspect which must be looked into by the AO. carbon frames, etc. have impacted the market
7.4  Another point which needs to be noted is positively. On the other hand, the lifestyle
that there are no exclusive or captive ancillary changes in the society and inclination towards
units in this industry. Typically the ancillary units premiumization in bicycles have also contributed
provide components and parts to two to three to changed outlook towards bicycles. The AO
manufacturers. There is a large informal market would, therefore, have to consider the issues of
for replacement of components and parts. Thus, globalization, changing technological, economic
these ancillary units have access to an extensive as well as market scenarios while carrying out
network of repair shops and a ready market exists investigation and assessment of the accounts of
for the components manufactured by them. This the assesses in this sector.

116
 Chapter

11
Power and Energy

1.  POWER SECTOR: BACKGROUND

AND GENERAL INFORMATION
Sector in Brief: Power is one of the crucial
elements of infrastructure and in the context of
a growing economy like India, even more so.
India is the third largest producer and the fourth
largest consumer of electricity in the world. It
also has the fifth largest installed capacity in the
world. The installed capacity is also one of the
most diversified with sources of power extending
from thermal to hydro to nuclear to wind to solar
to several other renewable sources. The power 3.  SHARE OF VARIOUS ENERGY
generation sector is also quite evenly distributed SOURCES IN TOTAL INSTALLED
with the public as well as private sectors making CAPACITY
substantial contributions.

2.  KEY CHARACTERISTIC OF POWER

PROJECTS IN INDIA
a. Long Gestation Period
b. Capital Intensive
c. Highly leveraged
d. Technology driven
e. Regulatory Issues
f. Reduced entry barrier to promote private
sector participation
g. Coal fired generation dominates the
generation portfolio Source: Ministry of Power

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4.  THE MAJOR PLAYERS—A 10.4 GW in 2016; the company aims to generate
COMPETITIVE MIX OF PUBLIC 20GW of power by 2020. The company is one
AND PRIVATE SECTOR of the world’s largest single location thermal
4.1  The total installed power generation capacity power plants in Mundra, Gujarat.
in India stands at 329.3 GW (as on 30 June, 4.5 NHPC is the largest hydro power utility in
2017). The share of the private sector stands at India with an installed capacity of 6.5 GW: It is
43.6%, while the State and Centre hold 31.5% has drawn up a massive capacity expansion plan
and 24.7% share respectively. Although the of adding 6.7 GW by 2017 NHPC is constructing
majority share of the installed capacity belongs 9 projects aggregating an installed capacity of
to the state-owned utilities such as NTPC, IPPs 4.2 GW.
are fast catching up. In the Eleventh FYP, the
private sector achieved 117.5% of its target by
contributing 23.0 GW to the overall capacity. It 5.  NEW REGULATIONS—BOOSTING
was far ahead of the State and Centre in terms COMPETITION IN THE SECTOR
of achieving the targeted capacity addition in 5.1 The utilities landscape has been evolving
the period. The private sector added 54.3 GW with the introduction of new regulations
of capacity in the Twelfth FYP achieving 115.9% that have enhanced competition. As per the
of its target. The Centre and the State achieved guidelines released by the Central Electricity
78.1% (20.4 GW) and 157.6% (24.4 GW) of the Regulatory Commission (CERC), post-tax return
target, respectively. on equity has been maintained at 15.5%, but
4.2  State owned NTPC is the largest generating the incentive structure has been linked to actual
utility in the country, with installed capacity of generation beyond the threshold level of 85%.
51,635 MW (including 7216 MW through JVs/ These have been framed to ensure that the end
Subsidiaries) comprising of 48 NTPC Stations consumer benefits from higher efficiency in the
(20 Coal based stations, 7 combined cycle gas/ system. The guidelines are expected to reduce
liquid fuel based stations, 1 Hydro based station), the profitability of state owned utilities. CERC
9 Joint Venture stations (8 coal based and one made it mandatory for state owned utilities such
gas based) and 12 renewable energy projects. as NTPC and NHPC to competitively bid for
By 2032, NTPC plans to reach 128,000 MW of projects after January 2011. Previously, state-
power capacity. owned utilities ensured offtake through MoUs
4.3 Tata Power is India’s largest integrated and were entitled to tariff based on the cost-plus
power company, with significant presence in mechanism. Competitive bidding would benefit
solar, hydro, wind and geothermal energy space. end customers in the form of reduced tariffs.
The company accounts for around 52% of total 5.2  In order to ensure growth of hydro power
generation capacity in the private sector. The generation, Govt. approved hydro projects
company has an installed capacity of 1.0 GW in exemption from competitive bidding through
FY 17. By 2022, the company plans to increase August 2022 and they will be awarded under
the generating capacity to 18GW, distribution cost-plus basis. Since the cost of generating
networks by 4 GW and energy resources by 25 hydro power is higher than that for thermal
million tonnes per annum. power, the absence of cost-plus tariff would
4.4  Adani Power is one of India’s largest private have been posed challenges to the hydro power
thermal power producers, with total capacity at offtake.

118
 Power and Energy

6.  MAJOR PLAYERS IN THE SECTOR AS ON 31ST MARCH 2017 (AS PER
OPERATIONAL INSTALLED CAPACITY IN GW)

Source: Company annual report, company websites

7.  KEY TRENDS 7.2  Increasing Role of the Private Sector

and Ongoing Consolidation in the Industry:
7.1 Accelerated Capacity Addition: Over
The private sector owned around 43.6% of the
the years, the Government increased focus on
total installed capacity in June, 2017. Installed
accelerating the rate of power capacity addition.
generation capacity owned by the private sector
Historically, the Indian power sector has
increased from 7GW in March 2002 to 143 GW
underperformed in terms of capacity addition,
in June 2017. The sector exceeded its targets by
missing the targets of various FYPs by close to 17.5% in the Eleventh FYP vis-a-vis achievement
50%. However, the performance of the sector of only 27.1% of the target in the Tenth FYP.
in the eleventh FYP was relatively better, having (The sector exceeded its target by 15.9% for the
realized close to 88% of the targeted capacity Twelfth FYP). The major players in the power
addition the targets was overachieved in the sector are acquiring power projects with fuel
Twelfth FYP, with 112% of the targeted capacity linkages, power purchase agreements and land
addition. Although Government–owned utilities acquisition approvals in place–thus acquiring
dominate the current installed capacity, private at a reasonable valuation, projects which have
sector led the capacity addition in the Eleventh overcome the regulatory bottlenecks.
and Twelfth FYP, contributing 42% and 54.7%
7.3 Nuclear Power Generation Gaining
share respectively.
Prominence: India has shown significant
7.1.1 While the GoI is attempting to reduce interest in expanding it domestic nuclear sector,
the demand supply gap by increasing the as a means to meet rapidly growing demand for
rate of capacity addition, there is a need to electricity, lower emissions through the adoption
simultaneously address other concerns such of low carbon power sources and capitalize on its
as emissions from thermal power plants and indigenous reserves of uranium and thorium. The
adequate fuel supply availability. government plans to source 25% of the country’s

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Techniques of Investigation for Assessment Vol. 3

electricity from nuclear energy by 2050, up from meters within monthly consumption range
the current level of 2.5% and the project pipeline of 200–500 units to be converted into smart
has strengthened in line with these targets. meters by 2019 and all meters with monthly
consumption above 500 units to be converted
7.4  Shift Toward Advanced/ Efficient
into smart meters by 2017 end. Smart meters
Technologies to Ensure Availability of
can reduce AT & D losses and improper billing.
Reasonably Priced Power: There is a clear
shift in the market towards large unit sixed 7.8  Use of Digital Technology, Automation
and supercritical technology (SCT). Leading and Analytics: Internet of Things, together with
players in the power sector are moving toward Big Data and Analytics can help reduce India’s
superior technologies for enhanced efficiency. power losses, thereby providing electricity to
Furthermore, NTPC and state utilities lined up millions of households that go without power
several projects based on SCT during the Twelfth every day. Smart Grids with automation,
FYP. SCT is expected to provide reasonably integrated controls and new technologies
priced power due to its efficient coal burning such as connected sensors can held in faster
mechanism, which provides 3% to 4% more restoration of electricity after outages, efficient
power on a unit of coal as compared to that power transmission, reduced management
provided by other existing technologies. expenses and integration of energy systems that
are based on green and renewable sources of
7.5 Regulatory Impetus to Renewables:
energy like wind and solar energy. This would
Growing demand for energy, technological
thus help in managing energy while reducing
advancement, depleting fossil fuel reserves and
dependency on non-renewable sources. The
concerns around global warming are driving the
recent investment decisions taken by GoI
development and use of renewable sources for
highlight the positive intent to adopt the latest
power generation. Government incentives such
and advanced technologies.
as tax rebates/ holidays, duty cuts, interest and
capital subsidy, and soft loans have encouraged
the development of renewable energy. As on 8.  KEY CHALLENGES
30 June, 2017, domestic renewable energy 8.1 Demand Supply Mismatch for Power:
generation capacity stood at 101.86 GW Substantial addition in generation & transmission
accounting for 31% of total generation. According capacity and widespread adoption of energy
to power ministry estimate, another 8.8 GW efficient measures has played a major role in
capacity is likely to be added in 2017, including augmenting supply of electricity. However, the
about 1.1 GW of rooftop solar installations. tepid industrial growth demand growth has result
7.6 Emerging Opportunities in the R&M in weak electricity demand resulting into declining
Space: Power equipment manufacturers have trend of Plant Load Factor (PLF) indicating an
an attractive opportunity in the renovation and under-utilisation of the existing capacity.
modernisation (R&M) of the ageing thermal 8.2 Decreasing Utilisation of Installed
generation fleet. Strong traction is foreseen in Capacity: The PLF of thermal power stations
up-rating, renovation and modernisation, with is an index of utilisation of the installed capacity.
more than 30GW of installed thermal capacities, The average PLF has been on a constant decline
currently over the age of 25 years. from 77.5% in FY 10 to 59.9% in FY 17. CERC
7.7 Smart Metering to Reduce AT & D norms provides incentives to the generation
Losses of Wrong Billing: The smart meter and distribution companies based on their PLF.
installed base in India could rise by a large Lower PLF will lead to lower incentives and will
number with the government mandating all have an impact on power unit margins.

120
 8.2 Decreasing Utilisation of Installed Capacity: The PLF of thermal power stations is
an index of utilisation of the installed capacity. The average PLF has been on a constant
decline from 77.5% in FY 10 to 59.9% in FY 17. CERC norms provides incentives to the
generation and distribution companies based on their PLF. Lower PLF will lead to lower
incentives and will have an impact on power unit margins. Power and
Power and Energy
Energy

Exhibit 7: Plant load factor for coal and lignite based plants
90.00%

77.50%
80.00%
75.10%
73.30%
69.90%
70.00%
65.60% 64.50% 64.50%
62.30%
59.90%
60.00%

50.00%

Series1
40.00%

30.00%

20.00%

10.00%

0.00%
FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18

Source:
Source:Ministry
MinistryofofPower
Power Source: Ministry of Power

8.3 Raising Price

8.3 Raising Price of of Inputs
Inputs Notably
Notably of 8.5
8.5  Effect of India’s Signing of of Paris
Paris
Coal:
Coal: TheThe increase
increase in in clean
clean energy
energy cess
cess from Agreement—Conscious Attempts to to Reduce
Reduce
159 Carbon Emissions: India is the third third largest
largest
INR
INR 200
200 per
per ton ton in
in FY
FY 1616 toto INR
INR 400
400 per
per ton
in
in FY
FY 17
17 isis likely
likely to
to increase
increase thethe cost
cost of
of coal
coal by CO2 emitter in the world behind china china and and thethe
INR 200
INR 200 per
per ton ton and
and will
will also
also raise
raise the
the cost
cost of United States. However, the country has has recently
recently
production by
production by 14–15
14–15 paisa
paisa perper ton.
ton. This
This surge taken important steps to curb coal use use for
for natural
natural
inthe
in the cost
cost of
of electricity
electricity will
will be
be further
further passed
passed to gas and renewable energy sources. A A few
few years
years
consumers. ago, the country had been on the path path to to triple
triple
consumers.
their coal-fired electricity generation by
generation by 2020 2020
8.4 Delay
8.4 Delay in in Project
Project Commissioning:
Commissioning: However, singing of the Paris agreement agreement and and
Archaic land
Archaic land acquisition
acquisition rules,
rules, frequent
frequent strike,
strike, the significant drop in renewable energy energy prices
prices
slow civil work, contractual dispute and delays in
slow civil work, contractual dispute and delays has led to a dramatic shift in strategy. strategy. As part
As part
obtaining procedural
obtaining procedural clearances
clearances have have impacted
impacted of the Paris Agreement, India has committed committed to to
the achievement
the achievement of of targeted
targeted capacity
capacity addition
addition 40% of Indi’s electricity capacity to come come fromfrom
inin previous
previous plans.
plans. During
During 12 12 FYP
th
th FYP,, difficulty
difficulty in renewable sources by 2030.
obtaining environmental
obtaining environmental approvals
approvals and and land 8.5.1 Another
8.5.1 Another issue for several thermal thermal proj-proj-
clearances resulted
clearances resulted inin significant
significant slippage
slippage to to the ects that registered with the Clean Development
Development
planned (88,537MW) capacity
planned (88,537MW) capacity additions targets. additions targets. Mechanism scheme for Renewable Energy Energy Cer- Cer-
AsAs perper 66thth Draft
Draft National
National Electricity
Electricity Plan,Plan, the the tificate (REC) trading, was the collapse
tificate (REC) trading, was the collapse in carbon in carbon
estimated slipped
slipped stands
stands at at 21386
21386 MW MW whichwhich prices after
prices after the
the global
global recession.
recession. (Renewable
(Renewable En- En-
estimated
ergy Certificates (REC’s) also known
ergy Certificates (REC’s) also known as ‘Green as ‘Green
isis 24%
24% of of the
the target
target capacity
capacity addition.
addition. Private
Private
Tags’ oror tradeable
tradeable Renewable
sector share
share in in this
this slippage
slippage capacity
capacity accounts
accounts Tags’ Renewable Energy Energy Credits
Credits
sector (TRC’s) are tradeable, non-tangible energy com-
(TRC’s) are tradeable, non-tangible energy com-
for almost 54% share during
for almost 54% share during 12 FYP. Delay 12 th
th FYP . Delay in in modities that
that represent
modities represent thethe fact
fact that
that 11 mega-
mega-
timelycompletion
completion of of power
power projects
projects has has resulted
resulted watt-hour (MWh)
(MWh) of
timely watt-hour of electricity
electricity was
was generated
generated
inin cost
cost and
and timetime overrun
overrun affecting
affecting the the overall
overall from a renewable energy sources and
from a renewable energy sources and was was fedfed
all financial
all financial health
health of of entities
entities undertaking
undertaking these these into shared systems of power lines that
into shared systems of power lines that transport transport
projects.
projects. electricity. These
electricity. These certificates
certificates can
can bebe sold,
sold, trade
trade oror

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Techniques of Investigation for Assessment Vol. 3

bartered). This reduced a once-anticipated rev- positive rating reflects sustained improvement in
enue stream in the form of REC trading/ selling domestic coal availability, as well as the Indian
for utilities. government’s policy initiatives, which will likely
lead to improvements in the financial position of
8.6  Advent of Solar Rooftops: India’s
state-owned electricity distribution companies in
electricity production per kilowatt solar
the next two to three years.
installation is the highest compared to any
other country in the world. This is because of 9.4 The recent approval of a particular coal
India’s geographical location on account of linkages policy will address the challenges
which it receives abundant tropical sunshine. associated with coal availability and is likely to
Rooftop Solar panel does not require high initial bring down the overall generation cost.
investment which allows ordinary households to 9.5 With such robust measures in place, the
generate their own electricity with government supply side dynamic of the power sector is set
subsidy and intense competition making them to improve. As for the demand side, a major
cheaper. The rise of “Prosumer” can threaten overhaul is required to ensure that a substantial
the very existence of thermal power plants amount of demand growth continues to support
that already struggle with decreasing PLF and the absorption of large scale capacity addition
sluggish demand. that is expected to get commissioned in the next
five years.
9.  THE WAY FORWARD
10.  POWER DISTRIBUTION
9.1 With capacity growing faster than the
demand, India is likely to emerge as a power The Indian power sector has historically been
surplus nation. Electricity consumption is dominated by the long term power market.
essential to support economic growth. With this State utilities/ distribution licensees (discoms)
understanding, power industry in the past has are the bulk purchasers of electricity, since
witnessed significant capacity addition across they have an obligation to supply electricity to
fuels (particularly in coal-fired thermal power the consumers. Most of the bulk supplies are
plants) and transmission segment. through long term power purchase agreements
(PPAs) with state generating companies, central
9.2 Recently, with aggressive targets, the generating companies and independent power
Government placed special focus on the producers (IPPs) etc. Of the total electricity
development of clean and sustainable energy, generated in India in 2015–16, around 90% was
Wind Power and solar power are emerging as procured by distribution companies through
important sources of sustainable clean energy. long term contracts and short term intra-state
The outlook for the sector is optimistic, with transactions.
policy thrust by the government and the rising
maturity/ reducing cost of technology. Factors
such as a smaller gestation period, attractive 11.  CHALLENGES SPECIFIC TO THE
feed-in tariffs, clean development mechanism POWER MARKET
credits and renewable purchase obligations on Due to the dynamic nature of the demand
distribution licenses are likely to continue driving supply situation, long term contracts are not able
renewable energy. to meet the full requirements of buyers in the
9.3 Moody’s Investors Service and its Indian national market. This is because of the following
affiliate, ICRA limited, upgraded the outlook challenges related to the power market:
for the Indian power sector to “stable” over the a. Electricity as a commodity cannot be
next 12–18 months in June 2017 with a Baa3 stored.

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 Power and Energy

b. Hourly consumption of power over a long 12.3 Volume of short-term transactions of

term without forecasting errors is difficult electricity (BU)
to predict.

Transactions directly
Transacted through

Transacted through
c. Long term contracts opf peak load

Total transactions
power exchanges

between discoms
requirement are economically inefficient.

trading licenses

UI transactions
Hence, development of a short term trading
market to complement the long term trades that

Year
cater to the core demand is very important for
efficient working of the power sector.
2009–10 26.72 7.19 25.81 6.19 65.90
2010–11 27.70 15.52 28.08 10.25 81.56
12.  SHORT TERM POWER MARKET 2011–12 35.84 15.54 27.76 15.37 94.51
12.1 The short term power market in India 2012–13 36.12 23.54 24.76 14.52 98.94
cover contracts of less than one year period 2013–14 35.11 30.67 21.48 17.38 104.64
for electricity supply. This includes electricity 2014–15 34.56 29.40 19.45 15.58 98.99
transacted under: 2015–16 35.43 35.01 20.75 24.04 115.23
a. Bilateral transactions through inter-state 12.4 Perusal of the above tables reveal that
trading licensees (only interstate part) the percentage of power traded remains fixed at
b. Power exchanges (Indian Energy Exchange around 9–10% whereas the absolute volumes
Ltd.(IEX) and Power Exchange India Ltd. have risen.
(PXIL)
c. Deviation settlement mechanism (DSM) 13.  VOLUME OF ELECTRICITY
i.e. uninterrupted interchange (UI) TRANSACTED THROUGH
transactions TRADERS AND POWER CHANGES

d. Transactions directly between DISCOMS

Electricity Transacted through

Electricity Transacted through

through PXIL
through IEX
Transacted

Transacted
12.2 Volume of short-term transactions with
Electricity

Electricity

IEX and PXIL (Bus) (B)

respect to total electricity generation:
(Bus)

(Bus)
traders (Bus) (A)
Short-term Transactions
Total Volume of Short-

Term Ahead

Term Ahead
Day Ahead

Day Ahead
term Transactions of

Percentage of Total
Generation (BU)

Market

Market

Market

Market
Total Electricity
Electricity (BU)

of Electricity as

Year
Generation

2008–09 21.92 2.62 0.15 2.77

Year

2009–10 26.72 6.17 0.10 0.92 0.003 7.19

2009–10 65.90 764.03 9% 2010–11 27.70 11.80 0.91 1.74 1.07 15.52
2010–11 81.56 809.45 10% 2011–12 35.84 13.79 0.62 1.03 0.11 15.54
2011–12 94.51 874.17 11% 2012–13 36.12 22.35 0.48 0.68 0.04 23.54
2012–13 98.94 907.49 11%
2013–14 35.11 28.92 0.34 1.11 0.30 30.67
2013–14 104.64 962.90 11%
2014–15 34.56 28.12 0.22 0.34 0.72 29.40
2014–15 98.99 1048.67 9%
2015–16 115.23 1107.82 10% 2015–16 35.43 33.96 0.33 0.14 0.58 35.01

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 Techniques of Investigation for Assessment Vol. 3

Note: The volume of electricity transacted Trading (9%) and Manikaran Power (8%).
through traders in 2008–09 (April to July The top seven traders together account for 83%
2008) includes-cross border trading and trading of the total electricity transacted by traders.
volume. The weighted average trading margin charged
Market Size:
14.  MARKET SIZE by trading licensees in 2015–16 was 0.03 INR/
Market Size:
Size of the bilateral trader and power exchange market (INR billion) kWh,
16.1 PTC India which ismarket
Ltd. leads the in forline with
execution thepowerCERC
of short-term Trading
market transactions in
Size of the bilateral trader and power exchange India with 29% of the total market share. Other leading traders include Tata Power Trading
Margin Regulations,
Size of the bilateral trader and power exchange market (INR billion) (12%), Mittal Processors (12%), JSW Power2010.
Trading (9%) and Manikaran Power (8%). The
market 300 (INR billion) top seven traders together account for 83% of the total electricity transacted by traders. The
Percentage share of electricity transacted by
weighted average trading margin charged by trading licensees in 2015–16 was 0.03 INR/ kWh,
which is in line with the CERC Trading Margin Regulations, 2010.
300 250
traders, 2015–16
250 200
148 146
156 151 SIZE OF BILATERAL PTC India Ltd.
200 150
150 148 TRADER MAREKT
133 156 151 146 SIZE OF BILATERAL
150 100 141
SIZE OF POWER
TRADER MAREKT Tata Power Trading Company (P) Ltd.
150
133 EXCHANGE MARKET
100 141
50 86 89 103 95 SIZE OF POWER
54 56 EXCHANGE MARKET
36 Mittal Processors (P) Ltd.
50 0 86 89 103 95
54 56
36
0
JSW Power Trading Company Ltd.

Manikaran Power Ltd.

Source: CERC

Source: CERC Others

15.  PRICING TRENDS
Source: CERC
Price
15. Pricing ofTrends:
electricity transacted through traders Share Figure
of Electricity Transacted by Traders, 2015–16
12: Share of Electricity Transacted by Traders, 2015–16

Price of electricity transacted through traders and power exchanges

15. and power
Pricing Trends: exchanges.
Price of electricity transacted through traders and power exchanges
17.  KEY CHALLENGES IN THE
5.26
4.96

4.79

6
4.33

4.29

POWER DISTRIBUTION SECTOR

4.28
4.18

4.11
4.29 3.67
4.33 3.57
3.57 3.47

3.5
5.26
4.96

2.9

2.7
4.79

4
6 ELECTRICITY
IN INDIA
4.28
4.18

4.11
3.67
3.47

3.5

2 POWER
2.9

2.7

4 ELECTRICITY
2 0 17.1  Poor Financial Health of Discoms:POWER
2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16
0 Although several states have raised tariffs
Price of2010-11
2009-10 electricity2011-12
transacted2012-13
through traders
2013-14(INR/ kWh) 2015-16
2014-15
Price of electricity
Price of electricity transacted transacted through
through power exchanges (DAM traders(INR/
+ TAM)(INR/ kWh)kWh) in recent years, financial condition of most
Price of electricity transacted through traders (INR/ kWh)
Price of electricity transacted through power exchanges
Price of electricity transacted through
discoms remains under stress. As a result, most
15.1 As
(DAM +is apparent
TAM)(INR/ from the power
bar exchanges
graph
kWh) above there(DAM + TAM)(INR/
is a substantial differencekWh)
in the price of
electricity transacted between traders vis-a-vis power exchanges. state discoms shy away from buying costly
15.1 As is apparent from the bar graph above there is a substantial difference in the price of
As is apparent
electricity transacted between
from the
tradersINvis-a-vis
barexchanges.
powerPOWER
graph above there is power from exchanges and prefer to opt for
16. MAJOR PLAYERS THE INDIAN MARKET TRANSACTIONS:
a substantial difference in the price of electricity load shedding instead. Moreover, poor financial
16. MAJOR PLAYERS IN THE INDIAN POWER MARKET TRANSACTIONS:
transacted between traders vis-a-vis power condition of discoms is putting power traders
exchanges. at risk. Currently, traders are supplying power
without any payment security mechanism and
16.  MAJOR PLAYERS IN THE INDIAN without a choice to terminate a contract, in case
POWER MARKET TRANSACTIONS of a payment default.
PTC India Ltd. leads the market for execution 17.2  High Competition Resulting in
of short-term power market transactions in Reduced Trading Margins: The competition
India with 29% of the total market share. Other in the power trading Industry has increased with
leading traders include Tata Power Trading issuance of multiple trading licenses by CERC.
(12%), Mittal Processors (12%), JSW Power This increasing competition has put considerable

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downward pressure on trading margins, which * (Case-1 bids are those where the quantum, time
has forced some companies to either surrender period of power procurement is known but fuel
their licenses or wilfully default in fee payments, type, source of location plant is not specified.)
leading to license revocation by the regulator. 17.7  Restrictions on Fuel (Coal)
17.3  Transmission Constraints: Power Availability: Thermal capacity addition
trading is also affected by continued corridor is restricted by the growing fuel availability
constraints for power flow. Adding to the chronic concerns. Coal supplies by CIL is restricted to
woe of transmission corridor congestion from around 65% of actual coal requirement by
NEW grid to Southern grid, some other crucial coal based thermal plants, leading to increased
dependence on imported coal that results in high
regional interlinks have started facing congestion
power generation costs. However, this situation
issues. Congestion has also arisen in flow of
is easing up as Indian Government has taken
power from the western region (region with
steps to increase coal production.
highest merchant generation) to northern region
(region with maximum demand.) 17.8  Equipment Shortage: the shortage
in primarily in the core components of Boilers,
17.4  Fuel Price Risk: Discoms have an Turbines and Generators. Also, there has been
obligation for competitive bidding through lack of adequate supply of Balance of Plant (BOP)
case I or Case II route for power procurement. equipment as well. These include primarily coal-
However, since the sellers are unwilling to take handling and ash-handling plants.
fuel price risks and prefer this risk to be built into
17.9  Delayed Land Acquisition and
the tariffs, procurement by discoms through case
Environment Clearance: Power plants
I or Case II route has been below the desired
and utilities face major constraints and delays
levels.
regarding the availability of land and obtaining
17.5  Lack of Regulatory Clarity for Trading the requisite environment and other clearance
of Imported Power: The Government of for the projects.
India has shifted the subject of import of power
from “restricted” category to “free” category. 18.  DISCUSSION ON TAXATION
However, there is limited regulatory clarity ISSUES
with regards to sale of imported power through 18.1 Given the relatively complex nature of
power exchanges, which is posing difficulties the power generation and distribution sector in
for power importers. Considering that India is India, as explained above, the taxation of the
envisaging to import large quantum of power same results in challenges on various issues like
from neighboring countries, setting up of an rates of purchase of raw material, applicable
appropriate regulatory framework for trading of and allowable deductions, depreciation claims,
imported power will be very important. taxation of subsidies extended to this sector,
issues relating to sale and lease back of power
17.6  Traders not Allowed to Participate assets, issues related to renewable energies,
in Case-1* Bidding: The Ministry of Power quantification of transmission and distribution
has revised the norms under which discoms losses, applicability of minimum alternate
purchase power on long-term and medium-term taxation (MAT) to such power generation and
basis. Under these revised norms, power traders transmission units, international taxation issues
are not allowed to participate in case-1 bidding, and transfer pricing issues. These issues are
thereby limiting their business opportunities. elaborated in some detail below:

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Techniques of Investigation for Assessment Vol. 3

18.2  Investigation of Raw Material Cost 18.10  Transfer Pricing Issues

a. Gross Calorific Value of Coal a. Purchase of coal from AEs
b. Boiler efficiency b. Loan transactions
c. Plant Load factor c. Corporate Guarantee
18.3  Issues Related to 80IA
d. Inter-unit transfer between exempted
a. Background and non-exempted unit
b. Debate of “setup” and “begin to
generate” 19.  INFLATION OF CONSUMPTION
c. Profits” derived from” 80IA OF RAW MATERIAL
d. Transfer Pricing and shifting of 19.1 Showing receipt of below par material
expenses/ profits i.e., coal with less thermal efficiency, high
18.4  Taxability of Subsidies Sulphur content and high ash content. Due
to this, the consumption of the coal may be
18.5 Issues Related to Sale and Lease
Back of Assets inflated and, thereby, the profits are reduced. In
order to investigate this, the AO should call for
a. New developments
the details of the boiler/ plant capacity, the Plant
b. Depreciation claims Load Factor (PLF) and the boiler efficiency
c. Checklist for genuineness of the specifications. This then needs to be co-related to
agreements the quantity of the coal claimed to be consumed
d. Dispute in the rates of TDS to produce the amount of power disclosed in its
books. As the production figures are difficult to
18.6  Issues Related to Renewable Energy
fudge, the boiler efficiency multiple may be used
a. Depreciation claims on wind mills to calculate the input tonnage of coal which
b. Taxability of Carbon credits would have been consumed to produce the
claimed quantum of power. While calculating
18.7  Transmission and Distribution
Losses the tonnage of coal, due consideration should
be given to the Gross Calorific Value (GCV) of
a. Genuineness
the coal which is being used. Higher the GCV of
b. Quantification coal, the higher the heat produced per unit and
18.8  Issue Related to Applicability of MAT: hence, higher is the cost price of coal.
Exceptions to Schedule VI in the Companies Act 19.2 Another modus operandi is showing
18.9  International Taxation Issues receipt of lesser coal from rail wagons or the
a. Severance of Supply of equipment and trucks than shown in purchase bills. This is
Services in EPC/ Turnkey contracts followed by lengthy procedure of filing claims
with the railways and coal companies that are
b. Non deduction of TDS
seldom settled. In order to investigate this, the
c. Other International taxation issues primary record regarding the quantity/ quality

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 Power and Energy

testing of the raw material at the time of receipt; Particulars of the Specified Exclusions/
and the receipt register along with the weigh bills Undertaking Period of Explanation if
Operations Any
of the trucks may be called for examination.
It is setup in any 1.4.1993 to
part of India for 31.3.2017
20.  APPLICABILITY OF SECTION 80IA the generation or
generation and
20.1 Background of Deduction u/s 80IA distribution of
of the Act: Section 80IA of the Income-tax Act, power
1961 provides for a deduction in respect of the It starts 1.4.1999 to The deduction
profits and gains from industrial undertakings transmission or 31.3.2017 in this case shall
distribution by be allowed only
or enterprises engaged in infrastructure laying a network of in relation to the
development. The power generation and new transmission profits derived
transmission sector falls under the purview of or distribution lines from laying of
such network
infrastructure development. The deduction of new lines for
envisages an amount equal to 100% of the transmission or
profits and gains derived from such business distribution

for 10 consecutive assessment years. The It undertakes 1.4.2004 to “Substantial

substantial 31.3.2017 renovation and
deduction is also available in case the enterprise/ renovation and modernisation”
undertaking undertakes substantial renovation modernisation shall mean an
and modernization of the existing transmission of the existing increase of plant
transmission or and machinery
or distribution lines. The deduction can be distribution lines by at least 50%
claimed at the option of the assessee for any 10 of the book value
consecutive assessment years out of 15 years of such plant and
machinery as on
beginning from the year in which the undertaking 1.4.2004.”
or the enterprise begins to generate power
or commences transmission or distribution of In addition to above, conditions u/s. 80IA(3)
power or undertakes substantial renovation and also need to be fulfilled to claim the benefit.
modernization of the existing transmission or 20.2 Debate of “Setup” and “Begin to
distribution lines. There are various conditions Generate”: Deduction u/s 80IA of the Act is
laid down regarding the organisation and allowable in respect of profits and gains derived
commencement of the undertaking which need from any business of an industrial undertaking or
to be complied with and also certain time lines enterprise engaged in infrastructure development,
have been laid down prescribing the period etc. A close perusal of the wording of the
when such activity should be commenced, for relevant Section of the Income-tax Act, reveals
availing of the deduction. that the deduction is eligible for an undertaking
which is ‘set up’ in any part of India for the
20.1.1 Tax Holiday—Section 80IA(4) (iv): generation/ distribution of power, if it begins to
The specific Section dealing with power generate power at any time between 1st April
generation and transmission companies is 1993 and 31st March 2017. As discussed earlier,
Section 80IA(4)(iv) of the Income-tax Act, 1961. power generation projects are capital intensive
The conditions to be fulfilled to claim the benefit and typically involve long gestation periods. In
are as follows: such circumstances, disputes may arise between

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Techniques of Investigation for Assessment Vol. 3

the assessee and the Tax Authorities on when of condition relating to setting up of the
exactly an undertaking was ‘set up’. This is a undertaking, may be carried out before allowing
contentious issue which needs to be resolved the deduction.
on a case-to-case basis taking into consideration 21.  Taxation of Receipt of Subsidies in the
the factual matrix of each case. The assessing Sector: To attract foreign investors, the government
officer may obtain documents relating to test has taken several initiatives such as introducing GBI
runs conducted by the undertaking before it (Generation Based Incentives) schemes to promote
begins to generate the power. projects under Independent Power Producers (IPP)
20.3 Meaning of Connotation “Profits mode for wind and solar power.
Derived from”: The Hon’ble Supreme Court in 21.1  In the case of CIT vs. Ponni Sugars and
the case of CIT vs. Sterling Foods [237 ITR 579] Chemicals Limited 306/ TR 392 (SC),the Hon’ble
has held that for the application of the words Supreme Court held that the character of receipt
“derived from” used in Section 80HH, there in the hands of assessee has to be determined
must be a “direct nexus” between the profit and with respect to the purpose for which subsidy is
the industrial undertaking. It was further held given. In other words, the, “Purpose test” is to
that profits out of sale of import entitlements be applied. The point of time when the subsidy
cannot be said to be profits “derived from” the is paid is not relevant. The source is immaterial.
industrial undertaking. This decision may be kept The form of subsidy is also immaterial. In this
in view while examining claims for deductions case, eligibility condition in the scheme was that
u/s 80IA of the Act. Some important decisions, incentive must be Utilised for repayment of loans
which may also be referred to in this regard are taken by the assessee for setting up of a new
Pandian Chemicals 262 ITR 278 (SC) and M/s. unit or substantial expansion of the unit. While
Liberty India (2009) 317 ITR 218 (SC). explaining the principle, the Hon’ble Court also
20.4  Determination of First/ Initial year of observed that if the object of the subsidy scheme
Claim of 80IA: Due care should be given to was to enable the assessee to run the business
the determination of the correct initial year in more profitably, then the receipt would be on
which the claim of deduction under Section 80IA revenue account. It further explained that on
would start. This determination may be prone the other hand, if the object of assistance under
to manipulation by some assessees. Since the the subsidy scheme was to enable the assessee
provisions of tax holiday u/s. 80 IA(4)(iv), now to setup a new unit or to expand its existing
has sunset Clause in the sense that the deduction units, then the receipt of subsidy was on capital
will not be available for the undertakings setup account.
beyond the period of 31.03.2017. In view of 21.2  In another landmark case of Sahny Steel
this, the Assessing Officer should be vigilant in and Press Works Limited vs. CIT 228 ITR 253
examining the claim where the assessee claims (SC), the Hon’ble Supreme Court analysed the
that, (a) it has setup undertaking for generation Scheme of subsidy granted by the Government
or generation and distribution of power, (b) it of Andhra Pradesh. According to the notification,
started transmission or distributions by laying certain facilities and incentives were to be given
a network of new transmission or distribution to all the new industrial undertaking which
lines, (c) it has undertaken substantial renovation commenced production on or after 01.01.1969
and modernization of existing transmission or within investment capital not exceeding Rs. 5
distribution lines upto 31.03.2017. The cases crores. The incentives were to be allowed for a
where tax payers have claimed setting up of period of 5 years from the date of commencement
industrial undertaking in the later period of F.Y. of production. The incentives were not available
2016–17, a detailed examination of fulfilment unless and until production had commenced.

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 Power and Energy

21.3  Another important judgment laying down that the collection could be retained to the extent
the principles was in the case of CIT vs. P.J. of 100% of capital expenditure. Whilst it might
Chemicals 210 ITR 830 (SC). Hon’ble Court ap- be tempting to read the linkage with capital
plied purpose test. The Court held that measure expenditure as not only applying to the limit, but
of subsidy was not relevant in determining the also implying an underlying intention that the
character. In this case, ITO was of the opinion capital expenditure would thereby be recouped,
that statutory concept of actual cost in Section the absence of any such condition should restrain
43(1) compelled deduction of central subsidy re- the Court from so concluding.’
ceived by the assessee. The Hon’ble Court held 21.6 The attention of the assessing officer is
that the govt. subsidy, in that case was an in- invited to provisions of Explanation 10 below,
centive not for the specific purpose of meeting a Section 43(1) relating to actual cost.
portion of the cost of assets, though quantified
as or geared to a percentage of such costs. If that 21.7  Amendment in Section 43(1) of
be so, it does not partake the character of pay- the I.T. Act, 1961: At the same time, the
ment intended directly or indirectly to meet the Government through appropriate legislation
actual cost. has sought to balance larger concerns like black
money/ unaccounted income with allowance of
21.4  ITAT, Pune in rulings rendered in deductions to undertakings operating in social
December 2017, in the case of Indo Enterprises sectors. An example is the recent amendment to
Pvt. Ltd. [ITA No.1362/ Pun/ 2011 and ITA No. Section 43(1) of the Income-tax Act, 1961 which
2389/ Pun/ 2012] and Patankar Wind Farms has comes into effect from 01-04-2018, providing
discussed the issue of tax treatment of subsidy that where an assessee incurs any expenditure
in detail while adjudicating the nature and for acquisition of an asset or part thereof,
character of Sales Tax subsidy received by the and payments made for the same exceeding
assessee on generation of power through wind Rs. 10,000/- in a day is made other than by an
mill, under the scheme of state government. The account payee cheque or electronic clearing,
judgment referred to a number of case laws on such excess expenditure shall be ignored for
the subject while discussing the issue. It was held purposes of determination of actual costs.
that the Sales Tax subsidy under the said scheme
was revenue in nature. 22.  SALE AND LEASE BACK OF
21.5 Hon’ble Delhi High Court in the case ASSETS
of CIT vs. Bhushan Steel & Strips Ltd. (2017) 22.1  New Developments and Depreciation
[83 taxmann.com 204 (Del.)] reversed the Claims: The Government of India has come up
ITAT’s rulings for A.Y. 1995–96 after analysis of with numerous policy initiatives to control the
Sales Tax subsidy Schemes. The Hon’ble High pollution caused by the coal based thermal power
Court held Sales Tax Subsidy to be a revenue plants. To measure the extent of polluting gases
receipt absent capital utilization condition. and the particulate matter, Air Quality Index
High Court approved revenue’s reliance on benchmarks have been formulated. The Central
Supreme Court’s ruling in Sahny Steel (supra) Pollution Control Board (CPCB) has also issued
wherein the Court was persuaded to hold that directions to Thermal Power Plants to ensure
the amount represented revenue receipt and not new norms on Sulphur Dioxide emission limits
capital because the payments were made only in coal fired power units be implemented in a
when assessee commenced its production. The phased implementation plan by the installation
Hon’ble High Court noted that ‘This subsidy of Flue Gas De-Sulphurization (FGD) and other
scheme had no strings attached. It merely stated emission control equipment. Based on the

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Techniques of Investigation for Assessment Vol. 3

discussions with Ministry of Environment, Forest same. In order to allow SEBs to use the asset,
and Climate Change (MoEF&CC), a revised these assets were then leased back to the SEB
phased implementation plan (to be implemented for their use. At the end of the lease period the
before the year 2022) for installation of Flue Gas assets were transferred back to the SEBs or sold
De-Sulphurization (FGD) in plants for a capacity to some other entity.
of 1,61,402 MW (414 Units) and upgradation of
22.2.2  There was considerable tax implication
Electrostatic Precipitator in plants for a capacity
in these transactions. The SEBs being loss-making
of 64,525 MW (222 units) has already been
units, were not paying any taxes including Capital
finalized.
gains on the sale of assets, whereas, the purchasers
22.1.1 From basic research on the internet, were investing funds and getting the benefit of
it is found that the capital expenditure (capex) depreciation, and hence obtaining tax benefits.
requirement of installation of FGD equipment
works out to be Rs. 50 Lakhs to Rs. 1 crore 22.2.3  In many cases of the so-called sale and
per MW of power generation. Roughly, the lease back transactions, the transactions were
opportunity size of this market is Rs. 46,000 found to be mere colorable devices due to the
crores. Siemens, GE Power, BHEL and ABB are following reasons:
the major suppliers of FGD technology in India. a. An asset which is supposed to have been
22.1.2 On this amount of equipment coming sold and leased back did not cease being
into the books of the power generators in the an asset with nominal value (not being
coming years, depreciation will be sought. The market value as on date) merely because
AO should be vigilant to ensure that the ownership it’s value was artificially jacked up to
of the said assets are undisputedly with the power provide occasion for depreciation.
generators (claimants of depreciation), so that b. There has been multiple financing, i.e., the
there is no double claim of depreciation on the same asset is sold and leased back to more
same set of assets. While doing so, the existence than one party.
of asset acquisition model, such as Sale and
c. Assets, which could not be legally sold, as
Lease Agreements, should be seen along with
they were charged to banks or others, were
the depreciation implications thereof.
made the subject matter of sale and lease
22.2  When the process of liberalization of the back transaction.
Indian economy was set in motion, state funding
d. These were not genuine finance lease
of the loss-making State Electricity Boards
transactions because the sale price was
(SEBs) was discontinued. They were required to
practically returned by way of advance
generate funds from their own resources. Some
lease rent with the result that the entire
SEBs developed the practice of ‘sale and lease
transaction was only by way of book entries
back of assets’, which operated as under.:
solely for purposes of tax avoidance.
22.2.1 SEBs were having old assets in their Where the amount was routed through a
Balance Sheet, depreciation available on which third party or a sister concern, the position
was entirely used. SEBs also could not do was the same. In other words, there was
without these assets. Hence, the SEBs revalued no real finance availed by the seller-lessee,
these assets and then sold them to entities who who merely made entries in the books to
were looking forward to investing their funds oblige the financier to get depreciation
and reduce their tax liabilities. Thus, the need of for such accommodation. A finance lease
SEBs for funds was met. The purchaser was able without an element of finance can hardly
to park its funds and claim depreciation on the ever be recognized as bona fide.

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22.2.4 Many companies which had entered was claiming depreciation on the purchase price
into sale and lease back transactions during the paid by him to the seller whereas, the seller
mid-nineties (especially for assets which, then, was claiming the amount of lease rentals paid
were entitled to 100 per cent depreciation) were by him to the lessor as revenue expenditure. In
denied depreciation on the ground that the order to curb such transactions Explanation 4A
entire transaction was a sham, designed only was inserted in Section 43(1) with effect from
for the avoidance of tax. Several such cases are October 1, 1996, to determine the written down
pending at different stages before the various value in a case where the assets, which have
appellate authorities. Thus, the Assessing previously been used by a person (hereinafter
Officers should gather the facts of the case and “first person”) and on which depreciation has
apply the law including the enunciation by the been allowed to him, are acquired by another
judicial authorities. and the assets have been let, hired or leased to
the ‘first person’. In such cases, the Actual Cost
22.3  Checklist for Verifying the
of such assets shall be the written down value of
genuineness of Sale and Lease Back
the said asset at the time of its transfer (by the
Agreements:
first person).
22.3.1  An illustrative check-list for this purpose
22.3.3  The CBDT issued guidelines for
may be as under:
investigation into finance lease agreements
a. Whether Sale & Lease back transactions (Instruction No. 1978, F.No. 225/ 190/ 98/ ITA-II
have taken place with proper dated December 31, 1999), wherein the issues
documentation? to be examined while investigating the cases of
such lease agreements have been delineated.
b. Whether the lessor provides real finance to The AO may examine invoking Explanation 4A
the lessee? to Section 43(1) in appropriate cases of sale and
c. Whether the lessor is the absolute owner lease back transaction, where the depreciation is
with a right to lease the sale? allowed to the lessor on the WDV of the asset in
the hands of the lessee at the time of the transfer.
d. Whether the value assigned is
commensurate with market value? 22.4  Rate of TDS

e. Whether the transaction is a bona fide 22.4.1  This issue pertains to deduction of tax
finance lease, with reputed finance at source by the owners of the power plants
companies in which the assessee has no while making payments to the operators of the
interest? power plants. In many cases, the power plant is
owned by one entity but the other entity deploys
f. Whether the transactions are carried personnel and generates power. The contentious
out at usual rate of lease rent. In other issue pertains to whether the service provided by
words, these transactions are as between the operator is a contractual service u/s. 194C
principals acting at arm’s length? or a service covered by the definition of Fee for
22.3.2 Prior to 30th September, 1996 the technical and professional services u/s. 194J.
cost of assets in the hands of purchaser was 22.4.2 The operator, in such instances, only
considered to be the purchase value paid by him provides technical personnel who only come
to the seller. Hence previously, the assets held by with the expertise and work on the equipment
the seller were transferred to the other person at of the owner. Therefore, the deductibility of
the price agreed between them. Subsequently, tax at source under correct Section needs to be
the purchaser used to give the assets to the seller examined. Disallowance u/s 40(a)(ia) may also
on lease. Under such arrangement, the lessor be explored.

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23.  ISSUES IN RENEWABLE 30). In order to investigate such claims, following

ENERGY SECTOR enquiries can be made:
The growth of the clean energy sector in India a. Survey of the location and physical
has been impressive. Currently, India permits verification
FDI up to 100 per cent in the sector under b. Report from State Government about
the automatic route in Renewable Energy allocation of land, wind speed, etc.
Generation and Distribution projects that are
subject to the provisions of the Electricity Act c. Report from the State Electricity
of 2003. Under the Act, no prior approval of Development Agency about the funding of
regulatory authorities is required. the project, installation of the asset, etc.
23.1 Accelerated Depreciation: Under d. Report of the SEB about the date on which
the Income-tax Act, companies involved in the windmill was connected to its grid and
renewable energy such as solar and wind was the amount of electricity generated from
provided with accelerated depreciation at 80 per the same.
cent. However, recently, by way of amendment e. Report from the State Agency responsible
rate has been restricted. The AO may refer to the for promoting use of alternate sources
Appendix for the purpose of applicable rates for of energy about the units of electricity
the relevant assessment year. generated from the location along with
23.1.1 Further, power companies have been date and time
provided with an option to claim depreciation 23.3 Taxation of Carbon Credits or
under Straight Line Method (SLM). For this Certified Emission Reduction (CER):
purpose rates have been prescribed separately Taxability of receipt on transfer of Certified
for power generating units. Emission Reduction (CER) has been subject
23.2  Depreciation on Wind Mills: In order matter of significant debate in the past. While
to boost the use of alternate source of energy taxpayers have claimed the same to be capital
other than carbon fuels, the Government of receipt not chargeable under the provisions of
India allowed 100% depreciation on assets used the Act, tax authorities have been contending
to generate power through use of Solar heat, the same to be business income chargeable to
Windmills, etc. Many Windmills were setup for tax.
generation of power in coastal areas of Gujarat, 23.3.1  There are judicial decisions holding that
Tamil Nadu and Andhra Pradesh. The rate of receipt from transfer of CERs arises due to world
depreciation allowance has undergone changes concern and awareness for reduced Green
several times, the AO may refer to the Appendix House Gases (GHG) emissions and thus cannot
for the purpose of applicable rates for the taxed as business income. The decisions held
relevant assessment year. that the amount so received has no element of
23.2.1 However, many entities misused the profit or gain and it being capital receipts, cannot
scheme by making false claim of purchase and be subjected to tax in light of the provisions of
installation of the windmills. These provisions sections 2(24), 28, 45 and 56 of the Act. The
were also misused by some genuine entities that same has been discussed at length in the decision
actually purchased and installed the assets, but of Hyderabad ITAT in the case of My Home
wrongly advanced the date of installation on Power Ltd. [TS-820-ITAT-2012(HYD)] which
records to claim 100 per cent depreciation (by was affirmed by the Hon’ble Andhra Pradesh
showing installation and use before September High Court [46 taxmann.com 314].

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23.3.2 A contrary view was taken by the (CERs) issued by Institute of Chartered
Appellate Tribunals in the case of Kalpataru Accountants of India to provide guidance on
Power Transmission Ltd. [2016] 68 taxmann. accounting for carbon credits, CERs should be
com 237 (Ahmedabad Trib.) and Apollo Tyres recognized in books when those are created
Ltd. [2014] 47 taxmann.com 416 (Cochin Trib.) by UNFCCC and/ or unconditionally available
holding that income on transfer of CERs should to the generating entity. Accordingly, CERs
be considered as benefits or perquisites under generally need to be credited to profit and loss
Section 28(iv) chargeable to tax as profits and account for the purposes of book profit.
gains of business or profession.
23.3.3  There is a good case for holding that the 24.  TRANSMISSION AND
receipt on account of carbon credits is a revenue DISTRIBUTION (T&D) LOSSES
receipt on the ground that the entities would not 24.1 One of the issues for examination in
have been entitled to CERs and would not have power cases is reliability of the extent of the
been remunerated for “carrying on its business claim of T&D losses. The assessing officer needs
in an environment friendly manner” had they to examine the quantification and genuineness
not been in the business in the first place. As a of such claim. The power lost in the process of
corollary, the accrual of CER is from the business
its transmission from the generating station to
of the assessee and hence should be taxed as
the end consumer is known as transmission and
business receipts only. Since, the benefit arises
distribution (T&D) loss. While ‘transmission loss’
from the business carried on by the enterprise,
occurs when the power is stepped up or stepped
the same falls within the provisions of Section
28. This fact has been corroborated by the down with the use of transformers for movement
introduction of Section 115BBG in the Act by upto the point of the distribution centre, the
the Finance Act, 2017, which may be referred to. ‘distribution loss’ occurs during the movement
of power from the receiving station through the
23.3.4  It may be mentioned that the cables upto the consumer point.
Memorandum to the Finance Bill clarifies that
the said amendment is introduced with a view to 24.2  The Transmission and Distribution system
encourage measures to protect the environment. in India has been developed and linked to the
Accordingly, the amendment intends to tax generating facilities i.e. the load centre. As SEBs
receipts from transfer of CERs, which are included were the key in establishing large thermal power
in total income of the taxpayer, at a concessional stations they also developed transmission network
tax rate of 10% as against corporate tax rate to distribute power to the consumer centre. The
of 30% plus being levied by tax authorities country had inadequate transmission, metering,
considering the receipts as business income. communicating, and controlling facilities, which
23.3.5 To summarize, the Section provides hampered the economic exchange of power
that, where total income of a taxpayer includes between different regions.
any income by way of transfer of carbon credits, 24.3 The T&D losses can be divided into (i)
gross receipts from transfer of carbon credits technical losses caused by–inadequate and
(without deduction of any expenditure or overloaded state grids, insufficient transformer
allowance) is subject to tax at the rate of 10% capacity, and losses due to stepping up and
(plus applicable surcharge and cess). down of the power transmission through the
23.3.6  Minimum Alternate Tax Applicability transformer; and (ii) normal losses in the
to CERs: As per Guidance Note on Accounting transmission system. The T & D losses are
for Self-Generated Certified Emission Reductions dependent on various factors such as:

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a. The distribution network system itself. as it is one of the factor which is seen by the
Regulator while approving the electricity tariffs
b. The existence of capacitors in the system.
in respect of various categories of consumers.
c. The length and area (spread) of the The utility gets negative marking for higher
distribution system. T&D loss than could reasonably be explained
d. The type of equipments used. as the Regulator will not allow inefficiency by
way of higher T&D loss to be passed on to the
e. The voltage at which the power is consumers. Therefore, there is little incentive for
transmitted-higher the voltage, the lower a utility to inflate the T&D losses. In case of doubt
the loss and vice versa. the authorities can call records of metering done
24.4  The type of consumers and the voltage at at the generating point, and at the receiving
which the power is taken by the consumers is point, which would yield the Transmission loss.
also a factor. For instance, if the power is sold to The balance would be Distribution loss.
an industrial consumer at a high voltage of 11 24.7  Wherever high T&D losses are claimed-it
KV, 33KV, 66 KV, then the T&D loss would be ought to be a gradual increase over the years
minimum as the entire consumption would get because of various reasons of both-the quality
recorded. In the event of distribution of power to of distribution system (such as quality of cables,
many consumers at lower voltage there would addition of capacitors, quality of transformers
be transmission losses due to the use of step- etc.), or conditions peculiar to the distribution
down transformers. area (like consumers being spread/ scattered
24.5  Technological factors also influence over large area requiring greater cable length).
the T&D losses. Earlier there was 11 KV If the consumers use gadgets of poor quality,
power distribution system. Later technological then also the Company would lose revenue and
improvements made it possible to transmit power this would be reflected in the form of a higher
at 66 KV, and then at 132 KV. Now it is possible T&D loss.
to transmit high voltage power at 400 KV. When
the power is transmitted at high voltage the 24.8  The greatest cause of concern in the T&D
transmission loss gets reduced. The transmission losses is the commercial loss or what is generally
losses are also impacted by the medium of known as theft of power. The AO should
transmission used i.e. aluminum cables, copper examine any excessive claim of T&D losses.
cables, etc., because different metals have The assessing officers need to examine the
different inherent resistance to transmission of T&D losses considering the facts obtaining in
power. A typical city distribution system, with each case.
compact distribution areas, would have lower
T&D losses as compared to a scattered state with 25.  ISSUES RELATED TO
long lines of transmission. Thus, demographic APPLICABILITY OF MAT—
distribution of consumers and the size of power EXCEPTIONS TO SCHEDULE VI
consumed by them also affects the T&D losses. IN THE COMPANIES ACT
24.6 The critical question is whether the Certain power generating and transmitting
claimed T&D losses are real or there is an companies have taken the plea of non-
element of doubt on their correctness. In view applicability of MAT provisions in their case.
of the establishment of the Tariff Regulatory The present Section 115JB was introduced
Commissions at the Central and State level, the from 01.04.2001. The main contention of the
scope for overstatement of Transmission loss is power generation/ transmission companies is
open to scrutiny by the Regulator (Commission) that Section 115JB(2) requires the assessee to

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prepare its profit and loss account as per part calculating the depreciation shall be the same
II & III of Schedule VI of the Companies Act as those which have been used in preparing
but as per Section 211 of the Companies Act, the accounts to be laid before AGM of the
the assessees, who are involved in the business Company. A coherent reading of the main
of generating electricity are exempted from Section 115JB and its proviso will show
maintaining the accounts as per part II and that the proviso is an enabling provision
III of Schedule VI of the Companies Act. It is rather than contradictory provision. The
contended that Section 115 JB (2) requires two accounts of power generating and transmitting
conditions to be satisfied: companies, including the profit and loss account,
as laid before the AGM are prepared as per the
a. assessee should be a company
Electricity Act, 2003. Thus the profit and loss
b. The provisions of Part-II & Part–III of account as per the annual report of the assessee
schedule VI to Companies Act must be company is the one which has been prepared
applicable to such company. according to the accounting policies, accounting
25.1 In the case of electricity generating/ standards and method and rate of depreciation
distributing companies, it is argued by them that contained in the accounts laid before the
these conditions are not satisfied together, such company in its annual general meeting. Thus
companies being governed by the Electricity the annual accounts of the assessee company
Act, 2003 and therefore Section 115JB will not fulfil the requirement of Section 115 JB(2) and
apply. Secondly the Section 115 JB(2) requires the first proviso under it. The book profit for the
that P&L account of such company should be purpose of Section 115JB can be easily derived
prepared as per Part–II and III of schedules VI and there is no inconsistency in applying the
to the Companies Act. However, proviso to this provisions of sec 115 JB. Legislative history
Section requires that P&L account should be of the provisions of MAT makes it clear that
prepared as per accounting policies, accounting the Electricity Companies are not excluded in
standards and methods and rates adopted for Section 115JB. The proviso to Section 115 JB(2)
calculating depreciation in preparing accounts is complimentary to the main Section 115JB
to be laid before the annual general meeting of and not contrary to it. Further legal arguments
the company. It is claimed that in the case of are elaborated in subsequent paragraphs.
a power generation/ transmission company, it is 25.3  Clarificatory MAT Amendment by the
not possible to fulfill both these conditions and for Finance Act, 2012: The Finance Act, 2012
that reason the provisions of the Section 115JB has inserted an Explanation 3 under Sub-section
shall not apply in the case of such assessee(s). 2 of Section 115JB. It has been clarified that for
25.2 Such an interpretation of Section 115 the purposes of Section 115JB, the assessee,
JB(2) is not harmonious and not as per the being a company to which the proviso to sub-
intent of the legislature. The proviso to this section (2) of Section 211 of the Companies Act,
Section instead of being contradictory to 1956 is applicable, has, for an assessment year
the main provision of Section 115 JB(2) commencing on or before the 1st day of April,
is only an extension of the main section. 2012, an option to prepare its profit and loss
The main Section 115JB(2) requires that the account for the relevant previous year either in
Profit & Loss Account should be prepared as accordance with the provisions of Part II and
per the Companies Act. However, the proviso Part III of Schedule VI to the Companies Act,
further states that in preparing the Profit & Loss 1956 or in accordance with the provisions of the
Account the accounting policies, accounting Act governing such company as provided by the
standards, the method & rates adopted for Income-tax Act,1961. The amendment does not

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say that the provisions of Section 115JB will be the decision of the Hon’ble Supreme Court in
applicable only from Assessment Year 2013– Ishikawajima-Harima Heavy Industries
14 but it has only given an option to prepare Limited vs. DCIT (“Ishikawajima”) [2007]
its accounts as per the provisions of the Act 288 ITR 408 (S.C.) to claim that the receipts
governing the power generation/ transmission are not taxable in India.
company. It shows that it has been clarified 26.2.1  In all such cases, the contract agreement
very clearly that the provisions are applicable should be called for by the AO and should be
since the inception of the Section 115JB in the examined meticulously. In many instances, it
Income-tax Act, 1961. The amendment is only would emerge that the agreement cannot be
clarificatory that the provisions of Section 115JB severed into supply of equipment and services,
are applicable on the assessee. but in fact, is a Composite agreement for the
installation of power plant with clear “cross breach
26.  INTERNATIONAL fall Clauses” wherein the failure/ dissatisfaction
TAXATION ISSUES in one part of the agreement would make the
26.1 Severance of Supply of Equipment entire agreement as null and void. The facts of
and Services in EPC/ Turnkey Contracts: the case can then be distinguished from that of
The taxation of Engineering, Procurement, and Ishikawajima-Harima Heavy Industries Limited
Construction (EPC)/ Turnkey contracts offers (supra). Consequently, it can be established that
various challenges and opportunities. The EPC the payments made for the import of equipment
contract can be structured as a single contract or and services needs to be brought to tax in India
as a divisible contracts. The selection of either (to the extent attributable in India). As a result,
option can cause a significant impact on the tax TDS needs to be made on the same. In default,
costs and working capital of the project. In many disallowance under Section 40(a)(ia) needs to
cases, the power plant and the related equipment be considered.
are imported from foreign entities. Such entities
are also contracted for onsite installation and, 27.  TRANSFER PRICING ISSUES
thereafter, for supply of expert personnel for 27.1  Shifting of Profits in Inter-unit
the operation of the equipment and also for Transfer between Eligible and Non-
imparting training to the domestic personnel. Eligible Units: The power sector has entered
26.2  Non Deduction of TDS and the domain of transfer pricing verification since
International Taxation Issues: In multiple the introduction of the provision relating to
instances, it has been found that no TDS was specified domestic transactions (SDT). As per
made on the payments being made to the these provisions, the transactions between tax
foreign entities. The foreign entity claims that exempt and tax paying entities are subjected to
the supply of equipment happens outside India scrutiny to identify whether the same had been
and, hence, is not taxable in India. Further, undertaken under arm’s length price conditions
the services which are provided as part of or uncontrolled/ third party conditions. Since,
installation and training do not “Make available” the entities generating power are eligible
anything substantial to the domestic assessee. for deduction u/s 80IA of the Act, there is a
For this reason, it is contended that the same is possibility that the profits of these entities are
not taxable as Fee for Technical Service (FTS). inflated by charging higher prices or booking
In certain cases the foreign entity asserts that lower cost allocations to these entities/ units.
the agreement is capable of being severed into The investigations which have been carried out
a supply of equipment agreement and a supply in the recent TP Audit cycles for which SDT
of service agreement and reliance is placed on transactions have been examined, significant tax

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evasion by booking higher than the ALP prices party from whom power has been purchased is
for the sale of power have been detected by the a distributor of electricity and is not a generator
transfer pricing officers. of electricity. The assets which are owned by the
27.2 The major issue which has emerged distributor include transmission and distribution
is that the power generating units sell power lines, load dispatch Centres as well as supporting
to other sister entities which are engaged in manpower and technical equipment to help the
manufacturing activities, e.g., a cement plant function. This is not a requirement of a captive
has a captive unit generating power and catering power producer which operates on equipments
primarily to the requirements of the cement like boilers and turbines, etc. Functionally, the
plant. Only in case of surplus the power is sold power generator is a manufacturer of power,
to third parties or electricity exchanges and in whereas, a distribution entity is a distributor or
certain cases, some power is mandatorily sold trader. The inputs for the power generator would
and fed to the government power distribution include raw materials viz., fuel, steam, water etc.
grid. Many a time, however, the manufacturing On the other hand, the input for the distributor
units need to buy power from external sources is a finally produced power itself and it does not
which are mainly the state electricity distribution do any processing to convert power into some
entities. It has been more or less a uniform other product. Considered thus, the two entities
practice that the price at which power is are not functionally comparable. As regards the
purchased from the distribution entities is used risks, the major loss of the distribution entities
as the price for the computation of revenue for is the transmission and distribution loss which
claiming the deduction of eligible power unit. In is completely inapplicable for a power producer.
the terminology of transfer pricing, the assessee Therefore, considering the FAR analysis, the
has used a comparable uncontrolled price (CUP) prices that a power producer charges cannot
which is the price at which the manufacturing or be compared with the prices that a power
non eligible entity or unit buys power from the distributor charges. Resultantly, adjustments
distributor entity or the market. The comparison have to be made to the rate for the functions
that has been done by the assesses while taking that the power producer does not do in order to
such a stand is that the transfer price rate is the arrive at the appropriate CUP for the transaction.
alternative source rate and had the captive unit A convenient and valid way to do so is to find
not been available, the rate at which power the rate at which power has been purchased by
would have to be purchased by it from the the distributor to which it has added value and
available alternate source is a valid CUP. In sold to the power consuming entities. Therefore,
other words, the assessee is comparing the rate the rate at which the power is purchased by
at which a power purchase transaction has been the distributor from whom the assessee has
made with a sister entity with the rate at which purchased power is a valid CUP and not the
power has been purchased from an independent rate at which the distributor has sold power. It
or third party. is pertinent to mention that this valid adjusted
27.3  This argument of the assessee has not CUP rate also takes care of the profit margin
been found to be valid one when the underlying that would have been charged by the power
principles of transfer pricing are applied. In producer while selling power to the distributor.
transfer pricing, the crucial elements are FAR This is an adjustment which is to be looked at by
which is the acronym for Function Asset and Risk. the TPO on a reference made by the AO.
If the FAR of the transaction is same or similar, 27.4  Another way of arriving at the appropriate
then only the prices under CUP method are pricing could be the determination of the cost
comparable. In the particular instance, the third of supply of power for similarly placed power

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producers and allowing them a return on 30. Purchase of Coal from AEs: In certain
capital, which is the criterion for profitability of cases, power producing units may have entered
the thermal power units as per Central Electricity into international transactions (or SDT) with
Regulatory Commission (CERC) guidelines. Associate Enterprises (AEs) for purchase of coal.
The TPO should explore the possibilities of using
28.  Case Study: In one case, the assessee had
CUP method. In this regard, he may examine
procured 255 million units (MU) of power from its
similar transactions undertaken by purchasing
AE which was an 80IA eligible unit. Towards this,
and selling parties with independent entities.
the assessee paid a fixed charge of Rs. 1.75/ Unit
Further, data available in the public domain, like
to its AE. From the perusal of the power purchase
TIPS database, Bloomberg Database and other
agreement, it was learnt that the assessee would
Indices in vogue in various countries capturing
supply fuel, raw water, service water/ potable
information of exports and imports, may also be
water and provide other utilities like switchyard
explored for application of external CUP.
required for generating the contracted portion of
power FREE OF COST to its AE. The assessee 31. Financial Transactions (Loans and
was asked to submit a comprehensive cost Guarantee): Since power plants involve huge
sheet incorporating the costs of all the above outlay of funds and are generally leveraged, there
items. The assessee then arrived at a cost price are financial transactions of loans and guarantees
of Rs. 4.27/ unit. Thereafter, the price at which between the Associated Enterprises. The TPO is
the power producers were selling power in the required to examine these transactions for bench
vicinity was examined. An independent search marking purposes. He should conduct FAR
was carried out on the website of IEX (Indian analysis and proceed to determine ALP. One of
Energy Exchange), where the average cost of the important aspects in benchmarking of loan
power sold by all the power generators in a transactions is the currency in which the loan is
particular region is available. The Arm’s Length to be repaid. This is because the foreign currency
Price (ALP) of power purchase was arrived at fluctuation risk is associated with the currency in
Rs. 2.51/ unit as against Rs. 4.27/ unit claimed which loan is to be repaid. It has been so held by
by the assessee. Consequently, an adjustment the Tribunals/ Courts (refer to the decision in the
was made to its income. case of Cotton Naturals–Delhi High Court). The
29.  In many cases of captive power plants, SDT TPOs, of late, have started using Bloomberg
transactions were scrutinized for determination Database for benchmarking of loans by
of ALP of power sold by eligible unit to non- conducting search into loan transactions using
eligible unit. Enquiries were conducted u/s. various filters. In addition to the transactions
133(6) and rate of power purchased by SEBs of loans between the AEs, the TPOs also come
and other entities functioning in the same region across the issue of benchmarking of guarantees
were collected and used as external CUP for the (corporate guarantees, performance guarantees,
purposes of determination of ALP. This resulted in letter of comforts). These transactions, after due
downward adjustment of ALP and consequential examination of FAR, may be benchmarked using
reduction in allowable deduction u/s. 80IA. CUP data or by way of interest saving approach.

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 Chapter

12
Ship Breaking Industry

1.  INTRODUCTION
1.1  Ship breaking is the name given to the
industry in which old and discarded marine
vessels are acquired, and completely dismantled.
Alang & Sosiya is the hub of ship breaking
activity in Gujarat. Alang, is a small town
situated in Bhavnagar district of Gujarat state.
In the past 3 decades its beaches have become
a major worldwide Centre for Ship Breaking.
The longest ship ever built “Sea wise Giant” was
beached and demolished in Dec 2009. There
are 183 ship-breaking plots in Alang and Sosiya distance, it should be shallow so that during high
villages. Together, they account for breakage of tide, the ship can reach up to the shore, and can
over 350 vessels per year, with aggregate weight be berthed right on the shore. Thereafter the ship
of over 26 Lakh tons. Large super tankers, car is dismantled beginning at the front and is pulled
ferries, container ships and occasional ocean- towards the beach as it is dismantled. The Alang
and Sosiya Ship breaking yards near Bhavnagar
liners are beached during high tide and during
in Gujarat, situated on the Gulf of Cambay on
low tide hundreds of manual laborers dismantle
the west coast of India, is considered one of the
the ship salvaging anything that is reusable and
most suitable locations for ship breaking.
reducing the rest to scrap, for usage in ancillary
business such as Re-rolling Mills, Ingots mfg. 2.  GENERAL INFORMATION
etc. During the year 2012–13 total 394 vessels
were demolished at the Alang and Sosiya Ship 2.1  The availability of ships for dismantling
breaking yards near Bhavnagar. One has to find depends on the international cargo freight
out a geographically suitable beach for such market. When the cargo traffic and international
freight rates are high, availability of ships for
activities.
dismantling becomes low and prices of ships go
1.2  Ship breaking requires a particular gradient up. Similarly, when international freight rates
of slope of the sea. The gradient should be very and cargo traffic is low, more ships become
steep at the beach, and thereafter, for some available for dismantling at lower prices.

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2.2  When the owner of a ship feels that a are not permitted in the ship-breaking yard.
particular ship is to be disposed off either In case, the ship has some cargo, it is liable to
because it is no longer economical to run it, or be confiscated. The Customs also prepare an
because the ship has met with an accident, he inventory of oil and lubricants contained in
contacts one of the several Agents who mediate the ship, and of electronic goods and goods of
in selling of ships, stationed at London, Dubai, consumption. Any sophisticated communication
Hong Kong or Singapore. These agents contact equipment on the ship is to be completely
their subagents stationed in India, most of them destroyed by the Customs authorities so as to
located at Bhavnagar. The subagents keep in prevent the same from falling into wrong hands.
touch with the local ship breakers, who may “Sounding” of quantity of oil is taken by the
be on a lookout for ships, mostly because they Customs authorities, and also by an independent
would already have dismantled the last ship Surveyor of ships. Once these formalities are
purchased or would be shortly completing the completed, the ship is “beached” in the “plot” of
process. The information about availability of the ship breaker. These “plots” are of various sizes
ships, the description of the ships, including its varying from 30x 90 meters to 120 x 90 meters.
name, height, width, name of the yard where The “beaching” of the ship can take place only
it was built, make and capacity of various during high tide. As discussed earlier, the gradient
generators, engines, motors and other similar of slope is very high at the beach, and thereafter
details are sent to the prospective buyers. On the sea is shallow. Thus, during high tide, the ship
receipt of this information, negotiations between can travel right up to the beach. Once the ship
the subagents and the ship breaker commence, is berthed, it is tied up with heavy metal chains
and the price is settled. The prices are in terms attached to 2 to 4 Winches. Thereafter, advance
of US Dollars per ton. Once prices are settled, payment of customs and central excise duty is
a Memorandum of Agreement (MOA) is signed made, and oil and lubricants are unloaded. Only
between the seller and the buyer, in which after unloading oil and lubricants, permission
details of the ship are mentioned along with to cut the ship is obtained in writing from the
the rate at which it is to be sold, the number of Maritime Board and Customs, and thereafter,
propellers and extra propellers, metal of which cutting of the ship is commenced. First of all, the
the propellers are made, time-period during cabin along with furniture, fixtures, furnishings,
which the ship is to be delivered etc. Once this electrical and electronic items, is disposed off.
agreement is entered, the seller brings the ship Thereafter, dismantling of other parts of the ship
to the safe anchorage in India. There the ship commences. The ship is dismantled from front
is inspected by the prospective buyer to verify and, simultaneously with dismantling, is pulled
whether it is as per the MOA executed by him. towards the beach.
If the ship is as per MOA, it is agreed to be
purchased and the ship breaker opens a Letter 3.  DETAILS OF DOCUMENTS
of Credit with the bank and releases the same EXECUTED
to the seller. If the ship is not as per the MOA,
the prospective buyer either rejects the deal, or 3.1  The following documents are executed
bargains with the seller for a lower rate. before dismantling of ship commences:

2.3  Thereafter, the officials of Customs a. Memorandum of Agreement (MOA)

department rummage the ship, to check whether b. Letter of Credit (L/C). Proforma of a typical
the ship contains any cargo, as ships with cargo L/ C is given in Annexure-7.

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c. Permission of boarding from Customs ship breaker and negotiable at the counters
authorities. of the sellers’ bank, payable to the seller.
Time of tendering “Notice of readiness”.
d. Permission of beaching from Customs
authorities. d. Documents agreed to be provided by the
seller to the ship breaker, e.g.:
e. Bill of Entry, and the inventory of bunkers,
foodstuffs, drinks etc.., prepared by the e. Signed Commercial Invoice and Bill of
Customs authorities. Sale with description of the vessel
f. Survey report, generally by an independent f. Certificate that the vessel is free from
Surveyor of ships. encumbrances/ debts/ mortgage/ lien etc.
g. Notice of readiness for delivery, physical g. Undertaking from seller that immediately
delivery certificate, (Proforma in on receipt of full purchase price, the vessel
Annaxure-9), deletion certificate, non- will be physically delivered.
encumbrance certificate, trim & stability h. Certificate of deletion from registering
booklet containing a blue print of the ship. authorities where the vessels is registered,
h. Bill of sale or commercial invoice. to be provided within two months.
i. LDT certificate from the shipping yard. i. Whether vessel is “laid-up” or is to be
delivered on the strength of its own power
j. Challans for payments of Customs duty,
(laid-up vessels are cheaper).
and various charges to Maritime Board.
j. Certificate of a reputed licensed Surveyor
k. Permission for breaking the ship obtained
certifying the metal of which the propeller
from Customs, and Maritime Board.
is made, (non-ferrous propellers are
l. Safety permit and Naked light certificate, valued at 6 to 10 times the value of ferrous
under the Factories Act. propellers) and also whether the weight of
3.2 MOA is executed between the seller of the the vessel is as per the “trim and stability
ship and the ship breaker on settlement of price booklet”.
and other terms of sale. It contains following k. The buyer also undertakes not to resell the
details: vessel under any circumstances.
a. Rate in US Dollars per Light displacement 3.3  Letter of Credit is released by bank of the
ton (LDT), and total price of the vessel. ship breaker to the bank of the seller, as agreed
b. Name of the vessel, its old names, place in the MOA, upon receipt of Notice of readiness
of registration, name of the yard where it from the seller. The L/C is irrevocable.
was built, length, breadth and the weight 3.4  Permission is obtained from the Customs
of the ship; type of engine, generator, for boarding of vessel for physical inspection, to
propeller, spare propeller, if any, spare tail verify whether the ship is as per terms agreed
shaft, if any, permanent ballast, the type of in the MOA. If the ship is as per MOA, the
construction of ship etc.. ship breaker agrees to purchase the ship, and
c. Mode of payment, mostly by irrevocable approaches the Customs to permit beaching of
letter of credit, opened with the bank of the the vessel at its plot.

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3.5 A Bill of Entry is prepared by the ship physical delivery certificate stating therein, that
breaker. It contains description of the type of oil, the ship is being handed over to the said person
stores, supplies, consumable goods, electrical in good floating condition. Within two months
and electronic goods found in the ship. On of sale of the ship, the seller provides a deletion
the basis of this declaration, customs duty is certificate from the registering authorities that
paid on the said goods. This is an important had registered the vessel, stating that the name
document. The quantity of furnace oil, light of this vessel has been deleted from their register.
diesel oil, lubricating and cylinder oil, and Light displacement tonnage (LDT) certificate is
various other oils is mentioned in the Bill of obtained from the ship-breaking yard where
Entry. In the assessment proceedings, the AO the ship was constructed. There is a register
may verify whether these oils, stores and other called Lloyds’ Register of Shipping, which is
supplies, have been disclosed either as Sales customarily accepted in International Shipping
or as closing Stock. It is normally claimed that trade, as authoritative record of ships operating
part of the oil was irrecoverable while some part in international waters. It contains details of all
was consumed by the ship between the time of old names of the ship(s), the shipyard where it
its inspection and it’s beaching. However, as has been constructed, and the bio-data of the
discussed later in this Chapter, this argument can ship. Further, to verify the details of the ship, the
be misleading. It is at times claimed that water ship breaker calls for LDT certificate from the
was found mixed with the oil. It may be noted yard in which it has been constructed.
that usually a certificate is given by the Master of 3.8  Bill of sale and commercial invoice mainly
the ship, Chief Engineer and the Superintendent state the details of the ship along with the fact
Customs that no water is found in the oil tanks. that the ship has been sold to the ship breaker.
Another document called “Inventory of bunkers,
food stuffs, cold drinks and other ship stores” is 3.9  Once the custom duty is paid, and the
also prepared. This is a declaration of the Master oil & lubricants have been removed from the
of the ship, duly verified by the Customs. ship, Customs and the Maritime Board permit
the ship breaker to start breaking of the ship.
3.6  Surveyor’s Report: Survey of the ship is This permission is conditional upon the ship
conducted by Licensed Surveyors, most famous breaker certifying that all oil has been removed.
of them being M/s Ericson and Richards. The
Thereafter, the Safety work permit and the Naked
Survey report contains verification of the metal of Light Certificate are obtained from authorities
which the propellers are made up. The Surveyor under Factories Act, and the dismantling of the
also takes “sounding” of oil and certifies the ship commences.
quantity of oil. They also certify whether the
“trim and stability booklet” is found on the ship,
and whether the ship has any leakage, ingress 4.  TYPES OF YIELDS
etc. The dismantling of ships yields Industrial
3.7  After the ship has arrived at the anchorage, machinery (lathes, boilers etc.) Electrical
and is ready for delivery, the Master of the ship machinery (Generators), Petroleum products
informs the Indian agent of the ship owner, that (Fuel Oil, Lubricants), Industrial materials, metal
the ship is ready for delivery. This, in turn, is (Ferrous and Non-ferrous sheets), Electrical,
communicated to the purchaser, and the L/C electromechanical & electronic appliances,
is released by the ship breaker’s bank to the (Generators, Domestic wares (Cutlery, Crockery,
seller’s bank. At the time of handing over of the linen), Communication equipment, Navigation
ship by the Master of the vessel to the agent of equipment & accessories, Tools and tackle,
the ship breaker, the Master also hands over a foods and beverage, furniture and fixtures,

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sanitary items and Safety devices etc. Further, the LDT of a ship represents its weight at the
the recovery of ferrous and non-ferrous metals time of its construction, it is possible to argue
is approximately as per Annexure-1. Most of the that the weight of the ship when it was delivered
material recovered, comprises ferrous metals. to the ship breaker, was much less than its LDT
However, the most valuable items in the ship are due to corrosion etc., suffered by the ship in
non-ferrous metals, which sell at up to 10–15 its operational life. Thus, quantity-wise tally
times the rate of ferrous materials. Large tax of the ship cut, and the material recovered
evasion is possible by understating the yield of is an extremely difficult, if not impossible,
non-ferrous materials, and instead, disclosing a proposition. This provides considerable scope
higher yield of ferrous materials. The yield of the for unscrupulous ship breakers to manipulate
non-ferrous material depends upon the type of production records/ data, and the valuation of
the ship. closing Stock to suit their convenience. Further,
since non-ferrous metals recovered are far more
5.  METHODS OF SHIP BREAKING valuable than ferrous material, showing higher
recovery of ferrous material and lower recovery
5.1  The main methods of breaking the vessels
of non-ferrous metals, has the advantage of
into big blocks of iron plates are:
showing good recovery in weight, but a lower
a. Dry dock method figure in terms of value/ price. This unstated/
b. Vessel moored at quay understated production of various materials
is then disposed of outside books. In this
c. Stern of the vessel moored towards the connection reference can be taken from the
quay fortnightly statements of Stock submitted to the
d. Side of the vessel moored along the quay banks (see Annaxure-8). The same can be useful
for verifying this issue. Further, co-relation can
e. Vessel grounded in the shallow that is
also be made with GST authorities to whom
beaching method
monthly returns in the form of GSTR-1 are
f. Special methods e.g.-Berthing on finger required to be submitted as per the prescribed
jetty; Fixed platform; Shiplift; Floating jetty Proforma. GSTR-1 is a monthly return of outward
5.2  Different ship breaking yards specialize in supplies. Essentially, it is a return showing all the
different methods of ship breaking & the same sales transactions of a business. If a person has
is being tabulated in Annexure-2. Similarly the entered into a transaction of supply of goods,
main equipments used in the ship breaking are then there must be someone who would be
tabulated in Annexure-3. the recipient of the supply of goods. Supplier
of the goods would be originating point of the
6.  METHODS OF TAX EVASION transaction and he would specify, in his return,
details of the supply along with the recipient to
6.1  Understatement of Production/ Yield/ whom supply has been effected. Thus, GSTR-1
Sales: Since the dismantling of a ship results in
is the base document which can be useful for
recovery of numerous types of material, most of
us to cross-verify the claim of the sales. GSTR-1
which are measured in different units, it is not
can be compared with the sales book/ Monthly
really possible to keep a complete day to day
Stock statement submitted to the bank.
quantity record of the recoveries of each of these
products. Besides, there are various losses in the 6.1.1  Sale Invoices are prepared at figures
process of ship breaking, e.g., cutting loss arising lower than the actual rate at which the goods
on gas cutting of metal plates. In addition, since have been sold. The bill amount is taken by

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Cheque/ Demand Draft and the balance is taken establish the market rate on a given day. Thus,
by cash. This activity is carried out not only in large cash Sales are affected without issuing bills.
respect of local Sales but also outstation Sales. When large amount of cash gets accumulated,
For example, in the course of a search, it was the requisite amount is introduced in the books
found that bills were issued at 70 to 80% of the as sale proceeds of Sales made to certain local
prevailing market rate for the class of commodity. traders, who may be genuine parties, but to
This amount was received by Demand Draft, whom no Sales would have been made.
while the balance was received in cash through 6.1.3  Information found during searches
the brokers. The purchaser was sending cash against many ship breakers, has brought out that
through angadia (courier), who would pay the the ship breaker first deposits his unaccounted
cash amount to the broker, and the broker would cash in the bank accounts of such parties, and
make payment to the ship breaker. then sale bills are issued in the names of these
6.1.2  Another method is to make cash sales parties, and the amount is shown as receipt
at market rate, without issue of bill and without of sale proceeds from these parties through
recording in books. Later, when cash is needed cheques/ DDs. These parties are paid small
in cashbook, this cash is introduced in the commission in cash, for their services. These
guise of Sales, albeit at a lower rate. The ship parties are generally active for certain period
breakers have to keep account of the weight of only. Thereafter they would shutdown their
the goods sold by them. There is little scope for business and start afresh with new name. They
manipulation of weight, although this is also being have complied with all agencies i.e they have
indulged in. However, most of the manipulation filed their return but shown meager income or
is being done in the rate of sale. For example, if in case of indirect taxes they have shown their
market rate for certain category of steel plates transactions at break-even margin. So, it is
were Rs. 32,000/- per ton, the Sales would be difficult to establish their bogus nature through
shown at Rs. 30,000/- per ton in the books. The assessment and shallow office enquiries. Thus,
balance Rs. 2,000/- will be siphoned away by the cash collected by the ship breaker from
the ship breaker. What makes things easy for the unaccounted/ unrecorded sales is pumped back
ship breaker and difficult for the department is into business. The main benefit, which accrues
that different grades of steel are obtained from to the ship breaker by such transactions, is that,
dismantling of ship, while same type of bill Sales are disclosed not at the going market rate,
may be issued for the entire disclosed ferrous but at a much lower rate. Further, since the
production, i.e. for mild steel. The bills may market rates are not easily ascertainable, and
not mention the grade of steel, which has been the quality of steel sold is not mentioned in the
sold. For example, steel of various thickness like bills, it is not possible for the AO to find out the
1”, 0.5”, 0.75” are sold, but the bills may only understatement of Sales. It is advisable to make
show ‘mild steel plate’, without any description random checks of sale rates, with those shown
about the quality or type or grade, or thickness by other ship breakers on the same day, it may
of steel. This problem is further compounded help.
because the price of steel changes almost every 6.1.4  During various actions it is also found that
day. Although the daily change is not very large it is a compulsion for a ship breaker to sell their
(plus or minus 1% to 2%), but since the rate stock as early as possible by whatever means i.e
is not uniform, and there is no agency to keep cash/ cheques. In the ship Breaking Industry it
watch on and/ or publish these rates. Again, the is a general practice that all ship breakers buy
nature of the sales is scrap sales. Therefore, it their ships through bank loans (CC/ LOU). For
becomes very difficult for the department to this bank loan they have to pay a good amount

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as interest. So in order to save this interest their that while sounding and reading of oil is taken in
primary focus is to finish the existing stock early, high sea when the ship is berthed at a distance
as possible, by way of cash/ cheques sales. For of 20 to 25 kms from the ship-breaking yard, the
example-a ship breaker avails a bank loan of ship is beached upto 15 days after taking this
Rs. 40 crore. Now, if we calculate the interest reading. It is claimed that during the intervening
@12%/ annually then that ship breaker needs to period and distance, oil and lubricant is used
pay around Rs. 40 Lacs/ Month as an interest. up. However, this argument is, to a large extent
Thus if a ship breaker sold their stock a month fallacious. Actually shortage in the oil depends
early then it will directly increase his profitability. upon the various factors which includes the
Therefore they always try to sell their stock situation of the tank, tank calibration, the
by whatever means as early as possible. By temperature of tank, balance of the tank, type
making the cash sales they generate huge cash. of vessels, last voyage of the ship, the density
Thereafter, in order to adjust the cash received of oil, the working life of the ship, the period
from the cash sales they have shown their sales after working lie to anchoring point, the stitch of
to various furnace plants/ rolling mills who in oil with tank etc. It may be noted here that the
turn purchases their stock from various scrap engine of the ship uses furnace oil for running
vendors/ cash sellers in cash only because they the ship and the generator uses diesel oil which
also want to regularize their books. This way supplies electricity to the rooms, kitchen etc.
they would take the bill entries of purchases When the ship is anchored at high sea, only one
from the ship breakers and purchase the stock or two generators of the ship remain working,
from various scrap vendors/ cash sellers. This and the engine of the ship is shut down. There
way both can successfully regularize their books is, thus, no question of using up any furnace oil
at agreed price and suppress the profit. In this since the engine is shut down. The generators
scenario, the AO can take the reference from the can also not use more than, say, one Metric
GSTR-1 and can conduct random checks with
Ton a day. Thus, only some margin can be
the sale rates shown by other ship breakers on
given for the consumption of oil by generators
the same day.
and for travelling from anchorage to berthing.
6.2 Sale of Oil and Lubricants: While the The balance quantity should be disclosed by
ship is in safe anchorage in sea, it is inspected way of Sales. Very often, the ship is brought
by Customs along with Surveyor of ship. They from anchorage to ship breaking plot by tugs,
take “sounding” of oil, as also the meter reading i.e. it does not travel on its own power, and is
of the oil tank. On this basis, they determine pulled by another vessel. In such cases, there
the quantity of various categories of oil and is no question of consumption of fuel oil after
lubricants like diesel oil, furnace oil, grease etc. the reading by Customs. If such disclosure is not
in the ship. They certify this for levy of customs made, the AO may take suitable measures.
duty. These details are available with the
Customs in the “Bill of Entry”. This document 6.3  Sale of Cabin Items: Each ship requires
is an excellent basis to judge whether the sale of several crew members to run it. Bigger the ship,
the full quantity of oil and lubricant present in more the crew members. All these crew members
the ship has been disclosed by the ship breaker have to be properly housed and fed. Besides, they
subject to consumption of oil during the period all have their working place on the ship. Thus,
of stay at the Anchorage. More often than not, ample space is provided for kitchen, bedrooms,
it has been found that sale of only 50% to 75%, working place, sophisticated equipment,
of the quantity as disclosed in ‘Bill of Entry’, is common room, bar room, emergency medical
disclosed in the books of accounts. It is explained room, stores etc. These cabins contain furniture,

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electric, electronic items like fridge, TV, VCR, CD etc. Thus, there is always ample scope to under-
players etc., depending on the type of the ship, value the closing stock. Therefore, the AO needs
the country to which it belongs and date, when to verify the sales of these items on the basis of
it is refurnished etc. Further, the cabin is made the size, utility, demand and sale recorded by the
of such items as plywood, fiber, fire wood, teak assessee in the books. Usually these machinery
wood etc. It also contains glassware, crockery, items are sold to willing purchaser but the ship
cutlery, and sanitary equipment. When the ship breaker discloses sales all by weight. Thus, they
is beached, various parties contact the ship suppress the actual amount of sales. Here the
breaker with offers to purchase all the above- AOs need to take care that the rates in GST is
mentioned items. The ship breaker accepts the different for different items and detailed analysis
best offer and all the above items are usually could result the suppression of some precious
sold in a lot. While dismantling and handing machinery items sale.
over these items, they are weighed and note 6.5  Valuation of Closing Stock: The closing
of these Sales is kept. Later in the books of stock of the ship breakers comprises of part-cut
accounts, the assessee does not disclose these ship, unsold machineries recovered from the
Sales to have been made as a lot to one party. ships in working condition, ferrous scrap, non-
Instead, he discloses some Sales of plywood, ferrous scrap, ropes, wires, tools, implements etc.
firewood, teak wood, sofa, chairs etc. and such At least, one of these items viz. part-cut or uncut
other items separately to separate parties. Thus, ships cannot be weighed. Thus, one cannot say
often while the cabin items are sold to one single with certainty whether 40% or 30% or 20% of
party as a lot, in the books of accounts, the ship the ship being cut, has been cut. There would
breaker discloses sales to number of parties, always be a margin of error in the estimation of
and of number of items, all by weight. Here the the uncut ship. This seemingly small margin of
AOs need to take care that the rates of GST is error of, say 10 to 20%, can mean a variation
different for different items and detailed analysis of 500 to 1000 tons that is Rs. 50,00,000/-
could result the suppression of some precious to Rs. 1,00,00,000/-. Usually ship breakers
electronic and fixture items sale. furnish fortnightly stock statements to banks. A
typical proforma of such statement is given in
6.4  Sale of Machinery Items: Items like
Annexure-8. This may be useful for verifying
machinery recovered from the ship cannot
the correctness of the closing stock disclosed to
be properly valued. The AO need to properly
the department and of course reference can be
scrutinize the sales of the items like Motors,
taken from the GSTR-1, which contains monthly
Generators, Cranes, Cylinders etc. There are
details of outward stock.
plenty of buyers available in the market who
can buy these items at any point of time. These 6.6  Payment of Black Money for Purchase
are heavy demand items and normally ship- of Ship Breaking Plots: All Ship breaking
breakers try to show the sales of these items plots in the state of Gujarat belong to Gujarat
either on the lump-sum basis or according to Maritime Board, which assigns permission to
their weight (as scrap sale). In fact a ship breaker utilize these plots on payment of certain charges.
himself does not know how much, for example, This permission to utilize ship-breaking plots is
a lathe machine would fetch him. Depending transferable. Thus, on paper, one ship breaker
on the customer, market situation, urgency of may transfer the permission of Gujarat Maritime
need the price of an item may vary 2 to 3 times. Board to utilize the ship-breaking plot, to another
Further, there are no norms on which to value ship breaker. Although, in practice, the plot is
such Stock i.e. at going market price, cost or transferred along with building, machinery etc.,
market price whichever is lower, or cost method in the books, often the ship breakers disclose

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such Sales at a nominal rate, on the ground that delivery of the ship. The payment for the ship is
the plot belongs to the Maritime Board. In one made on the expiry of 6 months from the date of
case, where a ship-breaking plot had changed delivery at the ship-breaking yard. For these 180
hands, on enquiry, it was found that the plot was days, the ship breaker has to pay interest on the
actually sold for handsome amounts. However, credit extended. This interest is generally paid to
when the matter was further examined, it a non-resident against the credit facility availed
turned out that most of the amount was paid for purchase of ship. Section 9 (I) (v) provides
for transfer of machinery (crane, winch etc.), that if interest is being paid to a non-resident,
building and some land near the ship-breaking then the interest payment is deemed to accrue
plot. However, no money had been shown for or arise in India. Therefore, tax is required to be
transfer of the permission of the Maritime Board deducted u/s 195, from the interest paid/ payable
to utilize the ship-breaking plot. This effectively to the nonresident. If such tax deduction is not
meant that the plot had been transferred without made, Section 40(a)(i) stipulates that the interest
any consideration. In another case, it was seen paid to the non-resident, cannot be allowed as a
that a very small amount had been paid against deductible expenditure.
the permission to utilize the ship-breaking plot.
6.7.1  However, in this connection, the
The explanation was that these plots were change in Section 10(15) vide Taxation laws
reserved for scheduled castes and scheduled (Amendment) Ordinance 2003 also merits
tribes, and there were no takers for the same. In attention. The amendment states that:
another case, the explanation offered was that
the beach appurtenant to the said plot was rocky “Clause (15) of Section 10 is a long provision
and therefore the plot commanded lower price. dealing with exemptions in regard to various
Someone else in this situation claimed that the categories of interest incomes. One more category
beach appurtenant to the plot was muddy and of such exempt income has been included in this
therefore the plot fetched a lower price. Thus, sub-section by adding a new sub-clause (iiib)
there are reasons galore, which are cited above with effect from April 1, 2001 which reads thus:
just as an indication of the nature of manipulation “(iiib) interest payable to the Nordic Investment
possible. The AO can call for details of transfer Bank, being a multilateral financial institution
of plots from the Maritime Board. Evidence constituted by the Governments of Denmark,
found during searches revealed that actually Finland, Iceland, Norway and Sweden, on
the ship breaking plots, being few in number, a loan advanced by it to a project approved
command a very high premium in black market, by the Central Government in terms of the
and usually their transfer involved exchange of Memorandum of Understanding entered into by
large amount of black money. Therefore, it is the Central Government with that Bank on the
necessary to obtain full details from the assessee 25th day of November, 1986.”
and the Maritime Board, and compare these
with the rates at which others have sold their plot 6.7.2  A new Explanation (numbered
at the same time. Explanation 2) has been added to sub-clause
(iv)(c) of clause (15) to clarify that ‘usance
6.7  Usance Interest: Before purchase of a interest payable outside India by an undertaking
ship, the ship breaker signs the MOA with the engaged in the business of ship breaking in
seller of the ship, containing full particulars of respect of purchase of a ship from outside India
the ship. One of the conditions normally (if the shall be deemed to be the interest payable on
ship is purchased by bank finance), is that an a debt incurred in a foreign country in respect
irrevocable L/C has to be opened by the ship of the purchase outside India. Further, in the
breaker for a period of 6 months from the date of Explanation 1 occurring below item (i), after

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Clause (d), the following Clause shall be inserted route, to the name of the consignor as well as
and shall be deemed to have been inserted with the consignee. Thus an E-way bill has to be
effect from the April, 1, 1991, namely: generated for all movement of goods—within or
outside a state—valued at more than Rs 50,000
“(da) the business of ship breaking; or”.
by prior online registration of the consignment.
6.7.3  In a decision in respect of this Section The supplier and the transporter can upload the
rendered in the case of Vijay Ship Breaking details about the shipment. An e-way bill will
Corporation vs. CIT [2008] 175 Taxmann 177, be valid for a day for a distance less than 100
the Supreme Court held that TDS obligation km. For every 100 km thereafter, the validity
arises only if the tax is assessable in India. Since will be an additional day from the relevant date.
in this case usance interest was read as exempt As per the Rule 138 of the CGST Rules, 2017
under the Act, the Apex Court held that there with reference to E-way bill mechanism states
was no question of TDS being deducted by the that ‘information is to be furnished prior to the
assessee. commencement of movement of goods’ and ‘is
6.8  TDS on Transportation Charges: One to be issued whether the movement is in relation
ossf the important inputs for cutting of ships to a supply or for reasons other than supply’. Till
is oxygen gas. LPG is burnt with oxygen to 31st May 2018, E-way bill generation for intra-
produce a flame, which cuts ships. Oxygen is state transaction was optional. However, from
provided by the oxygen manufacturewrs, some 1st June 2018 onwards, generation of E-way bill
of whom are sister concerns of the ship breakers. needs to be done for all types of transactions
The oxygen is supplied in cylinders, and as per where the distance is more than 10 km. Thus
normal business practice, a comprehensive from the E-way bill The AO can cross-verify
payment for oxygen manufacturing charges, the claims of the transporters/ suppliers. With
cylinder hire rent, and cylinder transportation, is the help of the E-way bill the AO can also cross
made. Thus, this transaction is in the nature of a verify the details of the actual seller/ purchase/
work contract. Therefore the person responsible value of the goods etc.
for paying any sum to the contractor for carrying 6.9 Compliance with the Provisions
out this work, is required to deduct tax @ 2% of Section 145A of the Act: In view of
of such sum. However, more often than not the the provisions of Section 145A of the Act,
provisions of Section 194C are not complied the assessee is required to determine its total
with. After implementation of GST, the AO can income by adjusting the purchase, sales and
check the purchase bill, where nature of the sale/ inventory by the value of tax, cess, duties, fees,
services is specified and GST applied accordingly etc. actually paid or incurred. Accordingly, when
and take the action accordingly.
the assessee specifically companies follows
6.8.1 In fact after rolling out the E-way bill exclusive method of accounting for purchases,
mechanism, things would be much easier than sales, the assessing officer is required to check
ever. E-way bill is an electronic documentation and examined the effect of adjustment of duties,
meant for tracking all the inter-state movement taxes, cess, levies, fees, etc. to the purchases,
of goods. This bill can be generated on the sales and inventories. Currently, indirect taxes
E-way bill portal. Post registration, for a specific are covered under CGST Act and IGST Act.
delivery a unique E-way bill number (EBN) Accordingly, the assessee is required to pay
is allocated to the supplier, recipient, and the Custom Duty and IGST (i.e. Integrated Goods
transporter. This e-receipt captures all the details and Services Tax) on the assessable value of
of the goods being transported right from point the ship determined as per Bill of Entry e-filed
of origin of the consignment, its destination and by the assessee. The AO is required to examine

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the Bill of Entry and Challans of Custom Duty of that M/s Maersk Line grants some financial
and IGST paid on the import purchase of ships relaxation to the buyer in the price but the
for demolition. In case of the assessee following buyer needs to go through a separate, rigorous
exclusive method of accounting in violation of audit carried out by Maersk for compliance. The
the provisions of Section 145A of the Income- price relaxation, thus increase the profitability of
tax Act but in accordance with the Accounting the ship breaker but on the other hand increase
Standards issued by the ICAI, the assessing the total time taken in dismantling process. The
officer is required to examine impact of IGST AO need to carefully consider these factors
on the profit for the year under assessment as the ship breakers may suppress the extra
since IGST is of recoverable nature. Where profit generated through green Ship re-cycling
the assessee follows the exclusive method of process.
accounting and claims reversal of Input tax credit
of GST, the AO is required to examine whether
such reversal of input credit of GST is allowable 7.  BYE LAWS OF GUJARAT MARITIME
expenditure in view of the provisions of Section BOARD
43B of the Income-tax Act, 1961. However, Gujarat Maritime Board (GMB) grants
the final conclusion would be based upon the permission to ship breakers to use the ship
appreciation of individual facts of the case. breaking plots. Thus, permission is of user only,
6.10  Green Plot and its Implications: The and is subject to numerous terms and conditions,
increasing waste and its improper management including payment of various charges. The ship
are one of the crises that countries across the breakers have no ownership right on the plots,
world are facing these days. Like any other whatsoever. The GMB charges Rs. 135 per
industry, the ship breaking industry, indeed unit of LDT for first year as recycling charges.
world’s biggest polluters, also creates a huge Further, GMB charges certain amounts for any
amount of waste every day. Therefore, in order change in constitution of partnership, change
to reduce the risks and impacts on workers in profit sharing ratios of the partners, etc. Such
and the environment of unsafe dismantling charges vary from Rs. 50,000/- to Rs. 2,00,000/-
practices & to provide safe storage, transport, Gist of some other financial provisions are as
and disposal options for hazardous materials mentioned in the Annexure-4.
derived from the recycling process have
given rise to a new term–green ship recycling. 8.  COMMERCIAL CATEGORIZATION
International Maritime Organisation’s Hong OF SHIPS
Kong International Convention for the Safe The recovery of ferrous/ non-ferrous metals, i.e.
and Environmentally Sound Recycling of Ships, percentage yield depends to a very large extent
2009 also strictly directed that vessels that are on the type of ship being cut. Usually bulk oil
being recycled after their service life should tankers, ore carriers, military vessels, etc. give
not pose any unnecessary risks to human higher yields. The various types of ships brought
health, safety and to the environment. Due to for dismantling is being given in the Annexure-5.
environmental norms, nowadays, Fleet owners 9.  Shipping Terms: Some of the shipping
such as M/s Maersk Line are seeking out recyclers terms generally used in ship breaking industry is
that have the capacity to recycle their ships at being given in the Annexure-6.
safe and environmentally responsible facilities.
10.  Proforma of some important documents
M/s Maersk does so by writing specific Clauses
into contracts with the intended buyers. In lieu 10.1  Letter of Credit—As per Annexure-7

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10.2  Stock statement—As per Annexure-8 asked to produce these parties. Naturally, some
of the parties could not be produced even after
10.3  Physical delivery certificate—As per
giving a number of opportunities. Some parties
Annexure-9
were produced, but it was clearly established
10.4  Commercial Invoice—As per during the course of their examination on oath
Annexure-10 that they did not have the capacity to introduce
lacs of rupees in their bank account, and to
11.  CASE STUDIES advance these to the assessee. The AO could,
therefore, probe the probability of substantial
11.1  In a search in the case of a ship-breaking
addition u/s 68 of the Act.
firm, it was found that the permission to utilize
ship-breaking plot of Gujarat Maritime Board, 11.3  In another case, the assessee had disclosed
was transferred by an outgoing concern to sale of certain quantity of furnace oil, diesel oil
the assessee. It was found that while the full that appeared to be on the lower side. The AO
consideration was approximately Rs. 3 Crores, examined the “Bills of Entry” in respect of all
only about 20% or approximately Rs. 60 lacs ships beached during the year. After the ship is
was disclosed in the books of accounts. The beached and before permission to start cutting
balance amount changed hands out of books. is given to the ship breaker, he has to certify
Similar transactions are taking place in which that all oil has been evacuated from the ship.
only part of the consideration is disclosed. Since the assessees does not have any storage
Several instances have come to light where no facility of oil, it can be safely inferred that by
payment is shown to have been made against the time the ship breaker certifies that all oil has
transfer of the ship-breaking plot. The disclosed been emptied, the entire quantity is sold. From
transaction would only show that plant and the ‘Bill of Entry’, the quantity of oil received
machinery, building etc. are transferred at book year-wise was available. However, in this case it
value. However, no amount is disclosed against was found that the assessee had disclosed sale of
transfer of the right to use the ship-breaking plot. only 50% of the total oil receipts.
11.2  In another case, it was found that the 11.4  Conclusion: While investigating the
assessee had opened bank accounts in the names cases pertaining to ship breaking the A O should
of several persons, including some employees. familiarize himself/ herself with the technical
Through these bank accounts, he would first terms of the industry and the prevalent by laws of
introduce cash, and then advance loans to his Maritime board. The AO should also be careful
firm as and when required. Some of the parties to study the type of ship dismantled during the
were small time traders who purchased scrap from relevant period. Needless to emphasize, the rules
Alang and sold in the open market. Some of the of GST, e-way bill, customs and labour laws will
names were altogether fictitious and could not be also play a major role in deciding the outcome
found on the given addresses. The assessee was of the investigation.

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Annexure–1
Recovery of Ferrous and Non-ferrous Metals in Ship-breaking
S. N. Metallic Recoveries Percentage Range
1 Reusable Steel Plates 0–5
2 Rerollable Scrap 60–70
3 Heavy Melting Scrap 5–10
4 Cast Iron Scrap 2–5
5 Non-ferrous Scrap 0.5–1
6 Nonmetallic Component (including wood) 3–5
7 Non Recoverable 10–15

(Source: Report of August 1997 of MECON, Ranchi, on ‘Present State of Ship Breaking in India’,
Ferrous Scrap Committee, Ministry of Steel, Government of India)

Annexure–2
Ship-breaking Yards with Specialization

S. N. Ship Breaking Method Ship Breaking Yards

1 Beaching the vessel bow forward during Alang, Sachana and
high tides with full force of the engine. Vishakapatnam
2 Mooring vessel along quay (berthing) Mumbai
3 Mooring vessel along quay (berthing) and Kolkata
dry docking

Annexure–3
Main Equipments Used in Ship Breaking
Activity Main Equipments
Preparation for breaking-up Oil Pump, Boiler, Cutting equipment
Breaking down to big blocks Floating crane, Tug boat, Rope carrying boat,
Cutting equipment
Breaking down to medium/ Gantry crane, Crawler crane, Hydraulic shovel
small sections with fork grip, Cutting equipment
Breaking down to members Gantry crane, Crawler crane, Cutting equipment
and pieces
Product delivery Forklift truck, Hydraulic shovel with fork grip,
Dumper truck, Truck Weigh scale

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Annexure–4
Gist of Various Charges/ Fees as per the Gujarat Government Gazette EX., 19-01-2016
a. Application money of Rs. 5 lakhs per plot is to be paid.
b. The amount of Security deposit is Rs. 5 lakhs per plot.
c. An annual development charges also needs to be paid to the GMB @ Rs. 2,700/- per Sq. meter
and will be escalated by 10% every three years.
d. An annual Plot rent is payable @ of Rs. 80/- per Sq. meter per annum.
e. The ship breaker has to pay to GMB, LDT charges @ Rs. 12/- per ton of ship broken. He is
bound to bring at least 30000 LDT of ships in each block of three consecutive financial years.
f. Dismantling permission shall be granted for ten financial years.
g. The plot cannot be used for any purpose other than ship breaking. Also any person other than
the ship breaker who has been so permitted cannot use it.
h. Separate permission needs to be taken for dismantling each ship, after oil and lubricants have
been unloaded from the ship.

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Annexure–5
Various Types of Ships Brought for Dismantling

Ship Types Basic Groupings

Liquefied gas tankers Liquid gas
Chemical tankers Chemicals
Oil tankers Oil
Molasses and, water tankers Other liquids
Bulk carriers, ore carriers Bulk dry
Bulk oil carrier, ore carriers Bulk dry/ oil
Self-discharging bulk carriers Self-discharging bulk dry
Cement, wood chips, urea carriers Other bulk dry
General cargo palletised cargo ships General cargo
Container ships Container
Refrigerated cargo ships Refrigerated cargo
Ro-ro cargo ships Ro-ro cargo
Container/ ro-ro cargo ships
Vehicles carriers
Landing crafts
Passenger/ ro-ro cargo ships Passenger/ ro-ro cargo
Passenger/ landing crafts
Passenger ships Passenger

Livestock carriers, Barge carriers, Heavy cargo carriers Other fishing

Trawlers, fishing vessels Fish catching

Fish factory ships and carriers etc.. Other fishing

Offshore support, drilling, well-production ships Other offshore

Research ships Research

Tugs, Pusher tugs Towing/ pushing

Dredgers, Hopper dredgers Dredging

Motor hoppers, sludge disposal vessels, crane ships, Other activities

cable ships, icebreakers etc.
Barges, pontoons, moored oil processing ships, moored Non-propelled ships
cement handling ships etc.
Yachts, sail training ships, naval auxiliary ships etc. Other ships structures

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Annexure–6
Some of the Shipping Terms Generally used in Ship-breaking Activity is given below:
Light Displacement Tonnage : The weight of a ship without stores, bunker fuel or
cargo.
Ballast : Water or solids like cement is used as ballast to keep
the vessel steady.
Bunker Tank : Ship-space for storing fuel (coal, oil, etc.)

Classification : Seagoing vessels of 100 GRT and more are built

under supervision of one of the officially recognized
classification societies, which have established rules
and regulations. For example, Lloyd’s Register of
Shipping, London.
Starboard side : Right side of the ship.

Port side : Left side of the ship.

Draught/ Draft : The depth necessary to submerge a ship to her load

line.
Bulkheads : To increase the safety of ship, it is divided into
watertight compartments so that in the case of
collision, the damage may be confined to one
compartment.
Hull Insurance : The Hull insurance policy covers the hull, machinery
and complete equipment of the ship.
Knot : A measure of speed, being one nautical mile of 6080
ft. Traversed in one hour.
Bonded goods : The goods deposited in a bonded warehouse until
such time as the duty upon them has been paid.
Lien : The right of holding goods until debt in respect of
such goods is satisfied.
Maritime Lien : Lien which travels with the ship even after change of
it’s ownership.
Bill of sale : A statutory document showing transfer of ownership
of vessel.
Rummaging : The search off a ship by customs for smuggled or
prohibited goods.
Laid-up ship : A ship which is not in use, put in a safe anchorage
with a view to activate it in future either for trading
or scrapping.

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Annexure–7
Typical Letter of Cedit Opened by a Ship Breaker is in the following Format:
Non-negotiable

Telex message no.

message from State bank of Saurashtra Darbargadh branch

Bhavnagar India

for SBI Frankfurt

: test non-negotiable for USD dated

opened our letter of credit no. dated for an amount not exceeding USD
favouring for account of for 180 days usance (hereinafter
referred as ‘beneficiary’) non-negotiable
(hereinafter referred as ‘applicant’)
and available by
beneficiary’s signed draft for maximum period of 180 days usance from the date of physical delivery
and opening bank for 100 per cent invoice value for delivery of old ship M.V. ex
for demolition purpose at Alang district Bhavnagar India. Draft must state drawn under our letter of
credit no. dated of stop drafts to be accompanied by the following documents in English.
1. Additional draft for USD for maximum period of 180 days usance drawn on applicant being
total purchase price of old ship M.V.
1a. Separate drafts drawn on applicant for maximum period of 180 days usance along with invoice
for USD being 7.5 per cent per annum interest amount for maximum 180 days usance from
the date of physical delivery, or at the prime rate of USA prevailing on the date of negotiation,
whichever is lower, as per MA dated ________. This amount is in addition to the L/C amount
and to be claimed on due date.
1b. Signed commercial invoice in sextuplicate certifying the details of the vessel as described below
and purchase price USD ___________ as per MA dated _________ and to mention L/ C number.

Description as under

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Techniques of Investigation for Assessment Vol. 3

Name (mention ex-names also) :

Type :
Built (year and country) :
Name of shipbuilder :
Converted (lengthened) :
Conversion year :
Flag and port of registry :
GRT/ NRT :
Original LDT :
Present LDT excl :
Permanent ballast :
Length (registered) :
Breadth :
Light draft :
Working propeller :
Spare propeller :
Spare tail shaft :
Main engine :
Auxiliaries/ generations :
Ballast tanks :
Insulation :
Construction :
2. Notarized/ legal bill of sale in favour of the applicant certifying that the vessel is free from all
encumbrances maritime liens and any other debts whatsoever duly signed under beneficiary’s
common stamps, dated and attested by notary public in Hamburg and/ or legalised by the Indian
consulate in Hamburg. The full name and designation of the signatories to the bill of sale should be
clearly specified on the bill of sale.
3. Original trim and stability book or capacity plan or letter from builders/ builders’ successors
substantiating the light weight or light ship displacement of the vessel as _______ metric tonnes or
__________ long tons excluding permanent ballast.
4. Certificate from the beneficiary certifying that the vessel at the time of delivery is free from all
encumbrances maritime liens and any other debts and liabilities of any description whatsoever, and
indemnifying the applicant against the consequences of any claim which have been incurred prior to
the time of delivery of the vessel.
5. Original certificate from registration authorities of the vessel’s present port of registry with their
seal and stamps and signed manually in original by concerned port authorities in the name of the
former owners certifying that the vessel_____________ is free from all encumbrances, mortgages,
maritime liens and debts on the vessel at the time of delivery of the vessel to the applicants. This
certificate must not be dated more than seven days prior to the date of negotiation of documents.

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6. Photocopy of bill of sale from the registered owners to ________________________ deleting the
purchase price.
7. Certificate from the negotiating bank certifying that they have paid the full purchase price of the
vessel ____________________ to the owner of the vessel as shown in the registration certificate.
8. Copy of the beneficiary’s telegram/ telex/ fax sent by beneficiary registered as owner in the
port of registry to the master of the vessel incorporating delivery instructions to deliver the vessel
___________________ physically to the applicant or their nominated representative on ‘as is where
is’ basis at Alang anchorage not before ___________ but not later than _________ unless extension of
delivery date is mutually agreed on condition as she is safely afloat port worthy, virtually intact, free
of fire damage, free of arms and ammunitions, free of hull leakage, free of cargo, charter fee, having
all her anchors in working condition and under her own power during business hours of a working
day, with repeat message to the applications.
9. Letter of undertaking from the beneficiaries guaranteeing that they will submit to the applicant a
deletion certificate from the authorities of the vessel’s port of registry as soon as possible but not later
than months from the date of delivery.
10. A tested telex/ cable from opening bank confirming that the applicant have received the notice
of readiness from the beneficiaries’ agent in Alang and that the vessel has been physically delivered
safely afloat at Alang anchorage.
11. Certificate from applicant that the vessel has been successfully beached at plot no. ________ at
Alang.
Special Instructions
1. All bank charges outside India are for beneficiary’s account including L/C advising charges of L/C
advising bank, whether L/C is Utilised or not.
2. Last date of delivery under this credit is ___________ and of negotiation is __________.
Instructions to the Negotiating Bank
1. They should invariably confirm prime rate prevailing on the date of negotiations of documents.
2. They should forward to opening bank the drafts and the original documents by the quickest
possible means i.e. international air courier service on the date of negotiations itself.
3. Please advise opening bank by urgent telex at no. ___________ or by cable addressed to branch,
____________, India receipt of documents in conformity with the letter or credit terms.
4. The negotiating bank should obtain reimbursement on due date as confirmed by opening bank
from ___________________________ certifying therein that the terms and conditions of the credit
have been complied with.
5. Negotiating bank to negotiate/ discount documents for USD _______ only of the invoice/ draft
amount and balance of USD _______ to be released by negotiating bank only if tested telex message
within seven days of negotiation is sent by opening bank to negotiating bank confirming successful
beaching of the vessel _________________ at plot no. ______ at Alang and also confirming receipt
of certificate of Lloyd’s approved agent duly counter signed by the applicant and Notarized by
public notary in Bhavnagar certifying therein all the details of vessel ____________ as described

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in Clause 1b of this letter of credit. The surveyors will also specifically confirm light displacement
tonnage excluding permanent ballast and weight and material of propeller and tail shaft of the vessel.
This is an operative instrument and no mail confirmation will follow. Please advise the beneficiary
accordingly. Please note that L/C advising charges, if any, to be paid by beneficiary whether the
L/C is Utilised or not. We hereby engage with drawer’s endorsers and bonfire holders of the drafts
drawn under and in compliance with the terms of this credit that such drafts shall be duly honoured
on presentation and delivery of documents as specified above. Except as otherwise expressly stated
this credit is subject to the uniform customs and practice for documentary credits (1993 revision)
International Chamber of Commerce publication no. 500.

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Annexure–8
A Typical Proforma of Fortnightly Stock Statement Given by a Ship Breaker to his
Bankers, is as Under:
State Bank of Saurashtra, Darbargadh branch, Bhavnagar
Fortnightly Stock statement as on ___________ M/s
PART–I

(a) Name : M.V.

(b) C.C. a/c no. :
(c) Import price :
(d) Total import price :
(e) Usance interest :
(f) Total import price with usance interest :
(g) Conversion rate :
(h) Total import price with usance int. :
(i) Other landing expenses
a.Custom :
b.Excise :
c. Port charges :
d. Insurance premium :
e. Beaching charges :
f. Other (bank charges) :
total :
(j) total landed cost. (h + i) :
(Rs. per M.T.)
(k) Average landed cost :
(l) Average cutting cost per LDT/ M.T. :
(m) Average total cost of broken Stock :

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PART–II UNBROKEN STOCK

M.T.
(a) Stock as on last fortnight :
(b) Stock broken during the fortnight :
(c) Stock as on the date of statement.
(a-b)
(d) Value of Stock as on the date of statement :
PART–II A SEMI-BROKEN STOCK
(a) Stock as on last fortnight :
(b) Stock broken during the fortnight :
(c) Total semifinished Stock :
(d) Goods finished :
(e) Stock of semi finished goods :
PART–III BROKEN STOCK
(a) Stock as on last fortnight :
(b) Stock broken during fortnight :
(Part II (b) less 10% cutting loss)
(c) Total broken Stock (a + b) :
(d) Stock sold during fortnight :
(e) Stock as on the date of statement :
(c-d)
(f) Value of the broken Stock :
PART–IV: TOTAL STOCK/ RECEIVABLES
(a) Total unbroken stock (Part-III)
(b) Total broken stock (Part III)
(b-1) Total semi finish stock (Part II-a) :
(c) Total stock (a + b) :
(d) Receivables :
(e) Total stock & receivables (c + d)
F.D.R. :
L.C. :
TOTAL :
PART–V PROGRESSIVE REPORT
Sales
(a) Sales upto last fortnight :
(b) Sales during this fortnight :
(c) Total Sales upto this fortnight :

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(d) Book-debts as on last fortnight :

(e) Gross addition to book-debts during :
fortnight
(f) Total book-debts. (d + e) :
(g) Book-debts realised during fortnight :
(h) Book-debts as on this fortnight :
(i) Deposit in CC/ TDR/ CD out of sales :
Certified that the details mentioned as above reflect the true and correct position obtained from out
of books of accounts. We also certify that the assets shown above are exclusively of our ownership
and no any other persons/ institute has any interest, line or charge thereon.
Date: Authorised Signatory

-------------------------------------------------------------------------------------------------------
(for bank’s use only)
Received on verified on entered on signature
Remark if any:
(1) Credit received upto last fortnight Rs.
(2) Credit received during the fortnight Rs.
(3) Total credit received upto fortnight Rs.

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Annexure–9
A typical physical delivery certificate issued by the Master of Ship, while handing over
possession of the ship to the ship breaker is in the following format:

I, ____________________________________ Master of the vessel M.V./ ____________ do hereby

physically deliver the said vessel at ALANG Anchorage at __________ hours on ________________.
The vessel is delivered safely afloat port worthy virtually intact charter free, free of cargo, free of hull/
stern gland leakage seepage, free of fire damage, free of arms and ammunitions, having both her
anchors in working condition and under her own Power/ tow. The vessel is delivered with everything
on board including __________ working propeller, __________ spare propeller ______ spare Tail
Shaft/ but excluding the personal effects of Master, Officers and crew and any Items on Hire.

As per the terms of the relevant MA between Buyers and the Sellers for M.V./ M.T. _______________
__________________________ and under Instructions from the Sellers the vessel is hereby delivered
to M/s. __________________________________ __________________________________________
______ represented by Mr. ____________________________________________________ to whom
I am also handing over all classification certificate and/ or copies for hull, engines anchors etc..
including ship’s Registry Book.

I, hereby confirm that the undersigned and Officers/ Crew of the vessel do not have any outstanding
dues on the vessel.

For _________ SHIPPING SERVICES PVT. LTD. (as seller’s agents)

MASTER

Taken delivery of M.V. ___________________ at ________ hours on _________ at ALANG/

ANCHORAGE at ALANG.

(Sd/-)

____________________________________________________________________________________

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Annexure–10
LETTER HEAD OF FOREIGN SUPPLIER
DATE: INVOICE NO.
PLOT NO. ______ SRY, ALANG,
DIST. BHAVNAGAR,
GUJARAT, INDIA.

COMMERCIAL INVOICE
WE CERTIFY THE DETAILS OF THE VESSEL AS DESCRIBED IN THE FIELD 45A
AND STATING TOTAL PURCHASE PRICE IN WORDS AND FIGURES USD (US

DOLLARS______________________________________________________________________

_______________________________) (INTEREST FREE) AS PER MOA DATED ___________________,

2016 AND ADDENDUM 01 DTD. _____________ L/C NO. _________________________.

45A: DESCRIPTION OF GOODS OR SERVICES DESCRIPTION OF THE VESSEL

NAME: _____________________________________

EX. NAME:__________________________________

TYPE:______________________________________

BUILT: ______________________________________

FLAG: ______________________________________

IMO NUMBER: ______________________________

LIGHTWEIGHT: _____________________________

WORKING PROPELLER: _____________________

DELIVERY: _______________________________________________,

ANY ADDITIONAL GENERATOR, EMERGENCY GENERATOR OR ANCHOR, STORES AND

SPARES, SPARE PROPELLER BLADE OR SPARE PROPELLER, SPARE TAILSHAFT, ANY

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Techniques of Investigation for Assessment Vol. 3

PERMANENT BALLAST, ANY CONTAINER, ANY PONTOON, LASHING MATERIAL, BUNKER

THOUGH NOT MENTIONED IN MEMORANDUM OF AGREEMENT BUT FOUND ON BOARD
WILL BE BUYER’S PROPERTY, WHICH IS INCLUDED IN THE COST OF SHIP.

L/C NO. DATED

........................................................ Director

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 Chapter

13
Road Transport
1.  INTRODUCTION
Road transport is a dominant mode of transport
in India, both in terms of traffic share and in
terms of contribution to the national economy.
Apart from facilitating the movement of goods
and passengers, road transport plays a key
role in promoting equitable socio-economic
development across regions of the country. Easy
accessibility, flexibility of operation, door-to-door
service and reliability have earned road transport
greater significance in both passenger and freight
traffic vis-à-vis other modes of transport. India
has one of the largest road networks of over 2.  The economic impact of roads on the GDP
56.17 lakh km comprising National Highways, of any country is immense. Higher the density
Expressways, State Highways, Major District of National Highways, higher is the Interstate
Roads, Other District Roads and Village Roads. Trade (Export + Import) as a percentage of
The table below shows the length distribution of Gross State Domestic Product (GSDP) in Indian
road network in India: States (Figures-A & B). A positive relationship

Road Network Length (km)

National Highways/ Express Way 1,15,530

Satate Highways* 1,76,166

Other Roads* 53,26,166

Total 56,17,812

Source: Ministry of Road Transport and Highways

Note: *As on 2015–16

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exists between density of NHs and the per 3.  STRUCTURE OF ROAD TRANSPORT
capita income in Indian States. Higher the   BBUSINESS
density of National Highways, higher is the 3.1 Usually, a large-scale transport operator has
per capita GSDP. Roads continue to constitute his own fleet of lorries. He may also hire lorries from
a significant component of India’s logistics others for carrying goods, when the business so
industry, accounting for 60 per cent of the demands. He also has a specified number of routes
total freight movement. Rapid progress in on which he is permitted to carry the goods. Branch
augmenting road infrastructure in recent years offices or agents are located along these routes for
is leading to efficient usage of road transport, attending to booking and delivery of consignments
given its ability to facilitate last mile connectivity from and to different places. The hierarchy of offices
and integrate various modes of transportation. may comprise the Booking-cum-Delivery offices,
India’s road freight market is valued at $150 Regional offices (variously known as Zonal office,
billion and is growing at a CAGR of 12%. Major Divisional office etc.) and the Head office.
players in this business include such marquee 3.2 The business of road transport begins at
names as Transport Corporation of India Ltd., the ‘Booking-cum-Delivery Office’. These are
Gati Infrastructure Pvt. Ltd., Sical Logistics Ltd., usually small offices and may be located in
Best Roadways Ltd. and All Cargo Logistics. metros as well as in small towns. Wherever there

Figure-A
Density of NHs and Trade as per cent of GSDP
Source: Ministry of Road Transport and Highways

Figure-B
Relation between Density of NHs and per capita GSDP
Source: Ministry of Road Transport and Highways

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 Road Transport

is no branch of the operator, there may be an d. Vouchers: These are prepared for local
arrangement for booking and delivery through lorry hire expenses and also relate to hire
a local agent. The ‘Booking-cum-Delivery charges incurred for engaging local lorries
Office’ accepts consignments from consignors to pick up consignments from consignors’
for transport to different destinations. It also doorstep or to make door delivery of
receives consignments from other stations for consignments at the destination station.
delivery to consignees. A booking office may e. Vouchers for Other Expenses are
be a local branch office or it could also be a prepared to vouch for expenses that may
regional or a higher-level office in the hierarchy. be incurred by a booking office on office
A booking office may transport goods on its own maintenance, stationery, telephones, petty
or may send the consignments to a nodal centre cash expenses, etc.
for transportation in a consolidated manner. It is
imperative for the Assessing Officer to understand 4.2  It is likely in some cases that the booking
the location and layout of various offices of office may not maintain elaborate accounts of
the transporter as well as of the agents so as transactions and instead may send periodical
to understand the overall business operation statements or reports to its controlling regional
and examine critical nodes of the network for office. Usually a statement of income and
ascertaining the likely tax evasion. expenditure along with supporting vouchers is
sent periodically.
4.  THE DOCUMENTS 4.3  E-way Billing: E-way Bill is an Electronic
Way Bill for movement of goods to be generated
4.1 Following documents are generally
on the E-way Bill Portal. A person registered for
prepared at the ‘Booking-cum-Delivery Office’:
GST cannot transport goods in a vehicle whose
a. The Consignment Note: It is prepared in value exceeds Rs. 50,000 or the applicable
multiple copies, one each for the consignor, amount (Single Invoice/ bill/ delivery challan)
the consignee, the controlling office of the without an E-way bill that is generated on https://
booking office, the destination office, and ewaybillgst.gov.in/. Alternatively, E-way bill can
one copy for the driver to carry en-route. also be generated or cancelled through SMS,
b. The Lorry Hire Contract: It is a very Android App and by site-to-site integration
important document and contains details through API. When an E-way bill is generated,
of the contract between the transporter a unique E-way Bill Number (EBN) is allocated
and the owner of the lorry being hired. and is available to the supplier, recipient, and
It contains information like lorry number, the transporter. Unregistered persons are also
starting station and destination station, required to generate E-way Bill. However,
number of packages loaded, weight of where a supply is made by an unregistered
the consignments loaded, the rate of hire person to a registered person, the receiver will
agreed upon, the total hire to be paid, have to ensure that all the compliances are
advance hire paid to the driver, details of met as if they were the suppliers. Transporters
fuel filled, etc. carrying goods by road, air, rail, etc. also need
to generate E-way Bill if the supplier has not
c. Lorry Challan: It is another important generated an E-Way Bill.
document prepared at the booking office.
It is prepared for each lorry engaged
5.  EXAMINATION OF ACCOUNTS
to carry goods, and contains details of
consignments carried on that particular 5.1 The modus operandi of tax evasion in the
lorry. case of road transport operators does not differ

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from that of other assessees, as they can also 6.  SUPPRESSION OF FREIGHT RECEIPTS
resort to suppression of receipts and inflation 6.1  In some cases, there may be strong reason
of expenses. The specific method followed to to suspect suppression of freight receipts. This is
conceal income, however, varies from case to more likely to happen in case of cash receipts.
case and requires a clear understanding of the Unlike inflation of expenses, suppression of
business set-up, nature of transactions at various receipts does not require fabrication of evidence.
stages and knowledge about the business practice Rather, it requires destruction or concealment of
followed by the consignors. The investigation in evidence. This requires the Assessing Officer to
such cases may result in unearthing tax evasion take recourse to indirect means to establish the
and a sustained and patient examination of the suppression.
various registers maintained can also lead to 6.2  Under the Motor Vehicles Act, 1988 every
finding concealment relating to purchases, sale, commercial motor owner is under a statutory
stock in the cases of the consignors, consignees obligation to maintain a ‘Good Vehicle Record’,
and such related parties. wherein day-to-day details of the movement of
5.2  As already mentioned, a transporter the vehicle and cargo carried by it are entered.
operates through many branch offices. Expenses Besides, the assessee itself may maintain similar
under major heads are incurred at the booking record (like ‘Trip Account Sheet’) for monitoring
offices. The freight receipts are also collected at expenses incurred in respect of each of its own
the booking office. Since the management is vehicles. These records contain details of the
not directly connected with collection of receipts movements of the vehicle and the freight carried
by it. In addition, there is also another important
and giving out cash for expenditure, it has to
document, called ‘Challan’/ ‘Bilti’, carried by the
necessarily depend on its lower level employees
lorry driver or the conductor, which records the
at branch level offices to siphon off cash by
details of the goods carried on that particular
inflating expenses or by suppressing income.
trip. These records can be used to verify whether
Thus, for a big transport operator with branches all trips and the connected freight receipts have
spread over different parts of the country, the been properly accounted for in the books of
siphoning off of cash can take place only at account of the assessee.
a few selected offices through a few trusted
employees. It should be kept in mind that large 6.3  The ‘Trip Account Sheet’ and other similar
scale operations have strict internal checks and record maintained by the assessee will have
balances to keep the employees in control and full information of the lorry’s trips and also
the management would have a regular reporting consumption of fuel. Even kilometre readings
at the start and end of a trip are noted. From
mechanism of its own. If such documentation
the distance covered by a lorry and the standard
is detected during the course of search/ survey
freight rate per tonne per kilometre, it is possible
operations, it may yield good insight into tax
to work out the freight earnings by a particular
evasion.
lorry during a given year which can be compared
5.3 The examination of accounts and line of with the receipts shown in the books of account.
investigation depends on the fact whether the Claims of empty return trips can also be verified
assessee owns or hires the vehicles used for from the trip sheets. The assessee may also be
transportation or has a mix of both. This fact called upon to furnish party-wise and lorry-
needs to be ascertained before commencing wise earnings. Party-wise earnings may be cross
detailed investigation as this would determine verified with the parties concerned and lorry-
the focus of investigation. wise earnings can be checked to see if they are

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commensurate with the distance run by the lorry. 7.2 Tyres and Tubes Expenses: This is
The AO may also examine the suppression of another major item of expenditure, which can
income from passengers/ goods on empty return be inflated easily. Usually, the assessees have
trips. a system of monitoring use of tyres. After
understanding the system followed, relevant
7.  INFLATION OF EXPENSES information i.e. purchase details/ retreading
details etc. may be cross verified with parties.
Major issues where there is a likelihood of
In such circumstances, fictitious billing is also a
inflation of expenses are as follows:
possibility to be checked.
7.1 Lorry Hire Charges: In the case of the
business being run on hired vehicles, a major 7.3  Fuel Expenses: The assessee may be
item of expenditure is the lorry hire charges paid inflating expenditure on fuel consumed also.
to third parties. There may be two types of lorry Most purchases are likely to be from one or a
hire charges paid; the assessee may be hiring few petrol pumps on a regular basis. It should
lorries for carrying goods from one station to be possible to work out the average fuel
another station or for local pick-ups and door consumption by the assessee’s lorries from their
delivery. The records maintained are likely to be trip sheets. Abnormally high consumption of
different for both kinds of hire charges. Local lorry fuel should always be examined in-depth. The
hire charges are petty amounts, normally paid in average fuel consumption can be verified from
cash and supported by the assessee’s self-made the websites of the vehicles manufacturers.
vouchers. Hire charges for long distance hiring
7.4  Other Expenses: Like repairs and
are normally of large amounts and are based
maintenance, salaries, advertisement, loading/
on the lorry hire contract, which is prepared in
unloading etc. may also require to be investigated
multiple copies. However, in a small operator’s
in particular cases. Copy of accounts of third
case such elaborate documentation may not be
parties invariably be called for by issuing notices
available as these are oral agreements. Wherever
possible, party-wise and lorry-wise details of the u/s 133(6) and summons/ commission and be
hire charges paid must be obtained and cross cross-verified with the books of account of the
verified with the lorry owners. If the assessee’s assessee.
records are not computerised, these details can 7.5  Bogus Depreciation Claim: In case of
be got computerised and then analysed party- large fleet owners, depreciation claim on second
wise and lorry-wise. The lorry numbers must be hand vehicles must be verified. Investigation in
got verified with the Road Transport authorities several cases has revealed that as the vehicles
and/ or website vahan.nic.in. It may, sometimes, age, the receipts are reduced to show low profit
emerge that hire charges are claimed to have as there is a lesser depreciation claim.
been paid for non-existent lorries, or for lorries
that were never at the place from where they 7.6  Scrap Sale: Depreciation on commercial
are claimed to have carried the goods for the vehicle is always higher, and so the WDV
assessee. It may be also found that the same lorry reduces substantially after 4/ 5 years. Also, big
is claimed to have plied to different destinations transporters do not use old vehicles and keep
(say, from Nagpur to Chennai and also to New selling vehicles as scrap. The scrap value should
Delhi) on the same date. Such evidence will be checked as to whether it is reasonable or
establish that the assessee is booking bogus hire not. Sale value is to be reduced from the block
charges. of assets for correct depreciation claim.

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8.  ROAD TRANSPORTERS CATERING 9.3  All these receipts are credited to an account
TO SHIPPING INDUSTRY in the books of the agent called the “Vessel
Voyage Collection Account”. The payments
Transport of bulk or Container cargo from
to various contractors such as transporters,
ports to destinations hinterland is a major part
stevedores, and other payments towards inland
of the road transport operations. However, the
haulage, freight rebate, and freight brokerage are
nature of this activity is in many ways different
debited to an account called the “Vessel Voyage
from inland transporters. These transporters are
Disbursement Account”. These accounts are
closely connected with Shipping and Clearing/
maintained vessel-wise and voyage-wise.
Forwarding agents.
9.4 There are certain expenses not directly
9.  SHIPPING AGENTS related to the voyage such as repair of the
Principals’ containers, which are directly debited
9.1 The functions of Shipping agents include to the Principal’s general account. The only
canvassing for and managing the business of expense pertaining to the voyage, which can
their Principals (i.e. the foreign ship owners/ be debited after the remittance of the freight,
Charterers) in India. They have to strive for is the ground rent charged by the Port Trust.
maximising the freight/ cargo being carried on One of the expenses debited to the “Vessel
the ships of their Principals arriving at Indian Voyage Disbursement Account” is the agency
ports. They provide services to the Principals’ commission receivable by the agent, which
ships while in Indian ports and are responsible is then credited to the agent’s P&L a/c. Other
for loading and unloading of containers/ cargo receipts and payments from the Voyage accounts
on these ships. In turn, they engage various are not credited or debited to the P&L account of
contractors for providing services, for example, the agent. The balances of all accounts however
transporters for handling the cargo inside the appear in the Balance Sheet of the Agent. The
port, Stevedores for stuffing and destuffing Agent’s P&L account, on the other hand, reflects
the cargo, Chandlers for provisions supplied receipt of agency commission and expenditure
to the ships, etc. The agents collect the freight incurred in maintenance of staff and office etc.
and make payments to these contractors. They
receive agency commission for rendering these 9.5  Another charge collected by the Agent from
services. Shipping agents also undertake the the Shipper (importer/ exporter), on behalf of the
work of handling the import/ export cargo of Principal is called “Container Detention Charge”
Indian importer/ exporter. (CDC). This charge is collected at rates fixed by
the Director General (Shipping), and Port Trusts.
9.2  The accounting system followed by This is dependent on the number of days that
Shipping agents needs to be understood. The the container remains within the port.
shipping agents receive the Gross freight,
Terminal Handling charges (THC), and Inland
10.  CONTAINER HANDLERS/
Haulage charges (IHC) from the importers/
TRANSPORTERS
exporters referred to as the Shippers. The THC
is fixed by the port authorities and includes 10.1  The shipping agents engage transporters/
transportation and handling charges for the container handlers for transportation within the
containers inside the port and stevedoring Port area as well as for inland transport. Often,
charges for stuffing and destuffing of containers. the transporters, in return for the contracts
The IHC is for transportation of containers from received, pay cash kickbacks/ commission to the
the Inland Container Depots (ICD) to the port of Shipping agents. Container handlers by the very
shipment. nature of the services provided couldn’t have

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unaccounted receipts except in one specific 10.4  Cash Cartage: Another area of
function ‘cash cartage’, discussed later. They concealment detected in the cases of such
have to account for their receipts because the transporters, pertains to suppression of cash
Shipping agent who is making payment to cartage receipts. Cash cartage refers to receipts
them is doing it on behalf of its Principal, and of cartage in cash at the Container Freight
each and every payment has to be accounted Stations (CFS) in the port area for loading and
for. Moreover, it is a deductible expense for unloading of containers. The main business of
the shipper, and he in turn requires bills for the these transporters is movement and handling
same. Hence, to generate the required cash for of containers inside the Port area. They
paying cash commissions to the Shipping agent, receive stuffed export containers after custom
the transporter has to book bogus expenses. examination, at pre-designated points called
The rates fixed between Shipping agents (on CFS. The transporter is required to load the
behalf of the Principal), and the transporters are containers on to his trailer at the CFS, and then
exorbitant, primarily because the commissions to carry it from point to point inside the Port like
that the agent expects to receive are built the stack point, storage yard, hook point, etc.,
into these. Searches in the case of prominent for various purposes, and finally to load these
transporters brought out evidence showing that on the ship. For this, they utilise their trailers,
bogus expenses were claimed under different forklifts, cranes and top-lifters etc.
heads on account of spare part and repairs, tyres
10.4.1  This cartage is received at a fixed rate
and petrol & diesel.
per 20 ft container, as fixed by transporters. The
10.2  Spare parts and repairs are the easiest area rationale behind such charges, according to
where bogus expenditure can be introduced. False the transporters, is that their contracts with the
vouchers are readily available through brokers Shipping agents cover movement of containers
and in return for cheques issued, cash is handed inside the Port area upto unloading of import
back on payment of a small commission. The containers and loading of export containers
AOs conducting enquiries in such cases should at the CFS. This extra loading/ unloading of
trace the route of such cheques issued in the some containers at the CFS is not covered by
names of parties who appear bogus especially the contract. Moreover, although the CFS is in
those, which appear as sundry creditors from the Port area it is deemed to be outside it and
year to year. the contract with the Shipping agent is only for
10.3 These transporters consume specialised movement inside the Port area. This cartage is
tyres, such as 1000/ 20 tyres, the bills for which received in cash by the transporters from the
are normally received from registered dealers exporters and importers or their Clearing agents.
of major tyre manufacturers. The dealer cannot 10.4.2  The Clearing agents who handle such
normally issue bogus bills since the discrepancy movement in the CFS always make payments in
can be easily detected on verification of his cash because they submit a lump sum bill to their
Stock register and his purchase bills. In one case, customers i.e. Importers/ Exporters, covering all
documentary evidence was found which showed services rendered. No supporting bills are given
that the dealer was giving bills to the assessee in and in turn the Clearing agents withdraw cash
respect of tyres sold to other parties who had and make cash payments. Since a major part of
made cash purchases and had not taken bills. their expenses are “speed money” paid in the
However, without documentary evidence it shall Port area and Custom house, they prefer such a
be difficult to prove such a transaction. The AOs system. In a search case, documentary evidence
should scrutinise the books for payments made in the form of diaries indicating actual receipts
to unregistered dealers for purchase of tyres. were found in the possession of the Supervisor

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in charge of their Port operations, showing 13.1  Section-44AE: Special provision for
that only 1/ 3 rd of such receipts were being computing profits and gains of business of
accounted. plying, hiring or leasing goods carriages
11. Road Transporters Catering to Air (2) For the purposes of sub-section (1), the profits
Cargo Industry: Similar to shipping agents, the and gains from each goods carriage:
air cargo agents or handling agents manage the (i)  being a heavy goods vehicle, shall be an
business of Airlines who handle air cargo in India. amount equal to one thousand rupees per
They are responsible for loading and unloading ton of gross vehicle weight or unladen
and transporting the cargo from its source to weight, as the case may be, for every
airport and vice versa. While scrutinizing the month or part of a month during which
transporters, the Assessing Officer may cross the heavy goods vehicle is owned by the
verify the books of accounts of agents debiting assessee in the previous year or an amount
the transportation cost to detect any probable claimed to have been actually earned from
suppression. such vehicle, whichever is higher;
12.  End to End Logistics: Recently, the end (ii)  other than heavy goods vehicle, shall be
to end logistics providers are increasing wherein an amount equal to seven thousand five
they provide the services like packing the hundred rupees for every month or part of
customer products, transporting the products a month during which the goods carriage
from one place to another, advertising the is owned by the assessee in the previous
products by creating the stalls in the shopping year or an amount claimed to have been
malls, etc. for the specific customers. These end actually earned from such goods carriage,
to end logistics provider engage transporters for whichever is higher.
moving the customer’s goods. While examining
the cases of road transporters, the Assessing 13.2  Section-40A: Expenses or
Officers should also collect information relating Payments not Deductible
to end to end logistics provider to whom they in certain circumstances
are catering and also to cross verify the same (3) Where the assessee incurs any expenditure
with the Assessing Officers of the Principals for in respect of which a payment or aggregate of
detection of tax evasion in the case of logistic payments made to a person in a day, otherwise
providers as well as the Principals. Mostly the than by an account payee cheque drawn on
logistics providers will incur cash expenses to a bank or account payee bank draft,[or use
engage various transporters and book their of electronic clearing system through a bank
expenses and these details should be collected account, exceeds ten thousand rupees,] no
while assessing transporters to detect any deduction shall be allowed in respect of such
possible evasion. expenditure.
…
13.  PROVISIONS OF THE ACT RELATED
Provided further that in the case of payment
TO ROAD TRANSPORTERS
made for plying, hiring or leasing goods carriages,
The Income-tax Act addresses the peculiarities the provisions of sub-sections (3) and (3A) shall
of the road transport business and provides for have effect as if for the words “[ten] thousand
the following provisions specifically to enable rupees”, the words “thirty-five thousand rupees”
the conduct of this business. had been substituted.

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13.3  Section–194C: Payments to a. To cross-check the registration details with

Contractors RTO to verify whether registration numbers
submitted are actually those of the goods
194C. (1) Any person responsible for paying
carrying vehicles as sometimes even fake
any sum to any resident (hereafter in this Section
numbers or numbers of two-wheelers etc.
referred to as the contractor) for carrying out any
are given. Further, it will also substantiate
work (including supply of labour for carrying out
whether the vehicles shown are having All
any work) in pursuance of a contract between
India permits or local permits.
the contractor and a specified person shall, at
the time of credit of such sum to the account of b. Normally the road transporter has a well-
the contractor or at the time of payment thereof established supply chain having several
in cash or by issue of a cheque or draft or by agents and entities spread across a wide
any other mode, whichever is earlier, deduct an geographical area, therefore, special
amount equal to: attention should be paid to check the
integrity and genuineness of the supply
i. one per cent where the payment is being
chain.
made or credit is being given to an
individual or a Hindu undivided family; c. Besides issuing notices u/s 133(6), in-
house verifications i.e. cross verification of
ii. two per cent where the payment is being
details with jurisdictional Assessing Officers
made or credit is being given to a person
of sub-contracting parties can be also very
other than an individual or a Hindu
fruitful.
undivided family,
d. Vouchers–substantial expenses involve
of such sum as Income-tax on income comprised
cash payments and cash payments are
therein.
made at various branch offices of the
…
business. These expenses are generally
…
supported by self-made vouchers more
(6) No deduction shall be made from any sum often than not without the signature of
credited or paid or likely to be credited or paid the person receiving the payment. These
during the previous year to the account of a expenses should receive special attention
contractor during the course of business of of the investigator.
plying, hiring or leasing goods carriages, where e. Details of TDS returns should be verified
such contractor owns ten or less goods carriages with the books of account. Even when the
at any time during the previous year and assessee does not deduct TDS, he needs
furnishes a declaration to that effect along to have a declaration from the person
with his Permanent Account Number, to receiving the payment that TDS need not
the person paying or crediting such sum. be deducted as per provisions of Section
The Assessing Officer is advised to go through 194C or 197. The PANs provided should
the statute and apply the provisions relating to be verified to establish the genuineness.
the assessment year concerned. f. This sector is unorganised and cash
expenses are involved and there is a
14.  CHECK SHEET FOR SCRUTINY
possibility of bogus billing. The Assessing
Following are the important points that should Officer should cross verify the details by
be investigated by the Assessing Officer while calling for information u/s 133(6) or issuing
scrutinizing the business of road transporter: summons/ commission u/s 131.

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g. Source of expenditure for statutory dues exceeded Rs. 20,000/-. However, it was noticed
should be cross-verified with the books of that a party received split cash payments like
account. Rs. 19,000/- on day-1, Rs. 18,000/- on day-2
h. Reconciliation of the following documents: and Rs. 19,000/- on day-3. The party did not
receive any money for next 15 days and again
(i) GST returns and ITR a similar pattern of split payment spread across
(ii) E-way billing system with Trip Account 3–4 days was noticed. This appeared a means to
Sheets circumvent the provisions of Section 40A. The
assessee was asked to produce vouchers for these
(iii) Tonnage–weighing station receipts (the
payments. On being asked to produce vouchers,
dharamkanta)
the assessee sought several adjournments
(iv) Data of current year with that of and thereafter submitted photo copies of few
previous year–the ratios clearly point to vouchers. The vouchers did not appear genuine
abnormalities in the way the business as most of them were unsigned and wherever
has changed from previous year to signed, appeared that one person had signed all
current year and lead the investigator to the vouchers as a receiver.
the places of possible manipulation and 15.4 The assessee was, therefore, asked to
tinkering of accounts: produce vouchers in original which the assessee
a. Branch/ booking office wise failed to do even after taking adjournments.
b. Expenditure (heads such as Summons u/s 131 was issued to the partner of
the assessee firm to produce original vouchers
repairs, spares, lorry hire, loading/
along with books of account. The assessee could
unloading etc.) wise
not produce original vouchers but the Tally
c. Fuel utilization backup of the accounts was produced. The Tally
d. Client wise backup accounts copy was seized.
e. Source/ Destination wise 15.5 The analysis of the accounts in Tally
revealed that the photocopies of vouchers
f. Cash deposits/ cash withdrawals–
earlier submitted were not reflected in the
across several offices account books. A simple test-check revealed
g. Toll charges that vouchers and Tally accounts could not be
genuine at the same time. In view of this, the
15.  CASE STUDY assessee was asked to show cause why books
15.1  The assessee is a firm and is a road should not be rejected and net profit revised
transporter with sales declared at more than Rs. upwards. The assessee could not explain on
30 Crores. However, the Net Income offered to what basis books of account were prepared and
tax was only Rs. 30 Lakhs. admitted that he had failed to maintain the books
of account properly because of various agents
15.2  The low net profit was also a reason for and branch offices spread across multiple states.
selection of the case under CASS. After analysis Consequentially, the Net profit was thereafter
of the expenditure pattern, it was discovered that estimated upwards.
most of the expenditure was towards lorry hire
15.6 Further in many cases on analysis of
charges to small time lorry owners–the assessee
cheque payment made to agents, it was noticed
was asked to submit cash book and ledger
that the cheques were not account payee
accounts of the various lorries which he hires.
cheques and the assessees inflated the expenses
15.3 Careful analysis of the cash book and by creating fictitious agents and were issuing
ledgers revealed a pattern wherein cash bearer cheques in the names of fictitious agents.
payments were split to ensure that payments The Assessing Officer should, therefore, carefully
made to one party on a single day never verify the details of cheque payments also.

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 Chapter

14
Shipping Industry
1.  INTRODUCTION
1.1  Industry Profile
Shipping is a global industry and its growth is a
reflection of the level of economic activity. This is
also the reason as to why the shipping market is
cyclical in nature and freight rates generally tend
to be volatile. Simply put, the freight rates and
earnings of the shipping companies are primarily
a function of demand and supply in the market.
The demand side is driven by growth in trade as
well as the geographical balance of trade (which
determines the length of haulage required) while 1.3 The Shipping Industry constitutes the
the supply side is driven by orders placed for backbone of Indian exports and imports
new ship building as well as the scrapping of accounting for almost 95% of the country’s
existing tonnage. merchandise trade by volume and approximately
1.2  The global shipping industry can be broadly 70% in terms of value. India has 12 major and
classified into wet bulk (like crude and petroleum 200 notified minor and intermediate ports. India
products), dry bulk (like iron ore and coal) and is the sixteenth largest maritime country in the
liners (like containers and others). There are world, with a coastline of about 7,517 km. The
various benchmarks that monitor and publish Indian Government promotes the sector by
freight rates for these segments. The prominent allowing Foreign Direct Investment (FDI) of up
amongst them are Baltic Freight Index, Baltic to 100 per cent under the automatic route for
Dry Index (for dry bulk segment) and Baltic port and harbour construction and maintenance
Clean and Dirty Tanker Index (for tankers). The projects. It provides a 10-year tax holiday to
industry is regulated by the rules and regulations enterprises that develop, maintain and operate
of International Maritime Organisation (IMO), ports, inland waterways and inland ports. In
International Association of Classification FY 2016–17, the Indian Port sector witnessed
Societies (and also other similar classification a capacity growth of 1,065 million tonnes per
societies) and the requirements of the concerned annum (MTPA), implying a CAGR of 7.8% since
flag state where the ship is registered. Apart from FY 07. The Cargo traffic during FY 17 for the
these, there are also the rules and regulations of three categories of solid, liquid and container
various countries where the vessel operates. cargo was 310.8, 212.4 and 124.6 MMT,

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Techniques of Investigation for Assessment Vol. 3

respectively which indicates a CAGR of 3.4% of the total fleet owned and controlled by Indian
between FY07–17. Similarly, during FY07– interests is also flagged overseas.
17 the container traffic rose to 124.6 MMT,
implying a CAGR of 5.9%. 2.  MAJOR INDIAN PLAYERS
1.4  Another feature of Indian Shipping is that The major Indian players in the shipping industry
the coastal trade of India is exclusively reserved are the following:
for Indian ships and for this purpose a ship
chartered by a citizen of India or a company a. Shipping Corporation of India Ltd.
which satisfied the requirements laid down in b. Great Eastern Shipping Companies Ltd.
Section 21 of the Merchant Shipping Act, 1958
c. Essar Shipping Ltd.
is deemed to be an Indian ship. A foreign ship
is normally not allowed to ply in the coastal d. Mercator Ltd.
trade of India except under certain conditions e. Seaways Shipping & Logistics Ltd.
and that too after a license is granted to it by an
officer authorized to issue it. This is the reason f. Tolani Shipping Pvt Ltd.
why a few foreign ship owners are now seeking
to register one or two of their ships under the 3.  BUSINESS OPERATION &
Indian flag to carry cargo on local routes. PROCESSES
1.5  A crucial aspect to be kept in mind is that 3.1  Operation & Processes: The Shipping
the shipping sector in India is largely served Industry plays a pivotal role in the export and
by International Shipping lines, which have import of goods. The Shipping line companies
considerable turnover and significant presence provide vessels/ ships for export/ import of
in the Indian Shipping business. These lines goods by the exporter/ supplier or importer/
fly a foreign flag. The market share of Indian customer. The ‘Shipper’ is the person whose
Shippers is less than 10% of the total cargo goods are transported or who places a shipment
movement while the foreign vessels carry over order with the shipping line. It is mentioned that
90% of Indian cargo. According to the latest data recently the Customs Department has revised the
from Indian National Shipowners’ Association, designation of ‘Customs House Agents’ (CHA) to
in FY15–16, the share of Indian ships in the that of ‘Customs Broker’ in line with international
carriage of EXIM cargo was a miniscule 7.86%. terminology. The business operation process of
Though, there are a few large Indian players, shipment of exports and imports are tabulated
but according to some estimates, around 35% below for easy comprehension.
3.2  Export Processes:
Process Process Owner
Booking is placed with the Shipping line by the Exporter or Forwarder or CHA Exporter/ Customs Broker (CHA)
(Customs House Agent)
Shipping line accepts the booking and release bookings for container pickup Shipping Line
from empty yard (called Delivery Order)
Exporter picks up containers from empty yard Exporter/ Customs Broker (CHA)
Shipping Bill and Invoice raised on customers prepared simultaneously for Exporter/ Customs Broker (CHA)
declaration to customs.
Shipper does stuffing activity in the containers either at the CFS (Container Exporter/ Customs Broker (CHA)
Freight Station) or at their factory premises.
Weighment done and Verified Gross Mass (VGM) work is done. Exporter/ Customs Broker (CHA)

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 Shipping Industry

Let Export Order (LEO) issued by Custom at the exit from CFS or designated Exporter/ Customs Broker (CHA)
area for factory stuffed container.
Shipper applies for Form 13 request to shipping line Exporter/ Customs Broker (CHA)
Copy of booking, checklist of shipping bills/ CLP (Classification, Labelling and Exporter/ Customs Broker (CHA)
Packaging), VGM is given to shipping line by CHA/ Exporter
Shipping Instructions (SI) is placed with shipping line by shipper either through Exporter/ Customs Broker (CHA)
online or off-line/ physical modes.

Form 13 is issued to the Exporter’s representative by the shipping line giving Shipping Line
details of the POD (Port of discharge), cut off time for loading.
Draft Bill of Lading (BL) prepared by CHA/ Shipper and is sent to Shipping Exporter/ Customs Broker (CHA)
Line. A typical draft BL contains the cargo details like type, dimension, weight,
charges (as agreed), consignee and consignor name, POO (Port of Origin),
POL (Port of Lading), Port of Discharge etc. It also includes the LC details if
there is one involved.
The shipping line checks the draft BL and prepares its BL and sent to Shipper Shipping Line
for final check. After that a final BL is issued by the Shipping Line giving all
payment terms also.
On-board of containers is conveyed to the shipper Shipping Line

3.3  Import Processes:

Process Process Owner

Order placed on foreign supplier. Terms of delivery, details of payment etc are Importer
all finalised. The Incoterms are decided i.e. whether CIF or FOB etc.

Supplier’s BL, certificate of origin, packing list, invoice and other certificates Foreign Supplier
sent to importer by courier.

On basis of documents the Importer/ Customs Broker files advance Bill of Entry Importer/ Customs Broker (CHA)
online (72 hours prior).

Assessment by Customs Appraiser/ Customs officer. Duty payable ordered. Customs

After payment of duty, examination of cargo is done and Out of Charge is given. Customs

The importer pays CFS charges and carries out the goods. In Maharashtra a Importer/ Customs Broker (CHA)
stamp duty 0.1% on assessable value of customs and customs duty combined.

The Shipping Line also takes a guarantee on stamp paper of Rs. 500/- as to the Shipping Line
safe return of the container.

The CFS verifies the payments online and allows delivery of the container. CFS

The Importer/ Customs Broker (CHA) arrange to return the Empty container Importer/ Customs Broker (CHA)
to the designated Empty Yard where the container is surveyed and offloaded if
found in sound condition. If it is damaged, the costs have to be paid.

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After Feb 2016 some Ports have started a Direct Government to keep the taxation at a low rate in
Port Delivery (DPD) scheme for full container order to ensure that the Indian shipping remains
load case. The other ‘less than container loads’ internationally competitive. The tonnage scheme
(LCL) are still being sent to CFS only. is optional and the shipping company can either
pay that tonnage tax or the normal corporate
4.  PROFIT MARGINS AND RATIO tax on its profits.
ANALYSIS 5.2 To be eligible for the tonnage tax, the
The profit margin in this industry depends upon shipping company has to be an Indian company,
the various factors of market and economy, having the place of effective management in
like any other industry. While the Shipping India. It should also own at least one qualifying
Industry can get itself assessed as an ordinary ship and the main object of the shipping
business entity, the Indian shipping industry is company should be to carry on the business
dominated by tonnage tax and gross basis of of operating ships. The term ‘Qualifying Ship’
taxation. The International shipping companies has been defined in Section 115VD of the Act
of non-residents on the other hand are governed to mean a sea going ship or vessel of fifteen net
by Section 172 of the Act in general or by tonnage or more and it should be registered
Section 44B of the Act if they have a permanent under the Merchant Shipping Act, 1958 or
establishment. These provisions also offer a should be functioning under a license issued by
gross basis of taxation for such companies. the Director-General of Shipping under Section
406 or 407 of the Merchant Shipping Act,
5.  SPECIAL PROVISIONS FOR 1958. It is also mandatory that in order to claim
CERTAIN INDIAN SHIPPING the tonnage tax the ship should have a valid
COMPANIES certificate in force indicating its net tonnage.
The provisions of tonnage tax do not apply to
5.1  Tonnage Scheme: As already mentioned a seagoing ship or vessel if the main purpose
earlier, the bulk of the shipping industry for which it is used is the provision of goods or
in India operates under foreign flags. The services of a kind normally provided on land. It
heavy investment, maintenance costs and the is also not applicable to fishing vessels, factory
international competition are features hampering ships, pleasure crafts, Harbour & river ferries,
the growth of the Indian shipping industry. To offshore installations and even a qualifying ship
support the industry, incentives were provided which is used as a fishing vessel for a period of
under the Income-tax Act, 1961 (hereinafter more than thirty days during a previous year.
the Act) under Section 33AC till Assessment
Year 2005–06. After AY 2005–06 a new 5.3 The tonnage tax scheme is a presumptive
Chapter XII-G was inserted in the Act, whereby scheme of taxation where the income arising
a presumptive method of tax computation from the operation of a qualifying ship is
for Indian Shipping Industry was introduced determined on the basis of its tonnage. Since,
based on the tonnage income. These provisions it is a preferential regime of taxation, conditions
were introduced to make the taxation process like the assessee has to transfer 20% of the book
simpler, providing certainty in taxation and to profit to a Tonnage Tax Reserve Account to be
promote further investment in this sector so as Utilised as per Section 115VT of the Act are
to avoid de-flagging of Indian ships (switching required to be met.
ships’ registration to a foreign jurisdiction). The 5.4  For the purpose of computing the income
tonnage tax is a common feature worldwide under tonnage tax scheme, the shipping business
and a conscious decision has been taken by the is to be considered as a separate business distinct

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from all other activities or business carried out transaction or arrangement which amounts to an
by the company. The assessee has to maintain abuse of the tonnage tax scheme. The tonnage
separate books of account and has to comply income is taxed as per the normal corporate
with the requirement of furnishing necessary rate applicable and the taxes are payable even if
audit report in the prescribed Form No. 66. The there is a loss. The CBDT Circular No. 5 of 2005
assessee has to make a specific claim that it seeks dated 15.07.2005 and Circular No. 3 of 2006
to opt for the tonnage tax scheme. The assessee dated 27.02.2016 contains the explanatory
has to make an application in this regard which notes regarding the Tonnage Tax Scheme.
needs to be approved in writing as per the 5.6  The income of a tonnage tax company for
provisions of Section 115VP of the Act. There a previous year is computed on the basis of its
are provisions for continuation/ discontinuation/ deemed daily tonnage income which is then
renewal/ prohibition from claiming of benefit of multiplied by the number of days in the previous
the tonnage tax scheme. There are also limits year or the number of days where the ship is
prescribed in terms of maximum percentage of operated as a qualifying ship for a part of the
chartered in net tonnage. previous year. Presently, the computation of
5.5 The tonnage tax scheme shall not apply tonnage income is done as mentioned in the
where a tonnage tax company is a party to any table below:

Qualifying ship having net tonnage Amount of daily tonnage income

(1) (2)
up to 1,000 Rs. 70 for each 100 tons
Exceeding 1,000 but not more than10,000 Rs. 700 plus Rs. 53 for each 100 tons exceeding 1,000
tons
Exceeding 10,000 but not more than 25,000 Rs. 5,470 plus Rs. 42 for each 100 tons
exceeding 10,000 tons
Exceeding 25,000 Rs. 11,770 plus Rs. 29 for each 100 tons
exceeding 25,000 tons.

5.7  As per Section 115VI of the Act, the relevant from core activities or incidental activities and
Shipping income of the tonnage tax company hence are required to be taxed separately.
means its profits from core activities referred to 5.8  Similarly, in the case of Shipping
in Sub-section (2) and the incidental activities Corporation of India Ltd vs. Addl. CIT (2014)
which are incidental to the core activities and are 31 ITR(T) 545 (Mumbai-Trib) it has been held
prescribed in Rule 11R of the Income-tax Rules that the profit on sale of ships and fixed ships
1962. The incidental activities are maritime is to be deduced from the turnover of core
consultancy charges, income from loading or activity of Shipping. Further, in this case, the
unloading of cargo, ship management fee or assessee had declared income from interest and
remuneration received for managed vessels and dividend as income from other sources but had
maritime education recruitment fees. In the case allocated administrative expenses against these
of Dredging Corporation of India Ltd vs. ACIT incomes claiming that the same is required to be
(2017) 167 ITD 485 (Vishakhapatnam), the treated as core shipping income and common
Hon’ble ITAT has held that the receipt of interest administrative expenses are to be allocated
from house building advances, liquidated amongst the different business activities of the
damages and the interest on the principal assessee on a reasonable basis in terms of the
amount of the arbitration award are not profit provisions of Section 115VJ of the Act. This

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explanation of the assessee was not found tonnage tax assets are retained since it is not
acceptable by the Assessing Officer who noted covered under the scope of ‘profits from core
that the apportionment of common cost as activities’, as mentioned in Section 115VI of the
envisaged in Section 115VJ(1) of the Act was Act.
amongst other “business” or “activity” carried
on by the tonnage tax company and such 6.  POINTS FOR INVESTIGATION IN
activity ought to be a business relate activity. The TONNAGE TAX SCHEME
AO held that the income earned by the assessee
on account of interest on monies deployed out The two main points for investigation under
of surplus funds as well as dividend income was the Tonnage Tax Scheme are elucidated as
chargeable to tax under the head “Income from under:
other sources” and the assessee therefore was a. The assessee may include the income not
not entitled to claim the deduction on account covered under the Tonnage Tax Scheme
of apportionment of common costs as provided in the Tonnage Tax qualifying income so
in Section 115VJ of the Act. He held that the as to reduce their tax incidence. In some
assessee was entitled to deduction against such reported cases, it has been found that
income only on account of expenditure wholly income under the head ‘Other Sources’ like
and exclusively incurred for the purpose of interest was also included in the Tonnage
earning such income to that extent available Tax qualifying income.
under Section 57(iii) of the Act.
b. Simultaneously, the expenses incurred in
5.9 The Act mandates that for the purposes Tonnage Tax business are diverted to non-
of the tonnage tax scheme, the tonnage of a qualifying business so as to reduce the
ship is indicated in the relevant certificate and non-qualifying income. In some cases, the
includes the deemed tonnage computed, as per major portion of common cost is allocated
Rule 11Q of the Income-tax Rules, 1962. These to non-qualifying activity. As regards the
rules give the computation of deemed tonnage expenses, Section 115VJ of the I.T. Act
in respect of an arrangement of purchase of slots provides for allocation of such expenses on
and slot charter and an arrangement of sharing a reasonable basis by the Assessing Officer.
of break-bulk vessel based on the container size, In majority of the cases, such expenses
cargo volume and cargo weight. The relevant are sought to be allocated on the basis
Form No. 66 gives detailed working notes for of turnover which need to be rationally
computing the deemed tonnage and incidental allotted after due verification.
activities. This Form should be carefully analysed
by the Assessing Officer. 7.  TAXATION OF FREIGHT INCOME
5.10 The tonnage scheme also provides for OF INTERNATIONAL SHIPPING
computing the chargeable capital gains on COMPANIES
transfer of tonnage tax assets, treating the written 7.1  The provisions for taxation of freight earned
down value of the block of qualifying assets, as a by a non-resident shipping company from its
separate block as per Section 115VN of the Act. operations in India are contained in Section 44B
and Section 172 of the Act.
5.11  For the purposes of MAT, the book profit
or loss derived from the activities of a tonnage 7.2  Section 44B: If a non-resident has
tax company is excluded from the book profit of a permanent establishment in India and is
the company for the purposes of Section 115JB engaged in the business of operation of ships,
but the capital gains arising from the transfer of it can choose to be taxed as per the provisions

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of Section 44B of the Act which provide that to make necessary arrangements for filing of
the income of the non-resident from its ship return and payment of taxes within 30 days of
activities would be calculated @ 7.5% of the departure of the vessel. A Port clearance u/s
sums: whether paid or payable, in India or out 172(6) shall be granted to ship only after such
of India, to the assessee or to any person on his satisfactory arrangement or the payment of tax.
behalf on account of carriage of passengers,
7.5  If the principal beneficiary has availed the
livestock, mail or goods shipped at any port in
benefit of freight tax paid u/s 172(2) of the Act, he
India; carriage of passengers, livestock, mail or
may file regular return u/s 44B of the Act before
goods shipped at any port outside India, and
the expiry of the assessment year concerned. For
Demurrage charges or handling charges and
this purpose, any tax paid during the previous
other similar charges. The issue of existence of
year u/s 172(2) shall be treated as a payment in
permanent establishment/ business connection
advance of the tax.
would then be examined at length as there is a
tendency on the part of the non-resident to mis- 7.6  On receipt of the return, the AO is required
represent the facts. to assess the income before the expiry of nine
7.3  Section 172: If the non-resident is engaged months from the end of the Financial Year in
in occasional shipping business (through owned which the return under Section 172(3) of the Act
or chartered ships) in international traffic, its is filed. In order to finalize the assessment u/s
taxation is governed by Section 172 of the Act, 172(4), the AO may call for such accounts or
which is an overriding provision with respect to documents as he may require i.e. bank accounts
occasional shipping business of a non-resident. details remittance of freight. The levy of and the
Where such a ship carries passengers, livestock, recovery of tax has to be from the Master of the
mail or goods shipped at a port in India, 7.5% of ship.
the amount paid or payable on account of such 7.7 Where the owner or charterer of the ship
carriage to the owner or the charterer or to any claims the benefit of Double Taxation Avoidance
person on his behalf is deemed to be the income Agreements the assessing officer should carefully
accruing in India to the owner or charterer on examine the claim of treaty benefit claimed.
account of such carriage irrespective of the fact Misrepresentation of facts with respect to claim
whether the amount is paid or payable in or out of treaty benefit has been noted in a number
of India. The income shall also be deemed on the of cases–especially with reference to UAE and
amount paid or payable by way of demurrage Singapore Treaty. It should be ensured that
charges or handling charges or any other amount the double taxation relief is granted subject to
of similar nature. The tax thereon is levied as per verification of tax paid/ payable outside country,
the rate or rates in force as referred to in Section wherever India had entered into any DTAA. The
194 of the Act. onus is on the assessee to produce the requisite
7.4  Before departure from any port in India of documents to evidence tax residency and
any such ship, the Master of the ship shall prepare eligibility to treaty benefit. A careful examination
and furnish a return of the full amount paid or of the Limitation of Benefit Clauses in the treaty
payable to the owner or charter or any person is a must.
on his behalf. The Master of the vessels or their 7.8 Some of the documents which require
authorized agent should file provisional return verification during assessment are, as under:
along with original copy of Master Certificate
issued by the Master of vessel before departure a. Original copies of Master Certificate.
of vessels. If the return cannot be filed before b. Incorporation certificate of principal
departure of the vessel, the Master is required beneficiary.

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c. Tax residency issued by the competent agreement has been entered into only to claim
authorities of outside countries. i.e. TRC is treaty benefit. There have been claims of India
issued on a year to year basis (i.e. every UAE DTAA by various parties who belonged to
calendar year). a non-treaty country claiming that the ship was
chartered by a UAE based associate. It is easy
d. Vessel registration certificate, if the vessel is to draw a charter party agreement between
owned by the principal. associates. Hence, the claim of treaty benefit
e. The Ship Manifest which indicates the should be examined closely as UAE Treaty
amount of freight collected; the expenses benefit is available only to a company wholly
including Agency Commission and managed and controlled in UAE and Article
Income-tax paid/ payable for the voyage; 29 prohibits Treaty abuse. In the international
and net surplus to the credit of the owner shipping business, chartering (hiring) of a ship
or deficit for the voyage. is very common. Many times, the actual person
who is transporting goods in a ship may be the
7.9 The income of the Non-resident Shipping second or the third charterer and not the original
company can be verified by ensuring that the owner of the ship. Many times, merely to take
following three amounts are the same: benefit of a treaty, a charterer having place of
a. The sum total of all the Bills of Lading management in a favourable country may claim
issued by the Indian Agent for a single to be the actual charterer although the freight may
voyage; have been paid to someone else. It is important
for the Assessing Officer to determine the actual
b. The amounts of freight collected for the freight beneficiary and then determine whether
voyage and deposited in the Collection the freight beneficiary has effective management
Account of the Non-Resident Shipping in the country whose DTAA benefit is being
company; and sought by the ship operator.
c. The amounts shown to the credit of the 8.2 In the case of Marine Links Shipping
voyage account as freight collected and Agencies [2013] 40 taxmann.com 88
credited through a bank account in the (Karnataka), it was noted that as per charter
books of Indian Agent. agreement the charterer merely retained
3.5% of the consideration and passed on the
7.10  Although Section 172 represents a
remaining amount to the ship owner. Under the
complete code in itself, reassessment proceedings
circumstances the Karnataka High Court denied
u/s 147 have been upheld in such cases by Delhi
the benefit to the charterer observing that the
High Court in the case of Emirates Shipping
appellant was acting as an agent of the owner
Line, FZE, [2012] 23 taxmann.com 400 (Delhi)
and not operating as a charterer.
8.3  In the case of DLJMB Mauritius Investment
8.  INTERPLAY OF DTAA AND POINTS
Co., [1997] 94 Taxmann 218 (AAR), it was
OF INVESTIGATION
held by AAR that the term ‘place of effective
8.1  In most of the DTAAs, the shipping income management’ would mean a place from where,
is taxed on the basis of residence. Shipping factually and effectively, the day-to-day affairs of
business can be carried out by an enterprise the companies are carried on and not the place
who can be the owner of the vessel, a charterer in which may reside the ultimate control of the
of the vessel or a lessee of the vessel. Hence, company. Similar view was held by ITAT in the
while examining a case of a charterer or a lessee, case of Integrated Container Feeder Service
it is important to find out whether the charter [2005] 96 ITD 371 (Mum).

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8.4 In case of ships owned/ chartered by of the assessee were not available. However, by
Singapore based entities, there have been excluding the fuel and port charges, the Voyage
frequent violation of Article 24 which limits charter rate were converted to Time Charter
treaty benefit to amount of income received rates and such derived Time Charter rates could
in Singapore. It has been noted that since be compared with Time Charter rates as per the
Singapore does not tax income which does not Clarkson Database. On an analysis, it was found
arise in Singapore, the freight collected in India is that out of 20 such transactions, the derived time
remitted to a branch in UK or any other country charter rates paid to the AE in 4 transactions was
while the benefit of India Singapore DTAA is higher than the Clarkson’s rate. Accordingly, an
claimed while filing the return. In the case of adjustment was made on account of vessel hire
Thoresen Chartering Singapore (Pte.) Ltd., charges paid to AE.
[2008] 24 SOT 433 (MUM.), the ITAT held that
the amount of income which was not remitted to 10.  COASTAL SHIPPING BY
or received in Singapore was not entitled to the NON-RESIDENT COMPANIES
benefit of article 8 as it was hit by Article 24.
Coastal shipping cannot be considered as
international shipping and hence a non-resident
9.  BENCHMARKING OF VESSEL offering costal shipping services is liable to tax in
HIRE CHARGES PAID BY INDIAN India. However, coastal shipping which forms a
COMPANY TO ITS AE part of the international shipping operations of
9.1 In one case, the Indian Company has an enterprise has been held to be in the nature of
taken various ships on hire from its Associated International shipping–Essar Oil Limited [2006]
Enterprise (AE) on Voyage Charter basis. In 5 SOT 669 (Mum) However, while dealing
Voyage Charter, the rates are charged on per with the issue of coastal shipping in the case of
tonne basis from one port to destination port. Poompuhar Shipping Corpn. Ltd. [2013] 38
It is different from a Time Charter. In Voyage taxmann.com 150 (Madras), the Madras High
Charter, the entire expense belongs to the Ship Court held that the amount paid to the ship
Owner whereas in Time Charter the fuel and the owner with respect to the ship chartered by the
port charges are to be borne by the Charterer. Indian party for operating in coastal shipping
In this particular case, the AE itself did not own was to be held as royalty and taxed as such
the ships also and had taken these ships on hire in India. The Court also held that when the
from third parties. However, the AE had taken Shipping Corporation enters into Time Charter
the ships on hire on Time Charter basis but agreements with foreign shipping companies and
had given them on hire to the Indian Company exclusive berthing facility at ports are guaranteed
on Voyage basis and had charged Freight and for ships of such companies, this amounts to
Demurrage charges as is usually done under Permanent Establishment and there is no need
Voyage Charter. of having a separate Permanent Establishment.
9.2 Under these circumstances, the Indian
11.  OTHER ISSUES IN
Company was asked to benchmark the Vessel
INTERNATIONAL SHIPPING
Hire charges paid to the AE using the Clarkson
CASES
Database. The Clarkson Research Services
Limited publishes Shipping Intelligence Weekly 11.1 Internal Haulage Charge: The IHC
Report containing the time charter rates of are charges which the Enterprises, which operate
vessels. It was to be noted that in the Clarkson’s ships in international traffic, collect from the Indian
database, the rates are of Time Charter rates and clients for undertaking transport of containers
the Voyage charter rates in the area of operation inland by arranging such transportation on their

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own or through third party service providers. 11.4  Many assessees engaged in international
Internal haulage charges, if incurred by the same shipping terminate their journeys at mother
person engaged in International Shipping, has ports viz. Colombo and thereafter transport
been held to be connected to and a part of the the goods to Indian ports by means of ‘feeder
income from International Shipping. However, vessels’ which were neither owned or chartered
it is important to examine whether the same by the assessee. The Department has regularly
party is carrying out the internal haulage work. held that the freight earned on account of such
Internal haulage carried out by a third party feeder vessels activities are not covered by the
cannot constitute a portion of the international DTAA concerned and the Department seeks
shipping activity of a non-resident. to distinguish that the feeder vessels are not
covered by the term ‘pool or slot arrangement’.
11.2  It is also to be noted that the Explanation
below Section 44B of the Act which specifically 11.5  Rig Haulage Charges etc.: If a rig is
mentions as under: hired by an Indian company for operation in
India, the income arising from mobilisation and
“Explanation.-For the purposes of this sub- demobilisation of drilling vessel outside India
section, the amount referred to in Clause (i) is taxable as fees from technical services under
or Clause (ii) shall include the amount paid or Section 9(1)(vii) of the Act. The issue has been
payable or received or deemed to be received, as set to rest by Uttarakhand High Court in many
the case may be, by way of demurrage charges cases including the case of CIT vs. Atwood
or handling charges or any other amount of Oceanics Pacific Ltd., dated May 19, 2010,
similar nature”. [2011] 338 ITR 156 (Uttarakhand).
The above Explanation, noscitur a sociis,
suggests that only the charges which are directly 12.  CBDT CIRCULARS
linked to the business of operation of ships can
12.1  Circular No. 30/ 2016
be considered u/s 44B of the Act. The IHC are
[F.No.500/05/2014-FTD-I],
charges collected for picking up and dropping
Dated 26-8-2016:
the goods to and fro the port to the warehouse
of the exporter/ importer. This could be by road This Circular was issued by CBDT in continuation
or rail or any other means but this income is of its earlier Circular No. 732 dated 20/12/1995.
certainly not shipping income and cannot be The earlier Circular had done away with the
taxed under Section 44B. procedure of obtaining NOC for each voyage in
cases covered by full DTAA. As per the Circular
11.3  Slot Chartering: Most of the Treaties No 732, the AO is competent to issue annual
entered into by India include income from NOC valid for a year after carefully verifying the
operation of ships, participation in a pooling applicability of DTAA. It was reiterated that the
arrangement and operation of a joint shipping annual NOC should clearly mention the names
business under the definition of shipping income of the ships owned by the foreign shipping
covered by the DTAAs. Hence, a travel agent company, names of the ships chartered or
solely engaged in slot chartering would not names of shipping companies from which ships
be covered by the Treaty benefits as held by are chartered by the foreign shipping company
Bombay ITAT in the case of Delta Airlines Inc and names of the members of the pool and their
[2015] 57 taxmann.com 1 (Mumbai-Trib.). This ships which are part of this pool. The AO was
was the case of an airline but the underlying also directed to continue to take the declaration
principle is the same. from the applicant that the treaty benefits

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would be available only in respect of freight in charterer and the port clearance is granted only
international traffic. The Circular also laid down after the return of the full amount to be paid is
the manner in which the Issuance of Voyage filed, evidence of payment of tax on such income
NOC is to be dealt. is produced before the Customs authorities,
12.2 The Circular also simplified the Voyage or satisfactory arrangements are made to file
Assessment process. It was directed that in cases the return and pay the tax within thirty days
where a foreign shipping company eligible for full of departure of the ship. In cases where such
treaty relief prefers to be assessed on a voyage- ships are owned by an enterprise belonging to
wise basis i.e., on a ship basis, the Port Assessing a country with which India has entered into an
Officer before whom such a voyage return has agreement on avoidance of double taxation,
been filed shall give due credit to the annual which provides for taxation of shipping profits
NOC issued by the AO. Assessment in such only in the country of which the enterprise is
cases must be expeditiously done and without a resident, no tax is payable by such ships at
conducting any further verification with respect the Indian ports. Under such circumstances, a
to the eligibility of the foreign shipping company ‘No Objection Certificate’ only is to be obtained
as regard to treaty benefits and the annual by the master of the ship from the concerned
NOC issued by the jurisdictional AO must be Income-tax authority. Vide the Circular No
honoured. In other cases, i.e., in a situation where 732 the CBDT had directed that where such a
the foreign shipping company files an intimation DTAA is applicable the Assessing Officer shall
under Section 172(7) expressing its willingness be competent to issue an annual NOC, valid
to be assessed on an annual basis instead of on for a year, in respect of taxation of shipping
a voyage basis, the voyage assessment before profits under Section 172 of the Income-tax Act,
the port Assessing Officer should cease and the 1961 after carefully verifying the applicability of
port Assessing officer shall intimate the details the relevant provisions concerning taxation of
of voyage and freight in respect of that foreign shipping profits in the DTAA with the country of
shipping company to the Assessing Officer which the owner or the charterer is a resident. It
issuing the annual NOC. was also directed that the AO should ensure that
12.3  Circular No. 9/ 2001 dated 09/07/ the non-resident shipping company is engaged in
2001: In the Circular No 9/ 2001, the CBDT ‘international traffic’, a term which is invariably
has directed that in case of a regular assessment defined in the DTAA itself. An undertaking from
under Section 172(7), the non-resident assessee the non-resident company that during the period
is liable to pay interest under sections 234B of the currency of the NOC, no ship belonging to
and 234C and is also entitled to receive interest it will be in any traffic other than ‘international
under Section 244A of the Income-tax Act, 1961 traffic’, shall be obtained before the issue of the
as the case may be. NOC. This Circular has been further elaborated
by Circular No 30/ 2016.
12.4  Circular No 732 dated 20.12.1995:
This Circular had provided for issuance of an 12.5  Circular No 723 dated 19/ 09/ 1995:
annual NOC, in respect of taxation of Shipping This Circular is in relation to Tax Deduction at
Profits under Section 172. Under this Section Source from payment made to foreign shipping
seven and a half per cent of the amount paid or companies under 194C and 195. This Circular
payable to the owner or charterer of a ship on had provided that Section 172 is a self-contained
account of carriage of passengers, livestock, mail code for the levy and recovery of the tax and the
or goods shipped at a port in India, is deemed to provisions of Section 172 are to apply and those
be income accruing in India to the owner or the of sections 194C and 195 will not apply.

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13.  SOURCES OF INFORMATION Container Freight Stations (CFS) or at Inland

Container Depots (ICDs). After examination by
13.1 Website and Statutes: The website
the Customs authorities, these goods have to be
www.dgshipping.com is the official website of
stuffed into empty containers. The containers are
Directorate General of Shipping, Government
then carried inside the port area upto the hook
of India and contains details of Shipping Act,
point of the ship, from where these are loaded
Shipping manual and other Shipping Laws
on to the ship. Similarly, an import container
which may be considered for clarifications
has to be unloaded from the ship and carried to
relating to ships registered in India.
the CFSs/ ICDs where the container is destuffed
13.2  The Registration of Ship in India is made for examination by the Customs authorities. The
with the Registrar of Indian ships, who issues he empty containers are removed from the port to
necessary certificate under Merchant Shipping the container storage yards. The Shipping agents
Act, 1958. The Registrar of Indian Ships also hire transporters for carrying the containers
issues Tonnage Certificate under the provisions inside the port area, and for movement to and
of the ‘International Convention of Tonnage from the container storage yards, for stacking of
Measurement of Ships (1969). This certificate the containers in the storage yards and for return
contains details of Gross Tonnage and Net of containers to the yard. These transporters
Tonnage along with dimensions of the ship. are also referred to as container handlers. They
are specialised transporters owning machines
14.  ADDITIONAL POINTS FOR such as Forklifts, Trailers, Reach Stackers, Top
INQUIRY/ INVESTIGATION lifters, etc.. There are other specialised service
14.1  Shipping Agents: In the cases of providers for stuffing and destuffing of containers
Shipping agents, the two areas where evasion called Stevedores. Moreover while the ship is at
has been detected by Officers are: the port, there are certain expenses to be met,
such as repairs, provisions etc.. The Shipping
a. Receipt of cash commission from
agents engage various contractors (Transporters,
contractors.
Stevedores) and make payments to them from
b. Receipt of excess freight from Shippers the freight collected on behalf of the Principals
without the knowledge of the Principals and remit the balance to the Principals. During
while in the Balance Sheet, the difference searches conducted in the cases of some Shipping
may be shown as amount payable to the agents and contractors at Mumbai, documentary
Principals. evidence was unearthed indicating that these
14.2 Receipt of Cash Commission: To Shipping agents were receiving 8% to 12% of
understand this aspect, the practices followed by the gross bill amount, as cash commission from
the Shipping agents and the contractors hired transporters and Stevedores in return for the
by them have to be understood. The cargo business given to them.
handled by Shipping agents is either Container 14.3  In the case of non-containerised/ Break
cargo or Break Bulk cargo. Broadly the modus bulk cargo the Shipping agents hire forklifts and
operandi remains the same but there are some trucks for movement of cargo inside the port. In
critical differences in the two kinds of cargos the case of container ships, the main vessels or
handled. As far as container cargo is concerned mother ships very rarely visit Indian ports and
the Shipping agents receive the goods to be feeder vessels carrying 1000 to 2000 containers
exported at pre-designated points called the visit Indian ports and carry the containers to

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and from trans-shipment or hub ports such as supposes that the Principals are aware of and
Colombo and Dubai. The turnaround time for agree to the fact that the agent has charged
such feeder vessels is around 48 hours or less, extra amount since the voyage account is sent
and hence certain services such as Chandelling to the Principals. On the other hand, the agent
(providing supplies to the ship) and fresh water may reflect only USD 200 in the voyage account
etc. are not required. On the other hand in case while actually receiving USD 300. In this case the
of break bulk cargo, the main vessels arrive at excess freight collected is reflected as part of the
Indian ports and their turnaround time is often balance payable to the Principal in the Balance
more than a week. Hence, various other services Sheet of the agents, whereas, in the statements
are to be provided by the Shipping agents through sent to the Principals the balances would be a
contractors on which they receive commission. lower figure since only the net freight is shown
Shipping agents are known to introduce bills in to him. Needless to say, the Principals are not
the names of bogus parties. These parties may aware of the difference.
appear as sundry creditors in the books of the 14.5 Most Shipping agents follow the first
agents. system of accounting, i.e., the entire gross freight
14.4  Balances Wrongly Shown as Payable is credited to the voyage account and brokerage
to the Principals: Another important area of @ 2% is debited from the same and credited
concealment pertains to balances lying in the to the brokerage payable account. The excess
books of shipping agents as due to the Principals. freight collected is debited and credited to a
This difference in balance as appearing in the Freight Rebate payable account. The accounting
accounts submitted to the Principals, and as in respect of brokerage payable account is that
reflected in the Balance Sheet of the agents, arises 2% of the gross freight is debited from every
out of certain practices followed by agents. The voyage accountand credited in the name of the
agents collect freight on behalf of the Principals Principals to an account called the brokerage
from the Shippers. The Principals have fixed payable account. Payments of brokerage are
fares from different destinations. Sometimes, the made out of the brokerage payable account.
agent acting through the Clearing & Forwarding Part of the brokerage provided for and credited
to the brokerage payable account is paid after
agents manage to get higher freight rates from the
a substantial period of time while part of the
Shippers. For example, the Principals may have
brokerage provided is never paid. Hence there
fixed a rate of USD 200 per 20 ft container for
are substantial balances in these accounts at all
Mumbai to Singapore but the agent may quote
times.
and get a rate of USD 300 from the shipper. The
agents normally follow two distinct practices to 14.6  Similar to these, are the Freight Rebate
account for the difference. On the one hand the payable accounts. The Shipping agents give
agent may reflect the entire amount of freight rebates out of the gross freight. These may
received (i.e. USD 300) as gross freight in the be because the agent is receiving more freight
voyage account and claim a deduction of USD than fixed by his Principals. The gross freight is
100 as freight rebate payable/ paid. This amount credited to the voyage account and all rebates
of USD 100 is then credited to an account called payable are debited to the voyage account and
Freight Rebate Payable Account, in the books credited to the freight rebate payable account
of the agent. Thus, the balances lie as freight of the Principals. The balances arise because
rebate payable. Only the net freight of USD some of the freight rebate provided for is never
200 is repatriable to the Principals. This pre- paid.

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14.7  Similarly, balances also remain in the these payments. No register or record indicating
Inland Haulage Payable accounts. IHC pertain the name of the freight broker or the person
to transportation charges of containers from ICD entitled to claim rebate was being maintained.
to the port of shipment. The Principals through Neither the bill of lading, nor the shipping bill, or
his agent charge the Shipper for the same. The the bill of entry carried the name of the broker
payment is made by the agent for the same to the or Clearing and Forwarding agent. The only
transporters handling the inland transportation, name appearing on these documents was of the
which in most cases is CONCOR, the subsidiary Custom house agent.
of Indian Railways, which is engaged in container 14.9  The Shipping agents are not in direct
movement. The accounting practice followed by contact with the Shippers. It is the Clearing and
the agents is that the IHC received/ receivable is
Forwarding agents and freight brokers who do
credited to the voyage account of the ship. The
the marketing functions. They approach the
IHC payable is debited to the voyage account,
prospective importers/ exporters and canvass
and then credited to a separate account called
for their business. They offer rates to them
Inland Haulage Payable Account. Subsequently,
and after bagging the business, they approach
haulage is paid by debiting Inland Haulage
different agents whose ships are plying on the
Payable Account. Sometimes for the same
desired route. They negotiate freight rates with
container IHC is recovered from the Principal
the Shipping agents. Often, they are able to get
as well as the Shipper (importers/ exporters).
better rates from the Shippers than the ones
This happens because, at times, the Principal
quoted by the Shipping agents. This difference
receives freight from the foreign party upto the
in rates is called freight rebate. If the Shipper
ICD point while the agent also collects the IHC
makes the payment directly to the Shipping
from the Shipper and debits the Principal’s
Voyage Account for the same. The balance in agents, then the amount of rebate is to be passed
the Inland Haulage Payable Account, represents on by the Shipping agents. On the other hand,
the excess inland haulage, collected by the if the payment is made through the Clearing &
Shipping agents. Such balances remain lying Forwarding agents, then the shipping agents
in the books of accounts for years and run into receives only the net freight and no question
crores of rupees. of paying any freight rebates arises. Moreover,
brokerage of 2% is the industry norm. Besides
14.8  The main points for investigation would bringing business the CFAs and freight brokers
be whether the payments have been actually also track the movement of the containers
made to genuine parties and if yes, for what inside the port. They are also responsible for
services rendered? And whether such balances timely collection of freight and port dues from
represent actual liabilities towards Principals or the Shipper. For these services, they receive the
other service providers or require to be treated brokerages and rebates.
as income of the agent. Investigations have
in some cases revealed that while the bills for
brokerage mentioned the term brokerage, the 15.  CLEARING & FORWARDING
bills for freight rebate, and marketing service AGENTS—A CASE STUDY
charges etc. were actually issued for shifting and 15.1  A leading Clearing and Forwarding
transportation. The payments of these charges agent of Gandhidham, engaged in stevedoring,
were being shown after a considerable length of clearing, forwarding, handling and transportation
time and no record was kept as to who received at Kandla port, was searched u/s 132. During

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these searches, it was found that the difference 15.3 During a search in another group of
between “funds receivable” and the ‘bill Gandhidham, engaged in stevedoring, clearing,
amount’, was collected in cash from the Shipper. forwarding and handling at the port of Kandla,
On an overall analysis of the seized papers, it small note books, in the nature of duplicate books
was admitted by the main partner/ director, that of accounts were seized from the residence of
an amount of Rs. 3.22 crore was received in one of the main persons. Bogus transportation
cash outside the books of account, from various and handling expenses were found debited in the
importers/ exporters, during FY 1994–95 & names of 7 concerns from which false bills were
1995–96. Two things became clear, namely, (i) obtained. The amounts paid to them by cheque
Large unaccounted funds were generated by were withdrawn from their bank accounts. In
reporting inflated figures of expenditure to the the statement u/s 132(4), it was admitted that (i)
Shippers, and (ii) Nearly 40% of the amount unaccounted cash is received from the Principals
was received from the Shippers in cash. for clearing and forwarding work; and (ii) excess/
15.2 Besides, from the office premises, a bogus expenses are claimed under the head
set of s, cheque books, pass books, blank handling and transportation for clearing and
vouchers of 21 bogus labour contractors were stevedoring work.
found, indicating that labour bills for the work 15.4  A racket was unearthed by the Customs
purportedly got done through these labour/ & DRI authorities at Kandla port in which a
transportation contractors, were inflated, and Clearing and Forwarding agent at Kandla Port,
such inflated amounts paid to them through and some brass scrap importers of Jamnagar,
cheques, were routed back to the assessee were involved. The Clearing and Forwarding
by using their blank signed cheque books agents become key persons in loading/ unloading
lying in the custody of the assessee. Some of operations of imported/ exported goods, as they
these persons were found to be employees of develop strong liaison with the Customs and Ports
the group; others were drivers of the trucks functionaries, with whom they meet on day-to-
owned by the group. After detailed inquiries, day basis. Having won their confidence, some
it was established that payment of Rs. 2.31 Clearing and Forwarding agents get involved in
crores made to these 21 parties was received fraudulent practices, in the process earning large
back in cash by the group after withdrawing unaccounted incomes. During FY 1994–95 when
the same from the respective bank accounts. the racket was unearthed the Customs duty on
It transpired that since many of the Shippers imported brass scrap was more than 100%. The
Clearing and Forwarding agent got in touch with
were PSUs who were not in a position to make
a few Delhi and Bombay exporters who were
cash payments, inflated bills were raised in their
holding advance import licenses against export
cases by showing bogus/ inflated expenses on
obligations, which entitled them to imports
their behalf in the names of bogus/ benami
without payment of duty. The real importers
concerns and withdrawing such amounts from of brass scrap of Jamnagar showed “high sea
the books through benami bank accounts. Sales” of their imports to these Delhi/ Bombay
Thus, on the one hand, unaccounted cash was exporters, who, in their turn, cleared the goods
being received from Shippers, and on the other without payment of custom duty at Kandla
hand, bogus expenses were being debited port on the basis of their advance import
through benami labour contractors. licenses against export obligations. The imported

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containers were delivered directly to the brass one warehouse to another, can be got done
importers at Jamnagar against cash payments of only through labour gangs supplied by the
65% to 70% of the payable duty in cash, to the ‘Dock Labour Board’, for which labour charges
CFA. The brass importers in turn, sold the imported are to be deposited beforehand, at prescribed
brass scrap in black market, without bills. rates. In the above case, the seized loose
papers showed unaccounted labour payments
15.5  In another search at Gandhidham in exceeding Rs. 120 lakhs (as also corresponding
the case of another Clearing agent, clinching receipts) during a period of about 6 months.
evidence of unaccounted payments to labour Since these labour payments are in violation of
gangs of Kandla Dock Labour Board was the Dock Labour Act, they cannot be allowed
seized. Under the Dock Labour Board Act, the as a deduction in view of the Explanation to
stevedoring work/ work of shifting cargo from Section 37.

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 Chapter

15
Medical Profession &
Nursing Homes
1.  GENERAL
1.1  Several systems of medicine are prevalent
in the world. However, allopathy is by far
the most acceptable system due to its global
character, scientific system of examination and
diagnosis based on continuing research on a
worldwide scale. Its practitioners enjoy good
status in the society and are assured of a decent
income. Experience indicates that there is a
large-scale tax evasion by medical professionals.
Some cases where action u/s 132 or 133A was
taken show that even leading professionals are a matter of procedure, he used to enter receipts
disclosing only a fraction of their actual receipts. from only the first 5 patients in his books while
the remaining 30 to 40 slips were destroyed every
1.2  The scale of evasion is illustrated by the case
day. These examples are only a pointer to the
of a surgeon in a metro city, in whose case, papers
massive generation of black money in medical
found during a search revealed that though he
profession.
was charging fees varying from Rs. 1,00,000/- to
Rs. 2,50,000/-, depending on the financial status 1.3  In metro cities homeopathy medicine has
and the urgency of the patient but was disclosing also gained wide acceptance among the urban
only about 5–10% of his actual receipts. His population, which has given rise to flourishing
receipts from some foreign patients were huge, of practitioners of homeopathy medicine. The
but hardly any of these, was entered in the books. practice of homeopathy usually is done along
He was found to be in possession of unaccounted with supply of medicines. So while investigating
cash of Rs. 59 lakhs. Besides, evidence of large such cases attention should be paid to both the
unaccounted investment in several immovable areas of fees being charged from patients and to
properties, and unaccounted expenditure on the business of selling medicines.
frequent foreign trips with his family members
were also uncovered. He eventually admitted 2.  SPECIAL FEATURES OF
concealed income of more than Rs. 20 crores. MEDICAL PROFESSION
In a case of an orthopaedic surgeon the search 2.1  It is difficult to verify the reasonableness of
brought to light a novel method of suppression. the income disclosed by medical professionals
Patient slips seized from his clinic revealed that as in absence of proper records and accounts of

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their receipts/ expenses and their investments. It, gifts by the patients or their families after the
therefore, becomes necessary to make a proper treatment. Detection of such ‘receipts in kind’ is
enquiry for making a reasonable estimate of not an easy task and their quantification all the
income. more difficult. Sometimes it may be akin to a
barter deal-medical professionals not charging
2.2 A sizable part of their receipts is in cash,
anything from legal professionals for the legal
which makes it difficult for an AO to verify the
services rendered by them and vice-versa.
correctness of the disclosed receipts. Cross-
verification becomes difficult in absence of 2.7 A common occurrence in these cases is
documentary evidence and the tendency the diversion of the black money of the doctors
amongst rich patients to pay in cash and/ or to their family members and relatives through
from their unaccounted sources. gifts including foreign gifts, agricultural income,
stridhan etc.
2.3 Doctors generally keep their accounts on
cash basis, and claim that only cash realisations
3.  CLASSIFICATION OF
and cash outgoings should be taken into account.
MEDICAL SERVICES
This allows them opportunity to postpone
the taxability of receipts due but not actually 3.1  Family Physicians: General practitioners
received. or GPs or family physicians is a popular group
of medical men. They are the first contact point
2.4  There are no fixed norms or standards for for a patient. GPs initially diagnose the ailment,
the scale of fees charged by a Practitioner. Fees refer the case to a Specialist and make house
vary depending on the locality, city etc. as also calls. They become family’s friends, philosophers
the professional competence, qualifications and and guides during a medical emergency. They
experience of the doctor. Therefore, where a decide the stage when reference is to be made
practitioner suppresses the figures of patients to Specialists, or a Surgeon or a Clinic for
treated or the fees received from them, or both, hospitalisation. Sometimes they also dispense
quantification of income becomes difficult. medicines from their clinics. Their charges may
2.5 It is not possible for an AO to make a vary from place to place and even locality to
reasonable estimate of income without collecting locality. Some families retain physicians on
data regarding the extent of practice of the doctor monthly or yearly basis. But most GPs charge
or his personal expenses & investments. Besides, fees on each consultation. Charges tend to be
it is quite possible that professional income significantly higher during house visits, and visits
may fluctuate from year to year, depending on during odd hours. Some general practitioners
several factors including competition, sudden also charge commission from Specialists,
outbreak of epidemics or unfavourable and Laboratories and Nursing homes. However,
favourable climates etc. This argument becomes in metro cities a large number of GPs are also
a convenient handle to manipulate the returned affiliated to large private hospitals where they
incomes. Professionals, as a class, return higher also provide consulting time.
incomes only in the year(s) in which they are 3.2 Specialists: Specialisations have come
required to account for some investments, or up in several medical fields–viz. Ophthalmology,
large personal expenditure. Orthopaedics, Gynaecology, ENT,
2.6 Sometimes doctors are also paid in kind Nephrology, Oncology, Urology, Paediatrics,
by affluent patients. It was noticed in some Dentistry, Neurology, Radiology, Cardiology,
cases that the doctors were given expensive Dermatology, and so on. The ‘Specialists’ in

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these fields develop lucrative practice after a TDS and other charges, and thus likely to be
few years of experience. Cases are referred to recorded in the accounts of the hospitals. The
these specialists either by general practitioners, visiting consultants may also have an option
or patients directly approach them. Surgeons where the consultant collects the fees from the
have income, both from consultation and from patients directly in cash for which no receipt is
performing operations though a large part comes likely to be issued unless the patient specifically
from operation fee. These specialists may be in asks for it. Similar is the case with the consultant
employment of Government or other hospitals surgeons who either collect their fees through
some of which do not permit private practice. hospital or directly from the patient, in cash.
Cases of Specialists having substantial private
practice require special probe. 4.  LEGAL PROVISIONS UNDER IT
3.3  Super Specialists: A new category of ACT 1961
Super-specialists is emerging because of the 4.1  An activity carried on by an individual
rapid advancement in medical sciences. Some by his personal skill is a professional activity
recent super-specialties relate to Psychosomatic & encompasses the services rendered by him
disorders; Immuno-deficiency disorders; using that skill. Revenue receipts arising from
Schizophrenia & delusional disorders; Delirium/ exercise of a profession including the medical
dementia/ sleep disorders; Muscular dystrophy profession are chargeable u/s 28 of the Act
& related disorders; Peripheral nerve disorders; even if they are of a casual & non-recurring
Optic nerve and Retinal problems and disorders nature. Earlier the main difficulty in correctly
of conjunctiva; Eye-lid and tear gland disorders; computing the income of the professionals was
Sports injuries; Electrical injuries, Children’s non-maintenance of proper books of account by
congenital defects; Blood disorders; and them. Therefore, Taxation Laws (Amendment)
mental disorders etc. There are also specialists
Act, 1975 introduced Section 44 AA with effect
in microsurgery; laser surgery; and transplant
from 01-04-1976, obliging medical professionals
of organs. The private super-specialists charge
to maintain such records as would enable the
very high fees. However, these specialists/
AO to compute his income in accordance with
super-specialists also spend substantially on
the Act.
periodic updates, journals and magazines,
familiarisation/ study trips abroad and acquiring 4.2 Rule 6F of IT Rules 1962 prescribes the
latest equipments. books of account & records required to be
maintained by certain medical professionals,
3.4 Hospital Consultants: The large under Section 44 AA of the Act. Section 44
private hospitals are of two types viz. corporate AB requires that professional having receipts
hospitals and hospitals registered as charitable
exceeding Rs. 50 lakh in any year will get their
trusts either u/s 12AA or 10(23C)(via). The
accounts audited and submit an audit report in
doctors that serve these hospitals are either full
the prescribed proforma.
time employee doctors or visiting consultants.
In case of employee doctors, all the payments 4.3  Section 44ADA was inserted by Finance
are routed through the hospital accounts and Act, 2016 w.e.f. A.Y. 2017–18, by virtue of which
after TDS wherever applicable. However, for the a professional whose gross receipt is less than
visiting consultants the hospital may collect the rupees fifty lakh will not be required to maintain
fee on behalf of the consultant which thereafter any books of accounts provided an income of
gets remitted to the account of the doctor after 50% or more of the gross receipt is declared.

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4.4  In the year 2009 the Medical Council of 1(v) to Section 153. This provision may be kept
India amended the Indian Medical Council in mind while investigating cases of investments
(Professional Conduct, Etiquette and Ethics) made by medical practitioners.
Regulations, 2002, imposing a prohibition on
the medical practitioner and their professional 5.  RECORDS NORMALLY
associations from taking any gift, travel facility, MAINTAINED BY MEDICAL
hospitality, cash or monetary grant from PROFESSIONALS
the pharmaceutical and allied health sector
industries. In pursuance of this amendment 5.1  It is often seen that most medical practitioners
the CBDT issued circular no. 5 of 2012 dated do not maintain reliable and proper books of
01-08-2012, which stipulates that the claim of any account. Some doctors maintain elementary
expense incurred in providing above mentioned books but these are not strictly according to
or similar freebees in violation of the provisions accounting norms. Some keep diaries or slips
of Indian Medical Council (Professional Conduct, but do not truthfully present them before the
Etiquette and Ethics) Regulations, 2002 shall be AOs. Records generally maintained comprise of
inadmissible under Section 37(1) in the hands the patient register or patient cards, appointment
of such pharmaceutical or allied health sector diary, receipt books, and a rudimentary form of
industries or other assessee which has provided cashbook.
aforesaid freebees. The Circular also stated
5.2 However, with the advent of computers,
that the sum equivalent to value of freebees
most of the professionally organized medical
enjoyed by the aforesaid medical practitioner
practitioners maintain records of their patients
or professional associations is also taxable as
on computers. Special computerized software
business income or income from other sources as
the case may be depending on the facts of each packages allow medical professionals ready
case. It must also be kept into consideration by access to the medical history of their patients.
the assessing officers that any practitioner who Most of these packages also enable maintenance
violates the Indian Medical Council (Professional of record of appointments, as also accounts.
Conduct, Etiquette and Ethics) Regulations, 2002 These may, therefore, have all the information
may suffer consequence leading to cancellation needed by the AO for verifying/ ascertaining the
of his/ her registration. income. However, it is possible that for income-
tax purposes the doctor may deny existence of
4.5  Finance (No. 2) Act 2014 has amended
these computerized accounting records.
the Section 142A w.e.f. 01-10-2014. After the
amendment the assessing officer may refer 5.3  Consumer Protection Act makes it
any case to the Valuation Officer to estimate obligatory for all hospitals and nursing homes
the value, including fair market value, of any to maintain registers of patients treated in their
asset, investment or property for the purpose institutions. One such important document is the
of assessment and reassessment. The assessing Operation Theatre (OT) register, which clearly
officer does not have to record a satisfaction bears evidence of the number of OT procedures
or to reject books of accounts while making a performed by each doctor during any particular
reference to the Valuation Officer u/s 142A. period. These records are kept by the medical
Further, once such reference is made, the institutions for a longer period even after the
assessing officer has the advantage of abatement expiry of the financial year and normally nobody
of assessment proceedings vide Explanation would take the risk of fudging such records.

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6.  DEVICES EMPLOYED BY MEDICAL were charging only nominal fees from the
PROFESSIONALS FOR TAX patients. However, when confronted with the
EVASION statements of the patients, he admitted these
facts. Ultimately both filed/ revised returns
6.1  Medical practitioners often not only suppress
admitting much higher incomes.
their receipts but also inflate the expenses and
divert the incomes as would be apparent from 6.4 The main allegation against a leading
following examples. cardiovascular surgeon was that he was charging
very high fees varying from Rs. 5 lakh to 12
6.2 A pediatrician having a large practice in
lakh per patient in cash for performing heart
a major city was also running a pathological
operations. The fee was either not accounted or
laboratory in the name of his wife. Information
was only partly accounted in the books. It was also
was received that the lady hardly had any
alleged that he was investing his unaccounted
proficiency to run the laboratory. Spot enquiries
income in real estate & had purchased several
and examination u/s 131 of the Act confirmed
immovable properties including agricultural land
that she was not even a graduate and hardly
around the city. After discreet enquiry, a search
visited the laboratory. The building where the
was conducted, which resulted in seizure of
laboratory was located was shown as belonging
unaccounted assets of more than Rs. 10 Crore.
to the assessee’s mother-in-law who was being
He was also found to have opened 17 bank
paid rent. On a sustained cross-examination the
accounts which were undisclosed and where
doctor admitted that the income of the pathology
unaccounted deposits of nearly Rs. 12.50 Crore
belonged to him, and that payment of rent was
were found.
only to inflate the expenses.
6.5 A surgeon was attached with 2 nursing
6.2.1  Generally, the nursing homes are
homes. However, in his return of income receipts
individual doctor centric. There is a tendency
from only one nursing home were being declared.
to employee family members. But most of the
During a survey u/s 133A papers found showed
times, their salaries are not commensurate with
that he was working in two shifts in two nursing
the work. At times they don’t contribute also but
homes but was suppressing receipts from the
salary is paid to them on paper. These expenses
are to be checked and verified in the light of second nursing home. His daily receipts were
provisions 40A(2)(b). around Rs. 50,000/- to Rs. 75,000/- though
disclosed receipts were not more than 40% of
6.3 In another case a husband-wife doctor this.
team was running a nursing home. The husband
was a surgeon and wife a gynecologist. Both 6.6 A search was conducted in the case of
were examining their patients in the same a ‘bone & joint’ expert of 12 years’ standing,
nursing home and maintained a common running 3 nursing homes. It emerged that he
Patients’ register. The register had no column had acquired a big farm house and 13 flats
for charges paid by the patients. Statements of including two in posh areas of the city in benami
four patients were recorded by the Inspector. names of his family members who hardly had
They categorically stated that they had each any ostensible source of income. Though he was
paid Rs. 500/- as consultation fee, and that an orthopaedic surgeon, his nursing home was
the doctor was not issuing any receipt. During mostly frequented by Arab patients for rest. These
cross-examination, the doctor initially stated patients used to be admitted in the nursing home
that there were no manipulations & and they for minor joint problems and small surgeries,

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and used to be kept there for 10–12 days against performed in a hospital can be obtained from
room charges of Rs. 3,000/- to Rs. 5,000/- per the OT register. Charges for each operation can
day besides other incidentals. Payments for be ascertained from the accounted for entries or
Consultation, Operation, and other surgical from the patient. Further the statement of the
charges were mostly in cash. Scrutiny of bank patient can be recorded and cross-checked with
pass books and account books revealed that the claim that they have made with the insurance
his income during preceding four years varied company or their employer, if applicable.
from Rs. 1 to 2 crore per annum, though the 6.10  Many a times medical practitioners,
returned incomes never exceeded Rs. 10 lakh. especially specialists, refer their patients to
Most of the properties were acquired in benami other specialists and diagnostics Centres
names during this period against substantial for consultation on specific issues. Many
cash payments to the sellers. Large unaccounted unscrupulous doctors resort to unnecessary
amounts were spent on renovations/ repairs referrals of patients for earning commission,
outside the books of account. When confronted which remain out of the tax net. There is likely
with this evidence he admitted that manipulation to be records maintained for such activities but
of books and admitted additional income as per
these cases can only be cracked during survey
the seized records. or search operation provided the search party
6.7  Private Hospitals tend to inflate the knows what these entries mean. Commission
capital expenditure. Corporate hospitals do on referrals by diagnostic Centres is the most
it to reduce the profit and trust hospitals do it common feature.
so that trustees can siphon off money from the
trust. The amended provision of Section 142A 7.  CHECKPOINTS FOR SCRUTINY
can be very useful in such cases. In the case of
one trust hospital the valuation report pointed 7.1 General: While taking up these cases
out pilferage of few crores of rupees though the for scrutiny, the AO should first ascertain the
Department lost the case on technical grounds, locality where the doctor’s clinic is located;
as the case pertained to a period prior to the his professional qualifications, experience &
amendment to Section 142A. expertise; and his standing, reputation and the
type of clientele he attracts.
6.8  It is also not uncommon that trust hospitals
disguise the fees received as corpus donation 7.2 Professional Receipts: Since suppression
from patients. The patient partly gains by of receipts is a very common feature in the cases of
claiming deduction u/s 80G and the trust has the medical practitioners, it is necessary to ascertain
advantage of having exemption u/s 11(1)(d), the scale of fees charged by them from their
which means they don’t have any obligation to patients for different types of services. The scale
apply such receipts. These facts can be checked of fees will vary for different types of practices,
by comparing similar cases in a hospital where e.g. General Physician, Specialists, Surgeons,
the bills vary by a wide margin. If that is tallied and Consultants etc. It will also depend upon the
with the list of corpus donation received, then type of facilities in the hospital/ clinic, where the
prima facie the department will have a case that services are being rendered. Therefore the AO
would be worth developing. should first find out:
6.9  It is also common knowledge that some a. The nature of services being provided by
surgeons take part-fees in cash, directly from the doctor/ clinic, and the structure of fees
the patients which are not accounted for. The for each of these services existing at the
number and types of operations a surgeon has relevant time.

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b. The amount of consultation fees charged f. Details regarding the attachment of the
from each patient. If the doctor is a doctor with various nursing homes and
surgeon, the normal range of fee charged private hospitals, as also retainer-ship with
for different types of major and minor companies and public sector undertakings
operations. The fees charged in the cases can be obtained, along with the terms of
of employees of Banks, PSUs, and such the contract
other bodies where medical expenses g. It is also useful to know the socioeconomic
of employees are reimbursed by the composition of the doctor’s clientele, e.g.
Employers, can be a good evidence of the whether he is treating a large number of
scale of actual fees being charged. The rates diplomats, foreigners, tourists, people from
prescribed by CGHS for treatment of it’s the upper income groups, as in such cases
beneficiaries in private/ approved hospitals fees may be very high.
for various ailments, can be another good
7.3  Based on the above information relating to
indicator. Similarly, fees charged in case of
the nature of practice, the professional standing/
reimbursement of medical bills of different
reputation of the doctor, the composition of his
types by Insurance companies, e.g. in
clientele, the volume of his practice, the number
Mediclaim Policies can also be a basis.
of patients that he examines per day on an
c. In the cases of dentists, the fees for average, and the nature of services provided by
extraction, filling and other dental him, it should be possible to make a reasonable,
treatments etc. may be found. Some though rough estimate of the likely annual
dentists specialize in Root-canal treatment receipts of the doctor.
where charges may be very high. Likewise
7.4 Professional Expenses: As regards the
some orthodontists specialize in other
reasonableness of the professional expenses
protracted dental treatments. It may be
claimed, it may be useful to obtain the following
necessary to find out the exact fee-structure
particulars:
for each type of treatment.
d. In the cases of ophthalmologists, fee a. Rent, Rates, Taxes and Insurance.
for consultations, for minor ailments, b. Expenses on water, electricity, cleanliness
for cataract operations etc. can be and maintenance, and security.
ascertained. The fees are still higher for
c. Telephone & digital expenses.
retinal, and other major problems. The
branch in which the doctor specializes and d. Expenses on papers, magazines, technical
the types of operations he performs can journals, TV and Internet.
be ascertained. Charges may also vary e. Salary or other payments to clinical staff
according to the technique employed, e.g.
e.g. Consultants, Anesthetists, Radiologists,
laser techniques.
Blood bank, junior doctors etc.
e. In all cases where surgical procedure is
used under anaesthesia, the Surgeons f. Expenses on membership of Professional
obtain written consents of the patient or associations, medical conferences, foreign
his relatives for carrying out the operation. trips, etc.
These consent letters are usually preserved 7.5 Personal Expenses and Investments:
for long periods. These can give an idea Since definitive checks are not possible on
of the number of operations carried out the actual professional earnings, particularly
during the year. in cases where proper books of accounts are

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not maintained, in a case where the disclosed Detailed guidelines for examination of bank
income appears to be grossly inadequate, it may accounts have been discussed in Volume I of the
be advisable to examine the outgoings in respect Manual, and may be referred to.
of personal expenses and investments, and 7.7 Statement of Total Wealth: Another
verify their reasonableness. For this purpose, a useful tool of investigation in these cases is
breakup of personal expenses can be obtained the power available u/s 142(1), to call for the
in respect of: statements of total wealth as at the beginning
a. Rent, taxes, Society charges, electricity and at the end of the accounting year. The AO
and water bills for residence can then examine the accretion in wealth, and
b. Expenses on cars, drivers etc. the personal expenses with reference to the
disclosed income. Detailed discussions regarding
c. Expenses on children’s education including
the calling of the statements of total wealth,
tutor’s fees
and their examination have also been made in
d. Salary to servants, chowkidars and other Volume I of this Manual, and may be referred to.
domestic aids
e. Travel and holiday expenses-both inland 8.  NURSING HOMES
& foreign 8.1 During the last three decades private
f. Expenses on entertainment, Club fees, nursing homes, maternity homes and polyclinics
hotel bills etc. have mushroomed in all big and small towns.
Huge investment is made in constructing and
g. Expenses on PPF, LIP contributions,
equipping these private nursing homes, which
Medicare premia, tax payments etc.
are constantly upgraded and expanded. Some
h. Gifts/ donations exceeding Rs. 10000/- of the nursing homes are as big as mini-hospitals
i. Expenses on Credit Card payments. with excellent surgical and nursing facilities. They
normally maintain Admission register; Births and
j. Expenses on purchase of expensive deaths register; Receipt book; ; Day book; Cash
Consumer Durables. book; Ledger; and Salary register etc., besides
k. Expenses on major functions, ceremonies, the records of the patients. On the basis of these
marriages etc. records, a Receipt and Expenditure statement
can be drawn.
l. Expenditure, if any, on purchase/
construction/ repairs/ interior decoration of 8.2  Verification of Receipts: Details relating
house. to preliminary consultations, room charges,
various Pathology tests/ X-ray charges, charges
m. Particulars of new investments in shares,
for Anaesthesia, Charges for Consultations with
fixed deposits, and other movable property.
other experts, Pre and Post-operative charges,
7.6  Bank Accounts: Though part of black money Operation fees and charges for medicines, and
earned by doctors & other professionals may be charges for blood transfusion etc., must be
spent on lavish lifestyle a part may indirectly find closely examined. Maternity homes are, by law,
way to bank accounts of the doctor, his spouse required to give intimation of births, and deaths at
and children etc. Therefore, scrutiny of bank their premises to the municipal authorities under
accounts often leads to discovery of vital clues the Registration of Births and Deaths Act. The
enabling an AO to collect sufficient evidence statutory records maintained under this Act can
of unaccounted deposits transfers, interest etc. give valuable information regarding the number

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of maternity cases handled in a year. Similarly costly equipment/ X-ray machines and manage
under the Medical Termination of Pregnancies to procure fake/ inflated bills
Act, the maternity homes are required to 8.5 Very often the involvement of family
maintain records relating to the abortions carried members is so skillfully planned that in the
out at their premises. Prominent nursing homes first instance it appears genuine. The devices
in important towns are approved by various mentioned below need to be carefully looked
Public Sector Undertakings, Private Limited into to ascertain the genuineness of such claims:
Companies, for treating their Directors/ Senior
Executives. Details of payments by the PSUs/ a. Showing the spouse of the assessee as the
Companies can be obtained from these concerns owner or main tenant of the building from
and cross-verified with the statements submitted where the clinic is run, and paying inflated
by the nursing homes. The rate structure of rent to such ostensible owner.
charges in these statements can be used to verify b. Showing the spouse or a relative as the
the reasonableness of receipts shown from other owner of a Pathology or a laboratory, or a
patients. medicine shop, or an expensive machine,
8.3 Verification of Expenses: Details of or an expensive service e.g. ambulances,
expenses on Rent, Rates & Taxes; Society needed by the Nursing home, and paying
charges; Expenses on laboratory; charges inflated charges to such concern.
on Technicians; Salaries; Laundry charges; 8.6 Bank Accounts: While investigating
Expenses on running and maintenance of cases of private nursing homes Bank passbooks
vehicles/ ambulance; Payments to associates; of the owners/ doctors and their family members
Expenses on medical journals, magazines; Misc. may also be examined. Detailed guidelines for
charges like postage, stationery, computer/ examination of Bank accounts have been given
internet etc. can be called and verified. The in Volume I of the Manual, which may be referred
genuineness of payments to associates, other to. In serious cases of tax evasion, Total Wealth
Specialists, junior doctors, nurses etc. should be statements of the main owners can be called, as
checked carefully with respect to their terms and discussed in Para 7.7 above.
of their engagements.
8.7 Verification of Billing of Rooms at
8.4 Investments: The investment in the Time of Discharge of Patients: At times,
construction of the nursing home and purchase/ at the time of discharge of patients there is a
installation of costly equipments must be tendency to leave the patients after 12:00 Noon
critically examined. There is a tendency to so that billing can be made for another day. In
understate the investment in purchase of land this manner, billing is made for two patients for
and construction of building to overcome the the same day but in the books only one is billed.
difficulty of explaining the source of investment. This idea is also being used in the Hotel Industry
On the other hand,-expenses incurred on air- where capacity utilization is more than 100%.
conditioning, special fitting/ sound proofing and In this regard the discharge timing should be
in purchase/ installation of expensive equipment/ thoroughly verified.
X-ray machines etc. is overstated to avail higher
loans from Banks, and higher depreciation.
9.  DIAGNOSTICS CENTRES
Therefore, these should also be properly looked
into. Often owners/ trustees of nursing homes During last few years a number of
connive with the suppliers/ manufacturers of Diagnostics and fitness centres have been

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setup with ‘state of the art’ medical facilities the sources of investment. Particularly, the first
and expert team of consultants. The concept, year of setting of Diagnostic Centres and Nursing
which is borrowed from foreign countries, is Homes is crucial, as the surplus amount of black
of ‘one-stop-shop’ for primary health care, money generated is invested in creating the
diagnostics & fitness. They provide facilities physical infrastructure. It is necessary to obtain
like-Medical & surgical consultations; Health a list of the services provided by various doctors/
screening; Pathology; Radiology & Imaging; experts attached. The AO should also obtain the
Physiotherapy; Dentistry; Hoemodialysis; Yoga list of major equipments installed, and examine
& Stress management etc. While examining such the source of investment in the same, as these
cases proper enquiry should be made regarding ultramodern health centres are often setup to
the reasonableness of the investment shown and invest unaccounted funds.

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 Chapter

Other Professions:
16
Other than Medical Profession

1.  GENERAL
1.1 The idea of valuation of human resource
material i.e. skilled individuals and professionals
in the financial statements is just gaining
acceptance. A ‘profession’ is defined as a
commercial practice or exploitation of one’s
individual skill, which can be across a large
number of activities required by a particular
Section of society at a particular point of time. With
the globalisation of economy and the new trend
of professionalization of services, professionals
are entering into new areas moving away from
their traditional roles of medical professionals, 2.  SCOPE OF PROFESSIONAL
advocates, legal advisors etc.. Therefore, there INCOME
is increasing demand for professional fashion
2.1 Under Section 2(36) of the Act, the term
designers and models, jewellery designers,
‘profession’ has been given an inclusive definition,
singers, industrial consultants, valuers, financial
to include vocation. Generally, ‘profession’ is an
analysts, interior decorators, event managers,
occupation requiring either purely intellectual
public relation consultants, private detectives,
skills, or some special manual skills of the
script-writers, Vastushastris, software consultants,
and so on. operator. Therefore, exercise of professional
skills is to be distinguished from operations
1.2 There is a boom in services sector of the involving production or sale of commodities. It
economy, which is providing new opportunities is often said that, “all professions are business
to these ‘skilled individuals’. It is also a fact that but all businesses are not professions”. There
service sector contributes a very large proportion are some subtle distinctions between the terms
to the over-all black economy. Investigation in the ‘business’ and ‘profession’, namely:
case of professionals pose an altogether different
kind of problem than those arising in the case of a. While ‘business, involves production
a trader or manufacturer, as the backward and or trading of a commodity or goods, no
forward linkages of the activities of professionals such items are required for profession.
with the clients to whom services are provided is A profession is basically commercial
not readily available. exploitation of one’s skill and knowledge.

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b. In ‘profession’, the capital requirement realisations and cash outgoings are taken into
is either low or nil; while in a business account. This allows them considerable flexibility
‘capital’ is one of the major input. in postponing taxable receipts to a later year
depending upon the cash flow situation.
Thus, professional activity can be understood as
an activity carried on by the individual by his 3.4  A very large part of professional receipts are
personal skill and intelligence, to offer specialised generally in cash. This is further compounded by
services to his clients. the fact that their clients also generally prefers to
2.2 In theory, a ‘profession’ can be carried make payments in cash from their unaccounted
out by an individual alone or by a group of income. Cash receipts can be easily concealed
individuals. All the revenue receipts arising from by simply not recording them in the regular
the exercise of a profession are chargeable u/s books of account and the detection of the same
28 of the Act, even if they are casual and non- is extremely difficult.
recurring in nature. Payments voluntarily made 3.5 The fees charged by the professionals
by persons, who are under no legal obligation vary widely, depending on the qualification,
to pay anything at all, would be income in the competence, and popularity of the professional,
hands of the recipient, if they were received in as also on the,paying capacity, relationship and
the course of exercise of profession. Therefore, standing of the client. For instance, in the case
an amount received by a lawyer from a person, of Architects the fees may range from 0.5% to
who was not a client but who had benefited 10% of the total cost, depending on the size of
by the lawyer’s professional service would be the project, the standing of the Architect, and his
taxable in the former’s hand. Similarly, shares relation with the builder. Such a situation offers
gifted by clients to a lawyer who had assisted in, a large scope for manipulating and understating
say floating a company, would also be taxable in theirprofessional income.
the latter’s hand.
3.6  Many a times professionals, like Advocates
3.  PROBLEMS IN DETERMINING also act as ‘retainers’ for which they get, a fixed
PROFESSIONAL INCOME amount of fee, as also perquisites in the form
of rent-free/ furnished accommodation, and/
3.1 The main problem in determination of or some other facilities. They also charge fees
professional income is the difficulty of verifying separately for appearing in the cases before
the correctness of the disclosed income various courts. The value of these perquisites
because these persons generally declare their and the full fee charged for such representation
income on estimate basis and do not maintain are at times not disclosed to the Department.
adequate records of their income, expenses and
investments. 3.7  Professionals often spend large amounts on
lavish lifestyles and conspicuous consumption to
3.2  Another problem is the possibility of large increase their clientele network, as also out of
fluctuation of annual incomes from year to sheer compulsions of their professional activities.
year. This provides them considerable scope to While the traditional professionals like lawyers,
manipulate disclosed incomes, and to disclose
architects etc. may fall in the former category;
larger income in the year in which some
the new breed of the glitterati world like fashion
investments are made while getting away by
gurus, pop singers, actors/ actresses, and
disclosing smaller incomes in other years.
models etc. flaunt lavish life styles due to their
3.3 Professionals, by and large, keep their professional demands and to profess that they
accounts on cash basis, as per which only cash are successful. Therefore, it becomes necessary

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to ascertain their lifestyle, personal expenses, professional activities, life style, expenses and
investments etc. of the professional tax payers. investments gathered from different sources.
3.8  Another problem common to all
professionals is of artificial diversion of income 5.  LEGAL PROFESSION
in the hands of near relatives, nominees & 5.1 The legal professionals may broadly be
benamidars etc., and its subsequent capitalisation categorized as Lawyers, commonly called
in their hand. This is done by taking recourse Counsels, Solicitors, or Advocates-on-record in
to various escape routes, such as gifts including the Supreme Court. The Advocates Act, 1961
foreign gifts, agricultural income, streedhan, regulates the legal profession. The Bar of the
fictitious ‘wills’ of deceased relatives etc.. Some Supreme Court is divided into three categories,
novel methods include relinquishing of rights in viz. Advocates-on-record; Advocates other than
shares in favour of close relative, and bartering Senior advocates; and Senior advocates.
assets at understated costs. Therefore, it becomes
necessary to examine the creation of wealth in 5.2 Senior Advocates: Section 16(2) of
the hands of the relatives/ benamidars etc. the Advocates Act provides that an advocate
may, with his consent, be designated as Senior
3.9  Every profession has its own distinct modus advocate if Supreme Court or a High Court is of
operandi, ambience and ethos depending upon the opinion that by virtue of his ability, experience
the Section of society, it is catering to. During an and standing at the Bar, he is deserving of such a
action u/s 132 against some fashion designers distinction. The pleading advocates, other than
at Delhi, their professional records and accounts senior advocates, whose names are entered on
were found to be in a state of complete disarray. the Common Roll, come in this category Junior
It emerged that they hardly had any time or advocates.
inclination to pay attention to such mundane
things, like their financial accounts & records. 5.3 Solicitors: The primary function of a
Solicitor is that of an agent for litigants whose
cases have gone before the High Courts. Under
4.  PROVISIONS OF IT ACT the rules of procedures of the Calcutta and
The main hurdle in correctly computing the Bombay High Courts, no Barrister or Advocate
income of professionals is the absence of proper can be engaged to plead a case before the High
maintenance of the books of account by a Court on the original side, unless he is instructed
professional. For this very reason, Section 44AA by a Solicitor. In other words, where a litigant
was inserted by the Taxation Laws (Amendment) wants to file a suit before these High Courts,
Act, 1975 with effect from 1-4-1976, making a Solicitor has to be engaged. The Solicitor’s
it obligatory for persons engaged in specified work includes drafting of petition, consultation,
professions to maintain such books of account, settling of petition, and such other miscellaneous
as may enable the AO to compute their income matters. They also often work as Liquidators or
under the Act. Further, Section 44AB of the Act Receivers, give legal advice or obtain it for their
requires a professional having gross receipt of clients, and handle legal aspects of setting up new
Rs. 50 lakhs and above, to get his accounts companies, issue of debentures, underwriting of
audited. The audit reports, wherever available, shares etc.
become an important tool of investigation.
However, in most cases these statutory norms 5.4 Advocates-on-Record: The Supreme
are not complied with. Therefore, by and large Court rules prescribe that no person other than
the cases of professionals have to be investigated an Advocate-on-record can appear and act for a
not only with the help of accounts produced by party and no advocate can appear for a party at
them, but with reference to information of their the hearing unless he is an Advocate-on-record

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or is instructed by an Advocate-on-record. Rule b. Solicitors can be asked to give complete

6 (c) of the Supreme Court Rules 1966 lays list of lawyers engaged by them on behalf
down as under: of their clients along with particulars of
payments made to them.
“Every advocate-on-record shall keep such
books of account as may be necessary to show c. Weekly/ fortnightly/ monthly cause-lists
and distinguish in connection with his practice of the High Courts can be obtained in
as an advocate-on-record, (i) moneys received cases of senior lawyers/ solicitors where
from or on account of and the money paid to concealment is suspected. As these lists
or on account of each of his clients; and (ii) the contain names of the solicitor/ advocate
moneys received and the moneys paid on his connected with each case, these provide
own account”. valuable information for cross-verification.
5.5 The Sub-rule (d) of Rule 6 lays down an d. The terms and conditions of retainerships,
important condition, namely: including discontinued retainerships, if
“Every advocate-on-record shall, before taxation any, can be examined.
of the Bill of Costs, file with the Taxing Officer a e. Particulars of other part-time activities and
Certificate showing the amount of fee paid to remunerations there from, such as part-
him or agreed to be paid to him by his client.” time lectures in law colleges and valuation
5.6  Thus, the duties of an advocate-on-record of answer sheets; appointment as receivers/
are similar to those of the Solicitor. They charge commissioners, arbitrators; giving opinions,
fees for consultation, drafting petitions, settling arranging negotiations/ out of court
petitions by the Senior Counsel, and filing papers settlements etc., can be verified.
in the Court, and collect lump sum amounts to f. In the cases of advocates handling high
defray expenses. The Solicitors and advocates- profile/ sensitive cases, discreet enquiries
on-record generally maintain Cash Book; can be carried out, particularly where
Clients’ ledger, Bills register; and Journals. there is information regarding huge pay-
5.7 An important issue needs mention here. offs/ package deals etc. In such cases,
While in the weekly or fortnightly cause-lists information could be forthcoming from
issued by the High Courts, the names of the the rival. Many times high profile and
both Solicitors and/ or lawyers who represent sensitive cases continue for years and
the litigants are mentioned, the cause-list of lawyers maintain separate accounts of
the Supreme Court gives names of only the such cases. These accounts should be
Advocates-on-record, who alone can furnish the closely scrutinised to find out whether
name of the Counsel appearing in a particular advances shown as liabilities are actually
case. It is, therefore, necessary that a list of fees final receipts. The expenses (debits) may
paid by an Advocate-on-record to different be also overstated or fictitious.
Counsels on behalf of his clients be obtained for g. Juniors/ Subordinates working under
verifying the receipts shown by an advocate. senior lawyers may have vital information
5.8  Checkpoints for Scrutiny about the extent of receipts and high profile
cases handled, during the year. Many a
a. A complete list of cases in which the lawyer
time remuneration to juniors is overstated
appeared before different courts, as also
to reduce the taxable income.
other cases handled by him during the year,
can be obtained from him. Receipts from h. Money deposited in the bank accounts
important/ major clients can be verified. of solicitors/ Advocates-on-record and

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claimed to be deposited by clients is often for an AO to get the details of clients of each
advanced for services to clients (including Chartered accountant or Tax practitioner.
fees for senior advocate, solicitor, clerkage
6.2  Some typical checks to be carried out by
and other incidentals). The veracity of such
the AO in these cases are, as under:
deposits needs to be closely examined, as
these may be unaccounted money of the a. Full list of cases can be obtained, showing
solicitors/ advocates. the fees received by the Chartered
Accountant for statutory audits, for other
i. Remunerations from services such as
audits, and for representation of the client
for floating new companies, negotiating
in income-tax, Sales Tax and other quasi-
sale of controlling interest in a company
judicial proceedings.
i.e. takeover deals of corporates, can be
verified. b. In the case of a Tax Practitioner, list of
payments received by him in connection
j. Sometimes interest, which may not at all
with the preparation of returns of income
relate to the professional activities of the
and appearances on behalf of the clients
lawyer, is debited to the accounts. Similarly,
in Income-tax/ Sales Tax matters can be
depreciation may be claimed in respect of
obtained.
items not connected with the professional
activities. While such amounts will have to c. Important particulars from these lists can
be disallowed, a scrutiny of the accounts be crosschecked with the corresponding
and the depreciation claimed may also details obtained from the concerned
give clues to the unaccounted investments. clients. Often Chartered accountants and
Tax Practitioners are also engaged as
k. In recent times, finance professionals
also handle work of multinationals and retainers by reputed concerns. The terms
sometimes services are rendered abroad and conditions of such retainerships can
for offshore clients. Taxability of this also be called for and examined.
income will be as per existing law. Since
global income of the individual is to be 7.  ARCHITECTS
taxed, the AO should examine this angle. 7.1  In the case of Architects also, the clientele
changes from time to time. For example, once
6.  CHARTERED ACCOUNTANTS & a particular project designed by an Architect is
TAX PRACTITIONERS complete, chances are that need for his services
6.1  Chartered accountants have basically may not arise to that client at least in the near
two specialisations-auditing and taxation. future.
The functions of the Tax practitioners and tax 7.2  Following points may be kept in mind in
consultants are, of course, limited to taxation these cases:
only. Besides auditing accounts, Chartered
a. A substantial part of unaccounted money
accountants also attend to taxation matters of
is consumed in real estate investments.
their clients. The checks elaborated with regard
Since the fee of an architect depends on
to the legal profession are also applicable to this
the size and cost of the project, a portion
class of professionals. However, the Chartered
of the Architect’s fee may also remain
accountants and Tax practitioners mostly have a
unaccounted.
permanent clientele, in contrast to the members
of the legal profession, who have a shifting b. Many architects are also Registered
clientele. Therefore, it is relatively less difficult Valuers. It must be seen whether the fees

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charged for valuation work have been receipts of established film artists etc. up-to-date
properly accounted for or not. Often extra information regarding their work will have to
fees are charged by these professional for be gathered from as many sources as possible.
understating the valuation of a property. Trade journals are of great help in this regard.
c. Many architects are known to take money 8.3 In the case of reputed singers, musicians
from contractors for certifying the quality and authors, it is necessary to ensure that the
of the work of a carpenter, a plumber, an royalties received by them from the recording
electrician or a civil contractor, which is companies/ publishers on the sale of their discs/
usually a certain percentage of the project publications etc. are properly disclosed. Famous
cost that he is certifying. musicians are also in demand for giving music
d. Inflation of expenditure, which is common concerts locally as well as in foreign countries.
to all professionals, is equally rampant There is a tendency to suppress the income from
in the cases of architects. For example, such programs, including the travelling and hotel
an architect may claim that he had paid expenses received. Efforts should, therefore, be
certain percentage of his fees to structural/ made to obtain the details of such payments
electrical/ plumbing designers, though from the organisers of the programs.
in actual fact he may not have paid any 8.4 Most authors do not keep proper books
such amount at all, or might have paid a of account. It is, therefore, necessary to verify
lesser per centage. Inflation of salary to the disclosed receipts with reference to the
staff (e.g. Draughtsman) is another mode information collected from the publishers. In
of understating the income. significant cases, the AO may obtain extracts
from the catalogues of major publishers which
8.  AUTHORS, ARTISTS give details of books including the name of the
AND MUSICIANS author, publisher etc. The information collected
could then be verified with reference to the
8.1  Uncertainty of Career: It is an admitted
receipts disclosed by the author.
fact that popularity of these professionals is of
a fleeting nature, depending on passing taste, 8.5  Royalty received from the publishers/
whims and fancy of the public. As a result, recording companies: The receiver normally
their careers fluctuate with popular demand, accounts for the Royalty on receipt basis, while
and are generally short-lived. Not unnaturally, the Publisher books expenditure on accrual
therefore, these people make efforts to earn basis. It cannot be denied that whenever an
as much as possible in the short time in which expenditure is booked by the payer, the same
their popularity is high. Therefore, they are can be treated to have accrued in the hands
often tempted to declare only a part of their of the recipient, regardless of as to whether
income. Even where they wish to declare their the same has been paid or not. Hence, in the
true income, the persons making payments case of publisher/ recording companies having
to them prefer to make payments out of their paid/ booked significant amount under the head
unaccounted income. “Royalty”, it might be proper to cross-check the
amount shown by the author/ musician via-a-
8.2  The Department’s experience in the cases
vis the accounting treatment adopted by the
of many established artists is that they do not
publisher/ recording companies.
maintain any books of account. They generally
file statements of receipts and expenses only. 8.6  On many occasions, expenditure on tour like
Many times omissions of receipts have been air-fare, hotel charges, charges for the musicians
detected in such statements. For ascertaining the who accompany them, and other incidental

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charges are paid by the organizers directly to outside club. Therefore, the income declared by
the persons who raise bill for these expenses. Jockeys/ trainers can be verified from the turf
Normally, the accounts are not credited by the clubs.
amount of reimbursement received since per se,
9.1.1 Trainers: Trainers normally receive:
these do not constitute income. However, even
then, the expenses may be claimed as deduction a. Basic Training Fees paid by the owners
in the accounts. This must be kept in mind while of the racehorses. This varies from season
scrutinizing the claim of such deduction. to season as per rates fixed by the parent
Turf club;
8.7 The eminent singers plan their tours in a
fashion that on a trip, more than one concert b. Commission from Racehorse Owners
is staged. However, most of them charge the is paid as perthe rules of the Turf clubs,
expenses like Air-fare, Hotel charges, Charges as a percentage of the prize money on
for the musicians, incidental charges etc. from the winning horses as well as for horses
all the organizers and such payment is normally ‘placed’ upto 3rd position in a race of 7
received in cash. The reimbursements received horses and upto 4th position in races of 8
are either not disclosed at all, or, at the most or more horses. The exact percentage of
single reimbursement is disclosed. Therefore, the prize money can be ascertained from the
receipts from all trips with significant duration concerned Turf club; and
are to be verified from this angle and reference c. Percentage of Cup Value as per rules of
may be made to the organizers, if required. the concerned club is also given to trainers.
8.8 On many occasions, the receipts from 9.1.2  While dealing with cases of the Trainers,
concerts/ stage shows/ private shows are the AO should check the expenses claimed
suppressed, either partially or fully, depending by them. Most of the Trainers claim large
on the nature of receipt from such organizers. expenses on horses in the races conducted by
The main auditoriums of the city where the artist other Turf clubs. These include transport of
has toured for a considerable length of time may horses, maintenance of horses at the outside
be contacted for details of programmes held club, stable rent, etc.. It is essential to verify the
during that period for ascertaining as to whether Club certificates to ascertain the exact position.
any programme of the artist concerned was held Some of these clubs as well as the parent clubs
there. From the said list also, organizers can be generally, subsidise transportation cost and the
traced out for verification. stable and maintenance expenses in respect
of horses participating in such races. Often
9.  RACE HORSE the horse owners bear most of such expenses.
TRAINERS AND JOCKEYS Generally, the trainers are not expected to bear
9.1  As per the rules of the Turf Clubs in general, the expenses outside the parent club premises.
they maintain detailed accounts of both, the 9.1.3  As regards the receipts of the trainers, it
trainers and Jockeys in relation to payments is essential to verify the Club’s circulars relating
made to them by racehorse owners, in respect of to the particular race and the ‘Racing guide’, for
the horses maintained in their stables, and for the determining the quantum of owner’s commission
races conducted in the race course of the club. as also the percentage receipt of the cup value.
The clubs also maintain accounts of the amounts In the case of a trainer who is also the owner of
receivable from other clubs in case, a horse from race horses, it will be necessary to examine both
their stable enters in a race conducted by an the accounts carefully, especially the amounts

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receivable by him, under the Club rules, as 9.2.4  The usual method adopted for
Trainer of his own horses. concealment by these professionals is not to
show the receipts other than those permitted
9.2  Jockeys by the Clubs. In the case of Trainers, the
expenditure account relating to horses entered in
9.2.1  Jockeys receive amounts from the owners races conducted by outside clubs need scrutiny
as per the rate fixed by the parent Turf club, from and verification.
the following sources:
a. Riding Fees is received from the owner 10.  INTERIOR DECORATORS
directly, or through the club, irrespective of
10.1  Some architects also do interior decoration
the fact whether the horse ridden by him work. But there are professional interior
wins or loses. decorators also, who specialise in lifestyles and
b. Commission from Owners also goes ambience. These professionals are concentrated
to the jockey of a winning horse. The in metropolitan cities where space constraints
jockey receives 10% and 7.5%, of the and the desire to lead aristocratic lifestyles go
prize money, for riding a horse placed together. Many interior decorators operate
through Architects.
first or second, respectively. In respect of
other horses “placed”, his share is 5% of 10.2  The clientele of the interior decorators is
the prize money. However, the jockey does generally developed through personal contacts
not receive any amount in respect of the and recommendations, which may not be on
cup value. records. This renders the traditional methods of
investigation of books of account, ineffective.
9.2.2  A jockey cannot claim expenses against Therefore, ascertaining particulars of clients to
his professional receipts except as specified in whom services were provided during the year
the statute viz., for insurance, transport etc. As is a difficult exercise. However, names of the
in the case of Trainers, it is essential to cross- architects are on the record of builders. The
verify the declared income with reference to the reputation of architects also contributes to the
accounts maintained by the club. market price of the project.
9.2.3  Apart from, the payments regulated 10.3  The scope of the work of an architect is
by the rules of the Turf Clubs, detailed above, visible through exterior structures, while the
there are other receipts also. It is well known that work of the interior decorator remains behind
Trainers and Jockeys receive substantial extra doors. Unless one enters the house, it is difficult
payments from the owners on certain occasions. to ascertain the cost or the quality of the interior
These are gratuitous payments especially when decoration. This enables the interior decorators
races are “fixed”. It is also commonly known that to operate on cash basis. Both, the cost of
the owners of horses share a part of their stake interior decoration, and the charges of designer
money with both the Trainers and Jockeys. It is are generally paid from unaccounted money.
learnt that in respect of “fixed” races heavy odds Naturally, therefore, the interior decorators
are offered and Trainers and Jockeys also share also do not offer for taxation, such receipts in
the earnings. “Joint Ventures” between Jockeys their books. Therefore, the AO has to focus
or between Trainers and Jockeys are also not on personal expenses, investments and bank
uncommon. It may be noted that turf clubs do accounts, rather than receipts.
not permit Trainers and Jockeys to bet or act as 10.4  The fees charged by interior decorators are
ordinary punters. often exorbitant. In most of the cases, it exceeds

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10% of the cost of renovation. In mega cities, of the fashion-designing world. Therefore, with
such as Mumbai, often the cost of renovation the advent of fashion designing, modelling has
exceeds the cost of the flat itself. In an action u/s also become a full time profession. Modelling
132 of the Act at Mumbai, it was noticed that has a wider scope than fashion designing.
a particular businessman had spent more than Modelling is intricately related to growth of
Rs. 2 crores on renovations, while the cost of consumerism and brand advertisement culture.
the flat was much less. The cash component in Several advertisement companies have exclusive
renovations was found to be more than 60%. In models, for their assignments.
nutshell, these professionals have large earnings 11.4  In the case of modelling, generally there
which is away from the public gaze. is a “contract” for certain period of time during
10.5  Many well-known interior decorators which the model has to work for the “Agency”,
are not even assessed to tax. In these cases, depending upon of the terms and conditions.
the Architects provide the crucial links. In The receipts of models, from the Agencies, are
majority of cases, the interior designer operates by and large, properly verifiable because the
through the Architects. Therefore verification “Agency” has to claim the payments made to
from the architects about the particulars of the models, as expenditure in its own case. Therefore,
interior decorator engaged may yield valuable inflation of expenses is a more common mode of
information. suppression of taxable income in these cases. It
is however, possible that a particular model may
11.  FASHION DESIGNERS AND have worked for several assignments with several
MODELS Agencies. In such cases, it may be necessary to
ensure that all receipts are accounted for.
11.1  These are a new class of professionals
operating in the glamorous Section of the 11.5  The profession of ‘fashion designers’ is an
society. This is a field where money is intrinsically exclusive field where, generally, considerations
associated with the fame of a person. Therefore, are kept confidential. For example, how can one
there are a large number of entrants, mostly ascertain the amount charged by the designer
upcoming and upwardly mobile youth, operating for the winning designer costume of say Miss
mainly in the black segment of the economy. Universe or any other pageant? Therefore, in
the case of these professionals, their life style,
11.2  The factors contributing to the rapid consumption pattern and personal expenses
growth of these professions are the widespread need to be thoroughly scrutinised. For instance,
industrialisation, urbanisation and growth of these professionals often travel abroad to
consumerism. The fashion and garment industry participate and/ or attend foreign fashion shows
has grown exponentially, benefiting the ‘designer and exhibitions etc.. Therefore, expenses on
houses’, and the in-house designers. Today, foreign trips can be an area of scrutiny.
leading chains of garment stores and brand
11.6  The professions of modelling and
movers in the garment industry are having in-
fashion designing etc.. are relatively new. Very
house fashion designers and consultants. People
often, these professionals are ignorant of their
like film celebrities, sports star, industrial icons,
obligations under the tax laws, particularly
models, film producers etc. are ready to spend
relating to maintenance of record. Therefore,
huge sums for acquiring a different look. the AO must try to collect outside information,
11.3  The relation between ‘models’ and fashion such as market and media reports in glamour
designers is akin to that between an actor and the periodicals and collect data regarding prominent
director of a film unit. Models are the mainstay fashion shows and exhibitions etc.

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12.  PAINTERS, SCULPTORS AND cricketers. Apart from income from Central
FINE ARTISTS and State bodies for national and international
matches, they have income from clubs and
12.1  Painters, sculptors and fine artists usually
franchisees and from tournaments like I-league,
market their art work to individual buyers, to art
ISL, Pro-kabaddi, Badminton League etc. and
galleries and may also work on commissioned
from advertisement campaigns.
projects, particularly in film and television
industries. Artists may also maintain their own 13.4  Like other professionals, sports personnel
studios. Overseas exhibition is also a source of also evade tax by under reporting income and
income. Income is mostly generated in cash and inflating expenses. Unaccounted income is
only a part of income is disclosed in the Income- usually spent in lavish life style, acquisition of
tax Return. Expenses are also incurred in cash wealth and exotic tours and travels.
and there is tendency to inflate expenditure to 13.5 Examination of contractual agreements/
reduce tax liability. Books of accounts are not documents of similar nature is absolutely
properly maintained. necessary in assessments of sports professionals.
12.2  In the case of these professionals it is very Reference to the clubs, franchisees, sponsors,
difficult to ascertain manpower input and output agents, corporate houses, media and publicity
therefrom. There is need to collect information agencies associated with advertisements
from exhibition houses, art gallery owners, should also be made to gather information
media including social media and art journals about income. Form 26AS, Bank statements
etc. Credible information may be collected by including credit/ debit cards, passports are
conducting survey in artist’s studio which may required to be scrutinized thoroughly to obtain
lead to detection of unaccounted income. clues of unaccounted income, expenditures and
investments.
13.  SPORTS PROFESSIONALS
14.  PROFESSIONAL ENGINEERS
13.1 In Indian standard, players, coaches
and support staff of a team are included in this 14.1  Professional engineers are usually
category. The country is known for sports like deriving income from providing professional
football, cricket, hockey, kabaddi, badminton, services, such as engineering, consultancy,
chess, snooker etc. but now, the most popular drawing & designing, procurements and
sport is cricket. project management etc. Rampant tax evasion
is prevalent in this class of professionals by
13.2 Cricket players earn more than other
suppressing income and overstating expenses.
players. Cricketers are categorized by the parent
body BCCI and are paid as per Central Contract, 14.2  During assessment, the AO should
which includes retainer fees, fees for Test/ ODI/ examine the document of contractual agreement/
T-20 matches, team performance bonus for a professional agreement to ascertain the income
match/ series/ tournament including IPL and components embedded therein and compare
individual performance bonus. There is also the same with ITR. Detailed project schedule,
income from respective club/ franchisee. They critical activities/ services rendered, involvement
have huge income from media advertisements of other parties/ agencies, inputs and logistics
and endorsements and also from sponsors. provided are required to be examined to identify
any hidden income.
13.3 Income of players and sport personnel
associated with other sports including football 14.3 ‘Contract for service’ or ‘contract of
are not so lucrative as compared to that of service’ is a controversial issue in this profession.

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The former is chargeable u/s 28 as professional become very large in comparison to the income
income but the later is chargeable u/s 15 as intended to be offered for taxation.
income from salary. Therefore, it is essential 15.2  Some points should be noted at the
to examine the related agreement critically to outset, viz.:
determine the correct head of income.
a. Fees received from unaccounted sources
14.4 The AO should examine whether the of the payer are normally not meant to be
engineer is working in single capacity or working disclosed by the professionals.
as consortium of other service providers like
interior designers, man power suppliers/ labour b. Professionals like lawyers/ advocates,
and other contractors, material suppliers etc. often do not account for the out-of-pocket
and verify expenses booked for such ancillary expenses, or the remuneration for an out-
services. of-court settlement etc.., received in high
profile/ sensitive cases.
14.5  Underreporting of income, income
offered after netting off, chargeable income c. When the fees/ remunerations is received
shown as advance, diversion of income to near in cash, the normal tendency is not to
relatives are certain common modes of tax account it in the books.
evasion. Splitting of income to divert chargeable d. Where receipts are not subject to proper
income to other year had also been noticed. It checks or verification, the only way out
is therefore, necessary to verify the disclosed is to proceed for verification of personal
income with reference to the income reported in expenses & investments.
26AS. Reference should be made to concerns/
agencies, who hired the professional to gather 15.3  Verification of Bank Accounts: This is
information of income and should be compared the best method of initiating an investigation in
with ITR. such cases. The trend of today’s financial world
is that most of transactions, including fraudulent
14.6 The matter of TDS on income from ones are routed through banks in some form
engineering professional service is another or the other. All large transactions have to go
highly debatable issue. Whether tax is deductible through banking channel at some point of time.
u/s 194C or 194J or 194H has always been A thorough examination of the debits and credits
a matter of great controversy. The AOs are of the bank account had yielded good results
required to examine all facts related to the case in a large number of cases. The points relating
very carefully for drawing a correct and logical to investigation of bank accounts have been
conclusion. discussed at length in Volume-1, which needs to
be kept in mind by the AO.
15.  GENERAL METHODS OF
EVASION, AND INVESTIGATION 15.4 Statement of Total Wealth: Another
important tool of investigation in these cases
15.1  The prevalent methods of tax evasion in
is calling of statements of total wealth at the
these cases are also basically the same, i.e. either
beginning & end of the investigation period,
suppression of receipts, or inflation of expenses
using the power available u/s 142(1) of the Act.
or both. Suppression of receipts is generally
resorted to where the fees/ payments received 15.5 Inquiries from Passport/ Travel
are either in cash or received out of unaccounted Agents: Verification of particulars of passport
sources of the payer. This is an easier method can bring out the details of foreign travel.
of evasion in these cases. The need for inflating Thereafter, verification from travel agents can
expenses arises only when the accounted receipts be made to find out expenses on air tickets,

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foreign exchange, hotels bookings etc.. Similarly designers; the estimates of cost of construction/
travel agencies patronised by these person can renovation of a project; the noting of actual
be a source of information for their domestic expenses etc., if found can be of immense use
travel, holidays, hotel bookings, and expenses during the course of investigation. Action u/s
on hospitality etc. Verification, from luxury 133A(5) at the end of an event like musical
hotels, caterers, event managers etc. can bring concert, stage show, exhibition etc. can be a
out information on expenses incurred on major useful tool to detect unaccounted income.
parties, functions & events etc.
15.7 Inquiries from Investment Agents/
15.6 Surveys u/s 133A: Lastly, surveys,
particularly in the case of architects, interior Advisers: Most of these people entrust their
designers, fashion designers, industrial investment work either to a trusted confidante
consultants and valuers etc.., can yield extremely or to a professional investment consultant/
useful information relating to suppression of adviser. Particulars of such person generally
income. Surveys sometime become inevitable become known, as they are paid fees for their
due to the fact that accounts of professional are services. Enquiries or even a survey in the case
generally not properly maintained. For instance, of these persons can often bring out a wealth of
appointment diary of lawyer/ advocates; list information regarding the actual investments of
of projects undertaken by architects, interior the professional concerned.

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17
Hospitality Industry
1.  INTRODUCTION

1.1 The direct contribution of tourism and

hospitality industry to GDP is expected to register
a Compound Annual Growth Rate (CAGR) of
roughly 14%. The launch of several marketing
initiatives by the Government of India, such
as Incredible India! & Atithi Devo Bhava, has
provided an impetus to the growth of this industry.
Now-a-days, the market players of the industry
are providing services in an integrated manner
on a single portal for ensuring better services
to the customers. For example, makemytrip.
com, cleartrip.com and a host of other websites a. Guest Houses with or without restaurants.
provide a comprehensive basket of facilities, b. Budget Hotels/ Boutique Hotels with no
which include outbound and inbound travel for star status.
leisure and business trips, hotels, transportation,
holiday packages etc., both for the domestic and c. Three or four star hotels in big towns.
international circuit. d. Five star hotels or seven star hotels in
1.2  The Indian Government has also initiated Metropolitan cities or at places of tourist
a fresh category of visa—the medical visa or attractions.
M-visa, to encourage medical tourism in India. e. Clubs and Resorts in the luxury sector.
Indian medical tourism is expected to reach
1.4  Broadly, the functioning of a hotel is divided
USD 8 billion by 2020. The growth of travel and
into Front Office and a Back Office. Then, there
tourism industry in India has paved the way for
are various sections, such as-Reception, Room
the growth of Hospitality Industry. The Indian
Service, Housekeeping, Laundry, Travel desk,
hospitality sector is highly fragmented with a
Health club, Gym, Bars, Pubs, Coffee shop,
large number of small and unorganized players.
Florist, Telephone, Kitchen, Business Centre,
However, competition is increasing day by day
Conference halls, Banquet hall, etc. Each of
due to the entry of new and bigger players.
the sections have a well-defined function and
1.3 In general, the hotel business can be maintains a separate account for each guest of
categorized into the following: the hotel along-with a folder in which all the

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Techniques of Investigation for Assessment Vol. 3

duly signed vouchers of the guests signatures are date and time, room number, mode of payment
kept. This basic record is Utilised for settling the and signature. The Guests are required to give
account of the guests, at the time of check out. their photo identity card and a copy of the same
A final bill is raised by the Account’s department is retained by the Hotel. In respect of foreign
based on these supporting vouchers sent by the travelers, the information in the registration
various sections. Thus, at the time of vacating a form also includes details regarding their
room, the settlement of the account of the guest nationality, passport number (date of issue,
is done by way of a consolidated bill, which place of issue, validity, Visa Number, and its
may be cleared by the customer through cash, validity period etc.). The information regarding
cheque, credit card, debit card, bank transfer, a foreign traveler/ guest is sent to the Police
RTGS etc. Commissioner’s office on the next working day,
against an acknowledgment. A copy of this
1.5 Apart from the front office, back office
acknowledgment is kept with hotel.
and administrative Section every hotel has two
critical sections namely, the Accommodation 2.4  The registration forms of guests maintained
Section & Service Section. by the hotel, is a starting point for any worthwhile
investigation on the occupancy and the room
2.  ACCOMMODATION SECTION rents offered to the guests. The AO’s can cross
check these with the registers maintained by room
2.1  The accommodation is provided normally service, restaurants, house-keeping and laundry
by the reception counter of the hotel. There etc. If a particular expenditure is mentioned in
are various types of guests in a hotel, such as, relation to a particular room in the room service
guests who have made the bookings through register, but if the occupancy register does not
the websites like Booking.com, Goibibo, Agoda, have any information about that person then an
expedia etc., company guests, regular guests, obvious inference can be drawn that the records
frequents travelers, walk-in guests, booked are not properly maintained and the case needs
guests, privileged guests, etc. further investigation. As soon as a guest arrives
2.2  Usually, there is an immediate allotment of and checks into the room, a key card is normally
room to the guests, who have already booked given for identification of the guest in the hotel
the accommodation at an agreed room rent. and, for utilization of the services of the hotel.
The hotel reception can also offer discount to 2.5  The information regarding the guests has to
walk-in guests, in case the hotel rooms are not be invariably sent to the house-keeping and the
fully occupied. Normally, the front manager room service sections from the reception counter.
is allowed to give discount from 20% to 30% The house keeping Section keeps the records
for which negotiations are carried out with the of duration of occupancy of the guest and the
customers. In most of the hotels, the booking needs of the guest. The room service keeps the
rates, agreed upon with a particular customer is records of various orders placed from the room
duly entered and maintained on a computer. along-with the time. Similar records are kept by
2.3  Guest’s Registration Forms: As a the laundry, restaurant, telephone, health club,
standard practice, all hotels require the guests gym, bar and pub etc. A floor-wise register is
to fill information in a registration form and the usually maintained by the house keeping Section
hotel guest register. The information required in to indicate the number of rooms occupied and
this form is in the nature of name, profession, the number of rooms lying vacant. Every floor
address, place of origin, arrival from, departure has house keepers, who besides maintaining the
to, arrival date and time, and expected departure rooms, has to maintain this register.

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2.6  Room Charges: The charges of a room market survey or call tenders from the suppliers
fixed by a hotel are normally based on size of on annual rate basis. Once the rates are finalized
the room; the amenities provided (fruit basket, for the entire year, the supplier has to supply the
welcome drink, soap, shower, caps, tooth brush, item throughout the year at the agreed rates
tooth paste, shampoo, toilet rolls etc.); the irrespective of the market rates of the items at
facilities provided in the room (TV, telephone, any particular point of time in the year. With the
wifi-facility, size of the bed, sitting area etc.); advent of online grocery stores, the optimum
other conveniences provided by the hotel to level of raw material is being maintained, leading
its guests such as free use of business centre, to reduced inventory cost and improved margin
swimming pool, health club etc.; tariffs of other of profit.
hotels of same category; overheads; Star rating 3.3 The AO’s should analyze the utilization
and exclusive nature of the facilities. of stock and the purchase vis-à-vis the sales
2.7  Closure Report: The reports of the night turnover of food and beverages, sale of rooms
auditors submitted every day are very important etc.
for the purposes of investigation of the accounts
of a hotel. These night auditors cross check the 4.  RECORDS MAINTAINED
accounts with respect to the services rendered
The books of accounts & records maintained by
by each department to a guest or a visitor to a
a hotel depend upon nature of its ownership,
restaurant, a party or a function organized in the
size of its activities, nature of services offered.
hotel. They have to ensure that all the services
The basic records maintained by the hotels, in
have been appropriately charged and in case
computerized or manual format, generally are:
of mistakes, they direct the correction of the
same. One set of the report of the night auditors a. Cash Book
remains with the Accounts Section in the back b. General ledger
office, and another set is sent to the front office.
c. Guest Register with guest registration
forms
3.  SERVICE SECTION
d. Occupancy register maintained by some of
3.1 This Section includes maintenance and the hotels.
upkeep of hotel building, machinery, equipment,
e. Debtors ledger
garden, electricity, kitchen, catering, appliances,
rooms etc. f. Stock register
3.2  Stores: Stores in a hotel are handled by a g. Suppliers ledger
store keeper or a Material Manager. The Materials h. Fixed assets ledger
Manager has to ensure that all the necessary
i. Salary register
items are available at all points of time for the
smooth running of the hotel. For maintenance j. Guest complaint register
of the desired level of stock, the manager has to k. Attendance Rolls of Employees
do various calculations with regard to each items
l. Excise register
based on the consumption of a particular item.
As soon as the stock of any item comes down,
the material manager and the store keeper take 5.  SOME COMMON METHODS OF
steps to replenish the same. Different hotels TAX EVASION
may follow different practices for purchase of 5.1 The actual data relating to store
consumable stores. For this they may conduct consumption is manipulated to match with the

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stock as per books of account. The records of 5.5 As soon as a guest arrives in a hotel and
the stores are generally, so manipulated that no is booked into the guest arrival register by
evidence is left with regard to actual purchase the Receptionist, the Receptionist informs
and the consumption of the stores. However, if the checking in of the guest to the various
the supplier’s records and the books of accounts departments of the hotel, namely, housekeeping,
of the assessee are cross checked & verified, room service, telephone operator, engineering
the actual purchases of stores made by a hotel department and the finance department. All
can be traced. By working out the average these departments open a separate ledger
consumption over different periods, the actual account for the particular guest in which the
stock consumption can be worked out. transactions relating to that guest are entered.
These departments send a note to the finance
5.2 Room occupancy is often understated in
department for billing at the time of checking
the books of account and shown at lower levels,
out. When a guest checks in, he may be asked to
even if the actual occupancy is quite high. It may
deposit a particular amount depending upon the
be mentioned that even if the room occupancy
duration of his stay and probable expenditure
register is manipulated, it is possible to cross-
in the hotel. In case the guest over stays or his
check the actual occupancy levels, with the
expenditure is more than the deposit amount,
help of the registers maintained in the different
the finance department/ reception takes a
sections of the hotel, such as room service
further deposit from the guest to cover the extra
register, housekeeping register, restaurant
expenses.
register, wi-fi charges, health club, gym register
etc., as it is impossible for an assessee to doctor 5.6 Thus, the finance department is kept
the entire actual record. If this cross checking abreast of the expenses incurred by a particular
is done methodically, it may be possible to guest in a hotel. Even if the records of the
work out the occupancy of the rooms. In fact, finance department are subsequently altered,
the guest registration register cannot be easily the position of occupancy as per the ledger
manipulated and should be invariably verified accounts and bills maintained by the various
by the AO Further, the GST returns may also be departments, should be examined to find out
verified to reconcile with the sale of rooms by the correct information. As per the international
the assessee. norms, the receipts of a hotel is generally 80%
from the room tariff and the balance 20% is
5.3 Many tourists who are on short visits are
on account of sale of food and other services
availing bed and breakfast services only. This is
utilised by the guests of the hotel.
generally a package deal. At times the guests do
not avail the package deal and the hotels, while 5.7  Electricity and water bills may be examined
charging the other customers for breakfast do to check inflation of expenses on these counts.
not account for the same as their sales as they 5.8  Manipulation in Receipts Pertaining to
are showing them as complimentary and setting the Banquet Halls: Understatement of catering
off the unavailed facility against other regular receipts from parties etc. by understating the
customers. number of people or the charges per persons or
5.4 The Assessing Officers may also verify both, is quite common. Normally, in large hotels
the sales made through the online agents like the information of any party to be held and the
GoIbibo, Booking.com, Agoda, OYO rooms etc. number of people likely to attend such a party is
and crosscheck the sales of the online agents immediately sent along with the approved menu
with the books of accounts of the hotel to detect to the kitchen, stores, engineering department,
possible suppression. reception, bell desk as also to vigilance and

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security, general manager, executive manager operators in this regard and also examine the
and housekeeping. The trail as to the actual expenses relating to Flight Kitchen services.
number of people who attended the party may 5.11 The assessee incurs sizeable expenditure
be left in several of these departments, and on renovation and repair and maintenance and
the registers maintained by them. If the store claim this as revenue expenditure. The Assessing
registers for the given day are properly checked officers may verify the nature of the expenditure
with respect to the quantity issued, the number and capitalize the same wherever necessary.
of person attending the party on that day can
be inferred. The manager has to give a Kitchen
Order Ticket (KOT) for the exact number of 6.  CASE STUDY ON BANQUET HALLS
people so that the kitchen would prepare the 6.1  In most parts of Southern India, a number
food for that many people. Two copies of this of marriage halls have come up which are used
KOT go to the kitchen, another copy goes to the for weddings as also other social functions. These
cashier or the finance department, and fourth halls are known as ‘Marriage Halls’. Many of these
copy remains in the books. In some outlets, the Marriage Halls are constructed by charitable
KOT has three copies, two of which will go to trusts claiming it as a charitable activity. The hire
the kitchen and third will remain in the book. charges received are sometimes disguised as
This KOT has to be maintained till the night donations or even donations towards corpus. This
auditor checks the accounts. This position is not tactic is employed to circumvent the provisions
only applicable for big parties, but also to the of Section 11 or to avoid the requirements
hotel guests or restaurants etc. The checking of regarding application or accumulation of funds.
the KOT in the kitchen and from the cashier can In fact, many of these Marriage Halls are pure
lead to clues with regard to the number of people and simple business propositions with the main
who attended a particular party or with regard to object of earning business profits. The hire
the occupancy of the hotel at a particular point charge is given by the user of the premises for
of time or also with regard to the actual receipts the function. A donation is a voluntary payment
in a restaurant of the hotel. KOT is a good tool given without any anticipation of return of any
in the hands of a diligent investigator. kind. Thus, such compulsory payments towards
hire charges involving quid-pro-quo are not
5.9  In corporate hotels, this manipulation has a
donations. The Hon’ble Supreme Court had in
different dimension. In such hotels, the bill of a
the case of CET vs. P.V.G. Raju [1975] 101 ITR
party of say 1000 persons is broken into various
465 (SC) had defined ‘donation’ as an act by
separate segments. Either it will be shown in the
which the owner of a thing voluntarily transfers
form of breakfast, lunch and dinner and thus a
the title and possession of the same from himself
single party of 1000 persons would be broken
to another, without any consideration. Therefore,
into three segments in different names or it will
the AO can examine and find evidence to prove
be shown as if three parties were held in the
that the alleged donations were actually rent or
same hall by three different persons. One of the
hire charges paid for the marriage functions.
names would be of the person who has actually
However, the onus of establishing that there
held the party and the other two names would
was a ‘quid-pro-quo’ is on the AO. As far as
be dummy.
the running of Marriage Halls is concerned it
5.10  If the hotel having flight kitchen is catering is a systematic activity for the purpose of profit
to airline operator, the books of accounts may earning and, therefore, the income earned is
be cross verified with the books of the airline a business income, which can be fortified with
operator. The Assessing Officer may verify the the decision of the Supreme Court in Municipal
agreements entered by Hotels with the Airline Corporation of Delhi vs. Children Book Trust

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[1992] 3 SCC 390; AIR 1902 SC 1456. In this b. Providing of decoration services.
case, the Hon’ble Supreme Court had dealt c. Taking various permissions from Police,
with the scope and effect of the term “charitable Municipality or other departments for
purpose” and as to what exactly was charity. organizing of a particular function.
Whether this income is ‘incidental’ to the avowed
charitable objects of the Trust may have to be d. Contract for music and sound appliances
examined and a discussion reported on pages provided to the hirers.
47 to 49 of 236 ITR is of relevance. e. Provision of food to the guests.
6.2  Another variation of these alleged donations f. Providing chairs, sofas, tables and other
is that while the donation is given in a particular seating arrangements.
name, however, the marriage function is
organized in the name of another person. Thus, g. Providing the services of daily wage
it would appear that there is no nexus between workers.
the donation and the marriage function. These h. Provision of marriage band or an orchestra.
tactics are applied to avoid scrutiny vis-a-vis
i. Charging of rent for the hall and for any or
the provisions of Section 11 of the Income-tax
all of the above services from the hirer.
Act. However, these marriage halls are booked
sometimes 6 to 8 months in advance. At the time j. Disposal & Cleaning of the various types
of booking an advance is given by the original of leftovers.
person, who is actually organizing the function. k. Providing telephone or fax services in the
In the entry for the advance it is clearly noted that hall.
certain amount has been received from Mr. X for
the purposes of a marriage on a particular date. l. Providing generators.
However, subsequently, the donation is given m. Providing gas burners, utensils and
in another name and the advance is refunded crockery.
to the original person. By seeing the advance
n. Providing video coverage.
register and by proving that the marriage or
other function was actually solemnized by the o. Providing for flower arrangement.
original person on that particular date in the
6.4 In such an organized activity, an AO will
hall, the management can be questioned as
have to examine as to whether proper accounts
to why no payment has been taken from the
have been maintained. If it is a case simply
original person for the said unction. If properly
of giving on hire the hall without attending to
investigated, the falsity of the claim of donation
any of the services mentioned above, then it is
by can be found out and the amount can be
a simple issue and the AO should tax the hire
brought to tax.
charges as business income. However, in case the
6.3  The above stipulation apart, some of these assessee is managing the hall and is providing or
Marriage Halls are constructed by individuals for organizing any of the above attendant services,
business purposes. Some of these halls are very relating to the function, then, the matter is slightly
lavishly constructed and charge heavily for the complicated, wherein the AO has to work out
use of the hall for each day. This activity involves the income earned from each of these activities
the following services provided either directly or for the purpose of taxation. It may also have to
through contractors: be examined by the AO, as to what is the profit
a. Running & maintenance of these halls on element in providing the attendant services. It
daily basis. also may have to be seen as to whether proper

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TDS has been made from the payments made to can also give clues regarding the occupancy
various contractors. of the halls, as also the income earned by the
6.5 Most of these Marriage Halls and the management of the halls.
management of the community halls make it
obligatory for the hirer to take the services for 7.  CASE STUDIES ON STAND-ALONE
furniture, decoration, sound system, flowers for RESTAURANTS
decoration, video coverage, food service etc. 7.1 Many stand-alone restaurants suppress
only from the management of the hall. In such their profit either by suppression of income or
cases, the entire receipts may have to be reflected inflation of purchases or manipulating the bills by
in the accounts maintained by the management removing some food and beverages items from
of the hall and the AO is required to examine the original bill or recording huge discount in the
same. system against bills fully paid by the customer.
6.6  Once the function is over all the 7.2  In a case of Search on a chain of restaurants,
paraphernalia is immediately removed within no owning/ controlling more than 40 restaurants in
time. The management may choose to show the Delhi, NCR, Mumbai, Pune; call interception and
hiring and occupancy as per its own sweet will CDR tower ID provided lead on key employees
and books of accounts can be suitably written. and the modus operandi. It was found that
Therefore, the AO would have to see as to what the assessee was using customised software
the type of management is and what financial ‘CSAT’ meant for hotel business and dedicated
control is being exercised by the management software expert was employed for manipulation
on the hiring activities. Records relating to of sales data. The hard disks from computers
the permissions obtained from the authorities were periodically removed to avoid forensic
for holding functions in the hall can provide data recovery. However, hard discs/ pen drive
information regarding the functions & the dates containing all accounting data were recovered
on which these were organized. If the telephone from the residence of key employees and all
and fax facilities are provided in the hall, the bills accounting data was found in pen drives. The
of those particular dates can provide clues about analysis of the data revealed large scale sales
the functions organized on those dates. suppression by:
6.7  Apart from suppressing the occupancy rate a. Recording huge discount in the system
the management can also inflate the expenditure against bills fully paid by customers.
on running and maintenance of the hall. The
number of workers actually employed on a b. Removing some food and beverages items
regular basis needs to be ascertained by the AO from the original bill.
by making relevant enquiries. Sometimes, some Therefore, during investigation the Assessing
of the management have many halls in different Officer should also carefully examine the software
parts of the cities, where the same workers are used by the restaurant owner and understand
deployed for the running and maintenance of the the possible manipulation of accounts.
halls. However, in the books of account, for each
7.3 In another case it was found that the
hall separate workers are shown to be employed
assessee was using accounting server and sales
for the purpose of running and maintenance.
server separately to compute the sales of 8 branches
6.8 These halls have regular contractors, for of their restaurants. It was found during the search
providing various services. A cross-check with that the assessee was systematically accounting
the books of accounts of these contractors the sales of only 7 branches and suppressing the

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Techniques of Investigation for Assessment Vol. 3

sales of one branch instead of suppressing the at the time of closure of business at the end of
sales at the point of sales. Hence, the Assessing the day and the survey team could catch hold of
Officer should compare the sales of all branches the actual sales figures for the day. Therefore, in
with the books of accounts in cases there are cases of restaurants, the Assessing Officer should
several branches of the restaurant. carefully plan their time of investigation towards
7.4 In the case of a restaurant and sweets the closure of business so that the actual sale
seller, it was found during the survey that the figures of the day could be obtained ruling out
assessee was having several branches in the any possibility of manipulation.
city and was also opening special counters on 7.5 Many restaurants these days use cash
festive occasions but the receipts from all the registers for generating the bills. The Assessing
branches were being systematically manipulated Officers should be conversant with the operation
to maintain the desired level of sales only. The of these machines as after the bills are raised,
modus operandi adopted was that the assessee many bills are kept by the cashier and receipts
would feed the data from all the branches at the are manipulated at the end of the day/ month.
end of the day in the computer and was using These registers have sufficient memory to record
custom made software to wipe clean the location the sales of several days. While investigating
of the file on the hard disc having the sales data such cases, the cash register should be examined
and copy the manipulated data in the hard disc. to verify probable manipulation of sales.
Normally a deleted file can be retrieved from the
hard disc but the assessee was going a step further 7.6 Since hospitality industry is making an
to manipulate the contents of the location on the extensive use of technology for all its activities, the
hard disc where the sales figures were stored and Assessing Officers also need to keep themselves
it was difficult to retrieve the actual data. After updated with these technologies for carrying out
several months, another survey was carried out effective investigation.

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18
Travel and Tour Industry
1.  INTRODUCTION
1.1  Tourism has emerged as one of the fastest
growing industry in the world. However, India’s
share in terms of world tourist arrivals and receipts
is negligible, hovering around 0.5% of the world-
wide market. The Foreign Exchange earnings
from tourism in INR terms is Rs. 1,54,146 Crore.
1.2 Tourism has great potential in India.
International institutions like the World Tourism
Organisation and World Travel and Tourism
Council have all predicted that India is going
to be an important destination in the 21st
century. India has a blend of rich cultural and services must exist to cater to the needs of tourists
scenic locations in the right proportion, offering from the time of arrival to their departure. The
a tourist options from snow capped peaks to businesses and organisations, which provide
beautiful beaches, the choicest hill stations, the facilities and services, make up the tourism
pilgrimage sites, health resorts, back waters industry.
etc.. If our infrastructure facilities could keep 1.4 Using the words ‘origin’ and ‘destination’,
pace with the growth in the tourism industry are two main ways to describe the movement
the tourism revenues can develop by leaps and of tourists from one place to another. ‘Inbound’
bounds. The World Travel and Tourism Council and ‘outbound’ tourists are terms commonly
estimates that the Tourism in India accounts used in the tourism industry. Inbound tourists
for 9.6% of GDP and is the 3rd largest foreign are tourists entering a country from their country
exchange earner for the country. According to of origin and outbound tourists are those who
World Tourist Organisation, the foreign tourist leave their country of origin to travel to another
arrival in India is expected to reach 15.3 million country. The words ‘in-bound’ and out-bound
by 2025. The Government of India has set a only apply on the outward journey at the
target of 20 million Foreign Tourist Arrivals beginning of the tourist place. On the return trip,
by 2020 and double the Forex earnings. The the tourist is simply returning home. Domestic
role of the travel agent, therefore, assumes tourist is the term used to describe tourist trips
significance. which takes place by tourists in their own
1.3  Before any country, can attract tourists on country, i.e., when the country of origin and the
a large scale, certain important facilities and country of destination are same.

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2.  THE RETAIL TRAVEL TRADE 2.4 By checking the declaration of revenues
2.1  The most visible element of retail travel trade of online travel platforms like makemytrip.
is the travel agency. This is the place, where the com, booking.com, cleartrip.com, Goibibo,
customer’s first visit to buy travel tickets, book etc., the tax authorities can detect evasion of
hotels, hire vehicles, buy holiday packages etc. In tax revenues by the clients. The data collected
general, travel agencies earn commission income from the online platforms in some cases had
for arranging and organizing these services. In also revealed concealment of income by various
this regard, the latest development is the arrival hotels and other service providers. Needless
of various online players like makemytrip.com, to mention here that there is a profit sharing
booking.com, cleartrip.com, Goibibo, etc. The agreement between the online platforms and
travel agents, therefore, operate and provide the service providers like hotels, transportation,
services nowadays both offline and online. air tickets etc., which needs to be investigated
and enquired in appropriate cases. Thus, the
2.2  Travel agents undertake a specific function
data available with the online platforms is
in the tourism industry. They make travel
very valuable from the point of view of a tax
arrangements on behalf of individuals or
investigator.
group. They act as intermediaries between the
customers and organisations that provide travel 2.5  The Directorate General of Central Excise
products and services. Travel agencies are the Intelligence (DGCEI) has investigated a large
retail arm of the travel and tourism industry. number of online travel companies for service tax
The fact that opening a travel agency does not evasion. It had been found that these companies
involve a heavy initial capital outlay attracts don’t deposit service tax which they collect from
many people to this trade. the customers. Thus, the information obtained
2.3  Travel agencies act on behalf of two parties from the GST Department is of prime importance
when they undertake their work. They are agents to check whether the online companies are
for the customers on whose behalf they are declaring their correct turnover or not in their
making the travel arrangements, and also for the returns of income.
company that is supplying the product i.e. the 2.6  A typical travel agency, offers a wide range
Principal. Travel agents earn commission from of products and services, which may include:
the Principals, whose products they sell. The a. Overseas and Domestic package tours.
commission payment is usually expressed as a
percentage and varies according to the product b. Air tickets, both domestic and international
being sold and the commission policy of the c. Rail tickets.
Principal. The percentage of commission offered
d. Car hire.
by the principal fluctuates, as per the prevailing
market condition. Some principals, also offer e. Coach services.
incentive commission, wherein the amount f. Cruise trips.
of commission increases as the sales turnover
g. Hotel and other accommodations
increases. Overriding commission is paid when
an office has sole agency status with a particular h. Arranging Guides for tourists
Principal. The overriding commission allows the i. Travel Insurance.
sole agency to pay standard commission to the
agents and retain a small override to cover its j. Foreign currency and traveler’s cheques
costs. k. Visa & Passport applications.

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All these items earn the travel agent commission past several years. However, many airlines
income, which keeps the business running. In have introduced productivity linked incentives
the case of airline, coach or rail tickets sold by of about 2% to be given to the agents over
a travel agency, the carrier pays the commission and above the fixed commission. The IATA
to the travel agent. But a high proportion of resolutions provide for special commission in
income of travel agents comes through selling respect of a tour operator, who is in charge of
holidays packages. or escorts a minimum of 10 passengers. In case
2.7  Impact of Information Technology: of a group size of 15 or more passengers, one
There has been a complete change in the travel free tour operator’s ticket is issued for every
agency business due to impact of information 15 passengers. If the group comprises of 10 to
technology and the internet. The travel agents 14 passengers, 50% of the applicable normal/
are moving from being mere ticket-issuers to special fair as paid by the group is applicable for
travel consultants providing end to end solutions the tour conductor. The travel agency makes the
to the customers’ needs. Today, the distribution payment of tickets to the airline after deducting
structure of the airline ticketing has changed with their commission and this practice is as per
about 75% being distributed through electronic the procedure laid down by the IATA, which
channels, airline portals and electronic travel provides for submitting the statement of tickets
agents like clear trip, makemytrip, goibibo etc. issued on a fortnightly basis. The IATA agents
and the remaining 25% is through the travel
also receive other incentives which may extend
agents. Further, almost all airlines have already
up to 25% of the fare. Besides the commission
begun e-ticketing or paperless tickets on the web.
and incentives, they are eligible for productivity
The concept of the travel agent is also changing
from just an agent charging commission to a linked benefits linked with the targets given by
consultant charging management fee. various airlines, depending on the volume of the
business done for the airlines.
3.  TICKETING BUSINESS 4.3  Billing & Settlement Plan: Commonly
known as BSP, this is a simple form which
There are a large number of travel agents who
are engaged in the ticketing of domestic and provides for the selling, reporting and making
international airlines. The travel agents can be remittances by the IATA agents. The key feature
broadly classified under the following heads: of the BSP is a single standard traffic document,
which is used by IATA agents on behalf of all the
a. Agents accredited with IATA.
participating airlines. Earlier, they were required
b. Non-IATA Agents
to prepare and keep separate stock and accounts
c. General Sales Agents for different airlines. BSP uses the services of the
Data Processing Centres to compute billing and
4.  IATA AGENTS monetary amounts, which agents are required
4.1 Almost all the important air carriers to remit to the appointed clearing banks. It also
are members of International Air Transport computes the division of the amounts collected
Association (IATA), which is an international by the banks for settlement amongst the airlines.
agency under the U.N. charter. All the approved The Centre conducts the editing and checking
air carriers are bound by resolutions of IATA. The of data from all documents and generates one
accreditation by IATA is granted after a thorough consolidated billing to each agent in respect of
scrutiny of the agent’s financial status. all the moneys owed to the BSP airlines. The
4.2 The airlines have been steadily bringing agent then makes a single remittance to the
down the commission of the agents, since appointed clearing bank.

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4.4  Accounting Procedures: The airlines that airline has its own office. The General Sales
provide the agents with the net fare chargeable Agent is entitled to an overriding commission of
for all tickets issued. The tickets are then 3% on all the sales made in his region.
recorded in the purchase register and payments
are made to the IATA BSP on a fortnightly basis. 7.  TAX EVASION & INVESTIGATIONS
These amounts are debited to the cost of sales
in INR through the purchase register. The net 7.1  The walk-in customers, generally purchase
fare charged by the airlines is decided at the tickets and tour packages in cash. The
beginning, right at the time of the issuance of the commission passed on to them is deducted in the
ticket. The incentives are also generally fixed in bill itself. The customers, therefore, are paying
the beginning of the year. During lean seasons, the net amount to the agent i.e., gross value of
the airlines announce concessional fares, which the air ticket minus commission passed on to
are the net fare payable to the airlines. As the them. Investigations in some cases indicate that
tickets show the full fare, the difference between the agents do not have any evidence in the form
the prices for which the ticket is sold and the net of vouchers/ receipts containing the signatures
fare paid to the airlines is the profit margin of of the customers. The evidence of passing of
the agent. As already stated, the payments are commission to the customers available with the
settled on a fortnightly basis through BSP. For the assessee is the bills given to the customers. These
tickets issued for the first fortnight, the payments bills also do not contain the signature of the
are made on the 30th of the month and for the customer. In the absence of such evidence, the
tickets issued in the second fortnight payments quantum of commission actually passed on to
are made on the 15th of the following month the customers cannot be properly ascertained. It
based on the fortnightly sales report prepared by is possible that the assessee after having given a
the agent for all the tickets issued in the fortnight. bill to such a customer can increase the quantum
of commission passed on to the customers in the
5.  NON-IATA AGENTS copy of the bill which remains with the assessee
and which forms a part of the books of account.
These are the subagents, who are not accredited
The quantum of commission claimed to have
by IATA. They do booking on behalf of various
been passed on to the walk-in customers is
IATA agents, who pass on to them, a part of the often as high as 30% to 40% and needs to be
commission received by them from the airlines. thoroughly investigated, particularly in cases,
These sub-agents also part with a small part where the commission has been passed on in the
of their commission to the walk-in customers, form of cash. In the case of search and survey
who purchase tickets from them. The extent of operations, the Tax Officials should get themselves
commission passed on to the customers depends fully acquainted with the tailor-made software
upon the competition and negotiating ability of used by the agents for the accounting purposes.
the customers. Non-IATA agents do not have No meaningful investigation can be carried out
stock of the air tickets. without understanding the nature of accounting
entries entered in the software package. Further,
6.  GENERAL SALES AGENTS the various consolidated reports generated from
The General Sales Agents are appointed by the software installed are of extreme importance
the scheduled airlines to sell the tickets of that for getting a bird’s eye-view of the entire business
particular airline in a particular territory. They operation of the agent.
cannot sell the tickets of any other airline, other 7.2 It is well known that the airlines provide
than the airline for which they are authorised. several incentives to the agents in the form of
They normally do not operate at a place, where free tickets and other freebies, which may not

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be disclosed by the agent. It is also possible them into the holidays that are offered for
that additional incentives and productivity sale through travel agents. Most of overseas
linked benefits are not fully disclosed by the ‘inclusive tours’ have three separate elements
agents. It would, therefore, be worthwhile to viz. Accommodation, Transportation and Other
collect information from the airlines directly services. The accommodation component of
about the commission and incentives paid to the package is provided in association with
the travel agents. The airlines should be asked hotels, motels, resorts, clubs etc. The transport
to provide circulars by which special fares element of a package holiday can be travelled
or various commission/ discount/ incentives by air, coach, rail or ship. Whichever mode of
were announced. Thus, as a first step towards transport is used, the tour operators are offered
investigation, the Tax Officials should collect all preferential discounted rates known as inclusive
the agreements, circulars, correspondence, letters tour rates. Apart from accommodation and
etc. in relation to the commission receivable and transport, a package holiday may usually also
then examine the same with reference to entries include other services such as transfers, the
of commission credited in the books of account. services of a representative, car hire, excursions,
Similarly, information may be collected from equipment hire etc.
sub-agents about the actual commission paid
to them. Inquiries in some of the cases revealed 9.  TOUR OPERATORS
that there is a difference between the amount 9.1 The tour operators can be divided into
of commission shown by sub-agents and that following four categories:
debited in the books of account of the agents. The
natural corollary is that either agents are passing a. Mass market operators.
less commission to the sub-agents compared b. Specialist operators.
to that shown in their books of account or sub-
agents are showing less commission than what c. Domestic operators.
they have actually received. d. Incoming tour operators.
9.2  Mass market operators include some of the
8.  PACKAGED HOLIDAYS & TOUR well-known names in the industry such as Thomas
OPERATORS Cook, Cox & Kings etc. These companies cover
8.1  Package holidays, also known as package a major share of the package holiday market.
tours, include transport to the destination; food The specialist operators offer holidays and other
and accommodation at the destination; services travel arrangements to a particular geographical
of a guide or tour-representative accompanying region or destination. Domestic operators
the travelers to guide and advice on excursions specialize in marketing of domestic tours only.
or sight-seeing tours. Most holidays advertised Inbound tour operators cater to the needs of
in holiday brochures contain these elements overseas visitors, who choose to visit India.
in one package. The people who put together
the above-mentioned facilities are called tour 10.  DISCOUNTING
operators. 10.1 Tour operators obtain different elements
8.2 Unlike the travel agents who sell the of their inclusive tours at discounted rates
holidays and other travel products, tour operators from suppliers such as hoteliers and airlines
actually develop and customize holiday plans who are happy to negotiate a discount in
putting together different packages tailored return for releasing an agreed amount of stock.
to suit the needs of an individual or group of Discounting is also prevalent at the other end
travelers. They book hotel space, airline seats of the distribution chain namely discounted
and other services in bulk and then repackage holidays offered for sale by a travel agency.

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10.2  The travel agent/ tour operator has to be from the customers for ECR (Emmigration
in touch with the following types of leisure facility Check Required).
operators and also get commission from them: d. Medi-claim policy is obtained when the
a. Establishments offering accommodation- passenger travels to European countries
for example, hotels, guest houses etc. and the United States. This insurance
protects the customers and all his medical
b. Catering & hospitality facilities-cafes,
expenses are taken care of. The premium
restaurant, fast food outlets, bars and pubs
amount is paid to the insurance company,
etc.
and in turn this is charged from the
c. Arts and entertainment venues-art customers.
galleries, theaters, casinos etc.
d. Sport & recreation facilities-parks, golf 11.  BOOKING PROCEDURES:
courses, outdoor stadiums. OUTBOUND TOURS
e. Heritage & Cultural facilities-including 11.1  The customers are booked at the branches
museums, historic places, gardens etc. by paying a certain amount of deposit depending
upon the tour which they want to undertake.
10.3  Now-a-days some of the travel agents/ tour The bookings are also received through travel
operators are tying up with the budget hotels on agents on behalf of the customers. The branch
an exclusive basis. It is learnt that travel agents accountant maintains client-wise accounts to keep
and tour operators are assuring the hotels of a track of his deposits and the expenses incurred.
steady business for a commission ranging from The branch office advises the bookings made for
25% to 35%. The tie up is on exclusive basis the day to the tour operation unit in the head
i.e. no business will be given to any other hotel office. The tour operation unit takes the booking
except the one with whom they had tied up or on record specifying the tour and date etc. and
in some cases two agencies enter into alliance it advises the land operator abroad for providing
with each other assuring to give business on necessary services in the respective countries.
exchange of good commission. The head office maintains the books of accounts
such as cash book, ledger, purchase and sale
10.4 The tour operators organize various
registers etc.. The payments are received at the
services, which are narrated as below:
branch office for which payment & receipt scrolls
a. Firstly, visas are arranged for allowing are prepared and forwarded to the head office.
the customer to enter their respective 11.2 The branch office receives payment in
destinations abroad. Apart from the visa INR and USD. The INR is spent towards meeting
fees paid to the embassies or consulates, expenses of visa, Mediclaim and ticketing and
fees are charged for the services rendered. the USD is spent towards land arrangements.
b. The stay arrangements for customers The sales register is normally maintained for all
include services such as hotel the payments received from the customers and
accommodation, meals, breakfast and details are reflected such as invoice number and
transfers. These services are provided, as date, customer’s name, tour and the amount.
per the brochures published. The sundry creditors register is maintained for
all Purchases done from airlines and the land
c. The POE (Protector of Emigration services) operators. Some of the tour operators do not
clearance is arranged for those persons for show receipts of amounts collected in forex on
whom emigration check is required. A hefty the plea that the passenger makes his payment
service charge is collected by the agents in rupees in India and US dollars abroad from

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his entitlement to the foreign tour operator for conditions as may be prescribed by the
meeting the land arrangements, meals, hotel parties for whom such ticket bookings and
accommodation etc. reservations are made.
11.3  The foreign exchange is received from the 12.2 The Indian company sends itemized
customers from their BTQ (Basic Travel Quota) invoices for each group giving the actual cost
entitlement. It is collected as per the tour; the for all services, after adding a mark-up. It may
customer is joining. If it is accounted in the also decide to charge a lump sum amount
books, the agent/ operator debits the amount depending upon the settlement with the
payable by the customer and credit is given to
overseas agent.
the various turnover accounts.
11.4  In case of fly-now-pay-later schemes, the 13.  ACCOUNTING FOR INBOUND
customer’s credibility is got assessed by some TOURS
finance company. The finance company makes
down payment after deducting their charges 13.1 The procedure adopted by the inbound
(10–15%) which is included in the package tour operators, in general, is as follows:
and makes the net payment to the travel agent a. For every tour, a separate ledger account
depending upon each tour. The customer makes is opened.
the equated payment to the finance company.
b. The bill raised on the overseas tour
operator is credited to this account.
12.  INBOUND TOURS c. All costs incurred for that tour, like air
12.1  Normally, under the agreement between tickets, hotel bills, transporters bills guide
a foreign travel agent and the Indian inbound charges etc.. are debited to this account.
tour operators, the Indian tour operator has to d. The difference between the bills raised and
provide the following services: cost incurred is transferred to the inbound
a. Arranging for and supplying tariff details tours commission account.
to cover the handling of tourists, including e. For all tours completed on or before 31st
hotel accommodation, boarding, air March, the tour commission is accounted
transportation between India and for in that financial year itself.
overseas, local transportation, sight-seeing
arrangements etc. f. If for any tour completed before 31st March,
some bills for cost are not received till 31st
b. Making all arrangements in India for March, then provision for that amount is
visits of tourists to different places of kept in that tour account and commission
interest including airport transfers, hotel is accounted for accordingly. In the next
accommodation, boarding, ground, year, expenses pertaining to that tour get
air and water transportation, providing adjusted towards the provisions.
qualified English or other language guides,
entertainment and such other facilities to 13.2  Tour Commission: For every tour, a bill
make the visit of the tourist comfortable. is raised on an overseas tour operator. Expenses
on tours like hotel, transport, air tickets, escort
c. Obtaining licenses or permits required to and guide charges are paid by the Indian agent.
enable the tourists to complete their tour The difference between amount billed to the
itineraries. overseas operator for a particular tour and the
d. Arranging in India for ticket bookings expenses incurred for that tour is booked as tour
and reservations subject to the terms and commission.

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13.3  Books of Account Maintained: numbers etc and most of these transactions
Normally following types of books are are done through cash. Therefore, care must
maintained: be taken during assessments on the details of
walk in customers where in a travel agent has
a. Domestic travel register
a chance to manipulate the commission passed
b. International travel register to them. The AOs should look in to these cash
c. Passport and visa register transactions in greater details.

d. Hotel register 14.2  The commission payable to sub agents is

debited in the profit and loss account but actually
e. Tour register (inbound and outbound) it is not paid. While, the travel agent debits this
f. Bill register amount as an expense, the sub agents do not
show such receipts on the ground that they are
g. Rail register etc.
maintaining accounts on cash basis.
h. The ledgers are general ledger, debit
14.3  Some tickets are given free by the airlines
and credit, travel, tour, hotel, airlines
which can be sold in the open market at the
ledgers etc.
prevailing rates. Some are given at discount for
the employees, which also can be en-cashed
14.  INVESTIGATION OF ACCOUNTS in open market. It may be verified whether
OF TRAVEL AGENTS/ TOUR these are properly accounted for in the books
OPERATORS of accounts. There are occasions when airlines
14.1  The basic issue, which arise in investigating have given luxury cars like Mercedes Benz to
the accounts of travel agents and tour operators the agents for achieving certain targets. Such,
relate to ascertaining the correct amount of expenses are debited under the sales promotion
commission/ discount received by them and account of the airlines. The AO may see as to
commission/ discount actually passed on to what treatment has been given by the agent to
the sub agents or customers. The travel agents such gifts.
get a good deal of commission in selling the 14.4 Further, on cancelled tickets, agents
packaged tours and the tour operators obtain mostly don’t pass the amount returned by
heavy discount from hotels, airlines and other the airlines to the walk-in customers and they
facility providers. Even for arranging shopping account this as payable to customers. The issue
from select shops and emporiums, for which of cancelled tickets and the refund of the ticket
the agent/ operator gets a certain amount of amount should be enquired by the AOs, during
commission. Though it is difficult to ascertain the assessment proceedings.
the exact amount of commission, discounts or
14.5  If there are no connecting flights, as also
incentive passed on in this trade, an attempt
in some other special circumstances, free stay
can be made by comparing these figures in the
in hotels is provided by the air carrier. These
books of the entity paying commission and that
facilities are sometimes charged by the travel
receiving it. A wide variation has been observed
agent.
in cases, where such relevant and appropriate
enquiries have been conducted. Further, most 14.6 Some of the agents, in their books of
of the travel agents are booking tickets in the accounts show income from ticketing only.
name of Walk in customers wherein they do Miscellaneous income earned by way of
not maintain proper details like address, contact passport and visa services, cancellation etc. are

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not shown. This may be proper investigated by the tour operator and the amount spent should
the AO. be examined by the AO and if there remains any
surplus, the same should be taxed.
14.7  In case of unskilled workers who go abroad
in groups, the amount towards the ticketing and
POE charges is received in cash. Substantial 15.  DEDUCTION U/S 80HHD OF THE
discounts may be shown in such cases, though INCOME-TAX ACT, 1961
in reality, it may not have been passed on. The
amount of discount given to the customers in 15.1 Both the travel agent and approved
such cases may be carefully examined. tour operators are eligible for deduction under
14.8  A glance at the profit and loss account of the provisions of this section. The term ‘Travel
major travel agents may reveal that they have Agent’ has been defined in Clause (a) of the
credited only net commission to the P/L account. Explanation at the end of the Section to mean a
If a part of the commission is given to a client out travel agent or other person (not being an airline
of the commission received from the airlines, the or a shipping company) who holds a valid
same is netted off from the commission account license granted by the Reserve Bank of India u/s
itself. The travel agent reduces his income with 32 of Foreign Exchange Management Act, 1999.
that amount instead of showing it as an expense. Similarly, the tour operator has to be approved
Similarly, for inbound tours, he essentially books by the Prescribed Authority, who is the Director
hotels, arrange transfers etc. on behalf of the General of Tourism. Unless these conditions are
overseas tour operators and earns commission satisfied, no deduction is available to the travel
in the process. Here also, only the net figure is agent or the tour operator.
credited to the P&L a/c after deducting expenses
incurred on providing services for each tour. In 15.2  The Section 80HHD provides for
view of this the AO may have to call for the books deduction in respect of earnings in convertible
of accounts and examine the ledger account of foreign exchange. Clause (c) of the Explanation
each tour to see what type of expenses have clarifies that services provided to foreign tourist
been debited and what discounts have been shall not include services by way of sale in any
received. Thus, the AO should invariably shop owned and managed by a hotel, tour
examine the nature of entries, representing the operator or travel agent. However, services
difference between the Gross commission and provided at health clubs, beauty parlors, barber
Net commission. shops etc. owned or managed by a hotel, tour
14.9  A large amount of commission/ handling operator or travel agent will be included in the
charges is sometimes paid to intermediaries term ‘services provided to the foreign tourist’
which are sister concerns of the agent. The and will be entitled to deduction under this
genuineness of services rendered by such Section. But if such health club, beauty parlors
concerns, as also the reasonableness of such etc. also sells some goods to foreign tourists, such
payments should be examined by the AO.
sale cannot be included in the term ‘services’
14.10  As mentioned earlier, the foreign provided to the foreign tourist.
exchange component collected from the
customers in respect of outbound tours is 15.3  The deduction is not restricted to the first
not reflected by the tour operators on the recipient of the convertible foreign exchange.
ground that payment is made abroad for land In some cases, the foreign tourist visits India on
arrangements. The receipts in forex charged by a package tour and makes payment in foreign

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exchange in one lump sum to a tour operator to profits derived there-from, subject to the
in India and the Indian tour operator, thereafter, condition that the payment in Indian currency
makes payments to the hotels, where the tourist is made out of funds obtained by conversion of
groups are lodged. The Section has been foreign exchange brought into India, through
amended [Explanation 1 below sub-section an authorized dealer in foreign exchange, by
(2) of Section 80HHD] to provide that in cases the tour operator, travel agent, or the airline on
where payments for services to the foreign tourist
behalf of the foreign tourist. The person claiming
provided by hotel, tour operator or a travel agent
are received in Indian currency from another tour the deduction is required to furnish along with
operator or travel agent or airline, the person the return of income a certificate obtained from
providing services to the foreign tourist will be the person making payment in Indian currency
eligible for the deduction u/s 80HHD in relation out of foreign exchange paid by the foreigner.

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 Chapter

19
Charitable Trusts and
Institutions
1.  INTRODUCTION
Various provisions regarding Trusts, Societies,
Institutions etc. claiming exemption are
administered mainly by Chief Commissioner
of Income-tax (Exemptions) and the
Commissioners of Income-tax functioning under
him in fourteen cities, namely, Ahemdabad,
Bangalore, Bhopal, Chandigarh, Chennai, Delhi,
Hyderabad, Jaipur, Kochi, Kolkata, Lucknow,
Mumbai, Patna and Pune. As per notification
no.52/ 2014/ F.No.18738/ 2014(ITA.I) dated 22
October, 2014, issued by CBDT, the jurisdiction a. It should be a public trust or society or a
of CsIT(Exemptions) is as follows: company registered under Section 8 of the
Companies Act; and
“All cases of persons in the territorial area
specified in column (4) claiming exemption b. It should carry out charitable purpose.
under Clauses (21), (22), (22A), (22B), (23), c. It should be registered with the Income-tax
(23A), (23AAA), (23B), (23C), (23F), (23FA), Department. The authority competent to
(24,) (46) and (47) of Section 10, Section 11, grant registration u/s 12AA (for claiming
Section 12, Section 13A and Section 13B of the exemption u/s 11 and 12) and 10(23C)(iv),
Income-tax Act, 1961”. (v), (vi) and (via) is the CIT(Exemptions).
d. It should fulfil the conditions laid down
2.  CONDITIONS FOR under Section 11, 12 and 13 or 10(23C)
CLAIMING EXEMPTIONS as the case may be.
Any trust or institution carrying out activities for
charitable purposes may claim exemption under 3.  CHARITABLE PURPOSE
Section 11 and 12 or under Section 10(23C) of
3.1 As per Section 2(15) of Income-tax Act,
the Income-tax Act, 1961. The trust or institution,
1961, “charitable purpose” includes:
to claim exemption under these sections; need
to satisfy the following conditions: a. Relief of the poor

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b. education activity in the nature of any other object

of general public utility. The AO should
c. yoga
carefully examine the objects of the Trust
d. medical relief and actual charitable activities being
e. preservation of environment (including undertaken. Whether the activities are in
watersheds, forests and wildlife) the nature of first six limbs of Section 2(15)
may be examined by information available
f. preservation of monuments or places or in the public domain, physical verifications,
objects of artistic or historic interest, and verifications from third parties such as
g. the advancement of any other object of the District Authorities where charitable
general public utility: activities were carried out or different
government agencies for whom projects
3.2  Whether Charitable? Proviso to
were carried out by the assessee.
Section 2(15)
b. The CIT (Exemption) while issuing the
3.2.1  Proviso to Section 2(15) provides that
certificate of registration specifically
the advancement of any other object of general
mentions the category of charitable
public utility shall not be a charitable purpose, if:
activities for which registration is granted.
a. it involves the carrying on of any activity in The AO should carefully go through the
the nature of trade, commerce or business, registration documents to examine whether
or any activity of rendering any service in the assessee has adhered to the nature of
relation to any trade, commerce or business, activities as per registration document
b. such activity is for a cess or fee or any other granted by the CIT (Exemptions).
consideration, irrespective of the nature c. The amount of receipts from such activities
of use or application, or retention, of the and whether the receipts exceed 20% of
income from such activity, the total receipt.
Unless
(i) such activity is undertaken in the 4.  CONDITIONS FOR EXEMPTION
course of actual carrying out of such AS PER SECTION 11, 12, 13 AND
advancement of any other object of 10(23C)
general public utility; and 4.1  Verification of Registration
(ii) the aggregate receipts from such activity
4.1.1  The first condition for claiming exemption
or activities during the previous year,
u/s 11&12 or 10(23C)(iv), (v), (vi) and (via) is
do not exceed twenty per cent of the
that the assesee shall have the requisite approval
total receipts, of the trust or institution
from the appropriate Income-tax Authority.
undertaking such activity or activities,
of that previous year; 4.1.2  Points of Investigation
Proviso to Section 2(15) is also applicable in the a. The Assessing Officer should examine
cases of trust or institution registered u/s 10(23C) whether a valid approval under Section
(iv), (v), (vi) and (via) as per 19th proviso to 11&12 or 10(23C)(iv), (v), (vi) and (via) is
Section 10(23C). available with the assessee.
3.2.2  Points of Investigation: b. The Assessing Officer should examine
a. The Assessing Officer should examine whether the approval is valid as on date.
whether the assessee is carrying out any There is a possibility that the approval

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has been withdrawn by the appropriate Society/ Non-profit company and the
authority on a later date after the grant places where the activities of the Trust/
of the approval. The updated list of such Institution are undertaken/ likely to
registrations/ withdrawals are available on be undertaken to satisfy the claimed
the website of the Income-tax Department objects.
at the following link:
(vi) Assessee shall file the return of income
https://www.incometaxindia.gov.in/Pages/ of its fund/ institution as per Section
utilities/exempted-institutions.aspx 139(1)/ (4A)/ (4C) of the Income-tax
The details of the registered institutions Act, 1961.
can also be verified from the registers
(vii) No cases or fee or any other consideration
maintained in the office of the CIT(E).
shall be received in violation of Section
c. The Assessing Officer should examine 2(15) of the Income-tax Act, 1961.
whether the conditions prescribed by the
authority granting approval have been (viii) No deduction shall be allowed u/s
fulfilled by the assesee. Generally, the 80G in respect of donation of any sum
following conditions are prescribed by the exceeding Res. 2000/- unless such sum
CIT(E) while granting the registration: is paid by any mode other than cash,
in view of Section 80G(5D) of the Act.
(i) Assessee shall maintain its accounts Any receipt issued in this regard should
regularly and also get them audited to clearly mention that donation exceeding
comply with Sec. 80G(5)(iv) read with Rs. 2000/- in cash shall not be eligible
Section 12A(1)(b) and 12A(1)(c) and for deduction u/s 80G of the Act.
submit the same before the assessing
officer by the due date as per Section d. The Assessing Officer should examine
139(1) of the Income-tax Act, 1961. whether the registration/ approval is
valid for the assessment year under
(ii) Every receipt issued to donor shall bear
consideration. The registration certificate
the number and date of this order and
shall state the date up to which this issued by appropriate authority is valid
certificate is valid. w.e.f. assessment year mentioned in the
certificate.
(iii) No change in the deed of the trust/
association shall be effected without 4.2  Meaning of Income
the due procedure of Law and its 4.2.1 As per Section 2(24) (iia) of the
intimation shall be given immediately
Act, income of the trust/ institution includes
to this office.
voluntary contributions. Income, however, does
(iv) The approval to the institution/ fund not include corpus donation (Section 11(1)
shall apply to the donations received (d)) and specified grants in view of decisions of
only if fund/ institution, established Hon’ble High Courts that have been accepted
in India for charitable purpose, fulfils by the Department (Gujarat High Court in
the conditions as laid down in Section Gujarat State Council for blood transfusion and
80G5(i), (ii), (iii), (iv), (v) & (5B) of the Punjab and Harayana High Court in Punjab
Income-tax Act, 1961. State e-Governance Society). Income generated
(v) This office and the assessing officer out of the charitable activities will also be part
shall also be informed about the of income of the trust/ institution that needs to
managing trustee of the assessee Trust/ be applied as per the provisions of the Act for

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Techniques of Investigation for Assessment Vol. 3

charitable purposes such as school fees, hospital used for the personal benefits of trustees.
receipts etc. Recording of statements of such persons
may reveal their actual usage.
4.2.2  Points of Investigation
4.3  Application of Income
a. The Assessing Officer should examine
whether any income has been directly 4.3.1 The trust or institution needs to apply
credited to the Balance Sheet in Reserve at least 85% of the income during the year for
and Surplus. Some examples may be charitable purposes. The application comprises
development fees, membership fees etc. both the revenue as well as capital expenses
directly taken to Balance Sheet. incurred for charitable purposes.
b. The Assessing Officer should examine 4.3.2  Points of Investigation
whether income arising out of investments
a. The Assessing Officer should examine
has been directly taken to the Balance
whether any fees concession has been
Sheet and added to the investment.
shown both in income and application
Such income also needs to be applied for
side of the Income & Expenditure account.
charitable purposes.
It will result in allowance of extra 15%
c. The Assessing Officer should examine application on such concession since
whether any income has been reported such concession does not form part of the
to the Income-tax Department by any income.
reporting entity that has not been disclosed
by the assessee in its computation of b. The Assessing Officer should examine
income. Such information can be accessed whether any capital asset was acquired
through Individual Transaction Statement out of borrowed funds and the cost of
(ITS) in ITBA/ ITD system. acquisition as well as the repayment of
loan has been claimed as application.
d. The AO should examine whether all Both the claims may also be made by the
the assets of trust/ institutions are being assesee in different years. This will result in
used for charitable purposes specially double deduction of the same application.
immovable properties. A list of immovable The AO should examine the financials and
property should be called for and physical
computation of income of relevant year
verification in sample cases may be carried
in which the asset was acquired, in case
out to find out instances of misuse of the
if repayment of loan is claimed during the
assets of the trust. There may be instances
year, to verify whether it is a case of double
where the trust properties are occupied
by the trustees or their relatives for their deduction.
personal use or running their businesses c. The Assessing Officer should examine
etc. At times such properties may not be whether the claim of application on
visible from Balance Sheet since they may account of different expenses is genuine
have been received as donation in kind and is supported by appropriate
and may not have been recorded in the documentary evidences. Here the focus
books of account. of the AO need to be on identification of
e. The AO should examine whether the cases of diversion of funds through bogus
resources of trust/ institution have been or inflated expenses. It need to be check
used for the personal benefits of trustees whether money has been taken away from
or other specified persons. There may be trust by booking such bogus expenses by
instances where the employees of trust are any of specified persons, in which case,

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 Charitable Trusts and Institutions

entire exemption may be denied as per the h. If the assessee has given donations to
provisions of Section 13(1)(c). However, other trusts/ institutions and claimed
for denial of exemption, the enquires as application, the AO should verify
should be carried out to establish linkage of whether the donee trust is also registered
siphoning of funds from trusts to benefit of as chartable institution with Income-tax
specified persons. The data available from Department and the donation is not in the
open source on the relationship between nature of corpus donation.
the parties in whose name expenses have
been booked by the trusts and specified 4.4 Donations
persons may be helpful. For example in
some cases the company to whom bogus 4.4.1  As per the provisions of Section 12, any
payments have been made is owned by voluntary contribution received by the trust or
one of specified persons. institution shall be deemed to be income of the
trust or institutions.
d. In certain cases, the person from whom
goods/ services have been claimed to 4.4.2  Points of Investigation
be purchased/ procured may not exist at
all. In some such cases, the case of such a. The Assessing Officer should examine
persons might have been selected in NMS whether all voluntary contributions have
(Non Filler Monitoring System) and the been shown as income by the assesee.
Donation register/ receipt register may be
notice served on such person might have
examined in this regard. Examination of
returned back. The AO may write to the
bank statements may also reveal some
AO of such person for getting information
receipts which have not been accounted
on existence of such parties. The names
for by the assessee.
of such persons may also be searched in
the list of entry operators circulated by b. A report by banks of charitable institutions
Department from time to time. is also filed with FIU. In appropriate cases
request may be made to FIU regarding the
e. Bank statements of third parties to whom bank accounts maintained by the assessee
payments have been claimed to be made which may reveal some undisclosed
by the assessee may also be examined to accounts.
verify the flow of funds.
c. As per the provisions of Section 80G(5D),
f. In suitable cases, the AO can also get no deduction u/s 80G will be allowed on
physical verification done to examine cash donations exceeding Rs. 2000/-.
the existence of assessee, genuineness Receipts registers/ 80G certificates may
of activities carried out and to gather be examined alongwith bank statement to
information about any non charitable find out instances of violation of Section
activity carried out by the assessee. 80G(5D).
g. The Assessing Officer should examine d. The Assessing Officer should examine
whether the application claimed is towards whether the receipts declared as voluntary
an object specifically stated in the deed of contributions are in the nature of donations
registration else such activities would be or receipts for carrying out some work or
beyond the scope of the trust/ institution rendering services. In case if the receipts
and would not be allowable. are for rendering services, applicability

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Techniques of Investigation for Assessment Vol. 3

of provisions of Section 11(4), 11(4A) 4.5.2  Points of Investigation

and proviso to Section 2(15) need to be The Assessing Officer should examine whether
examined. In case if TDS has been deducted the receipts claimed to be corpus donation by
on such transactions under Section 194C/ the assesee qualify the following conditions:
194J, the same would be reflected in Form
26AS which is available to AO as a part of a. The receipt is in the nature of donation
ITS (Individual Transaction Statement). b. The donation is made voluntarily
e. Copy of grant letters and agreements may c. The donor gives a specific direction that
also be examined to ascertain true nature the donation is for the corpus.
of receipt.
If the assessee has received fees from the
f. The Assessing Officer should examine applicant members/ students, it will not been in
whether the records with respect to the nature of donation since donation is made
identity of the donors are maintained by without any expectation of return. Secondly the
the assesee. In case if such records are not term voluntary clearly indicate the discretion of
maintained, donation may be treated as the donor both in term of making the donation
anonymous donation as per the provisions and the quantum of donation. In case, if the
of Section 115BBC in case of non-religious person giving money to the trust or institution
charitable institutions. In some cases, does not have discretion in terms of amount to
donation may not actually have been be paid then this cannot be regarded as corpus
given by such person. AO may verify such donation. For example in case of member ship
cases on sample basis by sending notices fees etc., there is no discretion regarding the
to the donors. amount to be paid. Further, there has to be a
g. In case of suspicious foreign donations, a specific direction of donation towards corpus
request may be made to FT&TR Division which can arise only when the donor has an
of CBDT to get information from respective option to choose.
countries about genuineness of donations. a. The Assessing Officer should examine
4.5  Corpus Donations whether corpus donation has been
received from another organisation on
4.5.1 Corpus donations are to be excluded or after A.Y. 18–19. In such cases as per
entirely from the assessable income of the trust explanation 2 to Section 11, such donor
or institution under Section 11(1)(d). In other will not be eligible to claim such donation
words, voluntary contributions received with a as application.
specific direction from the donor that they shall
form part of the corpus will get excluded from b. The Assessing Officer should examine
the taxable income of the trust or institution whether the corpus donations claimed
under Section 11(1)(d). However, there is by the assesee are genuine. In case if the
no such provision for charitable institution source of the donations is not found to the
claiming exemption u/s 10(23C). Further, as genuine, provisions of Section 68 read
per the provisions of explanation 2 to Section with Section 115BBE may be examined.
11 (w.e.f. A.Y. 2018–19), any corpus donation c. The Assessing Officer should examine
by a charitable institution to another shall not whether the receipts claimed to be corpus
qualify as applications for the donor charitable donation by the assesee are meant for
institution. permanent fund. Corpus donation means

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voluntary contribution towards permanent 15 per cent of the income derived during the
fund which had been given with specific year.
direction and, therefore, it cannot be used
4.6.2  Apart from accumulation of 15 per cent of
in any manner contrary to the direction
income permitted under Section 11(1)(a), a trust
of the donor. Normally, diversion of the
or institution is permitted under Section 11(2)
corpus fund for any purpose, whether
to accumulate or set apart income for specific
loans and advances, is a clear violation of
purpose(s). Such accumulation or setting apart
the specific direction of the donor and also
of income has to be for definite and concrete
against the spirit of the applicable laws of
purposes and should not be vague. Section
the land. A corpus is a permanent capital
11(2) has been amended w.e.f. A.Y. 2016–17
which normally cannot be used either as
which specifically provided that statement for
application or any loan & advance to any
accumulation in Form-10 shall be filed by the
other trust or party.
assesee before the due date of filing return of
d. The Assessing Officer should examine Income. Rule-17(2) has also been amended w.e.f.
whether any income on corpus fund has A.Y. 2016–17 specifically providing that Form-10
also been treated as corpus donation. The shall be submitted on or before due date of filing
income of corpus fund has to be treated return of Income as per the procedure laid down
as income and 85% thereof need to be by DGIT(Systems). As per the procedure laid
applied. down by DGIT(Systems), Form-10 needs to be
e. In certain cases, corpus donations may filed on e-filing portal. Stated briefly, the amount
be used as means of tax evasion since the sought to be accumulated under Section 11(2)
donor gets tax deductions u/s 80G and the shall be excluded from taxable income provided
donee’s income is also exempt. In cases the following conditions are satisfied:
where AO has reasons to doubt, detailed i. Form-10 need to be filed on e-filing portal
investigation may be carried out into the by the assesee, and
bank statements of both donor and donee
ii. The money so accumulated or set apart is
to find out instances of cash withdrawal if
invested in the forms or modes mentioned
any, the communication between donor
in Section 11(5).
and donee should also be examined to
verify the intention of donor, instances 4.6.3  As per Rule 17, the notice has to be
of donations by the same donor to other given on or before the due date of filing the
donees during the same period may also return under Section 139(1). However, subject
be helpful in ascertaining the genuineness to certain conditions, the Board has authorized
of transactions. the Commissioner or Director to extend the
aforesaid time limit if good and sufficient reason
4.6  Accumulation of Surplus
is shown for the inability to give the notice in
4.6.1  Under Section 11(1)(a), in addition to the time. The Circular stipulates satisfaction of five
income actually applied to charitable/ religious conditions before the time limit is extended.
purposes, income of the trust/ institution to the These are as under:
extent of 15 per cent of the income derived during
a. The genuineness of the trust is not in doubt;
the year, if accumulated or set apart for future
application to such purposes, is also eligible for b. The failure to give notice to the Assessing
exemption. No procedural requirements have Officer and invest the surplus in time was
been laid down for such accumulation of upto only due to over-sight;

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c. The trustees or settler have not benefited application with respect to any specified
by such failure directly or indirectly; grant in computation of income while the
income has been claimed to be exempt. In
d. The trust agrees to invest the surplus before
such cases, since specified grant has been
the extension of time is granted;
claimed to be not forming part of income,
e. The accumulation was necessary for hence 15% accumulation thereof shall not
carrying out the object of the trust. be allowed. For example:
4.6.4  Income accumulated or set apart under Income 200
Section 11(2) for attainment of specific purposes Specified grant 100
has to be used for the specified purposes within
Total 300
the specified period. An infringement of the
Less 15% accumulation allowed u/s 11(1)(a) 45
conditions of accumulation can occur on any or
Balance 255
all of the following grounds:
Specified grants not part of income 100
a. It is applied to purposes other than Balance income to be applied 155
charitable or religious purposes,
Actual application 155
b. It ceases to remain invested in the manner Thus, it can be seen from the above example
specified under Section 11(5), that required application of income should have
c. It is not applied for the purposes for which been 85% of Rs. 200 i.e. Rs. 170. But, the assesse
it was accumulated, or is claiming 15% of specified grant amounting to
Rs. 100 as well which is resulting in reduction of
d. It is credited or paid to any other charitable
required application from 170 to 155. This is not
or religious trust or institution or other
allowable.
such institution mentioned under Section
11(3)(d). a. The Assessing Officer should examine
whether Form-10 has been filed online.
4.6.5  Upon the occurrence of any of the
The Forms filed online are available
aforesaid events, the amount will be taken as the
on e-filing portal. The access of e-filing
income of the previous year in which such event
portal is available to all the AOs As per
takes place. It may happen that an assessee is
the provisions of Section 13(9), in case
unable to apply accumulated income for the
of non filing of Form 10 online as per
purposes for which it was accumulated because
the procedure laid down in the section,
of reasons beyond his control. In such a situation,
accumulation will not be allowed.
Section 11(3A) allows the assessee to make an
application to the assessing officer requesting for b. The Assessing Officer should examine
change of purpose(s) for application of income. whether Schedule-I of ITR has been
duly filled in by the assessee. It contains
4.6.6  Trust or institution is also allowed to the details of present as well as past
accumulate the surplus for 1 year as per the accumulations.
provisions of explanation 1(2) to Section 11(1).
However, the assesee needs to submit Form-9A c. The Assessing Officer should examine
in such case as per Rule-17(3) before due date whether the accumulations during previous
of furnishing return of income. year have been applied during the year.
The application out of previous years’
4.6.7  Points of Investigation accumulations during the year is required
a. The Assessing Officer should examine to be separately reported in Schedule-ER
whether the assesee has claimed 15% and Schedule-EC of ITR-7.

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4.7  Application Outside India 4.8.2  In case the sale consideration of capital
asset is not applied for charitable purposes, the
4.7.1 Section 11(1)(c) permits deduction of
sale consideration needs to be treated as income.
expenditure incurred outside India provided
The following table will make the legal position
that such application of income promotes
quite clear:
international welfare in which India is interested.
However, for deduction of such expenditure,

registered
prior approval of the Board is required.

u/s 12AA
Business
assessee

assessee
4.7.2  Points of Investigation
a. The Assessing Officer should examine

Deduction

Deduction
whether a valid approval from CBDT

Particulars

Amount
allowed

allowed
amount
for application outside India is available
with the assesee and whether the same is
applicable for the year under consideration Cost of acquisition 100 Nil 100 100
or not, which are based on the following
Depreciation 40 40 40 Nil
considerations:
WDV 60 60
(i) Whether the trust or institution is Sale consideration 45 45 (-)45
allowed to carry out activities outside Loss 15 15 15 Nil
India as per the deed of registration.
Cost of the use of 55 55 55 55
(ii) Whether the activities carried out asset
outside India are in the nature of
charitable activities as defined in 4.8.3  As seen from the above example, if the
Section 2(15). asset of Rs 100 is acquired by the assesse and
sold for Rs 45, the assessee has effectively spent
(iii) Whether the activities carried out side Rs 55 and, therefore, only Rs 55 shall be allowed
India tend to promote International as application. In the case of a normal business
Welfare in which India is interested. assesse, the assesse is not allowed the deduction
b. The AO should verify the transactions for the cost of the asset and is rather allowed
relating to foreign remittance reported in depreciation of Rs 40 and Rs 15 as loss on the
Form 15CA which are made available to same of asset. But in case of a trust, since the
the AO in ITS. expense of Rs 100 has already been allowed
as expense, at the time of the sale of asset, the
4.8  Transfer of Capital Asset
amount of Rs 45, being the sale consideration is
4.8.1  Section 11(1A) of the Act deals with to be taxed.
capital gains arising or accruing to a charitable 4.8.4  Points of Investigation
trust or institution. The position of law is that in
the case of a charitable trust or institution eligible a. The Assessing Officer should examine
for exemption under Section 11, capital gains, whether the assessee has claimed
whether long term or short term, will be deemed depreciation or cost of asset as application
to have been applied to charitable purposes and of income.
will be exempt from tax to the extent they are b. The Assessing Officer should examine
reinvested in a new capital asset. The provision whether the assessee has invested in new
applies with necessary modifications to cases capital asset as per the provision of Section
where the capital asset is held only partly (and 11(1A). In case if assessee fails to invest in
not wholly) for religious or charitable purpose. new asset as per the provision of Section

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Techniques of Investigation for Assessment Vol. 3

11(1A), the sale consideration of the asset source for the principal activities and another
transfer shall be treated as income. source for incidental activities.
4.9  Business Undertaking held by Assessee 4.10.3  Points of Investigation
4.9.1  At times, a business undertaking may be a. The Assessing Officer should examine
settled into trust or institution. In such a case, whether any TDS u/s 194C/ 194J of
if the income of such business undertaking is Income-tax Act, 1961 has been deducted
Utilised for charitable purposes for which trust in the case of the assesee. This information
or institution is registered then the income from
is available to the AO as per ITS statement.
such business undertaking will not be liable to
tax. The AO shall have the power to determine TDS u/s 194C is deducted for carrying out
the income of such undertaking in accordance contractual work and u/s 194J is deducted
with the provisions of Income-tax Act relating for rendering professional services. If the
to assessment and where the income so deter- assessee has disclosed certain receipts on
mined is in excess of income as shown in the which TDS under any of these two sections
account of undertaking then such excess shall be has been deducted then it needs to be
chargeable to tax. verified whether these receipts are from
4.9.2  Points of Investigation any business activity or not and secondly
whether such business activity is incidental
a. The Assessing Officer should examine to main activities of the trust or not.
whether the business undertaking is settled
as property held under trust. b. The Assessing Officer should examine
whether separate books of accounts are
b. The Assessing Officer should examine maintained by the assessee for trade or
whether the income of business undertaking business activities claimed to be incidental
has been applied for charitable purposes. as required by Section 11(4A).
The income of business undertaking needs
c. The Assessing Officer should examine
to be applied for charitable purposes
whether the business activities carried out
during the year as per the provisions of
by the assessee are necessary for carrying
Section 11(1)(a) of Income-tax Act.
out the main activities and are emanating
4.10  Incidental Business from the main activities.
4.10.1  Section 11(4A) deals with income of a 4.11  Permitted Modes of Investment
trust or institution by way of a business which 4.11.1  The Charitable trust/ institutions are
is incidental to attainment of its objects. The allowed to invest only in prescribed modes of
income of such a business will be entitled to investment. As per Section 13(1)(d), if a trust
exemption under Section11 if separate books of or institutions invests in any mode except these
account are maintained, otherwise, the income prescribed modes then the exemption u/s 11 and
will not be entitled to benefit of exemption under 12 shall be denied as per the provision of Section
Sections 11 and 12. 13(1)(d). Similar provision is also contained in
3rd proviso to Section 10(23C).
4.10.2 “Incidental” means, offshoot of the
main activities; inherent by-product of principal 4.11.2  Points of Investigation
activities. Activities to compliment and support a. The Assessing Officer should examine
the main objectives are not in the nature of whether the trust or institution has invested
incidental to the business. The genesis of its surplus only in prescribed modes of
incidental activities must be from the principal investment or there is any investment
activities themselves. There cannot be one beyond these modes.

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b. The Assessing Officer should examine 4.13  Modification of Objects

whether trust or institutions has any
4.13.1  As per the provisions of Section 12A(ab),
investment in shares of a company which
w.e.f. A.Y. 2018–19, if an assesee subsequent to
is not allowed as per Section 11(5).
its registration u/s 12AA, adopts or undertakes
c. The instances of violation of Section 11(5) modifications of objects which do not confirm to
and 13(1)(d) should be reported to the the conditions of registration then such trust or
CIT in view of Section 12AA(4). institutions shall apply for registration u/s 12AA
again within 30 days from the date of such
4.12  Treatment of Depreciation
modification/ adoption.
4.12.1  As per the provisions of Section 11(6),
depreciation is not allowed as application of 4.13.2  Points of Investigation and Techniques
income if the cost of assets has been claimed a. The Assessing Officer should examine
by the assessee as application. The assessee whether any modification has taken
has an option to claim either the cost of asset as place in the objects of the trust or
application or to claim depreciation thereon as institutions registered with the Income-
application. This provision has come into effect tax Department.
w.e.f. A.Y. 2015–16. Upto A.Y. 2014–15, Hon’ble
Supreme Court in the case of Commissioner of b. In case if any modification has taken place,
Income-tax-III, Pune v. Rajasthan & Gujarati whether application as per the provision of
Charitable Foundation Poona [2018] 89 Section 12A(1)(ab) has been filed by the
taxmann.com 127 (SC)/ [2018] 253 Taxmann assesee.
165 (SC)/[2018] 402 ITR 441 (SC)/ [2018] 300 c. The Assessing Officer should examine
CTR 1 (SC) has decided that both depreciations whether the trust or institution has received
as well as cost of asset has to be allowed to the registration u/s 12AA for the modified
assessee. objects.
4.12.2  Points of Investigation
4.14  Audit Report
a. The Assessing Officer should examine
whether the assessee has claimed 4.14.1  As per the provisions of Section 12A(b),
depreciation on assets or not. With effect every trust or institution is required to get its
from A.Y. 2015–16, in case if assessee accounts audited and submit audit report in
claims depreciation, it needs to be verified Form-10B if its total income without giving effect
whether cost of asset has also been claimed to provisions of Section 11 and 12 exceeds
by the assessee as application of income. maximum amount which is not chargeable to
tax. Similar provision is also contained in 10th
b. The Assessing Officer should examine
whether the assessee has taken loan proviso to Section 10(23C). The relevant from
against capital assets and claiming in such cases is Form-10BB. Circular: No. 143
repayment of loan as application of [F. No. 180/ 74/ 73-IT(A-I)], dated 20-8-1974
income since it will result in double claim needs to be referred in this regard.
of same application. 4.14.2  Points of Investigation
c. The Assessing Officer should examine
whether the sale consideration of an asset The Assessing Officer should examine whether
on which depreciation was claimed by audit report in Form-10B has been submitted by
the assessee has been treated in terms of the assessee in case the assessee is registered in
provisions of Section 11(1A). Section 12AA of Income-tax Act.

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Techniques of Investigation for Assessment Vol. 3

4.15  Filing of Return of Income b. The Assessing Officer should examine

whether the trust or institution has been
4.15.1  A charitable or religious trust or
created to give benefit to any particular
institution is mandatorily required to file a return
religious community or caste. Religious
of income under Section 139(4A) if its income
trust is allowed to be registered as per
without giving effect to the provisions of Sections
Section 11 and 12 but the benefits passed
11 and 12 exceeds the maximum amount not
on by such trust shall not be restricted to
chargeable to Income-tax. In other words, such
a particular religious community or caste.
a trust or institution must file a return of income
if it has taxable income for the year before 4.17  Benefits to Specified Person
claiming exemption under Sections 11 and 12. 4.17.1  Section 13(1)(c) provides that if the trust
The report of the auditor in Form 10B has to be or institution has directly or indirectly benefited
filed along with the return. any specified person, as referred to in Section
13(3), then exemption u/s 11 and 12 shall
4.15.2  Points of Investigation not be allowed to the assessee. Section 13(3)
a. The Assessing Officer should examine defines such persons which includes trustees,
whether the assessee has filed return of their relatives and their related concerns etc.
income by due date. In case if assessee The idea is that the management of the trust or
has not filed return of income by due date, institutions shall not derive any benefit either
w.e.f. A.Y. 2018–19 exemptions shall be directly or indirectly. For example, if a contract
denied to the trust or institution registered for constructing school building of the school
u/s 12AA. run by the assessee has been given to company
owned and managed by the trustee at a price
b. As per the provisions of Section 139(4A)
higher than market price, then a benefit has been
and (4C), return of income is required to be
passed on by the trust or institution to specified
submitted if income derived from property
person. Since the legislation has provided extra
exceeds the maximum amount which is
ordinary benefits to the trust or institutions in
not chargeable to tax without giving effect
the form of complete tax exemption, hence a
to provisions of Section 11 and 12.
responsibility has also been imposed on them to
4.16  Benefit not for Public maintain absolute fairness so that public money
4.16.1 If income of the trust or institution is is not misused. Therefore, in case of violations of
applied for the benefit of private purposes which Section 13(1)(c), entire exemption u/s 11 and 12
is not for public benefit then exemption u/s 11 is to be denied.
and 12 shall not be available. Courts have held 4.17.2  Section 13(2) provides instances where
that a Section of public shall also be considered a benefits directly or indirectly has been passed
to be public. on to specified persons as defined in Section
4.16.2  Points of Investigation 13(3). These instances includes use of trust
properties by specified persons without ade-
a. The Assessing Officer should examine quate consideration, payment of unreasonable
whether the beneficiaries are public at salary or allowances, purchase of sale of proper-
large or certain private individuals. In case ty without adequate consideration, diversion of
if benefit is given by the trust or institution income or property etc.
to certain individuals who are related to
each other by birth or caste or religion 4.17.3  Points of Investigation
then exemption u/s 11 and 12 shall not be a. The Assessing Officer should examine
available. whether transaction with specified person

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has been reported by the auditor in Form- a. Anonymous donations received by wholly
10B/ 10BB. In case of such reported religious institutions shall remain exempt
transaction, the reasonableness of the from tax.
consideration needs to be verified. b. In the case of partly religious and partly
b. The Assessing Officer should examine charitable institutions, anonymous
whether all the transaction with specified donations to medical or educational
persons have been reported by the auditor. institutions run by them will be taxable at
In some cases, advances or security 30 per cent if the same exceed 5 per cent
deposits are given by trust or institution of total donations received by such trust/
to the specified persons which are not institution or Rs. 1 lakh, whichever is more.
reported in Form-10B or 10BB. A careful Donations to partly religious and partly
scrutiny of Balance Sheet and Income & charitable institutions which do not run
Expenditure account may reveal such such medical or educational institutions
transactions. shall remain exempt from taxation.
c. The Assessing Officer should examine c. In the case of wholly charitable institutions,
whether trust or institution has entered anonymous donations will be taxable at
into transaction with the entities in which 30 per cent if such donations exceed 5 per
trustees, authors etc. have substantial cent of total donations received by such
interest. At times list of such entities may not trust or institution or Rs. 1 lakh, whichever
be readily available with the AO Publically is more.
available information on the website of
Ministry of Corporate Affairs etc. may help 4.18.2  Points of Investigation
the AO in tracing such entities. a. The Assessing Officer should examine
d. The violations of this Section should be whether the names and addresses of all the
reported to the CIT as per the provisions donors has been submitted by the trust or
of Section 12AA(4). institution.
b. The Assessing Officer should examine
4.18  Anonymous Donation whether the trust or institution has got
registered u/s 80G. In such case, religious
4.18.1  A significant legal change has been
activities cannot exceed 5% of its total
brought about by Finance Act, 2006 with effect
income during the previous year. Since,
from 01.04.2007 by inserting a new provision
exemption from Section 115BBC is
(Section 115BBC) whereby anonymous
available only to religious institutions
donations will not enjoy exemption but would
hence generally, both 80G and anonymous
be chargeable to tax at the rate of 30 per cent
donations exceeding specified limit should
from Assessment Year 2007–08 onwards.
not be allowed.
This provision, as it stands after further
amendment by Finance Act, 2009, lays down
4.19  Carry Forward of Losses
that from Assessment Year 2010–11 onwards,
tax treatment of anonymous donations (i.e. 4.19.1  A trust or institution is required to
donations in respect of which the assessee fund/ apply 85% of its income during the year. Thus
trust/ institution etc. does not maintain records it can accumulate 15% of its income without
of identity indicating the name and address, or any condition or intimation. For accumulating
other particulars of the donor as are prescribed more than 15%, filing of Form-10 is required
under the I-T Act) would be as follows: as discussed earlier. In case a trust applied

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Techniques of Investigation for Assessment Vol. 3

more than 85% of its income during the year, it c. Income of a charitable or religious trust
claims carry forward of such excess application. or institution under whose terms or rules
The Hon’ble Supreme Court in miscellaneous any part of its income directly or indirectly
application No. 941/ 2018 IN CIVIL APPEAL benefits the author/ founder/ trustee/
NO(s). 5171/ 2016 in the case of Commissioner manager or other such person specified
of Income-tax(Exemption) New Delhi–Vs- under Section 13(3)
Subros Educational Society, vide order dated d. Income of a charitable or religious trust
16th April, 2018 has allowed carry forward of or institution if any part of its income or
excess surplus. property is used or applied during the
previous year either directly or indirectly
4.19.2  Points of Investigation for the benefit of any person specified
a. What is the source of funds out of which under Section 13(3);
excess application has been made? e. Income of a charitable or religious trust or
b. Whether the carry forward has been institution, if any of its funds are invested or
claimed in the return of income? continue to remain this restriction will not
apply to a “religious” trust or institution.
4.20 Liability to Deduct TDS: As per
explanation (iii) to Section 11(1) and 12th f. invested otherwise than in the modes
proviso to Section 10(23C) w.e.f. A.Y.2019–20, specified under Section 11(5) during the
provisions of Section 40A(ia) and 40A(3) and previous year (this is subject to certain
40(3A) shall be applicable while arriving at specified exceptions such as assets held as
amount of application allowable to the assessee. corpus, accretions to the same by way of
Thus in case a trust or institution fails to deduct bonus shares, debentures acquired under
certain circumstances etc.);
TDS on an application, 30% thereof will be
disallowed. Similarly, where payment has been g. Income of a charitable trust or institution
made otherwise than through account payee engaged in the advancement of “any other
cheque, exceeding Rs. Twenty Thousand rupees object of general public utility” if it involves
the same will not be allowed as application. carrying on of any trade, commerce or
business activity.
5.  FORFEITURE OF EXEMPTION AND Provisions of Section 115TD may be invoked
ITS CONSEQUENCES in case of circumstances provided in Section
115TD.
Section 13 mentions the circumstances under
which benefit of provisions of Section 11 and
Section 12 shall not be available to an assessee. 6.  OTHER ASPECTS OF
These circumstances are listed as under: INVESTIGATION

a. Income from property held under trust for 6.1  Influential people build empires. There are
educational empires also. It is a common sight-a
private religious purposes and not for the
person who has had his field day in some other
benefit of public;
field like politics, starting a host of educational
b. Income of a charitable trust or institution institutions. Such institutions offer a safe haven
created or established for the benefit of for the black money earned elsewhere along
a particular religious community or caste with the scope for earning more money. They
(other than SC/ ST/ Backward Classes, pass off as educational or charitable institutions.
women and children); In such cases, a certain amount of enquiry and

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investigation is necessary in respect of donations society or company to retain the legal status it is
claimed as received, expenses incurred and necessary that it should have registered with the
amounts applied. concerned Registrar and should stay so. Once its
name is struck off the registers of the Registrar
6.2  In the case of an orphanage which gives
it loses its legal personality. Enquiries with the
children in adoption, scrutiny should be intense.
Registrar will be necessary in doubtful cases.
Such orphanages usually receive donations
(mostly from abroad) towards rearing expenses 7.2  Trusts engaged in social work have
of the children. While giving away the child in considerable interaction with State government
adoption they again collect the entire expenses agencies. Enquiries with these agencies help
from the adoptive parents. It should be checked in ascertaining the real state of affairs. Laws
whether the collections are duly accounted for. governing local self government (municipal
6.3  Instances are not rare where black money authorities) provide for concessional treatment
of persons associated with trusts are introduced to charitable institutions. The treatment accorded
into the trusts as donations received from others. by the local authority to the institution concerned
In one instance the employees of a bank-even is relevant for tax investigations.
those working in far-off branches-with which 7.3  The Charity Commissioner functioning
the person had accounts were issued receipts under the Bombay Public Trusts Act 1950
for supposed donations. While the person got
in Mahrashtra and Gujarat exercises general
his black income ‘whitened’, the employees got
superintendence over the affairs of charitable
deduction u/s 80 G for donations not given! In
such cases the person is not likely to be char- organisations. He is empowered to sanction sale,
itably dispositioned. In all probability what he mortgage, exchange, gift or lease of immovable
creates is a business edifice disguised as charity. property, hold enquiries, order special audit of
Such cases can be attacked from both the do- the accounts, frame or modify a scheme and
nation angle and the application angle. Probing give notice for cy pres application. Liaising with
the immediate source of the donor for the do- his office may be useful in trust investigations.
nation and a reference to his bank account will 7.4  In states like Tamilnadu, the agricultural
be rewarding. In all likelihood, the source-mon-
income of charitable institutions is exempt for
ey would have come into the account just that
day or a few days before. The supposed donor’s state agricultural income-tax purposes only
history also will reveal some interesting aspects. if the conditions for registration, application/
How the donor came to know of the trust will be accumulation of income, bar against benefit
another relevant question. to interested persons, etc., under the Income-
tax Act in 1961 are met. Even an institution
6.4  There are some trusts that are in the habit with only agricultural income is required to
of issuing receipts for supposed donations which
register u/s 12A with the CIT/ DIT and fulfill all
had not in fact been received. What they get
from the unscrupulous ‘donor’ is, not donation the conditions prescribed in Sections 11 to 13.
of the full amount, but a fraction-as commission. Cases of agricultural income not fulfilling these
This helps the donor to claim deduction for the conditions should be reported to the Agricultural
‘donation’. Enquiries on the lines similar to the Income-tax authorities.
above will help.
8.  CONCLUSION
7.  COORDINATION WITH 8.1  The idea behind the exemption provisions
OTHER AGENCIES in tax law is to regulate the affairs of the
7.1  The trust or institution should have legal organisations which claim to be charitable.
existence to qualify for exemption u/s 11. For a Here, we are dealing with a special category of

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Techniques of Investigation for Assessment Vol. 3

assessees who have come into being with the clear idea of what he is seeking to achieve. He
stated purpose of doing or promoting charity. should steer clear of foggy thought processes.
The focus, then, should be on encouraging real While investigating, the AO should be familiar
charity-on detecting violations and meting out with the case law on the point.
appropriate tax treatment and on identifying fake
organisations and denying them the exemption. 8.3  There are several trusts created with
Making big tax demands and collections anything but a charitable intention. Their objects
cannot by itself be the aim of any investigation. are noble, but activities are not. Many of them
Obsession with law often blunts investigations. are just money-spinning mechanisms. That the
The AO should not get carried too far by legal Legislature is aware of this evil is evident from
issues. The focus should be essentially on facts. the attempts it makes year after year to contain
Any claim made should be checked for factual it. The AO should keep in mind the larger social
veracity. If the AO fails to bring out relevant considerations while making investigations. He
facts, Department’s case is lost for ever. should be firm and unsparing with such trusts.
8.2  Investigation in trust cases should be But he should be discriminating enough to
purposeful, specific and pointed, as any spare the really good organisations from any
investigation should be. The AO should have a destructive scrutiny.

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 Chapter

20
Educational & Coaching
Institutes
1.  SALIENT FEATURES

1.1  Educational institutions functioning in

India are owned and managed either by
public trusts or by societies registered under
the Societies Registration Act of 1860. In some
of the States, for example, Maharashtra and
Gujarat, where local Public Trusts Acts have
been passed, all the societies registered under
the Societies Registration Act, are required to be 1.3 The colleges which are affiliated to the
simultaneously registered under the local Public State/ Central level Universities under the
Trusts Act. relevant University Act are required to have a
governing body or managing committee to
1.2 The public trusts are generally managed manage the affairs of the college concerned.
by Board of Trustees, one of whom may be The governing bodies/ managing committees
designated as Chairman or Managing Trustee. of educational institutions may be supported
Societies are autonomous bodies with office by various committees, e.g. finance committee,
bearers consisting of president, vice-president, library committee, science committee, sports
secretary, treasurer and executive committee committee, etc. for streamlining of the decision-
members. The general body consists of all the making process. Members of such committees
members of the society. Societies/ trusts which may be the members of governing body, teaching
run number of colleges, schools, etc., have a faculty and administrative staff depending upon
governing body for managing the affairs of each the nature of the functions of the committee.
individual school or college, wherein head of 1.4  Educational institutions which fulfill
the school/ college such as the principal of the the eligibility requirements laid down by the
college or the head master of the school may Government are eligible to get assistance in
be inducted as a member of the governing the form of Grant-in-aid from the Government.
body. The responsibility of governing body The grants are released on the basis of audited
is to manage the affairs and ensure smooth statements of accounts of the educational
functioning of individual school or college. institutions. Apart from grant, part of the

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Techniques of Investigation for Assessment Vol. 3

expenses of the educational institutions are 2.4  The Constitutional duty of the
met from the funds raised by the educational governments, both Central & State, is to ensure
institutions themselves, either by way of fees, or that educational institutions were not indulging
from donations collected from public. in commercialization and to make sure that
institutions function to spread education and not
2.  EXEMPTION OF INCOMES to make money. The Income-tax Department
OF CERTAIN EDUCATIONAL thus possesses the foremost responsibility
INSTITUTIONS AND PROVISIONS to check such maleficence by appropriate
RELATING TO TRUSTS RUNNING provisions under the Act. The job of the Assessing
EDUCATIONAL INSTITUTIONS Officer of the Educational Institutions, therefore,
is characterized rather as a watchdog and not as
2.1  In Indian taxation, educational institutions a tax collector.
enjoy a privileged position. There are many
tax exemption regimes available to educational 2.5 Before claiming the applicable exemption
institutions depending upon their constitution, under the Income-tax Act by any educational
objects, gross annual receipts and level of institution, there should be a legally existent
government finance they receive. Broadly, entity which can be registered and it should
Section 10(23C) and Section 11 of the Income- have a written instrument of creation or written
tax Act contain the provisions applicable to document evidencing its creation. A NPO can
educational institutions. The contents of the be created only in 3 major forms. The first one
succeeding paragraphs provide an overview being the Trust, is the most common mode
on principles involved in taxation of income of of creation. The next form is that of a Society
educational institutions in India. registered under the Societies Registration Act,
2.2  Education is treated as a noble occupation 1860. The third form and the least opted is that
on ‘no-profit-no-loss’ basis. It is for this reason of a Section 8 Company registered under the
that a recognised educational institution can Companies Act, 2013.
only be run by a non-profit organisation 2.6 These 3 types of non-profit organisations
(hereinafter NPO for brevity), be it a “Trust” or
have to get registered before the Commissioner
a “Society” or “a Section 8 Company”. Despite
of Income-tax (Exemptions) under S.12AA
such honourable position endowed upon
of the Act in order to enjoy the benefit of
them, it is seen that some of the Educational
Institutions have become the highest grossers of exemption u/s. 11. In respect of a Society or a
unaccounted wealth in the recent past. Those Section 8 Company, registration is mandatory
who establish and are managing the educational under the respective Acts. In respect of a Trust,
institutions are not expected to indulge in there is no compulsion that it has to be registered
profiteering or commercialize this noble activity. under the Indian Trust Act, 1882. Even oral
However, in reality, the situation is not apposite Trusts are eligible for registration under S.12AA.
to such principled intentions. However, the purpose of the Trust, and the
bye laws governing the Trust activity should be
2.3 Though education is now treated as an
drawn up in writing while filing the application in
‘occupation’ and, thus, has become a fundamental
Form 10A.
right guaranteed under Article 19(1) (g) of the
Constitution, at the same time shackles are put in 2.7 The provisions of S.11 & 12 apply to an
so far as this particular occupation is concerned, assessee, either it be a Trust or a Society or a
which is termed as noble. Therefore, profiteering Section 8 company. However, the provisions
and commercialization are not permitted and no of S.10(23C) applies to an institution operating
capitation fee can be charged. under the aegis of a Trust or a Society or a Section

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 Educational & Coaching Institutes

8 company. This distinction has to be borne of Clause (23C) of Section 10, any university or
in mind while granting approval u/s. 10(23C). other educational institution, hospital or other
The similar provisions are applicable to Section institution referred therein, shall be considered as
80G as well, which applies to an institution and being substantially financed by the Government
not that of an assessee. The contents of the for any previous year, if the Government
provisions of Section 10(23C) and Section 80G grant to such university or other educational
are “qua institution” while that of S.11 and 12 institution, hospital or other institution exceeds
are “qua person.” fifty per cent of the total receipts including any
2.8 Small educational institutions get covered voluntary contributions, of such university or
under Section 10(23C)(iiiad) which reads other educational institution, hospital or other
as follows: “(iiiad) any university or other institution, as the case may be, during the
educational institution existing solely for relevant previous year.”
educational purposes and not for purposes of 2.12  Other educational institutions not covered
profit if the aggregate annual receipts of such under sub-clause (iiiab) or (iiiad) of Section
university or educational institution do not 10(23C) are dealt with by Section 10(23C)(vi)
exceed the amount of annual receipts as may be as follows: “any university or other educational
prescribed;” institution existing solely for educational
2.9  Thus, institutions existing solely for purposes and not for purposes of profit, other
educational purposes and not for profit whose than those mentioned in sub-clause (iiiab) or
aggregate annual receipts do not exceed ₹1 sub-clause (iiiad) and which may be approved
crore [Rule 2BC of the I.T. Rules] are eligible for by the prescribed authority;”
tax exemption without any need for separate
2.13 Thus, institutions existing solely for
registration under Income-tax Act. For purpose
of exemption under Section 10(23C)(iiiad), educational purposes and not for profit which
‘aggregate annual receipts’ refers to receipts by are not wholly or substantially financed by Govt.
educational institution and not that of Society. and aggregate annual receipts of which exceeds
Receipts from more than one educational ₹1 crore, are required to obtain approval of
institutions run by assessee cannot be clubbed Commissioner/ Principal Commissioner of
for the purpose of denying exemption under Income-tax by applying in prescribed form No.
Section 10(23C)(iiiad). 56D. [Rule 2CA of I.T. Rules]
2.10  Educational institutions existing solely for 2.14 Some salient features of approval u/s.
educational purposes and wholly or substantially 10(23C) (vi) of the Act are:
financed by Government are exempt from tax a. The “educational institutions existing
as per Section 10(23C)(iiiab) without any need solely for educational purposes and not
for separate registration under the Income-tax for purposes of profit” are only eligible for
Act: “(iiiab) any university or other educational approval.
institution existing solely for educational
purposes and not for purposes of profit, and b. Any activity of the approved institution
which is wholly or substantially financed by the or amendment in object Clause by
Government; or” such institution which is not solely for
educational purposes will result into
2.11 The phrase ‘wholly or substantially
financed by the Government’ is explained by cancellation of approval.
CBDT through Notification No. 79/ 2014 by way c. No exemption u/s. 10(23C)(vi) shall apply
of insertion of Rule 2BBB as follows: “2BBB. in relation to any income of any university
For the purposes of sub-clauses (iiiab) and (iiiac) or other educational institution being

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profits and gains of business, unless the small amounts under different heads of fee
business is incidental to the attainment as profit making activity unless the amount
of its objectives and separate books of in the nature of ‘capitation fee’ is charged
accounts are maintained by it in respect of directly or indirectly.
such business. [Fourth proviso below sub-
2.15 Educational Institutions can alternatively
clause (vi) of Section 10(23C)]
claim exemption u/s. 11 r.w.s. 2(15) of the Act
d. No exemption shall be allowed by the on the basis of its registration as charitable NPO/
Assessing Officer under any of the Institution u/s. 12AA. In an event it is found
Clauses of Section 10(23C) in the case that the educational institution does not fulfill
of an institution for a previous year, if the the condition laid down u/s. 10(23C), except
provisions of the proviso to Section 2(15) in the case of invoking proviso to Section 2(15)
become applicable in the case of such read with 17th proviso to Section 10(23C), the
person in such previous year. [Seventeenth Assessing Officer is not empowered to undertake
Proviso to Section 10(23C)]. the assessment and complete it disentitling the
e. CBDT Circular No. 14/ 2015 dt. 17.08.15 assessee from claim of exemption u/s. 10(23C)
Clarifies on certain issues related to grant unlike that of denial of exemption u/s. 11 r.w.s.13.
of approval and claim of exemption u/s. 2.16  In case of violations to the provisions of
10(23C)(vi) of the Income-tax Act, 1961. Section 10(23C), the Assessing Officer has to
f. Principles laid down by the Apex Court in keep the proceedings in abeyance as per proviso
American Hotel and Lodging Association to Section 143(3) till such time the intimation
Educational Institute vs. CBDT [301 about the contravention reported to the approving
ITR 86 (2008)] must be followed while authority is acted upon. Alternatively, if the
considering the applications filed seeking assessee/ person is found eligible for exemption
approval for exemption u/s. 10(23C)(vi). u/s. 11 due to fulfilment of conditions laid
down therein, the educational institution can be
g. Section 10(23C)(vi) does not prescribe any
alternatively extended the benefit of Section 11.
stipulation which makes registration u/s.
12AA a mandatory pre or post condition. 2.17  Filing of Return of Income: As per Section
Hence obtaining prior registration before 139(4A), every charitable/ religious NPO, if its
granting approval u/s. 10(23C) cannot be total income (the total income for this purpose
insisted upon. being computed under this Act without giving
h. Mere generation of surplus by educational effect to the provisions of Sections 11 and 12)
institution from year to year cannot be a basis exceeds the maximum amount which is not
for rejection of application u/s. 10(23C)(vi) chargeable to Income-tax, shall furnish a return
if it is used for educational purposes unless of such income of the previous year in the
the accumulation is contrary to the manner prescribed form and all the provisions of this Act
prescribed under law. shall, so far as may be, apply as if it were a return
i. Collection of small and reasonable required to be furnished under sub-section (1).
amounts under different heads of fee, 2.18  As per sub-clause (e) to Section 139(4C)
which are essentially in the nature of of the Act, every university or other educational
fee connected with imparting education institution referred to in sub-clause (iiiab)* or sub-
and do not violate any Central or State clause (iiiad) or sub-clause (vi) of Clause (23C)
regulation does not, in general, represent of Section 10, shall, if the total income in respect
a profit making activity. Hence, there is of which such university or other educational
no justification for treating the charging of institution is assessable, without giving effect

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to the provisions of Section 10, exceeds the 3.  RECORDS TO BE MAINTAINED BY

maximum amount which is not chargeable to EDUCATIONAL INSTITUTIONS
Income-tax, furnish a return of such income of 3.1 Educational institutions are required to
the previous year in the prescribed form and all maintain proper books of account so as to
the provisions of this Act shall, so far as may comply with the terms and conditions laid-down
be, apply as if it were a return required to be for the purpose of grant and also to comply with
furnished under sub-section (1). the provisions of the Societies Registration Act,
2.19 With effect from A.Y. 2018–19, no 1860 or the provisions of the Public Trusts Act
exemption u/s. 11 can be claimed by any NPO as may be applicable and as may be in force in
unless it has furnished a return of income in the State in which the Institution is situated. In
addition, the provisions regarding maintenance
accordance with provisions of sub-section (4A)/
of accounts contained in the trust deed/ rules
(4C) of Section 139, within the time allowed
and regulations of the institution will also have
under that Section. [S. 12A(1)(ba)]
to be complied with. Normally, an educational
2.20 Furnishing of audit report: Where the institution is expected to keep such books as
charitable NPO/ institution claiming exemption are necessary to give a true and fair view of the
u/s. 11 is liable to file return of income as above, state of affairs and income and expenditure of
it is also liable to get is accounts audited and the institution. It must also ensure that there is
furnish audit report in form 10B. [Section 12A(1) effective internal control system in operation.
(b) r.w.r. 17B] 3.2  Educational institutions generally maintain
2.21  Where the educational institution referred Cash Book, Bank Book, Journal, General
to u/s 10(23C)(vi) is liable to file return of income Ledger, and subsidiary Ledgers. Besides, they
also maintain following records:
as above, it is also liable to get its accounts
audited and furnish audit report in form 10BB. a. Fees registers (to record admission fee,
[Tenth proviso to Section 10(23C)(vi) r.w.r. tuition fee, library fee, examination fee)
16CC] b. Register for Grants-in-aid.
2.22 Income-tax Act favours only genuine c. Register for scholarship and special
educational institutions/ NPOs subject to stipends.
approval/ registration under the Act, wherever
d. Registers for funds such as building,
necessary. And, if there is any deviation from library, laboratory, games, furniture and
basic objective of imparting education by equipment, endowment, provident fund,
such institutions to make profits, the Act is poor students fund, deposits etc.
well equipped to bring this mischief within the
tax bracket. There is no bar in undertaking e. Register of immovable properties and
other fixed assets.
commercial activities by such institutions, so long
as these activities are incidental and essential in f. Register of investments.
the given circumstances in order to achieve the g. Minute books.
prime objective of education. As far as any other
object of general public utility pursued by these 4.  SOURCES & APPLICATION
institutions is concerned, commercial activities OF FUNDS OF EDUCATIONAL
are permissible only to certain extent and only INSTITUTIONS
if these activities are incidental to the attainment 4.1  The main sources of funds of educational
of such objects. institutions are as under:

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a. Educational institutions are permitted (iii) Educational institutions also earn

to collect tuition fees, admission fees, interest/ dividends from investments in
development fees, sports fees, examination government securities, debentures and
fees, library fees etc., from the students as shares, and deposits with banks and
per the rules and limits prescribed by the post offices etc..
Government. No fees other than those (iv) Educational institutions may, in some
permitted can be collected. cases, derive income by way of rent by
b. The subscriptions, donations or letting out its premises.
endowments from the public may be (v) Educational institutions also receive grants
received either in cash or in kind to meet from local authorities or other charitable
recurring or nonrecurring expenditure institutions for payment of scholarships,
of the institutions like construction of stipends and other concessions to the
buildings, repairs, scholarships etc. The students. The institution will have to
donations in kind can be in the form of conform to the stipulations of such
land, buildings, shares, securities, utensils, authorities/ institutions, as per which the
furniture, fixtures and the like. grant is sanctioned.
c. Grants from State Government, Central 4.2 Educational institutions generally incur
Government and the University Grants recurring expenditure under the heads of salaries
Commission. From the accounting point of and allowances to teaching and non-teaching
view, the grants are classified as recurring staff; training expenses; rent, rates, taxes and
& non-recurring grants. insurance; Repairs and maintenance; stationery,
(i) Recurring Grants, in the form of printing, postage; telephone; electricity;
maintenance grants, are received in laboratory; drawing material; library; prizes and
installments throughout the year. The medals; etc..
formula for payment of maintenance 4.3  Educational institutions also incur
grants differs from State to State. nonrecurring expenditures on such items, as
In some cases the percentage of Construction of building; purchase of furniture/
permissible expenditure is reimbursed office equipment/ library books/ laboratory
to the institutions, while in other equipment/ sports equipment/ teaching aids/
cases entire admissible expenses and other assets.
of the institution are borne by the
Government and in addition a fixed 5.  ISSUES FOR VERIFICATION
percentage of admissible expenditure
is given for contingent expenses. 5.1  On the Receipts Side

(ii) Non-recurring Grants from the a. It is always advisable to have the knowledge
Government are in respect of of the local Trust Act of the State in
which the institution is located, and to
building, furniture, library, laboratory
familiarise with the regulations of the State
and other equipment. Building grants
Government regarding incorporation,
are sanctioned to the educational
functioning, supervision and control
institutions for the purposes of of educational institutions. Thereafter,
erecting, purchasing, expanding or the basic documents evidencing the
reconstructing school buildings. The constitution of the educational institution
building grants usually constitute a i.e., the Memorandum, Rules, Trust Deed
percentage of the total expenditure. etc. must be studied.

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b. Minute book of the meetings of the Certain institutions receive donations in

managing committee/ governing body cash which are not accounted in the books
contains valuable information which enable of accounts at all.
to comprehend salient developments/
events having bearing on the accounts. g. It may be verified whether interest earned
on fixed deposits, loans and securities
c. In case the institution has its own have been accounted or not. It may also
accounting manual or instructions, these be ascertained whether interest accrued
may be examined. but not received on loans have been
d. The latest audit report along with particulars accounted or not where the institution is
of preceding 2 to 3 years may be studied following mercantile system of accounting.
to examine the observations/ qualifications In this context, bank accounts can be
made by the Auditors therein. examined on test check basis to ascertain
that interest received is being accounted
e. In serious investigation cases, the Fee
properly.
collection register and other similar record
can be examined to verify the amounts h. Amounts due on account of lease money/
receivable from students on account of- rent as per to the terms of the lease deed/
admission fee; tuition fee; library fee; rent deed entered into in respect of any
examination fee; laboratory/ science portion of the premises let out by the
fee; sports fee; fines; miscellaneous institution, may be checked. Records
charges;contribution (for funds etc..); pertaining to temporary hire/ rental of
Hostel room/ service charges;mess & other the premises of the institution, e.g., for
charges. It may be worthwhile to check functions, examinations etc.., may be
whether the amounts shown as recoverable examined to ascertain whether recoveries
in the register of fees and charges are have been made and recorded at the
based on rates applicable/ stipulated for stipulated rates.
each category of students; and whether
i. It may also be worthwhile to verify the
the names of all students on the rolls of
nature of the various grants applied for
the institution have been duly entered. It
and sanctioned in favour of the institution
may also be examined whether bills have
and whether grants-in-aid are being
been raised, at prescribed intervals in
recorded in the books of account based
respect of all the students on the rolls of
on their nature and the purposes for which
the institution.
such grants are sanctioned-particular care
f. Most of the donations are received towards being taken to segregate recurring and
corpus. Therefore, it is often necessary to nonrecurring grants and those on capital
verify whether donations received are account or otherwise.
properly recorded in separate accounts
depending on the nature of and the purpose j. Reference may also be made to the related
for which the donations/ endowments discussions in the Chapter relating to
were given, i.e. towards corpus; or for a ‘Charitable trusts and institutions’.
specific purposes, e.g., for purchase of
capital equipment, grant of scholarships, 5.2  On the Expenditure Side
awards etc..; or for general purpose, as a. The remuneration payable to various
evidenced by the communication from the functionaries may be checked with respect
donors indicating their intention/ purpose. to the terms and conditions of appointment

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to each category of staff employed by the are diverted to sister concerns without
institution. Many institutions obtain receipts charging interest.
for higher amounts from their employees f. It is also necessary to check whether security
towards salary but the actual salary paid to deposits received from the students during
them is much less. The difference amount the previous year have been accounted.
is secreted away as concealed income. Similarly, refund of security and other
If necessary, statements of some of the deposits to students, may be checked with
employees can be recorded to ascertain reference to the acknowledgments from
the true facts. them on final settlement of dues. Often,
b. It may be checked whether scholarship security deposit is not refunded to some
amounts have been disbursed to eligible or many students at the time of leaving of
students in accordance with the criteria laid the school, however, an acknowledgment
down by the institution or the terms laid in that regard is obtained from the student/
down by the donors in case scholarships parent. In cases of such an allegation, the
are out of endowments/ grants etc. mode of payment i.e., cheque or cash may
be verified and in case it is felt necessary
c. In case of residential schools, expenses
the cross verification from the student/
on purchases, food grains, provisions,
guardian may be made.
electricity, water, rent, repairs, maintenance
etc., may need verifications. Often, g. Often fixed assets are purchased at inflated
these expenses are inflated to generate prices from connected parties etc.. The
unaccounted cash. excess money charged flows back to
the management/ controlling body. In
d. The correspondence regarding sanction/
appropriate cases fixed assets may be
disbursement of various grants can be
physically examined and their type, make,
examined to ensure that expenditure
model, quality etc., may be noted down
incurred in respect of grants for specific
and the market price of similar items may
purposes, is strictly in accordance with
also be ascertained by local enquiry to
the terms and conditions stipulated. The
ascertain whether the assets have been
utilisation of grants and expenditure
purchased at inflated rates.
incurred can be checked with reference
to–the original evidence/ supporting h. Often, surplus funds of the institution are
vouchers; entries in the cash book and diverted to sister/ group concerns of the
bank statements; minutes of the managing main persons managing the institution.
committee/ governing body as regards This aspect must be borne in mind, with
sanction of expenditure; and utilisation reference to provisions of Section 13.
certificates, if any, furnished to the i. Where any loans have been granted, the
authorities concerned as per the terms of authority and terms and conditions of
the grants. such loans may be verified. It may also
e. It may be necessary to verify the terms and be seen whether recovery of the principal
conditions of loans; whether loans have and interest amount is in accordance with
been taken on proper authority or not; the stipulated terms and conditions or not,
and whether these have been Utilised for and whether there is any nexus between
the specific purposes of the educational persons controlling the institution and the
institution or not. Often, loans obtained person to whom the loan has been given.

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j. It is also necessary to verify whether any would desist from applying such income. This
expenditure (capital or revenue) has scheme of denial of charity while at the same
been incurred or any property or funds time enjoying the benefits of deduction u/s. 11
applied for objects and purposes other was finally curtailed by the Finance Act, 2017
than those contained in the Trust Deed, which inserted a provision explaining that
Memorandum/ Rules of Society etc. corpus donations made to another trust will not
be treated as application of income.
6.  OTHER RELEVANT ISSUES 6.4  Certain educational institutions which
RELEVANT FOR EDUCATIONAL derive substantial income siphon off the funds
INSTITUTIONS for private benefit of the Trustees without
6.1 Charity delayed is charity denied. The passing the transactions through the books
income-tax department acts as a major catalyst of accounts. The most common practice is by
in fostering charity and ensuring that the granting construction contracts, service contracts
beneficiaries receive the benefits as swiftly as and supply contracts to the concerns run by the
possible. It is for this reason that the provisions of Trustees or their relatives. Such contracts are
Section 11 and third proviso to Section 10(23C) marked up with huge profit per centage, which
mandates that 85% of the income received are not at arm’s length or as per prevailing
during the year has to be applied within the year, market rates. Therefore, in case the contracts are
the exceptions being Explanation 2 to Section 11 not awarded to any reputed person and more
and Section 11(2). Corpus donations received particularly if it is given to a related enterprise,
by a NPO is exempt u/s. 11(1)(d) and the NPO such transactions should be examined
need not apply 85% of corpus donation. thoroughly. Transactions with persons specified
in Section 13(3) by an educational institution is
6.2 The most common method in denying
charity to beneficiaries and accumulating large not prohibited. However, the transactions have
reserves within the NPO is executed by granting to be at arm’s-length as determined u/s. 13(2)
corpus donations to other NPOs with similar of the Act. In case of construction contracts,
objects. Donation to another NPO was treated reference have to be made to the valuation
as application of income in the hands of the cell for determining the cost of construction.
donor NPO. However, the recipient or the donee Similarly, all other contracts awarded by the
NPO has to apply 85% of such income received educational institution to such related persons
as donation within the year u/s. 11(1) or within have to be verified and any amount paid in
the next year in case of exercise of the provisions excess of the fair market value will end up in
of Explanation 2 to S.11(1)(a). denial of exemption u/s. 11 r.w.s.13(1)(c).
6.3 A major educational institution created 7 6.5  A Trust running a medical college in South
satellite trusts with similar objects. The trust had Tamilnadu was in receipt huge capitation fees
an income of ₹200 crores approximately per for admitting students and an action u/s. 132
annum. It would be applying 70–80 crores for undertaken substantiated the allegation to
running and maintenance of the educational be true. The contents of the seized material
institution. The difference between the amount revealed that the trust had given ₹17.25 crores
applied and 85% of the income was donated as donation to another trust in Kerala to seek
to these 7 satellite trusts. In order to rescind admission in MBBS stream for the daughter of
from passing on the benefit to the beneficiaries, the Managing Trustee. The medical college had
the donor trust would donate funds as corpus also taken a building on hire for a rent of ₹1 lakh
donations to the recipient. By applying the per month. However, the intriguing part was that
provisions of Section 11(1)(d), the donee the medical college had paid a rental advance of

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₹3 crores to the Managing Trustee, the owner of of benefit being conferred on persons specified
the building hired. The rental advance was 300 u/s. 13(3) excluding the situation narrated in
times the monthly rent which was exorbitant and Section 12(2), the NPO loses exemption u/s. 11
unreasonable when compared to the market for all the years of such violation and the entire
practice where the maximum advance paid is 10 income has to be taxed. In case the benefit
months rent. This was a clear violation u/s. 13(2) neither reaches the beneficiaries nor the persons
r.w.s.13(1)(c) and the entire income of the Trust specified u/s. 13(3), then such quantum of
has to be brought to tax denying exemption benefit will be ineligible for exemption u/s. 11
u/s. 11. Even the grant of donation to another to the extent of such diversion as per Section
trust was reciprocated by a private benefit to the 11(3) and the balance income would continue
Managing Trustee and the violation u/s. 13(1)(c) to enjoy exemption, as long as it complied to the
was proven on an additional count. However, provisions of Section 11.
due to lack of understanding, the Assessing 6.7 The NPO has to apply 85% of its income
Officer instead of denying deduction u/s. 11 during the year. In case of shortfall, as long as
highlighting these issues, had disallowed these it complies to the other provisions u/s. 13, the
payments as ineligible expenditure. Despite the difference between the amount applied and
establishment of fact that the Trust had received 85% of the income has to be brought to tax. The
substantial capitation fees and had also violated exceptions are provided only when the assessee
the provisions of Section 11 r.w.s.13(1)(c), resorts to postponement by a year as per
the improper appreciation of the provisions of Explanation 2 to Section 11(1) or defers it by 5
taxation governing Trusts has resulted in framing years as per Section 11(2). If the NPO invokes
a incongruous order which did not stand the test the provisions of Explanation 2 to Section 11(1),
of appeal. the income to the extent not considered for
application during the year can be postponed
6.6  It is necessary that the principles of taxation by a year only.
of NPOs are understood properly, essentially
distinguishing the methodology involved in 6.8  The provisions also provided for long term
comparison to other profit making assessees. deferral of application of income. If the NPO
The income of a profitable organisation is envisages a major and concrete expenditure,
it can postpone the application of income by
determined as per “P&L account or Income
specifying the purpose of application in Form
& Expenditure account” while that of a NPO
No. 10 after passing a resolution to such effect
is neither of these and is determined as per
and file the same alongwith the return of
“Receipts & Payments account”. Here, there
income before the 139(1) limit. The purpose of
is no distinction between capital receipt or accumulation has to be specific, confined to the
revenue receipt. Even donations are treated objects of the NPO and cannot be general in
as income u/s. 2(24)(iia). Similarly, there is nature. It has to be one amongst the multifarious
no distinction between capital expenditure or objects for which the NPO stands created. In
revenue expenditure. Either way, irrespective of case the purpose for which it is accumulated is
their nature, they are classified as “application defeated or if the period of 5 years lapses or if
of income”. The NPO does not earn any such funds are donated to another NPO, then
profit or loss. It is either “Excess of receipts the accumulated sum would become taxable in
over payments” or “Excess of payments over the year of diversion. In case of lapse, wherein,
receipts”. The application of income should only the accumulated income is not Utilised within
confer benefits to the beneficiaries, irrespective of a period of 5 years, such income has to be
caste, community, creed or religion, identified in treated as taxable income in the financial year
the deed of NPO and not to anyone else. In case succeeding the last day of the 5th financial year.

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The NPO is not allowed to roll over the same for the surplus generated from the rental activity,
a further period of 5 years and the same has to business activity incidental to the objects and
be brought to tax as such. Since the provisions of income from other sources is to be treated as
Section 11(3) empowers the Assessing Officer to income for the purposes of Section 11 and 85%
tax such non application of income, there is no thereof should be applied.
need for cancellation of registration u/s. 12AA(3). 6.11 An educational institution, apart from
6.9  In case of educational institutions approved operating a school or college, would be
u/s. 10(23C)(vi), 85% of the income has to be running various business activities viz., plying
applied failing which the difference between of transport, selling books/ uniforms, running
the amount applied and 85% of the income is mess/ canteen/ hostels etc. These businesses do
deemed to be automatically accumulated. There not impart a characteristic of commercialization
is no necessity on the part of the educational to the educational institution as long as such
institution approved u/s. 10(23C)(vi) to file Form business activity is incidental and allied to the
No.10, since such educational institution exists main activity of imparting education. However,
for a solitary object to foster education only. in such area of activity, the quantum of income
However, in case of violation to the conditions for the purpose of Section 11, is the surplus
laid down under third proviso to Section generated from such business. The expenditure
10(23C), the Assessing Officer cannot bring such to earn income by these businesses cannot be
unutilised sum to tax directly. The 13th proviso treated as application of income. The educational
to Section 10(23C) has to be invoked by the institution has to thereafter apply 85% of the
competent authority and only after the approval surplus in order to be eligible for exemption
granted u/s. 10(23C)(vi) earlier, is withdrawn, u/s. 11. This rule applies for rental income and
the Assessing Officer can bring such unutilised income from other sources as well. For example,
sum to taxation. The competent authority is if the educational institution receives a rental
either the Chief Commissioner of Income-tax or income of ₹1 crore and spends ₹40 lakhs as
expenditure towards maintenance, the income
the Commissioner of Income-tax (Exemptions)
for the purpose of Section 11 of the educational
of that region. Since prior to 15/ 11/ 2014
institution is ₹60 lakhs and 85% of ₹60 lakhs
approvals u/s. 10(23C)(vi) were granted by the
being ₹51 lakhs has to be applied. Generally,
Chief Commissioner of Income-tax, in case of
while computing the income and application of
violations reported by the Assessing Officer, the
income, assessees resort to treating ₹40 lakhs
CCIT should alone pass the order for rescinding
spent to earn the rental income as application
the approval granted earlier. In case of approvals
of income and firm up an opinion that it has
granted from 15/ 11/ 2014, the cancellation can
to further spend ₹45 lakhs to be eligible for
be undertaken by the CIT(Exemptions). exemption u/s. 11. This arithmetic is incorrect
6.10 A NPO derives income either by way of and as per the provisions of the Act in the
donations (excluding corpus donations) defined illustration provided the assessee has to spend
in Section 2(24)(iia) or derived from property ₹91 lakhs in order to establish the compliance
held under the Trust. The properties can be of to the provisions of Section 11. It is emphasized
any kind which include business held under the that this concept of computing income applies
Trust. As per Board’s circular in No. 5-P(LXX-6) only to rental receipts, business activity and
of 1968, dated 19-6-1968, expenditure to earn income from other sources and does not apply
income from properties held under Trust will not to the main charitable activity undertaken by the
be treated as application of income. It is only educational institution.

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6.12 A NPO has to maintain its funds in taken a view that receipt of capitation fees is only
modes prescribed u/s. 11(5) r.w.r.17C and any prohibited under the State legislated Capitation
discrepancies/ violations to this mandate would Fees Prohibition Act and not under the Indian
result in invoking the provisions of Section Income-tax Act. It is, therefore, suggested that
13(1)(d) resulting in complete of Section 11 in case of detection of unaccounted cash or
exemption. undisclosed entries relating to such receipts care
6.13 An educational institution is eligible for should be taken to bring the same to taxation
exemption u/s. 10(23C)(vi) only if the objects under the provisions of Section 115BBC as an
are wholly and solely educational in nature. In anonymous donation as categorising the same
respect of NPOs governed by the provisions of as Capitation fee receipt and bringing it to tax
Section 11, the objects can be multifarious. If may not stand the test of judicial scrutiny.
such multiple objects pertain to one or more of 6.17  The provisions of Section 133A has been
the 6 main limbs of charity defined u/s. 2(15), amended w.e.f. 01/ 04/ 2017 to empower the
the proviso to Section 2(15) would not come Income-tax Authorities to undertake survey
into play. However, even if one of the object in case of a “Charitable Institutions” (Not to
relates to the residual category or the last limb of confuse with Religious Institutions) which was
charity, being an object of general public utility, hitherto confined to a place of Business or
it gets classified as a GPU and hence proviso to Profession only. While undertaking investigation
Section 2(15) would automatically apply. during the course of survey or search or at the
6.14 An NPO is characterised by its objects time of post survey or post search proceedings
and not by its activity. A business undertaken by or at the time of assessment proceedings, the
the NPO would not result in invoking proviso to focus of the Assessing Officer should be directed
Section 2(15) if the property being the business to check violations, diversion of funds for private
is held under trust. The proviso to Section 2(15) purposes, etc. and not to approach in a fashion
would apply only in an event that the property by which a business undertaking is dealt. The
being business is held by the Trust. provisions of sections 10, 11, 12, 115BBC and
80G are self-contained to deny benefits and to
6.15 An educational institution eligible for
bring the receipts to tax.
deduction u/s. 11 to remain free from the clutches
of proviso to Section 2(15) should necessarily 6.18 Some other methods of tax evasion
impart formal education, unlike coaching noticed in the cases of educational institutions
institutes, training centres, institutions rendering are listed below:
seminars, lectures, etc.,which do not fall under a. Cash donations are demanded and
the main limb of charity being “Education” u/s accepted from parents at the time of
2(15) of the Act. They would however be treated admission of the child/ ward without
as Charitable under the residual category and
issuance of any receipt for the same.
enjoy exemption u/s 11, provided proviso to
sec 2(15) does not come into play, by virtue of b. Some educational institutions insist that
the quantum of business activity, being informal donation be made to a particular charitable
education. trust and receipt for a specified sum be
obtained from that trust before admission
6.16 The capitation fees are prohibited under
is granted to the child.
the law enacted by respective state governments
under the Capitation Fees Prohibition Act c. The relatives of the trustee/ author of the
and hence the NPOs would not show the trust are appointed to responsible positions
corresponding receipts in the Receipts and in the institution and given handsome
Payment Account. However, the courts have salary and perquisites not commensurate

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either with their qualifications or the work bank statements were examined and it was found
done by them. that cheques have been issued in favour of reputed
jewellers and on further investigation, it surfaced
d. Property/ building etc., belonging to the
that the investment to the extent of Rs. 45 lakhs
relatives of the trust are leased out to the
was in violation of the provisions of Section 13(1)
educational institutions. The lease rental,
(d) thereby disentitling the Educational Institution
however, charged is quite high and not
from claim of deduction u/s. 11.
reasonable as per the market rentals for
the same property. 7.1.2  During the course of scrutiny proceedings,
the Authorized Representative tried to impress
e. Expenses relating to purchase of furniture,
that the bullion was purchased to convert them
fixtures, books, stationery, computers etc.,
into gold medals and reward them to meritorious
are inflated
students. This claim was proven to be bogus
f. Salary bill is inflated by paying amounts since the bills for conversion of bullion into gold
less than the amount for which receipts are medals could not be produced. The name and
obtained from the teachers. identity of the meritorious students to whom
g. Large sums are collected from students gold medals were awarded were not submitted.
Further on verification of the subsequent years
by way of donations are lent out to sister
financials, it was found that the equivalent
concerns without adequate interest.
quantity of gold was sold.
h. The school runs ancillary services e.g. book
7.1.3  Armed with such evidences, apart from
shops, Shops for school uniform, school other discrepancies noted in the earlier years
buses, etc. on commercial basis through and continued in the year under consideration,
its nominees. Often a separate firms are the claim of deduction u/s. 11 was denied. The
created to manipulate the income that is appeal before the ITAT was decided in favour
generated from such operations. of the department. While the assessee was
i. Since it is a statutory requirement for able to obtain relief on all other issues, the act
charitable trusts to apply 75% of their of invoking the provisions of Section 13(1)
(d), since investment in gold was a prohibited
income to charitable activities, many
investment u/s. 11(5), was upheld in favour of
institutions debit bogus expenses to obtain
the Department.
exemption u/s 11.
7.2.1  An Educational Trust, running an
Engineering College was undertaking continuous
7.  CASE STUDY OF AN EDUCATIONAL
transactions similar to that of the current account
INSTITUTE AND A COACHING
with the Managing Trustee and his spouse. The
INSTITUTE
provisions of Section 13(1)(c) comes into play
7.1.1 One Trust was running an Engineering only when the Trustee’s accounts exhibit a
College and specialized in imparting Maritime debit balance in the books of the Educational
Engineering. It possessed substantial surplus Institution. The assessee Trust ensured that the
and in order to gain better returns the Managing year end values are credit balances.
Trustee had purchased gold bullion worth 7.2.2  During the course of scrutiny proceedings,
Rs. 45 lakhs during the financial year 2009–10. the copies of ledger folio of the Trustees were
Since investment in gold is a prohibited mode obtained and on verification it was found that
of investment u/s. 11(5), the Balance Sheet in the month of October, the accounts of the
disguised the investment as on 31/ 03/ 2010 to Managing Trustee exhibited a debit balance of
be “Other Deposits”. The books of accounts and Rs. 20,98,480. Since the violation resulted in

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disqualification, the assessment was concluded Educational Institutions along with land &
denying exemption u/s. 11, since the Managing building worth Rs. 37,83,27,858 were received
Trustee, a specified person u/s. 13(3)(cc) was as donation and taken to the corpus of the
conferred benefit in the form of an advance Trust. This corpus donation received in kind was
which was given without adequate security and claimed exempt u/s. 11(1)(d).
adequate interest. 7.3.2  While examining the return of income it
7.2.3  Before the Appellate Commissioner, the was found that an amount of Rs. 15.76 crores
assessee pleaded that the wife of the Managing was shown as ‘Advances for property’. On
Trustee as on the date on which the peak debit verification, it surfaced that the nomenclature
balance appears in the books of the Trust in of the outstanding being ‘advance for property’
respect of the Managing Trustee, had a credit was bogus and the amount was actually given as
balance of Rs. 2,22,74,985. The Ld. CIT(A) set loan to the Managing Trustee. The audit report
off the debit balance relating to the Managing in Form No.10B did not disclose the Related
Trustee with that of the credit balance of the Party Transactions. In order to camouflage
spouse of the Managing Trustee and found that the transaction as a property advance, an
the consolidated value, being a credit balance unregistered deed of agreement was produced
does not result in disentitlement of deduction u/s. expressing that the Trust intended to buy a
11. The ITAT, however, after proper appreciation property owned by the Managing Trustee for a
of the facts, held that the transactions have to consideration of Rs. 20 crores and an advance
be viewed individually as a person and not of Rs. 15.76 crores was paid to the Managing
collectively. The debit balance standing in the Trustee. On further verifications it transpired
name of the Managing Trustee in the books of that the property intended to be sold by the
the Trust, in the month of October was, therefore, Managing Trustee to the Trust was purchased by
held to be a violation u/s. 13(1)(c) and the him at a cost of Rs. 3 crores and within a span of
Assessing Officer’s action to deny exemption u/s. 15 months, the Managing Trustee was selling it
11 was upheld. to the Trust at a price of Rs. 20 crores. Therefore,
the transactions were not found at arm’s length
7.2.4 The Assessing Officers while verifying
and the genuineness of the agreement remained
the transactions between the NPO and that
unsubstantiated. It was submitted by the
of the persons specified u/s. 13(3) should not
assessee that the agreement ultimately did not
confine themselves to the Balance Sheet figures. fructify. It was found that the Managing Trustee
The copies of the ledger folios of the specified on cancellation of the agreement did not return
persons as appearing in the books of the NPO the entire sum immediately but the funds were
has to be examined and even in a case of minor refunded to the Trust in the subsequent years in
violation, should result in denial of exemption piece meal. It was also found that the advance
u/s. 11. Proviso to 13(2)(g) provides that the given was without adequate security or adequate
provisions of Section 13(1)(c) will come into interest. Since the transactions between the Trust
play when the value of the property diverted to and its Managing Trustee resulted in conferring
persons specified u/s. 13(3) exceeds Rs. 1000. undue benefit to a specified person, the provisions
7.3.1  A Trust was running a group of of sec.13(1)(c) became operational. Further, the
Educational Institutions. The Trust was initially amount of Rs. 15.76 crores was invested in a
managed by members from two families. The mode which violated the provisions of sec.13(1)
Trust was thereafter bifurcated and members (d). Therefore, exemption u/s. 11 was denied.
of one family took complete control over the 7.3.3 It was also found that the amount of
affairs of the Trust. Due to certain arrangement, Rs. 15,76,00,000 was lent to the Founder

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and Managing Trustee without charging any purposes out of the contributions
interest. On the contrary, the Trust had paid an but the entire contributions received
interest of Rs. 2,10,68,997 on a term loan of Rs. by the fund became taxable in the
28,14,19,366 obtained from various banks. By hands of the fund and the fund has
the diversion of funds to the interested persons been assessed to tax on an income
free of interest, the Trust is overburdened with of ₹ 5,03,380 for the assessment year
interest costs. The value of benefit passed on 1971–72 and on ₹ 7,91,770 for the
to the interested person was worked out at Rs. assessment year 1972–73. If only
38,74,151 @10% being the rate of interest paid the voluntary contributions had been
by banks on deposits. Utilised strictly for charitable purposes
for which they were intended, the
7.3.4 The corpus fund of Rs. 37,83,27,858 Welfare Fund would not have been
was received by the assessee during the year, liable to pay any tax. By reason of the
in the form of donation of assets from 2 other misapplication of a portion of the fund,
Charitable Trusts. This receipt under the normal a heavy tax liability has been imposed
circumstances was eligible for exemption upon the fund. We hope and trust that,
u/s. 11(1)(d). But, it was held that the assessee in future at least, care is taken to see
was ineligible for exemption u/s. 11 due to that the contributions to the fund are
violations of provisions of Sections 13(1)(c) and strictly applied for the purposes for
13(1)(d). When Section 11 becomes inoperative, which they are intended and the fund
any income of the Trust becomes taxable and is not put to the necessity of paying
such income includes the corpus donation which any tax on such contributions.”
is otherwise exempt u/s 11(1)(d). Therefore, the
assessee was not found eligible for exemption of 7.4.1  A charitable Trust was running an
Rs. 37,83,27,858 being the donation received educational institution enjoying the benefit of
u/s. 11(1)(d). sec.10(23C)(vi) based on the approval granted
by the CCIT. On verification of the return of
7.3.5 A question arises, what would be the income for the AY 2011–12, it surfaced that
quantum of income that needs to be brought an amount of Rs. 172 crores was held as Fixed
to tax, by such violations. This issue has been Deposits. The income of the Trust through the
answered by the High Court of Andhra Pradesh years was hovering around Rs. 20 crores to Rs.
in the case of Chairman, Andhra Pradesh 30 crores per annum and a surplus of Rs. 172
Welfare Board vs. CIT reported in 12 Taxmann crores held as fixed deposit amply indicated
242 (AP). It held that: that the Trust was not applying its income in
“….where a Public Welfare Fund, accordance to the third proviso of sec.10(23C)
which has been constituted for the of the Act.
purpose of utilising the funds collected 7.4.2  On enquiry it was found that the assessee
for the welfare of the people in different had been accumulating unutilised income
spheres, has been made to pay tax on through the years without applying the same
the voluntary contributions received by subsequently. Based on the evidences gathered
it because the persons concerned with during the source of such enquiry, it was
the administering of the fund Utilised established that the Trust was habitual in its failure
a small part of the fund for extraneous to apply income. In all the years starting from
purposes not connected with the AY 1999–2000, the assessee Trust had applied
objects and purposes of the fund. The around 30% of its income in the respective years
result is that not only that small portion and the balance was automatically accumulated
of the fund which was Utilised for such as per third proviso to sec.10(23C).

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7.4.3  The same proviso also envisages that such concluded in all the years starting from AY
accumulated sums has to be applied within a 2006–07 wherein the benefit of exemption u/s.
period of 5 years (10 years till AY 2001–02) from 11(2) was denied. The total income brought to
the end of the relevant Financial year. However, tax through the years exceeded Rs. 150 crores.
the enquiry revealed that such accumulations The petition seeking waiver of interest u/s. 234A/
were never Utilised in future within the stipulated B/C was rejected by the Board.
period or even after the lapse of 5 yeaRs. 7.5.1  A Trust was running multiple schools at
The assessee had been consistently failing to various places. The objects of the Trust were
comply to third proviso to sec.10(23C) and directed at running of schools and also operating
based on the enquiry report the CCIT withdrew and maintenance of a Marriage Hall. In the
the approval earlier granted u/s. 10(23C)(vi) course of scrutiny proceedings it was found
w.e.f. AY 2003–04. that the rental income of the Marriage Hall
7.4.4  The assessments for all the years from AY was bifurcated into two portions. A sum of Rs.
2006–07 were reopened. Since the approval u/s. 20,000 was received as rent per day and the
10(23C)(vi) no longer subsisted, the assessee Trust billed Rs. 5,000 as rent and the balance Rs.
filed returns of income making an alternate 15,000 as corpus donation. The bifurcation was
claim of exemption u/s.11. The accumulations undertaken with a specific purpose to ensure that
were claimed exempt u/s.11(2). On verification the quantum of receipts in the nature of business
of the financials and the accounts, it was found does not exceed Rs. 10 lakhs which otherwise
that in certain years, advance was paid towards would result in invoking proviso to sec.2(15).
purchase of property, which was treated as 7.5.2 The assessee contended that running
application of income. Further, in the year of the educational institutions was its primary
when such advances for purchase of property objective and operations of Marriage Hall was
culminated in acquisition of a capital asset, the incidental and only helped in feeding the charity
entry in the fixed asset schedule of the Balance being education. The contentions of the assessee
Sheet was also treated as application of income. had to be rejected since the business of running
Thus there was duplicate claim of application of the Marriage Hall was, as per the objects of the
income once in the form of advance and again at Trust, a principal purpose. The Marriage Hall
the time of acquisition, which had to be rejected.
was created by the Trust out of its own funds
7.4.5  Since the approval u/s. 10(23C)(vi) was and, therefore, the property being the business
rescinded, the assessee was found ineligible of running the Marriage Hall was not ‘held under
for exemption. The alternate claim u/s. 11 Trust’ but ‘held by the Trust’. Since, one of the
was extended since the Trust was registered objectives was an object of general public utility,
u/s. 12A(a). However, the benefit claimed u/s. the Trust was found to get categorized in the last
11(2) was denied since the Form No.10 filed and residual category of charitable purpose and
did not specify the purpose of accumulation. did not belong to the main limbs of charity u/s.
The request for condonation of delay in filing 2(15). Further, the corpus donations were found
Form No.10 u/s. 119(2)(b) was also rejected and irretrievably attached to the renting of marriage
the surplus for the respective years being the hall. In order to be eligible for exemption
difference between the unutilised or unapplied u/s. 11(1)(d), the donation has to be ‘voluntary’
income and 15% of the income was brought to in nature. Since the receipt of Rs. 15,000 per
tax. The accumulated surplus of the preceding day was reciprocated by letting of marriage hall,
years which remained unutilised subsequently the voluntary nature got lost and therefore, the
within the stipulated period was brought to tax entire sum of Rs. 20,000 was treated as income
u/s. 11(3)(c). The assessments were therefore derived from the property of the Trust. Since

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the quantum of total receipts exceeded Rs. 10 8. Thus, if a property is held under
lakhs, the proviso to sec.2(15) r.w.s. 13(8) was trust, and such property is a business,
invoked thereby denying complete deduction the case would fall u/s. 11(4) and not
u/s. 11. The assessee’s appeal was allowed by u/s. 11(4A) of the Act. Section 11(4A)
the CIT(A) on a finding that the operations of of the Act would apply only to a case
the marriage hall was incidental to the charitable where the business is not held under
activity of the Trust. However, the ITAT upheld trust. Thus, there is difference between
the position as taken by the Assessing Officer on property or business held under trust
all counts and held as under: and business carried on by or on
behalf of the trust.
“6. We have heard both the parties
and perused the material on record. 9. This distinction was recognized
The issue before us is whether, on the by the Supreme Court in the case
facts and circumstances of the case and of Addl. CIT vs. Surat Art Silk Cloth
having regard to the terms of the Trust Manufacturers Association (1980) 121
Deed, it can be said that the activities ITR 1 wherein it was observed that if
carried on by the assessee in the form a business undertaking is held under
of running of community hall, viz. “CK trust for a charitable purpose, the
Marriage Halll” was itself held under income there from would be entitled
the Trust. For this purpose, it is proper to the exemption u/s. 11(1) of the Act.
to go through the objects for which In the present case, the finding of the
assessee-Trust is formed. The objects CIT(A) is that running of community
for which the Trust established are Hall was incidental to the object of the
enumerated in Trust Deed in Clause-5. trust, it was not business commenced/
carried on by the assessee. Though
The Objects of the Trust are:
the business was commenced by the
a. ………. trust and it was carried on by the Trust
g. To construct a community hall for after its formation, it cannot be said to
letting out to all peoples irrespective of constitute property held under trust.
casts, creed or religion for a nominal u/s. 11(4), it is only the business which
rent without making any point. is held under the trust that would enjoy
exemption in respect of its income
7. It is to be noted that Section 11(1) u/s. 11(1) of the I.T. Act and there is
of the Act grants exemption to the a distinction between the objects of
income derived from property held a trust and the powers given to the
under trust wholly for charitable trustees to effectuate the purpose of
or religious purposes, to the extent the trust. Though the objects of the
to which such income is applied to trust were charitable, they were mere
such purposes in India. There is no powers conferred upon the trustees to
exhaustive definition of the words carry on the business and the profits
“property held under trust” in the Act; from such business would benefit the
however, sub-section (4) says that for charitable objects. The exemption u/s.
the purposes of Section 11, the words 11 cannot be granted on the reason that
“Property held under trust” “includes the business itself was not in existence
a business undertaking so held”. at the time of formation of the trust
……….. and the property held under trust at

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Techniques of Investigation for Assessment Vol. 3

the time of formation of the trust was incidental to the attainment of the
not spelt out in the Trust Deed of the objects of the trust. We fail to see
assessee. The running of “ Community any connection between the activities
Hall” was not at all in existence at the relating to running of “Community
time of formation of the trust so as to Hall” was carried on and the attainment
say that the business is property held of the objects of the trust. The mere
under trust. Thus, the activities relating fact that whole or some part of the
to running of “Community Hall” was income from running of “Community
not even in the contemplation of the Hall” is used for charitable purposes
Trust Deed on the basis of which the would not render the business itself
Society is formed and, therefore, could being considered as incidental to the
not have been settled upon trust. The attainment of the objects. We are in
business carried on behalf of a trust agreement with the Department that
rather indicates a business which is not the application of income generated
held in trust, than a business of the trust by the business is not relevant
run by the assessee. In this case, the consideration and what is relevant is
activities viz., running of community whether the activity is so inextricably
hall, was carried on by the assessee for connected or linked with the objects of
and on behalf of the trust and it was the trust that it could be considered as
not business held under trust. Section incidental to those objectives.
11(1) of the Act confers exemption 11. It was contended by the Ld. AR
from tax only where the property is that the surplus funds generated
itself held under trust or other legal from the running of “Community
obligation; it does not apply to cases Hall” was spent towards charitable
where a trust or legal obligation is not activities and therefore, the assessee
created on any property but only the is entitled for exemption u/s. 11(4) of
income derived for a charitable or the I.T. Act. We are unable to accept
religious purpose. Surplus funds of a this contention. Initially, the assessee
trust, which was claimed to be exempt carried on the business itself which is
on the footing that it was property held not at all property held under trust.
under trust within the meaning of sec. This activity is a business activity and
11(1) of the Act, was not property the provisions of Section 11(4A) of the
held under trust since the property Act is applicable.
from which the surplus was generated
12. It was contended that if the profits
was itself not held under trust. In other
of the business carried on by the trust
words, merely carrying on business for
are Utilised by the trust for the purposes
and on behalf of the trust and applying
of achieving the objectives of the trust,
the profits of the same for the object of
then the business should be considered
the trust does not entitle for exemption
to be incidental to the attainment of
u/s. 11(4) of the Act unless the business
the objects of the trust as observed
is incidental to the attainment of the
by the Supreme Court in the case of
objects of the trust.
ACIT vs. Thanthi Trust (2001) 247 ITR
10. We now proceed to consider the 785 which is as under: “As it stands, all
question whether the said activities that it requires for the business income
carried on by the assessee were of a trust or institution to be exempt is

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that the business should be incidental and to create an awareness of self-

to the attainment of objectives of the reliance among the members of the
trust or institution. A business whose public etc. We are therefore, of the
income is Utilised by the trust or the opinion that the observations of the
institution for the purposes of achieving Supreme Court must be understood
the objectives of the trust ………..In and appreciated in the background of
any event, if there be any ambiguity in the fact in that case and should not be
the language employed, the provision extended indiscriminately to all cases.
must be construed in a manner that Being so, we are inclined to hold that
benefits the assessee”. the assessee is not entitled for any
exemption u/s. 11 of the I.T. Act.
13. Prima facie the above observation
would appear to support the assessee’s 15. In this case, it is brought on record
case in the sense that even if running by the AO that the assessee collected
of “Community Hall” is held not to ₹11,28,000 as corpus donation from
constitute a business held under trust, 93 persons who performed functions
but only as a business carried on by at “CK Marriage Hall”. In addition to
or on behalf of the trust, so long as this, ₹4,70,000 was rent for utilizing
the profits generated by it are applied the facilities of “CK Marriage Hall”
for the charitable objects of the trust, by 53 persons, totaling is ₹15,98,000.
the condition imposed u/s. 11(4A) of As against this, in guise of corpus
the Act should be held to be satisfied, donation collected ₹11,28,000 from
entitling the trust to the tax exemption. the persons, who have performed the
functions in the “CK Marriage Hall”.
14. In our opinion, these observations That amount of ₹11,28,000 cannot
have to be understood in the light of the be considered as corpus donation
facts before the Supreme Court in the instead it should be a rental income.
case of Thanthi Trust (supra), wherein On enquiry by assessing officer, it was
the trust carried on the business of a proved that the persons who paid rent
newspaper and that business itself of community hall and who paid the
was held under trust. The charitable corpus donation were same. This is an
object of the trust was the imparting act of quid pro for hiring the hall and
of education which falls u/s. 2(15) no question of voluntary contribution
of the Act. The newspaper business in this payment. It is also to be noted
was incidental to the attainment of that the dates exhibited in both cases
the object of the trust, namely that of were same. Being so, the provisions
imparting education and the profits of of sec.2(15) of the Act is squarely
the newspaper business are Utilised applicable as total receipts of rent
by the trust for achieving the object from community hall exceeds ₹10
of imparting education. In this case, lakhs, and we do not find any infirmity
there is no such nexus between the in the order of AO in rejecting the
activities carried on and the objects claim of exemption u/s. 11 of the Act.
of the assessee that can constitute an Accordingly, the order of Ld.CIT(A)
activity incidental to the attainment of is reversed and the order of AO
the objects, namely, to promote cause is restored.
of charity, mission activities, welfare,
employment, diffusion of useful 16. In the result, the appeal of Revenue
knowledge, upliftment and education is allowed.”

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7.6.1 M Society was created with a purpose it had nevertheless categorized the purpose of
to create awareness on various topics to the charity to be of “General Public Utility “and not
public. It claimed u/s. 11 on the pretext that its “Educational purpose”. It held as under:
activity belongs to the main limb of charity being “The assessee was a society of
‘education’. It was found that the objects of the Chartered Accounts registered under
Society amongst various objects included a few Societies Act, its predominant object
objects which was claimed as educational, which being dissemination of knowledge
were as under: and education of commercial and tax
a. To stimulate thought and efforts towards laws for the benefit of general public
the promotion and development of the and to hold seminars etc., for the
management education movement in purpose. The facts of such seminars
India more particularly in South India etc., were available to public at
through lectures, conferences seminars large. In the situation of explosion in
and other media. population, the vast changes brought
by the scientific technology and other
b. To make available the benefits of its
developments, more particularly, the
management educational activities and
universal concept of globalisation,
facilities to the public at large, without
new trends in the world order to
restricting the same only to the Members
meet the ever growing challenges to
of the Association.
organising seminars, conferences and
c. To publish journals, newsletters, and such workshops to educate the people of
other publications on developments and commercial laws, tax laws, auditing,
trends in Management Education. accounting, direct and indirect taxes
d. To maintain liaison with all organisations are of great general public utility, at
interested in Management Education least to a Section of people falling in
such as Trade Associations, Chambers the category of charitable institution. “
of Commerce, All India Management 7.6.3 The scheme deployed by the assessee
Association (AIMA), and its Regional was not found to be for charitable purpose
Councils, local management associations with the object of “Education” since it did
and similar professional bodies. not conduct any formal educational courses,
7.6.2  The sense in which the word ‘education’ nor was it affiliated to or registered with any
has been used in Section 2(15) is the systematic authority. The Delhi High court in the case of
instruction, schooling or training given to the DIT vs. The Institute of Chartered Accountants
young in preparation for the work of life. It of India, reported in 347 ITR 86 found ICAI to
also connotes the whole course of scholastic have always been an institution set up, inter
instruction which a person has received. The alia, for imparting formal education and for
issue with regard to the procedure employed in testing proficiency for entry to the profession of
dissemination of knowledge through Lectures, chartered accountants. The Institute imparted
Seminars and Workshops conducted by the formal education in accountancy and connected
Association was found to be dealt by the High subjects in an organized and systematic manner.
Court of Rajasthan in the case of CIT V. Jodhpur The Institute was accountable as per the
Chartered Accountants Society reported in 258 provisions of the Act establishing it and also had
ITR 548. Though the High Court had decided disciplinary control over the students who were
the issue in favour of the assessee and against the required to be registered with it in the first place
revenue, and held the Society to be “charitable”, and who appeared at the exams being held by

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the institute. Hence, the example of the Institute any trade, commerce or business, for a
of Chartered Accountants of India was not cess or fee or any other consideration,
apposite and the assessee was not at all found irrespective of the nature of use or
comparable to the said Institute. application, or retention, of the income
from such activity.”
7.6.4 The Association had thrived towards
achieving the principal object to simulate thought Therefore, the transactions squarely fall under
and efforts towards efficiency in management the ambit of the proviso to Sec.2(15).
through lectures, seminars, conferences and
7.6.6 Since the proviso to Section 2(15) got
other media. The activities and the source of
invoked, the provisions of Section 11 & 12
revenue was only by its activity of conducting
become inoperative. The entire earnings were
workshops, talks, certificate courses, industrial
held as income of the society. While the revenue
visits, personality development, convention,
expenditure corresponding to such income
video conferences, corporate training programs
earning activity was allowed, the expenses of
to improve skills etc. None of these activities
capital nature and expenditure not connected
undertaken comprised any of the three indices
to the income earning activity were not eligible
(formal education, accountability and control)
to be allowed as deduction. Therefore, the
as described above. Hence it was not held to
exemption u/s. 11 was denied. Further, Section
be an educational institution. However, the
13(8) prohibits applicability of Section 11 & 12
assessee society was found to be a charitable
in respect of any income of the society and is not
organisation with the charitable purpose being
restricted to the business activity of the Society.
the “Object of General Public Utility’.
Therefore, the surplus derived by the Society
7.6.5  The sums received by the society were the was entirely brought to taxation.
fees charged from the participants. The concept
7.7.1 A group of 7 firms were running
of charity is essentially pivoted to “voluntary”
coaching classes providing specialised coaching
nature in the receipts and not to those resulting
to students of 9th to 12th standard, besides
in reciprocation. The TDS certificates issued
vocational courses. It was not running a proper
by the participants or the institutions which
school but providing extra tuition classes to
engaged the services of the Society uniformly
the students studying in regular schools. It was
categorized the nature of payment to be towards
observed that though the number of students in
“Fees for Professional/ Technical services”.
The list of events, major & minor organized this coaching institute was very high, the income
by the Association and the description of the returned by the institution was meager. A survey
programme, signified that the services rendered u/s 133A was conducted and the books of
were in the nature of business. It was found that accounts of various firms were found available
the transactions were under the ambit of the in the form of computer print outs/ bound
proviso to Sec.2(15) of the Act, which stipulated red books, which showed nominal incomes.
as under: However, the transactions for the current year
were found recorded in rough exercise books in
“Provided that the advancement of the nature of cash book and ledger for each firm,
any other object of general public but these were not regular books of accounts.
utility shall not be a charitable A number of items in these rough cash book
purpose, if it involves the carrying on were not ledgerised. Although, the total of cash
of any activity in the nature of trade, balances of all the concerns as per these rough
commerce or business, or any activity cash books came to more than Rs. 1.19 Crores,
of rendering any service in relation to the cash available at the business premises, was

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a nominal amount. There was absolutely no after the completion of the year, the assessees
explanation as to why such huge cash would were replacing the fee receipt registers prepared
be kept as cash on hand, despite the fact that during the course of the year, by totally different
all the firms were operating their bank accounts fee receipt registers where the gross fee receipts
regularly. It was stated by one of the partners that were suppressed considerably. It was found
cash was lying partly at residence and partly in that these fee receipt registers meant for being
bank lockers. Further, as per these rough books produced before the department, were prepared
of accounts, the total profits of all the firms till at a stretch. Examination showed that the receipt
the date of action worked out to more than Rs. numbers issued to the students of the same
1.16 Crores, whereas the profits disclosed by concern were not always sequential. This gave
all the firms during all the preceding years put the clue that though the students might have been
together, was not even one tenth of this. The issued genuine fee receipts at the time of actual
advance tax payments for the current year were receipt of fees, the picture presented before the
very nominal, and as per these the total income department would be a make-believes picture
of all the firms put together the group would not created with the help of fabricated fee receipts
be more than Rs. 2 to 3 lac. registers, prepared at will after the close of the
accounting period. Names and addresses of some
7.7.2 The only conclusion, therefore, was
students were obtained and their statements
that the rough exercise books showed the real
recorded, and the fee receipts produced by them
incomes of these firms, but these were not meant
were compared with the figure of fees payment
to be disclosed to the department. It emerged
shown in the register. It turned out that there was
that the assessee group had been concealing
suppression of fees ranging between Rs. 800
its income during past assessment years by
to Rs. 6000/- per student. During the course of
rewriting the books of accounts and fee registers
search cash totaling Rs. 1.19 crores stashed away
after the close of the relevant financial years. It
in bank lockers, and cupboards at the residence,
also became clear that during the currency of
was found.
the FY these firms maintained regular accounts
but these were not meant to be disclosed to the 7.7.3  The other modus for concealing income
department. Therefore, the survey was converted adopted by the assessee was that the teachers
into a search. It finally emerged that, the were paid a salary lower than the figure debited
assessees were suppressing receipts by replacing in the books of accounts. Statements of some of
the rough books of accounts maintained during the teachers were recorded to establish this part
the course of the year, with rewritten “proper” of concealment. In fact, it came to light that one
books of accounts, prepared after the close of of the teachers was providing honorary service
the year. The disclosed Gross Profit rates varied and was charging no remuneration at all from
from 11.9% to 35.3%. However, the gross the assessee. However, the assessee had debited
profit rates as per books found varied from 70% a salary of around Rs. 25,000/- per month in the
to 82.58%. It was later found on enquiry that name of this teacher also.

268
 INDEX
Account,
Manufacturing, 13
Production, 13
— Monthly, 12
Vessel Voyage Collection, 170
Vessel Voyage Disbursement, 170
Agent,
Custom House, 188
Clearing & Forwarding, 187–88
General Sales, 223–24
Ahmedabad Textile Industrial Research
Association (ATIRA), 26, 55
American Blood Grade System, 71 Blow Room, 27, 29
Ancillarisation, 113 Boiler
Animal Fibre, 62, 69 Efficiency, 126
Apparel Export Promotion Council, 64 Plant Capacity, 126
Assembly, Bonded Goods, 154
Brake, 114 Book,
Handle, 114 Day, 26, 198
Pedal, 114 Lot, 84
Output, 33, 35
Ballast, 141, 154, 156, 158, 164 Pick Production, 33
Basic Travel Quota (BTQ), 227 Receipt, 81–82, 194, 198
Beat Up, 33 BTRA, 55
Begin to Generate, 126–27 Bulkheads, 154
Bill, Bunker Tank, 154
of Entry, 141–42, 144, 148–50, 177, 188 Bureau of Indian Standards (BIS), 94, 98
of Material (BOM), 20, 112
Octroi, 13 CAI Trader Mobile App, 44
of Sale, 141–42, 154, 156–57 Capacity,
Billing & Settlement Plane (BSP), 223–24 Installed, 14
Bilti, 168 Licensed, 14
Binolas, 24 Registered, 14
Birth and Deaths Register, 198 Carbon Credits, 126, 131, 133
Blending, 63, 81, 83 Cardboard, Corrugated, 91

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Carding, 28, 38, 47, 73–74, 81 Cotton Association of India (CAI), 32, 44,
Spinning & Reeling, 83 149, 266
Cash Cartage, 171 Cotton, Pressing, 24
Central Electricity Regulatory Commission Count, 27–30, 35, 62–64, 81, 84
(CERC), 118 120, 124–25, 138 Cups and Necks, 64
Central Silk Board, 46
Central Wool Development Board, 75, 78 Defect, 46
Certificate, Description, 82
Engineer, 48 Design, 82
Deviation Settlement Mechanism (DSM), 123
IWTO Combined, 75–76,
Direct Port Delivery (DPD), 178
LDT, 141–43, 149, 152, 156, 159
Directorate General of Central Excise
Master, 181
Intelligence (DGCEI), 222
Physical Delivery, 141–42, 150, 162
DISCOMS, 122–25
Certified Emission Reduction (CER), 131
Draft Bill of Lading, 177
C-Form, 10
Draught/ Draft, 154
Chain Wheel and Crank, 114
Challan, Drawing, 20, 29, 32, 38, 60, 74, 115, 175,
210–11, 252
Delivery, 11, 13
Dyeing, 34–37, 43, 50–51, 62–63, 67, 69,
Lorry, 167
74–75, 78, 80–83, 85
Charge,
Internal Haulage, 183–84 ECR (Emigration Check Required), 226
Rig Haulage, 184 Educational Institutions, 249
Terminal Handling, 170 Engineering, Procurement, and Construction
Testing and Development, 106 (EPC), 64–65, 126, 136
Understatement of Processing, 56 Enterprise Resource Planning (ERP), 18–22, 53
Chief Inspector, Written Notice to, 8 E-way Bill Number (EBN), 148, 167
Classification, 2–4, 6, 47, 60, 71–72, 154,
162, 175, 177, 192 Fees,
Combing, 28, 63, 74–78 Basic Training, 207
Units, 69, 74, 78 Capitation, 255–56, 258
Commodity by Commodity Matrix, 76 Flue Gas De-Sulphurization (FGD), 129–30
Company, Section 8, 248–49 Equipment, 130
Completely Knocked Down, 107, 110 Food Safety Standards Authority of India
Consignment Note, 167 (FSSAI), 94
Consultants, Hospital, 193 Forms,
Consumption, Standard, 34 GR and PP, 64
Container Detention Charge (CDC), 170 Guest’s Registration, 214
Container Freight Stations (CFS), 171, 176– Frame and Fork, 114–15
78, 186 Gate Pass Slip, 13
Contract, General Public Utility, 232, 244, 251, 258,
Book, 30, 84
262, 266–67
Lorry Hire, 167, 169
Ginning, 23–26, 38, 42–43, 59
for Service, 210
Turnkey, 126, 136 Roller, 24, 26
Controller of Import and Export, 45 Saw, 24, 26

270
Goods Inward Note (GIN), 20 Kitchen Order Ticket (KOT), 217
Goods Receipt Note (GRN), 20 Knitting, 29, 35–36, 44, 59–62, 64, 66–67, 69
Goods Receipts-cum-Inspection Note (GRIN), 20 Circular Machines, 35, 61–62, 66
Goods Vehicle Record, 168 Knitwear Sector, 60
Grant-in-aid, 247 Knot, 64, 73, 79–80, 83, 154
Green Plot, 149
Green Tags, 121, 128
Laid-Up, 141
Gross Calorific Value (GCV), 126 ship, 154
Laminated Tubes, 91–92
Handloom Export Promotion Council Let Export Order (LEO), 177
(HEPC), 39 Letter of Credit (L/C), 140–41, 149, 155, 158
Hank, 27, 62, 71, 81 Lien, 141, 154
Income, Application of, 234, 238–39, 241, Liners, 140, 175
255–57, 262, 264 Light Displacement Tonnage, 154
Independent Power Producers (IPP), 122, Loads, Less than Container, 178
128 Logistics, End-to-End, 172
Index, Loss,
Baltic Clean and Dirty Tanker, 175 Burning, 15
Baltic Dry, 175 Hooking, 83
Baltic Freight, 175 Transmission and Distribution (T&D), 126,
Indian Medical Council (Professional 133–34
Conduct, Etiquette and Ethics) Regulations
2002, 194, 202 Machines, Jacquard, 62
Inland Container Depots (ICD), 170, 186, Maritime Lien, 154, 156
188 Market,
Inland Haulage Charges (IHC), 170, 183–84, Information Network, 78
188 Mass Operators, 225
Insurance, Hull, 154 Material Requisition (MR), 20
Interbrand, 111 Mills, Composite, 69
Interest, Usance, 147, 159 Mixing, 27–28, 38, 47
International Air Transport Association (IATA),
223–24 NITRA, 55
International Maritime Organisation (IMO), Non-Profit Organization (NPO), 248, 250–51,
163, 175 255–58, 260
International Wool Textile Organisation Norms, Input-output, 64, 76, 115
(IWTO), 75–76 Notes, Bought, 25–26
Ishikawajima, 136 Notice of Readiness, 141, 157
IWTO Schlumberger Dry (Top & Noil Yield), 76
Occupancy, 216
Jhamba, 24 Oiling, 81, 83
Jockeys, 207–08
Package Holidays, 225
Kapas, 23–26 Packaging
Khadi and Village Industries Commission, 46 Flexible, 89–90, 92, 94, 96
Khanga, 59 Glass, 90
Kitange, 59 Metal, 90

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 Paper, 90, 93 Marketable Securities to Total Asset, 101–02
Peripherals, 92 Raw Material Consumed to Turnover, 104
Polymer, 90, 93 Risk Analysis through, Analysis and Setting
Primary, 90–91 Bench Marks, 101
Rigid, 90 Receipts, Aggregate Annual, 249
Secondary, 90–91 Reeling, 81, 86
Shrink Film, 92 Register,
Tertiary, 90–91 Admission, 198
Payment, of Adult Workers, 8
of Tax on Reverse Charge, 11 Attendance, 8
Vouchers, 20 Employee, 8
Picking, 33, 184 Excise, 35, 215
Fee Collection, 253
Plant Load Factor (PLF), 120, 122, 126
Inward, 13–14
Plastics, 89–91, 93, 96
Kanta, 33, 35
Port,
of Goods Produced, 7
of Discharge (POD), 177 Leave Account of Employees, 8
of Lading (POL), 177 Leave with Wages, 8
of Origin (POO), 177 of Loan, 8
Side, 154 Occupancy, 214–15
Power Purchase Agreement (PPA), 119, 122, OT, 196
138 Purchase, 13, 27, 77, 224
POY, 49 Recoveries, 8
Production, of Rest Days, 8
Capacity Utilised, 14 Sizing, 33, 35
Cycle, 14 Stock, 13–14, 26, 52, 77, 85–86, 98, 171,
Protector of Emigration Services (POE), 226, 215, 217
229 Wage, 8–9
Purchase, Waste, 33, 35
Order, 20 Report,
Requisition, 20 Closure, 215
Suspense, 84 Daily Market, 25
Purpose, Charitable, 218, 231–34, 239–40, of the Night Auditors, 215
261–64, 266–67 Spinning Master’s Daily Production, 86
Returns, Periodic, 8, 257
Qua Institution, 249 Ring Frames, 29
Qua Person, 249 Rummaging, 154
Qualifying Ship, 178–79
Quality, 46, 82 Scheme, Import Replenishment, 88
Scouring, 73–74, 77–78, 81, 83, 85
Racing Guide, 207 Seconds, 46
Ratio, Seeds Fibre, 62
Consumption-Yield, 76, 77 Services, Shared Cost, 106
Depreciation to Fixed Asset, 103 Setup, 59, 91, 101, 126–28, 131, 200
Inventory Turnover, 101 Shedding, 33, 124

272
Shipping Instructions (SI), 177 Units,
Shortage, Completely Built, 107, 110
and Elongation, 53 Knitwear and Woven Garments, 69
and wastage, 14, 83 Machine-Made Carpets Manufacturing, 69
Size, 82
SITRA, 55
Vahan.nic.in, 169
Slip of Measurement/ Weighment, 13 Value, Percentage of Cup, 207
Slot Chartering, 184 Verified Gross Mass (VGM), 176–77
Societies Registration Act of 1860, 247 Viscose, 27, 49, 58, 62–63, 66, 75
Society of Indian Automobile Manufacturers Warp,
(SIAM), 99 Knit Fabrics, 60
SOP of the Process House, 53 Knitting, 61
Sounding, 140, 142, 144
and weft, 42
Speed Frames, 29
Wastage Pattern, 14
Spindleage, 58
Weaving, 25, 32–34, 39, 41–42, 44, 49, 57,
Spinning, 25, 27, 29–31, 33–35, 38, 41–42,
77, 80, 82–83
46, 49, 62–64, 74, 77, 81, 85–86, 246
Weft, Knit Fabrics, 60
Count, 71–72
Wet Bulk, 175
Units, Worsted and Non-Worsted, 69
Starboard Side, 154 Willowing, 80–81, 83, 85
Stock Statement, 6, 16, 26, 67, 77, 143, 145, Wool Development Board, 46
150, 159 Wool Testing Authority, 75–76, 80
Stores, Wool & Woollen Export Promotion Council,
Consumed, 30–32, 86 78–88
Consumption Account, 85 Wool,
Super Specialists, 193 Grading of, 71
Greasy, 58, 63, 72–73, 75–78
Table, Input-Output, 76
Tally, 14, 17–19, 26, 34–35, 65, 143, 174 Woven Sacks, 92
Tax, Yarn Equivalent Factor (YEF), 46
Liability, Total, 104 Yarn,
Payments, Advance, 104
Actual Consumed, 34
Tonnage Scheme, 178–80
Temporary Sheds, 51 Count, 28, 63
Textile Committee of Inspection, 87–88 Shoddy, 73
Textile Upgradation Fund (TUF), 51 Synthetic and Man-made Fibre, 47
Tradable Renewable Energy Credits (TRC), Woollen, 74, 62–64, 70–71, 73–74, 76, 78
121, 182 Worsted, 73–74
Trim and Stability Booklet, 141–142
Trip Account Sheet, 168, 174 Zaffery, 80, 83, 85

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