Why Internal Audit is Important for any Business?

 We all are somewhat aware of different types of audits and the purposes that they serve. When we require our accounts and financials audited, we get done the statutory audit. For the non-financial aspect, we have the secretarial audit, and for the verification of cost accounts, the option of cost audit is available. The audits mentioned above are the most common types of audits that organisations have to get done mandatorily or voluntarily. 

But sometimes, organisations need to check the efficiency and effectiveness of their operations, which is when one needs internal auditing. Earlier, its scope was majorly limited to finance and related activities. It was more focused on the actions which were cost centric. But now its area has stretched and covers non-financial aspects as well.

It has become relatively easy for the management to track their organisation's performance in a better manner. Internal audit elevates the growth of the organisation. 

The purpose behind this audit should be understood first before going in-depth about this topic. Setting objectives and keeping in mind the requirement of internal audit and what we want to achieve through this audit is crucial because it helps develop the right path with the right actions. It is advisable to hire an internal audit consultant as they have immense experience in this field and this makes the task easy for the organisation. An internal audit gives the organisation assurance that its internal operations are working well in the way they are supposed to work. 

• It mainly assesses the risks present and checks if adequate mitigation techniques are there in place. 

• It assures that all the laws are complied with.

• The internal control system of the company is appraised.

• It detects fraud, if any, occurring or having the potential to happen in the organisation. 

INTERNAL AUDIT PROCESS

Like the other audits, internal auditing also has a procedure to be followed for better results. The process is highly simplified and consists of phases like planning, executing, reporting, tracking and follow-up. Here, we have briefly talked about the process from the point of view of the internal auditor and management.

By failing to prepare, you are preparing to fail. This statement holds great significance in the case of internal auditing. It is a must to prepare and plan for what you want to achieve from this audit and how you will execute it. For this step, thorough discussions with management are necessary. If the auditor is an outsider, then this step becomes even more critical. The audit scope should be set and defined so that no ambiguity is faced at the later stage. Various risks being faced by the organisation should be taken into account. 

The next step is to act on what you have planned. For this audit, samples are selected from the areas where the audit is required to be done. The selection could be of some transactions, documents or any other item representing the whole area to be reviewed. Controls are checked at this stage to make sure that they are working suitably. 

Audit execution, the essential thing in the whole process, is incomplete without reporting to the concerned management. All the material findings should be timely reported to the administration to take appropriate actions without further delay. The auditor and management should sit together and discuss the changes to be made. 

The last step in this procedure is follow-up. Follow up is the most significant step to increase the effectiveness and get the best results from this audit. If this step is absent from the procedure, there are chances that the changes may remain unimplemented. For this, management and the audit department maintain a database and update it regularly to work on the findings.

Companies Act, 2013 also recognises internal audit as a statutory requirement. Rule 13 of Companies (Accounts) Rule, 2014 makes it mandatory for the following companies to get the internal audit done-

• Listed companies

• Unlisted Public companies having-

1. paid-up share capital of 50 crores or more; or 
2. turnover of 250 crores or more; or
3. outstanding loans or borrowings exceeding 100 crores 
4. outstanding deposits of 25 crores or more.

• Private companies having-

1. turnover of 250 crores or more; or
2. outstanding loans and borrowings exceeding 100 crores.

An internal auditor is appointed to conduct the audit, and it is not mandatory to appoint a professional like CA, CS or CMA in place of the auditor. Even an employee of the company can conduct this audit. His appointment is made by passing a resolution at the board meeting. 

One of the major limitations this audit has is the independence of the auditor. As already mentioned, the auditor can also be an existing employee of the company, which reduces the chances of him being independent. One can appoint an internal audit service provider to overcome this problem of independence.

INTERNAL AUDIT REPORTING

Internal audit, as previously mentioned, is a simple process, but when it comes to reporting, there is no defined format which makes it challenging to present the findings. There is no single format that can prove out to be appropriate for all organisations. For reporting, one has to figure out a way to present the findings as per the management's requirement. It doesn't mean that no uniform format is needed. An organisation should try to follow a uniform format with some required changes for reporting every year, so it becomes easier for the management and other stakeholders to understand and analyse the report. 

The report should be comprehensive, clear, brief, and correct. 

Clear communication is a must for getting the best output from this reporting. Suppose the results and issues are poorly reported; in that case, likely, the management doesn't get the motive and points properly and end up achieving fewer benefits than it could get if the reporting were clear. 

All the findings should be reported to the management in a final internal audit report, but before that, it is very much needed that the auditor gets to discuss the points with the management and understand the matters from their point of view. For this, one should follow the below-mentioned steps.

• Discussion draft- It is better if the auditor first prepares a report based on his findings solely. All the results found and concluded based on fieldwork done by the auditor forms part of this draft report 

• Exit meeting- The auditor and management should meet and discuss the management's recommendations for the final report. 

• Formal draft- The recommendations made by the management in the exit meeting are then included in the formal draft.

• Final report- At last, a final report is made and submitted to the authority.  

Like any other audit, internal audit also has the scope of some mistakes which are very common to occur-

If the report lacks a flow and is unclear, readers are likely to misunderstand the information. Due to no proper format of reporting, the chances of this problem happening is high. 

Sampling is the most challenging task. Selecting the appropriate sample of a proper size that can accurately represent the whole population is not possible. There is always a scope of deviation. 

Generally, the reports are quite lengthy, which makes the reader less interested, and the readers often lose focus by the end of the document.  

To subdue this problem of lengthy reporting, a summary is prepared, attached at the start of the document and titled an executive summary. It is like a concise report that gives the reader a good brief of the whole piece and makes his task easy. This way, the reader can have a glimpse of all the topics covered and have the option to choose what matter he wants to read comprehensively. It should also include the auditor's opinion on the matters. 

This summary can significantly enhance the quality and impact of reporting. 

Internal audit is not paid much attention and importance compared to the other audits, but its outputs and findings can significantly help the organisation's growth. Advantages of internal audit cannot be over-emphasised as it reveals and gives insights about the organisation related to the entity's operations and are not adequately covered in any other audit. 

Source: https://www.manishanilgupta.com/blog-details/why-internal-audit-is-important-for-any-business

What is Financial Freedom? Have you ever thought of achieving this?

 "It's not about how much money you earn; it's all about how much money you keep, how that earned money works for you, as well as how many generations you keep it for."

 The biggest mistake that many of us make is to work hard for our entire life for money and not expect money to work for us in return.

As the behemoth of all the investors, Mr. Warren Buffet says “If you have only one source of income, you will work until you die.” This statement makes more sense during covid period wherein those who have only one source of income (mainly salary) struggles to meet their livelihood, on the other hand, those who have multiple sources (consisting active as well as passive income) spent their lockdown in ease in comparison. Hence it is the need of the hour that each citizen of India should understand the importance of Financial Literacy and Financial Freedom right from their schools. Although its never too late to know these things, but earlier the better, so that one can reap the benefits of 8^th wonder of the world i.e. Compounding.

 Hence in this blog, we will try to understand these things. We will start from meaning of Financial Literacy, Financial Freedom, the need of it, consequences if you don’t know about it etc. and then procced to the Types of Asset classes, Importance of Diversification etc. So let’s start now.

 WHAT IS FINANCIAL LITERACY?

 To be financially literate means having the capacity not to let money – or the shortage of it – get in the way of your ease as you work hard and build your dreams complete with a long and fulfilling retirement.

•  Financial literacy refers to a combination of critical financial skills and concepts.

•  Financially literate people are generally less vulnerable to financial deceptions.

•  A strong foundation of financial literacy can help us support various life objectives, such as savings for education or retirement, using debt responsibly, and running your business.

 WHAT IS FINANCIAL FREEDOM?

 Financial freedom generally means that one has enough savings, investments, and money in hand to live the life one wants to live for himself and his family too, without relying on anyone. The best way to achieve financial freedom is by making the timely investment. As it has been rightly said, "THE EARLIER YOU START YOUR RETIREMENT PLANNING, GREATER IS THE POTENTIAL RATE OF RETURN ON YOUR INVESTMENT."

 WHY THERE IS A NEED FOR FINANCIAL AWARENESS?

 For each person, financial awareness is as vital as any other basics as it will help you manage all your hard-earned money effectively for your safe plus secure future. It helps to become self-sufficient and self-governing. The same shortage will lack a solid foundation for your actions and choices concerning savings and investments. A crucial indicator of people’s expertise to make financial decisions is their level of financial literacy. Financial literacy is not only the awareness and understanding of financial notions and risks but also the skills, motivation, and courage to apply such knowledge and understanding to make efficient decisions across a range of financial contexts, to improve the financial well-being of selves and society, furthermore to enable participation in economic life. Effective and efficient financial planning has become part and parcel to lead a peaceful life in today's constantly changing environment.

 EFFECTS OF FINANCIAL ILLITERACY

•  Financial illiteracy not only affects a single age group or a particular group of society, but it affects all groups in terms of both age and socio-economic status.

• The lack of which could make a person to make wrong financial decisions, which could further result in large amounts of borrowings. Being financial uneducated has been a notable contributor to a lower standard of living.

• The higher the fiscal illiteracy rate, the lower will be the retirement planning rate. To live peacefully at old age, one needs to start future planning from a very young age. 

• People who don't manage their money are the most affected ones during their harsh times. They are left with only one option to opt for borrowings, and that too at very high rates.

• Poor financial decisions have a long-term impact on lifestyles; a small wrong financial decision has so many adverse consequences that could make a person to negotiate with his wants. 

 INVEST YOUR MONEY ON LONG TERM BASIS

 An investment made for the long term is the best way to maximise the growth potential of your savings. Long term investments provide more tax benefits on capital gains than short term investments. Furthermore, it also reduces the risk factor of market volatility. The best reason to invest for a long duration is the benefit of compounding.

 50/30/20 RULE

 The basic 50/30/20 RULE is very manageable in real-life practice. As the rule suggests to diversify our income into three subsequent parts, 50% of our earnings should contribute toour needs and necessary expenses, 30% should satisfy our wants, and the remaining 20 % of our earnings should be kept for savings and investment purposes. Most of us spend most of our earnings and save a little bit. So, the 50/30/20 RULE helps us to limit overspending and contribute to healthy financial habits.

 SHOULD WE DIVERSIFY OUR SAVINGS?

 It is one of the most common questions that most of us think should we finance all our savings in one investment tool or diversify? So, diversification is the most simplistic way to boost your returns and reduce the asset price movement risk. It is one of the crucial components of reaching long term financial objectives while lowering risk.

 EXAMPLES OF SOME INVESTMENT OPTIONS AVAILABLE:

•  Public Provident Fund(PPF)-Nowadays, PPF is considered as one of the most popular saving schemes. PPF replenishes deductions up to 150000 under 80C of the Income Tax Act,1961. Furthermore, interest accrued on the PPF scheme too is exempt from tax. It is most suitable for those investors who are looking for stable as well as high returns.

• Sukanya Samridhi Yojana-Investment made in (SSY) can be utilized for girls' child wedding and education. The above scheme provides deduction under section 80 C of the Income Tax Act. The rate of interest is also relatively high in comparison to other small saving schemes.

•  Fixed Deposit-It is the best-suited investment plan for those who are not willing to bear risk. Unlike other investment tools, FDs are not market-driven. Like PPFs, they too attract tax benefits under 80C of the Income Tax Act,1961. In case of critical cash need, we can take loans against FD rather than breaking it and making ourselves pronto penalties.When you invest in FD for a longer tenure, the basic principal value compounds over time and helps you earn a better interest rate.

•  Bonds-Bonds are considered to be less unsafe than stocks. Bonds provide you with regular passive incomes, and if bonds are held till maturity, bondholders get back the entire principal money along with premium or discount as the case may be. 

•  Real Estate-As it is a long-term investment, it provides you with benefits of capital appreciation and regular rental income. One added benefit is that it grants you various tax benefits as you can claim various expenses. It provides you with passive income as well as provides you long term securities.

•  Stock Market-Stocks are considered as one of the most liquid assets. The main reason most people are attracted to the stock market is the increasing inflation rate as bank FD or saving accounts failed to beat the inflation rate. Though the stock market provides a reasonable rate of return simultaneously, it is also precarious. You could lose your entire investment if you are involved in intraday trading as the market is highly unpredictable. In stock market, investors generally experience much higher rate of return if they hold their stocks for longer duration. 

•  Mutual Funds- The main benefit of mutual funds is that it allows us to pool our money with other investors, and professional portfolio managers take the investment decision. So, it is suitable for those who don't have knowledge of the stock market but want to invest their money.

•  Gold-Investing in gold is a widespread way to invest the money as it is easy to buy and sell. Furthermore, it safeguards you against inflation uncertainties. We can invest in gold by purchasing it in physical forms like coins, jewellery, bullions. Though there is a risk of theft and impurities in physical form, it is preferable to invest in gold through Gold ETFs, as they attract no wealth tax, no security transaction tax, no VAT, and no sales tax.

 LET’S CONCLUDE-

 Financial literacy is a vital part of eliminating financial blunders for a robust, safe and secure future. So, don't consider savings as punishment; invest your money wisely and at the right time. Being financially literate will help you make better financial decisions and cause you less financial stress and anxiety. So, your stress-free future depends on the financial decision you make today; for that each of us needs to understand the essence of being financially literate.

Source:https://www.manishanilgupta.com/blog-details/what-is-financial-freedom-have-you-ever-thought-of-achieving-this

Blockchain- Beyond Cryptocurrency

Blockchain is a topic that is the most popular among the crowd at the moment. It's a topic that is disruptive, accelerating and that may be your elevator pitch. Let's have a bird-eye view on this.

Imagine yourself as a bird flying high in the sky, and down you observes that the world is divided into blocks, blocks of massive information. But how can this information work for good if there is no common link between them? Here is the point when the word "Chain" comes into the picture.

Blockchain is the most talked-about form of distributed ledger technology. It works on decentralized & distributed ledger technology that stores transactional records in blocks, and it is accessed by the participants globally over the network. Every time a transaction takes place, a block is formed, which further develops a chain. It creates an irrevocable record of transactions that could not be undone. Blockchain organizes a peer-to-peer network that provides participants with a platform to communicate among themselves over the web & increases confidence, security, transparency, and the traceability of data shared over a network and delivers cost savings with new efficiencies.

Blockchain will gain you an edge as it is an open-source ledger; every transaction made is public, which leaves no room for fraud. The integrity is monitored by minors who have their eyes on all the transactions; hence it is more secure. It is responsible for keeping a record of all the transactions that cannot be revoked or manipulated. The user public can view transactions data at any point. This makes online transactions even more secure. Blockchain solutions can offer a speed of 100 to 10,000 transactions per second, hence saving your time.

But to implement this technology, you need to take care of a few critical things, such as the application must be updated on both ends of the P2P network. If any end doesn't accept the amendments, technology will fail. If you plan to have business applications, then they must have some business logic behind them.  This logic specifies how applications will perform within the sphere of business needs. By nature, blockchain uses more stringent logic that won't allow you to redesign without leading to the need for logical business changes to be acceptable to the blockchain solution. Now, blockchain is a complex set of protocols that require a big brain to solve Hyperledger, multichain, Corda, quorum theorems which one can't manage at the sole level; hence enrising the need to involve some third party help to add new features and expand the application without redeployment of the network.

Types of Blockchains: Deciding which one is better for your business.

The most basic function of this technology is to carry out transactions or exchange of information through a secure network. But the way people use blockchain varies from case to case. For instance, if we talk about Stock Market/Crypto, the reason blockchain got hyped into the scenario. Shares are digital holding certificates that get traded through blockchain technology. It is a type of blockchain in the nature of a public network giving the right to people from all over the world to become a node, verify other nodes and trade shares.

On the other hand, let us take an example of a bank using a private blockchain network. It is a restricted network where only concerned persons/employees of the bank can access confidential information. Thus, anyone out of this closed network can not gain access to the bank database. A private network is more bound to have only authorized nodes that a network admin must initially monitor. The information transmission through a private blockchain remains within the network. Any new node that wishes to become a part of a private network needs permission from the network admin. The bank decides the scale of their private blockchain for all their branches in a country.

Another famous type of blockchain that exists is Hybrid Blockchain. Some information can be circulated in a private blockchain network, and some parts can be mutually agreed to flow in a public blockchain network. The hybrid blockchain is so flexible that users can quickly join a private blockchain with multiple public blockchains. A transaction in a private part of a hybrid blockchain is usually authenticated within that network. But users can also shoot it in the public blockchain to get verified. The public blockchains increase the hashing and involve more nodes for verification, which enhances the security and transparency of the blockchain network.

Worry not with Blockchain Technology

• Each block holds a unique hash number and a key link that connects it to the previous & next block in a blockchain. The blocks cannot be altered. If there is any replacement, the hash sum would be altered, and the block would longer be valid, which further will lead to invalidation of the whole chain as each block is interconnected with the previous & the next one.

• Your all transactions are secured by cryptography. Each block contains a unique and private key that can be verified with a public key. If there is any change in transaction data, the block's unique key becomes invalid. As a result, the block is dismantled from the chain, again remembering each block of the chain is interconnected.

• The security of blockchain also depends on its decentralized and distributed nature. Failure is never at any single point as every block is interlinked, making it much harder to corrupt, thus making it invulnerable. Hacking into any one part of the system cannot affect other parts. However, in the case of a private blockchain, this advantage is partially lost as they have a single point of control and a limited number of nodes. This restricts users from making changes to the ledger. Organizations operate these kinds of blockchains for their internal use, allowing the company to control its processes.

• There is no principal body to authenticate and verify the transactions, yet every transaction in the blockchain is presumed to be completely secured and verified. It is because of the presence of the consensus protocol on which blockchain works.

• A consensus algorithm is a process through which all the peers in the blockchain reach a mutually predecided agreement about the present state of the distributed ledger. In this way, consensus achieves reliability in the Blockchain network and establish trust between peers in a distributed network. Most importantly, the consensus protocol verifies whether the new block that is added to the blockchain is the sole version of the truth agreed upon by all the nodes in the blockchain.

 To sum up, the blockchain is a peer-to-peer framework that offers the potential to transform current business processes by disintermediating central processes, thus improving efficiencies and creating an immutable trail of transactions. This provides the opportunity to reduce costs, interaction times and improve transparency for all the users. This transformational framework could change the way financial institutions conduct business as many transactions are peer to peer in nature.

While the benefits are in front, there are many risks that may be imposed by this nascent technology. Understanding of blockchain technology and its associated risks may evolve as this technology endures to mature. It’s therefore imperative for all organizations to continuously monitor for the scope of development in this technology and its application to various cases.

Blockchain technology contains the potential to reengineer business models from a human-oriented model to an algorithm oriented model, which might expose businesses to risks that they have not encountered before. In order to react to such risks, businesses should consider establishing a robust risk management strategy, governance, and controls framework.

Future Of Blockchain

 

Blockchain is already picking up the pace, here are examples of successful blockchain projects:

 

Helium is a decentralized wireless infrastructure. The network allows everyone worldwide to connect to the infrastructure wirelessly without having any expensive data plan. By using their plug-and-play hotspots, anyone from anywhere can join the Helium network.

 

Forward Protocol is a decentralized knowledge protocol that emancipates education by rewarding the users with the “earn well, learn well” model. It incentives students for completing a course and provide royalties to teachers when their students finish a project. The protocol aims to link job seekers with the vacancies such as Monster, Upwork, and Fiverr.

 

Theta TV is a decentralized video streaming network that allows us to watch content, earn virtual currency and give total administration to the content maker. Many YouTubers are also publishing videos on Theta since they can get 100% of the profit generated.

 

Future of Blockchain in Accounting

 

In the long run, Blockchain proves to be a disruptive technology for accounting like digital photography disrupted the conventional film photography, pagers & land-line phones were utterly disrupted by mobile phones. 

 

Blockchain is a multi-faced technology that also plays the role of accounting technology, which helps with the transfer of ownership of assets and maintaining a ledger with accurate financial figures. Implementation of blockchain assists in increasing the potential of the accounting profession by reducing the cost of maintaining and reconciling ledgers. This strength may be a threat to accountants as automation in reconciliations cut the work of accountants. But, Blockchain empowers the accountants that assets exist with proven authenticity.

 

We have always come across double-entry bookkeeping when talking about accounting, but Blockchain works on triple entry bookkeeping. Now it will be, with Blockchain, each transaction will be recorded by the third party/all blocks, and the third party/block verifies each transaction (Cryptographically), and a receipt will be issued. What will be the outcome of the same? Every transaction will be simultaneously recorded in the books of a third party to be verified by the Blockchain. As the transactions are entered in three places, and hence called as Triple entry system.

 

How will it change the attitude of Accountants towards the work? Well, Blockchain proves to be disruptive, but when coming to betterment, it has its gain over in the following manner:

 

Accountants are experts in recording, bookkeeping,application of taxation and related rules, with theBlockchain Technology; they get opportunities to becomeBlockchain advisors and can join the blockchain network.

 

Accountants can spend less time on identifying errorsand mistakes and reconciliation work; instead, they canconcentrate on areas like technical knowhow, advisory and

related activities.

 

To conclude, while the landscape for Blockchain technology is still in its infancy, its potential is transformational. Blockchain protocol offers the greatest opportunities for change in various accounting mechanisms and creates a new platform to reshapethe world of business and transform the accounting and auditing profession. Its potential disruption in theaccounting industry cannot be overlooked. Various past developments, such as the emergence of computers, ERPsystems, and cloud computing, have just changed theauditors’ work instead of making them irrelevant. Auditorswill need to develop a more data-centric approach anduse it with a forward rather than historical perspective.In this way, the auditors will be able to provide a veryhigher-valued service. Firms adopting new technologies pretty earlythat account for these potential disruptions will be better off in the long run. 

 

Authored by Himanshu Sharma & assisted by Simar DS
For any queries or suggestions, reach at info@manishanilgupta.com

Source: https://www.manishanilgupta.com/blog-details/blockchain-beyond-cryptocurrency

Rental Income - Income Under the Head ‘House Property’ or ‘Business Income’, Where to Disclose?

Treatment of income from renting immovable properties for the purpose of calculating taxes has been a common point of dispute between the Income Tax department and the taxpayers. Rental income of property has different connotations depending on whether it is treated as house property or business income. Accordingly, such income may broadly fall under the following two heads of income in the Income Tax Act –

• Income from House Property, or

• Income from Business and Profession

In case the property income is declared as income from house property, then according to section 24 of the Income Tax Act, 1961, a maximum tax deduction of 30% of Net Annual Value may be claimed. This deduction is towards the repair and maintenance of the property. Besides standard deduction, only municipal taxes and interest paid on capital borrowed for the purposes of acquisition, construction, reconstruction, repair, etc. (subject to limitations provided under the Act) are allowed as a deduction against the rental income. This deduction is irrespective of the actual expenses incurred by the owner. It limits the overall tax benefits available to the assessee.

On the other hand, if taxed as income from business, any expense incurred wholly and exclusively for the business of renting shall be permitted as a deduction for tax determination.

As there are no constraints on deductions under the head PGBP, assessees prefer classifying rental income received from the lease of immovable property as income from business, which will, in turn, mean revenue loss for the government. Therefore, the Income Tax department scrutinizes every such case to dissuade taxpayers from claiming it as business income.

The stand taken by the department in such cases is based on the judgement in the case of East India Housing and Land Development Trust Ltd vs CIT wherein the Hon’ble Supreme Court held that specific provisions prevail over general provisions and hence the income derived by the company from shops and stalls is income received from property and falls under the specific head ‘Income from House Property’ only as it is received by the company formed with the object of developing and setting up markets.

Hence, the department believes that when there is a particular head for property income, i.e., ‘Income from House Property’ under the Act, then the income earned from renting of immovable property should be charged under such head only.

This is the point of dispute between taxpayers and the department on the taxability of rental income earned from leasing the immovable property. However, over time and after many judicial pronouncements, certain fundamental principles have emerged as cornerstones for characterizing rental income under the head PGBP.

Prominent principles to classify Rental Income as Business Income –

• The intent of the assessee is to do business – this intention may be inferred from the agreement for lease, objectives listed in the Memorandum of Association and consequent conduct of the parties.

• Active ownership of property – if property yields rental income because of its own legal existence, it would be categorized as passive ownership and may be classified as House Property.

• Constitution documents of the assessee provide that the principal objective is to hold the properties (presumably not for gains) and lease them out to earn rental income – the activities conducted by the assessee should be in line with the constitution documents.

To have a better understanding of the principles as mentioned above, let’s have a look at some of the related case judgements –

Chennai Properties and Investment Ltd. vs Commissioner of Income Tax, (2015)

In this case, the assessee company was incorporated with the primary objective, as mentioned in the Memorandum of Association, to procure the properties in the city and let out those properties.

The Hon’ble Supreme Court held that since holding the properties and earning income by letting them out is the main objective of the company, as stated in the Memorandum of Association, the income so derived is in the nature of business income and shall be disclosed under the head ‘Income from Business or Profession’ and not under ‘Income from House Property’.

Rayala Corporation (P.) Limited vs ACIT, (2016)

In this case, the assessee company was in the business of renting its properties and was receiving rent as its business income. The assessee company claimed that the said income should be taxed under the head ‘Profits and Gains from Business or Profession’ and not under ‘Income from House Property’. In the appeal filed before the High Court, the revenue department argued that leasing and letting out of shops and properties was not the main business of the assessee-company as per the Memorandum of Association and, therefore, the income earned by the assessee-company should be treated as income earned from house property.

However, the Apex court held that the assessee company has only one business: leasing its property and earning rental income. Therefore, the income so derived should be treated as its business income.

Raj Dadarkar & Associates vs ACIT, (2017)

In the above-mentioned case, the Hon’ble Supreme Court held that apart from relying on the object clause, the assessee would be required to provide or refer any other material to prove the conduct of activities according to its constitution documents.

Based on the material provided by the taxpayer, it was held that the assessee was not able to establish that he was engaged in any systematic or organized activity of rendering services to the occupiers of the shops to consider receipts from them as income from the business.

Sultan Brothers (P) Ltd. vs Commissioner of Income Tax, (1964)

In this case, the Appellant had let out the building fully equipped and furnished for a period of six years for running a hotel and for other ancillary purposes.

The Apex court observed that whether a particular letting is business has to be determined as per the circumstances of every case. Further, it was observed that “every case has to be looked at from the point of view of a businessman to find out whether the renting out was the doing of a business or the utilization of his property by an owner”.

Accordingly, in the facts of the above case, the Supreme Court held the income to be in the nature of business income.

Karanpura Development Co. Ltd. vs Commissioner of Income Tax, (1961)

The facts before the Supreme Court, in this case, were that the income had been received pursuant to the leasing of coal mining rights. The assessee company was incorporated with the object of acquiring and disposing of the underground coal mining rights in specific coal fields. It had limited its activities to procuring coal mining leases over large areas, developing them as coalfields and then sub-leasing them to collieries and other companies.

The taxpayer had shown the income as business income. The Supreme Court observed that the objective and the manner of its activities and the nature of its dealings with its properties need to be taken into account. Accordingly, it had held the income to be in the nature of business income for the above case and not as house property income.

Interpretation

Hence, the trend of judicial pronouncements and directions issued by the Central Board of Direct Taxes (CBDT) show that the authorities are now accepting that owning a property and renting it out may also be done as part of a business, besides as a mere owner of the property.

The Hon’ble Supreme Court, in several cases, held that the deciding element is not the ownership of the property but the nature of the activity of the assessee and the nature of the operations concerning the same. Further, it has emphasized that for income to be characterized as business income, the activities actually carried out by the assessee need to be in line with its primary object, according to its constitution documents.

As seen above, in the case of Raj Dadarkar & Associates vs ACIT, Supreme Court held that apart from depending on the object clause, the assessee would be required to provide or refer any other material to show that the conduct of activities is as per its constitution documents. Therefore, reduced litigation is expected on this issue if taxpayers are able to provide factual material to prove that their activities are in the nature of their business and according to their constitution documents.

Moreover, the CBDT released circular no. 16/2017 on 25^th April 2017, wherein it has been clarified that the income from renting out of premises/developed space with other facilities in an industrial park/ Special Economic Zone is to be leviable to tax under the head PGBP and has instructed the revenue department to not file any appeals on this matter and to withdraw/not press upon appeals already filed.

Another point worth noting here is that residential and commercial properties are treated in the same way from a tax perspective. The deciding factor is the main line of business of the owner, irrespective of the fact that whether the property is residential or commercial. If the individual is in the business of letting out property, then the rental income, even from the residential property, will be accounted for as a business income.

Conclusion:

• The Rental Income may only be considered under the head ‘Profits or Gains from Business or Profession’ if the person can substantiate that the same is in accordance with the firm’s primary objective from its constitution documents and conduct of activities.

• Since it is mandatory to substantiate that the rental income is in accordance with the ancillary or the main objective of business, it is prudent for the individuals to consider the rental income under the head 'Income from House Property' if they are not having a business of a similar objective.

• And if they wish to consider it as business income, they must have solid grounds and documentary evidence to substantiate that the rental income is in line with the ancillary/main objective of its business activity.

• The above-discussed treatment is applicable to rental income from both residential and commercial properties in the same manner for the purpose of their classification.

Disclaimer-The information given above is to provide a general guidance to the readers. This information should not be sought as a substitute for legal opinion.

 Source: https://www.manishanilgupta.com/blog-details/rental-income-income-under-the-head-house-property-or-business-income-where-to-disclose