Q: My brother and I have a partnership firm in India. I am a dormant partner as I am working in the Gulf. The firm sold a commercial building at a huge profit. Depreciation was claimed by the firm on the building. My chartered accountant informs me that the profit will be treated as short-term capital gains. Is he right? I also want to know whether the firm can set off the loss it made on sale of shares which were held for more than three years against such capital gains. P.S. Lodha, Sharjah
A: Since your firm had claimed depreciation on the building used by it for business, the capital gains made on the sale would be treated as being of a short-term nature. This is in view of the specific provision contained in section 50 of the Income-tax Act which exclusively applies to assets of a business in respect of which depreciation has been claimed. The effect of this provision is that profits made on sale of depreciated assets are taxed at the normal rate of 30 per cent instead of the concessional rate of 20 per cent which is applicable to long-term capital gains. However, section 50 is a deeming provision which artificially treats a long-term depreciated asset as if it is a short-term one. The setting off of a loss against capital gains is covered by section 74 which is independent in nature and is not affected by the artificial provision of section 50. Therefore, the long-term loss made on sale of shares can be set off against the capital gains which your firm has made on sale of the building.
Q: A British company had entered into a joint venture with an Indian company for manufacture, distribution and sale of electronic components. It is now proposed to terminate the joint venture and the British company will receive compensation for surrendering its rights under the agreement. Will this amount be taxable as business income? K.R. Mathew, Manama
A: Generally, compensation received on termination of an agreement is a capital receipt. However, section 55(2)(a) of the Income-tax Act which has been amended from April, 1 2002, provides that where a capital asset is transferred, the cost of acquisition would be the purchase price and if no amount was paid for acquisition of such asset, the cost of acquisition would be taken to be nil. Hence, the entire sale price received would be liable to tax as capital gains where the cost of acquisition is treated as nil. This provision applies to goodwill of a business, trademark or brand name associated with a business, a right to manufacture, produce or process any article or thing, a right to carry on any business or profession, and compensation received on surrender or transfer of tenancy rights. Therefore, the consideration received by the British company would not attract tax at the higher rate applicable to business profits, but would be taxed at the lower rate of 20 per cent applicable to capital gains.
Q: My family runs a hotel in Bengaluru. Many customers who pay by credit card add the tips on the charge slip while settling the bill. The hotel then pays the tips in full to the waiters. The income tax department has taken the stand that the hotel should have deducted tax at source from the tips paid to the waiters and has levied a penalty for not doing so. Is this legally justifiable? S.P. Hegde, Sharjah
A: The question of deducting tax at source arises only in respect of remuneration which an employer pays to its employees for services rendered. The Supreme Court of India has held that tips paid by customers to hotel employees cannot be treated as remuneration paid by an employer to its employees. Hence, such tips are not in the nature of salary taxable under section 15 of the Income-tax Act. Therefore, there is no requirement to deduct tax at source under section 192 of the Act from the tips paid by a hotel to its employees. In view of this categorical decision of the Supreme Court, you must file an appeal within 30 days of receipt of the penalty order. Since the tips are not taxable as income, the question of withholding tax does not apply and penalty levied for non-deduction of tax at source is illegal and would be set aside by the appellate authorities.