Brokerages squeeze out jobs

The below reproduced article has appeared in the Economic times (Mumbai edition) on 28th March 2008 - Again this article only confirms what I had predicted in my earlier article titled "Kindly Bear with Me" regarding how this so called new leveraged finance whiz kids risk losing their jobs.... Q.E.D



MUMBAI: The year would have been much better for Naveen Khadilkar (name changed), had he not lost his job months before his marriage. The 26-year-old, who worked as a relationship manager with a Mumbai-headquartered brokerage, walked into office last week only to be told that his services had been terminated.

But Naveen is not the only one who is bearing the brunt of a bear run in the market. If market sources are to be believed, top brokerages have already begun downsizing staff (or stalling new recruitment) to reduce costs in what has been a nightmarish quarter. Following the market crash in late January, most retail brokerages have been hit by a double whammy of bad debts and a sharp drop in daily turnover.

Last year, many brokerages had expanded their branch network, hoping that they could get private equity investors to pay more for a wider presence. But uncertain market conditions are forcing many brokerages to have second thoughts on the need for so many branches and staff. “Underperformance” is cited as the most common reason given for laying off people.

“This is a normal trend and it doesn’t have anything to do with the current market conditions. Employees who have not done well even after giving adequate training and support are asked to leave at all times,” said Indiabulls Securities CEO Divyesh Shah.

Lacklustre market and lack of interest on the part of investors to participate in daily proceedings have put a question mark over earnings for most broking firms. The business model of most broking firms (and also fund houses) is highly correlated to general market conditions. Indian financial services institutions are expected to do better in times of good markets. Pursuant to the fall, brokerages are focusing more on distribution of insurance products to make up for losses in equity broking.

More than specific functionaries like dealers and research analysts, it is relationship managers who are finding the future of their jobs up in the air. A mid-size brokerage could have anywhere between 500 and 1,000 relationship managers in its rolls. The job profile of relationship managers includes marketing and selling of financial products, client servicing, acquiring new clients, garnering more business and advising HNIs on their long-term and short-term investments. Relationship managers are paid in the range of Rs 5-12 lakh depending on their experience and performance. They are bound to stiff and at times impossible-to-achieve targets.

“We set stiff internal targets for our relationship managers, but at the same time, we do not hesitate to revise them (targets) when markets are down,” said India Infoline vice-president (strategy & planning) Harshad Apte. “And as far as laying off underperformers are concerned, we do that even in the time of good market conditions. In fact, the bad market is the best time to test your relationship managers,” Mr Apte added.



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The below reproduced article has appeared in the Economic times (Mumbai edition) on 28th March 2008 - Again this article only confirms what I had predicted in my earlier article titled "Kindly Bear with Me" regarding how this so called new leveraged finance whiz kids risk losing their jobs.... Q.E.D



MUMBAI:
The year would have been much better for Naveen Khadilkar (name changed), had he not lost his job months before his marriage. The 26-year-old, who worked as a relationship manager with a Mumbai-headquartered brokerage, walked into office last week only to be told that his services had been terminated.



But Naveen is not the only one who is bearing the brunt of a bear run in the market. If market sources are to be believed, top brokerages have already begun downsizing staff (or stalling new recruitment) to reduce costs in what has been a nightmarish quarter. Following the market crash in late January, most retail brokerages have been hit by a double whammy of bad debts and a sharp drop in daily turnover.



Last year, many brokerages had expanded their branch network, hoping that they could get private equity investors to pay more for a wider presence. But uncertain market conditions are forcing many brokerages to have second thoughts on the need for so many branches and staff. “Underperformance” is cited as the most common reason given for laying off people.



“This is a normal trend and it doesn’t have anything to do with the current market conditions. Employees who have not done well even after giving adequate training and support are asked to leave at all times,” said Indiabulls Securities CEO Divyesh Shah.

Lacklustre market and lack of interest on the part of investors to participate in daily proceedings have put a question mark over earnings for most broking firms. The business model of most broking firms (and also fund houses) is highly correlated to general market conditions. Indian financial services institutions are expected to do better in times of good markets. Pursuant to the fall, brokerages are focusing more on distribution of insurance products to make up for losses in equity broking.

More than specific functionaries like dealers and research analysts, it is relationship managers who are finding the future of their jobs up in the air. A mid-size brokerage could have anywhere between 500 and 1,000 relationship managers in its rolls. The job profile of relationship managers includes marketing and selling of financial products, client servicing, acquiring new clients, garnering more business and advising HNIs on their long-term and short-term investments.

Relationship managers are paid in the range of Rs 5-12 lakh depending on their experience and performance. They are bound to stiff and at times impossible-to-achieve targets.

“We set stiff internal targets for our relationship managers, but at the same time, we do not hesitate to revise them (targets) when markets are down,” said India Infoline vice-president (strategy & planning) Harshad Apte. “And as far as laying off underperformers are concerned, we do that even in the time of good market conditions. In fact, the bad market is the best time to test your relationship managers,” Mr Apte added.



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Meghnad Desai's view of risk and risk takers

Six
months ago when the first signs of the financial crisis appeared many were taken
by surprise. It was predictable in principle that after years of cheap liquidity
and a lot of new risk vehicles in which people were investing, sooner or later
something would give way.



The
difficulty with economics is that while one can predict an event is likely to
happen given the various related phenomena, one cannot forecast the date and
time when it will happen. Economists are not astrologers; they aspire to be more
like astronomers. They observe remote movements in markets and map their
dynamics. It is an imperfect science, yet it has some lessons to
teach.



Also at that time last
summer, many were saying that somehow the emerging economies - especially China
and India - had decoupled themselves from the developed country markets and so
India would be spared the worst of the crisis. We know better now. Financial
markets, much more so than real economies, are interlinked by fast flowing funds
which can come and go. This is not worrying because these flows move Sensex and
other indices up and down, but the speed and volatility by themselves insulate
the real economy against these fluctuations. Of course, this assumes that
monetary policy is sound and financial regulation
works.



The financial economy is
global and fast moving; the real economies are integrated only through traded
goods and services which leave a lot of the economy in each country to
experience such shocks with some delay. The 1973 oil price rise was different
because it was a direct shock to the real economy and not via financial markets.
What we have seen is that while there has been turmoil in financial markets it
has had little impact on the real
side.



Those who buy and sell in
the stock markets should know that volatility is the name of the game; indeed
great stock market players like George Soros make their fortunes by being one
step ahead of volatility. If you make losses by the same token that is your
problem. There is no need to rescue rich losers on the stock markets. What we
are seeing on Wall Street now is that when large losses are made somehow the
believers in free markets rush to the government for help. Thus they are
socialists when they make losses and free market fundamentalists in good
times.



The rescue of Bear
Stearns by the Federal Reserve was a prime example of this whereby J P Morgan
got the assets at a throwaway price (even after the recent upping of the bid
from $2 to $10 a share). The Fed has taken a possible loss of up to $25 to $30
billion while J P Morgan only loses at most $5 to $6 billion but then will
profit from its acquisition. This under a government which believes in free
markets! Ben Bernanke has devised a generous injection of liquidity which will
come back to haunt the American
economy.



The Bank of England is
more independent compared to the Fed. Mervyn King, the bank governor, has taken
the correct view that if banks make foolish deals they should pay for any help
he can give them to get them out of trouble. He has been much criticised since
the powerful lobby of the rich players in financial markets and their apologists
in the media and parliament are howling with rage that the bank is not doling
out cheap money.



Northern Rock
was a smaller mortgage lender than Bear Stearns, which was an investment bank,
and when it was in trouble the first step was to assure the depositors that
their money was safe. But after that, instead of giving it to a private firm to
profit from this rescue, the government took Northern Rock over. When it has
paid


off its support loan of
£25 billion it will be denationalised. In the meantime, the shareholders
are likely to get what their shares were truly worth when the firm was rescued,
i.e. zero.



I wish governments
enforced market logic more rigorously rather than helping out risk takers. A lot
of these hedge funds or banks have made money by borrowing a large multiple of
what their paid-up capital is. In the case of Carlyle Corporation, this was up
to 30 times. Leveraging, as this is called, is financed by short-term loans.
While the investments keep going up, the company is happy as are its lenders.




But then suddenly even triple
A securities issued by the US government-backed housing finance companies, Fanny
Mae and Freddy Mack, found that their shares declined massively. Firms, which
had borrowed 30 times, found their value collapsing and their lenders demanding
money on the dot. So a multi-billion company like Carlyle went bust.




Sensex has had its gyrations,
going down to below 15,000 and now struggling back up. This is as it should be.
Stock markets are for grown-ups. As President Truman said in the context of
politics, one can say about stock markets: "If you can't stand the heat, get out
of the kitchen". In any case one hopes the government does not give any help to
the losers. It is one thing to help farmers who are in debt, but another to help
financiers who thrive on debt. Let them pay the
price.



The above article has been written by Meghnad Desai - The writer is a member
of the British House of Lords and it only affirms what I have written in my earlier article "Kindly Bear with me"!!!!!

Hey guys,
have a look at the video - It is a parody of the popular Police number - "Every Breath you take" and takes a dig on the financial markets

lovely video --- an absolute must watch


http://hk.youtube.com/watch?v=3u2qRXb4xCU

Kindly "BEAR" with me......

JAO MAT DOST ..... SHOW ABHI BAAKI HAI!!!!!!

All you so called new gurus of the stock markets ......Welcome to the grim realities of the stock market!!!. The stock market has taken its 2nd bigger ever hit sliding over 951 points on Monday, 17th March 2008.The major falls of sensex have been -

21-1-2008: 1408 pts
17-3-2008: 951 pts
3-3-2008: 900 pts
22-1-2008: 875 pts
11-2-2008: 834 pts
18-5-2006: 826 pts
13-3-2008: 771 pts
18-10-2007: 717 pts
18-1-2008: 687 pts

The sensex recorded its peak on January 8, 2008 touching 20873. On 17th March i.e 3 months later the sensex is at 14800 levels ie a fall of 29% (6073 pts).Oil prices have crossed the $100 barrier. Gold has shot past Rs.12000 giving a clear indication of the tough times ahead. I, for one, am not at all complaining about the scenario - for this was something that was waiting to happen - anyone who did not anticipate this was clearly blind as a bat and stupid as an owl.

But what pisses me off is the so called "stock market pundits" turning a blind eye towards the pressure build up and thereby failing to issue the clarion call to the investors. What were the so called tie toting smug looking research analysts (who were in anycase being paid many times over their real intellectual worth) doing all these while? It is only after the meltdown happens that these stupid dilbert like characters come out and say that the scenario looks bleak --- shuttttt up... now even my 10 year old son can say that the situtation is grim - I dont need a overpaid, Mr.know it all to tell me that on CNBC.

Some of the so called big shots (or people in the know as I prefer to call them) have issued statement which go as under (the quotes have appeared in ET on 18th March 2008- just for the records)(the words in italics are my comments and not theirs!!!:-
Mr. R. Venkataraman (ED - India infoline) says "It will take some time for the sentiment to change (ha ha as if this is something new). There is a need for large institutions like LIC to start buying frontliners to provide a filip to sentiment (Why Mr Venkataraman? LIC ne market ka theka le rakha hai kya? When you were filling your pockets during the boom time did you pass on some of your positions to LIC telling them to keep the profits - Why should they come to the rescue of the market - so that to ensure that you make a profit ? SORRRRRRY SIR - that is not what LIC is there for).

Mr. Motilal Oswal (CMD Motilal Oswal Securities) (This one takes the cake) - This is time to accumulate good quality stocks from medium to long term perspective. They can go for old economy stocks like GSK, Bharti etc (In my humble opinion old economy stocks meant TISCO, ACC etc since when has Bharti become a old economy stock).... and Now comes the punch line - read this - " Markets have overreacted to global events.But that does not mean that they cannot go further. Now I am confused - should I buy old economy stocks or should I wait for them to go down.

I mean you dont need to be a genius to tell someone that the markets may either go up or it may go down... DUHHHH.. what kind of a view is that -- even my ghar ka kaamwaali bai can tell that --- gimme a break Mr. Oswal.This only proves that no one ... I repeat no one has any clue about which direction the market is going to take - If that is the case then may I call upon CNBC to please invite my kaamvali bai and ask her to give an opinion on the markets - my apologies to the viewers that she wont sport a tie nor will she speak in broken english and she wont refer to complex charts - in any case to tell that a stock market will either go up or down you dont need any of these.

Mr. Venkataraman's call to LIC seems totally devoid of any logic - why doesnt he call upon the Pvt Sector Mutual funds to start buying (if he sees value in today's stock prices?) - these guys wont because they are worried about their annual fat bonuses getting hit - it is the bechara LIC fund manager who is any way not entitled to the hefty bonuses that is being called upon so that the market can be revived and the private sector fund managers can look forward to a vacation in Seychelles out of their hard earned Bonus ...(Sic) . Talking about the private sector brings me to another interesting development - The Bear Sterns Collapse ---So much for the young investment turks who give an appearance that they started wearing ties even before their momma taught them how to tie diapers....armed with a degree from one of the management institutes these Mr. Know it all think that the only way the market can go is up - and start designing fancy instruments and have no inkling about the risks associated with them . Having seen two scams and over 17 years in the capital market my only word to them - "Kiddos.......welcome to world of MEN"

Now we will see the other repurcussions happening on the employment front in the financial sectors - the brokerages and investment houses will soon implement pay slashes which will result in a myriad of problems to these financial sector kiddos who have anyway leveraged their present earnings many times over to buy plush houses and fancy cars.. now we will see pink slips being issued in a lot of broking houses who will start cutting down costs if there is a further market slide.

It is also rumored that DBS of singapore has instructed its traders to limit its exposure to Lehman Bros. So the goldman sachs, JPs of the world be careful.... you might not be god's gift to mankind after all .

I wonder why none of these pundits actually gave a sell call when these signals started originating - I mean we all knew US was entering into a recession, we all knew that oil prices was spiralling up fuelling inflation, we all knew gold prices was shooting up giving a clear indication that global investors were jittery against currencies especially dollars, we all knew that dollar was getting hit against all major currencies especially Yen... hey wait a minute - I have been saying we all knew - am I missing something out here - dont these pundits read newspapers or do they read some other news paper I am not aware of....Till last week I was receiving research reports from some big brokerage houses recommending a value buy based on FUNDAMENTALS. I am tempted to quote a oft repeated joke in the market circles " FUNDAMENTALS pe mat jaana - pehle FUND jaayega phir tum MENTAL ho jaaoge" !!!!!!

What we lack in this market are people who are willing to stick out their neck and say with conviction which way the market will go - if they cant take a view then let them have conviction to tell that they are clue less rather than pretending to be the nose in the air know it all gurus.

My view - the market is going to be in a bear grip for atleast 6 months - and my reasons - US recession, failure to control oil prices might triger global inflation, slow down in new projects due to bearish sentiments in the financial sector...Interest rates definitely looking to go up in the near term and with March around the corner lot of banks will have to book losses on mark to market procedures on their investments - so they might be loathe to taking fresh buying - If I am proven wrong then so be it - I will be a happy person because my portfolio value would increase and If i am proven right - I can always proclaim "I said so"!!!! . So it is heads I win tails you lose........

55 Amendments that go against the court rulings

In Budget 2008 there are 55 amendments to the Income-Tax Act, 1961. Amendments to statutory provisions are made because of (i) changes in the economy, (ii) to plug the existing loopholes, and (iii) to provide a fillip to priority areas.

While a push given to certain sectors of the economy by means of incentives and tax holidays is generally welcomed by taxpayers, changes made to plug the loopholes in the provisions are normally not. In addition to the aforementioned reasons, amendments are made to unsettle court decisions which favour the taxpayers.

The following are some of the amendments which have approved or negatived some of the current court decisions.

Agricultural income

Income from saplings or seedlings grown in a nursery was held as agricultural income in the CIT vs Soundarya Nursery (2000 241 ITR 530 Madras) case. A contra decision can be found in H. H. Maharaja Vibhuti Narain Singh vs State of UP (1967 65 ITR 364 Allahabad).

The Finance Bill, 2008 has proposed to confirm the decision rendered in the Soundarya Nursery case by deeming such nursery income as agricultural income. Because of the amendment, even where basic operations are not carried out on land, such income will be deemed as agricultural income, eligible for exemption.

Charitable purpose

Any activity in relation to trade, commerce or business for a cess or fee is not tax-free from the assessment year 2009-10. This amendment nullifies the Supreme Court decision in the CIT vs Gujarat Maritime Board (2007 295 ITR 561 SC) case.

In this case, the Maritime Board was meant for the development and maintenance of minor ports in Gujarat. The application for registration was rejected and it was held that the assessee’s predominant purpose was to develop minor ports in the Gujarat and, hence, is eligible for registration under Section 12A. Now this decision stands nullified because of the amendment.

Business expenditure

Expenditure paid otherwise than by account-payee crossed cheque or account-payee crossed bank draft in excess of Rs 20,000 is not allowable. Taxpayers generally resort to more than one payment with each being within the monetary limit and, thereby, avoid disallowance. More than one payment in a single day was accepted by the courts (CIT vs Aloo Supply Company — 1980 121 ITR 680 Orissa) as not violative of Section 40A(3).

Now the amendment says that if the aggregate payment to a person in a day exceeds Rs 20,000 otherwise than by the prescribed mode, it is to be disallowed.

Book Profit

Deferred tax liability debited to profit and loss (P&L) account was not to be added to the net profit while computing the book profit under Section 115 JB (Shree Umaid Mills Ltd vs CIT — 2007 17 SOT 72 JP; CIT vs Balarampur Chini Mills Ltd — 2007 14 SOT 372 Kolkata).

The Finance Bill, 2008 provides for retrospective amendment for adding the amount of deferred tax provision debited to P&L account and thereby nullifies the tribunal decisions.

Deemed satisfaction

While completing the assessment, the assessing officer (AO) must record his satisfaction about the concealment for levy of penalty. The amendment now says that it is sufficient if the order contains a direction for initiation of penal proceedings. Such remark in the assessment order shall be deemed as the AO being satisfied about the need for initiating penalty proceedings.

This amendment nullifies the decision in the CIT vs Ram Commercial Enterprises Ltd (2000 246 ITR 568 Delhi) case.

Reasons for reassessment

For issue of notice under Section 148, sanction must be obtained from the Joint Commissioner. In Dr Shashi Kant Garg vs CIT (285 ITR 158 Allahabad), it was held that the Joint Commissioner must issue the notice. Now the amendment proposed by inserting Explanation to Section 151(2) says that it is enough if the AO has recorded the reasons and the Joint Commissioner or the Commissioner is satisfied about the fitness of the case. The amendment, retrospectively applicable, nullifies the court decision.

Reassessment of pending appeal

Where the assessment is completed and pending before the appellate authorities, the AO cannot initiate reassessment proceedings even in respect of other matters. Now a proviso to Section 147 is proposed to be inserted to allow reassessment of the matters other than those which are in appeal, reference or revision.

In CIT vs Sakseria Cotton Mills Ltd (124 ITR 570), it was held that only the points on which the appeal is made would merge with appellate order and in respect of other matters the limitation would start from the date of original order.

In effect, reassessment in respect of uncontested issues might get time barred if the proceedings are initiated after the disposal by the appellate authority. To overcome this difficulty, the Finance Bill, 2008 proposes to empower the AO to reassess the income in respect of matters other than those which are subject to appeal.

Monetary limit for appeal

In Berger Paints India Ltd vs CIT (Civil Appeal Nos.1081 to 1083 of 2004) it was held by the apex court that in one case if the appeal is not made, on the very same issue in the case of any other assessee an appeal cannot be made. To nullify the decision a new Section 268 A is proposed to be inserted, whereby an appeal not filed for an assessment year is no bar for preferring an appeal in another assessment year or in any other case.

The aforementioned decisions are ones that have been nullified by the Finance Bill, 2008. Every year it has become routine to find some of the court decisions favouring the assessee being upset by the amendments, sometimes retrospectively and where it could not be backed by reasons, by means of deeming provisions.

55 Amendments that go against the court rulings

In Budget 2008 there are 55 amendments to the Income-Tax Act, 1961. Amendments to statutory provisions are made because of (i) changes in the economy, (ii) to plug the existing loopholes, and (iii) to provide a fillip to priority areas.

While a push given to certain sectors of the economy by means of incentives and tax holidays is generally welcomed by taxpayers, changes made to plug the loopholes in the provisions are normally not. In addition to the aforementioned reasons, amendments are made to unsettle court decisions which favour the taxpayers.

The following are some of the amendments which have approved or negatived some of the current court decisions.

Agricultural income

Income from saplings or seedlings grown in a nursery was held as agricultural income in the CIT vs Soundarya Nursery (2000 241 ITR 530 Madras) case. A contra decision can be found in H. H. Maharaja Vibhuti Narain Singh vs State of UP (1967 65 ITR 364 Allahabad).

The Finance Bill, 2008 has proposed to confirm the decision rendered in the Soundarya Nursery case by deeming such nursery income as agricultural income. Because of the amendment, even where basic operations are not carried out on land, such income will be deemed as agricultural income, eligible for exemption.

Charitable purpose

Any activity in relation to trade, commerce or business for a cess or fee is not tax-free from the assessment year 2009-10. This amendment nullifies the Supreme Court decision in the CIT vs Gujarat Maritime Board (2007 295 ITR 561 SC) case.

In this case, the Maritime Board was meant for the development and maintenance of minor ports in Gujarat. The application for registration was rejected and it was held that the assessee’s predominant purpose was to develop minor ports in the Gujarat and, hence, is eligible for registration under Section 12A. Now this decision stands nullified because of the amendment.

Business expenditure

Expenditure paid otherwise than by account-payee crossed cheque or account-payee crossed bank draft in excess of Rs 20,000 is not allowable. Taxpayers generally resort to more than one payment with each being within the monetary limit and, thereby, avoid disallowance. More than one payment in a single day was accepted by the courts (CIT vs Aloo Supply Company — 1980 121 ITR 680 Orissa) as not violative of Section 40A(3).

Now the amendment says that if the aggregate payment to a person in a day exceeds Rs 20,000 otherwise than by the prescribed mode, it is to be disallowed.

Book Profit

Deferred tax liability debited to profit and loss (P&L) account was not to be added to the net profit while computing the book profit under Section 115 JB (Shree Umaid Mills Ltd vs CIT — 2007 17 SOT 72 JP; CIT vs Balarampur Chini Mills Ltd — 2007 14 SOT 372 Kolkata).

The Finance Bill, 2008 provides for retrospective amendment for adding the amount of deferred tax provision debited to P&L account and thereby nullifies the tribunal decisions.

Deemed satisfaction

While completing the assessment, the assessing officer (AO) must record his satisfaction about the concealment for levy of penalty. The amendment now says that it is sufficient if the order contains a direction for initiation of penal proceedings. Such remark in the assessment order shall be deemed as the AO being satisfied about the need for initiating penalty proceedings.

This amendment nullifies the decision in the CIT vs Ram Commercial Enterprises Ltd (2000 246 ITR 568 Delhi) case.

Reasons for reassessment

For issue of notice under Section 148, sanction must be obtained from the Joint Commissioner. In Dr Shashi Kant Garg vs CIT (285 ITR 158 Allahabad), it was held that the Joint Commissioner must issue the notice. Now the amendment proposed by inserting Explanation to Section 151(2) says that it is enough if the AO has recorded the reasons and the Joint Commissioner or the Commissioner is satisfied about the fitness of the case. The amendment, retrospectively applicable, nullifies the court decision.

Reassessment of pending appeal

Where the assessment is completed and pending before the appellate authorities, the AO cannot initiate reassessment proceedings even in respect of other matters. Now a proviso to Section 147 is proposed to be inserted to allow reassessment of the matters other than those which are in appeal, reference or revision.

In CIT vs Sakseria Cotton Mills Ltd (124 ITR 570), it was held that only the points on which the appeal is made would merge with appellate order and in respect of other matters the limitation would start from the date of original order.

In effect, reassessment in respect of uncontested issues might get time barred if the proceedings are initiated after the disposal by the appellate authority. To overcome this difficulty, the Finance Bill, 2008 proposes to empower the AO to reassess the income in respect of matters other than those which are subject to appeal.

Monetary limit for appeal

In Berger Paints India Ltd vs CIT (Civil Appeal Nos.1081 to 1083 of 2004) it was held by the apex court that in one case if the appeal is not made, on the very same issue in the case of any other assessee an appeal cannot be made. To nullify the decision a new Section 268 A is proposed to be inserted, whereby an appeal not filed for an assessment year is no bar for preferring an appeal in another assessment year or in any other case.

The aforementioned decisions are ones that have been nullified by the Finance Bill, 2008. Every year it has become routine to find some of the court decisions favouring the assessee being upset by the amendments, sometimes retrospectively and where it could not be backed by reasons, by means of deeming provisions.

E-payment of tax mandatory w.e.f 1-4-2008

No.402/92/2006-MC (05 of 2008)

Government of India / Ministry of Finance

Department of Revenue

Central Board of Direct Taxes

***

New Delhi dated the 23rd January 2008

PRESS RELEASE

The
optional scheme of electronic payment of taxes for income-tax payers was
introduced in 2004. With a view to expand the scope of electronic payment of
taxes, it is proposed to make the scheme mandatory for the following categories
of tax-payers:-

(i) All corporate assesses;

(ii) All assesses (other than company) to
whom provisions of section 44AB of the Income Tax Act are applicable.

2. The scheme of mandatory electronic
payment of taxes for income-tax payers is proposed to be made applicable from
1st April, 2008.

3. Tax-payers can make electronic payment
of taxes through the internet banking facility offered by the authorized banks.
They will also be provided with an option to make electronic payment of taxes
through internet by way of credit or debit cards.

What is the budget preparation process

The Budget process is a
massive exercise. The exercise has different stages and each stage
kicks off at a different stage of Budget making process.

The two sides of the Budget

Like our family budget, the nation's General Budget has two major parts: Revenue and Expenditure.

Assessing
the revenues from different central taxes is the primary function of
the Department of Revenue and the expenditure estimates for the current
and the next year for various expenditure heads are assessed by the
Department of Expenditure. The Department of Expenditure also assesses
the resources of the public sector undertakings (PSUs).

The
Budget division is a part of the Department of Economic Affairs. The
Finance Secretary coordinates the overall Budget-making process. All of
them keep the finance minister informed and seek directions from time
to time. The Chief Economic Advisor assists the concerned departmental
officer in this process.

1) Resources (Revenues) side

Leaving
aside the tax receipts, the other sources of the revenue which go into
the Budget are the dividends paid by the PSUs on the government
shareholdings, including the interim dividends and the capital receipts
on account of the divestment of the government share holdings.

• How the Budget affects the Sensex

Besides
external receipts on account borrowing from international agencies like
World Bank, ADB, etc, are also estimated and included in the assessment
of the gross budgetary resources of various programmes under various
ministries.

Resources of the public sector undertakings,
including their operating surplus and the borrowings by them, also
constitute an important component of the gross budgetary resources and
goes to fund their plan.

The general policy is to fund the plans
of the PSUs through their own resources except in some strategic and
economically vital areas where the budgetary support is provided based
on the recommendations of the Planning Commission.

This
assessment of the Internal and External Budgetary Resources(IEBR)
conducted by the Department of Expenditure forms part of the total plan
resources and is also reflected in the budget documents.

• Tax? 10 things to do before March 31

To
estimate the earnings of PSUs, the government invites CMDs or the
finance directors of the PSUs to the North Block. A joint secretary
level officer of the ministry of finance holds one-on-one meeting with
the PSU chairmen and estimates revenue.

He passes on the
information to Expenditure Secretary, who in turn, passes on the
information to Finance Secretary. This exercise starts usually in the
month of August/September. This revenue forms a part of plan
expenditure.

Now comes role of the ministries of the
government. Each ministry has a financial advisor. The financial
advisor is called by the ministry of finance and asked about the
expenditure of the amount allocated to his ministry. Generally,
ministries are not able to spend the allocated amount but some may
overspend as well.

Based on the inputs of different ministries
Revised Estimate (RE) is prepared. Revised Estimate means as to how
much is actually required by the ministry.

• India's 10 fastest growing cities

As
a part of the expenditure management, the government has issued
instructions to various ministries to adhere to the quarterly
expenditure schedule and to avoid bunching of the expenditure in the
last quarter.

Additional funds are also provided in the RE stage. Important is the estimates of the non-plan requirement for the next year.

Plan
allocations are to be provided by the Planning Commission later based
on the total gross budgetary support (GBS) indicated by the ministry of
finance. This exercise starts in the month of October-December.

As
is known, the Department of Revenue, the ministry of finance has two
boards -- Central Board of Direct Taxes (CBDT) and Central Board of
Excise and Customs (CBEC). By mid-January, these boards give the figure
of tax collection up to December 31. For remaining three months, tax
collection is assumed on the basis of previous trends.

The boards
also estimate the tax revenue expected in next financial year. The
integrity of the budget making depends on the realistic nature of these
estimates particularly in the face of the fiscal discipline imposed by
the FRBM Act.

It is a happy development in the past two or three years the estimates are generally not very wide off the mark.

2) Expenditure side

Parallel
to all this, the Planning Commission goes into stock-taking mode. It
starts meeting with individual ministries in the month of
September-October and reviews ongoing schemes of the ministries,
considers allocation for them, etc. It may decide to stop some ongoing
scheme or merge two similar schemes.

Thus, an estimate of Plan
Budget is prepared. The Planning Commission conveys to the ministry of
finance that it requires so and so amount to run planned schemes for
next financial year.

The finance minister and the Deputy Chairman
of Planning Commission discuss the demand in detail. This way Plan
Expenditure is ready. Different ministries are also asked to tell about
their fund requirement, which forms a part of budget estimate.

Side
by side, Department of Economic Affairs meets representatives of trade
unions, industry chambers, economists and other groups. In the
Budget-making exercise, suggestions of different stakeholders are kept
in mind.

FM has to decide with his team

By this
time, the finance minister is in a position to estimate as to how much
it will get through taxes and how much it has to spend in coming
financial year.

The finance minister has other constraints also.
He has to abide by FRBM Act and cut fiscal deficit. Keeping in mind all
these, the finance minister -- with his team -- decides whether some
new taxes should be levied to collect more tax, how to widen tax net in
order to earn more revenue. While doing so the suggestions from various
interest groups are duly taken into account.

GDP assessment

The
Department of Expenditure and the Department of Economic Affairs sit to
decide GDP assessment for next year. Generally, a nominal growth in GDP
is projected. Actual growth in GDP is nominal growth of GDP reduced by
inflation figure.

The Budget Speech of the FM

Now
comes the Budget Speech. It is fine-tuned to the last minute. Around
February 15, some of the Budget documents are almost ready and goes for
printing to a press located in North Block itself. Security agencies
cordon off the press and entry is almost prohibited.

The D-Day:
The finance minister delivers the Budget Speech in Parliament.
Normally, on February 28, the finance minister delivers the Budget
Speech in Lok Sabha. After which Budget documents are made available.

These are also put on the Web site www.finmin.nic.in.

However, 2008 being a leap year, this time the Budget would be presented to Parliament on February 29.

LIBOR, the London Interbank Offered Rate, is the most active interest rate market in the world. It is determined by rates that banks participating in the London money market offer each other for short-term deposits. LIBOR is used in determining the price of many other financial derivatives, including interest rate futures, swaps and Eurodollars. Due to London's importance as a global financial center, LIBOR applies not only to the Pound Sterling, but also to major currencies such as the US Dollar, Swiss Franc, Japanese Yen and Canadian Dollar.

LIBOR is determined every morning at 11:00am London time. A department of the British Bankers Association averages the inter-bank interest rate being offered by its membership. LIBOR is calculated for periods as short as overnight and as long as one year. While the rates banks offer each other vary continuously throughout the day, LIBOR is fixed for the 24 hour period. Generally, the difference between the instantaneous rate and LIBOR is very small, especially for short durations.

The most important financial derivatives related to LIBOR are Eurodollar futures. Traded at the Chicago Mercantile Exchange (CME), Eurodollars are US dollars deposited at banks outside the United States, primarily in Europe. By holding the deposits outside the country, US depositors are not subject to Federal Reserve margin requirements, allowing higher leverage of the funds. The interest rate paid on Eurodollars is largely determined by LIBOR, and Eurodollar futures provide a way of betting on or hedging against future interest rate changes.

Interest rate swaps are another significant financial derivative dependent on LIBOR. In an interest rate swap, two parties exchange sets of interest payments on a given amount of capital. Generally, one party will have a fixed interest payment, while the other will have a variable rate. The variable rate payment stream is often defined in terms of LIBOR. Interest rate swaps, and by extension LIBOR, are extremely important in providing a liquid secondary market for residential mortgages, which in turn allows lower interest rates on US mortgages.

While LIBOR does have implications for transactions conducted in Euros, the advent of the Euro has brought with it the creation of the Euribor. Conceptually similar to the LIBOR, the Euribor benchmark is defined and maintained by the European Banking Federation.

There is a paradigm shift in the pattern of the auditing question paper
of the professional competency course (PCC) compared to what it was in
the erstwhile professional education II (PE-II) course. Candidates are
required to answer all the questions as against six among the eight in
PE II.
‘True or false’ questions have been introduced. These cover a wide

range of topics and test the conceptual clarity of the candidates. The
students have to be careful as 20 marks are at stake and how well they
tackle this section can have a bearing on the overall result.

The focus continues to be on audit and assurance standards (AAS) and
company audit, with 57 marks earmarked to the two topics, at 38 and 19
respectively. Perhaps, this has been done keeping in mind the fact that
the candidates are writing the examinations after completing a certain
period of articled training.Thus, by the time they take the examination,
they would have (under normal circumstances) undergone considerable
amount of practicaltraining.

Question 1: Candidates have to answer 10 of the 12 ‘true or false’ questions — four of these are on AAS and six on company audit.

Question 2: This 20-mark question is on comments of the auditor with regard to AAS and it covers three different standards.

Question 3: This is on precautions to be taken in applying test
checks; a purely text-bookish question. The second part (Question
3(b)), on directors’ responsibility statement, might have taken the
candidates by surprise. Only those with practical experience could have
tackled this question comfortably.

Question 4: Part (a) of this question, on computer-aided audit

techniques, tests more the writing skills of the candidates. And part
(b), on differences between capital expenditure and deferred revenue
expenditure, would have lured many candidates, but the answer to the
question is not as simple as it appears.

Question 5: Divided into two parts, on inherent limitations of

internal control systems and special audit, this question would have
been handled easily by those used to rote learning.

Question 6: Part (a) of this question, on examining the income

and collections by an NGO, would have been a brain teaser. So is part
(b) of the query on AS 1, where there are about ten areas in which
different accounting policies may be encountered.

The candidates may, readily, have thought of depreciation and

valuation of inventories. And, at best, they may have recollected two
or three more. Going beyond six items at the PCC level is a tall order.

Question 7: This 10-mark question is on vouching/verification.

In the PE-II format, 16 marks were allotted to this topic. On the audit
procedures chapter, the opportunity to score marks has been reduced as
the paper has only a two-part question for five marks each as against
the usual four parts of four marks each. So is the case with Question 8
on short notes, where the marks allocated have been curtailed to 10
from the earlier 16.

The marks for certain topics, earlier considered to be the mainstay

of an auditing paper, such as EDP audit, government audit, audit of
specialised institutions such as educational institutions and hotels,
audit procedures of vouching and verification, have been reduced.

Overall, the question paper is balanced and has a wide coverage of

topics. Unless one is conceptually clear and has put in sufficient
amount of preparation for the examination, scoring high marks would be
difficult.

But those candidates who depended only on the study modules of the

ICAI and other academic publications would also have done
satisfactorily as a part of the paper is purely academic.

It is better the candidates adapt to the changed pattern and consider if their preparation methods warrant a change.

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DISTINCTION BETWEEN SHARES HELD AS INVESTMENTS AND THOSE HELD AS STOCK IN TRADE

Distinction between shares held as stock-in-trade and shares held as investment - tests for such a distinction

The Income Tax Act, 1961 makes a distinction between a capital asset and a trading asset.

2. Capital asset is defined in Section 2(14) of the Act. Long-term capital assets and gains are dealt with under Section 2(29A) and Section 2(29B). Short-term capital assets and gains are dealt with under Section 2(42A) and Section 2(42B).

3. Trading asset is dealt with under Section 28 of the Act.

4. The Central Board of Direct Taxes (CBDT) through Instruction No.1827 dated August 31, 1989 had brought to the notice of the assessing officers that there is a distinction between shares held as investment (capital asset) and shares held as stock-in-trade (trading asset). In the light of a number of judicial decisions pronounced after the issue of the above instructions, it is proposed to update the above instructions for the information of assessees as well as for guidance of the assessing officers.

5. In the case of Commissioner of Income Tax (Central), Calcutta Vs Associated Industrial Development Company (P) Ltd (82 ITR 586), the Supreme Court observed that:

Whether a particular holding of shares is by way of investment or forms part of the stock-in-trade is a matter which is within the knowledge of the assessee who holds the shares and it should, in normal circumstances, be in a position to produce evidence from its records as to whether it has maintained any distinction between those shares which are its stock-in-trade and those which are held by way of investment.

6. In the case of Commissioner of Income Tax, Bombay Vs H. Holck Larsen (160 ITR 67), the Supreme Court observed :

The High Court, in our opinion, made a mistake in observing whether transactions of sale and purchase of shares were trading transactions or whether these were in the nature of investment was a question of law. This was a mixed question of law and fact.

7. The principles laid down by the Supreme Court in the above two cases afford adequate guidance to the assessing officers.

8. The Authority for Advance Rulings (AAR) (288 ITR 641), referring to the decisions of the Supreme Court in several cases, has culled out the following principles :-

(i) Where a company purchases and sells shares, it must be shown that they were held as stock-in-trade and that existence of the power to purchase and sell shares in the memorandum of association is not decisive of the nature of transaction;

(ii) the substantial nature of transactions, the manner of maintaining books of accounts, the magnitude of purchases and sales and the ratio between purchases and sales and the holding would furnish a good guide to determine the nature of transactions;

(iii) ordinarily the purchase and sale of shares with the motive of earning a profit, would result in the transaction being in the nature of trade/adventure in the nature of trade; but where the object of the investment in shares of a company is to derive income by way of dividend etc. then the profits accruing by change in such investment (by sale of shares) will yield capital gain and not revenue receipt.

9. Dealing with the above three principles, the AAR has observed in the case of Fidelity group as under:-

We shall revert to the aforementioned principles. The first principle requires us to ascertain whether the purchase of shares by a FII in exercise of the power in the memorandum of association/trust deed was as stock-in-trade as the mere existence of the power to purchase and sell shares will not by itself be decisive of the nature of transaction. We have to verify as to how the shares were valued/held in the books of account i.e. whether they were valued as stock-in-trade at the end of the financial year for the purpose of arriving at business income or held as investment in capital assets. The second principle furnishes a guide for determining the nature of transaction by verifying whether there are substantial transactions, their magnitude, etc., maintenance of books of account and finding the ratio between purchases and sales. It will not be out of place to mention that regulation 18 of the SEBI Regulations enjoins upon every FII to keep and maintain books of account containing true and fair accounts relating to remittance of initial corpus of buying and selling and realizing capital gains on investments and accounts of remittance to India for investment in India and realizing capital gains on investment from such remittances. The third principle suggests that ordinarily purchases and sales of shares with the motive of realizing profit would lead to inference of trade/adventure in the nature of trade; where the object of the investment in shares of companies is to derive income by way of dividends etc., the transactions of purchases and sales of shares would yield capital gains and not business profits.

10. CBDT also wishes to emphasise that it is possible for a tax payer to have two portfolios, i.e., an investment portfolio comprising of securities which are to be treated as capital assets and a trading portfolio comprising of stock-in-trade which are to be treated as trading assets. Where an assessee has two portfolios, the assessee may have income under both heads i.e., capital gains as well as business income.

11. Assessing officers are advised that the above principles should guide them in determining whether, in a given case, the shares are held by the assessee as investment (and therefore giving rise to capital gains) or as stock-in-trade (and therefore giving rise to business profits). The assessing officers are further advised that no single principle would be decisive and the total effect of all the principles should be considered to determine whether, in a given case, the shares are held by the assessee as investment or stock-in-trade.

12. These instructions shall supplement the earlier Instruction no. 1827 dated August 31, 1989.

(F.No.149/287/2005-TPL)

SOLUTION TO NOVEMBER 2007 – AUDIT PAPER

Situation analysis

Q1(a): A company has debited Rs 1.75 lakh to Delivery Van Account received from a customer against credit sales of Rs 1.5 lakh to him who is not able to pay the amount. The delivery van has not been registered in the name of the company with R.T.O. till the date of finalisation of accounts.

Since the vehicle is a movable property, it is governed by sale of goods Act, wherein title in goods passes on delivery.

In the instant case, when the company received the delivery van from the debtor, title passed on to the company since he would have signed on the necessary documents. Registration of the delivery van is merely to further secure the title in the name of the company.

Therefore, the company is justified in debiting the delivery van account on receiving it, the fact that it was not registered in its name notwithstanding.

When the sale was for Rs 1.5 lakh, debiting the delivery van with the same amount would appear reasonable.

As per AS 10, in case of exchange of assets, the company can value the asset at the value of the old asset or the new asset, whichever can be determined with reasonable accuracy.

Thus, if the delivery van was valued at Rs 1.75 lakh by an independent expert (such as an automobile engineer), it would be justified in debiting the van with the same amount.

In such a situation, the difference of Rs 25,000 should be treated as profit and taken to profit and loss account and the company can charge depreciation on Rs 1.75 lakh.

Q1(b) PQ Ltd has given donations of Rs 50,000 each to a charitable school and a trust for blinds during the year ended March 31, 2007. The average net profit of the company during last three financial years amounts to Rs 12 lakh. The Companies Act places certain restrictions on donations to political parties.

These restrictions are not applicable to donations made to non-government organisations such as those mentioned in the question.

Therefore, the company has not made any violation in making such donations.

Q1(c): AAS Ltd had provided for doubtful debts to the extent of Rs 23 lakh during the year 2004-05. The amount since had been collected in the year 2006-07. Another debt of Rs 25 lakh had been identified to be doubtful during the year 2006-07. The company made an additional provision of Rs 2 lakh during the year. The profit and loss account for the year ended March 31, 2007 disclosed in debit side — provision for doubtful debts Rs 2 lakh.

Collection of doubtful debts provided in earlier years has no relevance to the debts of current year being identified as doubtful. They belong to two accounting periods. The provision of Rs 23 lakh made in the year 2004-05 should be written back since it is no longer required. A fresh provision of Rs 25 lakh is to be made for the current year.

Setting off the provision of an earlier year against a provision to be made for the current year vitiates the true and fair view of the profit and loss account.

In the given question, the entry made by the company does not portray the information about collection of debtors pertaining to 2004-05 and that further Rs 25 lakh are identified doubtful in the current year. Therefore, the entry passed by the company is not acceptable.

Q1(d): Alagar Ltd is a company engaged in the business of chassis building and bus transportation services. It accounts all expenses and income in profit and loss account under various heads explaining clearly the nature of operations. The auditor of the company requires that the profit and loss account should depict the profit or loss from the businesses of assembly as well as of operation of bus services separately.

Preparation and presentation of the financial statements is the responsibility of the management. The auditor merely expresses an opinion whether or not the financial statements give a true and fair view of the financial position of the entity.

Provisions of the Company Law require every company to maintain its accounts so that profit or loss can be determined. AS 17 on segment reporting also requires companies to report on activities of various segments as an additional information. There is nothing in the Companies Act or in Accounting Standard that requires the profit and loss account to depict separately profit or loss from different activities.

Thus, the auditor requiring the company to depict the profit or loss from the businesses of assembly as well as of operation of bus services separately is not justified.

SOME Comments

2(a): Seeman & Co had been the company auditor for Amudhan Company Ltd for the year 2006-07. The company had three branches located at Chennai, Delhi and Mumbai. The audit of branches in Chennai, Delhi were looked after by the company auditors themselves. The audit of Mumbai branch had been done by another auditor M/s Vasan & Co, a local auditor in Mumbai. The branch auditor had completed the audit and had given his report too. After this, but before finalisation, the company auditor wanted to visit Mumbai branch and have access to the inventory records maintained at the branch. The management objects to this on the grounds of the company auditor is transgressing the scope of audit areas agreed.

The Auditor of a company has certain statutory rights under the Companies Act, which can not be restricted by the company or the directors. Such rights include right to visit the branches in India and right to access records of the company.

The fact that the branch is audited by another auditor cannot be a reason for restricting the statutory auditor from visiting the branches. The auditor enjoys independence in deciding the nature, extent and timing of audit procedures to be carried out. In the given question, the company cannot say there is any transgression of the scope of audit. Hence, the company is not justified in saying so.

2(b): AB & Associates, the auditor of Ajanta Ltd refused to deliver the Books of Account of the company, which were given to them for the purpose of audit, as the audit fees is not paid to them in full.

The provisions of auditors lien state that the books of account should come to the auditor in the normal course and that he cannot resort to unfair means to secure the books of account on lien.

He can exercise lien on those books on which the work was carried out for which remuneration was receivable. Board of directors should pass a resolution to that effect and deliver the books of account to the auditor. The auditor in the given case is not justified in refusing to return the books of account with him on the ground that audit fees is not paid in full. Since the books of account were still with him it indicates that the books of account pertain to the current year. Fees for the current year becomes payable after the completion of the audit. Current year books cannot be retained for non payment of fees of an earlier year.

2(c): Mr A was appointed as auditor of X Ltd for the year ended March 31, 2008 in the AGN held on August 16, 2007. Mr A had indebted to the company for a sum of Rs 2,500 as on April 1, 2007, the opening date of the accounting year which had bee subject to his audit. Upon learning that he might be appointed as the auditor, he repaid the amount on August 14, 2007. Mr B, a shareholder complained that the appointment of Mr A as auditor was invalid and he incurred disqualification under Section 226 of the Indian Companies Act 1956 and his independence had been vitiated in relation to the accounting year of his audit. The Section 226 states any indebtedness of an amount exceeding Rs 1,000 as a disqualification to be appointed as an auditor.

In the given question, the auditor has repaid the amount before he was appointed as auditor of the company. As on the date of his appointment, he does not have any disqualification.

An auditor is appointed at the AGM from the conclusion of one AGM to the completion of the next AGM and not for the year ended March 31, 2008. Therefore the contention of Mr B is invalid.

2(d): The financial controller of AS Ltd refuses to provide for proposed dividend in books of accounts for the year ended March 31, 2007 on the ground that it is pending approval of shareholders in Annual General Meeting to be held on September 16, 2007.

The Section 205 dealing with dividends requires that the dividends be proposed by the board of directors and declared at the AGM by the shareholders. The dividends declared by the shareholders cannot be more than the dividends as proposed by the board of directors

Once the board of directors propose dividends, the same is to be declared by the shareholders. Such dividends are to be paid out of the profit made by the company for the year ended March 31, 2007. Therefore, it is proper to make the provision for such dividends.

Declaring of dividends is an event occurring after on the date of the balance sheet, which confirms a situation existing as on the date of balance sheet.

AS 4 on events occurring after the date of balance sheet classifies such events as adjusting events and non-adjusting events. Declaring of dividends is an adjusting event, for which a provision is to be made in the accounts. For the same reason proposed, dividends merely appear as a provision (item no 9 under the head current liabilities and provisions) and not as a current liability. It assumes the nature of a current liability once the dividends are declared at the AGM. Therefore, the contention of the financial controller is not justified.

HINDU-MENTOR

Bos/Ancmnet/Srvc-tax/227/41/2007 August 3, 2007

Sub: Guidelines to the students appearing in Professional Competence Examination and Final

Examination to be held in November, 2007

Professional Competence Examination

Paper 5: Taxation, Part –II Service Tax and VAT

It is clarified that in Part –II : Service Tax and VAT of Paper 5 : Taxation, students will not be tested on

specific questions covering individual taxable services.

Final Examination (Old Course)

Paper 8 : Indirect Taxes

It is clarified that in respect of taxable services covered in the syllabus of Paper 8 : Indirect Taxes, students

will be examined only in respect of the following taxable services:

.. Intellectual Property Services

1. Franchise services

2. Intellectual property services

.. Financial services

3. Banking & other financial services

4. Credit rating agency’s services

5. Stock broking services

.. Transport of goods services

6. Goods transport agency’s services

7. Courier services

8. Mailing list compilation and mailing services

9. Transport of goods by air services

10. Clearing and forwarding services

11. Cargo handling services

12. Customs house agent’s services

13. Storage and warehousing services

14. Transport of goods through pipeline or other conduit

15. Transport of goods in containers by rail by any person, other than government railway

.. Professional Services

16. Practising chartered accountant’s services

17. Management or business consultancy services

18. Consulting engineer’s services

19. Scientific and technical consultancy services

20. Technical testing and analysis services

21. Market research services

22. Opinion poll services

23. Public relations services

.. Real estate & infrastructure services

24. Construction services in respect of commercial or industrial buildings or civil structures

25. Construction services in respect of residential complexes

26. Architect’s services

27. Real estate agent’s services

28. Site preparation and clearance, excavation, earthmoving and demolition services

29. Interior decorator’s services

.. Business services

30. Business auxiliary services

31. Business support services

32. Manpower recruitment or supply agency’s services

Director of Studies

Q: What is a weather derivative?

A: It's a financial instrument that seems like an insurance policy but is more like an option. Most weather derivatives are based on how much the temperature goes above or below 65 degrees. But weather derivatives can be based on anything measurable.

Q: An example of weather derivative

A: A ski area could pay a $250,000 premium to collect, say, $100,000 for every inch of snow this winter under the "strike" amount of 100 inches. This is like a "put" option. The ski area is out the premium whether or not snowfall is inadequate. Or, it could enter into a "swap" with another party, paying no premium and getting $100,000 for every inch under 100 and paying $100,000 for every inch over. Increased ticket sales in good winters would cover the cost.

There is also a "call" option where the ski area receives a premium of $250,000 and pays $100,000 for every inch over the strike 100 inches, again assuming higher revenue with heavy snowfall.

Q: Why would anyone assume financial risk by taking the other side?

A: Some are speculators. They believe they understand the probabilities of weather and are willing to wager just as a football fan might bet against a football team because he believes the quarterback is injured. But most parties take the other side of a weather derivative because they also are hedging. Cities, for example, might want to hedge against heavy snowfall because of the cost to clear the streets.

Q: What makes a weather derivative different than other derivatives?

A: All derivatives are used to hedge against bad news. Airlines use derivatives to protect against soaring jet fuel prices. Derivatives are commonly used to avoid fluctuations in interest rates or foreign currencies. What makes weather derivatives unique: They are not derived from anything with an underlying value.

Q: How big is the weather derivatives market?

A: Not very. The first wasn't sold until 1997. It has grown to $12 billion and there are signs that some small companies are interested. Last June, the Rock Garden in London became the first restaurant to hedge against the cool weather that keeps customers from populating its outdoor tables. Aquila predicts $50 billion in weather derivative contracts by 2005, while the value of all derivatives traded worldwide is $100 trillion.

Q: Are there problems with weather derivatives?

A: Small fortunes can ride on weather instruments that are fallible. Gauges have gone unfixed for years. The National Weather Service sometimes moves instruments, and we've all seen rainstorms that hit on one side of the street but not the other. Unlike insurance, which spreads premiums and risks over time, derivatives are one-shot, risky deals that create big winners and losers in a hurry. It looks ripe for lawsuits, but traders say that hasn't been the case. Also, financial markets need simplicity to trade in large blocks, but weather derivatives usually need to be customized to individual needs.

Computing the income chargeable to tax as per the provisions of the Income-Tax Act, 1961 is the first step in tax compliance. The natural sequence thereafter would be filing the return of income and awaiting approval of the tax authorities in respect of the income returned by means of an assessment order.

Section 139 (1) enjoins on all corporate and partnership firms to file return of income whether or not they have income or loss. In the case of other assessees i.e., individuals, HUFs etc., the return of income has to be filed only if the income exceeds the prescribed basic limit.

This write-up discusses the scrutiny procedure prescribed by the Central Board of Direct Taxes (CBDT) for the current financial year and the related issues.

Legal provisions

As per Section 143 (1) if any tax or interest is due, an intimation is required to be issued to the assessee. Similarly, where there is any refund due on the basis of return filed by the assessee, an intimation is required to be issued by the Assessing Officer (AO). The time limit for giving intimation is one year from the end of the financial year in which the return was filed. For example, for the assessment year 2006-07 if the return is filed on June 5, 2007, the time limit for giving intimation under Section 143(1) is available up to March 31, 2009.

Where the AO believes that the claim of loss, exemption, deduction, allowance or relief in the return is inadmissible or if he considers it necessary to ensure that the assessee has not understated his income, a notice under Section 143 (2) would be issued for verifying the books of account and other relevant documents and evidences. The culmination of this exercise would be scrutiny assessment envisaged in Section 143(3).

The time limit for service of scrutiny notice is 12 months from the end of the month in which the return was filed by the taxpayer. The time limit for completing the assessment is 21 months from the end of the assessment year in which the return was first assessable.

For the assessment year 2007-08 if the return is filed after June 1, 2007 the time limit for completing scrutiny assessment would expire after December 31, 2009. The time limit for issuing intimation under Section 143(1) for non scrutiny cases, however, is available up to March 31, 2010 (i.e.2 years from the end of the financial year in which the return was filed).

The CBDT instruction

The CBDT has given norms for current fiscal for selection of cases meant for scrutiny.

For corporates: All banks and public Sector undertakings are liable for scrutiny. Also, all NSE-500 companies and BSE-A group companies listed in Bombay Stock Exchange as on March 31, 2007, are covered. Companies in Delhi, Mumbai, Chen nai, Kolkata, Pune, Hyderabad, Bangalore and Ahmedabad paying book profit tax under Section 115 JB on the book profit of Rs 50 lakh and above are liable for scrutiny. In the case of companies in other places the monetary limit for book profit is Rs 25 lakh.

All non-banking financial corporations and investment companies having paid up capital of Rs 10 crore are covered. Companies who have amalgamated and seeking set off of loss under Section 72 A are also to be scrutinised. Where the fresh capital introduced is Rs 50 lakh during the year such assessees are liable for scrutiny assessment.

For non-corporates: If the fresh capital introduced exceeds Rs 50 lakh in respect of cases in Delhi, Mumbai, Chennai, Kolkata, Pune, Hyderabad, Bangalore and Ahmedabad are liable for scrutiny. In respect of other places the monetary li mit for fresh capital introduction is Rs 10 lakh for scrutiny selection.

Where the unsecured loans introduced during the year exceeds Rs 25 lakh, such case is also covered. All market committees and statutory bodies are liable for compulsory scrutiny. Professionals with gross receipts of Rs 20 lakh or more but the income returned is less than 20 per cent are liable for scrutiny of their cases.

Common to all taxpayers

The following criteria apply for all the taxpayers regardless of their status.

All search and seizure cases and surveys conducted under Section 133 A.

Cases where deduction under chapter VI-A exceeds Rs 25 lakh.

Cases were the CIT or ITAT has confirmed addition or disallowance of Rs 5 lakh or above in an earlier year and the identical issue arising in the current year.

All cases in which the appeal is pending before CIT or pending before ITAT in respect of appeal preferred by the Department relating to addition or disallowance of Rs 5 lakh and the identical issue arising in the current year.

Charitable trusts claiming exemption under Section 11 with gross receipt exceeding Rs 5 crore in 8 cities viz Delhi, Mumbai, Chennai, Kolkata, Pune, Hyderabad, Bangalore and Ahmedabad. For other places the monetary limit is Rs 1 crore.

Educational institutions, hospitals (being non profit organisations) with aggregate receipt exceeding Rs 10 crore (including corpus donations) in 8 cities and Rs 5 crore in other places. However, it will not apply to those which are su bstantially financed by the Government.

All cases where the total value of International Transactions for the year exceeds Rs 15 crore.

Stock brokers and commodity brokers where the brokerage exceeds Rs 1 crore.

Stock brokers and commodity brokers including sub-brokers if the bad debt claim is Rs 5 lakh. For corporates, if the bad debt claim is Rs 10 lakh or more it will be liable for scrutiny.

All cases where deduction under Sections 10A/10B/10BA/10AA exceeds Rs 25 lakh.

Contracts (other than transporters) whose contract receipt exceeds Rs 1 crore and the income declared is less than 5 per cent of gross contract receipts.

Loss from house property if more than Rs 2.50 lakh.

Investment in property is more than 5 times the gross income (including agriculture and other exempt incomes).

Short-term capital gains covered under Section 111A and long-term capital gains exceeding Rs 25 lakh.

Sale of property as per AIR return but no capital gain declared in the return of income.

Commission paid during the year if more than Rs 10 lakh.

Real estate business with gross turnover of Rs 5 crore.

Business of hotels/tour operators with gross turnover exceeding Rs 5 crore but the net profit is less than 0.05 per cent.

All cases where depreciation claimed at the rates of 80 per cent and 100 per cent is more than Rs 25 lakh.

All cases where the net agricultural income is more than Rs 10 lakh.

Deduction under Sections 80-IA (4), 80-IB, 80-IAB, 80-IC, 10(23C), 10A, 10AA, 10B or 10BA is claimed for the first time. All returns filed in response to notice under Section 148 shall be liable for scrutiny.

Some issues

While above the parameters set for selection of cases for scrutiny is welcome, there is no general exemption or relief from scrutiny for admitting higher income by the taxpayers.

For example, if the taxpayer admits 30 per cent more than the previous year income still he can be subjected to scrutiny assessment if any transaction therein is covered by the above-said criteria. Indiscriminate issue of Section 148 notice and thereby subjecting the taxpayer to scrutiny assessment is possible. Necessary safeguards have to be introduced for preventing its misuse.

Currently, even exempted entities and taxpayers with below taxable income do not get exemption certificate from AO without going through the rigours of approval from the Joint Commissioner. While justification of such bureaucratic measures remains on one side, the difficulties of the small assessees require objective consideration.

At present, approval of scrutiny draft orders by the higher authorities delays the completion of assessment and causes hardship to the taxpayers. The AO who is empowered to make assessment in law must be permitted to complete the assessment without procedural bottlenecks. The administrative delay could be reduced by fixing the responsibility on the AOs wholly and solely for completing the scrutiny assessments.

If the AO chooses a case for scrutiny deviating from the norms fixed by the Board then the assessee can challenge the selection of case by means of a writ. There is no provision within the statute book for preventing the AO from proceeding further. However, even after the completion of assessment it could be challenged. Favourable decisions could be found in Nayana P. Dedhia vs Asst. CIT (86 ITD 398); Bombay Cloth Syndicate vs CIT (214 ITR 210) and CIT vs Savoy Enterprises Ltd (211 ITR 192). Contrary decision could be found in Setalvad Brothers vs M.K.Meerani, Addtl. CIT (253 ITR 530)