Investigation Manual

Techniques of Investigation for Assessment, Volume 2 Chapter 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Heading Engineering Industry Cotton Textile Industry Handloom And Powerloom Process House Woollen Mills Woollen Hosiery Industry Woollen Carpet Industry Packaging Industry Automobile Industry Bicycle Industry Power And Energy Ship Breaking Industry Road Transport Shipping Lines Medical Profession & Nursing Homes Other Professions Hospitality Industry Travel And Tour Industry Charitable Trusts And Institutions Educational & Coaching Institutes

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Computer Training Institutes Expert group constituted by CBDT Acknowledgments Directortate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter - I ENGINEERING INDUSTRY Introduction 1.1 According to Websters dictionary (1961 Edition), the word Industry means (i) systematic labour especially for the creation of value, (ii) a department or branch of craft, art, business or manufacture, a division of productive and profit-making labour especially one that employs a large personnel and capital in manufacturing, and (iii) a group of productive or profit making enterprises or organizations that have a similar technological structure of production and that produce or supply technically substitutable goods, services or sources of income. This definition has been referred to by the Honble Supreme Court in the case of

Harakchand Ratanchand Banthia V/s Union of India 1969 (SCC) 166. 1.2 Industrial sector - Industrial sector consists of five sub-sectors as under

Procurement and processing of raw material Manufacturing and production Mining and quarrying Electricity, energy, gas and water supply Engineering Industry

1.3 Source of output / value added data - There are five distinct sources of output/value-added data of the industrial sector NAS National Accounts of Statistics - compiled and published by Central Statistics Organisations II P Index of Industrial Product - prepared by Department of Industries (Govt. of India) ASI Annual Survey of Industries - Governmental Survey RBI Bulletins Published by Reserve Bank of India after survey of Industries. CMIE Surveys of different Industrial sectors published by Centre for Monitoring Indian Economy. 1.4 Production process - It is necessary for an AO to have an overview of the production process, for being able to make basic judgments of the various claims being made

before him. For this, he must have information on the following points

Product types, varieties Manufacturing process Number and levels of workers involved in manufacture Input-output ratios Capital investment per unit of production of main items Physical measures / value of output, installed capacity and its utilisation, etc.. Type / level of technology / automation. Profitability ratios.

Engineering industry 2.1 Engineering Industry has a very wide reach and coverage - in terms of the variety of products, the level of technology, the size / capacity, geographic dispersal, and levels of employment potential. Some of the main products of this Industry are

Electric motors Automobile and auto parts manufacturing machines Hand tools manufacturing machines Mathematical instruments Locomotive machineries Machinery related with ships and aircrafts Bicycles, motorbikes and auto cycles Auto Rickshaws, tempos etc.

Boilers and steam generating plants Steam engines, turbine and internal combustion engines Electrical machines and appliances manufacturing machines Tele-communication equipment machinery Radio and electronic equipment machinery T.V., A.C, refrigerator, wireless, mobile phone manufacturing machines Electric wire and cable producing machines Machines used for production of bolts, nuts, rivets and washers Jute, textile and netting machinery Batteries manufacturing machines Railway coaches and wagons manufacturing machinery Mechanical pumps machinery Earth moving machinery Harvester machinery Bright steel bars and shafting machinery Steel melting works machinery Steel rolling mills machinery Household goods manufacturing machines Power-driven pumps

The National Industrial Classification Code1998 (NIC) gives descriptive classification of groups, class, sub-class of engineering Industries. This is available in the market, under Central Excise Classification / Valuation publications. Basically, the Engineering enterprises are

classified as Heavy engineering enterprises and Light engineering enterprises. 2.2 Heavy engineering enterprises - Heavy engineering enterprises are basically industries producing machines, heavy vehicles, motors, etc. For example, Larson and Toubro, Bharat Heavy Electricals Ltd., Hindustan Aeronautical Ltd., Bharat Engineering Works, Hindustan Machine tools. These are capital intensive, their ownership patterns vary and their gestation periods are large. They can be in Public or Private sector. 2.3 Light engineering enterprises - Light engineering enterprises are mainly those industries which produce common consumer / engineering goods, with or without sophisticated technology. These can be industries producing marketable products with independent manufacturing units, or ancillary industries dependent upon other big industries manufacturing engineering machinery, goods, etc.. Some examples of these are

Watch manufacturing units Rerolling units Steel rods and sheets manufacturing units Metal Box industry Container manufacturing units Bucket producers Hurricane lanterns manufacturers Stove manufacturers Cycle and automobiles parts manufacturers Bearing manufacturers Small pumps producers

Hand set pump producers Diesel oil engine manufacturers Sheet metal parts manufacturers Rubber based industries Plastic components manufacturers Small industrial machinery manufacturers

and

parts

Manufacturing process 3.1 Raw materials - Engineering industries include a large number of industries, producing a variety of goods. The exact raw material used by a particular industry will depend upon the finished goods it is producing and the technology it is using. Therefore, it is necessary to ascertain the particulars of the raw materials being used and the source of their supply in a given case. A broad classification of the engineering industries, in terms of their finished products can be as under:

Industries using basic metals, alloys and steel products. Industries using tin plates, tin bars, galvanized plates, & iron sheets. Industries using nonferrous metal and alloys. Industries using copper, zinc and lead. Metal products industries, like producer of wire nails, nuts, bolts, spanners, utensils, razor blades, wire ropes. Non-electrical machinery industries which produce machines for mining, cotton textile, jute mills, sugar mills, cement, pulp and paper, earth

movers, tractors, machine tools, typewriters, calculators, sewing machines, ball bearings, compressors, batteries etc.. Industries which manufacture electric machinery, appliances, instruments etc., switch gear and control gear, transformers, electric fan, electric lamp, electric motor, electric wires and cables. Electronic industries which include manufacturers of radio sets, photo camera, X-rays machine, sonography machine, T.V. sets, mobile phone sets, wireless, transmitters, computer and related equipments. Transport equipment manufacturing industry, which includes the automobiles industry - cars, trucks, three wheelers, two wheelers, buses, motorcycles, cycles and their equipments and parts. Other industries, manufacturing items like watches and clocks, house service meters, scientific instruments, surgical instruments, asbestos brake lining, grinding wheels etc..

The basic raw materials and components are procured from definite sources which might be a steel plant, an aluminum plant or other large plants making various grades of metals. At times these raw materials are procured from open market from traders. The quantity details of the consumption of raw material and its opening and closing Stock can be available if records are maintained methodically. The range of wastage and process losses in a particular type of Light Engineering

Industry can be determined and compared with other units in the same line of business using similar raw material and technology. 3.2 Manufacturing - It is essential for an AO to have full knowledge of the manufacturing process in a given case. Without this, he will not be able to judge the reasonableness of the production results, yield, burning losses, shortages and the input : output ratio. Some of the heavy engineering Industries involve complicated manufacturing process. Similarly, some light engineering industries may also have complex activities of manufacturing. There would not be a common manufacturing process because of the varieties of the industries and their products. However, some steps of manufacturing process may be common. An Assessing Officer will have to comprehend full details of manufacturing process in a given case. While going through the whole process one has to be clear about the technology and quality of machinery used by the assessee. If a manufacturing unit employs latest technology using sophisticated manufacturing process, it would be able to process the raw material and consumables in a more efficient way giving better production in terms of quantity as well as quality, as compared to a unit which employs a labour-intensive, out dated technology or older technology. The exact manufacturing process will vary from industry to industry. An overview of the manufacturing process in some of the major engineering industries is given in succeeding paragraphs.

Electric motors 4.1 Electrical motors can be either of DC type or AC type. The AC motors can also be either single phase or three phase. Single phase AC motors can again be of several different types, depending upon their usage, as under Split-Phase - Owing to their high starting currents, splitphase motors are generally used for loads of low inertia and frequent starting. Where a higher starting current can be tolerated, motors of the higher torque rating can be used. Capacitor-Start Induction-Run - These motors, having higher starting torques and low starting currents than splitphase motors, are more suitable for loads of higher inertia and more frequent starting. Capacitor-Start Capacitor-Run - These motors have characteristics similar to capacitor-start induction-run motors, but are useful when greater degree of quietness or a higher efficiency and power factor are desired. Capacitor-start and Run - These motors are useful where low starting torques are acceptable. They are also generally quieter than split-start induction-run motors. Shaded-Pole - These motors are suitable for all applications where only very low starting torque is required and motor efficiency is unimportant. Universal - These motors are series-wound or compensated series-wound, which may be operated either on direct current or single-phase alternating current at approximately the same speed and out-put, and are suitable for applications where speeding up on light loads

is desirable. In these motors, it is possible to get gradually high speed. Therefore, they are suitable for domestic mixers, grinder juicers, sewing machines, domestic monoblock pumps etc.. Capacitor-start Induction-Run, and Capacitor-Start Capacitor-Run motors are mainly used by the cottage industries, for domestic mono-block pumps, domestic grinders, washing machines, air conditioners, exhaust fans, bore-well pumps, cooking Chula, water cooler, air cooler, refrigerator, etc.. Due to such wide applications, there is big market of these motors. Indian Standard specifications for single phase small AC and Universal Electric Motors IS: 996-1964 have been issued by Indian Standard Institution. Testing guide lines, 7572-1974 are also published by the ISI. Separate publications are also published by the ISI for special purpose motors. 4.2 There are three main types of 3-Phase motors, viz Squirrel Cage Induction Motors, Slipring Electric Motors, Synchronous Electric Motors. These have their own advantages and disadvantages. Industries select the motors as per their applications / sustainability. SSI Units manufacture mostly upto to 10 HP motors. Motors below 10 HP are mainly in Squirrel cage only. The Squirrel cage motor has two main parts, i.e. stator and rotor. These are made from laminations (stampings). The stator has 24 to 36 slots. Depending upon the requirements of speed of motor, manufacturers wind the stators with enameled copper wire. These motors are made of copper bars threaded through slots in a laminated rotor core, with their ends short - circuited with short ring. Some manufacturers

use aluminum die cast rotor. Generally, most of the SSI units procure these die cast from lamination manufacturer or get these made on job basis from die cast industries. 4.3 The various stages involved in manufacture of motors can be listed as under

Casting enclosures of motor with the help of patterns. Machining of motor body. Machining of motor side cover. Machining of motor shaft. Machining of motor shaft-rotor. Grinding of motor shaft-rotor. Drilling all parts of enclosures. Binding stator lamination on press. Fixing of stator inside body on press. Winding coil from super enameled wire. Cutting the insulation paper. Fixing insulation paper in slot of stator. Inserting coil in stator slots. Winding coil connection. Winding pre-heating at 120 C in oven for 1 hr. Winding high voltage insulation test. Winding varnishing. Varnish curing in oven at required temperature. Fixing bearings on shaft. Assembling the motor. Routine or type testing of motor. Terminal connections. Colour processing

Registration and labeling.

Central air conditioning plants 5.1 Central air conditioning plants comprise of compressors, condensers, air-handling units, water chillers and cooling towers. It also includes pumps, gauges, ducts, and cables. The compressors used in vapour compression plants are of three types:

Reciprocating Compressor. Screw Compressor. Centrifugal Compressor.

All or some of these parts may be manufactured in-house, and remaining purchased from outside sources for assembling. Batteries 6.1 Battery is a power generating device which converts stored chemical energy into work of an electrical nature. There can be Primary batteries (which are not rechargeable, and are used in electronic equipments); and, Secondary Batteries (which are electrically rechargeable, eg., Lead Oxide and Nickel Cadmium). Bearing industry 7.1 Bearing industry has grown up substantially in Saurashtra, North India and Bangalore region. Bearings facilitate the relative motion of metal surfaces in contact, with limited consumption of energy. This lowers the friction and thereby the energy required. The roller bearings

consist of an inner ring, an outer ring, a cage, and rolling elements. Roller bearings are divided according to the type of the roller as under:

Taper Roller Bearings Cylindrical Roller Bearing Needle Roller Bearings Spherical Roller Bearings

7.2 Roller bearings are different from ball bearings. Ball bearings have higher limiting speeds than roller bearings. Manufacturing of bearings comprises of following stages:

Inner recess Outer recess Rollers Cages Assembly, and Technical inspection

Inner recess involves face grinding, large outer-grinding, bore-grinding, side-cut rough grinding, side-cut finish grinding, track rough / finished grinding, dimensional and visual assembly. At the time of final assembly, a technical inspection is made to check the bore and outer dimensions; the height of Taper roller bearing ; the radial run of outer race with reference to stationary inner race ; and, the perfection of contact angle between rolling elements and the recess. Gears

8.1 Earlier most of the gear manufacturing machines were based on conventional technology but now gear engineering and gear motors manufacturers have switched over to CNC versions. The latest CNC version machines are being imported, and work on 3-axis control. Now a days zero error gear motors are being manufactured which need higher kinematics. Electronic typewriters 9.1 The main components of electronic typewriters are

Mother board or Logic board Printer unit Paper service group Keyboard, and Power supply unit.

The mother board is the main controller for all operation. It has a chip known as micro processor, which does this job. The memory unit is utilised to store text which are of frequent usages. Control of various government departments 10.1 Various engineering industries come under the statutory control of various different departments, e.g., Central Excise, Sales Tax, Pollution Control, Factory Inspector, Industries, Labour, Consumer, Weights & Measures, Electricity Boards, Fire safety, Octroi, etc.. Besides, they have dealings with banks and financial institutions

10.2 Information furnished to these departments can be a good source for the AO. For example, an industrial gas producing unit might be disclosing a lower yield ratio in its books, whereas in the project report submitted to the Pollution Control Department or Energy Department or District Industry Center, it might disclose the actual yield. Similarly, information given to banks may be materially different from that given in the books of accounts. 10.3 Industrial laws applicable to engineering industries - Engineering industries are subject to several important industrial legislation relating to safety, labour welfare, consumer welfare, quality control, etc.. Some times actions under these laws by the concerned departments can give important clues to the Assessing Officer. Some of these central laws are as under

Industrial Disputes Act, 1947 Factories Act, 1948 Fatal Accidents Act, 1855 Apprentices Act, 1961 Boilers Act, 1923 Contract Labour (Regulation and Abolition) Act, 1970 Dock Labourers Act, 1934 Dock Workers (Regulation of Employment) Act, 1948 Employees Provident Funds and Miscellaneous Provisions Act, 1952 Employees State Insurance Act, 1948 Equal Remuneration Act, 1976

Industries (Development and Regulation) Act, 1951 Interstate Migrant Workmen Act, 1979 Maternity Benefits Act, 1961 Mines Act, 1952 Minimum Wages Act, 1948 Payment of Bonus Act, 1965 Payment of Gratuity Act, 1972 Payment of Wages Act, 193 Plantations Labour Act, 1951 Trade Unions Act, 1926

Most of these laws have a direct relevance for the assessment proceedings. For example, Factories Act 1948 imposes certain obligations and responsibilities on the occupier of factory. As per section 7 of this Act occupier shall, at least 15 days before he begins to occupy or use any premises as a factory, send to the Chief Inspector a written notice containing name and situation of factory, name and addresses of occupier and owner of the premises, nature of the manufacturing process carried on in the factory, total rated horse power installed in premises, name of the manager of the factory, number of workers likely to be employed, average number of workers per day employed and other particulars. This information submitted to the competent authority is relevant for assessment proceeding. There may be a situation that factory has already been started but return of income is filed later concealing the date of start of manufacturing process or completion of project or installation of plants etc. An AO can find out the date of actual installation of

the plant and machinery, where there is dispute about claim of depreciation. Again, u/s 62 of the Factories Act 1948 manager of the factory has to maintain register of adult workers, which can be scrutinised to check the correctness of the claims of expenditure on salary or wages. U/s 110 of Factories Act, the manager, occupiers or owners of the factory have to submit returns periodically to the concerned authority, which can be a source of information for the AO. Similarly, information submitted under the Payment of Bonus Act, Payment of Gratuity Act, and Employees Provident Funds Act 1952, can become important source for an AO. 10.4 Central Excise Act 1944 - Every manufacturer of excisable goods is required by law to get himself registered with the Central Excise department, before commencement of production. Similarly every importer or dealer who desires to issue Modvat invoices must also get himself registered with Central Excise. Some important provisions of the Central Excise Act are as under (i) Physical control is applicable only to manufacture of tobacco/cigarettes (ii) Manufacturers coming under the Self-removal procedure or the Self- assessment procedure, are required to file classification declaration for their goods under Rule 173B to the Excise Department informing the claimed rate of duty applicable to their goods. If any change in rate is claimed, assessee should file a new declaration. (iii) If any manufacturer claims a rate of duty as ad valorem, and sells goods to a related person or he has

factories manufacturing different goods in different Central Excise divisions or Commissionerates or he removes goods for captive consumption or he transfers goods to depot or branches, he is required to file a price declaration under Rule 173C in the prescribed form in advance. (iv) Every registered manufacturer is required to file by 15th April in each Financial Year a declaration of Marketing Pattern and Discount Structure in the prescribed format. (v) If a manufacturer desires to have Modvat credit benefit, he can do so on filing a declaration for eligible inputs under Rules 57A, 57G. (vi) A separate declaration has to be filed for capital goods under Rules 57Q and 57T. (vii) If the Asstt. Commissioner (Central Excise), does not agree with the declared classification or value or Modvat availment, he shall, after due inquiry and after giving show-cause notice to the assessee, reassess the goods or disallow Modvat credit. (viii) After filing the declaration, a manufacturer can assess the duty on the goods himself in accordance with his declarations and pay the duty by debiting to Personal Ledger Account, or Modvat account vide provision related to R.G. 23A Part I&II and R.G. 23C, and he can remove the goods under the cover of an invoice signed by him without needing permission of the Central Excise. (ix) Assessees paying Rs. 5 crores or more of duty from Personal Ledger A/c in a financial year, have been exempted from pre-authentication of each foil or invoice

book and from intimating serial numbers of the invoice book. Invoices are issued in the format prescribed under Rule 52A. (x) Invoice books should be maintained in two sets, one for clearance for home consumption, and the other for clearance for export. (xi) Every manufacturer has to maintain an account of production and removals of goods in Form RG-1, and an account of principal raw materials, specified by the Central Excise Commissioner, in Form IV, known as raw material register. (xii) With effect from 1.10.96 clearance invoices are not required to be enclosed with monthly R.T. 12 returns. Routine assessments and verification of invoices and returns has now been replaced by a system of selective audit. As per new provisions large factories are audited once a year, and small scale and medium scale units are audited once in 2 years. These audits are done after giving one weeks notice. (xiii) As per Section 14A of the Excise Act, units showing suspicious marketing pattern and discount structure may be subjected to special audit by cost accountants. (xiv) The audit party comprises of Superintendent and Inspectors and may spend two to seven days in the factory and check clearance invoices selectively with private and statutory records of the factory to see that valuation and assessment are correct. It also checks the statutory records with factorys private records, balance sheets, bank statement etc..

(xv) Collection of central excise duty at the point of consumption operates for Khandsari units, where molasses is consumed for manufacture of alcohol. (xvi) Another important method adopted for levy of excise duty is on the basis of capacity of production as per new Section 3A introduced by Finance Act 1997. (xvii) Any manufactured goods cleared from the factory and afterward found to be defective, can be brought back to the factory for repair, reconditioning etc. within one year either under refund procedure under Rule 173L or on quantity to quantity basis vide rule 173H. (xviii) A manufacturer is not under obligation to pay excise duty again, on duty-paid parts purchased from market and used in repair of defective goods. (xix) After deletion of Rule 50, manufacturers are now free to remove non-excisable goods from their factory without permission from Central Excise authority. (xx) There are various concessions in Excise duty for SSI units. However, one has to be clear about the applicability of the concessional rates. For example, in respect of Air conditioning and Refrigerator equipments the rate structure is as under Value of clearances (Rs.) 0-30 lakhs 30-50 lakhs Over Rs. 50 lakhs Rate of duty Nil 50% of normal duty Normal duty

(xxi) Central Excise duty is leviable only on a new article which comes into existence as a result of manufacturing activity unless otherwise provided in law. 10.5 Removal of Excisable goods on determination of duty by manufacturers - Under Chapter VII-A of Central Excise Rules 1944, provisions have been made regarding self-removal of Excisable goods, as under Rule 173A 173B Provision Applicability clause Every manufacturer has to file with the Superintendent a declaration of goods manufactured in the factory. Every manufacturer who produces goods or is having such goods in warehouses, shall declare the value u/s 4 of the Act. Under this rule an officer duly empowered may fix the quantum and period of time when the production in the assessees factory was considered normal having regard to the installed capacity of the factory, raw material utilization, labour employed, power consumed and other relevant factors. The normal quantum of production during a given time, determined

173C

173E

after affording reasonable opportunity to the assessee, shall be the norm. A manufacturer has to determine duty due on the goods and can 173F remove them on payment of such duty. Every manufacturer shall keep an account - current with Commissioner separately for each 173G excisable good falling under different chapters of the schedule to Central Excise Tariff Act 1985 Form RG 23. Commissioner may prohibit a manufacturer from storage of dutypaid goods near the factory 173GG premises, if such assessee has been punished for any offence under the Act. Retention in or bringing into a 173H factory or warehouse, of duty paid goods. Special procedure for movement of duty-paid materials or component 173K parts for use in the manufacture of finished excisable goods other than the declared excisable goods. 173L Refund of duty on goods returned

to factory. Goods cleared for export to be 173M returned to the factory. Procedure in respect of 173N warehoused goods. Remission of duty on goods used 173P for special industrial purposes. 173Q Confiscation and penalty. 10.6 Modvat credit, money credit etc. - At present Excise duty is leviable at different stages of manufacture, whether, intermediates, components, subassemblies, assemblies, capital goods, or final products. Therefore, it became necessary to devise a scheme to neutralize the cumulative effect of multi-point levies and their cascading effect on the price of the final product. The following schemes are in operation to provide input duty relief.

Modvat Credit Scheme for inputs vide Rules 57A to 57J of Central Excise Rules. Modvat Credit Scheme for capital goods vide Rule 57Q to 57U. Exemption for captive use vide Rule 57D and Notification No.67/95 C.E. Remission of duty for special industrial purposes vide Chapter X of the Rules. Money Credit Scheme vide Rules 57K to 57P.

10.7 Exports benefits

Export rebate is available for all manufactured goods, export of which is not specifically prohibited. Export under bond is permissible to Nepal and Bhutan, subject to the realisation of export proceeds in freely convertible currency, and against an irrevocable letter of credit. There is a rebate of input Excise Duty on the inputs required for export production, and obtained on payment of duty. Where end-product is exported under bond, the input credit of Modvat taken on account of export can be utilized for paying duty on similar final products cleared for home consumption. In a case where it is not possible, cash refund is given to the assessee. Benefit of tax is available to units setup in Free Trade Zone, Export Processing Zones, Electronics Technology Parks and Jewellery Complexes and 100% Export - Oriented Units. There is a benefit of drawback of customs and Central Excise Duty in respect of both indigenous and imported inputs. A new scheme known as DEPB, patterned on the credit-debit system of Central Excise Modvat Scheme is in force.

Under EPCG Scheme, 10% concession is available on import of capital goods subject to export obligation. Benefit is also available for import of repair or jobbing, free of duties subject to bond for their re-export with 10% value addition.

10.8 Books / records required to be maintained - The engineering industries coming under the purview of section 44 AA of the I T Act, are required to maintain the records prescribed under that provision, in addition to the records under the Excise and Sales tax laws. Where these concerns are corporate bodies, records prescribed under the Companies Act, 1956 are also required to be maintained. The industries to which Cost Accounting / Audit rules are applicable u/s 209 of the Companies Act, are obliged to maintain cost audit records. Details regarding statutory audits under the Companies Act, Cost Audit, and special audit have already been discussed in Volume - I. Examination accounts of manufacturing-cum-trading

11.1 Purchases - Inflation of purchases is a common mode of tax evasion. Different type of assessee use different documents and registers for purchases, for example -

Purchase invoice, purchase bills, proforma invoice. Delivery challans. Bill of transportation Slip of measurement, weighment Octroi bill or cess charging bill of municipal corporation Unloading expense voucher Gate pass slip Inward register Purchase register Stock register Store register

Common and general methods of inflation of purchases have been discussed in the Chapters relating to Trading Account, and Manufacturing Account, in Volume-I. 11.2 Production account - Examination of Manufacturing / Production account is of paramount importance in these cases. For this, co-relation of quantity records of consumption of raw materials and production of finished goods, and the knowledge of the input : output ratios of the particular industry, is essential. It is useful to first examine following details before taking up serious investigation work

Licenced / Registered / Installed capacity of the unit

Type and quality of finished goods and main by-products Production capacity utilised by the assessee Capacity enhanced by installation of new machineries Level of technology being employed Purchase of new machinery Age of Plant and Machinery and technology Actual production shown by the assessee Reasons for variation of production vis-a-vis the installed capacity Shortage and wastage shown by the assessee Standard or norms fixed by Trade Association, Government authorities or available in project reports of the assessee or financial institutions Time taken in one complete production cycle.

It may be useful to cross verify the quantity particulars appearing in the inward register and Stock register with the corresponding entries in first part of production register, and thereafter with the production of the finished goods in same register. Input - output ratios can be worked out for selected periods, i.e., months, fortnights, weeks, etc.., on random basis and compared with industry norms. Any abnormal variations may require detailed examination. There may be some difficulty in working out input - output ratios

where the units of measurement of the input are different from those of the output. In these cases, standard conversion factors have to be applied. The chart below shows a case study made for working out cost of production of a 3 horse power/ 1400 rpm motor S.N. Input Material 1 Stamping stator 2 Stamping Rotor 3 Cast iron enclosure 4 Bearing Pulley side 6206 5 Bearing fan side 6205 6 Cooling fan 7 Cooling fan cover 8 Terminal block 9 Terminal box 10 Carbon steel En 8 shaft

Qty Unit Rate Amount Share Percentage (Rs.) (Rs.) 9.9 Kg 95 1 940.50 0.2668 26.67692 0.1588 15.88418 0.1037 10.36726 0.0425 4.254692

No 560 560 365.50

21.5 Kg 17 1

No 150 150

1 1 1 1

No 105 105 No 17 No 25 No 9 17 25 9 10 64.40

0.0298 2.978284 0.0048 0.482198 0.0071 0.70912 0.0026 0.25528 0.0028 0.1 0.0183 1.82668

1 No 10 2.8 Kg 23

11 Eye bolt 1 Kg 12 Winding 2.76 Kg enameled wire 13 Varnish insulation, lead 14 Name plate, key etc. 15 Colour 16 Nuts, Bolts, Grease 17 Labour charges 18 Over heads expenditure 19 Replacement expenditure Total

13 13 187 516.12

0.0037 0.36874 0.1460 14.63954

55

55

0.0156 1.56005

35 25 40

35 25 40

0.0099 0.99276 0.0071 0.70915 0.0113 1.13458 0.1205 12.05496 0.0425 4.25469 0.0057 0.56729

425 425 150 150 20 20

3,525.52 0.9962 99.62

This shows that, cost of production of one 3HP electrical motor comes to Rs. 3525.52. This may vary because of the cost of raw material, and level of technology used in such motors. From an analysis of this nature it is possible to ascertain the composition of the various inputs in the cost of production of one electrical motor. In the above chart, expense on labour charges and wastage, appear to be on higher side. Therefore, further

investigations can then be focussed on these items. 11.3 Wastage in production account - There are visible as well as invisible wastage in engineering industry, which have a direct impact on gross profit. In order to find out the wastage, quantitative details have to be obtained and examined with reference to the quantity of raw materials consumed and quantity of finished goods and by-product produced. The normal percentages of loss due to shortage / wastage, varies from industry to industry and also depends upon the type of raw materials and technology used. Industry norms of wastage are usually available from trade bodies, Government authorities, etc.. Many times, assessees try to present their accounts in such a way that over-all wastage in terms of percentage will conform to industry norms. However, if month wise or fortnightly accounts are prepared, an entirely different picture may emerge. Therefore, the AO should test-check the production register and work out percentage of wastage on particular dates. If such percentages tally with overall final result disclosed by assessee and wastage are not apparently on higher side, the book result cannot be easily doubted but where test-check shows abnormal variations in wastage percentage of different periods, this may require detailed examination.

11.4 Wastage pattern in various industries - In engineering industry wastage pattern is not uniform but varies from unit to unit, industry to industry, product to product and plant to plant. In an older unit, having older technology, wastage may be high. If at the out-set it appears that wastage is on higher side, the AO can investigate the accounts with reference to normal standards or some comparable cases. If cases are not available for comparison and standard is not found applicable, one can always go by testcheck of input and output ratio on a few random dates of production which may bring out wastage ratios different from those disclosed by the assessee in the final statements of account. If records of wastage are not kept on a day-to-day or weekly or fortnightly basis, then the production records may not be reliable. Different types of wastage / losses incurred in the production process in some engineering industries are discussed below (i) Steel re-rolling mills - In steel rolling mills and re-rolling mills two types of wastage are shown i.e. burning loss, and, melting loss. Burning loss is invisible loss whereas melting loss is visible loss. The burning process can be through coal-fired or oil-fired furnaces. Studies reveal that, in case of oil-fired furnaces, the normal burning loss is between 2% to 2.5%. In case of coal-fired

furnace, burning loss can be from 4% to 5%. If an assessee claims an excessive burning loss then examination of the entire manufacturing process, input: output ratio, quality of raw materials, rate of raw materials, as also study of other comparable cases has to be made. (ii) Auto-parts manufacturers - Due to a large number of units manufacturing different type of pistons, rings and auto parts, it is difficult to have standard pattern of this industry. In most of the cases raw material is purchased by weight whereas goods are produced and sold in numbers. Therefore it is difficult to have a quantity-wise correlation between purchases and sales. As regards wastage one has to go into details of day-today production. The products of auto parts manufacturers, are normally of standard specifications, and variation is only in respect of sizes. Therefore, input and output ratios can not be abnormal. In these industries, burning loss or process loss may also be there. (iii) Electric motors - While investigating the case of electric motor manufacturers it has to be kept in mind that electric motors vary from motors of small fractional horse power to

special purpose giant motors. The cost of production of electric motors comprises of

Stampings for stator and for rotor. (Stampings are made out of dynamo grade electrical steel lamination sheets. The purpose of the stamping is to carry the electromagnetic flux). Enamel covered copper wires are used in the windings of stators and rotors. The wires carry the input current to induce the electromagnetic flux. Copper bars and end rings or aluminum for rotors (other than wound rotors). Steel round bars for making shaft. Castings for enclosure of the motor and for other parts. Ball bearings used for smooth running of the rotor. Bush bearings are often used in small motors. Insulation materials such as papers, varnish, etc.. Hardware, paints and small components.

A study reveals that total wastage in the manufacturing of motors ranges from 4.3 to 5.2%. 11.5 Manufacturing account (i) The general issues relating to examination of manufacturing account have been discussed in

the chapter relating to Manufacturing Account, in Volume(ii) In the engineering industry manufacturing expenses include expenses on raw materials, consumables, power and fuel, wages and salary of factory, repairs and maintenance, deprecation and other overhead expenses. While going through the manufacturing account, the AO must verify the input:output ratios of main raw materials, power and fuel vis--vis the production of individual products. The AO has also to compare actual physical consumption per unit of production with reference to standards available in literature, & studies of trade associations etc.. At times assessees claim correct expenditure on power and fuel but understate the productions. Therefore, suppression of production can be detected by applying standard input - output ratios. (iii) The AO must distinguish between direct labour cost on production and indirect employee cost on production. He should also verify total man days of direct labour employed during the year and average number of workers employed for the year. Thereafter, he has to examine direct labour cost per unit of production. This will give a clue as to whether wages and salaries have been inflated. (iv) Manufacturing expenses also include -

Stores and Spares expenses Maintenance and Repair Outside Contract Repair Charges Purchase of Miscellaneous items

It is easy to inflate expenditure under above heads by creating self made vouchers. A scrutiny of such vouchers may show that the signatures appearing on revenue stamps for payment are of the same persons. 11.6 Closing stock (i) Value of closing stock, in most cases, is shown in a ambiguous fashion. It is very common to exclude or undervalue the work in progress. (ii) Many assessees value their raw material on the basis of purchase bills of 15th to 30th March. Often direct expenses like transportation, duties, cess, fees, Octroi, unloading charges, are not included in the value of closing Stock of raw materials. This is contrary to Supreme Court judgment in CIT Vs. British Paints (India) Ltd. (1991) 188 ITR 44 (SC). (iii) In one case, the assessee had valued finished goods on the basis of last sale bill dt. 24th March, as no sale was affected thereafter. While investigating the case, the AO found considerable difference between the sale price of 24th March and the sale bill of 1st April.

(iv) Often goods-in-transit, and / or goods sent for approval, are not included in the inventory of closing stock. (v) It is always useful to compare the Stock statement furnished by the assessee to financial institutions and banks. If Stock statement given to the bank differs from Stock declared in books, the difference in stock can be added to the closing Stock as suppression of closing stock. This issue has now been settled by the Supreme Court of India in the case of Ghasiram Agrawal V/s. CIT 201 ITR Page 192 while dismissing the SLP of the assessee against the judgment of Honble Gauhati High Court. (vi) Consignment Sales present another area of suppression of closing Stock. Some assessees do not include the goods sent to consignee in their closing Stock. (vii) Some other malpractices for undervaluation of closing Stock are as under

Undervaluation of Stock by fixing up predetermined GP rate, and showing the balancing figure as closing Stock. Undervaluation of Stock by mis-referring the purchase bills Undervaluation of Stock on the basis of purchase bills but without including direct expenses

Undervaluation of Stock by referring to some sale bills of month of March, but not of 31st March Undervaluation of Stock on the basis of market price by referring to under-invoiced sale bills of last week of March Undervaluation of Stock by taking average purchase cost Undervaluation of Stock on the basis of nongenuine purchases of March Undervaluation of Stock of work-in-progress or unfinished goods Undervaluation of Stock of semifinished goods

11.7 Under invoicing of sales - Suppression of sales is often resorted in various manners. There may be cases of outright understatement of sale price in bills and collecting a part in cash outside the books. Under invoicing can also be done through intermediary arrangements. Goods are sold directly to the ultimate purchaser but documents are prepared to show sales through a chain of intermediaries. The sale made to the real purchaser at the end of the chain is invoiced at real market rate. All these intermediaries are legally constituted and most of them file their returns of income. But in this arrangement premium or profit is split-up at various stages to reduce the incidence of tax. In some cases of under-invoicing, some assessees issue Debit

Memo or Debit Note in later period after close of the accounting year to misappropriate the respective amounts. While verifying sale bills, the AO has to examine the system adopted for preparing the invoices and recording the figure of sales in accounts. It must be verified whether manufacturer has a system for writing sales figure in terms of both quantity and value for each type of product by grouping of invoices. If that is there then invoices must be reconciled with figure of sales. Than, the AO can prepare a price-profile of that product and thereafter tally it with the sale proceeds made to the various parties. Tax audit and cost audit reports 12.1 The revised Form 3CD for Tax Audit Reports contains important data including financial ratios and quantity data of production / consumption etc. These audit reports can be an important tool in the hands of AO investigating the case of a manufacturing concern. The issues arising from these audit reports have been discussed in the Chapters relating to Tax Audit Reports and Making Quality Assessments in Volume-I. Similarly, where cost audit rules apply to a concern, Cost Audit Reports can be examined by the AO. This subject has been discussed in the Chapter titled Cost Audit, in Volume-I. Recourse can also be taken to special audit u/s 142(2A) in appropriate cases.

Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter - II COTTON TEXTILE INDUSTRY Introduction 1. The cotton textile industry is one of the oldest industries in India. In the 18th Century, the famous muslin manufactured at Dacca were exported to Europe. Thus, this industry has a very important place in the national economy. It not only contributes substantially to the state and national exchequers but also brings in a large amount of foreign exchange by way of export. The industry gives employment to large number of people, particularly in Maharashtra, Gujarat and Tamilnadu, where the bulk of the textile mills of the country are located. The manufacture of textiles involves different stages of processing through the various units of a textile mill. Ginning

2.1 Ginning is the process of separating the cotton seeds from raw cotton or kapas, in order to get the lint (cotton in a fluffy state). The process is done in ginning factories which purchase kapas and convert it into lint and seeds. 2.2 There are two kinds of ginning - roller ginning and saw ginning. Roller ginning is also of two kinds - single and double. The latter produces a superior quality of lint. Roller ginning 3.1 Roller ginning of kapas is carried out manually. The kapas is also taken to the opener or jhamba manually. This removes the impurities. It is then taken to the roller machines. Labourers put the kapas into the rolling machine by hand. These machines separate cotton from cotton seeds. The ginned cotton is carried in loose bales to the godown, where it is stored for processing. Saw ginning 4.1 Saw ginning came into use only about 25 years back and is popular particularly with the textile mills of Mumbai. In this process the services of the opener i.e. jhamba, which removes impurities, are dispensed with, as it has an automatic opener. The raw kapas is sucked through the pipe into the saw machine. It is then fed into the opener which removes dust, and other impurities mixed in the kapas. This opener or jhamba automatically opens the kapas. The kapas is then fed into the machine which separates cotton from cotton seeds. Cotton seeds are automatically separated to one side, while the lint is sucked into the perforated pipes where it is cleared of impurities. The cleared cotton is then put into bags. These

bags are stocked in godown and later transferred to the pressing section. 4.2 The saw ginning process gives more refined cotton, as it entails cleaning at two places. This, however, gives a lesser yield because, apart from impurities, some lint is also left on binolas. The yield and shortage depends on quality of cotton and type of machine. However, labour expenses are lower in this process because of automation. Saw ginning is now losing ground because of the excessive loss involved in the process. Cotton Pressing 5.1 In some ginning factories, there is also a Pressing section. After ginning, the lint obtained is in a fluffy state. It is pressed and packed in this section. If the ginning factory has no Pressing section, the lint is taken to a pressing factory, where it is pressed and packed into bales, against fixed pressing charges per bale. 5.2 The device usually adopted by the Pressing factory to reduce its profit is to inflate the quantity of iron hoops and hessian purchased and utilised for baling. Quantitative details of these two articles should be obtained and the reasonableness of the consumption checked with reference to the bales packed. Usually, a fixed quantity of iron hoops and hessian is required for each bale pressed and packed. The expenses on stores and wages should also be examined thoroughly. Types of Presses 6.1 Generally, there are three types of presses in use. These are double press single press, and

 common press The Presses are run either by steam from a coal-fired furnace or by electricity. The difference in these three types of Presses is that the double Press has the maximum capacity, while the single Press has less capacity and the common Press has the minimum capacity. Purchases of raw cotton 7.1 The purchases may be either directly from cotton growers or from dealers / brokers in raw cotton. The purchase rate of kapas depends upon its quality. The purchases of raw cotton from dealers and through brokers are generally verifiable, whereas purchases made from growers are usually not capable of proper verification. However, daily market reports are available in major cotton centres and it may be useful to compare the purchase rates of a few selected items as shown by the assessee with the market rates given in those reports. Cash Purchases 8.1 Since most of the purchases are from cultivators, there may not be satisfactory evidence to prove all the purchases. It is usual to inflate kapas purchases, both in terms of quantity and value. Where the cotton traders or the spinning and weaving mills themselves own a ginning factory, the chances of making such inflation are more. For instance, in one case, the partners of a firm running a textile mill owned certain lands on which cotton was grown. In their personal accounts, they showed large credits for sales of raw cotton or kapas to a ginning factory in support of such purchases. The books of the ginning factory correspondingly showed large quantities of

kapas purchases from these partners at the highest market rate. However, on close scrutiny, it was found that the quantity shown was much higher than could have been obtained from the area of land owned by them, even at the highest yield for cotton recorded by the District Agricultural Officer. An inference could, therefore be drawn that either fictitious sales had been entered, in order to bring into books undisclosed income of these partners, or they had purchased kapas from agriculturists outside the books, and had recorded only the sales, thus bringing their undisclosed income into books of account surreptitiously. 8.2 Similarly, when the disclosed output of lint is poor and / or the wastage excessive, a possible reason can be that the kapas purchased was of an inferior quality, in which case the average purchase rate ought to be less than in other similar cases. 8.3 Where there are both cash and credit purchases, the rates paid for cash purchases from agriculturists should ordinarily be less than the rate paid for kapas purchased from the market or in auction. If the rate for cash purchases is higher, it may indicate inflation of purchases. Purchases through suspense accounts 9.1 Such purchases are usually supported by bought notes issued by the owners of ginning factories. At times, when money is drawn for making purchases from growers, a suspense account is opened. It is necessary that purchases financed through suspense account, are scrutinised properly for detecting any inflation of purchases. In some cases the value of purchases exceeds the money taken to the suspense account for financing

such purchases. If this is noticed, it will be necessary to inquire as to how such purchases have been financed. In the absence of a proper explanation, the presumption would be that the purchases have been inflated. 9.2 A rough and ready method of determining the extent of inflation of such purchases is to deduct from the value of the goods purchased the money passed through the suspense account less the travelling, lodging and boarding expenses of the employees. The dates of purchases made from the purchase centres by the employees and the dates on which funds were withdrawn from the suspense account should also be carefully looked into. The mode of taking money by employees to the purchase centres should then be verified for detecting any manipulation of purchases. 9.3 Sometimes, claims are made that the funds withdrawn by the employees through the suspense account have not been utilised fully and these are deposited back in the books of accounts. Such claims should be thoroughly checked with reference to the purchase and stock registers. The time lag between the dates of withdrawals and the dates of bringing the money back into the books would help to establish whether the funds advanced have been utilised for purchases or for some other purposes. The day book should also be scrutinized for finding out any cash deficit, as the funds withdrawn for purchases are usually adjusted in the books at assessees convenience. 9.4 At times, funds are withdrawn from the books for financing purchases from growers, and bank drafts are purchased. Such bank drafts are encashed at the purchasing centres for payments to growers. It would be

necessary to verify the withdrawal of the money for purchasing the drafts and the dates of encashment of the bank drafts at the purchasing centres. Such dates can be correlated with the dates of purchases made at the purchasing centres, the bought notes, and the day book. The stock register can also be checked up with reference to the dates of such purchases. Scrutiny of purchases 10.1 The rates of the purchases made directly from the growers should be compared with the purchases made through brokers / dealers in raw cotton. It is necessary that the purchases made directly from the growers should be carefully enquired into for detecting any inflation. Apart from inquiring into the sources of funds and the dates of purchases, the stock register and the day book should also be scrutinised. Output from ginning factories 11.1 While examining the accounts of a ginning factory, it is always necessary to judge the reasonableness of the output of lint and seeds with reference to the quantity of kapas ginned. The yield in processing of raw cotton into lint depends upon the quality of the raw cotton and the type of machines used. The normal yield and the shortages are as under Process Type Yield Shortage Saw ginning Roller ginning Long staple quality Desi kapas 32% to 34% 36% 1.5% to 2.5% 1.5%

11.2 Studies conducted by Ahmedabad Textile Industrys Research Association, (ATIRA) for improving ginning technology reveal the following When Indian cottons are compared with foreign cottons, Indian cottons are comparable or even superior than foreign cottons in fibre length, fineness and strength. In foreign countries mechanical harvesting is adopted and trash content is 20 to 25%. This is 7 to 8% in most of the Indian kapas material. The trash content after ginning process, is not more than 2 to 3% in foreign cotton bales while in Indian bales, it is 4 to 6%. Average trash content in Indian cotton bales is 6 to 7% and the maximum level is 15% inspite of the manual harvesting system. 11.3 If cleaning machines at ginning, post-ginning cleaner (to remove seed-coat fragments), and pneumatic cotton conveying system are adopted, contaminants in cotton can be reduced thereby improving the cotton quality. Enquiries can be made to find out whether such modernisation has been carried out. Accordingly, cotton realisation percentage may be verified from the books of accounts. In case the yield and shortages are abnormal, the accounts should be scrutinised for detecting possible manipulation of purchases. SPINNING MILLS Spinning process 12.1 Spinning is the mechanical process of converting cotton into yarn suitable for manufacture of cloth or other cotton fabrics.

12.2 An important parameter in spinning process is count by which the quality of yarn is determined. The count of the yarn depends on its weight. Yarn of 840 yards is called a hank. If one hank of yarn weighs one pound, then count of that yarn is 1. If 40 hanks of yarn weigh one pound, then the count of that yarn is 40. The higher the count, the finer will be the yarn. 12.3 Raw material - With development of technology, now in addition to cotton, jute and also other man-made fibres such as viscose and polyester are used as raw material either singly or in combination so as to manufacture mixed fabrics such as terry cot. The factors which make fibres suitable for textiles are length, strength, pliability, diameter, abrasion, resistance and power of cohesion etc. Besides, fibres must be pleasant to touch, absorbent to the extent that they can be dyed, comfortable to wear and washable by some method. Not all the desirable properties are available in any one fibre. Cotton is a natural fibre which is still considered as one of the most suitable textile fibres. 12.4 As the raw material constitutes about 55 per cent of the total cost of yarn, and about 50 per cent of the total cost of cloth, raw material procurement plays a significant part in textile industry. Apart from being proficient in finalising deals at the right time to take advantage of the market, one must be adept in selecting the right cotton to suit the end use and must have intimate knowledge of the amenability of various types of cottons / fibre to spinning. Nowadays, the knowledge and practice of hand sampling of classier cotton is supplemented with the physical properties measured by sophisticated instruments. Once

raw material has been brought and is ready for use, its processing starts with the help of machines and the men on the floor. 12.5 Mixing - The basic objective here is to mix the different types of cotton together to take advantage of the desirable characteristics of each component in the mix. By a judicious blend of the different varieties, the mixing cost could be kept at a minimum and consistency in yarn quality between the seasons can also be maintained. Mixing for open end spinning may contain virgin cotton and waste (like comber nails, flat strips, roving ends, droppings, sliver bits and lap bits). 12.6 Usually, a purchase register which records all the purchases with the details of quality, and variety, weight and ex-mill cost of each bale is maintained. An Issue Register is maintained for issue of raw material to the mixing department. Yet another register is maintained for insurance purposes for arriving at the stock on hand at a particular time with the details of storage place. 12.7 Usually, mills adopt moving average cost or lot-wise cost method for arriving at the value of the Issues and the stock on hand. As the mills maintain lot wise register on the basis of their arrivals, it is easy to identify each lot and arrive at the cost of each lot (usually a lot contains 55 fully pressed bales). The closing stock also is maintained at cost on the basis of the cost of each lot. Blow room 13.1 The essential functions of the blow room are to open the cotton into loose mass; clean the cotton by removing the trash, seeds, leaves etc.; and

 deliver the cotton in the form of a reasonably uniform sheet rolled into the form of a lap which facilitates easy handling in the subsequent process. 13.2 The cotton bales are opened in the bale breaker in which hard compressed slabs of cotton are broken into a fluffy state. Thereafter, different types of cotton which have been mixed in calculated proportions to obtain the particular quality or count of yarn are put in the opener. Here, the mixing is done. The mixed cotton is then folded into a sheet form called lap. For processing man-made fibre, there is a provision to bypass the beating points. 13.3 The laps produced are designed to have a predetermined weight per yard. Hence all the laps should have the same weight within allowable tolerance. Any serious deviation in lap weights will result in variation in yarn count which is undesirable. The mills maintain a lap register indicating the production of laps and their weights Carding 14.1 The maxim to card well is to spin well emphasises the importance of this process. The function of this process is to open the lap, separate the fibre, remove the impurities and short fibres in the lap. This is done by subjecting the fibres to the action of a large number of metallic wire points. Here, the end product is delivered in the continuous form of a sliver (resembling thin ropes of cotton) deposited into a vertical container namely sliver can for feeding the next process viz. drawing / combing. The important parameters in this are the flat speed and

the allied settings as the removal of short fibres is dependent upon these factors. 14.2 Usually the mills maintain a register of production of sliver cans by each carding machine. For producing quality yarn, it is necessary to periodically grind the metallic wire and flat tops. Preparatory process 15.1 All subsequent processes after carding are for the following objectives To lay the fibres parallel which will facilitate drafting and yield uniform yarn; To achieve uniformity in weight per unit length by the necessary processes; and To attenuate or draft the sliver into thinner strands at stages to achieve the desired ultimate yarn count. Combing 16.1 This operation is an optional one. Usually yarns are produced in carded form (without going through this process) or in combed form. Previously, foreign cotton needed for production of fine yarns such as 80, 100 and 120 used to be combed but now even Indian cotton is also combed. This is an expensive process. It reduces the output of yarn from cotton. Hence, it is gone through only if the selling price is remunerative. Usually other raw materials are not combed. 16.2 The fibres are combed by means of a rotating cylinder, having a number of pins. The sliver obtained from Carding department are passed through pairs of drafting rollers. This helps in parallelisation of fibres. The resultant sheet of fibres is wound on a spool (sliver lap). Six such sliver laps are passed through a series of pairs of drafting

rollers. This helps in parallelisation of fibres and six sliver laps fed are combined into one ribbon lap. This ribbon lap is next fed into another machine, where the sheet of fibre is gripped firmly between a pair of nippers, over which the combing cylinder passes, removing the short fibres of less than a preset length. The sliver is coiled in vertical cans for feeding the next process - drawing. Drawing 17.1 This process passes multiple carding sliver through a series of pairs of rollers, moving at progressively increasing surface speeds. This helps in parallelisation of fibres, removal of hooks, regularisation of weight per unit length. Normally, two passages of drawings are employed but depending upon the requirements of the end product, use of three passages is also adopted. Speed frames 18.1 The sliver received from the Drawing department is passed between pairs of rollers. The object of this process is to reduce the draw frame sliver to a size suitable for final spinning by employing necessary drafts. The strands thus produced are given a slight twist by the machine to obtain cohesive strength. The resultant material, called roving, is wound on a plastic bobbin. 18.2 The conventional systems used either two or three pairs of speed frames called slubber, inter and roving where the drawing sliver was drafted in stages. However, with the development of apron drafting systems it is possible to employ high drafts both in speed frame and ring frame. Hence, modern spinning sequence uses only one stage of roving generally called can-inter, thereby reducing process costs.

Ring frames 19.1 This is the final stage of process in which the raw material is converted into yarn. Depending upon the count to be spun, drafts are employed and the delivered strand is imparted necessary twist. The amount of twist to be put is decided by the quality of cotton and the end use of the yarn. Yarn meant for warp in fabrics is generally twisted more because it has to withstand a lot of stress and strain in further processes whereas yarn meant for knitting or hosiery for manufacture of banians etc. is generally soft spun with less twist necessary to get soft feel and fullness in knitted garments. Finally, the twisted strand called yarn is wound around a slim bobbin. The amount of twist put and the speeds in spinning play a significant role in the manufacturing cost. Open end spinning 20.1 This is a new development for production of yarn by replacing speed frame and ring frame department. Here, the drawing sliver is separated into single fibres by means of a saw toothed or pinned roller called opening roller and thrown on the circumference of a rotor rotating at a high speed of over 50,000 rpm. The fibres are deposited on the collecting groove forming a fibrous ribbon which is then doffed at the yarn forming point, and is collected on a tube to form a cheese. 20.2 The advantage of open-end spinning is the huge production as well as use of comber waste and flat strips along with virgin cotton, thereby substantially reducing the manufacturing cost. Cotton input and output

21.1 The cotton fed into the blow room undergoes various processes. In each stage, loss of material takes place in the form of waste. This waste varies from mill to mill because of the machinery conditions, the quality of cotton, and the end product. Coarser counts are produced with cheaper variety of cotton. Hence waste is higher compared to fine counts that are produced with superior cotton. In the output statement for spinning, only the salable waste is considered for calculating the invisible loss. The usable waste collected is normally reused, in which case it need not be considered. Otherwise, it should be. Wherever yarn is conditioned for improving its quality, weight gain takes place and the invisible loss comes down. For monitoring and controlling of wastes the waste collected is analysed, and percentage of waste at various stages is calculated variety-wise. Points for investigation 22.1 The P& L account of the spinning mills shows

direct cost - Value of cotton consumed, wages, stores consumed, fuel power and indirect cost - Salary, interest, repairs and renewals and other administrative expenses.

22.2 Cotton purchases - Usually cotton is purchased on contract basis and a contract book is maintained showing the serial number of the contract, the date of the contract, the names and addresses of the parties concerned, the quality and quantity of cotton contracted, and the rates and period of delivery, etc. It is a common practice that certain percentage known as cut is secreted out of the

Purchase account and pocketed by the Directors. An investigator has to look into the market indicators and various parameters in the cotton market such as reduction in supply of yarn. 22.3 Wages - Wages have a direct relation to the quantity of yarn produced. While checking expenses on wages, figures of earlier years may be compared with the relevant year in relation to production and abnormal variations, if any, properly scrutinised. Generally, the textile industry is in the process of modernisation. Modernisation results in reducing the manpower and wages. The AO may see whether expenses on installation of sophisticated machineries are commensurate with the reduction in wage bill. 22.4 Stores consumed - The expenses on stores, and on fuel and power have a direct bearing on the cotton consumed. The reasonableness of these expenses should therefore, be examined with reference to the quantum of cotton consumed. The figures for one year may also be compared with those of earlier years, and in comparable cases. Where the component of stores consumption in the cost of production is high, it may be necessary to obtain comparative details of the quantity and value of certain selected items of stores consumed for different accounting years, as this will reveal the items in which there has been a substantial increase. A pursuit of the purchases of such stores may result in detection of inflation in those items. In one particular mills case, stores purchases were inflated. On investigation, it was noticed no purchase was actually made. The Internal Auditor managed to get bogus vouchers for purchase of stores.

22.5 Sales - In a spinning mill, the main item of sales are yarn and cotton waste. Generally, the yarn produced is subject to excise duty and as such there is control over production and dispatches by the Central Excise authorities. However, while assessing a spinning mill, it is necessary to verify and reconcile the quantities of yarn produced, with those sold and dispatched. In some cases, verification of the dispatches of yarn, recorded in the gate pass book revealed double numbers in the gate passes showing dispatches of additional bales without being brought in the books. Sometimes, it is also found that the mills have sold yarn at rates which are less than the prevailing market rates. It is, therefore, necessary to compare the selling rates of the quality of yarn sold on particular dates with the prevailing market price. 22.6 Wastage - In this industry, invisible wastage is normally between 1.5 to 2.5 per cent. In the case of use of method of Comber, invisible wastage may be a little more. 22.7 Sale of waste, scraps, etc. - In a leading textile group, during search operations, it was found that the Directors used to collect extra money on sale of waste, scraps and to inflate wages account and as a result, cash more than Rs. 2 crores was seized. To unearth this practice, only search or survey will be useful. 22.8 Final output - Yarn realisation is generally between 80 to 88 per cent of the cotton used and in the case of open-end spinning, the percentage range is 70 to 75 per cent. 22.9.1 Repairs and renewals - Most textile mills are in modernisation process. Replacements mostly of full items of machinery take place. These replacements are capital

in character. However, often the assessees claim that the expenditure is revenue. In this effort the following propositions are conveniently forgotten Machinery does not cease to be machinery merely because it has to be used in conjunction with one or more machines. Nor does it cease to be machinery merely because it is, for instance, installed as part of a manufacturing or industrial plant. Broadly speaking, outlay is deemed to be capital when is made for the initiation of a business, for extension of a business, or for a substantial replacement of equipment. (Lord Sands) 22.9.2 The arguments against holding such expenditure as revenue are many The new machinery will lose its character as a capital asset consequent to the artificial allowance of the cost incurred on it as a revenue expenditure. This violates the definition of capital asset in Section 2(14) and of block of assets given in Section 2(11). It leads to an unacceptable situation where a revenue item is created either by an admixture of capital and revenue assets or only revenue assets (when all the old machineries are replaced). A capital asset does not get expended on revenue account either at the time of its acquisition or in the course of production . Section 43A mandates that exchange rate fluctuation relating to an asset acquired outside India should be adjusted in the actual cost of the asset as per Section 43(1) of the Act. If the cost of the asset is allowed as

revenue expenditure, the exchange rate fluctuation has to be treated as capital expenditure, resulting in an abnormal situation wherein part of the value of the machinery is revenue and the other capital. This can not be logical. The Income tax Act, the Accounting Standards of the ICAI, the decisions of the Supreme Court and lastly the commercially prudent policies adopted by the assessees themselves while computing the profits and declaring dividends, do not envisage a situation where final salable product is manufactured by a mixture of capital and revenue assets or by revenue assets themselves. 22.9.3 While faced with this situation the AO should not confine himself to the legal aspects alone. In fact, success depends largely on marshaling the facts and bringing them out in the order. The particular machinery may be inspected, its functions studied and the AO may come to a conclusion whether such replacement is capital or revenue. After drawing a proper conclusion, assessment order may be passed citing appropriate case laws. 22.9.4 The purchase bills for machineries may also be analysed. In a particular case, one machinery was said to have been purchased from a place which is not known for textile machinery. On further investigation, it was found that to be a bogus purchase. 22.10 Modvat credit - In one case, it was noticed that the MODVAT credit taken was credited to Stores purchase account. But when stores consumption was accounted in the P & L Account, the stores consumed were valued at cost including excise duty. Thus, the stores consumed was shown at an inflated figure. Hence, it is always better

to analyse modvat credit and to find out whether it is properly accounted in the P & L Account. WEAVING MILLS The warping process 23.1 Many cotton textile mills weave the yarn spun by them into cotton fabrics. Weaving consists in converting the yarn into fabric. The yarn supplied to weaving mills is in cones of weights of 1.5 to 2 Kgs. To construct a fabric, this yarn needs to be converted from cone to sheet form. 23.2 The cloth to be woven has two major components of yarn called the warp (the lengthwise yarn) and the weft (the breadth wise yarn). A part of the cones from the spinning section is sent to the pirn-winding department to make pirns which go to the weaving shed for making the weft yarn. The conversion of cloth demands the warp ends to be prepared in sheet form by arranging the cones in a creel. As many as 650 to 800 ends are taken from the creel and wound on to a beam. This is called warping. Electronic sensors are provided to detect yarn breaks during the process for rectification. Sizing 24.1 To overcome the strain of warp ends during cloth formation on the loom, the yarn is given a protective coating, called sizing. Sizing is done by applying starchbased adhesives to the yarn in sheet from, with proper drying arrangements. The width of fabric determines the number of warp ends to be sized. The beams are arranged one behind the other in tandem to deliver the designated warp ends of the fabric to be sized. The sheet of warp ends are immersed in the size mix and squeezed to remove excess material and taken over a series of hot

cylinders for uniform drying. In this process, called size retention, the warp yarn gains weight. The size retention is about 40 per cent of the sizing materials used. The mill is expected to maintain a sizing register and a waste register which record the weight of the sized yarn and the wastage. Formation of cloth 25.1 The beams of sized warp yarn are then transferred to the loom shed for weaving. This final stage of weaving consists of three steps the division of the warped yarn and lifting / lowering of its strands, so that the weft or cross thread may be interwoven or interlaced between them, known as shedding ; the insertion of the weft or the cross thread, known as picking; and the striking of each weft thread into its appointed position in the fabric, known as beat up. Cloth varieties 26.1 The cloth produced is divided mainly into four categories viz. coarse, medium, fine and superfine. The output of medium and coarse cotton fabrics ranges from 40 to 50 yards per loom per shift, whereas the output of fine and superfine cotton fabrics vary from 32 to 40 yards per loom per shift, although the output varies according to the quality of cotton used. Generally the production of coarse cloth works out to about 2.7 yards, medium about 4.8 yards, fine about 5.2 yards and superfine about 8.5. yards per pound of yarn consumed. Where there is defect in the manufacture, the defective cloth is sold separately as seconds, rejects, rags, and chindies.

Books maintained 27.1 The design of the texture, the width, the weave and the pattern of the cloth are all determined by the weaving master before weaving commences on the loom. The cotton fabric emerging from the looms is called gray cloth. Each weaver is paid on the basis of the gray cloth woven by him, which as it comes out of the loom is immediately recorded in a pick production book, weaver wise. This is the initial record in the factory, for cloth production. In most factories pieces handled by weavers are also weighed and the weight recorded, in addition to other particulars, weaver wise, and loom wise, in a production account termed kanta register. Thereafter the gray cloth is transferred to the folding department where it is actually measured mechanically or manually, rejecting defective pieces. The correct yardage or meter length is then recorded in the output book from which the daily production report is prepared, showing quality wise manufacture of all cotton fabrics. This corresponds to the daily production statement in the spinning section. If the cloth is to be marketed in its gray condition, it is subjected to calendering, stamping, packing and baling. In most of the mills, the gray cloth is subjected to further processes before marketing. These include bleaching, dyeing, printing, mercerising and sanforising. Thereafter, the pieces are folded and sent to the stamping department where the trade mark is stamped on each piece. Tax investigation 28.1 Production - It is necessary to reconcile the production of cloth with the consumption of yarn and the consumption of sizing material. The sizing retention is

usually about 40 per cent of the quantity of sizing material consumed. On this basis, the yarn consumed can be worked out as under Weight of sized yarn =a dd: Weight of wastage =b produced in sizing ess: Weight of unsized =c yarn Difference, being size =d=a+bgiven to warp c = (d x 100) / Percentage difference c=m Less: Size retained at = 40 d / c 40% of d / c x 100 Net weight of yarn in = m - 40 d / cloth c Add : Weight of weft yarn =n produced in weaving Yarn consumed in cloth = m - 40 d / produced c+n This figure of yarn consumed i.e. (m - 40d / c + n) should then be compared with the actual yarn consumed. If there is a variation the reasons have to be enquired into. 28.2 Another method of reconciling the yarn shown as issued for weaving and the cloth manufactured is as under Adjusted production = Production as as per RG 1 register per RG 1 (+ )closing stock of

cloth in process ()opening stock of cloth in process pening stock of yarn in the weaving shed Yarn issued to weaving Closing stock of yarn in the weaving shed Actual yarn consumption =a =b =c = (a + b) - c

This actual consumption is then to be compared with the standard consumption. Standard consumption = adjusted production as per RG1 register x standard yarn consumption per yard 28.3 Where quantitative details of the sizing materials issued are not available the test should be to see whether the output statement reveals any sizing retention at all. Normally the total on the right hand side of the above table should be more than the total in the left hand side, and the excess represents the size retention. If no gain due to size retention is recorded, it may indicate inflation of yarn issued or suppression of cloth produced or manipulations in the closing stock in the process. 28.4 A quantitative tally should be made showing the cloth produced, issued and sold. This can easily be found out

from the Central Excise records. The output of cloth can also be checked with reference to average production per loom or the production per pound of yarn consumed on the basis of the average given earlier. But this is only a rough check and if wide deviations come to light a deeper probe may be required. 28.5 The following records / registers are generally maintained and need scrutiny

Sizing register Waste register Weaver wise production book, and Kanta register Daily production report Output book The following verifications should be done for a meaningful investigation -

Reconciling of cloth with reference to yarn and sizing material consumed. Quantitative tally of cloth issued and sold should be verified from Central Excise Register. Overall production should be checked with the Average production per loom or per pound of yarn consumed. KNITTING INDUSTRY

Knitting 29.1 Hosiery goods are manufactured in various parts of the country. Tirupur in Tamilnadu is the major centre of

this industry. The town is known the world over for hosiery manufacture and exports. Manufacturing process 30.1 In cotton hosiery, cotton yarn is the main raw material. The cotton yarn is supplied by various spinning mills. Cotton of long staple is imported from America and Egypt to manufacture super fine cotton yarn. The yarn comes in various counts. Usually, single count of yarn of 8 to 60 is used for manufacturing T-shirts, undergarments, ladies garments, nighties, sports wear, etc. The double count yarn is used for manufacturing collars, cotton sweaters, etc. Double count yarn is considered finer than the single cotton yarn e.g. yarn of 2 / 60 count is finer than the yarn of 1/ 30 count. 30.2 The spinning mills supply either the grey yarn or the dyed yarn. Grey yarn is suitable for single colour garments and the dyed yarn is suitable for multi-coloured garments. The spinning mills supply yarn on paper cones. For dyeing, the grey yarn is first wound on steel cones, and is then dyed. It is then dried in the dryer, and re-wound on paper cones. The dyed or the grey yarn is then knitted on circular knitting machines. If the cloth has been knitted on dyed yarn, it is washed and calendered (pressed). In case the cloth has been knitted from grey yarn, the knitted cloth is sent for dyeing. Some overseas buyers insist upon the manufacturers to dye the yarn before converting into fabric. The latest development in dyeing is the introduction of computerised dyeing machines which ensures dyeing in correct shades. The bleached and dyed fabric is then subjected to steam calendering, a process in which the fabric is passed over hot rollers to remove wrinkles.

Nowadays, compacting machines are steadily replacing the calendering machines. These machines ensure uniform width of the fabric and also minimise shrinkage. The processed cloth is then cut into the required sizes and shapes. Stitching and labeling make the goods ready for dispatch. 30.3 In cotton hosiery, knitting is done on circular knitting machines. Most of these machines are imported. The machines imported from Germany & Italy are expensive and produce cloth of finer quality. The machines imported from Korea, Taiwan, China are cheaper but the cloth manufactured by these machines is not of very fine quality. The price of the imported circular knitting machine varies between 15 lakhs to 80 lakh depending upon the extent of computerization and other facilities available in the machine. The quality of the fabric depends upon the various factors like the quality of raw material, type of the machine used for manufacturing and the skill of the labour. 30.4 The units which undertake all the manufacturing processes are known as composite units. A majority of the manufacturers of hosiery goods prefer to out source the various processing. 30.5 There is a significant difference in the business outlook of export units and the units which manufacture goods for domestic consumption. The export units are customer-oriented. They first procure orders from overseas buyers and get samples approved, and then start procuring the raw materials. The domestic manufacturers manufacture goods according to local fashion, in standard sizes and patterns. Their procurement of raw materials does not depend on orders.

Examination of accounts 31.1 Inflation of expenses - A widespread practice for suppressing income is to inflate the expenses on fabrication charges, bleaching and dyeing charges, stitching charges etc. A diligent analysis of input-output ratio may help the AO to find out the extent of inflation of expenses. Whenever goods are taken out for processing or goods are received back from processing, delivery notes are prepared either by manufacturer or by the person who does the processing. The scrutiny of delivery notes would be useful to ascertain whether the assessee had got the goods processed. Processing charges like dyeing charges vary depending upon the specifications. As there are no uniform rates the AO may find it difficult to analyse the dyeing charges. Rest of the processing charges have uniform rates and it would not be difficult to examine the correctness of the claim. 31.2 Suppression of closing stock - Units, other than composite units, send goods for processing. At any point of time, some goods will be with the processors. The manufacturers often do not take into account the goods in process in the closing stock. 31.3 In export units, separate sheets of work in progress are maintained for each order. Normally, it takes about 40 days (in the case of a unit outsourcing the processing) for export units to execute the orders. The AO can check the order sheets. Many exporters indicate, for easy identification, the export order number in the bills received from processors. Crosschecking of bills with the export orders will bring to light the malpractices attempted in this regard. Analysis of purchase and expense vouchers for

February and March with reference to the export order would be useful. 31.4 In the case of the manufacturers of goods for domestic consumption, the manufacturing process takes only 15 days as the approval of buyers are not required at every stage. The summer months are the peak season for the hosiery goods in India. Production of hosiery goods peaks in the months of February and March. The assessee is likely to have substantial work in progress as on 31st March. A low closing stock of work in progress or finished goods may require scrutiny. 31.5 Most of the hosiery goods are sold on consignment. Suppression of the stock of goods with the consignees is often resorted to by the manufacturers. The AO would do well to check the account statements from the consignees. Comparison of purchase of raw materials made during the last quarter of the previous year (January-March) with the output achieved would be very useful in ascertaining the correctness of the closing stock . 31.6 Suppression in sale of waste - Wastage arises at each manufacturing stage starting from the wastage of cones, the wastage at knitting stage (wastage of gray fabric), the wastage when the dyeing or printing are not properly done. In the semifinished stage, improper cutting and stitching produce wastage. Rejected pieces cannot be sold. In the case of a composite manufacturer, the AO can fix the sale of wastage at 1 to 2 per cent of the total turnover of the manufactured goods. 31.7 The manufactures who out source activities such as dyeing etc. realise the cost of the rejects from the processors. The AO may verify whether the cost

recovered from the processors is properly accounted for. There would also be sale of waste. This aspect also has to be examined. Annexure - 1 GINNING PROCESS RAW COTTON / LOOSE BAGS GINNING MACHINE REMOVAL OF SEEDS / OTHER IMPURITIES COMPRESSED BALES OF C COTTON SPINNING PROCESS COMPRESSED BALES OF COTTON LOOSE COTTON MIXING UNIT BLOW ROOM LAP CARDING UNIT

SLIVER DRAWING (PROCESSED SLIVER) SIMPLEX (ROVING) SPINNING (YARN) YARN PACKING OF YARN YARN [SINGLE YARN / DOUBLE YARN] CONE WINDING CONE Annexure - 2 WEAVING Yarn from spinning frames CONE WINDING ______________________________________

 WINDING pirms) (to PIRM prepare

WARPING SIZING weft yarn in

DRAWING IN _____I_____________________ _________________ ____ _ SALES GRAY FINISHING

 (Bleachin g, dyeing, WEAVING mercerising and sanforising) PACKING FOLDING, STAMPING AND PACKING DISPATCH Annexure - 3 MANUFACTURING PROCESSES FOR COTTON HOSIERY Cotton yarn purchased from market __________________________I____________________ I I

cones) I

Grey yarn (on paper Grey / dyed yarn (on paper cones) I Winding on steel

cones I I Dyeing I I Drying I I Rewinding on paper cones I I Dyed Yarn ________________________________________I I Knitting on circular knitting machine

I Knitted cloth I Dyeing or washing of cloth I Drying/Calendering I Finished cloth I Cutting/Stitching/Overlocaking/Button holing I Finished garment

Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter III HANDLOOM AND POWERLOOM HANDLOOM Introduction 1.1 At the national level, the handloom industry ranks next only to agriculture in providing employment. It is the oldest and biggest cottage industry constituting a vital sector of the village economy. It is spread throughout the country with long tradition of excellence and unrivaled craftsmanship. For well over 2000 years our country has enjoyed the position of preeminence as a producer of handloom cloth. The handloom industry not only met the requirements of our country, it also exported its best products to countries far and near. 1.2 Handloom products have been the main item of trade between India and foreign countries. In the post-Mauryan period, and especially during the Gupta period, one of the main items of foreign trade was handloom products. Foreign travellers visiting India during the said period have made special reference to the fine hand woven cloth. During the medieval and post-medieval periods also handloom products were well known and well received outside India. It was with the coming of the British that the Indian Handloom industry received a set back. The British wanted market for their home products, and as a result

weavers engaged in handloom industry in India were discouraged in many ways. Nevertheless, the industry survived mainly due to its quality and artistic approach. Fabrics like Dacca Muslin, Kalamkaries of Masulipatnam, Brocades of Gujarat and Bhagalpuri Silk are some of the names with which everyone is familiar and which represent but a few of the many rich traditional varieties for which India has been justly famous for centuries. 1.3 Though the machine age sounded the death knell to Indian excellence in the field of cotton fabrics, the handloom industry has displayed innate resilience and has survived the onslaught of the more efficiently organised mill industry and the decentralised powerloom industry. The handloom industry has passed through many vicissitudes in its long checkered career and has managed to exist and has been playing its role in the national economy. Socioeconomic imperatives 2.1 Handlooms constitute a vital sector of the village economy next only to agriculture. The number of handlooms in the country is estimated to be 3.49 millions scattered over the entire length and breadth of the country. The production in handloom sector during 199899 was 6792 million sq. meters. The handloom cloth production target for 2001-2002 is 8800 million sq. meters. 2.2 The Contribution of handloom sector to foreign exchange earnings is also considerable. The countries to which handloom products are many - South Africa, Togoland, Australia, New Zealand, Republic of Benin, the USA, Japan, Fiji, the UK, Germany, France, Sweden,

Belgium, Italy, the Netherlands, Spain, Denmark, Finland, Singapore, Malaysia and Taiwan. The export earnings during 1997-98 and 1998-99 are as under Year Cotton Cotton Total handloom handloom madeexports fabrics ups earnings 1997- Rs. 219.68 Rs. 1,634.82 Rs. 1,854.41 98 Crore Crore Crore 1998- Rs. 223.49 Rs. 1,784.42 Rs. 2,007.91 99 Crore Crore Crore By the year 2001-2002, the export of handloom fabrics and made-ups has been projected at US$ 659 million. How it functions 3.1 Handloom cloth is woven on looms worked by manual labour. It is a cottage industry and the looms are set up even in the houses of the weavers. The middle man plays a vital role here. The usual practice in this trade is that the master weaver employs several weavers. Yarn is supplied by the master weaver and the cloth woven by the weaver is taken back, and wages paid. The handloom cloth is not subject to Central Excise Duty. Tax investigation 4.1 Tax evasion is a complex problem. Investigation of tax evasion is a challenging task requiring imagination, intuition, skill, aptitude and experience. Techniques of tax evasion become more and more complex as methods of detection become sophisticated.

4.2 In recent years many primary cooperative societies have been formed at various production centres and there is an apex body regulating the primary cooperative societies. Thus, Section 80P comes into operation in such cases and the income from this mostly gets deducted. The Department has, therefore, to deal with both manufacturers and merchants. The merchants may be either wholesalers or retailers. Points for investigation 5.1 In a typical case, the master weaver keeps a ledger account for such weavers showing the quantity of yarn supplied, the quantity of cloth taken back and wages paid. The consumption of yarn and the production of cloth in such cases, as recorded in the assessees book should, therefore, be compared with the consumption and production shown in the weavers accounts. Where such ledger account is not produced, the only way to get at the information is to take resort to action under Section 133A and take into possession the ledger account and prepare an inventory which in time should be compared with the consumption and production shown in the weavers accounts. 5.2 However, since master weavers do not generally keep a regular stock book, it would also be necessary to check up their production with reference to the yarn consumed and the cloth produced in the indirect way as follows : Yarn Opening consumed stock of =a

yarn Yarn =b purchased Total = a+ b Less : Yarn in the =c closing stock Balance ( a = yarn +b-c) consumed Closing Cloth stock of produced = yarn in process quantity of = cloth sold closing stock of = cloth Total of = above Less : Opening = stock of cloth Less : Opening = stock of yarn in -

process Balance = quantity of cloth manufactured

5.3 The cloth manufactured can be arrived at both in terms of weight and in terms of yards or meters. In a particular area there will be standard output of cloth either in terms of yards or in terms of meters with reference to every 1 Kg. of yarn consumed. Thus, if the output of a particular type of cloth is not upto the standard production shown in the accepted cases, it would be necessary to subject the accounts to a thorough scrutiny. 5.4 In the decentralised powerloom, hosiery and handloom sector, the details of conversion ratios using 1 kg of yarn to produce fabrics as per Ministry of Textiles (Office of the Textile Commissioner, Mumbai) are as under Input - Output ratios for estimating production of cloth in decentralised sector Type of yarn Conversion ratio per 1 kg of yarn Linear meter Square meter 10.75 12.40 11.10 12.90 11.10 13.00 12.90 16.00

Cotton yarn Blended yarn 100% Non-cotton Spun yarn

Viscose

filament yarn

Nylon filament yarn Polyester filament yarn

25.00 13.00

31.00 14.50

The details regarding the estimates of fabric from khadi, wool and silk, can be collected from Khadi and Village Industries Commission, Wool Development Board and Central Silk Board respectively. 5.5 As per the Census of Handlooms (1987-88), the productivity per loom per day in different States was as under State wise productivity per loom

States

Productivity per loom per day

Andhra Pradesh Arunachal Pradesh Assam Bihar Delhi Goa Gujarat Haryana Himachal Pradesh Jammu & Kashmir Karnataka Kerala Madhya Pradesh Maharashtra

4.91 meter 1.26 0.63 11.79 14.20 6.97 11.95 11.72 2.36 5.60 5.93 6.04 12.06 8.33 1.86

Manipur Meghalaya Nagaland Orissa Punjab Rajasthan Tamil Nadu Tripura Uttar Pradesh West Bengal Average

1.50 0.22 1.21 7.56 12.58 8.14 4.77 2.30 11.31 10.17

* In a day there is generally one shift of 10 to 12 hours. The above data can be made use of to estimate the production per loom for comparing the same with the actual production shown. 5.6 Sometimes, inferior or substandard quality of production is shown as sold, whereas production is of standard quality. This practice is resorted to pocket the excess sale proceeds. 5.7 As regards suppression of sales, it would be necessary to verify the sales with reference to the railway and road bookings. It would be useful to take contemporaneous extracts from the railway stations and transport companies, as some cloth bales are booked by the master weaver against self address and the RR is usually sent to their agents stationed at Calcutta or Bombay or the important trade centres. The agents take money from the purchasers and clear the RR through a bank and then sell bales. Very often, such sales for which invoices are fabricated in a different name, are omitted from the books. Therefore, in respect of consignments sent by rail or by road from the station where production centre is situated, if such extracts are taken and checked, suppression can be unearthed. Registers of transporters should also be checked to find inflation in purchases. 5.8 The material used in the manufacture of handloom products is often purchased by the manufacturers from the local dealers. The dealers in turn bring the raw material from various centres by means of trucks or rail in bogus names, i.e. either in the names of employees or other persons. In such cases, in order to properly investigate the

accounts of the manufacturers, examination of the registers of transporters in a few selected cases will be necessary. 5.9 Some of the manufacturers mix art silk yarn with cotton yarn and sell the product. Art silk yarn is obtained by getting import licences. These licences are sold at premium and regular rackets flourish in the sale of this quota. In such cases, the production and sale account would be sham, there being no production or sale, the art silk licences having been sold. Wherever an assessee is found to have purchased a licence, his account calls for intensive scrutiny. As the upcountry merchants purchase the licences after payment of the premium, the enquiry should be to find out whether the manufacturer has utilised the licence by (a) importing the yarn and paying for it, (b) clearing the yarn, (c) transporting the same to his place of manufacture, and (d) utilising the same in the business. Liaison with the Controller of Import and Export, Customs etc. would be helpful. Expenditure account also should be scrutinised to see whether any bogus expenditure is claimed. 5.10 Some dealers purchase at discount, finished products from the cooperatives and other handloom producer and resell them when the market conditions are favourable after inflating the purchase price. 5.11 In some cases, wages are inflated and huge advances are shown to be pending from the weavers but on examination these are found to be not true. Thus, wherever huge advances are shown contrary to the

normal practice prevailing in the area, examination of the weavers and others concerned will be essential. 5.12 Where business is carried out through branches situated at various places it is necessary to see that branch accounts are reconciled with the head office. The transfer of stocks from head office to branch office should be properly checked to verify the sale and outgoing from the branch office. 5.13 There are also instances where accounts of societies or master weavers are debited with interest payable to weavers on their deposits. The genuineness of the deposits in such cases should invariably be verified as chances are that these weavers may not have any credit balance with the master weaver or the societies. 5.14 The handloom trade like the cloth trade is subject to fluctuations - periods of lull followed by boom. The price of inputs as well as outputs has been constantly going up from year to year. Thus, huge profit is made on the inventory itself and consequently the general level of profits ought to be distinctly higher depending upon the stock held. The dealers suppress these profits by manipulation of the stock accounts, omission of sales or inflation of purchases. The investigator has to analyse the trends in the market, verify and workout the stock position before the rise in the prices and check up how much of the stocks has been really sold and whether the final closing stock is real. If the stocks are regularly sold in the lull period, further investigation into the accounts is necessary. POWERLOOMS

The industry 6.1 Besides the textile mills, cloth is also manufactured by smaller units called powerlooms using indigenous looms run by power. The cloth output of powerlooms is also subject to central excise duty. Factories having only two looms working one or more shifts or factories having less than four looms working only one shift are exempt from excise duty. The powerloom factories generally purchase yarn from spinning mills and weave various types of cotton fabrics. The powerloom weaving industry has undergone major changes in terms of modernization of machinery and technological upgradation of the process of manufacture. However, the old methods of tax evasion continue. Tax investigation 7.1 In powerloom cases also, there should be reconciliation of the yarn consumed and the cloth produced, as in the case of the composite mills. To operate a powerloom factory a permit from the Textile Commissioner is needed. There is excise control also. All powerloom units big and small are under the supervision of the Central Excise officer of a particular area. They are required to each keep a register showing the particulars of the owners, location of the factory, total number of looms, number of looms working on non-cotton fabrics, the names and addresses of the master weavers, etc. Similarly, in respect of master weavers, the CE Range Officer has to maintain a register showing the names and addresses of the master weavers, their licence numbers, location of their work premises, the total number of

powerlooms employed on non-cotton fabrics, etc. The AO may go through this register to see whether a master weaver has disclosed all the production which he gets done through the other weavers employed for the purchase. 7.2 Traditional methods like resorting to inflation of purchases and production expenditure, claims of excessive wastage in the manufacturing process and suppression of production and sales are still in vogue. These can be countered by a close scrutiny of the yarn purchase account including cross-checking. Some of the factories may totally suppress yarn purchases and production of cloth. During a time of scarcity they may purchase yarn in the black market which is not supported by proper invoices or bills. In such cases, the yarn purchase account should be cross-checked with the books of the spinning mill or yarn dealer. 7.3 As regards sales, sometimes cloth bales are booked on self by the powerloom factories for important trade centres like Calcutta and Mumbai . The Railway Receipts or RRs are sent to their agents in those places. The agents take money from the purchasers, clear the RRs through a bank and then sell the bales. Often such sales for which invoices are fabricated in a different name or names are omitted from the books. It is useful to take contemporaneous extracts from railway stations and transport companies at the place of the assessees factory and check them. 7.4 As a result of the levy of excise duty, some of the bigger powerloom factories have resorted to the device of

splitting their capacity into units of four looms or less, with a view to escape the duty and incidentally income-tax also. There are also cases where looms in small units are owned by the proprietors of bigger units in the names of benamidars. The AO should be watchful in such cases. Successful cases 8.1 A company, which manufactures terry-towels on powerlooms, suppressed its profits by inflating the cost of manufacture. The person behind the company floated several concerns in the names of his family members and got job work done in their names. The company made excessive payments to these concerns. Such income was reintroduced in to the main business in the form of share application money in the names of the family members and cash credits. The fair market value of the services in this industry is a dependent variable. It may vary from place to place depending on the adequacy of power supply, opportunity cost of labour, cost of credit, etc. It may also vary from season to season. Therefore, it is imperative for the AO to carefully look in to the avenues through which the assessee may attempt to plough back the unaccounted income earned. 8.2 An assessee claimed that he was a mere trader in cloth. It was found out that he actually manufactured the cloth he sold. He entrusted the weaving job to several powerlooms. In his books, the cost of manufacture consisting of the cost of purchase of yarn and the charges paid for weaving were not accounted for. Instead, he included the cost of manufacture, and more, in the purchase cost of woven cloth. A search brought to light

this inflation. In order to show on records that he was purchasing cloth for the purpose of trading, the assessee and his son raised bogus purchase bills. This assessee also earned further unaccounted income by selling a part of the cloth produced through three benami concerns that were not assessed to tax. During the course of the normal assessment proceedings, such a modus operandi can be brought to light either by resorting to a survey u/s 133A or by extensive field enquiries at the addresses given in the purchase bills. 8.3 In another case, the assessee who is a manufacturer of lungis made on powerlooms sold the bulk of his produce at the neighboring states. He simultaneously adopted both the methods of tax evasion by resorting to inflating purchases by accounting fabricated purchase bills and by making sales outside the books of account, which resulted in unaccounted stock of finished lungis. He sold a part of the unaccounted stock through his own sales outlet. Besides, periodically he opened, operated and closed undisclosed bank accounts. On his visits to the neighbouring states for collecting the sale proceeds, he received a part of the sales proceeds in cash and took demand drafts favouring the undisclosed bank accounts and realised the demand drafts through those accounts. At a time, he used to operate only one such bank account. He invested the amount in various movable and immovable properties and also introduced a part into the business by way of fictitious cash credits. In such a case where a parallel bank account was operated undisclosed, the Gross Profit ratio to the accounted sales could be a

good indicator of the sales taking place outside the books of account. 8.4 A lungi manufacturer, purchased yarn and after dyeing issued it to weavers for manufacture of lungis. He maintained individual Weavers register for each weaver and recorded the number of bundles of yarn issued and the number of lungis received. He recorded the weight of each bundle of yarn issued to the weavers as 4.400 kg. The actual weight was 4.540 kg. It meant excess quantity of 0.140 kg in the hands of the weavers. He claimed the difference of 0.140 kg as wastage. In reality, the weavers manufactured more number of lungis than that admitted. The assessee purchased these extra lungis at a price equal to the price of the yarn and sold them in the open market at the prevailing market price. Through this modus operandi he earned substantial unaccounted profits. Also, he periodically sold pieces with minor defects as seconds without bills. A search brought these facts to light. Such a defective system of accounting can probably be detected only if the AO attempts a quantity tally of the input, throughput and output and questions the assessee on wastage.

Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter - IV PROCESS HOUSE

Introduction 1.1 The demand for synthetic fabrics has gone up in India due to increase in population, direct and indirect exports, durability and low cost of the fabrics, besides several other favourable factors as compared to cotton fabrics. The consumption of the fabrics, specially non-cotton fabrics, has increased four times in the last two decades and exports also have registered a growth of 30 per cent per annum in the last four years. The indigenous growth rate in textile industry has been around 12 per cent per annum. The per capita consumption of cloth in India is 13.25 meters per annum which is below the average of any developed country. Thus, at the macro level, there are good prospects for the textile units. What is a process house

2.1 A process house is an institution where colouring and finishing work is executed on gray cloth with the help of machines. It is an important limb of the textile industry. Gujarat (Surat and Ahmedabad), Haryana (Panipat and Rewari), Tamil Nadu (Coimbatore and Salem) and Maharashtra (Mumbai and Thane) are the states where major processing houses are located. 2.2 The input of raw material in the process house is gray cloth. Here the gray cloth is subjected to various technical processes before it is converted into finished fabric. The processing consists of three stages, namely, bleaching, dyeing and printing and finishing. This series of technical processes which the gray cloth is subjected to is called the processing of cloth. 2.3 The quality of the finished fabric is largely dependent on the efficiency of the bleaching operation. Bleaching of cotton refers to the sequence of purification process used for making the fabric whiter as compared to the gray fabric. The requirement of bleaching varies with the end use of the material and this is partly responsible for the variety of bleaching methods used. For fabrics meant for dyeing and printing, absorbency is the primary requirement, whereas for fabrics to be finished as white, uniformity and permanency of whiteness are the main requirements. For this, natural as well as the added impurities have to be removed. Setting is necessary to give dimensional stability and crease resistance to the fabric.

2.4 The quality of the final product is developed in stages as the cloth passes through various stages. Ideally, the product should conform to the quality standard set for every intermediate stage. In practice, however, several permutations exist. While the quality at the final stage is the primary concern of the management, information about the route through which the product passes is of interest to the Department. The process 3.1 In a process house a series of activities take place. To begin with, the gray cloth is received as the raw material. It is entered in the godown register and stored in gray cloth godown. The activities that follow are discussed in the following paragraphs. 3.2 Gray Checking - The Cloth coming from looms is seldom free from weaving defects. The purpose of gray checking is to mend these defects to the extent possible. The defects are mainly jala, chira, floats etc. Long threads are also cut during checking. Further, the cloth also contains oil stains and it is necessary to remove these stains before the cloth is sent for other processes. This is done by spotting the stains with a stain removing agent and rubbing the spot. The oil gets emulsified and is removed subsequently. It is preferable to use a water based stain removing agent such as Stainfree-L; as an organic solvent based product can make the cotton super absorbent at these places during scouring. These spots show as dark patches on dyeing.

3.3 Stitching - This is an important operation and is carried out to obtain a sufficient length of the cloth. Usually, the length of a gray piece is about 60 to 100 meters and therefore, several such pieces (100 to 300) are stitched together to make a lot. Before stitching, each piece is marked properly for sort numbers and lot numbers. For stitching, two pieces are arranged selvedge to selvedge and the ends are stitched on a special end to end stitching machine with the overlap. The operation is simple but is not carefully performed many a times. If stitching is not done properly, it can lead to creases in dyeing and tearing of selvedges. Number of stitches per inch depends upon the type of fabric; for coating 10-12, voil 8-10 and dhoti 6-8 stitches/inch are inserted. Normally, 3/40s, 4/36s, 6/30s and 6/28s yarn are used for the purpose. Polyster threads are used for fabrics to be carbonized. Sometimes 2 to 3 threads are taken together. 3.4 Shearing and Cropping - The objective of shearing and cropping is to remove fibres and loose yarns from the surface of the fabric. The yarns of only upto about 8 cm length can be cut in this operation; longer yarns should be cut during gray checking. The fabric is passed between the cutters twice in a single run. The setting of ledger blades and spiral cutters should be done correctly to ensure optimum results. The machine runs at about 60-70 m/min speed and the production per shift is around 20,000 m. The wider width machines can accommodate two ends

resulting in higher production. Direct labour employment is 2-3 workers/shift. The latest machines are equipped with seam detectors i.e. when a stitch comes, the gap between the blade and the roller increases so that the stitch passes without damaging the cutters. It is, therefore, necessary that the number of stitches in a lot should be kept to minimum as these affect the efficacy of the operation - the more the number of stitches, the less is the efficiency. 3.5 Singeing - Yarns after spinning contain considerable proportion of protruding fibres and this is known as hairiness in the yarn. In order to obtain clean surface of the fabric, it is essential to remove these protruding fibres. The removal of these fibres is carried out by the application of heat with the result that the fibres are burnt off. The process is known as Singeing. Three types of singeing machines are known - plate, roller and gas. Of the three, gas singeing machine is the most common and possible the only one employed currently. In a gas singeing machine, petrol and air are used for producing a combustible gas. The burners are in the form of a narrow slit and the height of the flame is adjustable. After singeing the fabric is quenched to extinguish sparks, if any. Usual practice is to pass the fabric through a desize liquor bath. If desizing is not to be done or singeing is performed later in the sequence, a steam chamber can be employed for quenching. The speed of the machines is around 125 m/min and production per shift is about 50,000 m. Direct labour employment is 2 workers/shift.

3.6 Desizing - The purpose of desizing is to remove sizing ingredients, chiefly starches, gums, PVA etc. The gums and PVA are removed by a simple hot wash but starch has to be degraded first into small molecules. These molecules being soluble in water are removed through a hot wash. The process can be carried out by the following methods

Rot steeping Acid desizing Alkali desizing Enzymatic desizing Oxidative desizing

Rot Steeping - This method of desizing is a primitive one wherein the cloth is impregnated with hot water, squeezed and then stored for about 24 hours in the pits. During the long dwell natural micro-organisms degrade the starch into water soluble, small molecules. The fabric is then given hot and cold washes. The process is very slow and is rarely employed these days. Acid Desizing - Desizing can also be achieved by the use of mineral acids - sulphuric or hydrochloric. Inspite of the process being fast it is not advisable to follow due to the danger of degradation of cotton itself. The fabric is padded with 0.5% sulphuric acid and stored for about 60 min; during storage care should be taken that local drying does not take place. This is followed by thorough hot and cold washes and if required neutralization.

Alkali Desizing - like acid, desizing can also be performed by sodium hydroxide. The cloth can be padded with 2-3% sodium hydroxide (owf) at about 50o C and stored for 4-6 hrs. This is followed by hot wash. Here, some scouring action also take place but the chemical cost of desizing is very high thus limiting its usage. Also, the danger of oxycellulose formation because of local drying exists. This method, however, is very suitable for fabrics sized with PVA and/or acrylics. Enzymatic Desizing - This is by far the most acceptable method of desizing because it is both economical and safe. Enzymatic desizing scores over rot steeping in that the process is quicker. Further, unlike in acid and alkali desizing, cellulose i.e. the fibre does not get tendered. The temperature of the bath should be kept around 60o C and pH 5.5 - 6.5. The fabric is padded with a solution containing the following and stored for about 8 hrs.

Bacterial enzyme 1.5-2 g/l Common salt 1-2 g/l Wetting agent 102 g/l Acetic acid to adjust the pH

Oxidative Desizing - Oxidative desizing can be achieved through the use of sodium hypochlorite, hydrogen peroxide or sodium bromite. For desizing with sodium hypochlorite cloth is padded with a solution containing about 2 g/l available chlorine at room temperature and stored for 90-120 min; alternatively the fabric can be treated in a cistern. In desizing with hydrogen peroxide (H2O2) the fabric attains some whiteness accompanied by

a moderate scouring action. The fabric is padded with the following:

H2O2 (50%) 1% Sodium silicate 1% Sodium carbonate 0.5%

and then steamed for 30-35 minutes followed by washing. The method is not in use in our country because of prohibitive cost. 3.7 Scouring - This operation is meant to remove the natural and added impurities such as waxes, nitrogenous matter, seed husks, leaves, softeners, etc. The cloth should become absorbent after scouring. If scouring is not efficient, bleaching, dyeing and printing will not be efficient. Table - 1 Scourin Cost in Rupees g Lot size = 1800 Kg. (18,000 m) System Chemical Wage Electricit Strea Wate Tota s s y m r l Kier (include s 146 520 106 122 630 850 loading / 3 unloadin g J-box 118 (1000 650 68 88 270 108 4 kg)

Pad-Roll 144 650 168 270 270 90 system 8 Taken from Third report of ATIRA on Process House Edition February, 1989 Note : The above costs have been worked out on the following basis but the investment cost, has not been considered

Wages / worker shift Rs. 45.00 Electricity KWH Rs. 1.00 Steam / kg. Rs. 0.20 Water /1000 Litre Rs. 2.00

3.8 Chemicking - The purpose of chemicking is to destroy natural colouring matters present in cotton. The mills carry out chemicking either in cisterns or in a rope washing machine. The fabric is saturated with sodium hypochlorite solution in the washing machine and stored for about 6090 minutes. After chemicking the cloth is washed thoroughly to remove traces of chlorine. In normal practice, chemicking is followed by souring. 3.9 Souring second stage - Souring is the treatment of cloth with hydrochloric acid performed in a cistern. The objectives of souring are to remove (i) traces of chlorine, and (ii) surface deposits from the fabric. Here again, the cloth is allowed to remain saturated with acid for a short time only to avoid the danger of tendering. After souring, the fabric is given two thorough cold washes so that the acid is removed completely

3.10 Bleaching - This includes either hypochlorite or peroxide or both the treatments for cellulosics and sodium chlorite for synthetic fibre-fabrics. Hydrogen Peroxide Bleaching - H2O2 treatment conventionally is carried out in an open kier at about 8085oC for 8 hrs. Bleaching of coloured woven goods - The bleaching of goods containing dyed yarn such as sushies and checks needs to be carried in mild conditions because in strong alkaline medium and at high temperature bleeding of colour takes place. Following two systems can be used. (i) The cloth is first desized followed by scouring in an open kier with soda ash in the presence of a mild oxidizing agent such as Resist Salt L at about 80oC for 6-8 hrs. Afterwards it is washed followed by chemicking and H2O2 treatment. In scouring soda ash 2% (owf) and mild oxidant about 0.1% (owf) may be used. (ii) In another process (ATIRA short process) the cloth is desized and then chemicked with sodium hypochlorite 2 g/l available chlorine strength. After this the cloth is squeezed and without washing piled in an open kier. Here, it is treated at about 60-70oC for 6-8 hours with H2O2 (50%) 0.5% Soda ash 1.0% Sodium Silicate 1.0% Wetting agent 0.1% The cloth is then washed and dried. The process results in satisfactory bleaching.

3.11 Mercerisation - The process when performed under tension results in increased, (i) luster (ii) strength and (iii) dye-uptake. It also removes immature fibres. Two types of machines are employed (a) chain, and (b) chainlesspadless. The chain marcerising machine runs at about 40 m/min whereas, chainless-padless at 18-20 m/min. Mercerisation can be carried out either in the beginning (gray) or in between (scoured) or at the end (bleached) of a bleaching sequence. For carrying out mercerization at the last two stages, the cloth is opened on a scutcher and usually dried Table 2 Data on Speed of Bleaching Machine Machine Singeing Rope Washing Cistern Scutcher Pad-Roll System Mercerisation (i) Chain (ii) Chainless-padless 40 18-20 Speed m/min 100-125 100-125 100-125 100-120 40-50 Shearing and Cropping 60-70

Drying Range 40-60 Taken from Third report of ATIRA on process house Edition February, 1989

3.12 Heat Setting - Polyester being a thermoplastic fibre undergoes physical changes when subjected to heating and cooling cycles. It is, therefore, necessary to stabilize it at a temperature much higher than it is likely to be subjected during subsequent processing and usage. The process of conferring dimensional stability is known as heat setting. Usually, heat setting is carried out at 180200oC for 30-60 sec. However, the fabrics with textured filaments should be heat set at about 170-175oC to preserve the bulkiness. Equipment for Heat Setting - Heat setting is carried out on a pin stenter as it keeps the fabric under dimensional control. Hot air is conventionally used as a heating medium but these days a mixture of air and superheated steam is increasingly used for the purpose. The time of heat setting or in other words the productivity depends upon heating medium, equipment and fabric type. In general, 15-20 sec. for light weight and 20-40 sec. for heavy weight materials are adequate on modern stenters. Overfeed - In order to counter fibre contraction during heat setting overfeed to the extent of +2 to +5% is given to the fabrics. It also gives bulkiness to the fabrics. 3.13 Dyeing (i) Plant Structure:

The plant structure of Dyeing consist of following machineries: o Ordinary Jiggers

o o o o o o o

Auto & Semi Auto Jiggers Pad Batch Pad Dry Continuous Dyeing Range HTHP Plant Jet Dyeing (Conventional) Jet Dyeing (Rapid)

The Jet Dyeing machine and automatic Jiggers have entered the Industry in the recent past. (ii) Process of Dyeing - The cloth is sent to the Dyeing and Printing Department where it is dyed and printed according to the Program given to the Dyeing and Printing Masters. (iii)Selection of dyes - There are three primary concerns before a dyer, e.g. (1) to match a shade exactly, (2) to produce solid shades, and (3) to ensure absence of defects. The need for exact matching presupposes that the quality of the starting material is consistent. It is most economical to dye at as late a stage in the manufacturing sequence as possible. However, for special effects, it is necessary to dye at earlier stages also. The following machines are used for the said process :

Jet dyeing machine Fully automatic / Jumbo jigger machine Float dryer with padding mangal Semi automatic / automatic flat-bed screen printing machine Rotary printing machine Fabric mercerizing machine

Here, it may be noted that there are two types of dyeing viz., Polyester Dyeing and Cotton Dyeing. (a) For 100% polyester fabric dyeing, the heat-set material is entered into a jet machine where it is subjected to a temperature of 130 degree centigrade for about two hours. In case of blended fabric, after passing through jet dyeing machine, the same is put through jigger machine for dyeing of the cotton blend. (b) For 100% cotton fabric Dyeing, the cloth is subjected to the dyeing process in Jigger machine. (iv) Average Cost of DyeingThe cost of Dyeing consist of cost of Colour, Chemical, Accessories, Spares, Fuel, Power, Water, Wages and Salaries. The average cost of Dyeing along with above mentioned elementaries cost have been collected by ATIRA, Ahmedabad at Regional and national level. Table-3 Average cost of Dyeing (Rs. per kg. Cloth) Particulars (1) Cost of Colours (2) Cost of Chemicals (3) Cost of Accessories & Spares (4) Wages Region wise Maharashtra South India Gujarat 4.88 4.93 7.10 1.61 0.25 1.93 0.35 2.41 0.35 National average 5.73 1.97 0.31

1.13

0.15

1.70

1.41

(5) Salaries 0.32 (6) Cost of Power 0.44 (7) Cost of Fuel 1.39 (8) Cost of Water 0.47 Aggregate cost 10.33

0.31 0.36 1.62 0.14 10.76

0.55 1.10 2.50 0.19 15.51

0.40 0.66 1.91 0.22 12.34

Taken from Third report of ATIRA on process house Edition February, 1989 It is important to mention here that the difference between the costs incurred by exclusive Process Houses and Composite Mills was marginal. The average cost of Dyeing in exclusive process house is Rs.11.26/kg. of cloth as against Rs.12.60/kg. cloth in composite mill. (v) Consumption of inputs

Consumption of Dyes (grams/kg. Cloth) 28.12 25.68

(a) Cellulosic clothes 21.59 to (b) Cellulosic part blended 11.75 to (c) Polyester part blended 9.90 to 11.87

Consumption of Power (KWH/100 Kgs. Cloth) 43 to 55 Steam (Kgs/100 kgs. Cloth) 950 to 1064 Water (Litres/kg. Cloth) 83 to 110

It is further observed that both power and steam requirement increases with the increase in proportion of blended cloth in the total quantity of cloth dyed.

(vi) Quantity of In process Inventory during dyeing process The in-process inventory is expressed in terms of calendar days production. The details of in-process inventories varies Region wise and sector wise and are summarized as under:Table - 4 In process inventory (in terms of calendar days production) Cellulosic Blended clothes clothes Gujarat 15 22 Maharashtra 31 32 South India 13 40 Public Sector 21 13 Private Sector 12 26 Taken from Third report of ATIRA on process house Edition February, 1989 3.14 Printing (i) Plant structure: The Plant structure for printing consist of one or in combination of following printing machineries.

Region

Only Roller Printing Only Rotary Only Flat Bed Table and Roller Table and Rotary Table and Flat Bed

Roller and Rotary Rotary and Flat Bed Roller, Rotary and Flat Bed

During a survey conducted by ATIRA it is observed that approximately half of the process houses have only one type of printing machine and the rest have a combination of 2/3 type of machines. (ii) Process of Printing - The beginnings of the art of decorating textile material by printing coloured designs are lost in antiquity. Historians, however, agree that this art originated in the far east where Hindus and Chinese practised hand printing with wooden blocks. The art migrated towards the west and was mechanised by Bell, a Scotsman, around 1783 when he invented a roller printing machine. There has been a sea change since then in the technology of printing. The introduction of a wide range of new fibres, new fabric constructions, fast bright colours and a variety of application techniques have enlarged the horizon for presenting ideas conceived by designers in an effective manner. This is, however, possible only if the specialist craftsmen work with a determination to achieve the best at each stage from the conceptualisation of a design to the final marketing. There is a need, therefore, for effective cross communication for ensuring excellent results. Printing is often described as localised dyeing. This essentially means that the basic chemistry of coloration is the same and one is required to make appropriate changes to satisfy the need that the colour should not cross the boundary dictated by the design. The

design is transferred to the copper roller, bolting cloth or nickel screen. This process is commonly referred to as "engraving". The selection of materials and efficiency of the engraving operation play a vital role in deciding the final effect. Even when the supporting needs are optimally balanced, it becomes necessary for the printer to supervise and to manipulate the actual printing operation continuously. The problem becomes serious when the supporting needs are not optimally balanced in the interest of economy. There is, however, one basic difference in the case of printing (as against bleaching, dyeing and finishing) which forces the printer to be guided by his "personal skill" in preference to the technological assessment of pros and cons. There is no scope for "correction" in printing. A printer, therefore, is unwilling to change the operating conditions, even if a few steps/operations appear to be illogical, as long as the printing effect is satisfactory. Another reason is that of relatively poor correlation between the bulk working results and the results obtained in the laboratory. In spite of these limitations, the practicing technologists have used the findings presented by research workers and information supplied by dyestuff and machine manufacturers in deciding working parameters that give satisfactory results. While the levels of these parameters vary over a wide range, those levels that appear to be more common are mentioned in this chapter. The operations with which a printing department is concerned may be listed as :

Preparation of stock thickening Preparation of a printing paste

Printing (and drying) Fixation After treatment (i.e., soaping, etc.) Drying Each of the above operations will be governed by some universal printing needs, as well as some specific needs, in relation to either the class of dye, the machine, or the type of fabric.

(iii) Cost Structure of Printing: The average cost of printing consist of cost of Colour, Chemicals, Accessories & spares, Power, Steam & Water, Wages & Salaries. Table - 5 Average Cost of Printing (Rs./meter) Process Composite House Mill (1) Colour 0.37 0.55 (2) Chemicals 0.43 0.62 (3) Accessories & Spares 0.14 0.36 (4) Wages 0.39 0.41 (5) Salaries 0.41 0.27 (6) Power 0.10 0.16 (7) Fuel 0.13 0.20 (8) Water 0.02 0.06 Aggregate Cost 1.98 2.39 * Taken from Third report of ATIRA on process house Edition February, 1989 Amongst three types of machines, cost of printing on rotary machine is highest at Rs.3.09/meter as against average cost of printing at Rs.1.98 and Rs.2.39/meter of cloth. Component of Cost

(iv) Cost of Colour and Chemicals fabric wise The cost of colour and chemicals consumed (Rs./meter) for printing of different variety of fabrics varies as under:Cellulosic fabrics : 1.16Blended fabrics : 1.19Synthetic fabrics : 1.57 (v) Quantitative consumption of power, steam and water Consumption of power, steam and water varies for roller, rotary and flat bed printing machine .Consumption of Power, Steam and Water Flat Common Overall bed Power 4.19 8.44 7.13 to 4.41 to 9.51 to (KWH/100 to to 7.97 7.10 12.11 mtrs.) 4.89 8.52 Steam 85 45 to 29 to 76 to (Kgs./100 to 62 to 63 55 46 92 meters) 88 Water 334 334 to 334 to 334 to 334 to (litres/100 to 704 704 704 704 meters) 704 3.15.1 Finishing - Finishing is carried out for improving the aesthetics / serviceability of fabric or to impart certain desirable properties. Finishes that are washed away during washing or laundering are called temporary finishes, whereas those finishes which are not washed away during laundering or washing are called durable finishes. The process of finishing generally takes place in one or more stages. The fabric is impregnated with a finishing paste, squeezed and then dried on a stenter or on a felt calender. For the durable finishing treatment, the Consumption Roller Rotary

fabric is padded with a solution containing the required chemicals and dried / cured. After finishing on a stenter or curing in a polymeriser, the fabric is washed with soap and soda ash, dried and then calendered to improve the feel, luster, etc. or processed on a compressive shrinking range to impart dimensional stability or processed on a decatising machine to confer the required setto the fabric. 3.15.2 After being subjected to the process of drying the fabric is shifted to the folder machine where it is folded and is ready for dispatch. After the fabric becomes ready for dispatch, it is shifted in defined lots to the finished godown where it is entered into finished godown register. 3.16 Shrinkage - The Textile associations (ATIRA, BTRA, ITRA and NITRA) have prescribed the following norms of residual shrinkage

All cotton Cotton / viscose 67/33 polyester / cotton shirting 67/33 polyester / cotton suiting

- 1.0% +/- 1.5% +/- 1.0% +/- 1.5%

67/33 polyester / viscose +/- 1.5% shirting 67/33 polyester / viscose +/- 2.0% suiting

48/52 polyester / viscose +/- 3.0% suiting

(Norms for the Textile Industry -1989 Edition - jointly published by ATIRA, BTRA, NITR and SITRA) Records maintained

4.1 The following records are usually maintained in a process house

Cash book Bank books ledger Debtors book Party wise ledger Store records Records under Central Excise Act Records under Labour Acts Records under Central & State Sales Tax Act applicable

Statutes

5.1 Depending upon the constitution of the process house, the following industrial and other laws are applicable :

The Companies Act 1956 The Partnership Act (in case of partnership concerns) The Factories Act Provident Fund Act Employees State Insurance Act Minimum Wage Act

Industrial Disputes Act Contract Labour Act Equal Remuneration Act Maternity Benefits Act The Payment of Gratuity Act Boiler Act Central and State Sales Tax Act Central Excise Act Shops and Establishment Act Bonus payment Act Municipality Act

Forms and returns under the Excise Act 6.1 There are a number of statutory forms that are required to be maintained by a process house under the Excise Rules. These are the forms

Invoice for removal of excisable goods from factory /warehouse on payment of duty TR-6 challan (Under Treasury Rules, 1992) Proforma for filing declaration under Rule, 173-B Modvat on capital goods - Proforma for declaration in ANNEXURE 163 Monthly / quarterly returns of excise goods manufactured / received without payment of duty - Form RT-12 Personal Ledger Account Form RG-1 - Daily stock account Form RG-23A (Part 1) - Stock account of inputs for use in relation to the manufacture of final products

Form RG-23A (Part 2) - Entry book of duty credit. Annexure 89 - Proforma for declaration to be filed under Rule 57G for availing credit of duty paid on inputs under Rule 57A Form RG-23C (Part 1) - Stock account of capital goods to be used for or in relation to the manufacture of final product Form RG-23C (Part 2) - Entry book of duty credit of capital goods

Finance Act 2000 provides that all the statutory excise records will be dispensed with for all assessees from 1st July 2000 and the Excise Department is required to examine the records maintained by manufacturers. 6.2 There are three main returns that are required to be filed with the Department :

RT-3 : It is a return of monthly production RT-12 : It is a return of monthly/quarterly production of excisable goods RT-13 : It is a monthly return for production for 100% export oriented unit which use the goods in their own factory under Excise Act

Procedures

7.1 The following procedures under the Central Excise Act are to be followed by a processing house -

First, apply in Form No. AL-3 under Central Excise and Salt Act 1944 for obtaining a licence for production of cloth. After the receipt of the licence, make an application in form No: AL-4 for the purpose of production of excisable goods (in this case the processed fabrics). After the excisable goods are produced, make an application in form No: AL-5 requesting for the storage of the goods in a private warehouse. For this purpose prior approval of the Department is to be obtained. In case the finished goods are to be stored without Duty, the entry is required to be made in the entry book marked as EB-4. Otherwise it is to be entered in RG-1, which is a daily stock book for this purpose.

7.2 Another register, RG-23 is required to be maintained in which the inputs for manufacture of the final products are to be accounted for. In RG-23A ( Parts I & II), a current account is to be maintained with the Excise Department to cover the Excise Duty that becomes payable in the event of production of excisable goods. Besides, a declaration is to be given in Form D-3 to the Department whenever excisable goods are received in the factory. Before the finished fabric is transported from the factory to its destination in the market, gate pass invoices are to be issued. Levy of Excise Duty 8.1 Knowledge of the relevant provisions of the Central

Excise Act and the Rules is necessary for any meaningful investigation in the case of a processing house. Otherwise, it is impossible to decide the line of investigation / enquiry. 8.2 For Excise Duty purposes an independent processor is treated differently from a composite mill. An independent processor is a manufacturer who is engaged primarily in the processing of the fabrics with the aid of power and who also has the facility in his factory for carrying out heatsetting or drying, with the aid of power or steam in a hot air stenter and who has no proprietary interest in any factory primarily and substantially engaged in the spinning of yarn or weaving or knitting of fabrics, on or after the 10th December, 1998. (Explanation 1 to the Rule 96 ZQ of Central Excise Rules 1944). Composite mills are those whose inputs are synthetic or cotton fibre and final product is the man-made synthetic or cotton fabrics. 8.3 The Excise laws use the words man-made fibres / fabrics and natural fibres / cotton fabrics. These words have special meanings. Man-made fibresmean artificial and synthetic fibres. Natural fibres are those made from cellulose, cotton, silk, etc. Presently, there is no difference in the rate of duty levied on man-made fabrics and cotton fabrics .8.4 Excise Duty is levied, either at the flat rate or on the ad-valorem value of the finished product. Ad-valorem value means the total value of the finished product minus all the post manufacturing expenses including any tax, cess, duties, if leviable on the finished fabric. Section 4 of the Central Excise Act 1944 levies maximum duty at the

rate of 8 per cent ad-valorem, on the value of the finished product. This is known as the basic duty. That apart, additional duty at the rate of 8 per cent is levied. The additional duty is levied instead of sales tax. Levy of sales tax is chiefly the concern of the state government. However, in terms of an agreement between the central and the state governments, textile, sugar and tobacco are exempted from sales tax , in lieu of additional duty. The additional duty collected is distributed among the states. Evasion of Excise Duty becomes attractive in monetary terms to the processing houses. The preventive wing of the Excise Department frequently conducts searches and surveys on the processing houses. 8.5 With effect from 16 / 12 / 1998, Excise Duty is levied on independent processing houses with reference to the number of chambers in the stenter. As per the new provision, the processor is required to pay the lump sum Excise Duty at the rate of Rs. 1.5 lac per chamber per month. Composite mills are still under the old duty regime 8.6 The Finance Act 2000 has proposed to change the scheme of levy under Section 3A of Central Excise Act as under

Existing rate of Rs. 1.5 lakh per chamber per month has now been increased to Rs. 2 lakh per chamber per month. The existing rate of Rs. 2 lakh per chamber per month has now been increased to Rs. 2.5 lakh per chamber per month.

Interest rate on delayed payment has now been fixed at 24%. Provision has been made for deemed modvat at Re. 1 per sq. meter each in respect of BED and AED (ST) to the user. Existing basic duty rates of 5% / 12% on gray cotton fabrics not containing any other textile material and other woven fabric have been rationalized to single rate.

Specific rate of excise duty (without modvat benefit) has been fixed for independent texturising unit manufacturing taxturised yarn of polyester. 8.7 Modvat benefits - A processing house is entitled to claim the credit of duty paid on inputs or on the capital goods. It means the duty that is included in the cost of the inputs and capital goods can be adjusted against the excise duty payable on the finished product. Rule 57R(8) of the Central Excise Rules 1944 lays down that the processor shall not be able to claim the above credit of the excise duty charged on the capital goods, if either it claims depreciation under Section 32 of the Income tax Act 1961 on the amount of duty or claims deduction of duty as revenue expenditure under any provision of the Income tax Act. Export of fabrics 9.1 Exports of fabrics to the USA, Canada and the European Union are covered by restraints under the provisions of Agreement on Textile and Clothing. The exports require allotment of export entitlements to these

countries under the Yarn, Fabrics and Made-ups Export Entitlement (Quota) Policy for 20002004 (Notification No. 1/129/99 Export I dated 12th November 1999 by Ministry of Textiles). The Executive Directors of the respective Export Promotion Councils are the quota administering authorities. They make the allotments. There are fixed norms for the allotment. The Ministry of Textiles has the right to allot entitlements in variation with the above, in case it is considered so desirable in view of changes in demand patterns or other relevant factors. 9.2 Enquiries regarding exports of the fabrics may be made to the competent authorities. Location of the offices and telephone numbers of these authorities may be obtained from the Internet web site of the Ministry of Textiles having address http://texmin.nic.in/. Verification of major inputs 10.1 Investigation in the case of a process houses should generally follow the same pattern as in other major Industries. In a manufacturing operation based on a chemical process, consumption of inputs provides a major area for investigation. In process houses, quantity of inputs is predetermined at every stage of processing.The starting point of investigation in such cases is to know the proportion of each input that is given to obtain the product in each stage. The ratio thus ascertained may be used as the standard with which to compare the actual ratio disclosed in a given case. The ahmedabad Textile Industrial Research Association (ATIRA), carries out surveys of various textile units in India and prepares a

report on a cost-wise and region-wise comparison of inputs, productivity and damages in processing activities. 10.2 The consumption pattern of chemicals, colour, other material, water, steam, power and wages and salary in each manufacturing stage of process house has been discussed in earlier paragraphs. The consumption norms are available in the third report of the ATIRA (Edition 1989) and in the norms of the textile Industry jointly published by all the four textile associations in India (ATIRA, BTRA, NITRA and SITRA) Edition 1989. The latest report of ATIRA is in the final stage of completion and will be available shortly. 10.3 The AO may examine the reasons for the variation between the actual consumption and the standards prescribed by the ATIRA taking into account the efficiencies in respect of each stage of processing. Comparison of consumption with Industry norms would indicate whether such variations are real or manipulated. The internal records maintained by the manufacturer must be studied closely to trace the ultimate destination of consumption and output of the batch concerned. Subject to the above general remarks the quantity and value of input and process cloth may be verified step by step as indicated below (i) Ascertain the quantity of production batch wise. (ii) Convert actual production as percentage of installed capacity and examine the reasons for the shortfall if any, in the production as compared to installed capacity. In this connection, it will be

necessary to take into account addition to production capacity during the year of account and in the immediately preceding year. (iii) Loss of production due to shrinkage of finished fabrics may be ascertained and examined with reference to norms of shrinkage as mentioned in Para 7.17. Similarly, loss of production capacity may be critically examined. Any abnormal reasons for low production/loss of capacity/idle time must merit special attention (iv) Co-relate production to the norms of consumption of water, steam, power and wages and salary as prescribed by ATIRA. Reconcile the quantity of production with that of sales. (vi) In appropriate cases actual production of intermediary processes must be compared with the capacity of the various manufacturing segments so as to ensure that the end product of one segment has been fully put through the succeeding segments and the final product obtained has been fully accounted for. The point to be noted here is that there is bound to be some imbalance between the capacities of various segments of a plant and, particularly in cases where the final segment has a higher capacity it is always possible to use that capacity to process intermediary processed clothes purchased outside the books of accounts. Investigation based on Excise Duty

11.1 To decide the line of inquiry / investigation in the case of a process house, it is absolutely necessary to ascertain in the beginning itself, under which scheme of excise duty the concern's case falls, i.e. whether the processor pays excise duty on lump sum basis on the capacity of the stenter or on the value of the finished fabrics. Payment of duty on lump sum basis is attractive to big processors but this scheme is not beneficial to the small processor. The reason is obvious. Under the old provisions applicable prior to 16 /12 /1998, to save itself from the burden of Excise Duty, processors used to understate the production. It is now learnt that large processors are now showing overproduction. The production of other units is also being shown as production in these units. 11.2 In the annual accounts, a process house has to disclose the installed capacity and production capacity. If production is more than the installed capacity, it may be a case of overproduction. So long as the concern discloses profit corresponding to this production, there is no problem. However, such disclosures rarely happen. To compensate for the resulting excess profit, the assessee may debit bogus bills for purchase of raw material like gray fabrics and chemicals. It may not be possible to reduce the huge profit by debiting bogus expenses as disproportionate overhead expenses may catch the attention of AO very easily. Ratio analysis of the expenses with the quantity of production would help in picking up the points for investigation .Evasion of Excise Duty

12.1 Prior to 16-12-98 there used to be large scale evasion of Excise Duty by all processing houses. Now, independent processors are covered by the lump sum duty scheme. Evading duty is no longer beneficial to them. Others may still find duty evasion attractive. It is necessary that the AO looks carefully into the various Excise records kept by the processor. Excise offenses may be put in three categories :

Clandestine removal of finished goods; Undervaluation of inputs; and False modvat credit.

12.2.1 Clandestine removal of finished goods - The processors often remove fabric without issuing GPIs / invoices to evade payment of Excise Duty. Duty evasion automatically results in income tax evasion. To counter this the following course can be adopted 12.2.2 Under the Excise Rules every processor is obliged to maintain a register called the Lot Register. There is no particular form for this Register. This Register is important from the Excise angle and also from Income tax angle. The Register records all details pertaining to gray fabrics received by the processor in his factory for processing. It contains important details of the fabric, namely, length, width, counts, etc. A unique identification number is given to a lot, which has to remain on the fabric throughout the processing till its removal. There is a requirement to record the lot number in the RG-1 register and the RG-1 register number in the Lot Register. In the RG1 register, under the Excise rules, stock account of finished fabrics is

noted. It contains date wise details of opening stock, quantity manufactured, goods dispatched (with duty and without duty) and the closing stock of finished goods. A comparison of the Lot Register with the RG-1 Register will throw up many valuable clues for investigation. 12.2.3 Before any gray fabric is taken for processing in the factory, it has to be entered in the Lot Register. It is given a particular lot number. After the gray fabric is processed, and finished, it is entered in the RG-1 Register. The lot number is also entered. Normally, depending upon the type of processing involved, the processing should be over in two or three days. But, sometimes, the gray fabric received under the particular number continues to be shown pending in the Lot Register for months together. When the discrepancy is questioned, the usual explanation runs like this: The quality of processing was not upto the mark or to the expectation of the client / customer. The lot was again taken up for processing and hence remained with the factory for this long a time. The AO should not be so gullible as to fall for this explanation. In all probability, the finished goods had been removed without payment of the Duty and the same lot number given to a new lot of gray fabrics. In such cases, it is necessary to identify the particular customer whose name appears in the Lot Register against such a lot number and question him with regard to the quantity of gray fabrics given by him for processing and the mode of payment (whether in cash or by cheque) 12.2.4 If on the basis of comparison of Lot Register and RG-1 register, it is noticed that a particular lot is cleared

after a long interval, and there are many such occurrences, there is every possibility that the assessee is recording only a part of the production in the regular books of accounts. Monthlies details of processing vis--vis chemical consumption as well as electricity consumption would also help in establishing any such understatement of production. After this exercise, the AO should collect evidence of understatement of production by making third party inquiries, and bank inquiries, etc. In every factory there is a system of maintenance of inward and outward register so as to enable the management to know what items have entered in the factory and taken out from the factory. Cross tally with the RG-1 register can give evidence of understating of production. 12.2.5 Inflated shortage - Processing shortage is often claimed by Processors sometimes. If this shortage is in excess of the standard, enquiry is necessary. Shortage depends upon the quality of the fabric and also the type of processing. 12.3 Undervaluation of inputs - Excise duty is levied on ad-valorem value of the finished goods (value of goods minus post-manufacturing expenses). Therefore, there is a tendency to undervalue the inputs. This is resorted to in a variety of ways. Hand processing does not attract excise duty. A part of the processing is often claimed to have been done on hand. 12.4 False Modvat credit - Processors are entitled to claim credit of excise duty paid on the inputs and capital goods against the actual payment of excise duty payable on the finished fabrics. To claim false credit, Processors

often produce bogus invoices of excisable capital goods and inputs of higher value. It is advisable to examine the genuineness of such purchases. In order to make a purposeful enquiry, the AO should be in touch with the concerned Excise authority. He should have a proper understanding of the nature of the trade and the practices bearing on the Duty levy. Detected cases 13.1 In the case of a process house, verification of major inputs led to detection of a significant amount of concealed income. The concern admitted the income before the Settlement Commission. The facts are as follows : The AO suspected excess claim of consumption of colour and chemicals. The consumption claimed was at Rs. 3.8 per meter of gray cloth during that year as compared to Rs. 2.74 in the preceding year. The AO after making investigations was able to detect bogus purchases of colour and chemicals to the tune of Rs. 56 lakhs. He also detected bogus processing charges in the name of fictitious parties after a scrutiny of the input of wages and salary .13.2 In another case the assessee reported a shortage of 2.29 per cent of cloth during processing activities. The Industry norms of shrinkage of cloth during processing activity were much lower. Further investigation revealed that the assessee had claimed purchase of processed cloth for trading. All these purchases were found to be bogus and the production that was shown as shortage was in fact shown as bogus purchases for trading.

Unaccounted production of Rs. 41.65 lakhs was detected in this case. 13.3 It is a common practice in this line of business not to record a part of the production in the books of account. However, the concerns try to maintain ratio of consumption of various inputs including power with production. Obviously, if full production done is not to be recorded in the books, consumption of the corresponding quantities of inputs like chemicals, coal, power etc. are also not recorded so as to avoid detection of the unrecorded production. 13.4 In one case, as a result of action under Section 132, it was found that the assessee had an electric generating set. In the books the use of the generating set for running the plant was shown for an insignificant period. The plant was shown as running one shift only on the power drawn from the Electricity Board. In fact, it was being run in two shifts. During the search, a register was found which included the details of power generation and consumption of diesel on day to day basis. With a view to maintain the ratio of consumption of power with that of the production, the assessee ran the second shift exclusively by using the set. The corresponding expenses on diesel were not recorded in the books. A rough cash book found at the premises of one of the directors of the company showed that the actual purchases of coal and chemicals were far in excess of the purchases shown in the regular books of account.

13.5 It is useful to see if the assessee is maintaining a generating set, and if so,

whether the plant is being shown as run in one or two shifts , and whether the quantum of consumption of diesel and the number of hours for which the plant is shown as run on the generating set is in consonance.

If the answer to both these questions is in the affirmative, it is worthwhile to carry out discreet enquiries at first to ascertain the correct state of affairs. In appropriate cases of large evasion, actions under Section 133A or even under Section 132 may have to be considered. 13.6 Processing houses usually do job work only. They receive raw-material, i.e. gray cloth, from their customers and, after processing it, return the processed cloth to them. A novel method of tax evasion was found in one case. The processing house A received X quantity of gray cloth for processing from a party B and returned the same quantity to B after processing. In its records, however, it showed the quantity as Y, which was only a small fraction of X. The quantity Y was shown as purchased from a fictitious party. It raised a bill for sale of Y in the name of B. Thus, the processing charge that was received from B for processing quantity X was shown as received as sale price of quantity Y. Thus, A depressed its profits. The receipt on account of processing charge was recorded in As accounts as sale proceeds. However, A also debited its accounts for purchases of corresponding quantity of gray

cloth. Of course, A must have incurred some unrecorded expenses on consumption of chemicals, coal, power, etc. This arrangement suited B also. B had to account for investment in only Y quantity that was much less than the actual investment made in quantity X, and the processing charges payable on that. In such a case, verification of the purchases, particularly those for which payments were either not made within a reasonable time or shown to have been made in cash, will help. 13.7 Understatement of processing charges is prevalent in this line. As a result of action u/s 132 in a case, it was found that, though the assessee was in receipt of processing charges at the rate of Rs. 3.5 to 4.5 per meter of cloth (as indicated in the seized records), it disclosed only the rate of Rs. 2 to 2.5 in its books. It is useful to compare the processing charges shown as received by the assessee with that shown by other concerns. Particularly, the receipts shown by the public sector units will provide a good indicator. 13.8 Understatement of sale price is also resorted to depress the income. Excise Duty is chargeable on the sale price of the cloth. The sale price is often understated in order to save on the Duty. Action u/s 132 in a case led to detection of understatement of sale price by Rs. 6 crores. In another case, understatement of sale price by about Rs. 2 crores was admitted by the assessee. It is advisable to obtain quality-wise details of production and sale of fabric and correlate the sale price of each quality of fabric with the sale price of similar quality admitted by other

manufacturers during the same period. If significant difference is noticed, it may call for deeper investigation.

Directorate of Income Tax ( Systems )

Investigation Manual Volume - 2 Chapter - V WOOLLEN MILLS

Introduction 1.1 Wool is a natural fibre growing on the skin of the sheep. It is composed of protein called keratin which is a non-conductor of heat. Wool is a relatively coarse fibre as compared with other fibres. Wool is crimpy (wavy) and has scales on its surface, which provide air packs for insulation. The fineness and the softness of the wool fibre depend upon the nature of scales on the surface. If the scales are smooth and are large in number, the fibre would be finer, softer and warmer. However, if the scales

are rough and not many, the fibre is thicker, coarser and less warm. The soft and fine wool fibres are suitable for garments and clothing whereas the coarse fibres are used for making carpets. The two main characteristics of wool fibre are susceptibility to heat and the felting property, which is because of the scales on its surface. Wool fibres are also very good absorbents. It can absorb water upto 20 per cent of its weight without giving the feeling of dampness. It can absorb water upto 50 per cent of its weight without dripping. Because of this property, wool fibres are ideal for the outer wear on cool and damp days. 1.2 There are also some hair fibres that have the qualities of wool. These are Alpaca, Llama, Guanco, Angora, Cashmere etc. These are obtained from the hair of goat or camel. 1.3 In old days, primitive people killed sheep for food and used its felts to cover their bodies. With passage of time, the fluffy undercoat became matted. Later on, people discovered that a series of sheep fibres could be twisted into continuous yarn. This led to invention of different implements like Charkha to aid and improve the process of twisting and spinning. At present, various types of sheep are reared for wool. There are about 40 breeds and over 200 cross-breeds of sheep, from the hair of which wool is obtained. However, Merino sheep gives the best wool in terms of diameter, crimps and scales. It is used in the best types of wool clothing. The breeding of Merino sheep started in Spain long time back. The wool obtained

from merino sheep is of such an excellent quality that exporting merino sheep from Spain was a capital offence. 1.4 For getting wool, shearing of sheep is done from time to time. Usually, it is done in the spring season. Earlier, the shearing of the sheep was done by hand clippers and now it is being done by machine clippers as one piece. Different parts of the body of the sheep give different quality of wool. The wool from the shoulders and the sides of the sheep is considered superior and is called first fleece. The wool from the head, chest, belly and shanks of a sheep is not very fine. The first wool sheared from a six to eight months old lamb is called lambs wool. That wool is of very fine quality. The fibres obtained from the lambs wool produce softness in the fabric. Since raw wool obtained from the sheep contains natural oils, it is called greasy wool. The grease, also known as yolk, taken out from the greasy wool is used in pharmaceutical and cosmetic industries. The quality of wool depends upon various factors like breeding, food, general care, health of the sheep and the climate of the area. Australia, New Zealand, Argentina, South Africa, Uruguay, USA, Portugal, Kazakistan etc. are the main wool producing countries in the world. 1.5 The fineness of the wool depends upon various factors like diameter and length of the wool fibre. The diameter i.e. the thickness of the fibre is measured in microns (micro-metres). The fibre with lower thickness is considered finer. The length of the fibre is measured in millimetres. The fibre having greater length is finer than

the fibre with lower length. For manufacturing yarn of various counts, wool of different microns is required. For spinning wool yarn of 80s, 70s, 64s count, the micron of the wool should be 20 or less and the length of the fibre should be 70 mm or more. For spinning wool yarn of 56s count, the micron of the wool should not be more than 21.5 and its length should also not be less than 70 mm. Similarly, for manufacturing wool yarn having 42s or 32s count, the micron of the wool should not be more than 24 and 27 respectively. The wool having different microns is used for different purposes. The merino wool/greasy wool having 19 to 22 microns is used for suitings. Wool of 18 to 24 microns is used for manufacturing shawls and wool of 24 micron to 30 microns is used in hosiery. Wool of 31 microns to 36 microns is also used in hosiery after blending with Mohair. The wool of 36 or higher microns is used for manufacture of carpets. 1.6 India produces nearly 45 million Kg wool every year and stands 11th in production of wool in the world. However, this wool is not suitable for apparel production due to its coarse quality and is mainly used for carpets and blankets. Indian wool industry, therefore, depends upon wool mainly imported from Australia and New Zealand. About 60% wool comes from Australia, 25% from New Zealand and 15% from South Africa. The wool imported from Australia and New Zealand is most suitable for suiting, shawls and hosiery whereas the New Zealand wool is suitable for carpets. Development of wool in India

2.1 Before the second World War, there was no planned growth of woollen units in the country. After the war, there was some expansion and many spinning units were installed with old machinery. There were 19 mills with an installed capacity of 48000 woollen and worsted spindles, 1500 power looms and 500 handlooms in 1946. These were located in Bombay, Amritsar, Banglore, Kanpur, Dhariwal, Srinagar, Allahabad,Mirzapur, Baroda. Since 1947, the woollen Industry in India has made tremendous progress in all directions. As on 31st October,1998 there were about 700 registered units in the woollen industry having installed capacity of 5.63 lakh Worsted spindles, 3.99 lakh non worsted spindles, 7107 power looms . The combing mills have the capacity to comb 32.70 million kg of wool. The woollen industry employs approximately 12 lakh people in the country. 2.2 Presently, India is not only manufacturing woollen products for domestic use but is also making export of woollens in a big way. In 1956, the country made woollen exports of only Rs.1.40 crore. However, in the year 199899 these rose to 1870.42 crore. These exports are to various countries like USA, Canada, Russia, Hong Kong, Germany, France, UAE, etc. The export of woollens from India includes worsted fabrics, woollen blankets, knitwears, shawls, scarves, mufflers, carpets, wool top, yarn and woollen readymade garments. To promote the export of woollen products, the Government of India set up the Wool and Woollens Export Promotion Council (WWEP) in 1964 with the cooperation of Industry and Trade. The Council helps the importers through out the

world to gain access to quality products made in India through a network of more than 800 member- exporters. The WWEP also keeps track of international fashion trends and makes fashion forecasts for Indian exporters. 2.3 Indian woollen industry manufacturer various woollen items like worsted yarn, woollen yarn, woollen tops, fabrics, shoddy yarn, blankets, etc. Classification of woollen yarn 3.1 Broadly, woollen yarn is classified in three categories woollen yarn, worsted yarn and shoddy yarn. Woollen yarn is manufactured from shorter stapled wool whereas worsted yarn is manufactured from longer stapled wool. The woollen yarn is quite loosely spun with little twist and the fibres are also not very parallel. However, in worsted yarn, the fibres are made as parallel as possible and the yarn is also smooth with relatively high twist. The woollen fabrics have a soft fuzzy surface. Tweeds, Shetland, Cashmere are the examples of woollen fabrics. Gabardine, Whipcord Serge, Worsted Cheviot, Tropical Worsted and Bed Ford Cord are examples of worsted fabrics. The woollen fabrics are warmer than the worsted fabrics but they are not as durable as the worsted garments. Woollen yarn is generally less expensive than the worsted. 3.2 To meet the increasing demand of wool and in view of the limited supply of new wool, worsted fibres have to be recovered from old clothings, rags and waste from wool manufacturing. This wool is known as shoddy wool. The

shoddy sector provides cheaper clothes. Besides, the hardier shoddy fibres obtained from good original stock blended with new wool from lamb etc add durability to the soft new wool. Therefore, besides providing wool clothing at reasonable rates, shoddy fibres also contribute ability to the soft wool to withstand hard wear, though the fabric may not be that warm or soft. Manufacturing process - stages 4.1 The manufacturing process of woollen yarn can be divided into two stages. The first stage is combing and the second, spinning. Combing 5.1 Combing relates to manufacture of wool top from greasy wool. Till 1961, the Indian woollen industry depended entirely on the imported wool tops for making worsted yarn. In order to make adequate quantity of wool top available from indigenous sources and thereby save foreign exchange, the Government of India issued licenses in 1960 for establishing wool combing units in the country. The first modern wool combing unit was set up by the Wool Combers of India Ltd. in 1961. In 1975, the number of wool combing units rose to 15. At present, there are about 70 combing units in the country having combing capacity of tonne to 10 tonnes per day. Most of these units are located at Ludhiana and Amritsar. However, some combing units are also located in the states of Haryana, Maharasthra, Rajasthan, West Bengal, etc.

5.2 The raw wool is imported in two forms greasy wool and scoured wool. The greasy wool contains the natural oils of sheep, dust, and other impurities that are picked up by the sheep from the bushes and plants where they had been grazing. The scoured wool is washed by the supplier before the same is exported and hence it does not contain the oils and dust. It is directly sent for carding. However, in the case of greasy wool, the first process involved is the scouring or washing. Before the greasy wool is washed, it is passed through a machine called the wool duster or wool opener. In this machine, thick knots in the raw wool are opened. This machine consists of cylindrical drums that have pins on their outer surface. When the raw wool rolls along with the drums, the pins separate the thick knots from the wool. The knots and other undesirable materials such as dust fall down through an opening and the wool is delivered out from where it is collected. After opening, the wool is thoroughly washed in scouring machines. The scouring machine consists of five chambers called balls. The chambers are equipped with automatic rakes, which stir the wool. The rollers between the vats squeeze out the water. The connection of steam is given to all the Chambers from the boiler. Temperature of 70 degree Celsius is maintained in these chambers. Water, detergents and a mild solution of soda ash are added to the first four chambers. In these chambers, the grease and dust is removed from the raw wool. The fifth Chamber contains clean water, in which wool coming out of the fourth Chamber is washed. In addition to washing, the clean water also removes the grease, if any. After scouring, the wool is passed through the dryer for drying.

However, it is not fully dried. Instead, 12 to 16 percent moisture is left in wool to condition it for subsequent handling. 5.3 After drying, the wool is passed through various carding machines for carding. The purpose of carding is to individualize and parallelise the fibre and remove the vegetable matters from it. There is difference in carding for woollen yarn and worsted yarn. In the case of woollen yarn, the main objective of carding is to individualize the fibre by passing the wool fibre through various rollers covered with fine wire teeth. The wool fibres are brushed and individualized by wires after which they become somewhat parallel. Some dirt and foreign matter are also removed at this stage. Since the woollen yarn should be some what rough and fuzzy, it is not necessary to make the fibre too parallel. One sliver of wool is placed diagonally overlapping an other sliver by use of an oscillating device. With this, the fibres are disentangled and are made somewhat parallel. This also provides a fuzzy surface to the yarn. After this process, the woollen slivers go directly to the spinning operations. However, in the case of worsted yarn, the essential purpose of the carding is to make the fibre as parallel as possible. After carding, the carded wool is sent to the gilling boxes for gilling process. This process separates the wool fibre having short staples and also straightens the fibre. This process is continued in the combing operation also. The combing process removes the shorter fibers called first noils, second noils, shoddy wool and burrs. Besides, the foreign elements like twigs are also removed from the

wool during the combing process. Combing also places the longer fibres called wool tops as parallel as possible. After combing, the slivers of wool top are doubled and redoubled by drawing process. The drawing process makes the slivers more compact and thin after various rounds of drawing. After drawing, the slivers of wool fibre are given slight twisting through roving frames to hold the fibres together. This brings the wool to the stage of wool top. 5.4 Here it is pointed out that various wool producing countries have wool testing authorities, which issue a certificate to the supplier regarding the probable results expected from a particular lot of the wool consignment. These authorities are Australian Wool Testing Authority in Australia, SGS Wool Testing Services in New Zealand and Wool Testing Board in South Africa. This certificate is issued on the basis of samples taken from the lot of the wool being despatched by the supplier. The certificate gives such details as the wool base, mean fibre diametre, vegetable matter base and clean weight of the consignment. Clean weight represents the quantity of wool top, noils, shoddy and burrs likely to be obtained from the consignment of the greasy wool after the combing process. This also includes the amount of moisture contained in the wool. The wool base is the weight of dry wool (excluding moisture) likely to be contained in the consignment. The mean fibre diameter represents the average thickness of the fibre in microns(micro-metres). The vegetable matter base is the amount of vegetable matter present in the greasy wool. After combing, the

comber also issues similar certificate to the importer on the basis of actual combing results. Usually, there is no variation in the actual results and the anticipated results shown in the certificate issued by concerned the Wool Testing Authority. Spinning 6.1 In the spinning process, the wool top is spun into yarn. The wool top slivers obtained after combing are first of all passed through gill boxes and rubbing frames. These machines have several pairs of rollers, each revolving at a progressively faster speed. This action pulls the staple lengthwise and makes the sliver thinner. The sliver is also given a little twist in this process. The drawing out and twisting continues till the fibre is about the diameter of a pencil lead. After these processes, the fibre is placed in the spinning frames where it passes through a series of rollers running at successively higher speeds. The fibre is ultimately drawn out to the yarn of the desired size. After passing through spinning frames, the yarn goes to the winders for winding on cones. Now the yarn is ready to be used by the fabric manufacturers. Output 7.1 The first step involved in the investigation of accounts in the case of a woollen mill is the verification of the consumption yield ratio. The yield should be seen at two stages at the stage of conversion of wool top from greasy wool, and at the stage of the conversion of wool top into yarn. As far as conversion from greasy wool to wool top is

concerned, there is no fixed ratio of yield since it depends upon the quality of the greasy wool. Usually, the wastage at this stage varies between 30 to 40 per cent although it may go up to 70 per cent if the quality of the wool is inferior. 7.2 Before despatch, most of the consignments of greasy wool sent by foreign suppliers are tested by the wool testing authority of the concerned country. All these authorities issue a certificate called IWTO Combined Certificate. This certificate contains details of the mean staple length, mean diameter of the fibre, dry weight of the fibre free from all impurities (also called wool base), vegetable matters base, IWTO Schlum Berger Dry Top & Noil Yield (i.e. the amount of Top and Noil that can be combed from the greasy wool) etc. The Indian comber also issues similar certificate to the importer after actual combing. Usually, the results found on actual combing are marginally better than the results shown in the certificate issued by the wool testing authority concerned. In case there is substantial variation between the results, the reasons should be enquired into. It is likely that cheaper and inferior quality wool might have been blended with the imported wool. The AO may go through the correspondence between the comber and the importer to find out the reasons for the variation. The correspondence of the importer with the supplier may also be gone through as, usually, the importer lodges the claim for compensation with the foreign supplier, through its indenting agent, in case there is any substantial variation between the expected results as shown in the certificate

issued by the Wool Testing Authority and the actual results. In case the assessee has not lodged any claim for compensation, the genuineness of the low recovery of wool top from the greasy wool shown by the assessee becomes all the more doubtful. 7.3 For verifying the yield of wool top from the scoured wool or the yield of yarn from wool top, it will be worthwhile to compare the results shown by the assessee with the input-output norms for various industries prescribed by the Director General of Foreign Trade. As discussed in the chapter on Woollen Hosiery Industry the DGFT has prescribed these norms after making thorough studies. The AO should go through these norms. In case, there is any substantial variation between the yield shown by the assessee and the input-output norms prescribed by the DGFT, the AO should thoroughly investigate the case for detecting possible bogus purchases, inflated expenses or suppressed sales. Input-output norms for some of the items manufactured by the woollen mills are given in ANNEXURE-1. 7.4 The woollen industry has to pay Central Excise Duty on wool top and wool yarn. Currently, the excise duty is 9.20 per cent (Basic 8% + surcharge @ 15%) on wool top and the wool yarn separately. The combing mills and the spinning mills have to maintain certain statutory registers like Register in Form IV and R.G.-1 Register under Central Excise Act. R.G.-1 Register contains the day to day details of quantity manufactured and cleared from the factory. The amount of excise duty paid and total quantity of wool

top or yarn manufactured can be gathered from this register. This figure may be cross-checked with the figure of production shown in the account books. The register in Form IV gives information regarding the raw material used in manufacture of various goods. In this register, the quantity of raw material issued for manufacturer is entered daily. This register also gives such information as the opening balance, quantity of raw material purchased, visible wastage, invisible wastage, closing balance of raw material, etc. 7.5 The AO should prepare a monthwise consumptionyield ratio chart on the basis of the information available in these registers. In case the yield shown by the assessee for some months is substantially lower than the yield shown in other months, the AO should investigate the reasons for the same. The assessee might have introduced bogus purchase bills or might have shown excess wastage in the months in which the yield shown is significantly lower. It will also be worthwhile to compare the figures of stock appearing at the end of each month with the stock shown by the assessee in the stock statements given to the bank for the corresponding months. This exercise may reveal any unaccounted stock hypothecated by the assessee to the bank. Accounting for grease 8.1 The greasy wool scouring, the oils are be obtained from pharmaceutical and contains natural oils of sheep. After removed from the wool. Grease can these oils, which is used in cosmetic industries. Most of the

combing plants have installed machinery for extraction of grease from the oils removed from the greasy wool. The AO should find out whether such grease has been accounted for in the books of accounts by the comber or not. Valuation of stock 9.1 The valuation of closing stock also needs to be checked carefully. Sometimes, the customs duty on the raw material is not included in the value of closing stock resulting in undervaluation of closing stock. The duty paid by the assessee on imported raw material constitutes an important element in the total cost of the goods and, accordingly, requires to be added to the value of imported raw material. Further the AO should also verify whether the material sent by the assessee for combing or dyeing during the year but not received back till 31st March, has been included in the closing stock or not. Penalties under the Excise, and Customs Acts 10.1 The AO should also check up whether the Central Excise or the Customs authorities have imposed any penalty on the assessee. Sometimes, the assessee debits the penalty to the purchase account without showing the same as penalty. The assessee may even debit the penalty to the capital account of the partners so that the fact of the imposition of the penalty does not come to the notice of the Department. The assessee should be clearly asked as to whether any such penalty has been imposed on him. It would be worthwhile to go through the vouchers

relating to the clearing agents as they make the payment on account of custom duty or the penalty to the Custom Department on behalf of the assessee. Penalties paid by the assessee cannot be allowed as deduction. Besides, the penalties may reveal the modus operandi adopted by the assessee for earning unaccounted profits. The assessee might be importing fine quality wool under the garb of rags or inferior quality wool thereby making unaccounted investment on purchases outside the books of account. Annexure - 1 INPUT-OUTPUT NORMS FIXED BY DIRECTOR GENERAL OF FOREIGN TRADE FOR VARIOUS PRODUCTS Item manufactured Raw material Quantity of raw material required 1.13 kg / kg of polyester

Woollen blended Polyester fibre yarn containing polyester / Wool /acrylic / viscose (gray / dyed) 1 kg. Polyester tow Wool tops Acrylic fibre

1.08 kg / kg of polyester 1.10 kg / kg of wool 1.13 kg /kg

acrylic Acrylic tow 1.05 kg / kg of acrylic Viscose fibre 1.115 kg / kg Tinting agent 0.005 kg Softening agent 0.010 kg Disperse dyes of 2% of weight 100% strength of polyester Acrylic dyes of 2% of weight 100% strength of acrylic Metal complex 2% of weight dyes of 100% of wool strength Pigment / 2% weight of Napthol / Direct / viscose Dyes of 100 % strength 100% woolen Scoured wool 1.211 kg worsted (gray) 1 kg. Tinting agent 0.005 kg Softening agent 0.010 kg Wool tops dyed / Scoured wool 1.110 kg Undyed 1 kg. Metal complex 1.5% of dyes of 100% weight of wool strength

Woolen shoddy Woollen rags yarn 1 kg. Wool waste Woollen yarn 1 Scoured wool kg. Worsted spun Polyester fibre yarn (dyed) 1 Kg. Polyester tow

1.40 kg / kg of content 1.15 kg / kg of wool 1.15 kg / kg of wool

1.13 kg / kg of Polyester 1.08 kg / kg of polyester Wool tops 1.10 kg / kg of wool Tinting agent 0.005 kg Disperse dyes of 2% of weight 100% strength of wool Metal complex 1.5% of dyes of 100% weight of wool strength

Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter VI WOOLLEN HOSIERY INDUSTRY Introduction 1.1 Hosiery industry refers to the manufacture of garments made out of cotton, woollen, or man-made yarn for the use of gents, ladies and children. The word hosiery is derived from the word hose appearing in hose top. (Hose top is a cylindrical garment worn on the leg below the knee and above the ankle.) Various hosiery items manufactured are pullovers, cardigans, under pants, woollen vests, trousers, mufflers, hose tops, stockings, shirts, sport wears, jackets, scarves, skirts, frocks, tops, baby blankets, bloomers, night suits, etc. 1.2 Plainly speaking, knitting refers to the manufacture of fabric with the help of needles. Before knitting started, the fabric was manufactured by weaving. The fabric thus manufactured was called woven fabric. The popularity of knitting has increased tremendously in recent years because of the increased versatility of the technique, the adaptability of many new man-made fibres, and because of the growth in demand for wrinkle free, stretchable, snug-fitting fabrics, particularly in the greatly expanding areas of sportswear and other casual garments. 1.3 Because of its looped structure, the knitted garments have the following advantages over the woven garments -

Price of a knitted garment is lesser than that of a woven garment since yarn to fabric conversion is simpler and faster. Knitted garments are more comfortable than woven garments because of their flexibility and stretchability. Knitted garments are more suitable for leisure and sports activities. Knitted garments are light weight, soft touch and have excellent wrinkle resistance. Knitwear can also be piece knitted like sweaters and socks thus eliminating cutting and sewing.

Because of these advantages, the usage of knitted fabrics ranges from hosiery, underwear, sweaters, slacks, suits, coats to rugs and other home-furnishings. At present, the knitting Industry meets an estimated 45% of the clothing needs in developed countries like USA, Europe and Japan. Development of the industry 2.1 The hosiery industry in India is about 107 years old. The first hosiery unit was set up in Calcutta in the year 1893 by Mr. Anand Mukherjee. After independence, the industry recorded impressive growth. In 1956, knitting and hosiery Industry was placed in the reserved list for smallscale sector. Production shifted to small and scattered cottage, tiny and small scale units in Ludhiana, Calcutta, Delhi, Bombay, Varanasi, Patna, Gwalior, Bangalore, Pune and Jaipur.

2.2 At present, Ludhiana is the main centre of hosiery in India and is known as the Manchester of India. The share of Ludhiana in the total production of woollen hosiery in the country is 90 percent. The hosiery industry was established at Ludhiana in the early 20th century with the setting up of a socks manufacturing unit in 190203. There are about 14000 hosiery units in the city. The estimated value of hosiery production in the year 1998 was Rs. 2300 crore. The direct export of hosiery goods from Ludhiana is estimated at about Rs. 600 crore during the year 1998. About 4 lakh persons are directly or indirectly employed in the hosiery industry at Ludhiana alone. The labour employed in hosiery units consists mainly of migrants from UP and Bihar. 2.3 Indias hosiery and woollen industry has come a long way from being a cottage industry predominantly catering to the local community. It has now entered a new era in which the industry is able to meet international standards through constant innovation of techniques, styles, textures and colours. All wool and blended fabrics, cardigans, pullovers, mufflers, shawls, socks, gloves, garments, blankets are being exported to various countries like the U.K., the USA, Canada, France, Italy, Germany, Kyrgistan, Ukraine, Kazakhstan, Saudi Arabia and Hong Kong. Indias wool and woollen goods exports registered a spectacular growth in the last few years. The new five year export and import policy for the period 1997-2002 aims at giving a major thrust to the acceleration of Indias exports through restructuring and revamping of various export promotion schemes and wide ranging measures for simplification and streamlining of procedures with a view

to make them more transparent and easy to administer. The policy aims at consolidating the achievements made possible during the preceding five years while continuing the trade reforms and liberalisation with a view to achieve a higher rate of export growth. Construction of knitted fabric 3.1 Knitting consists of constructing a fabric on needles by interlooping one or more yarns. It may be done by hand or machine. The basis of a knitted fabric is the loop or stitch by setting up a loop on a needle and drawing a strand through it to make a second loop. A chain of loops, each drawn through the other forms a knitted fabric. 3.2 The construction of knitted fabric is evaluated by the number of stitches or loops. When the interlocking loops run lengthwise, each row is called a wale. When the loop runs across the fabric each row is called a course. The quality of the needle effects the quality of the fabric. If the thickness of the loop varies from needle to needle the stitches vary in width. If all other parameters remain constant the fabric with more wales in it will be more rigid and stable in width, but a fabric with more courses in it will be more rigid and stable in length. Classification of knitted fabrics 4.1 There are two broad categories of knitted fabrics

Weft knit fabrics, where one continuous yarn forms courses across the fabric. Warp knit fabrics, where a series of yarns form wales in the lengthwise direction of the fabric.

Weft knitting 5.1 There are three stitches in weft knitting - i) Plain knit stitch, ii) Purl stitch, and iii) Rib stitch. 5.2 The plain knit stitch is a basic knit. This basic knit can be produced in flat knit or in tubular (circular) form. The flat knit is also called the jersey stitch. The knitting is done with a row of latch or bearded needles arranged in linear position on a cylinder. All the needles are evenly spaced side by side and are moved by cams, which act on the needle butts. The spacing of the needles is referred to as the gauge or cut. It usually refers to the number of needles per 1 inch e.g. if a machine has 8 needles per inch the gauge of that machine would be 12. In cases where needles are adjustable, gauge refers to the number of needles per inch. The plain knit is made by needles intermeshing, loops drawn to one side of the fabric. Although there is a technical face and technical back to the plain knit, either side may be used as the face. The plain knit produces a relatively lightweight fabric compared to the thicker fabrics produced by the other stitches. It has high rate of production and is inexpensive. It is useful for variation in designs by pattern devices. These variations include stripes, multicoloured patterns, textured surfaces produced by raised designs and pile effects. Horizontal stripes can be knitted by using different coloured yarns/textured yarns on different feeders or by setting certain feeds to knit a looser stitch. Multicoloured designs called Intartia can also be created through the use of highly specialized single bed machines.

5.3 The purl stitch is also called the links-and-links stitch. It is made on flat bed or circular machines by using needles that have hooks on both ends, to alternately draw loops to the front of the fabric in one course and to the back in the next course. The fabric looks the same on both the sides and resembles the back of the plain knit. It is often used in childrens wear. 5.4 The rib stitch fabrics have alternating rows of purl and plain stitches so that the front and back of the fabric look alike. In a rib machine, one set of needles pulls the loops to the front and the other set pulls the loops to the back of the fabric. Each set of needles alternately draws loops in its own direction, depending on the width of the rib desired. Ribs have excellent width wise elasticity and are often used in underwears, socks, wristbands of sleeves and waist bands of garments. Warp knitting 6.1 In warp knitting, each needle loops its own thread. The needles produce parallel rows of loops simultaneously that are interlocked in a zigzag pattern. The stitches on the face of the fabric appear vertically at an angle and the stitches on the back appear horizontally. The warp knits are very popular and are appreciated for their smoothness, possible sheerness, wrinkle and shrink resistance, strength and abrasion resistance. Products ranging from hairnets to rugs may be manufactured by warp-knitting depending upon the machine and the technique employed. There are many types of warp knitting machines but those mainly used are Tricot and Raschel machines.

Machinery used 7.1 Normally, three types of machines are used in hosiery knitting. These are round knitting machines, flat knitting machine and circular knitting machines. The size of the machine is known by its gauge. The gauge refers to the total number of needles in 1 inch. The higher the gauge of the machine, the finer the cloth it manufactures. 7.2 The round knitting machines are circular in shape and are used to manufacture socks and gloves. These machines may be hand operated or power operated. The socks and gloves manufactured by hand operated machines are of coarse quality whereas the power operated machine manufactures finer quality socks and gloves. 7.3 The flat knitting machines are flat and square in shape because of which they are called flat knitting machines. The flat knitting machines may be either hand operated or power operated. The hand operated flat knitting machine is of 4 gauge to 14 gauge whereas the power operated flat knitting machine is of 8 gauge to 14 gauge. These machines are used for manufacturing sweaters, cardigans etc. Flat machine may also be computerized to get a particular design 7.4 The circular knitting machine is one in which the yarn is fed through yarn feeders.' The bed of the machine moves whereas the feeders and cams move to assist in the knitting process. These machines knit cloth in tubular form. This machine is used to knit various yarns like cotton, acrylic, polyester, nylon and their blends.

7.5 In the last decade, the machinery used in the hosiery and knitwear has undergone a sea change. Since the industry is highly labour intensive, locally manufactured and fabricated machinery and equipment suited to the capabilities of the lesser educated workforce are being used by the industry in almost all the operations involved in the manufacturing of low-end hosiery products right from the dyeing of yarn to stitching and packaging. However, more recently, the units that have diversified their manufacturing activities from the low-end products to high value-added fashion garments, have added the computerized / motorized flat bed / circular knitting machines, jacquard machines, modern stitching machines like flat, chain and lock stitch machine, computerized embroidery heads along with other gadgets and equipments. Similarly, ancillary supporting units like dyeing and finishing houses have also updated themselves with the latest version of machinery and equipment in soft flow dyeing, high pressure fabric dyeing and microprocessor-controlled piece dyeing, pole drying equipment, tubular calendering and stentering machines, colour matching and colour fastness testing equipment, etc. These machines, though quite expensive, have increased the production many times and have also substantially reduced wastage and rejections. Raw materials 8.1 The basic raw materials used for the manufacture of hosiery products are four. The first among them is the animal fibre. These fibres include sheep wool, angora wool, lamb's wool, mohair, etc. These yarns are supplied

by spinning mills located at Ludhiana and Amritsar. Some of these mills supply dyed woollen yarn wound on cones. Others supply grey yarn in the form of hanks that is separately dyed in dyeing houses. Some yarns like Cashmere yarn and Pashmina yarn and also yarns of finer quality and some blended yarns are imported. Woollen yarns of various counts, mainly 2/32, 2/48, 3/11, 1/28 and 1/22 counts, are used. 8.2 The second type of raw materials are seeds fibre like cotton. The cotton yarn is obtained from various spinning mills located in Punjab and outside. The spinning mills supply grey or dyed cotton yarn of different counts wound on cones. The main counts used in the manufacture of cotton knitwear are 10s, 20s, 24s, 30s, 34s and 40s. 8.3 The third category of raw materials are man-made fibres. These are polyester, nylon, viscose, acrylic, etc. In this category polyester, nylon and acrylic are the yarns mainly used for the manufacture of knitwear either in pure form or in blended form. This yarn is manufactured by various large-scale units like JCT Ltd. Reliance Industries Ltd., IPCL Ltd and Modi Pon Ltd. 8.4 The fourth is blended yarn. The synthetic fibres are also blended with animal as well as cellulose fibres to give them strength and durability. The main blends available in the market are polyester-cotton, polyester-viscose, woolacrylic in different blends. Apart from the blending of the synthetic fibres, artificial silk is also blended either with wool or cotton to prepare yarn for manufacturing high fashion knitwear.

8.5 In addition to the above, certain other materials like buttons, zips, fasteners, sewing threads, embroidery threads, lining materials, tapes, laces, labels, size stickers and pipings are also used in the production of knitwear. Yarn count 9.1 There is a fixed relationship between the weight of the original quantity of fibre and the length of the yarn produced from that raw material. This relationship indicates the thickness of the yarn and is designated by a number called the yarn count. The measurement of this relationship differs in cotton yarn and woollen yarn. In the case of cotton yarn, if one pound of fibre is drawn to make 840 yards of yarn, the resultant thickness represents 1 count. If the yarn is drawn out further, so that one pound makes twice 840 yards, the resultant count will be 2. If one pound of fibre is drawn out to make 32 times 840 yards i.e. about 15 Kms long yarn, the resultant count will be 32 or 32s i.e. 32 single. If two yarns of 32 count are twisted around each other, the result will be 2 / 32 and so on. The purpose of twisting around two yarns is to make the yarn stronger. 9.2 In the case of woollen yarn, if one pound of yarn is drawn to make yarn of 560 yards length, the resultant thickness of the yarn will represent 1 count. If the yarn of 1 count is further drawn out to make yarn of 32 times 560 yards i.e. about 10 Km, the yarn produced will have count of 1/ 32. In the case of man-made fibres, the thickness is measured in terms of deniers. If one gm of fibre is drawn to a length of 9000 meters, the resultant thickness of the yarn will represent 1 denier. If one gm of fibre is drawn to

100 meters yarn, the yarn would be of 90 deniers and so on. Therefore, in the case of woollen yarn and the cotton yarn, the higher the count of the yarn, the finer the yarn will be. However, in case of man-made fibres, the lower the denier of the fibre, the finer the yarn will be. Manufacturing processes in woollen hosiery 10.1 The basic raw material used in woollen hosiery is woollen yarn, which is obtained from greasy wool, mainly imported from Australia, New Zealand and South Africa. There are no restrictions on the import of wool. Any person having Exporter/ Importer Code Number from RBI can import wool. India produces about 45 million kg wool annually. However, it is not fit for apparel production because of its poor quality. It is mainly used in blankets and carpets. 10.2 The greasy wool is first of all scoured, carded and combed in a combing mill. There are 70 combing mills of various sizes in India mostly located in Ludhiana. Some combing mills are also located in places like Calcutta, Bhilwara, Mumbai and Baroda. After combing, the greasy wool gets converted into wool top. The wool top is spun into yarn in a spinning mill. A multiplicity of processes is involved in combing and spinning but these are not discussed here in detail as these processes are discussed elaborately in the chapter relating to Woollen mills. Only a few units have composite manufacturing facilities of combing, spinning, dyeing and fabrication. 10.3 For the woollen industry, yarn constitutes the main raw material. The quality of yarn depends upon various factors like its composition, count, knots, twist per inch,

breaking strength etc. Mainly yarn of 1/16, 2/20, 2/28, 2/32 count is used for manufacture of sweaters and cardigans. The yarn having 1/16, 1/28, 1/32, 1/42, 1/44, 1/48, 1/54, 1/56, 1/64, 2/30, 2/40, 2/42, 2/44, 2/48, 2/52, 2/64 count is used for manufacturing shawls. For blankets, the yarn having single count of 2 to 10 is used. The fineness of the woollen yarn can also be known from its micron. Wool of 18 micron is considered as the finest. Wool having 18 to 24 microns is used in shawls whereas wool having 24 to 30 micron is used in hosiery. 10.4 Yarn is obtained by a garment manufacturer from a spinning mill. The yarn passes through many processes before the final garment is manufactured. First of all panels of the garment are knitted on flat knitting machines. Then they are checked and mended. The panels are then washed and steam-pressed after which the panels are cut according to the desired sizes. After doing embroidery work, if any, the panels are stitched together. Then the cups and necks are linked with the help of linking machines. After stitching buttons and fitting zips, the garment is washed or dry cleaned. Then the garment is inspected manually for any possible defect. After steam processing, the garment is ready for despatch. Various processes involved in woollen hosiery industry are tabulated in ANNEXURE-1. Classification for investigation 11.1 For the purpose of investigations, the units engaged in hosiery industry can be classified as follows -

Units engaged in exports. Units catering to defence and other government requirements. Units catering to the internal civil requirements.

No doubt some units would deal in more than one type of goods, but broadly speaking, the units fall into one of the above three categories. Their modus operandi and the points for investigation involved in the above three categories are discussed here. Manufacture for exports 12.1 For export of knitwear, there is no need to obtain licence for export as it does not fall in the list of restricted items. An exporter is primarily required to register himself with the concerned export promotion council (EPC) like the Wool & Woollens Export Promotion Council, and the Apparel Export Promotion Council. It is pertinent to mention here that effective 1.1.1997, an exporter is no more required to register itself with RBI. In other words, he is not required to obtain the Export Code Number from RBI. The concerned EPC allots a Code Number to its members. The Customs authorities will not allow the exporter to export goods unless the exporter is having Export Code Number. This number is required to be filled in the shipping bill and other documents. This number is also required to be mentioned in various foreign exchange declarations form like GR and PP forms. The Registration Cum Membership Certificate issued by the concerned EPC helps the exporters to obtain incentives like cash assistance, duty draw back and replenishment licences.

12.2 An export invoice is required to be prepared by the exporter both in terms of quantity and weight. Even the tare weight is mentioned therein. The AO, while examining the accounts, should work out the quantity of raw material embedded in the sale and tally it with the quantitative details of consumption, production etc. filed by the assessee. 12.3 The exports are to be made in bulk. While examining the accounts, the AO should look into the investment in purchases of different raw materials and payment of different expenses like wages, electricity, job charges etc. The source of generation of funds for making payment of these expenses by the assessee should be thoroughly examined. The assessee might have introduced its own unaccounted money in the guise of loans, advances, etc. for making payment of various expenses. 12.4 The AO should also work out the G.P rate in respect of export sales and domestic sales separately and should try to find out the reasons, if there is a substantial variation in the two. It is possible that the assessee might have diverted the expenditure relatable to export business to the domestic business so as to claim higher deduction under Section 80 HHC. 12.5 The AO should obtain billwise details of sales and various benefits received on account of duty draw back, cash assistance and import entitlement in order to see whether all the benefits have been reflected in the books of account or not. 12.6 The AO should independently verify from the bankers of the exporters, the details of convertible foreign

exchange credited to the exporters account as the deduction under Section 80HHC is to be allowed only in respect of convertible foreign exchange brought into India within six months from the end of the relevant previous year or within the extended period u/s 80HHC. 12.7 The AO should also look into the sale of visible wastage. Scrap is generated in various manufacturing processes like cutting, and tailoring. It should be seen whether the assessee has shown any sale proceeds of the waste material. Further, such sale should be considered as domestic sale for computing deduction u/s 80 HHC. 12.8 The AO should also examine the accounts of the assessee to find out the fabrication and other expenses paid to its sister concerns. The charges paid by the assessee to its sister concerns may be lower than the market rates. By doing so, the assessee may inflate its export income eligible for deduction under Section 80 HHC and suppress the domestic income of the sister concerns. 12.9 The hosiery industry is a seasonal industry. Usually, the manufacturing activity is at its peak from the month of August to November. There is sharp fluctuation of labour employed in the peak season and in the off season. With the higher employment of labour in the peak season, the requirement for the machinery also goes up. The AO should see whether the machinery required for the peak season manufacturing is duly reflected in the account books or not. Supplies to Defence and other Government departments

13.1 Earlier all the purchases made by the defence forces were centralised with the Director General of Supplies and Disposals. However, to avoid delay in making procurements, the three wings of the Defence - the army, the navy and the air force - have been authorised to make purchases from the market. The purchases by the Army are made through the Director General of Ordinance Services whereas the Naval Head Quarters and the Air Force Head Quarters make purchases for Navy and Air Force respectively. Although, the Army has also its own factories to produce hosiery goods, it purchases various hosiery items from the market also. 13.2 For making purchases, the concerned wing of the Defence floats tenders. The tenders include such information as the quantity, price, duration of the contract etc. Besides, the manufacturer is required to supply the goods as per specifications stipulated by the concerned department. These include such details as the weight and size of the product, the details of yarn used. These departments lift the supplies after getting the goods inspected through various sources like the laboratory of the Textile Committee and Quality Marketing Centre. Mostly, yarn made out of pure wool or blended with nylon or nylon and viscose is used for defence supplies. 13.3 The manufacturers of defence goods use circular knitting machine, or flat knitting machines. Hand-operated round knitting machines are used for manufacturing socks and the power operated circular knitting machines are used for manufacturing vests. The hand-operated flat knitting machines are used for manufacturing jerseys.

13.4 Most of the units manufacturing hosiery goods for defence forces do not maintain quantitative details. They are not maintaining any consumption or production records. Even if they maintain such records, they deny their maintenance. In such a situation, an important point for investigation is the gross profit rate shown by the assessee. The gross profit rate shown in a particular year should be compared with the rates shown in the past and the rates shown by similar manufacturers. If the rate of gross profit shown by the assessee is lower, efforts should be made to find out the reasons for low gross profit rate. 13.5 The AO should obtain copies of all the contracts executed by the assessee during the year. As discussed earlier, the contract orders give the details of raw materials to be used in the production of a particular item. The gross weight of the final product and the weight of the raw material to be used is specified in these documents. Therefore, the consumption of yarn required for manufacture of various items supplied by the assessee can be worked out. 13.6 The disclosed consumption of yarn can be checked from the figures of opening stock, purchases and closing stock shown in the books of account. In case, the consumption shown by the assessee is on the higher side, the reasons for it may be investigated. It is possible that the assessee may have inflated the purchases in the books. Besides, the consumption of other materials like buttons and zips should be looked into. The wastage shown by the assessee at various stages like knitting, cutting, tailoring may also be examined. The nature of the

penalties, if any, levied on the assessee for breach of warranty should be ascertained and examined for tax angle. Units catering to other domestic requirements 14.1 The third category of manufacturers are those who cater to the general population of the country. In these cases, wastage is the first item that should engage the AOs attention. He should enquire into the extent of wastage generated at different stages of production. The extent of wastage depends on the item being manufactured and the level of technology. It would be worthwhile to visit the factory premises of the assessee to have an idea of various processes involved in manufacturing. Nowadays, the manufacturers are using sophisticated computerised knitting machines. These machines are efficient. They generate very low wastage. The assessee might be claiming wastage on the basis of wastage shown in earlier years. 14.2 The Director General of Foreign Trade (DGFT) makes studies on input - output analysis in respect of various items from time to time after making detailed studies. The Ministry of Commerce publishes a Hand Book for Procedure in which the details of input -output norms for various industries are given. This Hand Book is available in any office of the DGFT. While investigating the case of a manufacturer, the AO should go through this Hand Book to have an idea of the input- output norms in the concerned Industry. Input -output norms stipulated by the DGFT for some of the products of the hosiery Industry are given in ANNEXURE-2. In case there is any

substantial variation in consumption shown by the assessee and the consumption indicated in these norms, the AO should investigate the case thoroughly to find out the reasons for the same. 14.3 The AO should also compare the GP rate shown in a particular year with that shown in the earlier years. He should also compare the GP rate shown by the assessee with that shown by other persons in the same trade. In case there is significant variation, the reasons may be investigated. The assessee might have suppressed production or debited bogus expenses in the books. 14.4 The AO may also verify the genuineness of some of the purchases. However, the AO should carefully select the purchases in respect of which investigation is to be made. He may examine the purchases made by the assessee in the month of March. Any suspicious looking purchase bill should be investigated. The AO may also investigate the purchases made by the assessee ostensibly against credit but the payment in respect of which has been made subsequently through cash on various dates. Further, the purchases made during the year the in respect of which payment has not been made at all during the year, may also be picked up for investigation. The assessee might have introduced bogus purchase bills in the name of non-existing parties. 14.5 The purchases made by the assessee in the month of March or at the fag end of the season should be examined to see that these are either accounted for in production or in closing stock. The valuation of closing stock should be checked to ensure that the stock is valued

properly keeping in view the purchase rates of the last purchase bills. Usually, the production in the woollen hosiery units continues upto the month of November or December. The purchases of needles made in the last part of the manufacturing season should be verified to ensure that the unconsumed needles are duly shown in the closing stock. Further, the AO should verify whether the material sent by the assessee for combing, spinning, dyeing, fabrication during the year but not received back till 31st March has been duly shown in the closing stock. The copies of the stock statements given by the assessee to the bank during the year for availing cash credit (hypothecation) facilities should be called for directly from the bank. The stock hypothecated to the bank may be more than the stock appearing in the assessees books indicating unaccounted investment made in stock. 14.6 Most of the hosiery manufacturers make payments to the workers on piece-rate basis to optimise their production. However, in the books of accounts, they show the payments to the workers on monthly lump sum basis. The thumb impressions and the signatures of the workers appearing in the wages register / muster roll may be examined. These signatures and thumb impressions may be similar as, usually, these registers are prepared afterwards. In case of such a situation, the possibility of invoking the provisions contained in Section 145 may be examined. In case the assessee has got any particular work done on piece-rate basis, the total quantity of the production may be worked out on the basis of the charges paid for the work during the year. The figure of production

thus arrived at may be checked with the number of pieces accounted for in the sale and the closing stock. 14.7 In the hosiery trade, most of the spinners make substantial cash sale of yarn. The cash sales of yarn made by the spinners are undoubtedly the unaccounted purchases of the hosiery manufacturers. To unearth such purchases, the possibility of conducting surveys under Section 133A during the peak season (August to November) may be examined. 14.8 The proceeds of the hosiery products sold outside the books of accounts are generally received through bank drafts. These drafts are not likely to be crossed or made account payee. They are generally purchased in favour of fictitious individuals for amounts below Rs. 20000/-. Till these drafts are encashed, they are transferred from one party to another merely through delivery. Ultimately, these drafts reach the commission agents / brokers who make payments of these drafts by deducting brokerage. The brokers get these drafts credited in their bank accounts or some benami accounts. Such unaccounted sales cannot be detected through the normal enquiry process. To unearth such unaccounted sales, surveys under Section 133A may be necessary. 14.9 The AO should collect information from the Sales tax Department about the cases of tax evasion detected by them. Action, if any, required to be taken for income tax on the basis of the said information should be taken. Annexure - 1

MANUFACTURING PROCESS IN WOOLLEN HOSIERY INDUSTRY OPERATION MACHINERY USED Hand operated flat knitting machine or Power operated /computerized flatbed knitting m/c or fully fashioned knitting machine or warp / Rachel knitting machine. Manual Milling machine, Tumbler drying, Hydroextractor

Knitting of panels as per the approved samples & designs.

Checking / Mending of panels Washing or Milling

Steam Pressing Cutting of panels to dimension as per sizes. Embroidery Stitching of panels to make garments including Label fixing

Steam Press Straight blade electric cutting m/c / hand scissors Hand or Compturized embroidery machine Lock stitch, overlock machines

Power operated Linking cup linking seaming, machines or Neck joining industrial machines. Power Button holing operated / Button automatic stitching, zip buttonholing fitting. & stitching machines. Washing / Dry cleaning

Dry cleaning plant, Hydrofor finishing extractor, Tumbler Drying Final checking of Manual garments Annexure - 2 INPUT- OUTPUT NORMS FIXED BY DIRECTOR GENERAL OF FOREIGN TRADE FOR HOSIERY AND KNITTING ITEMS Item manufactured Quantity Raw Quantity of material raw material 100% Dyed acrylic 1 kg Acrylic 1.10 kg fabrics fibre Acrylic blended 1 kg Acrylic 1.30 kg / knitwear of acrylic and fibre kg cotton fibre Acrylic shawls 1 kg Acrylic 1.30 kg fibre Bleached knitted 1 kg Knitted 1.02 kg fabrics containing fabric polyester / cotton Dyed knitted fabrics of 1 kg Yarn 1.08 kg polyester / viscose yarn Grey / dyed / printed 1 sq. m. Relevant 1.01 sq. m.

fabrics with embroidery !00% Cotton fabric-grey 1 kg. 100% Cotton fabric1 kg dyed Bleached & dyed cotton 1 kg or knitted fabrics

fabric Cotton yarn Cotton yarn Cotton yarn Cotton fabric Cotton yarn Cotton yarn Wool / mohair yarn Woollen yarn Synthetic woollen yarn Cotton yarn Cotton yarn Cotton (knitted)

1.05 kg 1.10.kg 1.05 kg 1.025kg

Cotton fabric dyed and printed 100% Cotton knitted briefs Hosiery / knitwear made of 100% Mohair / wool Hosiery / knitwear made of 100% wool Hosiery / knitwear made of woollen blended yarn Cotton knitted seamless gloves Cotton socks / stockings knitted Cotton knitted sports vest

1 kg 1 kg 1 kg

1.10 kg 1.15 kg 1.18 kg

1 kg 1 kg

1.143 kg 1.138kg

1Pair 1 kg 1 kg

1.05 kg 1.05 kg 1.15 kg

Gents half sleeve shirts 1 No. Ladies night wear Vests Vest made of nylon 1 No. 1 No. 1 Pc

Knitted woollen 1 kg mufflers Knitted woollen shawls. 1 kg Mens / ladies T-shirt 1 Pc (full sleeve) Mens / ladies T- shirt 1 Pc (short sleeve) Childrens T-shirt (large 1 Pc size)

Relevant fabric Relevant fabric - do Nylon fabric Woollen yarn Woollen yarn Relevant fabric - do - do -

2.15 sq. m. 2.695 sq. m. 1 kg 1.05 sq. m. 1.100 kg 1.100 kg 2.60 sq. m. 2.20 sq. m. 2.10 sq. m.

Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter VII WOOLLEN CARPET INDUSTRY

Introduction 1.1 The deep pile Indian hand knotted carpets come in magnificent colours with designs that are oriental, exotic and uniquely modern. The sizes and prices are designed to cater to the needs of modern markets all over the world. Important carpet producing centres in India are Mirzapur, Bhadohi, Gopiganj, Khamaria and Agra in Uttar Pradesh, Srinagar in Jammu and Kashmir; Amritsar in Punjab; Panipat in Haryana; Jaipur and Bikaner in Rajasthan; Gwalior in Madhya Pradesh, Eluru and Warangal in Andhra Pradesh; Madras and Walajapet in Tamil Nadu and Obra in Bihar. The popular qualities of Bhadohi and Mirzapur in Uttar Pradesh vary from ordinary to medium fine; finer varieties are from Agra, Jaipur, Amritsar and superior varieties come from the Kashmir. The rough Berber and Shaggy carpets are in complementary colours while the Hamadan variety is brightly coloured and heavy. The exquisite mulberry silk carpets are light, silky, glossy and woven in multiplies shades. 1.2 Indian carpets are available in different sizes and lengths of pile, which may be as low as 1/5 of an inch as in Kashmir carpets or as high as 7/ 8 of an inch as in the

Indo-berber variety. Amongst Persian carpets the different qualities are generally known as - 3 / 28, 5 / 40, 7/ 52, 8 / 56, 9 /45, 9 / 60, 10 / 62, 10 / 48, 11 / 55, 12 / 60, 14 / 70, 16 / 80, 15 / 75. Knots per sq. inch can be obtained by multiplying both the figures and dividing it by 4. For example - 3 / 28 means (3x38) / 4 or 21 knots per sq. inch. 1.3 Some general information about the carpet industry may be noted

The warp is always of cotton or jute except in a few special carpets like Bokhara in which woollen warp is used. When wool is used for warp also, the carpet clings to the floor and is considered superior. The quality of the carpet depends upon the knots per sq. inch, which varies from 6 to 1000. Generally, it is 20 to 400. Indian handmade woollen carpets are made with following tools A loop made of wood, and costing from Rs. 1000/- to Rs. 15000/ Chhura: It is a curved steel knife for cutting the thread after a knot is tied. Panja: It is a heavy comb of iron with wooden handle for beating the waft and the pile tufts. Kainchi: or scissors for cutting pile level. Generally, for hand-woven woollen carpets, machine made yarn is used but hand-spun

yarn is regarded as superior to machine spun yarn. Spring clipped wool is considered superior to autumn clipped wool. The former is stronger and gives better results. There is also a difference in sheeps and lambs wool. An average weaver can make about 12000 knots in a day. The minimum knots expected of a weaver are 15 per minute or 900 per hour. In other words lowest quality Persian carpet can be woven by a weaver at the rate of about 4 sq. ft. per day, while superior quality carpets like 12/60 and onwards, can be woven at the rate of sq. ft. per weaver per day. The above average knotting also varies with different types of knots. The knots are of five types or namely: Persian or Turkish, or Tufted, or Tibetan or Nepali. The last three knots are on four strings of warp instead of two, and carpets made with these knot are considered only half as good as the carpet with the other knots.

Manufacturing process 2.1 The process of carpet manufacturing can be broadly divided into three stages

Manufacturing of woollen yarn from raw wool;

Dyeing of woollen yarn in different colours as per requirement; and Carpet-weaving and process of finishing of carpet.

The first stage, namely, manufacturing of woollen yarn is generally carried out separately except in some cases where all the three stages are carried out by the same covers. Traditionally dyeing used to be done by the manufacturing concerns themselves but these days separate dyeing units are established by many independent houses. 2.2 Raw materials - The raw materials for the woollen carpet industry comprises of imported raw wool, indigenous wool, both indigenous and imported man-made fibres, and imported woollen rags. The subject of wastage, shortages and losses at various processing stages in the carpet industry is both peculiar and important affecting the profitability and the cost. 2.3 Shortage / gains in transit - As per standards fixed by International Wool Testing Authority (IWTA), the imported wool is sold on conditioned basis. For each article of wool, certain standard regains are fixed in respect of imported wool. In the case of the carpet wool, the conditioned weight is about 16 to 17 per cent. Every lot is accompanied by a certificate from a Conditioning House in which the moisture content is mentioned. This is called regain percentage. It would therefore, be desirable for the AO to go through the original vouchers of imported wool and ascertain the narration about the conditioning and the

weight for which the price is charged. IWTA has fixed norms of conditioning loss or regains to avoid disputes amongst the parties making transactions across the world. When there is a higher content of moisture in the atmosphere, the weight of wool increases as it absorbs moisture of even 25 per cent or more. However, in the case of Indian wool, the original vouchers for purchase do not indicate the moisture content. The moisture content in the wool is normally the same as in the atmosphere. The loss in weight on account of driage / loss in transit may vary from 2 to 5 per cent. 2.4 Willowing - The first operation in the case of woollen carpet yarn is willowing or zaffery. During this, the wool is passed through a willowing machine, which removes dust, thorns etc. from the wool. The shortage in willowing varies from 5 to 8 per cent depending upon the quality of wool. The waste material recovered is not capable of reuse and is sold as manure. The assessees not having willowing machines, engage labour for beating the wool to separate the dust, thorns etc. This operation is called zaffery. The loss in zaffery may vary from 5 to 6 per cent. 2.5 Blending and oiling - After willowing has been completed, the process of blending and oiling is performed. Different grades of wool or other fibres are blended with the willowed wool. For manufacture of woollen yarn, different colours and qualities of wool fibre or the reprocessed yarn are blended in the desired combination. This is done to reduce the cost of yarn as

also to create a mix of colours or special effects. It also helps in the spinning process. The Mills maintain a Blending Register that contains particulars of recovery, wastage, and wastes delivered to the wool godown including soft, hard, shoddy, sweepings and invisible loss, etc. These particulars are also available along with the oil (Mahua or castor oil) and the chemicals used in the woollen blend card - a card maintained in the Blending section to reconcile the various results, recoveries and shortages. This card is submitted to the mills office on completion of the blending process. This information if checked up, at random, will give a clear picture of the working of the mill. A specimen of such a card is in ANNEXURE-1. 2.6 Carding and spinning - After this, the yarn is sent for carding, spinning and dyeing. Carding is done by passing wool through the machines where its locks are separated, and the rearranged fibres come out. All out efforts are made to open, separate and straighten the individual fibres of the stock. The fibres are rearranged in different directions, crossing and re-crossing as much as possible. Short / broken fibres can be accepted. In this process there is also some invisible waste which should be compared with assessees previous records, as also with similar cases. This occurs when some fibres go into the air and fly away. Visible loss is on account of miscellaneous impurities, still left over which are removed at this stage. For verifying these losses, the AO can call for the records maintained in the carding section. A specimen card is reproduced in ANNEXURE-2. In this details of quality,

counts of carding silver, spinning counts etc. Are recorded. Carding and spinning are complementary processes and are done together. The bobbins are brought into a machine called Mule, on which the yarn is spun. The wastage / shortage during carding and spinning process varies between 6 to 10 per cent. The usable waste recovered from carding and spinning operations is as high as 60 per cent of the total wastage in this operation. Out of the wastage in carding and spinning operations, 40 to 50 per cent is reusable visible waste that can be reused; and 10 to 20 per cent is unusable visible waste that is sold to shoddy manufactures. Some mills maintain record of waste / loss recovery in the form given in ANNEXURE-3. 2.7 Reeling, scouring, and dyeing processes - The yarn is unfolded from the bobbins and rewound into hanks. This is known as reeling and is done mostly by hand, for which reeling wages are paid according to quantity reeled. The production by each reeler is noted in the Register for Reeling production. The count of yarn is a term used to express the fineness of yarn, i.e., the number of hanks of yarn which weigh one kg. The yarn after being unfolded from bobbins and rewound into hanks, is either sold in market or sent for scouring and dyeing. The object of scouring is to remove the oil added before spinning and other impurities in the wool. The loss in scouring may vary from 12 to 15 per cent and that there is no recovery of visible waste. A vigilant AO should carefully scrutinize the cases of assessees who are not themselves performing all the operations involved in spinning of yarn and manufacturing of carpets, and have instead formed

different sister operations.

concerns

for

carrying

on

different

2.8 Dyeing process - In the dyeing section, there are a number of dyeing machines of different sizes in which different colours and proportionate weights of yarn are put together. Expenses on colours and chemicals should be compared with other comparable cases and the assessees earlier record. Normally wastage or shortage in dyeing should range between 2 to 3 per cent depending upon the wool and yarns quality, and, whether the process is of machine-dyeing or hand dyeing. The dyeing section, maintains a receipt book that contains information on shortages / wastage. If the claim under this head is excessive, this book can be examined. If dyeing is got done through independent dye houses, the loss in dyeing and the details of yarn dyed in terms of weight, colour and dyeing charges can be cross-verified from the books of the dye houses 2.9.1 Weaving process - After all these processes, the yarn is ready for weaving - either by hand if the carpet is to be hand-knotted and hand tufted or by machines. In the first case, the weavers can be either assessees own fulltime employees; or working full time on contract basis; or outside weavers running their independent weaving business. Generally, hand weaving is got done through weavers working full time on contract basis for the assessee. 2.9.2 The processed yarn is given to weavers. Weaving, finishing, cutting, clipping etc. is done in the weaving

section, after which the carpet is ready according to the design and specification given to weavers. It is extremely difficult to have an idea of wastage in this Section, as it depends upon the expertise of the weaver, his moods, experience and the quality of supervision etc. 2.9.3 Hand weaving involves following steps

Issue of raw material (woollen yarn, cotton yarn) to weavers. Supply of design / map with the materials. Description of quality, size to be manufactured.

The material is issued through purja that serves as gate pass also. In some cases, separate gate passes are issued. From these purjas the issue register is prepared with following columns S. No. / Name Raw material issued Order purja Date of and No. issue address of weaver woollen yarn(kg) cotton yarn(kg) DESIGN

DESCRIPTION SIZE QUALITY

2.9.4 The weavers take the raw material and waves the carpet as per the design given to the, on loom - either alone or with some other weavers depending upon the

size of carpets. The loss in weaving process is negligible when the Weavers complete weaving they return the carpet to the manufacturing houses. At that time entries of manufactured carpet are made by the assessee in the Bazar Register, which has following columns Date Size Name / Quality Design Raw Weaving Discount material charges Katauti address Consumed of weaver 2.9.5 Generally the carpet manufacturer employs the same weaver for weaving carpet, year after year. These weavers may be employed as regular employees or on contract basis. The percentage by a particular weaver can be cross-checked with the percentage wastage by the same weaver on earlier occasions for a carpet of the same quality. As the weavers become more experienced, the wastage should come down. The weaver can also be summoned to verify the claim of shortage .2.9.6 Most of the big mills maintain detailed information about the receipt of yarn, daily production of carpets therefrom, quality, colour of yarn, weight of carpets etc. on cards maintained in the weaving section. A copy of these cards is in ANNEXURE-4 . 2.10 Finishing - The various finishing processes such as cutting, grossing, washing, back burring, clipping (embossing in embossed carpets), binding, stretching etc. are generally done in the premises of the manufacturing houses. However, in recent years, a practice of getting the

carpets washed by different units is becoming popular. In Persian carpets, the weaving charges vary from Rs. 200 per sq. yard to 5500/- per sq. yard . 2.11 The processes of manufacturing the Tufted and Tibetan carpets are almost similar, with the following variations

Tufted - Separate looms made of pipe are used. The tufting is made on cloth and then put on the loom. After finishing tufting latex, jute and the thick cloth are used to support the tufted carpet. The weaving of this carpet generally takes less time compared to Persian carpets. Weaving is done generally on contract basis / job work basis and Weaving charges vary from 200-250 per sq. yard. Tibetan - Separate looms made of girders are used. The weaving process is very simple and require less time compared to Persian carpets. No knots can be found in these carpets, Weaving is generally on contract basis / job work basis and weaving charges are 200-250 per sq. yard.

2.12 Netting - After the carpet has been made, netting is done with cotton net or jute net to give support to the yarn and to make a base for the carpet. Cotton net is used as base for hand-tufted carpets and jute net is used for machine made ones. Liquid rubber is also used to even out the backside of carpet and to give it support and to properly hold the yarn. This special quality rubber called

latex is issued on licences issued by the Rubber Board. Usually, 5 to 6 liters of liquid rubber is consumed for every square yard of carpet area. Manufacturing losses and shortages 3.1 In opening and reel-making stages, the wastage could be 1 to 1.5 per cent depending upon whether this is done by machine or by hand. The hooking loss can be between 2.5 to 5 per cent. Further, in cutting, finishing and clipping, the process shortage may be between 4 - 5 per cent. The clipping wastage is sold to kabaris or used as shoddy. The overall shortages / loss in various processes can be between 25 to 35 per cent. In some cases, losses of upto 40 per cent have been claimed. These require probe from primary books and cards/ registers discussed above. 3.2 The normal wastage at different stages can be summarized as under

Willowing / zaffery = 5 to 8% Blending = 1 to 2% Oiling = Nil (in fact, oiling adds to weight of wool ) Carding, spinning & reeling = 6 to 10% Scouring = 12 to 15% Dyeing = 2 to 3% Wastage in excess of the above will require details enquiries.

Cost accounting and profitability

4.1 Apart from various shortage and wastage discussed above, the manufacturing / production expenses may also require investigation. The normal thickness (i.e. height of the yarn) of carpets is 12-18 mm for hand made carpets and 6-8 mm for machine made carpets. The consumption of yarn per sq. meter depends upon the thickness of yarn. This varies from 1.5 to 2.00 kg per sq. meter from hand made carpets and is around 1 kg per sq. meter for machine made carpets. Therefore, the proportion between the total yarn consumed and the total carpet area should be calculated with other similar cases. In a number of cases of carpets of normal thickness, the average consumption was found to be around 30 gms of yarn per square foot. 4.2 The average cost per square foot of Persian carpet depends on the cost of yarn, the consumption of yarn per sq. meter and the weaving charges. Other carpets such as tufted etc. are cheaper and highly in demand. A specimen copy of a carpet cost sheet prepared by a big woollen mill to have an idea of the cost of material, cost of production, wages, ordered size and actual size of carpets made along with carpets weight, loss of material and its percentage, is in ANNEXURE- 5. 4.3 The G.P. rates in these cases vary from 15-25 per cent due to the highly ambulatory nature of this industry. These percentages are after excluding the credit of cash entitlements, subsidies and incentives from the trading account since the amounts of these incentives go on varying every year.

Bank loans 5.1 Advances are taken by the carpet manufacturer / exporters in two stages. The first is the pre-shipment stage in which they have to hypothecate the stock to the bank. The second is the post-shipment stage of packing credit where the exporting unit obtains the advance against the bill drawn on the foreign buyer. Inflation in purchases 6.1 Usually wool is purchased on contract basis. A contract book is maintained showing the serial number of the contract, date of the contract, names and addresses of the parties, quality and quantity contracted, rates and period of delivery etc. A receipt register is also kept showing the details of wool received and weighed in the factor, showing the date of weighment, contract number, partys name, quality, rates etc. The weighed wool is given a lot number before being consigned to the godown. A lot book is also maintained showing the lot number, quantity, quality, date of receipt, rates, suppliers name, weight, dates of issue and mixing. In suspected cases of tax evasion, it is necessary to obtain a full list of the wool purchases showing lot-wise details. 6.2 In one case, it was found that in the lot-wise statement a purchase of Rs. 1,50,000/- was shown together with the lot number but in the lot book there was no entry of the particular lot number. This suggested that no such lot had actually been purchased and utilized. On enquiry, it emerged that this amount of Rs. 1,50,000/- was carriage

expenses for removing work. But according to the contract, wool was to be delivered with freight fully paid at the assessees factory premises. Ultimately, it turned out that the amount Rs. 1,50,000/- was a transfer entry by which a similar debit in the account of the managing agents was squared up. Thus a comparison of the terms of the contract and the entries in the lot book, etc. would enable the AO to pick out fictitious or inflated items of purchases. In some cases, even the contracts were manipulated to show purchase rates higher than the rates at which they were actually contracted, thereby substantially inflating the value of the wool purchased. There are also instances where, although the average count of yarn spun is comparatively low, the average cost of work consumed is disproportionately high. In such cases collusion between the assessee / its representatives and the wool supplier may be suspected. 6.3 Fictitious purchases - Where a mill shows abnormally low profits or losses as against good profits shown by similar others in the line, there may be reasons to suspect inflation in the rate and value of wool purchased or in quantity. Such quantitative inflation would be reflected in the low output of yarn or large invisible wastage. These low rates can be the starting point for further detailed investigation. In such cases, purchases that appear to be from dealers who have not much of a standing or who have not made supplies either before or after should be selected and cross-checked. Such an enquiry might reveal the bogus nature of the item

particularly when it is pursued as to its movement, storage, payment of godown rent etc. 6.4 Suspense purchases - In some case, there is also the practice of suspense purchases. Under this system, the seller gives possession to the buyer but retains the right to fix the price on future date of his choice, after taking advance of about 50 to 60% of the current market price of the wool sold. If the price is not fixed by the seller before the end of the accounting year of the buyer, the purchaser takes the rate prevailing on the last day of the accounting year and debits the purchases account with corresponding credit to the seller. On the first day of next succeeding year the entries are reversed until the rate is finally fixed between the seller and the buyer. This system lends itself to evasion of tax as the assessee might make an entry showing that prices were fixed when the market was very high. But careful enquiry with the seller may show the rate at which he actually sold the wool. It is useful to refer to trade journals such as Wool intelligence Bulletin and Wool and woollens of India. These contain wool purchases rates from time to time. Inflated claims of wastage 7.1 Reference may be made to the discussion in Para 2 above. The loss in weight on account of driage / loss in transit may vary from 2 to 5 per cent. The AO can find out inflated claims of driage or loss in transit in the case of imported wool by referring to the original vouchers and ascertaining the percentage of moisture content. The loss in zaffery may vary from 5 to 6 per cent. If an assessee is

showing loss in both zaffery and willowing, the AO must make a thorough probe. Inflation of charges 8.1 Inflation of charges, particularly scouring charges paid to other concerns, is a common malpractice. In one case, it was found that the assessee was carrying on the business of manufacture of carpets but was not manufacturing yarn itself. It would purchase raw wool from the market and give it to its sister concern after zaffery for spinning of yarn. The spun yarn was then given to another sister concern for dyeing. The dyed yarn was then to be used for manufacture of carpets. Neither the assessee nor the sister concern carrying on spinning of yarn had shown recovery of visible waste. Again, to inflate its expenses, the assessee had paid scouring charges to both the sister concerns. Scouring charges were paid at the rate of 10/per kg. to the sister concern spinning yarn for the assessee at the rate of Rs. 20/- per kg. to the sister concern spinning yarn for the assessee. On going through the past records, it was found that, in none of the earlier years, scouring charges were paid at two stages. In the year under consideration, the assessee had bumper profits and it adopted this tactics to reduce its income. Inflation in stores account 9.1 Usually, purchases of stores are debited to the stores account and periodical transfers are made to the stores consumption account, which ultimately appears in the

manufacturing amount. The following tax evasion devices are found to have been adopted. 9.2 In one case, a mill advanced large amounts to sundry parties in one year. In the subsequent year, these advances were squared up by transferring the same to the stores account, for which stores bills were prepared to make it appear that the mill had purchased stores from these parties. Although receipts and issues of stores were shown in the stock register, there were no slips issued to the storekeeper for issue of these stores. Besides, the stores suppliers could not be traced out. 9.3 In another case the stores account showed purchase usually ranging from Rs. 1000/- to Rs. 5000/- on various dates from various parties. In respect of five items however, the purchases in cash exceeded Rs. 15000/- On investigation it was found that the alleged suppliers had given bills showing the names and address far off places. These bills also showed telegraphic code and telephone number etc. On enquiry, with the postal department it was found that there was no such telegraphic code or telephone number, nor was there any such dealer at the address given. Besides, no freight charges were claimed for the transport of the stores. The explanation was that the stores were brought by the agents of the suppliers when they visited the mill. There was no correspondence and the payments were made by bearer cheques although even in respect of lesser items the payments had been made by crossed cheques. When the matter was further pursued, it was found that the bearer cheques were

actually encashed over the Banks counter by the mills manager. When the manager was examined, he admitted that the money encashed had been paid to the managing partner and that he did not know the alleged suppliers. 9.4 Where the component of stores consumption in the cost of production is high it would be necessary to obtain comparative details of the quantity and value of certain selected item of stores consumed for different accounting year, as this will reveal the items in which there has been substantial increase and a further pursuit of purchases of such stores may result in the detection of inflation in those items. 9.5 Rate of purchase of stores may also be inflated in collusion with suppliers. Some times the suppliers may be only benamis of the assessee or the concerns in which it is interested. Inflation of wages 10.1 This is another area in which expenses can be easily inflated,. In the case of permanent employees a regular muster roll is kept under the Factories Act. The inflation is usually in the muster roll for temporary employees. In one case, a perusal of the muster roll for temporary employees showed that lump sums were added at the end of the each week to the total of the temporary wages shown in the Temporary wages register and the whole amount was debited to the wages account of the mill. These lump sums were withdrawn by the partners. In some cases only

thumb impressions of the so-called labourers were taken and their whereabouts or names were not available. Capital expenditure as repairs 11.1 Some times, capital expenses such as construction of a new shed or a wing etc. are claimed as revenue expenditure through this account. Besides, cash advances might be shown in one year in the name of some sundry parties and they would also be shown in sundry debtors balance. In the subsequent year, these advances are squared up by transferring the same to the repairs account on the basis of certain typed bills alleging that these persons carried out repairs to the building or roads in the mill premises. While expenses on looms can be capitalized for the purpose of depreciation as per rules, the reasonableness of the expenditure on other tools and consumable stores should be watched carefully. The life of the other tools is not so short and if excessive or unreasonable expenditure on tools and consumable stores is claimed, the AO must make a thorough probe. Production and control of Excise authorities 12.1 Under the Excise Act, the woollen mills are obliged to maintain records of yarn production, detailed stock accounts, quantities removed from the factory, gate pass particulars, description of goods removed etc., in various prescribed registers in RG-1, RT-12 and Form IV. At present, woollen yarn is a non-excisable item but there is excise control over machine-made carpets. Yarns of certain description are still dutiable, for instance, shoddy

yarn containing more than 5 per cent virgin wool. In any case, the mills maintain such records, and these can be quite useful for investigations. It is also useful to examine the Spinning Masters daily production report and compare it with the Spinning register, which records the production at the spinning point. The spinning production can then be compared with the reeling production which should normally be higher, as yarn gathers weight in the reeling process due to moisture content, but by the time the reeled yarn is bundled and baled, some of the moisture content is again lost. Therefore, the baling production is more or less equal to the spinning production. 12.2 In one case where search was conducted u/s 132, it was found that the yarn production was recorded in the stock register at a figure much less than the daily production report submitted by the spinning master. In fact, duplicate daily report statements were got prepared to support the entries in the stock register. The actual production so diverted was sold through the mills retail depot to weavers and dealers in yarn. Therefore, in suspected cases of evasion it is essential to gather stock and production details from the primary books of entry including original production reports. Suppression of sales 13.1 Suppression of sales is common in this line. In the case of a carpet manufacturer, some special arrangements were made for sales during specific periods which indicated a departure from the normal established procedures. It was found that it was selling its products to

some firms on consignment basis. The assessee had agreed to bear the cost of freight, storage, godown and other allied charges till the date of sale of the goods. Goods that could not be sold were returned to the assessee. These firms used to pledge the goods with the bank and dispatch the amounts to the assessee that would pay the interest on the amounts advanced. The commission paid along with other expenses as interest, godown charges, freight cartage, Octroi etc. worked out to be more than 20 per cent of the sale proceeds. Enquiries revealed that these dealers were getting favoured treatment. The arrangement of sale on consignment basis was found to be a contrivance for diverting a part of profits to these dealers with whom the assessee had entered into collusive arrangement. 13.2 In cases of sale of carpets to tourists, often advances are received against the sale proceeds, but these do not find any mention in the regular receipts. A German national visited a carpet factory where she selected a carpet for 2800 dollars and paid advance of 800 dollars with an agreement that the remaining amount of 2000 dollars would be sent as soon as the carpet was dispatched to Germany. In the order-form, copy of which was supplied to the German national, the manufacturer mentioned the advance of 800 dollars. However, in the invoice that was dispatched along with other papers to the Clearing Agent the amount mentioned was 2000 dollars only. It so happened that the carpet was lost in transit and did not reach the destination. When the German national claimed damages from the insurance company, the

insurance company offered 2000 dollars only i.e. the sum mentioned in the invoice. She lodged a complaint with the authorities after which the assessees premises were raided. It was then found that the advance of 800 dollars was mentioned only in the order form and was not entered in the regular books. Therefore, while scrutinizing accounts, the order forms that are usually issued at the time of advances received from the customers or at the time of booking should also be thoroughly scrutinized. 13.3 Very often sale of wool waste is shown at a reduced rate. Such sale may be to persons who are dummies or benamidars of the assessee. Exports and imports 14.1 The carpet industry in India is basically exportoriented and its local demand is limited. With an estimated 1,00,000 looms employing about five lakhs weavers, the industry has a fairly large production base in the country. Export is an important area to investigate in suitable cases and examine from the various angles discussed below. 14.2 Non-repatriation / non-realization of the export sale proceeds is a major issue. Often exporters enter in collusive arrangements to realize fully or partly the outstanding proceeds and retained these abroad. Simultaneously these amounts are claimed as irrecoverable bad debts. The foreign exchange so accumulated is used for personal expenses on visits abroad.

14.3 Information relevant to income tax assessments can also be gathered from the offices of Textile Committee of Inspection, Controllers of Imports and Exports and Regional Textile Commissioner functioning under the Commerce Ministry. The Textile Committee inspects the quality and quantity of the intended exports, and issues a certificate regarding the fitness of the goods for export on the basis of which Government allows incentives to the exporters. The Textile Commissioners office has useful information regarding the quality of goods and raw material imported, license no. and the actual user of the goods, total production etc., Similar, information can also be obtained from the Regional Controllers of Imports and Exports. 14.4 The Indian woollen industry is heavily dependent on imported raw wool and wool tops. India buys raw wool mainly from Australia, New Zealand and Japan. The AO may, in suitable cases, verify whether the importer has properly utilized the imported material for the purpose for which it was imported or the same was sold off in the black market at premium and has fabricated his production and sale accounts. 14.5 The AO should also ensure that all cash assistance whether due or received has been properly accounted for in the relevant year according to the system of accounting followed regularly by the assessee. It may be useful to collect full information regarding payment of cash assistance from the regional offices of the Controllers of

Imports and Exports to find out if there is any discrepancy in accounting for such receipts in the respective accounts 14.6 Import entitlements - The object of Import Replenishment Scheme is to provide registered exporters import replenishment licences, to import material required by them for manufacturing the product to be exported. The rate of the replenishment licence against export is given in the import policy which is normally announced in the month of April each year. Such REP licences are also transferable, unless they are held by Import Houses and used for importing OGL items for actual users. The AO may verify the correctness of transactions relating to transfer of REP licences at a particular rate of premium. Where the commodity to be imported against a REP licence is a scarce one, the possibility of the transaction involving on-money cannot be wholly ruled out. 14.7 Cash incentives etc. - It is also often necessary to verify whether various cash incentives, subsidies and entitlements given to exporters are properly reflected in the books of accounts. These incentives are allowed to increase the export of carpets. The cash compensatory support in case of carpets is paid upto even 20 per cent on the FOB value. Sources of information 15.1 Some of the main trade bodies, and departments having technical data / expertise on export trade are specified here :

All Indian Handicrafts Board.

Wool and Woollen Export Promotion Council Institute for Carpet Technology at Bhadohi (UP) Regional Textile Commissioner Textile Committee of Inspection Chief Controller of Imports and Exports and its Regional Offices. Reserve Bank of India (Foreign Exchange Department) Directorate of Enforcement (Foreign Exchange) Customs & Central Excise Department All Indian Carpet Manufacturers Association Bhadohi.

15.2 The Shops and Establishments Act, Factories Act, Provident Fund Act, ESI Act, Customs Acts, FEMA etc. also apply in these cases. 15.3 Specimen copies of the following forms are annexed

Certificate of Chartered Accountant for issue of special import licence to superstar trading House - ANNEXURE -6 Letter to bank for negotiation of documents ANNEXURE - 7 Declaration for draw back claim - ANNEXURE - 8 Invoice - ANNEXURE - 9 Request for packing credit - ANNEXURE - 10

Annexure -1 WOOLLEN YARN BLEND CARD Weaving Yarn/ Woollen Yarn / Hosiery Yarn Blend No. Blend Description of Counts

BLEND UNWILLOWED WILLOWED REMARKS DETAILS MAHUA OIL CHEMICALS TOTAL

SPINNING YARN SPUN YIELD COMPLETED ON

Annexure - 2

CARDING SECTION 1. Blend No. 2. Quality 3. Counts of carding silver 4. Shipping counts 5. Twist 6. Draft on sponge frames 7. Quality required (greasy) 8. Date commences

Annexure - 3 WASTES DELIVERED TO WOOL GODOWN Kg. SOFT LOSSES %

HARD SHODDY SWEEPINGS TOTAL INVISIBLE LOSS YARNLOSSES WOUND YARN SPUN HARD WASTE LOSS INVISIBLE LOSS CARPET & HOSIERY YARN ONLY YARN REELED HARD WASTE LOSS INVISIBLE LOSS CARPET YARN ONLY

YARN SCOURED ACTUAL LOSS STANDARD LOSS TWIST TWIST STRENGTH QUALITY STD TPD STRENGTH STD.

CONTROL ACTUAL ACTUAL TPD REMARK SIGNATURE Annexure - 4

WEAVING CARD M/s A Carpet manufacturing Company FACTORY Than Loom No. Serial No. Colour Design No. No. Size Quality -

Weavers name Dat Total Dat Total Dat Total Dat Total e Producti e Producti e Producti e Producti on on on on

OFF LOOM -

Than No ... . Loom No.. . . Quality of yarn... .. Order No.......... Particulars Actual Size Colour Ordered Particulars Length Width Area Tani Charges Weaving Others Total Wages

Carpet No..

. .... . Quality .. ......... Weavers name .... .............. Date ....... Quantity Rate Value

Particulars Quality Woollen Yarn Warp Sarshi Budka Total

Weight of material = Weight of carpet = Loss = Cost of carpet = Loss % RECEIPTS Tufted Shade No. Date Quality / Colour Weight

Cost of material = Total wages =

Sarshi

Budka

Date Quality Date Quality Weight Weight

Annexure - 5 CARPET COST SHEET Than No Date WOOLLEN

Carpet No. -------------------Quantity Rate Value Quantity Kg. Design Colour Pile Tupe of yarn No. of piles COTTON Ordered size Actual size Length Width AREA Total cost of material Consumption D.W. Warp weft Wages in Rs. per 1000 knots Rs. in Kg. Per

Tani Wages Total cost of production Extras Total cost of finished carpet Total material in Kgs. Cost per sq. m. on ordered size (Rs.) Weight of carpet in Kgs. Cost per sq. m. on actual size (Rs.) Loss of Material in Kgs. Std. average weight per Meter in Kgs. Percentage Loss Actual average weight per Meter in Kgs. FACT ORY MANAGER Annexure - 6

CERTIFICATE OF CHARTERED ACCOUNTANT FOR ISSUE OF SPECIAL IMPORT LICENCE TO SUPER STAR TRADING HOUSE / STAR TRADING HOUSE / TRADING HOUSE / EXPORT HOUSE 1. M/s. have made the exports during-----2. The value of licences issued to M/s. including their

supporting / associates / Co- manufacturers during the period ---------------- except EPCG licence/Special Import Licence and the Licences surrendered during the validity period is Rs. ---. 3. The following documents / records have been furnished by the applicant and have been examined and verified by me / us namely 4. Export Order / Contracts, Shipping Bills, Bill of Lading (and / or Airway Bills / Receipts ) . Customs / Bank attested invoices. Bank Certificate of exports showing exports made in freely convertible currency in their own name and connected books of accounts. 5. Import licences issued to them including their supporting / associates / Co-manufacturers. (Applicable in case of claims on NFE basis. The stipulation about exports made in freely convertible currency in subPara (a) and (b) above shall not be applicable in the case of SIL to PH / TH / STH / SSTH ) 6. The relevant registers have been authenticated under my / our seal / signature. 7. The financial information given in the above statement is in agreement with the relevant register and records; the same has been incorporated in the books of accounts maintained by the exporter; and is also true and correct. 8. It has been ensured that the information furnished is true and correct in all respect ; no part of it is false or misleading and no relevant information has been concealed or withheld. Neither I nor any of my partners is a partner, director, or an employee of the above

named or its associated concerns. Details of Net Foreign Exchange realised Total FO Equiva QualifyingE B lent xports val FOB ue value Rs.

Equiva lent FOB value USD

Date NI SI Entitle of L L ment realisa Ra tion te

Products coveredunder Chapter B Products manufacturedby SSI Agriculture products. Selected notified countries North Eastern states Others

Note : 1) The CIF value of only those licences is to be deducted which are issued during the period------------------against which SIL is claimed. 2) The value of such licences shall be deducted against the value of SSI products. DECLARATION / UNDERTAKING 1. I / We hereby declare that the particulars and the statements made in this application are true and correct to the best my/our knowledge and belief and nothing has been concealed or held therefrom. 2. I / We fully understand that any information furnished in the application if proved incorrect or false will render me / us liable for any penal action or other

consequences as may be prescribed in law or otherwise warranted. 3. I / We undertake to abide by the provisions of the Foreign Trade (Development and Regulation) Act, 1992, the Rules and Orders framed thereunder, the Export and Import Policy and the Handbook of Procedures. 4. I hereby certify that I am authorised to verify and sign this declaration as per Paragraph 3.8 of the Policy. Signature of the Applicant Name and address Place : Date : Annexure - 7 LETTER TO BANK FOR COLLECTION / NEGOTIATION OF DOCUMENTS Drawer (Exporter) Drawee (Consignee) _____________________ ___________ Buyers Order No. & Date RBI Code No I.E. Code Invoice No. & Date Exporters Reference

Bank

Pre-Carriage by Place of receipt Vessel Flight No. Port of Loading Port of Discharge Final Destination

Drawee (If other than consignee)

ECGC Policy No. & Date _____________________ ________ _____________________ __________ Please receive the following documents for For Banks use disposal as per instruction _____________________ Documents __________ Number Instructions (Please tick as required) 1. Invoice No. & 1. Collect date Commercial - 2. Purchase / Discount 3. Dispatch documents by Consular registered air / courier Customs 4. Release documents 2. Packing list No. & date against payment 3. Bill of lading No. & date acceptance Non-negotiable 5. Cable advice of Air way bill No. & date nonacceptance Post parcel receipt No. & 6. In case of nonpayment, date nonacceptance, 4. Certificate of origin No. protest / do not protest

& date 5. GSP certificate of Origin No. & date 6. Inspection certificate No. & date 7. Insurance policy certificate No. & date 8. Draft No. date Sight / Usance Amount 9. Letter of credit Amount Expiry date 10. GR No. and date 11. Bank certificate 12. Copy of declaration to ECGC regarding Shipment 13. Any other document .................. (Specify)

7. Negotiable documents drawn under L/C No. issued by ......................... 8. Credit our a/c No. .......... on realization of payment 9. Advice payment by telex /cable /fax 10. Deduct charges/ collect charges from ...... 11. Do not waive / charges interest recoverable from drawee 12. Collect interest ....p.a. from 13. Adjust packing credit and / or credit the proceeds to cash credit / current account. 14. In case of need, refer to ...................... 15. Return ................. copies of bank certificates and ................... copies of commercial invoice duty certified by you 16. Return L / C after negotiation 17. Any other instruction specify

Declaration I / We declare that the particular given herein are true and correct and that I / We accept Banks conditions printed overleaf Signature & Date

TERMS & CONDITIONS 1. We agree to accept the rate of exchange ruling on the day that the documents are approved by your authorised office and undertaking to agree to any consequent, adjustment in the rupee equivalent if the proceeds have been credited / paid to us. However, in case of the bills, being covered by a specified forward contract, the above shall not apply and the terms of the forward contract shall be binding on us. 2. In case of any discrepancy / discrepancies noticed by the Bank, please treat the documents on collection basis / return the documents to us. 3. Negotiation are undertaken on the understanding that the Bank retains recourse to its customers, not only for the due payment of the bills at the original maturity date as stated in the bills but also for any loss which may be incurred owning to a moratorium or currency restrictions imposed, or to be imposed, in the country of payment. Moreover, negotiations are undertaken only on

the terms that the Bank is not liable for loss, damage, or delay however cause which is not directly due to the negligence or default of its own officers or servants. 4. If the bill which has been purchased / discounted remains unpaid / unaccepted , the amount due on the bill together which interest and other charges may be debited to my / our account or otherwise recovered from me / us. 5. We authorise the Bank to take delivery and also to do all other acts necessary for the safety, preservation and storage of the merchandise relative to the accompanying documents and to sell without further notice to us at our risk, cost and expenses part or while of the said merchandise accompanying this bill, or otherwise coming into your possession towards the realisation of any dues, costs, or expenses incurred by the Bank or otherwise outstanding against us at any time on this or any other account, and that the account of sale and of your expenses shall be accepted by us as correct and conclusive. 6. We agree that the Bank shall not be responsible for : Any act, omission, default, suspension, insolvency or bankruptcy of my agent or subagent, or For any delay in remittance or loss in exchange during transmission or in the course of collection, or

For loss of any bill of exchange or documents in transit or in the possession of any correspondent agent or subagent.

7. Unless otherwise specified, this collection is subject to the uniform Rules for the collections of Commercial Paper, International Chamber of Commerce Brochure No. 322. (Unless otherwise and agree to pay to the Bank specified, I / We also undertake and hereby authorise the Bank to reimburse itself for all commission and collection charges and all expenses incurred in the handling of this item if such charges and expenses are not paid by the drawee). DATE : PLACE : Stamp & Signature of the Exporter. . CERTIFICATE Form of Certificate to be given by exporters support of payment of freight in rupees on export or reimport of goods previously exported To : _____________________________ ____________________________ ____________________________

Vessel___________________________ Sailed on_________________________ Bombay__________________________ B/L No.__________________________ Dear Sirs, (A) * We hereby certify that the shipment in respect of which a sum of Rs. ____________ Rupees ______________________________________________ ____ in the freight, has been declared from GR / EP No. ________________________________________ OR (B) * We hereby certify that the shipment in respect of which a sum of Rs. _________ (Rupees ______________________________________________ _______ the freight, has been passed by the Customs authorities for shipment without declaration on GR / EP from AND (C) ** We further certify that the shipment referred to above has not been sold to any part resident outside India on f.o.b. f.a.s. or any other terms under which freight on the shipment has to be born by non-resident part and that the payment is not being made by us on behalf of any non-resident. OR (D) ** We further certify that payment of freight is being made by us on behalf of the non-resident buyer against contract with the buyer on f.o.b. f.a.s. or similar terms

under which freight on the shipment has to be born by the non-resident partly and we undertake to add the amount on the invoice and recover the payment so made from the buyer in an approved manner. OR (E) ** We attach there to the Reserve Bank approval obtained for payment the about freight in rupees by us. (F) We hereby certify that the sum of Rs. _______________________ Rupees _____________________________________ represents freight on ______________________ reimported (Particulars of cargo) per ______________________________________ The goods wear previous exported against a declaration (Name of vessel / airline) on GR / EP No .____________ Yours faithfully, Place : ____________ Date : ____________ Exporter Cod NO. ____________________________ Stamp and Signature of Exporter Annexure - 8 DECLARATION IN CASES OF EXPORT OF GOODS ELIGIBLE FOR DRAWBACK I / We

____________________________________________ (Name of the Exporters) do hereby declare as follows

That the quality and specification of the goods as stated in this shipping bill are in accordance with the terms of the export contract entered into with the buyer/consignee in pursuance of which the goods are being exported. That the duties of Custom and Central Excise have been paid in respect of the containers, packing materials and other materials used in the manufacturers of the export goods on which drawback is being claimed and that in respect of such containers packing materials or other materials, on separate claim for rebate of duty under rule 12A or rule 191A of the Central Excise rule 1944 has been made or will be made to the Central Excise authorities. That there is no charge in the manufacturing formula and in the quantum per unit of the imported material or components if any, utilised in the Manufacturer of exports goods and that the materials or components, which have been stated in the application under rule 6 or rule, 7 to have been imported continue to be so imported and are not being obtained from indigenous sources. That the present market value in the goods is as follows. That the goods are not manufactured and/or exported in discharge of an export obligation against an advance licence issued under the duty exemption

scheme vide relevant import and export policy in force. That the goods are not manufactured and/or exported by a unit Licenced as a 100% export oriented unit in terms of the import and export force. That the goods are not manufactured and/or exported by a unit situated in any free Trade Zone/Export processing Zone or any such other Zone. That the goods are not manufactured partly or wholly in bonds under Section 65 of the Customs Act, 1962. That the goods are not manufactured partly or wholly in bonds under rule 191B of the Central Excise Rule, 1944. That the export value of each of the good covered by this Shipping Bill is not less than the Total value of all imported materials used in the manufacture of such goods.

Note: Strike out whichever is not applicable. Name & Signature of the Exporter ____________________ __________________________________________________ __________________ For use by Customs authorities Shipping Bill No. & Date _______________________________ Name & Signature of the Customs Officer ____________________ Annexure - 9 INVOICE

Exporter No. & Date

Invoice Exporters Reference

Buyers Order No. & date Consignee Buyer (If other than consignee) Country of origin of goods | Country of final destination Terms of delivery and payment Pre-carriage by Place of receipt by pre-carrier Vessel / Port of loading Port of discharge / Final destination Marks & Nos. No. & kind of packages Description of goods Quantity Rate Amount

Total ____

Declaration We declare that this invoice shows the actual price of the goods described and that all particulars are true and correct Signature & date

Annexure - 10 REQUEST FOR PACKING CREDIT Date _________ To, The Manager _____________________ Bank, Dear Sir, In accordance with our under mentioned contract with buyers, M/s _____________________I am / We are arranging for the shipment goods as per particulars given hereunder

Details of L/C Date and No. of contract Name and address of consignee Name of Vessel Shipment to Description of goods Quantity Market Invoice Value Advance

Pursuant to and as per the terms and conditions of the PACKING CREDIT AGREEMENT already executed by me / us on ____________________________ I/we request you to advance Rs. ______________________ against the shipment goods. I/We have already deposited with you the relative document listed overleaf drawn / endorsed in your favour I/we further undertake that we have not availed any pre-shipment credit against the aforesaid order from any other Bank. Packing Credit FOBP

Yours Limit ____________________ faithfully ______________ ____________________ Balance _______________ ____________________ Overdue _____________ FOR BANK USE ONLY Current A/c No. Recommending Officer Authority Chief Manager Sanctioning

CONTRA TRANSFER JOURNAL TRANSFER

ENTRY NO. _________________ DEBIT __________ PCR __________________________________________ Rs. P. PACKING LIST Exporter Invoice No. & Date Buyers Order No. & Date

Marks & Nos. No. & Kind of Quantity Remarks Packages Description

Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter VIII

PACKAGING INDUSTRY

General 1.1 Packaging industry has acquired importance in the context of the need for preservation of commodities, articles and goods of various types. The concept of packaging is an extension of what mother nature has endowed on her creation. The organic decay would be much rapid if we peel off the outer covering of the fruits and vegetables, nuts and dry fruits. 1.2 From the idea of preservation, the concept of packaging has evolved itself into adding value to the product itself. Now a days the brands are identified with their packaging. The appeal of a product is enhanced by the kind of packing in which it is contained, be it a toothpaste or perfume or for that matter bread or cake or basmati rice or snacks. The packing affects the psychology of the consumer in a big way. Before really appreciating the quality of a product, what affects a consumer, is the nature of its packing, its aesthetic value, the message conveyed by the packing, and similarity with the packing of reputed brands of products in the market.

Thus packaging has added to the commercial value of the products. 1.3 With the advancements in metallurgy, new packing materials have been produced, which not only serve an aesthetic purpose but also enhance the shelf life of the product itself. The perishables are now being packed in special packing material that extends their shelf life to many months. For instance, cold drink, fruit juices, curds, oil, dried powders of spices and other eatables, cosmetics, baby foods confectionery items, medicines can be preserved for a longer duration without any change in taste, flavour and utility value. Types of packaging 2.1 Basically the packaging industry can be categorized into - Flexible packaging; and Rigid packaging 2.2 Flexible packaging includes a wide category of packaging materials used in different combinations for packing detergents, powders, spices, cereals, jams, honey, shampoos and all other types of food products, cosmetics, fast moving consumer goods, pharmaceuticals, and industrial items like cement etc.. 2.3 Rigid packaging has also got wide applications, and are used as outer protective packing for flexible packaging materials. Their applications extend to packing of pharmaceuticals, white goods and other miscellaneous applications.

2.4 Some of the films commonly used by the packaging industry in different combinations are - Paper, Copolymers, Foils, BOPP, Polyester, HDPE, Nylon, and PVC 2.5 The combination used depends upon the shelf life desired; the sensitivity of the product to sunlight, moisture and other environmental factors; the type of the barrier required; aesthetic appeal to be provided; end-users segment; and the cost factor. Important segments of flexible packaging 3.1 Aseptic packaging - Various aseptic packing systems have emerged on the Indian scene. Tetra pack system is being used commercially for more than five years now and has been found successful. Milk, juice and Soya-based beverages have been marketed by various producers. The system was introduced by the National Dairy Development Board under their Operation Flood program by extending the advantages of the system to milk producers. Subsequently, the system found its utility in other sectors too. It is designed for consumer packaging of liquid foods to extend their shelf life without refrigeration. The packaging material used is a multi-layer laminate of paper and plastic. Aluminum foil is additionally used to provide longer shelf-life. 3.2 Aseptic packaging & rural development - Three fourth of India lives in rural areas. An estimated 450 million people of the country depend on agriculture. In India, 5 to 25% of agriculture produce is wasted for various reasons.

One of which is improper packaging. Extension of modern technology, which saves material, cost and energy, will benefit the producer by raising his standard of living. An aseptic packaging system provides various advantages, namely - it extends the shelf-life of the product giving an opportunity to the producer to have a direct link between him and the market, eliminating the middleman. It also gives an opportunity to the producer to balance the seasonal variations of production and demand, thereby maximizing the return on his produce. It saves on the total everyday requirement, and assures the consumer about the quality of the product and its availability throughout the year. 3.3 Packaging of ready-to-use consumer items - In this sector, the packaging industry is going through a revolutionary change. Items, which could not be thought of being packed in small pouches about a decade ago (for example shampoos, in 5 to 10 gms pouches) are now packed in smaller units. This has brought premium products within the reach of common man. This has been made possible by advanced extrusion lamination technology. The various substances and their combinations used commonly are - Polyester / Poly, Foil / Poly, Metallised Polyester / Poly, Paper / Poly / Foil / Poly, Paper / poly, BOPP / poly. Some of the commonly seen packing of this kind are

Polyester / poly is generally used to pack 1 kg to 5 kgs of rice, cereals, ready-to-eat snacks like chips, chocolates.

Foil / poly is used in the strip packing of tablets and capsules in the pharmaceuticals industry. Metallised polyester / poly is generally used for packing of pan masala and gutka products. Paper/ poly / foil / poly is used where a high barrier is required e.g. in oral dehydration mixtures, tea, coffee, milk powders etc. Paper / poly and BOPP / poly is used widely for soap raps and low priced detergent powders. Various combinations of different grades of polyethylene are used for producing excluded films for packing of milk and edible oils.

3.4 The functions of various substrates are briefly outlined as under

Poly - This is used as a salient layer. Poly is generally a short from for polyethylene. This can be LDPE (Low Density Polyethylene), LLDPE (Liner Low Density Polyethylene) or HDPE (High Density Polyethylene). The selection of grade depends on the type of the product to be packed. Polyester - This is used for giving good printability and aesthetic effects to the laminate. This also acts as a barrier against gas and moisture. Aluminum - Aluminum foil is an excellent barrier against gas, moisture and light. This film is used to protect the ingredients from environmental factors.

Paper - This provides the body to the laminate and is used wherever the laminate requires strength.

Leading manufacturers of packing materials 4.1 With the advancement of the packaging industry in the country a revolution has taken place in this sector. At present, packaging has touched almost every aspect of our lives. When we get up in the morning our toothpaste comes from a flexible package. The first cup of tea in the morning is prepared with the help of a tea bag which consists of soft packaging. On the breakfast table, cheese cubes, butter, jam, pickles, fruit juice, bread, bakery items comes to the dining tables in soft packaging. Likewise the whole routine of life is intermingled with consumer products coming some one form of packaging. A large number of manufacturers are engaged in the manufacturing of packaging materials of different kinds. The major operators are -Flex Industries Ltd., India Foils Ltd., Paper products Ltd., Sharp Industries Ltd., Essel packaging Ltd., Tetra pack Ltd. Materials used in the packaging industry 5.1 Some of the important raw material are tabulated below Raw Material Form Low density Film & Polyethylene Sheeting Application General-purpose produce packing milk

sachets, carrier bags, protection covers, shrink film, heavy-duty sacks. Bottles & Cosmetic and collapsible Pharmaceutical tubes product packing Foam Packing of fragile goods and lamination to PVC sheeting Bubble film Packing of electronic goods Laminates Aluminum foil/LDPE, Glassine/ LDPE laminates as pharmaceutical strip packs and milk cartons High density Film & Carrier bags, packing poly Sheeting of food products Containers, Vanaspati, edible oil jar packs, Jerry cans Detergents, Drinking water bottles Woven sacks packing of fertilizers and chemicals Go-extruded Packing of hygroscopic film food Polypropylene Tubular Packing of food and

proquench film polyethylene BI-axial oriented film

hosiery products, garment bags. Food products, lamination to carton board Woven sacks Packing of fertilizers and chemicals Polypropylene Light engineering goods, shoes and Corrugated electronic items. Board Film & Packing of textile, Sheeting piece goods shrink film, Blister pack film for pharmaceutical industry, Medical products - pouch pack for saline glucose transfusion kits. Thermoformed cups for jams/ jellies/ ketchup and pickles Thermoformed cups, tubs for packing of edible food products like shrikhand, sweet meats, cooked food and ice cream. Industrial and light

PS

HIP foil & Sheeting

PS foam

engineering goods appliances.

5.2 To understand the current trends in packaging, it would be best to take each raw material and mention its status and prospects in the medium term. 5.2.1 LDPE - With the success of Operation Flood programme, milk pouch distribution system has been firmly established. It utilizes a high tonnage of raw material produced in the country. This is either as a single layer or composite construction. The Tetrapak aseptic milk carton pouch has also been accepted by the consumers. A remarkable growth rate in consumption has occurred in the area of extrusion coating of high density polyethylene raffia, which goes into the fabrication of a fertilizer/chemical woven sack. 5.2.2 LLDPE - IPCL has been carrying out a limited seeding programme but as appropriate processing machinery is not available, its acceptance is being gained as a blend polymer with LDPE for blown film application. With two cast film lines due to come on stream later this year, we may shortly see the advent of LLDPE cast film availability. 5.2.3 HDPE - The success which HDPE has had in the packing area has been entirely due to its utilization as a carrier bag for consumer packaging applications. The current estimate of conversion to film by the blown film process is 6000 tonnes. The other success story has been

the woven sack. The woven sack, is economically priced as it is produced on circular looms. 5.2.4 PP - A significant large tonnage (10,000 tonnes per annum) of PP homopolymer produced by IPCL is converted as tubular quency film and the quantum of growth rate of 1% continues. With the availability of random PP grade copolymer sheet processors have the opportunity to introduce thermoformed cups and tubs to the food packing industry. The Polypropylene corrugated board, which was introduced to the trade in 1980, has now been recognized for its value added performance. Some recent established applications are in the engineering and textile sector e.g. as cartons for 1.5 HP hermetically sealed compressor (Voltas). Pump spares (KSB Pumps), polyester year (Nirlon & JK Synthetics), tobacco (Godrey & Philips); items such as boxes and trays for cigarette packs etc.. 5.2.5 PVC - A total indigenous production of 75,000 tonnes p.a. of PVC supported and unsupported film and sheeting finds various applications. Of this about 800 tonnes per annum is marketed as rigid films which has outlets as blister/skin pack film for packing pharmaceuticals/health care and toys and consumer products. Thin clear PVC film has also been accepted by confectionery manufacturers as sweet/coffee twist wrap to substitute regenerated cellulose film. A small tonnage is marketed as shrink film for textile wrap and shrink on tubing for dry cell batteries. It is expected that shrink film

market would grow considerable with the advent of consumers demand, shrink-on sleeves for cap labels. 5.2.6 PET - The PET film production is estimated at about 1,800 tonnes per annum of which about 1000 tonnes per annum is marketed for packaging applications (noodles, carton lamination, chocolate, confectionery, potato crisps etc.) . The growth rate will be maintained with more fast food producers setting up distribution channels within the country (Instant coffee, soup mixes, health drink powders). The exposure of the PET bottle to the packing industry has just been about 6 months. Prospects for its usage for packaging edible oils and pesticides/ insecticides/herbicides are bright. 5.2.7 NYLON - The introduction of nylon 6/ isomol pouch as a substitute for tin and HDPE container as an edible oil pack for litre and 1 litre container had initial acceptability problem. However, with imported processing machinery available to produce both single layers nylon 6 film and composites thereof, the industry will accept this packaging medium for packing edible oils, motor oils, greases and fruit juices besides meat, spices, fruits, cheese and precooked vegetables for domestic consumption and the export market. 5.2.8 PS - Whilst the PS expanded foam products have been firmly established as packing material since the 1970s, its growth rate, continues to be significant. The light engineering industry utilizes it for packing of fans, motors, typewriters, automobile parts, fuel pumps, textile instruments, sewing machines and consumer appliances.

The electrical and electronics industry utilizes it for packing of radios, transistors, amplifiers, cassette recorders, TV Calculators, digital clocks, computer components and telephone equipment. Other user industries of expanded foams include laboratory equipments, instrumentation, food and perishable pack consumer packs like picnic boxes and beer bottles. However recently extruded PS foam has been introduced for packing of food products and perishables, in the form of disposable trays. General machines required for flexible packaging industry 6.1 Laminating machines - A wide range of laminating machines is available both indigenously made as well as imported. The machine used depends upon the type of the laminate to be made. A laminate can be made starting from a simple 2 layer laminate like polyester/poly or paper/poly to a 5 layer laminate like laminates used for laminated tubes for tetra pack. Laminating machines can be suitable for adhesive lamination or extrusion lamination. In adhesive lamination, adhesives are used to bind different substrates. 6.2 Slitting machines - After the lamination is done the laminate passes through the slitting machines for being cut into requisite sizes. 6.3 Printing machines - The printing is done as per the customers requirement. The printing machine can be of 2 colours to 6 colours.

6.4 Pouching machines - If the customer needs premade pouches then the laminate is sent to the pouching machines to make such pouches. If the customer does not need such pouches then the rolls are given to the user to be fed into F.F.S (form fill sealing machines). Indian industry has been technologically advanced to cater to the demand of the packaging industry. All the different types of machines are generally produced in our country itself. However for specialized items like producing laminated tubes, filling of toothpastes, high speed lines for shampoo packing, the machines are still being imported. The investments for packaging industry can be anywhere between Rs. 10 lacs to 10 crores depending upon various factors e.g. the type of laminate to be produced, the number of colours to be printed on the laminate, the enduser industry, the output desired from a particular industry, qualified machine operators, the quality control checks, the availability of captive power. Suggested lines of enquiry 7.1 Acquisition of machinery - The investment made by the assessee for the purchase & installation of various machines should be enquired into. Parts of these machines are manufactured in India while some of these are manufactured outside the country. Purchase price of the machinery and installation expenditure should be enquired into from the suppliers of such machinery. In the case of machinery purchased from abroad, the documents of import, various duties paid, mode of payment, channel of payment should be enquired into. For this purpose

information should be directly collected and verified with the help of Government agencies / Departments and various other organizations whose assistance/channel are used by the assessee for the purchase of machinery. Most of the time services of specialist / Engineers are required for installation of machinery as per the specification of the manufacturers. A direct enquiry from the agencies providing such services, will give information to the AO with regard to the movement of the machinery from the place of manufacturers to the place of the buyer and the process of its installation and other incidental activities. These enquiries will provide comprehensive information about the purchase of machinery by the assessee. 7.2 Purchases of raw material - A major area of manipulation of accounts is in the purchase of raw material. Purchases are inflated to reduce profits chargeable to tax. For proper enquiries, first the exact nature & quality of the products being manufactured by the assessee with their full specifications should be obtained. This is because the requirements of raw material is directly dependent on the type of packaging material manufactured by the assessee for different kinds of products as discussed in the preceding paragraphs. There are different requirements of raw material depending upon the type & quality of the product to be packed, shelf life required, sensitivity of the product to the temperature variation and humidity etc.. For this purpose, few pieces of finished goods of the assessee can be examined, analysed and disintegrated, to give an idea of the requirement of raw materials. Alternatively, a test run of

the production process can be carried out to ascertain the average input : output ratios of various raw materials required for each category of the finished product. This will also bring out average norms for wastage & by-products. The disclosed consumption / production can then be verified, and logical conclusion regarding inflation of purchases can be drawn. Thereafter, disclosed purchases of raw material can be verified from the suppliers of raw material, for both, quantity and price. 7.3 Sales of finished products - The sales of finished goods to various customers should be directly verified from the data available in the books of the customers. In case of discrepancies / suppression of sales, the same should be confronted to the assessee and adverse view may be taken where discrepancies are not properly explained by the assessee with reliable evidence. It should also be ensured that total production of finished goods is equal to the total of goods sold and those available in the closing stock and work in process. Of course, finished goods available in the opening stock should be deducted from this total. Most of the time, large expenditures are shown on publicity, research & development, advertisement, hiring services of experts etc.. These expenditure should be examined properly after due cross verification from the recipient of such payments and in the light of the business requirements. 7.4 Disposal of wastage - Most of the ingredients required for the manufacture of packaging material are valuable items. Their cuttings, leftovers etc. carry some

value, as these can be recycled to produce the same material once again. Proper accounts of such wastage, should be obtained from the assessee so that income / receipts from sales of these items is properly charged to tax. For this purpose, the quantitative analysis of raw material purchased & consumed, wastage and finished goods produced should be made. The stock register of the assessee, should be examined, along with gate pass register. Purchase of raw material, its distribution to various sections of the workshop, semifinished goods at various stages of the process, production & sales of finished goods, and wastage generated, can be checked with the help of dates recorded in the stock register.

Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter IX

AUTOMOBILE INDUSTRY

AUTOMOBILE MANUFACTURERS The auto scene now 1.1 The automobile industry in India has undergone a transformation owing to the opening up of the economy. There existed a situation in the country where consumers had to wait for years before they could get a desired vehicle. If they wanted the vehicle sooner, they had to go under some quota scheme like government quota and NRI payment quota. The quota ensured a slightly shorter waiting time. That was all. The position now is very different. The dealer has to hard sell his product to survive competition. Several foreign brands like Mercedes Benz, Fiat, Honda, Mitsubishi, Hyundai, Daewoo, General Motors and Ford are in the Indian market vying with each other to attract the Indian buyer. They have either set up wholly owned subsidiaries or entered into a collaborative joint-venture with an existing Indian player. The industry perception is that the market is in favour of the consumer now because of the fierce competition and price wars. In two or three years they expect to see the fallout of the international reorganisation in the car market in India and hope that the tilt in favour of the consumer will be corrected and the market will become more balanced. 1.2 The automobile manufacturing process involves either integrated manufacturing in India with very little import

content, as in the case of Hyundai or Fiat or the more or less glorified screw-driver technology wherein completely knocked down (CKD) kits are brought into the country and assembled with minimum indigenisation, as in the case of Daewoo and General Motors. Many of the locally made cars are being exported using the reach of the multinational car making companies which have set up shop in India. The entry of new models has posed a challenge to the local ancillary industries who have to diversify on a large scale to produce newer parts with new technology. 1.3 Two wheelers have emerged as the vehicles for the middle class used alike by office-goers, milk vendors, vegetable vendors and small businessmen. They are popular on account of their affordability and maneuverability. They are suited for the narrow and/or congested Indian roads. Urban areas where public transport is inadequate have witnessed a sharper growth in demand for two wheelers. 1.4 During the 1950s and 1960s a number of industries for manufacturing motorbikes and scooters with foreign collaborations were started. Certain companies entered into collaborations with foreign companies to bring out better and fuel-efficient models. With the liberalisation in the nineties the two-wheeler manufacture field also became active and new models started rolling out. With the country becoming environment-conscious and the pollution control laws becoming strict, the manufacturers are shifting to environment-friendly models. Several

products in the market now are Euro 2000 norms compliant. The Indian two wheeler industry has grown at around 10 per cent in 1999-2000. Of late, there is a marked shift in consumer preference from scooters to motorcycles. Even within the motorcycle segment there has been a shift in preference towards 4-stroke vehicles. 1.5 There are a number of new entrants in the automanufacturing line. The entry barriers for players are brands, distribution network, business economics and network of components suppliers. There is high import content in products of new ventures. With competition hotting up in all segments, the product offering technological superiority, style and low-pricing acquires an edge. It is felt that in future earnings of companies will be volume-driven rather than through high margins and that they will have to increase their budgets for advertising and sales promotion. Exchange fluctuation loss 2.1 The import of completely knocked down kits involves large outgo in terms of foreign exchange. In most cases such imports are done from the Indian entitys mother company based abroad or through them-where such parts are not directly produced by them but only acquired from suppliers. Payment terms are easy and spread over a long time as there is no danger of delayed payments, since the Indian company is closely related to the foreign company. Therefore, at the end of the year, the Indian company seeks to revalue its foreign liability based on the then existing rate of exchange. The additional liability, if any, is

charged to the Profit & Loss account with the notation Exchange Fluctuation Loss. 2.2 The provision of such an exchange fluctuation loss is only a notional loss since it has really been calculated on the basis of the then existing rate of exchange. A real loss can occur only when the payment is ultimately made. This can be debited to the Profit & Loss account as a real loss. On account of this issue importance. Board has issued guidelines in No. 228/31/91-ITA-II/dt. 05-05-1993, communicating opinion of the Ministry of Law that any increase in such liability calculated before the payment is actually made, on account of difference in foreign exchange rate as on a particular date is only notional, and hence is not an allowable expenditure. Warranty liability 3.1 Unlike in India warranty liability abroad is very stringent. For cars sold in India service and warranty are provided by the dealer who is reimbursed the cost involved. As regards warranty in respect of cars exported, many manufacturers make a provision towards warranty. This is a purely a contingent and unascertained liability and accordingly liable to be disallowed. Over-invoiced imports 4.1 Another issue which comes up on account of heavy imports by the Indian subsidiary or collaborative venture from the foreign principal is the question whether the costs of imports are reasonable. They may be loaded against

the Indian subsidiary with a view to siphon away the profits of the Indian subsidiary. 4.2 Two aspects need to be kept in mind here. First, the Indian subsidiaries are in many cases making much larger profits than their foreign principals, e.g. Maruti Suzuki visa-vis Suzuki. Secondly, many of the Indian ventures have also been set up as joint ventures with an Indian partner. For both these reasons, over-invoicing of the exports to the Indian subsidiaries or joint ventures is a distinct possibility. For some time now, we have been hearing of the reluctance of multinationals in passing on technology to their Indian joint ventures. These issues lie in the field of transfer pricing which deals with the question whether the goods transferred from a company in one country to an affiliated company in another have been charged at the prevailing market price. In the Indian tax context, the issue will be the disallowability of such part of the expenditure which has been proved to have not been incurred wholly and exclusively for the purpose of the business of the company. This is all the more so in view of the close relationship between the Indian company and the foreign exporter. Excise duty manipulations 5.1 A concessional rate of excise duty is levied on vehicles sold for being used as taxis. This is on the basis of a notification of the Central Government granting partial exemption from excise duty in respect of motor vehicles registered as taxis. The exemption is conditional on submission of a certificate from the Registering Authority

about registration of such vehicle as a taxi within the stipulated period and the passing on of the benefit of the reduced excise duty by the manufacturer to the taxi owner. The manufacturer was required initially to pay the excise duty at the full rate while clearing the vehicles for sale. After the vehicles were registered as taxis and the necessary evidence of that registration obtained and payment of the excise concession to the buyers, the manufacturer was required to submit application to the excise authority and obtain refund of the concessional duty. 5.2 The original excise duty collected from the buyers is, at that time, credited by the assessee and similarly the excise duty paid on account of sale is debited to accounts initially. As and when the assessee passes on the benefit of concessional excise duty to taxi owners, it ought also to credit the refund receivable from the Central Excise department. There cannot be only a charge on the profit in respect of payments made without the corresponding receipt being accounted, considering that the mercantile system is normally followed in such cases. Instances have come to notice where assessees have claimed refund of concessional duty to taxi owners charged to Profit and Loss account without recognising the income on account of refund due from the Central Excise department. In such cases income accruing to the assessee on account of excise duty receivable by it as per law, should also be brought to tax. Research and development

6.1 Research and development is an essential part of any progressive industry. All automobile manufacturers are incurring expenses in this area especially with a view to do away with the dependence on foreign technology. Whenever large claims are made, it is prudent to make a visit to the factory premises, inspect the activity and ascertain the allowable R & D expenditure, both capital and revenue. The AO should be cautious about normal commercial activities including quality control measures being disguised as R & D activities. Other issues 7.1 The major issues to be looked into while examining the manufacturing accounts of the automobile manufacturers, have been listed in the chapter on scrutiny of Manufacturing accounts in Volume-I of this manual. Personal inspection of plant facilities is bound to be a valuable aid to tax investigations. Recourse should be had to the primary records maintained by the assessee for internal management and control as valuable clues to concealment of income lie therein. 7.2 Very often parts going into the final product are manufactured by group companies or by other ancillary industries which are dependent on the principal manufacturer. Job works are also got done through such concerns. There is considerable scope for manipulation of cost of the parts purchased from such ancillaries or the cost incurred on such job works. Thus, this aspect requires deep scrutiny.

7.3 The manufacturers generally get certain important parts of the vehicle manufactured by others. Engines and tyres are usually purchased from engine / tyre manufacturers. These two items may not fit the other brands. Verification of the inventory of these items will throw light on whether the number of vehicles shown as manufactured tallies with the purchases of engines and tyres. If the number of vehicles manufactured is less, then there should be a stock of tyres/engines in the inventory. This is an area requiring attention. The industry facing an ever-increasing competition may have to abandon certain models and switch over to newer, better and more attractive models. It may be worthwhile to see how the stock of unutilised parts ordered for the models abandoned midway, are disposed of. 7.4 Another area to go into would be the manner in which the scrap generated in the manufacturing process is dealt with. The income derived from scrap disposal often goes unaccounted. Misuse of incentive provisions 8.1 Misuse of incentive provisions is often carried out in several ways. For instance, deduction u/s 35(1)(iv) for capital expenditure on scientific research may be claimed, in respect of acquisition / construction of non-R&D assets claiming them to be R&D assets. A separate chapter on Misuse of Incentive Provisions deals with such attempts. It may be referred to for further information and guidance. The misuses peculiar to automobile manufacturing industries are discussed here.

8.2 A spin-off arising from technological upgradation and the diversity of product availability is the need for diversification by ancillary manufacturers also, based on the demands from the manufacturer. As a result, the ancillary manufacturer has to set up new product lines to meet the demand from the principal. On account of the availability of benefits under section 80HH and 80IA, the ancillaries often set up such lines in places where such benefits are available. Though new product lines may entail losses in the initial years due to heavy investment cost, there is also a tax opportunity in the sense that, if the profits of these new units are high, extra deductions u/s 80HH and 80IA become available to the assessee. This can also become a fertile area for tax evasion by inflating the profits of these units with a view to get higher deductions. 8.3 In the case of an auto ancillary manufacturer at Chennai belonging to a leading auto ancillaries group, it was found that profit of the new production line was inflated to an unreasonable level so as to claim extra benefits u/s 80HH for which the new unit was eligible. The company was very well run and belonged to a reputed group. The basic suspicion of tax evasion arose from the fact that the net profit declared for the company as a whole comprised only the net profit of the new unit, whereas the existing unit which was equally well run and had far more successful production lines would show a net loss if the profits of the new unit were excluded from the total profit. Consequently, a survey u/s 133A was undertaken at the new unit set up in a backward area. It

was found that even expenses directly related to the unit such as turnover tax (sales tax), superannuation fund payment of the employees of that particular unit, gratuity payment, rent payment etc.. had not been debited to the units Profit and Loss account. These facts were conceded by the assessee. In addition, expenses like R&D charges, sales promotion expenses, interest payments and foreign travel expenses had also not been allocated, though it ought to have been charged to the new unit also. Based on these facts the real profit of the new unit was worked out. Thus, this is one of the areas which needs deep scrutiny. MOTOR PART DEALERS Suppression of sales 9.1 The trade in automobile ancillaries is characterised by good margins. The tendency to suppress sales is also very high. According to certain estimates, the ratio of unrecorded sales to recorded sales is as high as 1:1. Cross-verification and comparison of copies of account of the suppliers with that of the assessee may be helpful in detecting suppression of sales, but this may not always succeed. The manufacturer or the wholesaler, as the case may be, may himself be a participant in suppression. Spurious parts abound in this trade, and their sales are outside the books. 9.2 Properly planned and executed surveys u/s 133A are quite effective in unearthing suppression and sales of

duplicate parts. Coordination with the sales tax authorities may also yield good results. Stock discrepancies 10.1 In this line discrepancy in stock account is a common occurrence. The best way of finding out the discrepancy is through a survey u/s 133A followed by a reconciliation of stock position vis-a-vis item, quantity, rate and value. However, this could be a tedious process for assessees having several branches. One of the ways to get over this is to have a special audit u/s 142(2A). Such an exercise can show up a number of discrepancies in the stock position. 10.2 The initial months of the year may reveal sales (at cost price) far outstripping the stock available in terms of opening stock and purchases made. This deficiency may be on account of the closing stock of the earlier year having been suppressed. The final accounts, as at the end of the year may show the stock position tallying. However, the purchases made at a later date cannot account for the sales made earlier. Hence, the assessee will also have to explain as to what was done with the stock purchased at a later date to the extent of the deficiency reflected in the earlier months. A natural presumption would be that such stock has been sold outside the books. 10.3 Again, an analysis of the stock position in the later months may show that the stock available at the end of the year is far less than the stock which should be available if one were to take the opening stock and

purchases from a certain cut off date and reduce the sales (at cost price) made thereafter as also the closing stock remaining at the end of the year. Needless to say, the tallying of stock would have to be done in such cases in terms of both items, quantity, rate and value. 10.4 Where a deficiency of stock is noticed in the earlier months as discussed above, though it may be on account of stock having been suppressed in the earlier year, the best treatment to be given in the interest of revenue would be not to disturb the assessees claim in terms of the stock position confirmed as relating to the earlier year. In the result, the assessee would be assessable in terms of the value of the unaccounted purchases made to effect the sales made. If the assessee is unable to explain the whereabouts of certain purchases, then the implication would be that it has sold these purchases outside the books of accounts. Since these purchases are duly accounted for, only the gross profit on such sales needs to be assessed. However, there is no reason for telescoping the addition made on account of unaccounted purchases discussed earlier against the unaccounted sales, since these sales are out of the accounted purchases. 10.5 As regards any alteration to be made in the closing stock for the year on account of discrepancies found it would be feasible to assess it as suppression of closing stock. However, one would then have to give the assessee the benefit of an adjustment of a higher figure as opening stock of the next year with all the possibilities for adjusting its profits and accounting this excess stock

during the next year without further affecting the profitability of that year. This would be especially so in a case where the accounts for the next year have not been finalised yet or the return of income has not been filed. Hence, another option would be to accept the declared closing stock as correct and hold that the unexplained stock has been sold outside the books of accounts with a resultant addition of unexplained income being the gross profit on such sales. If the gross profit in the particular trade is marginal, then the option of revaluing the closing stock would be the better one. Considering that this suppression is worked out on the basis of accounted purchases there would be no scope for an addition in terms of investments in such stocks. Conclusion 11.1 In view of the nature of operations, investigations in cases of automobile manufacturers need to be selective. The AO should be watchful for unusual features and direct enquiries accordingly. In cases of motor parts dealers, stock account and duplicate parts need attention Enquiries directed from these angles are likely to give good results. Remember, patience and persistence pays.

Directorate of Income Tax ( Systems )

Investigation Manual Volume - 2 Chapter - X BICYCLE INDUSTRY

1.1 India is the largest manufacturer of bicycles in the world after China. As per a study by the National Council for Applied Economic Research (NCAER), there were around 12 crores bicycles on the Indian roads as on 31st December, 1998. The Bicycle industry has seen a growth rate of 8% per annum for the last 15 years. The future prospects of this industry are also considered to be bright. For an Indian, the first consumer durable to be purchased is a wrist watch and the second most desired consumer durable is a bicycle. Considering this factor, demand for the standard roadster model of bicycle is directly linked with the increase in population and the rising purchasing power of the poor in the country. The Bicycle industry is expected to grow at an average rate of 10% or more per annum from the year 2004. 2.1 There are some unique characteristics of this industry, which have a determining influence on the structure and the manner in which cycles are produced and sold -

There is a high degree of ancillarisation where parts and components are sourced out to small units. Some of the big manufacturers have slowly developed backward integration but still large number of components and parts are obtained from ancillaries, some of which operate in the informal sector. There is a strong brand identity with respect to the assembling and marketing of bicycles. Four of the largest manufacturers in the country, namely Hero, Atlas, Avon and Tube India (TI) account for more than 93% of the annual production. The manufacturing process is divided into a number of sub- assemblies. There are a large number of cycle parts and component manufacturing units which are involved in manufacture of the subassemblies. There is an exclusive distribution network for bicycles wherein distributors and retailers sell only bicycles and do not keep any other consumer durable in their stores.

The exclusive kind of distribution channel and the strong brand identity makes it very difficult for new entrants to penetrate this industry. Thus, the structure of the industry has a strange kind of dualism. On the one hand are the large cycle manufacturing companies like Hero Cycles, Atlas Cycles etc.. and on the other side of the spectrum are small or medium sized ancillary units supplying some

or the other component to these companies. This implies that the large companies involved in the manufacture of complete bicycle have a stranglehold over the small scale ancillaries, which places them at a great advantage in any bargain involving these two types of players. Process of manufacture 3.1 A bicycle consists of more than 500 different components and parts. Its manufacturing process involves several subassemblies like frame, fork, handle, pedal, mudguard, brake set, chain wheel and crank set, saddle, rims, hubs etc.. The standard procedure is to assemble the main components on the workshop floor and send them in batches to the main assembly shed. All the major manufacturers dispatch the cycles in knocked down kits which are assembled at the retail outlets. This form of dispatch is necessitated by considerations the transport cost. Some of the major sub-assembling processes in the manufacture of a cycle can be described as follows : Frame and fork - Steel tubes are usually procured from the market already cut to the required sizes. Sheet metal components for fork sub assemblies are produced in the unit or purchased from the market. The tubes are aligned with the components and fabricated in the tubular department through various operations, brazed up and machined to the requirement. Afterwards these two subassemblies are bonded together. The bonded subassemblies are painted and finished and sent into shed for final assembly of the cycle.

Handle assembly - Handle is assembled in the processing shop, brazed up, bent and machined as per design specifications. Then they are polished and nickel chrome plated. Handle along with its small components are assembled and wrapped in the assembly shop. Brake assembly - Brake components, purchased as well as processed in the press shop, are barreled, polished and plated as per requirements. These are then finally assembled and wrapped for dispatch. Pedal assembly - Sheet metal components of the pedal are produced in the press shop, these are barreled and plated. All the components are assembled along with few components bought from the market and then finally packed. Chain wheel and crank - Chain wheels are produced from cold rolled strip through various press tools in the press shop and then polished and plated. Bought out crank forging are machined through various stages and then polished and plated. Both are assembled, wrapped and packed finally. Main machinery required 4.1 The machinery installed in any cycle manufacturing unit depends on its dependence on ancillaries for different components and the degree of automation in the manufacturing process. But a typical unit would have the following main machines

Power presses. MIG welding sets

Gas brazing sets Painting shop Rim rolling mill Mudguard rolling mills Dip brazingfurnaces Debrassing plant Electroplating plant Jigs and fixtures and special tools. Some of the manufacturers have installed robotics processors / automatic processors for different subassemblies, particularly frame and fork sub- assembly.

Cost analysis of different components of a bicycle 5.1 It is difficult to provide a generalised cost analysis of the components of a bicycle because of the large number of models available in the market. These models differ in size, colour, weight of the components and are manufactured to cater to different market segments of the bicycle market. Each large cycle manufacturer makes at least 20 different models. But more than 70% of the demand is for the standard roadster model of the bicycle. Thus, the cost analysis of a standard roadster model can be of great assistance to an AO. The attempt at providing the cost analysis of the different components is only an approximation and it applies to the standard roadster model of the bicycle. This Cost analysis should be considered indicative and cannot be applied ipso facto to any particular company. In other words, it is an average and indicative analysis of the cost of different components for general guidance of the AOs to cross-verify whether a

manufacturer is booking excessive cost with respect to specific components. This analysis would be useful in cases where the bicycle manufacturer purchases some components from concerns in which its directors/partners have substantial interest. Cost analysis of roadster model of bicycle S.N. Item Raw material (Rs.) 103.5 43 31 240 Process Cost (Rs. ) 29.5 9 5.5 2.5 2.5 1 5 Total Cost (Rs.) (Rs. ) 133 52 36.5 240 14.25 19 24 16.5 9.5 88 25 85 32 20

1 2 3 4 5 6 7 8 9 10 11 12 13 14

Frame Fork Handle Wheel assembly Hub front 11.75 Hub rear 16.5 Mudguard 23 B.B. part 16.5 Head part 9.5 Gear 88 assembly Brake 25 assembly Saddle 85 Paddle & 32 Reflector Paint 15

15 16 17

18

Plating Packing Boiler running cost Overheads TOTAL

40 27 -

3 5 -

43 32 12.25

470 1,363

Standard input-output norms for different parts of a bicycle 6.1 Exact input-output norms for different parts of a cycle are not available. The exercise involved is complex in view of the large number of models of cycles available in the market. But from an investigators point of view, the inputoutput norms provide a useful tool to verify the raw material cost debited by the manufacturing units in the books of accounts. Ministry of Commerce, Government of India, periodically conducts input-output surveys of different parts of a cycle. Information so generated is used for various duty exemptions available to the cycle industry. These norms also take into account the likely wastage in manufacturing different parts of a cycle. The following data collected from the Handbook of Procedures, a publication of the Ministry of Commerce, provides a broad outline for any investigation to be conducted to cross verify the utilization of raw material for manufacturing different components of a cycle. It is reiterated that the figures given below are the average standard input-output norms for different components and cannot be directly applied to any particular cycle or cycle-parts manufacturer. But if in a

particular case, it is found that the raw material used for a particular component is much more than given in these norms or is shown of a quality and nature different than that given in these norms, then the AO must check the purchases of the raw material and its utilization to manufacture different components of a cycle. Name of the component Type of raw material and quantity required Quantity Weight BB axle (wt. 1 piece 235 gms) BB cup (set of 1 Set 2) (Wt. 82 gms) Side (Weight gms) stand 1 piece 231 MS/ Non-alloy steel 282 round / rods gms HR Sheets / Coils 169 (Seconds / gms defective) 1) HR Sheets / Coils 305 (Seconds / gms defective) 266 2) MS Rounds / Rod gms 1) HR Sheets / Coils 771 (Seconds / gms defective) 65 gms 2) MS Rounds / Rod 18 gms 3a) Carbon Black 42 gms 3b) Synthetic Butyl Rubber

Brake set (wt. 1 set 539 gms for item 1, 9 gms for item 2, 70 gms for item 3

Brake Shoes 1 pair (Set of 2) (Wt. 22 gms for item 1, 4 gms for item 2, 35 gms for item 3)

1) HR Sheets / Coils 31 gms (Seconds / 4 gms defective) 2) MS Rods Rounds / 36 gms

3) Carbon Black /Natural/ Synthetic Rubber Chain Stay 1 piece (Weight 350 gms ) Chain (110 1 piece links) (Weight 334 gms for item 1, 81 gms for item 2) HR Sheets / Coils 382 (Seconds / gms defective) 1) HR Sheets / Coils 444 (Seconds / gms defective) 95 gms 2) MS / Non Alloy Steel Rounds / Rod HR Sheets / Coils 686 (Seconds / gms defective) HR Sheets / Coils 1263 (Seconds / gms defective) HR Sheets / Coils 47 gms (Seconds /

Chain wheel 1 piece (Weight 352 gms) Fork (Weight 1 piece 1061 gms) Frame Cup set 1 set of 2 (wt. 39

gms) Frame Lug set 1 set of 3 (wt. 212 gms) Frame wheel 1 piece (wt. 108 gm for item 1, 99 gm for item 2)

defective) HR Sheets / Coils 262 (Seconds / gms defective) 1) HR Sheets / Coils 259 (Seconds / gms defective) 160 2) MS / Non-Alloy gms Steel Rounds / Rod MS Sheet / Coil / 1.10 kg strip including seconds / defectives but excluding coated 1) HR Sheets / Coils 1108 (Seconds / gms 5 defective) 2) MS gms Round / Rod

Front / Back 1 piece Mudguard

Full Chain 1 piece Cover (wt. 924 gms for item 1, 4 gms for item 2) Half Chain 1 piece Cover (wt. 501 gms for item 1, 4 gms for item 2) Handle Bar (wt. 1 set 869 gms for

1) HR Sheets / Coils 641 (Seconds/defective) gms 2) MS Round / Rod 5 gms

1) HR Sheets / Coils 1156 (Seconds/defective)

item 1, 594 gms for item 2, 40 gms for item 3)

2) MS Round / Rod gms 3) Polystyrene PVC / 642 gms 42 gms

Hub (Rear) (wt. 1 piece 229 gms for item 1, 126 gms for item 2)

1) HR Sheets / Coils 297 (Seconds / gms defective) 2) MS / Non-Alloy Steel 293 gms Rounds / Rod 1) HR Sheets / Coils 1026 (Seconds / gms defective) 2) MS / Non-Alloy Steel 258 gms Rounds / Rod Non alloy steel bar / 350 Round for Axle gms MS / Non-Alloy Steel 102 Rounds / Rod gms MS / Non-Alloy Steel 151 Rounds / Rod gms HR Sheets / Coils 2568 (Seconds / gms defective)

Mudguard (wt. 1 pair 933 gms for item 1, 246 gms for item 2)

Paddle Polypropylene

1 pair

(wt. 450 gms) Hub front axle 1 piece (wt. 85 gms ) Hub rear axle 1 piece (wt. 126 gms) Rim (wt. 2233 1 pair gms )

Spokes set of 1 set 72 pieces (wt. 31 gms for item 1, 611 gms for item 2, 105 gms for item 3

1) HR Sheets / Coils 43 gms (Seconds / 672 defective) gms 2) MS / Non-Alloy Steel Rounds / Rod 113 gms 3) Brass

Other points for investigation 7.1 Cycle components require a high degree of standardization and the norms of variation from any given standard are provided in any contract entered into by a cycle manufacturer with the ancillary units. Normally, an ancillary contract is accompanied by detailed drawings of the component to be manufacturer specifying the weight of the component, and the degree of variation permitted in weight or machining of that component. This primary record is of vital importance to investigate the raw material requirement for manufacturing the components or parts by the ancillary units. If the AO finds that the raw material debited by the ancillary units is of different quality than that given in the contract or the quantity debited by the ancillary unit is much more than warranted by the detailed drawing of the component and the standard input-output norms of the component, then this information can be a good starting point for detailed inquiry to determine excess raw material cost debited or to establish that the ancillary unit is showing less production and Sales in the books of accounts as compared to actual production.

7.2 The AO must keep up-to-date with the new techniques of production becoming available in this industry. With increase in competition manufacturers are striving to reduce wastage of raw material and to recycle the waste generated. What was once considered waste material and sold as scrap, is finding new buyers and users. For instance, in the manufacturing of chain wheel, the HR sheet or coil cut by press to make holes in it, was being sold as scrap and waste. But lately, this scrap is being used to manufacture metallic washers for the automobile industry. Similarly, the bonding of lugs and tubes used in the frame sub-assembly of the bicycle was traditionally done by using brass. But with improvement in technology, brass is no longer required for bonding and consequently the raw material cost of frame sub-assembly has come down. 7.3 The AO must look into the nature of plant and machinery and the likely decline in labour and production cost as a consequence of addition to new machinery. In most of the units, for instance, frame assembly is a labour intensive process. It involves the heating of the frame and tubes and lugs in furnace. A frame assembly team in this method of production consists of six to eight labourers. With the installation of robotic assembly of frames, the same task is performed by one trained person. Thus with the introduction of one such robotic frame assembly unit, the labour requirement and cost for assembling the frame declines to say one-sixth to one-eighth of the original cost. Same is the case with the fixing of spokes in the wheel rim. The labour working on mechanised wheel spoke

fitting apparatus are three to four times more efficient than the traditional manual wheel spoke fitters. Therefore, the importance of linking the installation of new machinery with decline in some of the production cost is an aspect which must be looked into by the AO. 7.4 Another point which needs to be noted is that there are no exclusive or captive ancillary units in this industry. Typically the ancillary units provide components and parts to two to three manufacturers. There is a large informal market for replacement of components and parts. Thus, these ancillary units have access to an extensive network of repair shops and a ready market exists for the components manufactured by them. This segment is largely in informal and unstructured sector and is the likely channel through which unrecorded production of components manufactured by these ancillaries are sold. 7.5 The AO assessing the cases of the directors or partners of large cycle manufacturers must remember that these persons exercise great control over the small ancillaries which supply components to these concerns. The profitability, and in most of the cases the very existence of these ancillary units, depends on the orders received from the big units. Given the unequal power of the two players in this arrangement, the issue of pay-offs to these individuals at the time of granting ancillary contract has to be kept in mind. Evidence of this nature must be looked for during any survey or search in these cases.

7.6 A recent trend in this industry is to import readymade cycles from China and other South East Asian countries, and to sell these under local brand names after stamping of local trade marks. Such an activity will normally not qualify for reliefs u/s 80I and 80HHA of the Act.

Directorate of Income Tax ( Systems )

Investigation Manual Volume - 2 Chapter - XI POWER & ENERGY Background 1.1 The supply of electricity to consumers for lighting commenced in India in 1880 with the commissioning of a small 130 KW Hydroelectric plant at Darjeeling in West Bengal. The legal provisions to regulate the energy sector was first brought in through The Indian Electricity Act, 1910. Subsequently the The Electricity (Supply) Act, 1948, provided for establishment of Electricity Boards in the States. The Indian Electricity Rules were first framed in

1937 and were revised by the Indian Electricity Rules, 1956. 1.2 The electricity generation over the years has achieved a compound annual growth of about 7.5 percent. At the time of independence the generating capacity was 1,362 MW, which currently stands at approximately 88,000 MW. 1.3 Power occupies a very important position in the field of infrastructure development of a country. The power sector is expected to grow at around 9 percent annually. Huge investment would be necessary to achieve this growth. Government has given necessary thrust by not only encouraging Indian promoters to set-up independent power generation capacity, but, also captive capacities, besides, encouraging investments from overseas. 1.4 Considering the importance of Power sector, the Constitution has placed it in concurrent list. While the Central Government is responsible for formulating the national power policy, the actual development and regulation work is the responsibility of the State and Central Governments both. The globalisation of Indian economy is putting additional pressure on the country to provide efficient infrastructure, which includes availability of quality power to business in a cost-effective and competitive manner. Ownership Profile 2.1 The pattern of ownership of the countrys installed capacity of power generation, as on March 31, 1998, was as follows -

Ownership

Mega watts 28646 54406 4717 Power 1120 88889

(%)

Central Sector State Sector Private Sector Independent Producers Total

32.0 61.0 5.0 2.0 100.0

Regulation of power sector 3.1 The power sector is highly regulated and controlled. The Ministry of Power and Non-Conventional Energy Sources along with the Department of Atomic Energy and the Atomic Energy Council are at the top of the industry structure. The State Electricity Boards and Electricity Departments are statutory bodies appointed by the State Governments. The proposed Central and State Electricity Regulatory Commissions would look into the tariff related matters at the inter-State and State levels respectively.

Ministry of Power (MoP) - The Ministry of Power and Non-Conventional Energy Sources comprises the Department of Power (DoP) and the Department of Non-conventional Energy Sources. Development of nuclear power is the responsibility of the Department of Atomic Energy and does not fall under the MoP.

Department of Power - The DoP is responsible for the development and regulation of the power sector. It coordinates and lays down policies for speedy development of power infrastructure. It also gives guidance to the States for bringing about policy changes and setting regulatory mechanism so that private sector and foreign investment is attracted. The efforts of the DoP have resulted in some of the States establishing State level Regulatory Commissions. Central Electricity Authority - The CEA is a statutory body constituted under the Electricity (Supply) Act, 1948. Its main task is to develop a national power policy for overall development of the sector. Its other functions include advisory assistance to the DoP and the State Electricity Boards (SEBs) on technical and economic matters, evaluation of the financial performance of SEBs, acting as an arbitrator between SEBI and other entities, and development, planning and sanctioning of power projects. Central Electricity Regulatory Commission (CERC) - The Electricity Regulatory Commission (ERC) Act provided for the creation of the CERC, which was set up in August 1998. The main functions of the CERC are to o Regulate the tariffs of generating companies owned or controlled by the Central Government

Regulate inter-State transmission and tariff of utilities. Aid and advise the Centre in the formation of a tariff policy.

State Electricity Boards (SEBs) - SEBs are State-level authorities responsible for generation, transmission and distribution of power to end users within the respective States. They also buy power generated by Central Sector and Independent Power Producers (IPPs). They account for 95% of the power sold in the country. The Plant Load Factor of the SEBs varies widely from State to State. On an average it is 60% as against over 71% for Central Sector power stations. Some IPPs operate at over 90% Plant Load Factor. Power Grid Corporation of India Limited (PGCIL) - The role of PGCIL is to establish and operate the regional and national grids so as to facilitate transfer of large blocks of power from surplus to deficit areas. It is also responsible for construction of high voltage and extra high voltage transmission lines, sub-stations and load dispatch centres. Regional Electricity Boards (REBs) - The REBs co-ordinate regional activities and are responsible for inter-State power exchanges, generation schedules, overhaul and maintenance programmes and concomitant tariffs.

Power Finance Corporation Limited (PFC) PFC is a public sector undertaking under the Department of Power entrusted with the task of providing term finance for power projects, transmission, distribution, system improvement and development programmes. It mainly provides financial assistance to SEBs for implementing projects. Rural Electrification Corporation (REC) REC provides financial assistance for rural electrification programmes and assists the SEBs in undertaking system improvement projects. Central Sector Organizations The Government owns and controls the Central Sector Organizations involved in bulk generation. These account for 32% of the countrys installed capacity. Transmission of power generated by these organizations is carried out through the grids of PGCIL. The power is sold to SEBs, which distribute it to the end users. These organizations also sell power directly to certain high-tension consumers like the Railways. The main Central Sector Organizations are National Thermal Power Corporation Limited (NTPC) having a capacity of 16,795 MW, National Hydroelectric Power Corporation Limited (NHPC) having capacity of 2,115 MW and Nuclear Power Corporation of India Limited (NPCIL) having a capacity of 2,025 MW. In addition, Neyveli Lignite Corporation Limited (NLC) having a capacity of

2,070 MW, North Eastern Electric Power Corporation Limited (NEEPCO) having a capacity of 595 MW, Damodar Valley Corporation (DVC) having a capacity 2,142 MW and Bhakra Beas Management Board (BBMB) having a capacity of 2,704 MW were formed to exploit certain regionspecific potentials. 3.2 Licencees - Licensees are players who may purchase and distribute; or generate, purchase and distribute electricity. The licensed area for each licensee is defined. Presently there are about 57 distribution licenses, which include distribution licenses given to Municipal Corporations. However, in the private sector there are only four major Companies i.e. TECI, AEC, SEC and CESC. While SEC is only a distribution licensee, others undertake generation, transmission and distribution of electricity. There is also number of private generating Companies. A licensee can also supply electricity to a SEB in which case the generating station becomes a SEB controlled station. The Central Government, have now provided for licenses for a period of 30 years in the first instance and renewal for 20 years instead of the earlier 20 and 10 years, for encouraging power generation and distribution by licensees. Rate of return has also been increased to 5% above the RBI rate in place of the previous 2% above RBI rate. Further, notifications have been issued in May, 1999 permitting partial delinking of the return based on RBI rate, and permitting capitalization of interest during construction (IDC) at actual cost (for expansion project also) as against

1% above the RBI rate before. Special appropriation from profits for debt redemption is also provided. 3.3 Licencees obligations - The Indian Electricity Rules, 1956 provide the guidelines on various issues which a licensee has to observe with regard to its license, e.g. laying down of lines, general safety requirements of various apparatus at consumers premises, Rules regarding inspection and testing of consumers installations, supply and use of energy, installation of measuring instrument i.e. meters, its ceiling replacement, etc.., and Rules regarding reference to electrical inspector for any dispute relating to the above. Relevant laws 4.1 The following Acts regulate the power sector

The Indian Electricity Act, 1910 The Electricity (Supply) Act, 1948 The Indian Electricity Rules, 1956 The Atomic Energy Act, 1962 The Central Electricity Regulation Act, 1998 The State Electricity Regulation Act Environment Protection Act and Rules, 1986 Factories Act, 1946 Air (Prevention and Control of Pollution) Act, 1981 and Rules made there under Hazardous Waste (Management and Handling) Rules, 1989 The Electricity Regulatory Commissions Act, 1998

Key suppliers of power plant equipments 5.1 Bharat Heavy Electricals Limited (BHEL), a Public Sector Undertaking, is one of the largest suppliers of power plants. It also undertakes turnkey contracts for erection of power plants. Since import of power plant equipments was not permitted till recently, 65% of the present generating capacity has equipments supplied by BHEL. BHEL also manufactures Meters, Switchgears, Control Panels, etc.. They have also started manufacture of coal handling plants for thermal units. BHEL has foreign collaborations with multinational power plant manufacturing companies viz. Siemens, GE, etc.. 5.2 With the liberalisation of India economy, Indian Power industries can now import equipments from foreign suppliers. Therefore, several foreign equipment manufacturers have opened offices in the country and some of them have also started manufacturing activities. Prominent among them is ABB, which has taken over the manufacturing facilities of ACC Babcock at Durgapur in West Bengal, and is now known as ABB-ABL. The other company is Thermax of Pune, which manufactures boilers of upto 60 MW capacities. Foster Wheeler has also set up office in Chennai and they quote for supply of boilers manufactured overseas. The other overseas suppliers are Raytheon, and Siemens India, which also has some manufacturing facilities in India for Switchgears, and Transmission and Distribution panels. 5.3 The major companies in manufacture of coal plant equipments are as under -

Elecon Engineering Limited Indian Conveyor LimitedIndure Limited DCIPL Limited United Conveyor Corporation Mahindra and Mahindra Limited BSBK Company Limited

5.4 The major companies engaged in construction of Cooling Towers are as under

Paharpur Limited Gammon India Limited Shree Ram Cooling Tower Limited GEA Cooling Tower Limited

5.5 The major manufacturers of transformers are

ABB Atlanta Electricals Limited Bharat Bijlee Limited BHEL Crompton Greaves Limited NGEF Limited Patson Transformers Limited Voltamp Transformers Limited

5.6 The major cable manufacturers are

Fort Gloster India Limited Industrial Cables India Limited Cable Corporation of India Limited Torrent Cables Limited Universal Cables Limited

Unique Cables Limited R.S. Electricals

5.7 The major manufacturers of Meters are

Baroda Electric Meters Limited VXL Landies and Gyr. Limited Secure Meters Limited Jaipur Metals and Electricals Limited BHEL, Bangalore

Opening-up of power generation to private sector 6.1 Power sector is the first sector in the infrastructure development of the country to be thrown open for private sector investment. In particular the setting-up of new generating capacity was made easier for private enterprise. The requirement of obtaining clearances has been streamlined and currently following clearances are required Type of Clearance Clearing Authority required Statutory Clearances Cost estimates Central Electricity Authority Techno-economic Central Electricity Authority clearances Publication of scheme State Governments Water availability State Governments, CWC SEB clearance SEBs, State Governments Air and Water pollution State/ Central Pollution

clearances Control Board Environment & forest State Governments. Ministry clearance of Environment and Forests Civil Aviation clearance National Airport Authority for chimney height Company registration Registrar of Companies Rehabilitation and State Governments, Ministry resettlement of families of Environment and forests displaced by Land acquisition Hydroelectric projects Ministry of water resources Equipment procurement DGTD, CCI & E Non-statutory Clearances Land availability State Governments Fuel linkage Department of coal, Department of Petroleum and Natural Gas Financing CEA, Department of Power, Department of Economic Affairs, Financial Institutions Transportation of fuel Department of Coal, Ministry of Petroleum and Natural Gas, Ministry of Railways, Shipping and Surface Transport Independent Power Producers (IPPs)

7.1 These are private power generating companies selling power, mainly to SEBs under long-term power purchase agreements. To give a push to this Sector, Government thought of giving a guarantee for payment of their dues. The eight fast track power project conceived in 1992-93 were as under

Dabhol Power project Phase I = 740 MW (Naphtha), Phase II = 1444 MW (LNG) Mangalore Thermal Power project = 1,000 MW (Imported coal) Vishakapatnam Thermal Power project = 2 x 520 MW (Coal) IBB Valley Thermal Power project = 500 MW (Coal) Jegru Padu Thermal Power project = 235 MW (Gas) Zero Unit Thermal Power project = 250 MW (Lignite) Kakinada Thermal Power project (A.P.) = 208 MW (Gas / Naphtha)

Bhadrawati Power project = 2 x 541 MW (Coal) The Dabhol Power Project, Jegru Padu Thermal Power Project and Kakinada Thermal Power Project (Andhra Pradesh) have reached the commissioning stage. The others are in various stages of getting clearances/ achieving financial closure. The main hurdle in reaching

financial closure is the Government guarantee, because in cases of long delays, fresh approvals from Central Electricity Authority and Ministry of Power for capital cost become necessary. 7.2 The Government of India has relaxed following conditions to encourage private sector in the field of power generation and distribution

Promoters contribution is reduced to 11% of total outlay Promoters can have a debt equity ratio of 4: 1 Foreign private investor is permitted 100% foreign equity participation for project set up The condition of balancing dividends by export earnings, normally applied for foreign investors, is not applied to investment in power sector Rate of depreciation has been liberalized Import of equipment is permitted where foreign suppliers extend concessional credit Customs Duty for import of power equipment is reduced to 20% A five year tax holiday and a deduction of 30% of profit for further five years is allowed to Companies engaged in generation or generation and distribution of power, commencing generation of power on or before 31.3.2003. This benefit can be availed of in any ten consecutive

years out of first fifteen years from the year in which such unit commences generation. A company can avail this benefit by setting up a new plant before 31.03.2003. Similar benefit is extended to an undertaking setting up new transmission lines between 01.04.1999 to 31.03.2003. (SECTION 80IA)

Return of upto 16% on foreign equity in foreign currency can be included in the tariff Fixed cost can be recovered at 68.5% P.L.F. in case of thermal plant and 90% for hydel plants Incentives prescribed for performance beyond the above-specified norms.

IPPs, which do not have the Central guarantee face the difficulty in obtaining Escrow facility and guarantee from the financial institutions for the repayment of Foreign currency loan and other overseas borrowing. Escrow facility is generally used in the Foreign Exchange Department of banks dealing in various currencies and maintaining accounts of other banks. The word Escrow means Our account with you. Another similar word is Vostro account, which is again a French word meaning Your account with us. In the Banking industry, in Foreign Exchange transactions, Bankers make payments on behalf of the other Banker for the customer of the other Banker through debit/credit in the above accounts so as to recover / pay the amount due to each other. With liberalisation and opening up of Power Sector for private

entrepreneurs the concept has been brought in the power industry also. An independent power generating company has to pay the cost of fuel and other operation charges upfront, and therefore, it needs an assurance from the distribution company to which power is provided, that the payment is received within a reasonable time of the raising of the bill. In view of the peculiar situation in the country where Power distribution work is with the SEBs, which have also to give subsidised power to agriculture and other sectors, the private sector generating companies would not invest their money unless revenue stream is assured. With this in mind, they insist on an Escrow account facility. A good industrial client or a group of residential consumers who are likely to pay their bills as soon as they are raised, are requested to deposit the amount of the bill in a designated bank account, termed as Escrow account on which the distribution entity does not have any lien. The sum has to be utilised for payment to be made to the generating company by the said bank. If there is surplus after the bills of the generating company are settled, the distribution company can obtain a confirmation from the generating company addressed to the banker, to release the funds to the distribution entity. 7.3 Operational norms for generating companies to qualify for 16% return on equity - In case of thermal plants, the capital expenditure of the project is as per the financial package set out in the techno-economic clearance of the Authority. This includes capitalized value of initial spares. However, the criterion for fixing the tariff is

the actual capital expenditure incurred on the project. Where the actual cost exceeds the approved cost, the excess approved by the Authority is included in the capital expenditure for the fixation of tariffs. However, if the PPA between the SEB and the IPP provides a ceiling on capital expenditure, the capital cost is limited to the ceiling. Plant Load Factor - During stabilization period 4500 hours per KW per year; subsequently 6000 hours per KW per year Station heat rate for Coal-based plants - During stabilization period 2600 kcal per kWh. Subsequently 2500 kcal per kWh. (For 500 Mw plants where boiler feed pumps are electrically operated, the heat rate of 40 kcal per kWh is to be reduced from the station heat rate) Station heat rate for Gas-based stations - For open cycle: 2900 k Cal per kWh; subsequently f2000 k Cal per kWh Secondary fuel oil consumption for Coal-based Plants - During stabilization period 5 mm per kWh; subsequently 3.5 ml per kWh State Electricity Boards (SEBs) 8.1State Electricity Boards are statutory authorities, whose management is vested in a committee of three to seven members appointed by the State Government. The SEBs together own and operate 61% of the total installed capacity in the country, 67% of their capacity is thermalbased, while rest is hydro-based. SEBs control 95% of the

distribution of power in the country for which they purchase power from central sector utilities, other SEBs, Private utilities and from IPPs. The average PLF of thermal plants of SEBs for 1997-98 was 61% compared to 75% of NTPC and over 90% of the IPPs. 8.2 The low capacity utilization and higher T & D losses of SEBs upset their financial position, which is further aggravated due to low HT and LT ratio, limited transformer capacity and a large subsidized sector of agriculture and domestic consumers. Under the Indian Electricity Act, the SEBs are required to earn minimum 3% on the capital invested. However, they do not earn the same and are supported by subsidies from State. Recent reforms of setting-up of an independent Central Electricity Regulatory Commission and the direction of the Power Ministry to set up State level regulatory commissions, are meant to force the Boards to charge economic tariffs and to improve the operating parameters to reduce the man: megawatt ratios. State Electricity Regulatory Commission (SERC) 9.1 The recent ERC Act has empowered the State Governments to set up SERCs to look into tariff-related matters of the State. The SERCs would determine wholesale, bulk, grid and retail tariffs and tariffs payable for uses of transmission facilities for the state. They would also regulate power purchase and procurement of transmission utilities. Power pooling arrangements and regional grids

10.1 Efficiently functioning `power pools are operating in several advanced countries. In a power pool arrangement, all energy is centrally dispatched as if all available generating resources belonged to the dispatching entity. The dispatching is normally done on a `merit order, within generation and transmission constraints, to minimize the variable operating costs. In this situation, the scheduling and dispatching is on a minute-to-minute basis. The members of the pool do not know in advance, the prices that they will pay for the minute-to-minute transactions. Status of grids in India 11.1 Indias Transmission and Distribution (T & D) network is grouped into five regional systems as under Northern Region - Haryana, Punjab, Rajasthan, Uttar Pradesh Western Pradesh Region Gujarat, Maharashtra, Madhya

Southern Region - Andhra Pradesh, Tamil Nadu, Karnataka Eastern Region - Bihar, Orissa, West Bengal Northeastern Region - Assam The Regional Electricity Boards co-ordinate inter-State power exchanges, generation schedules, overhaul and maintenance programmes and concomitant tariffs.Power Grid Corporation of India Limited (PGCIL) is the only High Voltage Transmission Company in the country.

POWERGRID has been declared as a Central Transmission Utility (CTU) under the Electricity Laws (Amendment) Act, 1998. With this, it will now be able to identify the transmission projects to be established at national / regional level by private parties. In discharge of this responsibility, POWERGRID is planning to facilitate private participation both through independent Power Transmission Company (PTC) and joint venture routes. Private investors can now enter as Transmission Licensees under the regulatory umbrella of CERC/ SERCs. Methods and process of power generation 12.1 Following different methods can be used for power generation depending upon the fuel/source

Thermal - Coal/ Lignite or Gas Liquid Fuel Naphtha, LHSH, Oil, Diesel, etc.. Nuclear power/ Atomic energy Hydro electric power station Natural i.e. Windmill, Biogas, Solar energy, Ocean waves energy, etc.. Non-conventional source of energy

Process of generation 12.2.1 Thermal energy using coal / lignite as fuel - The process involves generation of electricity using water and fossil fuel as raw materials. The coal / lignite is burnt in a

pulverized fuel-fired boiler, where it generates steam at high pressure and temperature. This steam is then fed through the turbine where, by virtue of the adiabatic expansion of steam, work is done on the turbine rotor causing it to rotate. The turbine in turn is coupled to an electric generator rotor, which by rotating against an electromagnetic field induces electrical power. 12.2.2 Thermal energy using gas on combined cycle mode - The combined cycle gas-based power plants comprise of two gas turbine generators, two Heat recovery steam generators (HRSG) and one steam turbine generator. The gas turbine units have combustors. The combustion of air-fuel mixture takes place in the combustor and the hot combustion gas is expanded in the turbine, which drives on one end the generator and on the other end the axial compressor. The axial compressor provides the combustion air. The inlet air system draws atmospheric air into the compressor unit and the exhaust system allows exhaust gases to go out through a heat recovery steam generator. The heat recovery steam generator is of double pressure, unfired boiler with selfsupporting stack of 30 Meter height. The heat transfer section is positioned in the HRSG to absorb the maximum heat energy of the exhaust gas. Steam from HRSG is supplied to a condenser type steam turbine through main steam piping. By virtue of adiabatic expansion of steam, work is done on the turbine rotor causing it to rotate. The turbine in turn is coupled to an electric generator motor, which by rotating against an Electromagnetic field induces electrical power.

12.2.3 Generation process using liquid fuel - The process of generation of power with the help of liquid fuel is simpler as compared to other fuels. The air compressor takes air from atmosphere for combustion of gas in the gas turbine. Gas and the liquid fuel are supplied to the combustion chamber through gas skid. In the combustion process gas expands and rotates the turbines. The exhaust gas from the turbine is either released in the atmosphere (open cycle) or passed through the heat recovery steam generator to generate steam, which is used to run the steam turbines and generate further power (combined cycle mode). 12.2.4 Nuclear power generation process - The process involves generation of electricity using Uranium and other radioactive ore as fuel. In a nuclear reactor Uranium/ radioactive ore is charged through chain reaction of neutron particles. The heat energy available through nuclear process is used to generate steam at high pressure and temperature. This steam is then fed through the turbine, where by virtue of the adiabatic expansion of steam, work is done on the turbine rotor causing it to rotate. The turbine in turn is coupled to an electric generator rotor, which by rotating against an electromagnetic field induces electrical power. 12.2.5 Hydroelectric power generation - The source of energy for hydropower station is potential energy of the waterfall. The water is stored by construction of dam at a suitable point. Water stored in big reservoir at a high altitude is slowly released. Due to gravitation force, highlevel water generates high speed and pressure, which

ultimately rotates the turbine rotor. The turbine in turn is coupled to an electric generator rotor, which by rotating against an electromagnetic field induces electrical power. The electrical power so generated is then stepped up by means of a transformer to a higher voltage and connected to the switchyard bus bars. Transmission lines emanating from the switchyard carry the power to various load centers where it is suitably stepped down and is distributed to various categories of consumers at voltages of 11 KV, 415 V or 230 V. 12.3 The thermal, nuclear and hydro are the three conventional source of power supply in India contributing 72%, 22% and 3% of the total power production respectively. The bulk of addition to the generating capacity is planned in thermal sector. In the coming years, with the decline in the availability of fossil fuel including liquid fuel, reliance on nuclear and non- conventional energy sources will have to be increased. However, in the medium term the addition to generation capacity would be through thermal plants. 12.4 Non-conventional sources of energy - The Nonconventional sources of energy comprises of energy generated through

Solar energy i.e. energy through sunlight Biogas energy i.e. energy generated through the use of waste biogas.

Wind energy i.e. harnessing the force of wind near the seacoast or hilly areas through the use of windmills.

Government of India has established Indian Renewable Energy Development Agency Limited, to promote the use of non-conventional energy sources. India is endowed with an abundance of renewable energy resources. These include biomass, sun, wind, ocean waters, urban and industrial wastes, hill hydro and canal heads suitable for small and mini hydel sets etc.. Various programs have been launched by the Government to exploit the potential of the alternate energy sources. At present only 1.5% of the total power generation in the country is through the renewable sources. The target is to raise the level to at least 10% by 2012. 12.5 Auxiliary consumption - A power station while generating power also uses some power. This is known as auxiliary consumption. The auxiliary consumption varies from plant to plant, based on the size of the generating unit and the fuel used. The higher the plant capacity (generating unit) the lower would be percentage of auxiliary consumption. Combined cycle gas-based plants are more efficient than thermal plants, which use coal. The gas-based plants have an auxiliary consumption of 2 to 3% compared to 7-10% for thermal plants using coal as fuel. The auxiliary consumption also varies from season to season - it is higher in winter and monsoon and lower in summer. Fuel

12.6.1 Coal - Solid fossil fuels i.e. coal, lignite, etc. are under the monopoly of Government of India. Their transportation via Railways is also under the Central Government. Therefore, the Government has set-up a Coordination committee with officials from the Coal Ministry, the Railways and representative from various SEBs, Collieries, and the Power generating units. These processes are also being liberalized. Upto now there has been a Coal linkage committee which decided on the transportation of coal / lignite to various power plants, based on their past consumption, expected consumption and the conditions for transport of fuel viz. season, etc.. However, this is being gradually replaced by the Fuel supply agreements entered between the concerned colliery/ lignite mining company, and the new power plant. These plants are required to sign a Fuel supply agreement with the collieries, a transport agreement with the Railways, etc.. Similarly agreements for supply of fuel are to be entered into by power generating Companies using petroleum fuels i.e. oil, gas, diesel, LHSH, Naphtha, etc.. A transport agreement with Railways for transportation of this fuel is also entered. The amount of coal required to generate one unit of electricity varies depending on the process employed, the size of the generating station, and the quality of coal i.e. its heat value, ash content, etc.. Normally, a unit of electricity generation requires 500 to 750 Gms of Indian coal of about 25% ash content. Coal with higher carbon content and less ash would generate one unit of electricity even in less than 500 Gms. However, boiler has to be

designed keeping specification of the quality of fossil fuel to be used. 12.6.2 Gas - Natural gas is another fuel used in power generation. Gas-based power stations are set up at places where gas is available. Gas Authority of India Limited and Oil and Natural Gas Corporation are the two agencies, which supply gas to the utilities for power generation. The utilities are required to obtain approval from Ministry of Petroleum as also Ministry of Power for usage of gas. Gas is the cleanest fuel for power generation. However, its allocation and continuous supply with the rated pressure is a problem at some of the utilities and therefore they have to ensure that their power plants are also capable of using liquid fuel. 12.6.3 Liquefied natural gas (LNG) - This is also one of the clean and cheaper fuel for power generation. Government of India is therefore planning to import LNG, and encouraging setting up of large power stations based on LNG fuel in coastal areas. The import of LNG requires special facilities to be created at the Ports. It is only economical to import this fuel in a particular size and create facilities for its conversion to gas. Therefore, capacities based on this are generally planned in coastal area. 12.6.4 Liquid fuels - The liquid fuels used in power generation are diesel, oil, LSHS, etc.. These fuels are costly and their prices vary according to the international movement of oil prices. The prices also change due to the fluctuation in the exchange rates.

12.6.5 Technologies for use of new fuels are in the process of being developed viz. technology for converting coal into gas and using it as fuel on combined cycle basis in gas turbines, which increases the efficiency of the fuel and gives higher output. However, these technologies are new and therefore costly. Cheaper fuel such as liquid coal is also being progressively experimented in the world, but these technologies have so far not been commercially operated. Transmission and Distribution losses 13.1 The power lost in the process of its transmission from the generating station to the end consumer is known as transmission and distribution (T&D) loss. While transmission loss occurs when the power is stepped up or stepped down with the use of transformers for movement upto the point of the distribution centre. The distribution loss occurs during the movement of power from the receiving station through the cables upto the consumer point. 13.2 The Transmission and Distribution system in India has been developed and linked to the generating facilities i.e. the load centre. As SEBs were the key in establishing large thermal power stations they also developed transmission network to distribute power to the consumer centre. The country had inadequate transmission, metering, communicating, and controlling facilities, which hampered the economic exchange of power between different regions. 13.3 The T&D losses can be divided into (i) technical losses caused by inadequate and overloaded state

grids, insufficient transformer capacity, and losses due to stepping up and down of the power transmission through the transformer; and (ii) normal losses in the transmission system. The T & D losses are dependent on various factors such as The distribution network system itself. The existence of capacitors in the system. The length and area (spread) of the distribution system. The type of equipments used. The voltage at which the power is transmitted higher the voltage, the lower the loss and vice-aversa. The type of consumers and the voltage at which the power is taken by the consumers e.g. if the power is given to an industrial consumer at a high voltage of 11 KV, 33KV, 66 KV, then the T&D loss would be minimum as the entire consumption would get recorded. In the event of distribution of power to many consumers at lower voltage there would be technical losses due to the use of step-down transformers. Technological factors also influence the T & D loss. Earlier there was 11 KV power distribution system. Later technological improvements made it possible to transmit power at 66 KV, and then at 132 KV. Now it is possible to transmit high voltage power at 400 KV. When the power is

transmitted at high voltage the transmission loss gets reduced. The transmission losses are also affected by the medium of transmission used i.e. aluminum cables, copper cables, etc.. because different metals have different inherent resistance to transmission of power. A typical city distribution system, with compact distribution areas, would have lower T & D losses as compared to a scattered state with long lines of transmission. Thus, demographic distribution of consumers and the size of power consumed by them also affects the T & D losses. The greatest cause of concern in the T & D losses is the commercial loss or what is generally known as theft of power. An average of 8 to 12% loss in the units sent in to the system and ultimately metered to the consumer is considered normal. Anything above 11% limit in a distribution system would indicate commercial loss or theft of power. 13.4 Thus, in each case the percentage of T & D loss could vary depending upon the distribution network, the number of transformers installed, and the voltage at which the power is transmitted. For example an old distribution system established 70/80 years back would have 3 KV distribution system and would be stretched by drawing further cables which would lead to higher T & D loss, compared to a new city, which could have high voltage distribution of 11 KV, 33 KV and 66 KV, etc.. Similarly a

commercial city or a city with a large residential consumer population would have higher T & D loss compared to a city which supplies bulk of its power to industrial consumers. Therefore this is a subjective matter and would need to be analyzed giving due weightage to various factors listed above. 13.5 Various companies use various methods to adjust the T & D losses. Some companies charge it to the customers account on a proportionate basis as per the formula given in the Electricity Act, to work out the price to be paid by the consumer. Other companies show it as a loss in the Profit and loss account. 13.6 The critical question is whether the claimed T & D losses are real or there is an element of doubt on their correctness. In view of the establishment of the Tariff regulatory commissions at the Central and State level, the scope for overstatement of Transmission loss is open to scrutiny by the Regulator (Commission) as it is one of the factor which is seen by the Regulator while approving the electricity tariffs in respect of various categories of consumers. The utility gets negative marking for higher T & D loss than could reasonably be explained as the Regulator will not allow inefficiency by way of higher T & D loss to be passed on to the consumers. Therefore, there is little incentive for a utility to inflate the T&D losses in the system. In case of doubt the authorities can call records of metering done at the generating point, and at the receiving point, which would give Transmission loss. The balance would be Distribution loss.

13.7 Wherever high T & D losses are claimed - it ought to be a gradual increase over the years because of various reasons of both- the quality of distribution system (such as quality of cables, addition of capacitors, quality of transformers etc.), or conditions peculiar to the distribution area (like consumers being spread /scattered over large area requiring greater cable length). If the consumers use gadgets of poor quality, then also the Company would loose revenue and this would be reflected in the form of a higher T & D loss. Terminology 14.1 Following terms are commonly used in this industry KW - Kilowatt = 1000 Watts. MW - Megawatt = 1000 KW or 106 Watts kWh - Kilowatt hour = Use of 1000 watts for one hour = 1 kWh MWh - Megawatt hour = Use of 1000 KWs for one hour = 1MWh Gwh - Gigawatt hour = 109 watt hour = 106 kWh = 1000 MWh M U - Million Units = 106 kWh Btu - British Thermal Unit K.Cal - Kilo Calorie

Average Demand = Energy in kWh used over a specific period divided by number of hours in that period. Demand Factor = Ratio of the maximum demand of a system to the load rating assigned to it M D = Maximum demand in KW. This is the maximum energy in kWh, used per any half an hour, over a specific period, generally a calendar month. LF= Load Factor Ratio of average demand / Maximum demand (M D) over any specific period = Energy in KWh in a specified time

M D in KW x No. of hours in the specified time Peak Load = The peak is the maximum load consumed or supplied during a specified period. Installed Capacity = Name Plate rating of the generating source. Derated Capacity = Actual capacity of a generating source as against its nameplate capacity. (Aging is the cause of derating) Captive Generation = A consumer having its own generating source for his use only Availability factor = The ratio of the number of hours in a period a generating source is available to the total number of hours in that period.

Plant Load Factor = This is the ratio of units supplied during a period to the units that could have been supplied if the generating source had worked at full capacity throughout that period. Accounting policies 15.1 Section 57 of the Electricity (Supply) Act, 1948 specifies that the provisions of the Sixth Schedule of the said Act shall be deemed to have been incorporated in the license of every licensee. This Schedule is designed to ensure that the licensees do not earn more than a reasonable return. However, it takes care to enable them to raise necessary funds from the market for proper discharge of their duties under the license. All licensees can fix their tariffs so as to recover their costs (including interest and tax) and earn return on shareholders funds. The tariff cannot be enhanced more than once in a year. However, if the licensee has not adjusted the tariff in any year and if the clear profit of the licensee does not exceed 20% of the reasonable return, then licensee will not be deemed to have failed to adjust the charges. 15.2 Reasonable return - Reasonable return is defined as the total of the following sums

An amount calculated by applying the standard rate to the capital base at the end of the Financial year. The standard rate to be applied is as follows Rate applicable

Capital base

As on March 31, 1965 7% Additions made from March RBI rate + 31,1965 to October 15,1991 2% Additions made after October RBI rate + 15,1991 5% The current bank rate is 12%. Hence licensees can earn return of 17% on investments made after 1991 The income from investments other than those included in Capital base, i.e. 0.5% of the approved loans, debenture capital, development reserve, and security deposits from consumers 15.3 Capital base - For determining the reasonable return, standard rate mentioned as above is applied to capital base. Capital base under the Sixth Schedule is the total of the following Original cost of fixed assets Original cost of work in progress Cost of intangible assets Contribution towards contingency reserve and depreciation One twelfth of the sum of book cost of stores material and supplies including fuel on hand, cash and bank balances including call and short term deposits at the end of each month of the year of account i.e. average monthly cash and inventory minus the amount written off for depreciation and intangible assets; specified loans from SEB; Debenture capital; Security deposit of consumers;

and, the amount outstanding to the credit of the Tariffs and Dividends Control reserve at the beginning of the year. Original Cost of fixed assets includes cost of the asset to the licensee including cost of delivery plus all charges incurred to put the asset in use; and interest charges on capital expenditure incurred during the period between the date of grant of the license and the date when the licensee commences supply from borrowed money. 15.4 Clear Profit - The provisions of the Sixth schedule restrict the earning of the licensee to the clear profit as per the working provided in that schedule. Clear profit is defined as - the difference between the amount of Income; and the sum of expenditure and special appropriations; where income, expenditure and special appropriations are arrived at as under Income - Net receipt from sale of energy after discounts add: rental of meters and other apparatus hired to consumers; add: sale and repair of lamps and apparatus; add: rents, less outgoing not otherwise provided for; add: transfer fees; add: income derived from investments, fixed and call deposits and banks interests; add: other general receipts accountable in the assessment of Indian income tax and arising from and ancillary or incidental to the business of electricity supply;

Expenditure - Expenditure incurred on Generation and purchase of energy Distribution and sale of energy Rents, rates and taxes, other than all taxes on income and profits Interest on loans advanced by SEB and those borrowed from organizations Interest on Debentures issued by the licensee Interest on Securities Legal charges, bad debts, auditors fees, managerial remuneration, Salary including bonus and contribution to Provident Fund and staff Pension Fund Gratuity payable under the Payment of Gratuity Act or under an approved Scheme Depreciation as notified by the Central Government under the provisions of Section 43(2), 68 (1) and 75A (3) of Electricity (Supply) Act. The rates of depreciation are fixed on the basis of life of the each asset separately. Till 31st March, 1993, the rates of depreciation notified were low as compared to those provided under the Companies Act, 1956 and Income Tax Act, 1961. However, these were revised upward with effect from 1993-94.

Special Appropriation sufficient to cover previous losses, all taxes on income and profits, installment of written down amounts in respect of intangible assets (as mentioned above in Para 15.3), contribution to the contingency reserve, arrears of depreciation, contribution to development reserve and other special appropriations permitted by the State Government. 15.5 As stated above ideally the clear profit should be equal to the reasonable return. If clear profit exceeds the reasonable return, then one third of the excess (not exceeding 5% of the reasonable return) will be at the disposal of the undertaking. Of the balance, one half would be appropriated to the Tariffs and dividend control reserve. The remaining will have to be distributed to the consumers as proportional rebate or carried forward in the accounts of the licensee for distribution to the consumers in the future. The Tariffs and dividends control reserve is available to the licensee only to the extent clear profit is less than the reasonable return in any year of account. In order to enable the licensee to earn a clear profit equal to the reasonable return, the Act permits a licensee to adjust tariffs once in a year. However, the licensee has to give a notice of 60 days before such revision to the concerned SEB. They cannot increase tariffs by more than 20% of the reasonable return at a time. 15.6 Statutory appropriations - Statutory appropriations include Contingency reserve; Tariff and dividend control reserve; Development reserve; and Project cost reserve.

Licensees have to make statutory provisions every year for specific purposes. These reserves are through additional tariffs imposed on consumers. All statutory reserves are therefore funds contributed by the consumers and not shareholders. Hence, statutory reserves cannot be distributed as dividends to the shareholders. Therefore, net profit for distribution are calculated after deducting statutory reserves from the profit. Determination of cost of production of electricity 16.1 The Eighth Schedule to the Electricity (Supply) Act lays down the method of calculating and taking into account the cost, charges and allowances for determining cost of production at a generating station in respect of the year of account. The broad heading of expenses is as under

Sums spent for fuel, oil, and water, stores consumed; for salaries and wages and any contribution by the licensee for pensions, provident fund, superannuation and insurance of officers and other employees; for repairs and maintenance and renewals not chargeable to capital account; Sums paid in respect of insurance, rents, rates and taxes A proportion of management and general establishment charges properly attributable to the station;

Any other expenses on revenue account properly attributable to the station; Interest on the depreciated cost of the station shown in the books of the undertaking and properly attributable to the station and interest on working capital properly attributable to the station and the production of electricity therein. An allowance for depreciation of an amount determined in respect of the station in accordance with the provisions of Para VI of the Sixth Schedule.

Preparation and submission of accounts 17.1 Rule 26 of the Indian Electricity Act, 1956 provides for submission of annual accounts to the State Government within six months from the end of the accounting year. The State Government can extend the date for submission of such accounts for proper and sufficient reasons. Normally licensees are Companies registered under the Companies Act, 1956. Hence, they have to prepare their Profit and Loss Account and Balance Sheet as per the provisions of the Companies Act, 1956. However, Section 616 of the said Act provides that wherever the provisions of the Electricity (Supply) Act are inconsistent with the provisions of Companies Act, the provisions in Electricity (Supply) Act, 1948 would prevail. Audit

18.1 The accounts of the licensee are subject to audit by Commissioner of Electricity appointed by the State Government. Taxes on electricity 19.1 Electricity Duty - Under the provisions of the Bombay Electricity Duty Act, Government of Gujarat levies Electricity duty at different rates on the cost of electricity as under

Residential consumers Upto 40 Units per month - 25% More than 40 Units per month - 40% Commercial consumers - 60% High Tension consumers - 20% LTP / LTMD - 10%

This may differ in other states. 19.2 Sales Tax - Under the provisions of the Gujarat Tax on Sale of Electricity Act, 1985, Sales Tax @ 4% is levied by Government of Gujarat on the cost of electricity consumed by the consumer. 19.3 The Electricity companies have to recover the above taxes from the consumers and to pay to the Government within the stipulated time. Since these taxes are received by the Electricity Companies on behalf of the Government such taxes neither form part of income nor expenditure of

the Electricity Companies and hence are not required to be incorporated in Profit and Loss Account of the Company. Separate records for such taxes are required to be maintained and monthly returns are required to be submitted to the appropriate authorities. Relevant provisions of Income tax Act 20.1 Section 10(23G) of I T Act, and Rule 2E of IT Rules - Section 10(23G) of the Income-tax Act, 1961, provides for exemption of certain incomes arising out of investment made by an infrastructure capital fund or an infrastructure capital company in an enterprise wholly engaged in the business of (I) developing, (ii) maintaining and operating, or (iii) developing, maintaining and operating any infrastructure facility. The exemption is subject to the condition that the enterprise is approved by the Central Government in this regard. The incentive of exempting the income arising out of long-term finance advanced to the infrastructure facility is intended to help such facility to raise adequate funds. The term infrastructure facility has been defined in Explanation 1 to Section 10(23G) and includes an industrial undertaking which

is set up in any part of India for the generation or generation and distribution of power if it begins to generate power at any time during the period beginning on the 1st day of April, 1993 and ending on the 31st day of March, 2003, starts transmission or distribution by laying a net work of new transmission or distribution lines at

any time during the period beginning on the 1st day of April, 1999 and ending on the 31st day of March, 2003,

The approval u/s 10(23G) is granted subject to the following conditions (i) the enterprise/ industrial undertaking will conform to and comply with the provisions of section 10(23G) of the Income Tax Act, 1961, read with rule 2E of the Income Tax Rules, 1962; (ii) the Central Government shall withdraw this approval if the enterprise / industrial undertaking -

ceases to carry on the infrastructure facility; or fails to maintain books of accounts and get such accounts audited by an accountant as required by Rule 2E (7) of Income Tax Rules, 1962; or fails to furnish the audit report as required by Rule 2E (7) of the Income Tax Rules, 1962.

20.2 Rule 2E of the Income-tax Rules, 1962 provides for monitoring of the approval granted under this section and withdrawal of the same under certain circumstances. In this connection, Board has issued Instruction No. 1958 dated 27.1.99. Further, the CBDT has vide Circular no. 780 dated 4.10.1999, clarified that the net income after taking into account all expenses incurred to earn the same, is exempt u/s 10(23G), and not the gross income.

The Board has further clarified that the exemption of interest is only for those assessment years for which the enterprise is approved u/s 10(23G). The Board has also stated in the same circular that tax is required to be deducted on payment of interest by such approved infrastructure enterprises, unless the infrastructure capital company or fund files the requisite certificate for lower deduction of tax issued by the AO u/s 197 of IT Act. 20.3 Section 80IA - Under Section 80IA deduction is allowed from the profits and gains derived from any business of any industrial undertaking which

is set up in any part of India for the generation or generation and distribution of power if it begins to generate power at any time during the period beginning on the 1st day of April, 1993 and ending on the 31st day of March, 2003; starts transmission or distribution by laying a network of new transmission or distribution lines at any time during the period beginning on the 1st day of April, 1999 and ending on the 31st day of March, 2003;

Provided that the deduction under this section to an industrial undertaking under sub-clause (b) shall be allowed only in relation to the profits derived from laying of such network of new lines for transmission or distribution. Section 80IA gives deduction upto 100% of the profits and gains derived from such undertakings for first five assessment years and thereafter 25% (30% in the case of

a Company) of the profits and gains for further five assessment years. The deduction can be claimed at the option of the assessee for any ten consecutive assessment years out of fifteen years beginning from the year in which the undertaking generates power or commences transmission or distribution of power. 20.4.1 Capital expenditure Vs Revenue expenditure The original cost of fixed assets is defined under the provision of the Sixth Schedule of the Electricity (Supply) Act, 1948. The method of calculation of original cost of fixed assets has been enumerated under the head Capital Base explained herein before. 20.4.2 Normally the licensees install generating stations keeping in mind present demand of electricity and future growth of five to ten years. Hence, they are required to expand their generating capacity to meet the increased demand from time to time. For this they are required to borrow from financial institution and / or banks. Interest paid on borrowings for such expansion has been permitted to be treated as revenue expenditure as the definition of capital base includes only the interest charges incurred during the period between the date of grant of license and the date of commencement of supply. Licensees are also required to install transformers and service line cables for which they have to raise the funds. Interest on such working capital is also treated as revenue expenditure. 20.4.3 The licensees and SEBs are inter-linked in transmission and distribution network to enable them to supply uninterrupted and quality power to their consumers.

For this purpose the licensees have to install import point for receiving electricity from SEBs. In turn, the SEBs have to lay down the service lines and install circuit breaker at receiving ends of the licensee. The expenditure incurred for such arrangement is to be treated as revenue expenditure. Here, by importing power the average overhead cost of supply per unit to the consumers of the licensee also goes down, resulting in higher profits. Further, the service lines remain the property of the SEBs, which are to be maintained by them. The SEBs retain the right to tap the service lines for giving power to other consumers. Hence, the licensee does not acquire any asset and as such, this expenditure qualifies as revenue expenditure. Rate of depreciation 20.5.1 Section 32 of the Income Tax Act provides for deduction of depreciation on fixed assets, from the profits for determining the taxable income from business or profession and certain categories of income from other sources. A change has been introduced vide Income Tax (Amendment) Act, 1998 for deduction of depreciation for the electricity generating and distributing companies with effect from 1st April 1998. Under the amended section 32(1)(i) depreciation will be allowed on the actual cost of the assets of the undertaking acquired on or after 1st April 1997. Such rates are prescribed in Appendix 1A to IT. Rules. The depreciation is allowed as a percentage of actual cost i.e. it is on straight-line method instead of on written down value method. This provision was added with the view to enable the power generating units to

depreciate their capital assets in a straight line method at the same rate at which it is allowed under the Electricity (Supply) Act, 1948. The aggregate depreciation allowed in respect of any asset for different assessment years shall not exceed the actual cost of the said asset. As per the proviso to Rule 5(1A) of the I T Rules, such an undertaking has an option that, instead of the depreciation specified in Appendix 1-A, it might be allowed depreciation under Rule 5(1) read with Appendix 1. The option is to be exercised before the due date of furnishing of return of income under section 139(1) of the Act. Once the option is exercised, it will be final and it will apply to all subsequent assessment years. 20.5.2 The Finance (No. 2) Act, 1996, has amended section 32 (1) (a) by inserting the words wholly and partly after the words plant or furniture owned. Accordingly, with effect from April 1, 1997, even fractional ownership of an asset is statutorily recognised for the purpose of depreciation. This amendment was brought in to supersede the ratio of the Supreme Court decision in the case of Seth Banarsi Das Gupta v CIT (1987) 166 ITR 783 (SC). At present, several big projects are being undertaken, in which the assets are financed by a number of companies and therefore, each of the participating company owns only a fraction of the asset. Areas for investigations 21.1 Most of the electricity generating units manipulate the accounts and records in the following areas -

Consumption of raw materials - particularly in thermal power projects Inflation of the expenses relating to maintenance of Boilers, turbines, etc., Inflation of labour charges, Inflation of T&D losses.

21.2 The consumption of raw material is inflated by following methods

Showing receipt of below par material i.e., coal with less thermal efficiency, high sulphur content and high ash content. Due to this, the consumption of the coal is inflated and thereby the profits are reduced. Showing receipt of less coal from rail wagons or the trucks. This is followed by lengthy procedure of filing claims with the railways and coal companies that are seldom settled.

In order to investigate this, the primary record regarding the quality testing of the raw material at the time of receipt; and the receipt register along with the weigh bills of the trucks should be called for examination. 21.3 Inflation of expenses - Boilers require annual maintenance as per the Boilers Act. These also require day-to-day maintenance. Since this machine together with the turbines are the lifelines of the generating units, considerable effort and manpower is spent on their

maintenance. However, often false bills are created to inflate the expenses claiming emergency break down. In such circumstances, the production records of the unit and the record of the main control room where every break down is recorded should be called for and examined. Inflation of labour charges for handling of material can be examined by verifying the bills of the contractor and cross tallying it with the details of the receipt or dispatch of the material and the payments for the same. 21.4 Deduction u/s 80 IA - Deduction u/s 80IA of the IT. Act is allowable in respect of profits and gains derived from any business of an industrial undertaking or enterprise engaged in infrastructure development, etc.. The Supreme Court in the case of CIT Vs. Sterling Foods [237 ITR 579] has held that for the application of the words derived from used in Section 80HH, there must be a direct nexus between the profit and the industrial undertaking. The Honble Supreme Court held that profits out of sale of import entitlements cannot be said to be profits derived from the industrial undertaking. This decision may be kept in view while examining claims for deductions u/s 80IA of the Act. 21.5 Depreciation on wind mills - In order to boost the use of alternate source of energy other than Carbon fuels, the Government of India allowed 100 % depreciation on assets used to generate power through use of Solar heat, Windmills, etc.. Many Windmills were set up for generation of power in coastal areas of Gujarat, Tamilnadu and Andhra Pradesh. However, many unscrupulous

entrepreneurs misused the scheme by making false claim of purchase and installation of the windmills. These provisions were also misused by some genuine entities that actually purchased and installed the assets, but advanced the date of installation on records to claim 100 % depreciation (by showing installation and use before September 30). In order to investigate such claims, following enquiries can be made

Survey of the location and physical verification Report from State Government about allocation of land, wind speed, etc.. Report from the State Electricity Development Agency about the funding of the project, installation of the asset, etc.. Report of the SEB about the date on which the windmill was connected to its grid and the amount of electricity generated from the same. Report from the State Agency responsible for promoting use of alternate sources of energy about the units of electricity generated from the location along with date and time

The above enquiries can be easily made to check the genuineness of the claim for 100 % depreciation. Most of the manufacturers like NEPC Mecon, Pearl Infrastructure, etc.., had imported the windmills in knocked down condition. These were then assembled in India before

being sold and installed at various sites in Gujarat, Tamil Nadu and Andhra Pradesh. 21.6.1 Sale and Lease back of assets - When the process of liberalization of the Indian economy was set in motion, state funding of the loss-making SEBs was discontinued. They were directed to generate funds from their own resources. Some SEBs developed the practice of sale and lease back of assets, which operated as under SEBs were having old assets in their Balance Sheet, depreciation available on which was entirely used. SEBs also could also not do without these assets. Hence, the SEBs revalued these assets and then sold these to entities who were looking forward to investing their funds and reduce their tax liabilities. Thus, the need of SEBs for funds was met. The purchaser was able to park its funds and claim depreciation on the same. In order to allow SEBs to use the asset, these assets were then leased back to the SEB for their use. At the end of the lease period the assets were transferred back to the SEBs or sold to some other entity. There was considerable Income Tax implication in these transactions because, the SEBs being loss-making units were not paying any taxes including Capital gains on the sale of assets, whereas the purchasers were investing funds and getting the benefit of depreciation, and hence obtaining tax benefits. 21.6.2 In many cases of the so-called sale and lease back transactions, the transactions were found to be mere colourable devices on following grounds -

An asset which is supposed to have been sold and leased back did not cease being an asset with nominal value (not being market value as on date) merely because its value was artificially jacked up to provide occasion for depreciation. There has been multiple financing, i.e., the same asset is sold and leased back to more than one party. Assets, which could not be legally sold, as they were charged to banks or others, were made the subject matter of sale and lease back transaction. These were not genuine finance lease transactions because the sale price was practically returned by way of advance lease rent with the result that the entire transaction was only by way of book entries solely for purposes of tax avoidance. Where the amount is routed through a third party, which is a sister concern, the position is the same. In other words, there was no real finance availed by the seller-lessee, who merely made entries in the books to oblige the financier to get depreciation himself availing 15 per cent to 20 per cent (being the difference between alleged sale value and full lease rent received in advance) for such accommodation. A finance lease without finance can hardly ever be recognised. 21.6.3 Many companies which had entered into sale and leaseback transactions during the mid-nineties (especially for assets which were entitled to 100 per cent

depreciation) have been denied depreciation on the ground that the entire transaction was a sham, designed only for the avoidance of tax. Several such cases are pending at different stages before the various appellate authorities. However, in the following circumstances, the Tribunal in Insurance Management Financing & Leasing (P) Ltd. V/s. Dy. CIT (1994) 51 ID 566 (Del.) had upheld the validity of sale & lease back transactions. Sale & Lease back transactions have taken place with proper documentation. The lessor provides real finance to the lessee. The lessor is the absolute owner with a right to lease the sale. The value placed is commensurate with market value. The items are also eligible for depreciation @100% though it is not necessary that all transactions in respect of assets eligible for 100% depreciation should be treated as bad. The transaction is a bonfire finance lease, with reputed finance companies in which the assessee has no interest. They are at usual rate of lease rent. In other words, these transactions are as between principals acting at arms length. 21.6.4 Prior to 30th September, 1996 the cost of assets in the hands of purchaser was considered to be the purchase value paid by him to the seller. Hence previously, the assets held by the seller were transferred

to the other person at the price agreed between them. Subsequently the purchaser used to give the assets to the seller on lease. Under such arrangement the lessor was claiming depreciation on the purchase price paid by him to the seller whereas seller was claiming the amount of lease rentals paid by him to the lessor as revenue expenditure. In order to curb such transactions Explanation 4A has been inserted in section 43(1) with effect from October 1, 1996 to determine the written down value in a case where the assets, which have previously been used by a person (hereinafter referred to as first person) and on which depreciation has been allowed to him, are acquired by another and the assets have been let, hired or leased to the first person. In such cases, the Actual cost of such assets shall be the written down value of the said asset at the time of its transfer (by the first person). In the case of Karma Chand Thapar & Brothers V/s. Dy. CIT (1998) 66 ID 39 (Cal.) it was held that Explanation 4A to Section 43(1) was never intended to be retrospective in operation and hence it has no application for the assessment years prior to the assessment year 1997-98. 21.7.5 The CBDT has issued guidelines for investigation into finance Lease agreements (Instruction No. 1978, F.No. 225/190/98/ITA-II dated December 31, 1999), where the issues to be examined into while investigating the cases of such lease agreements have been elaborately dealt. The AO should invoke Explanation 4A to section 43(1) in cases of sale and lease back transaction, where the depreciation is allowed to the lessor on the WDV of the asset in the hands of the lessee at the time of the transfer.

Reference material / additional information on power sector 22.1 (i) Ministry of Power, `Indias electricity sector widening scope for private participation (ii) Annual publication on `Energy Centre for Monitoring Indian Economy (iii) Credit Rating Information Services India Ltd. (CRISIL) publication on `Power (iv) Power Line magazine (v) Investment Promotion Cell, Ministry Of Power, Government of India, Shram Shakti Bhavan, New Delhi 110001, Telephone: 011- 3310247. Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter XII

SHIP BREAKING INDUSTRY

Introduction 1.1 Ship breaking is the name given to the industry in which old and discarded marine vessels are acquired, and completely dismantled. The scrap and other items recovered are disposed off separately. As per Lloyds Register and other records, over 70,000 vessels are afloat in the world. If the average life of a vessel is taken at 35 years, approximately 2,000 vessels would be getting condemned every year. Because of the peculiar nature of the industry, this activity cannot be carried out at just any place. One has to find out a beach suitable for such activities. The Alang and Sosiya Ship breaking yards near Bhavnagar in Gujarat, situated on the Gulf of Cambay on the west coast of, is considered one of the most suitable locations for ship breaking. 1.2 Each and every part of the condemned ship - tools, machineries, implements, metal sheet, wood, plywood, furniture, etc.. are systematically dismantled so that these items can be reused. The dismantled items are then sold in the market. Ship breaking initially started in Bombay around 1963 (Darukhana). The industry, later, found an excellent location at Alang and Sosiya villages near Bhavnagar in Gujarat. These ship breaking yards together account for 90% of ships dismantled, by weight, in India. Other places where ship breaking is carried out are S. State No. Site No. of clients

a. Alang & 183 Sosiya b. Sachana 11 (Jamnagar) 2 Maharashtra a. Mankule 4 b. Mumbai 20 3 Karnataka a. Manglore 4 b. Tachi 3 4 Kerala a. Cochin 1 b. Calicut 1 c. Beppur 1 5 Andhra Vishakhpatnam 2 Pradesh 6 Tamilnadu a. Chennai 1 b. Valinokkan 1 7 West a. Calcutta 4 Bengal TOTAL 236 (as on 31-12-1999) 1.3 There are 183 ship-breaking plots in Alang and Sosiya villages. Together, they account for breakage of over 350 vessels per year, with aggregate weight of over 25 lacs tonnes. Ship breaking activity has ensured that price of steel has not risen in India, inflation and devaluation notwithstanding. Therein lies the importance of this industry for the Indian economy. Not only does it employ over 50,000 people directly, and over 4,00,000 people

Gujarat

indirectly, it also provides over 15% of steel production of the country, which stabilizes the price of steel. 1.4 Ship breaking requires a particular gradient of slope of the sea. The gradient should be very steep at the beach, and thereafter, for some distance, it should be shallow so that during high tide, the ship can reach upto the shore, and can be berthed right on the shore. Thereafter the ship is dismantled beginning at the front, and is pulled towards the beach as it is dismantled. General information 2.1 The availability of ships for dismantling depends on the international cargo freight market. When the cargo traffic and international freight rates are high, availability of ships for dismantling becomes low and prices of ships go up. Similarly, when international freight rates and cargo traffic is low, more ships become available for dismantling at lower prices. 2.2 When the owner of a ship feels that a particular ship is to be disposed off either because it is no longer economical to run it, or because the ship has met with an accident, he contacts one of the several Agents who mediate in selling of ships, stationed at London, Dubai, Hong Kong or Singapore. These agents contact their subagents stationed in India, most of them located at Bhavnagar. The subagents keep in touch with the local ship breakers, who may be on a lookout for ships, mostly because they would already have dismantled the last ship purchased, or would be shortly completing the process.

The information about availability of ships, the description of the ships, including its name, height, width, name of the yard where it was built, make and capacity of various generators, engines, motors and other similar details are sent to the prospective buyers. On receipt of this information, negotiations between the subagents and the ship breaker commence, and the price is settled. The prices are in terms of US Dollars per ton. Once prices are settled, a Memorandum of Agreement (MA) is signed between the seller and the buyer, in which details of the ship are mentioned along with the rate at which it is to be sold, the number of propellers and extra propellers, metal of which the propellers are made, time-period during which the ship is to be delivered etc.. Once this agreement is entered into, the seller brings the ship to the safe anchorage in India. There the ship is inspected by the prospective buyer to verify whether it is as per the MA executed by him. If the ship is as per MA, it is agreed to be purchased and the ship breaker opens a Letter of Credit with the bank, and releases the same to the seller. If the ship is not as per the MA, the prospective buyer either rejects the deal, or bargains for a lower rate. 2.3 Thereafter, the officials of Customs department rummage the ship, to check whether the ship contains any cargo, as ships with cargo are not permitted in the shipbreaking yard. In case the ship has some cargo, it is liable to be confiscated. The Customs also prepare an inventory of oil and lubricants contained in the ship, and of electronic goods and goods of consumption. Any sophisticated communication equipments on the ship are to be

completely destroyed by the Customs authorities so as to prevent the same from falling into wrong hands. Sounding of quantity of oil is taken by the Customs authorities, and also by an independent Surveyor of ships. Once these formalities are completed, the ship is beached in the plot of the ship breaker. These plots are of various sizes varying from 30x 90 meters. to 120 x 90 meters. The beaching of the ship can take place only during high tide. As discussed earlier, the gradient of slope is very high at the beach, and thereafter the sea is shallow. Thus, during high tide, the ship can travel right upto the beach. Once the ship is berthed, it is tied up with heavy metal chains attached to 2 to 4 Winches. Thereafter, advance payment of customs and central excise duty is made, and oil and lubricants are unloaded. Only after unloading oil and lubricants, permission to cut the ship is obtained in writing from the Maritime Board and Customs, and thereafter, cutting of the ship is commenced. First of all, the cabin along with furniture, fixtures, furnishings, electrical and electronic items, is disposed off. Thereafter, dismantling of other parts of the ship commences. The ship is dismantled from front and, simultaneously with dismantling, is pulled towards the beach. Details of documents executed 3.1 The following documents are executed before dismantling of ship commences

Memorandum of Agreement ( MA )

Letter of Credit (L / C). Proforma of a typical L / C is in Para 11.1. Permission of boarding from Customs authorities. Permission of beaching from Customs authorities. Bill of Entry, and the inventory of bunkers, foodstuffs, drinks etc.., prepared by the Customs authorities. Survey report, generally by an independent Surveyor of ships. Notice of readiness for delivery, physical delivery certificate, (Proforma in Para 11.3), deletion certificate, non-encumbrance certificate, trim & stability booklet containing a blue print of the ship. Bill of sale or commercial invoice. LDT certificate from the shipping yard. Challans for payments of Customs duty, and various charges to Maritime Board. Permission for breaking the ship obtained from Customs, and Maritime Board. Safety permit and Naked light certificate, under the Factories Act.

3.2 MA is executed between the seller of the ship and the ship breaker on settlement of price and other terms of sale. It contains following details

Rate in US Dollars per Light displacement ton (LDT), and total price of the vessel. Name of the vessel, its old names, place of registration, name of the yard where it was built, length, breadth and the weight of the ship; type of engine, generator, propeller, spare propeller, spare tail shaft, permanent ballast, the type of construction of ship etc.. Mode of payment, mostly by irrevocable letter of credit, opened with the bank of the ship breaker and negotiable at the counters of the sellers bank, payable to the seller. Time of tendering Notice of readiness. Documents agreed to be provided by the seller to the ship breaker, e.g. Signed commercial invoice and Bill of sale with description of the vessel Certificate that the vessel is free from encumbrances / debts / mortgage / lien etc.. Undertaking from seller that immediately on receipt of full purchase price, the vessel will be physically delivered.

Certificate of deletion from registering authorities where the vessels is registered, to be provided within two months. Whether vessel is laid-up or is to be delivered on the strength of its own power (laid-up vessels are cheaper). Certificate of a reputed licensed Surveyor certifying the metal of which the propeller is made, (non-ferrous propellers are valued at 6 to 10 times the value of ferrous propellers) and also whether the weight of the vessel is as per the trim and stability booklet. The buyer also undertakes not to resell the vessel under any circumstances.

3.3 Letter of Credit is released by bank of the ship breaker to the bank of the seller, as agreed in the MA, upon receipt of Notice of readiness from the seller. The L/C is irrevocable. 3.4 Permission is obtained from the Customs for boarding of vessel for physical inspection, to verify whether the ship is as per terms agreed in the MA. If the ship is as per MA, the ship breaker agrees to purchase the ship, and approaches the Customs to permit beaching of the vessel at its plot. 3.5 A Bill of Entry is prepared by the ship breaker. It contains description of the type of oil, stores, supplies, consumable goods, electrical and electronic goods found

in the ship. On the basis of this declaration, customs duty is paid on the said goods. This is an important document. The quantity of furnace oil, light diesel oil, lubricating and cylinder oil, and various other oils is mentioned in the Bill of Entry. In the assessment proceedings, the AO may verify whether these oils, stores and other supplies, have been disclosed either as Sales or as closing Stock. It is normally claimed that part of the oil was irrecoverable while some part was consumed by the ship between the time of its inspection and its beaching. However, as discussed later in this Chapter, this argument can be misleading. It is at times claimed that water was found mixed with the oil. It may be noted that usually a certificate is given by the Master of the ship, Chief Engineer and the Superintendent Customs that no water is found in the oil tanks. Another document called Inventory of bunkers, food stuffs, cold drinks and other ship stores is also prepared. This is a declaration of the Master of the ship, duly verified by the Customs. 3.6 Surveyors report - Survey of the ship is conducted by Licensed Surveyors, most famous of them being M/s Ericson and Richards. The Survey report contains verification of the metal of which the propellers are made up. The Surveyor also takes sounding of oil and certifies the quantity of oil. They also certify whether the trim and stability booklet is found on the ship, and whether the ship has any leakage, ingress etc.. 3.7 After the ship has arrived at the anchorage, and is ready for delivery, the Master of the ship informs the

Indian agent of the ship owner, that the ship is ready for delivery. This, in turn, is communicated to the purchaser, and the L/C is released by the ship breakers bank to the sellers bank. At the time of handing over the ship by the Master of the vessel to the agent of the ship breaker, the Master also hands over a physical delivery certificate stating therein, that the ship is being handed over to the said person in good floating condition. Within two months of sale of the ship, the seller provides a deletion certificate from the registering authorities that had registered the vessel, stating that the name of this vessel has been deleted from their register. Light displacement tonnage (LDT) certificate is obtained from the ship-breaking yard where the ship was constructed. There is a register called Lloyds Register of Shipping, which is customarily accepted in International Shipping trade, as authoritative record of ships operating in international waters. It contains details of all old names of the ship(s), the shipyard where it has been constructed, and the bio-data of the ship. Further, to verify the details of the ship, the ship breaker calls for LDT certificate from the yard in which it has been constructed. 3.8 Bill of sale and commercial invoice mainly state the details of the ship along with the fact that the ship has been sold to the ship breaker. 3.9 Once the custom duty is paid, and the oil & lubricants have been removed from the ship, Customs and the Maritime Board permit the ship breaker to start breaking the ship. This permission is conditional upon the ship

breaker certifying that all oil has been removed. Thereafter, the Safety work permit and the Naked Light Certificate are obtained from authorities under Factories Act, and the dismantling of the ship commences. Types of yields 4.1The dismantling of ships yields Industrial machinery (lathes, boilers etc..) Electrical machinery (Generators), Petroleum products (Fuel Oil, Lubricants), Industrial materials, metal (Ferrous and Non-ferrous sheets), Electrical, electromechanical & electronic appliances, (Generators, Domestic wares (Cutlery, Crockery, linen), Communication equipments, Navigation equipment & accessories, Tools and tackle, and Safety devices etc.. 4.2 The recovery of ferrous and non-ferrous metals is usually as under S.N. Metallic Percentage recoveries range 1 Reusable Steel 0-5 Plates 2 Rerollable Scrap 60 - 70 3 Heavy Melting 5 - 10 Scrap 4 Cast Iron Scrap 2-5 5 Non-ferrous Scrap 0.5 - 1 6 Nonmetallic 3-5 Component

7 Non Recoverable

10 - 15

(Source - Report of August 1997 of MECON, Ranchi, on Present state of ship breaking in India, Ferrous Scrap Committee, Ministry of Steel, Government of India. ) Most of the material recovered, comprises ferrous metals. However, the most valuable items in the ship are nonferrous metals, which sell at upto 10 - 15 times the rate of ferrous materials. Large tax evasion is possible by understating the yield of non-ferrous materials, and instead, disclosing a higher yield of ferrous materials. Methods of ship breaking 5.1 The main methods of breaking the vessels into big blocks of iron plates are

Dry dock method Vessel moored at quay Stern of the vessel moored towards the quay Side of the vessel moored along the quay Vessel grounded in the shallow that is beaching method Special methods e.g. - Berthing on finger jetty; Fixed platform; Shiplift; Floating jetty

5.2 Different ship breaking yards specialise in different methods of ship, breaking -

S. N. 1

Ship breaking method

2 3

Ship breaking Yards Beaching the vessel bow Alang Sachana and forward during high tides with Vishakapatnam full force of the engine. Mooring vessel along quay Bombay (berthing) Mooring vessel along quay Calcutta (berthing) and dry docking

5.3 The main equipments used in ship breaking are as follows Activity Preparation for breakingup Breaking down to big blocks Breaking down to medium/small sections Breaking down to members and pieces Product delivery Main equipments Oil Pump, Boiler, Cutting equipment Floating crane, Tug boat, Rope carrying boat,Cutting equipment Gantry crane, Crawler crane, Hydraulic shovel with fork grip, Cutting equipment Gantry crane, Crawler crane, Cutting equipment Forklift truck, Hydraulic shovel with fork grip, Dumper truck, Truck Weigh scale

Methods of tax evasion

6.1.1 Understatement of production / yield / sales Since the dismantling of a ship results in recovery of numerous types of material, most of which are measured in different units, it is not really possible to keep a complete day to day quantity record of the recoveries of each of these products. Besides, there are various losses in the process of ship breaking, e.g., cutting loss arising on gas cutting of metal plates. In addition, since the LDT of a ship represents its weight at the time of its construction, it is possible to argue that the weight of the ship when it was delivered to the ship breaker, was much less than its LDT due to corrosion etc.., suffered by the ship in its operational life. Thus, quantity-wise tally of the ship cut, and the material recovered is an extremely difficult, if not impossible, proposition. This provides considerable scope for unscrupulous ship breakers to manipulate production records / data, and the valuation of closing Stock to suit their convenience. Further, since non-ferrous metals recovered are far more valuable than ferrous material, showing higher recovery of ferrous material and lower recovery of non-ferrous metals, has the advantage of showing good recovery in weight, but a lower figure in terms of value / price. This unstated / understated production of various materials is then disposed of outside books. Fortnightly statements of Stock submitted to banks (see Para 11.2) can be useful for verifying this issue. Corelation can also be made with Sales tax and Excise authorities to whom monthly returns are required to be submitted as per proforma reproduced in Para 11.4 of this chapter.

6.1.2 Sale Invoices are prepared at figures lower than the actual rate at which the goods have been sold. The bill amount is taken by Cheque / Demand Draft and the balance is taken by cash. This activity is carried out not only in respect of local Sales but also outstation Sales. For example, in the course of a search, it was found that bills were issued at 70 to 80% of the prevailing market rate for the class of commodity. This amount was received by Demand Draft, while the balance was received in cash through the brokers. The purchaser was sending cash through angadia (courier), who would pay the cash amount to the broker, and the broker would make payment to the ship breaker. 6.1.3 Another method is to make cash sales at market rate, without issue of bill and without recording in books. Later, when cash is needed in cashbook, this cash is introduced in the guise of Sales, albeit at a lower rate. The ship breakers have to keep account of the weight of the goods sold by them. There is little scope for manipulation of weight, although this is also being indulged in. However, most of the manipulation is being done in the rate of sale. For example, if market rate for certain category of steel plates were Rs. 8,000/- per ton, the Sales would be shown at Rs. 7,000/- per ton in the books. The balance Rs.1,000/- will be siphoned away by the ship breaker. What makes things easy for the ship breaker and difficult for the department is that different grades of steel are obtained from dismantling of ship, while same type of bill may be issued for the entire disclosed ferrous production, i.e. for mild steel. The bills may not mention the grade of

steel, which has been sold. For example, steel of various thickness like 1, 0.5, 0.75 are sold, but the bills may only show mild steel plate, without any description about the quality or type or grade, or thickness of steel. This problem is further compounded because the price of steel changes almost every day. Although the daily change is not very large (plus or minus 1% to 2%), but since the rate is not uniform, and there is no agency to keep watch on and/or publish these rates, it becomes very difficult for the department to establish the market rate on a given day. Thus, large cash Sales are affected without issuing bills. When large amount of cash gets accumulated, the requisite amount is introduced in the books as sale proceeds of Sales made to certain local traders, who may be genuine parties, but to whom no Sales would have been made. Information found during searches against many ship breakers, has brought out that the ship breaker first deposits his unaccounted cash in the bank accounts of such parties, and then sale bills are issued in the names of these parties, and the amount is shown as receipt of sale proceeds from these parties through cheques / DDs. These parties are paid small commission in cash, for their services. Thus, the cash collected by the ship breaker from unaccounted / unrecorded Sales is pumped back into business. The main benefit, which accrues to the ship breaker by such transactions, is that, Sales are disclosed not at the going market rate, but at a much lower rate. Further, since the market rates are not easily ascertainable, and the quality of steel sold is not mentioned in the bills, it is not possible for the AO to find out the understatement of Sales. It is advisable to make

random checks of sale rates, with those shown by other ship breakers on the same day. 6.2 Sale of oil and lubricants - While the ship is in safe anchorage in sea, it is inspected by Customs along with Surveyor of ship. They take sounding of oil, as also the meter reading of the oil tank. On this basis, they determine the quantity of various categories of oil and lubricants like diesel oil, furnace oil, grease etc. in the ship. They certify this for levy of customs duty. These details are available with the Customs and Central Excise in the Bill of Entry. This document is an excellent basis to judge whether the sale of the full quantity of oil and lubricant present in the ship have been disclosed by the ship breaker. More often than not, it has been found that Sale of only 50% to 75%, of the quantity disclosed in Bill of Entry, is disclosed in the books of accounts. It is explained that while sounding and reading of oil is taken in high sea when the ship is berthed at a distance of 20 to 25 kms from the shipbreaking yard, the ship is beached upto 15 days after taking this reading. It is claimed that during the intervening period and distance, oil and lubricant is used up. However, this argument is, to a large extent fallacious. It may be noted here that the engine of the ship uses furnace oil for running the ship and the generator uses diesel oil which supplies electricity to the rooms, kitchen etc.. When the ship is anchored at high sea, only one or two generators of the ship remain working, and the engine of the ship is shut down. There is thus no question of using up any furnace oil since the engine is shut down. The generators can also not use more than, say, one Metric Ton a day. Thus, only

some margin can be given for the consumption of oil by generators and for traveling from anchorage to berthing. The balance quantity should be disclosed by way of Sales. Very often, the ship is brought from anchorage to ship breaking plot by tugs, i.e. it does not travel on its own power, and is pulled by another vessel. In such cases, there is no question of consumption of fuel oil after the reading by Customs. If such disclosure is not made, the AO may take suitable measures. 6.3 Sale of cabin Items - Each ship requires several crew members to run it. Bigger the ship, more the crew members. All these crew members have to be properly housed and fed. Besides, they all have their working place on the ship. Thus, ample space is provided for kitchen, bedrooms, working place, sophisticated equipments, common room, bar room, emergency medical room, stores etc. These cabins contain furniture, electric, electronic items like fridge, TV, VCR, CD players etc., depending on the type of the ship, the country to which it belongs and date, when it is refurnished etc. Further, the cabin is made of such items as plywood, fibre, fire wood, teak wood etc.. It also contains glassware, crockery, cutlery, and sanitary equipments. When the ship is beached, various parties contact the ship breaker with offers to purchase all the above-mentioned items. The ship breaker accepts the best offer and all the above items are usually sold in a lot. While dismantling and handing over these items, they are weighed and note of these Sales is kept. Later in the books of accounts, the assessee does not disclose these Sales to have been

made as a lot to one party. Instead, he discloses some Sales of plywood, firewood, teak wood, sofa, chairs etc.. and such other items separately to separate parties. Thus, often while the cabin items are sold to one single party as a lot, in the books of accounts, the ship breaker discloses Sales to a number of parties, and of a number of items, all by weight. This is also because Sales tax rates are different for different items. 6.4 Payment of black money for purchase of ship breaking plots - All Ship breaking plots in the state of Gujarat belong to Gujarat Maritime Board, which assigns permission to utilise these plots on payment of certain charges. This permission to utilise ship-breaking plots is transferable. Thus, on paper, one ship breaker may transfer the permission of Gujarat Maritime Board to utilise the ship-breaking plot, to another ship breaker. Although, in practice, the plot is transferred along with building, machinery etc., in the books, often the ship breakers disclose such Sales at a nominal rate, on the ground that the plot belongs to the Maritime Board. In one case, a ship-breaking plot had changed hands. On enquiry, it was found that the plot was sold for handsome amounts. However, when the matter was further examined, it turned out that most of the amount was paid for transfer of machinery (crane, winch etc.), building and some land near the ship-breaking plot. However, no money had been shown for transfer of the permission of the Maritime Board to utilise the ship-breaking plot. This effectively meant that the plot had been transferred without any consideration. In another case, it was seen that a very small amount had

been paid against the permission to utilise the shipbreaking plot. The explanation was that these plots were reserved for scheduled castes and scheduled tribes, and there were no takers for the same. In another case, the explanation offered was that the beach appurtenant to the said plot was rocky and therefore the plot commanded lower price. Someone else in this situation claimed that the beach appurtenant to the plot was muddy and therefore the plot fetched a lower price. Thus, there are reasons galore. The AO can call for details of transfer of plots from the Maritime Board. Evidence found during searches revealed that actually the ship breaking plots, being few in number, command a very high premium in black market, and usually their transfer involved exchange of large amount of black money. Therefore, it is necessary to obtain full details from the assessee and the Maritime Board, and compare these with the rates at which others have sold their plot at the same time. 6.5 Valuation of Closing Stock - The closing Stock of the ship breakers comprises of part-cut ship, unsold machineries recovered from the ships in working condition, ferrous scrap, non-ferrous scrap, ropes, wires, tools, implements etc.. At least, one of these items viz. part-cut or uncut ships cannot be weighed. Thus, one cannot say with certainty whether 40% or 30% or 20% of the ship being cut, has been cut. There would always be a margin of error in the estimation of the uncut ship. This seemingly small margin of error of, say 10 to 20%, can mean a variation of 500 to 1000 tons that is Rs. 50,00,000/- to Rs. 1,00,00,000/-. Usually ship breakers

furnish fortnightly Stock statements to banks. A typical proforma of such statement is given in Para 11.2. This may be useful for verifying the correctness of the closing Stock disclosed to the department. Again, items like machinery recovered from the ship cannot be properly valued. The ship breaker himself does not know how much, for example, a lathe machine would fetch him. Depending on the customer, market situation, urgency of need the price of an item may vary 2 to 3 times. Further, there are no norms on which to value such Stock i.e. At going market price, cost or market price which is lower, or cost method etc.. Thus, there is always ample scope to under value the closing Stock. 6.6 Usance Interest - Before purchase of a ship, the ship breaker signs the MA with the seller of the ship, containing full particulars of the ship. One of the conditions normally (if the ship is purchased by bank finance), is that an irrevocable L/C has to be opened by the ship breaker for a period of 6 months from the date of delivery of the ship. The payment for the ship is made on the expiry of 6 months from the date of delivery at the ship-breaking yard. For these 180 days, the ship breaker has to pay interest on the credit extended. This interest is generally paid to a nonresident against the credit facility availed for purchase of ship. Section 9 (I) (v) provides that if interest is being paid to a nonresident, then the interest payment is deemed to accrue or arise in India. Therefore, tax is required to be deducted u/s 195, from the interest paid / payable to the nonresident. If such tax deduction is not

made, Section 40(a)(i) stipulates that the interest paid to the nonresident, cannot be allowed as a deductible expenditure. This position, now, is also supported by Honble Supreme Court in the decision of Transmission Corporation of A.P. Ltd. Vs. Commissioner of Income-tax 239 ITR 587 (SC) 6.7 TDS on transportation charges - One of the important inputs for cutting of ships is oxygen gas. LPG is burnt with oxygen to produce a flame, which cuts ships. Oxygen is provided by the oxygen manufacturers, some of whom are sister concerns of the ship breakers. The oxygen is supplied in cylinders, and as per normal business practice, a comprehensive payment for oxygen manufacturing charges, cylinder hire rent, and cylinder transportation, is made. Thus, this transaction is in the nature of a work contract. Therefore the person responsible for paying any sum to the contractor for carrying out this work, is required to deduct tax @ 2% of such sum. However, more often than not the provisions of Section 194C are not complied with. Bye laws of Gujarat Maritime Board 7.1 The Gujarat Maritime Board (GMB) grants permission to ship breakers to use the ship breaking plots. Thus, permission is of user only, and is subject to numerous terms and conditions, including payment of various charges. The ship breakers have no ownership right on the plots, whatsoever. The GMB charges Rs. 12/- per ton of vessels dismantled during the year with a rider that within a period of 3 years, at least 30,000 tons of ship

should be dismantled failing which minimum charges on 30,000 tons have to be paid. Further, GMB charges certain amounts for any change in constitution of partnership, change in profit sharing ratios of the partners, etc.. Such charges vary from Rs. 50,000/- to Rs. 2,00,000/-. Gist of some other provisions is as under

Application money of Rs. 5 lakhs per plot is to be paid. The amount of Security deposit is Rs. 5 lakhs per plot. A one-time premium is payable @ Rs. 2,700/- per Sq. meter on the size of plot, which varies from 2700 Sq. m. to 10,800 Sq. m.. An annual Plot charge is payable @ of Rs. 600/per 10 Sq. meter per annum. The ship breaker has to pay to GMB, LDT charges @ Rs. 12/- per ton of ship broken. He is bound to bring at least 30000 LDT of ships in each block of three consecutive financial years. Dismantling permission shall be granted for ten financial years. The plot cannot be used for any purpose other than ship breaking. Also any person other than the ship breaker who has been so permitted cannot use it.

Separate permission needs to be taken for dismantling each ship, after oil and lubricants have been unloaded from the ship.

Case studies 8.1 In a search in the case of a ship-breaking firm, it was found that the permission to utilise ship-breaking plot of Gujarat Maritime Board, was transferred by an outgoing concern to the assessee. It was found that while the full consideration was approximately Rs. 3 Crores, only about 20% or approximately Rs. 60 lakhs was disclosed in the books of accounts. The balance amount changed hands out of books. Similar transactions are taking place in which only part of the consideration is disclosed. Several instances have come to light where no payment is shown to have been made against transfer of the ship-breaking plot. The disclosed transaction would only show that plant and machinery, building etc.. are transferred at book value. However, no amount is disclosed against transfer of the right to use the ship-breaking plot. 8.2 In another case, it was found that the assessee had opened bank accounts in the names of several persons, including some employees. Through these bank accounts, he would first introduce cash, and then advance loans to his firm as and when required. Some of the parties were small time traders who purchased scrap from Alang and sold in the open market. Some of the names were altogether fictitious and could not be found on the given addresses. The assessee was asked to produce these parties. Naturally, some of the parties could not be

produced even after giving a number of opportunities. Some parties were produced, but it was clearly established during the course of their examination on oath that they did not have the capacity to introduce lakhs of rupees in their bank account, and to advance these to the assessee. The department could therefore make substantial addition u/s 68 of the Act. 8.3 In another case, the assessee had disclosed sale of certain quantity of furnace oil, diesel oil that appeared to be on the lower side. The AO examined the Bills of Entry in respect of all ships beached during the year. After the ship is beached and before permission to start cutting is given to the ship breaker, he has to certify that all oil has been evacuated from the ship. Since the assessees do not have any storage facility of oil, it can be safely inferred that by the time the ship breaker certifies that all oil has been emptied, the entire quantity is sold. From the Bill of Entry, the quantity of oil received year was available. However, in this case it was found that the assessee had disclosed sale of only 50% of the total oil receipts. Commercial categorisation of ships 9.1 The recovery of ferrous / non-ferrous metals, i.e. percentage yield depends to a very large extent on the type of ship being cut. Usually Bulk oil tankers, ore carriers, military vessels, etc.. give higher yields. The various types of ships brought for dismantling are Ship types Liquefied gas tankers Basic groupings liquid gas

Chemical tankers Oil tankers Molasses and, water tankers Bulk carriers, ore carriers Bulk oil carrier, ore carriers Self-discharging bulk carriers Cement, wood chips, urea carriers General cargo palletised cargo ships Container ships Refrigerated cargo ships Ro-ro cargo shipsContainer / ro-ro cargo shipsVehicles carriersLanding crafts Passenger / ro-ro cargo shipsPassenger / landing crafts Passenger ships Livestock carriers, Barge carriers, Heavy cargo carriers Trawlers, fishing vessels Fish factory ships and carriers etc.. Offshore support, drilling, well-production ships

chemicals oil other liquids bulk dry bulk dry/oil self-discharging bulk dry other bulk dry general cargo container refrigerated cargo ro-ro cargo

Passenger / ro-ro cargo

passenger other fishing fish catching other fishing other offshore

Research ships Tugs, Pusher tugs Dredgers, Hopper dredgers Motor hoppers, sludge disposal vessels, crane ships, cable ships, icebreakers etc. Barges, pontoons, moored oil processing ships, moored cement handling ships etc. Yachts, sail training ships, naval auxiliary ships etc.. Shipping terms

research towing/pushing dredging other activities

non-propelled ships

other ships structures

10.1 Some of the shipping terms generally used ship breaking activity is given below:Light Displacement Tonnage : The weight of a ship without stores, bunker fuel or cargo. Ballast : Water or solids like cement is used as ballast to keep the vessel steady. Bunker Tank fuel (coal, oil, etc.) : Ship-space for storing

Classification : Seagoing vessels of 100 GRT and more are built under supervision of one of the officially recognised classification societies, which have established rules

and regulations. For example, Lloyds Register of Shipping, London. Starboard side Port side : Right side of the ship. : Left side of the ship.

Draught/Draft : The depth necessary to submerge a ship to her load line. Bulkheads : To increase the safety of ship, it is divided into watertight compartments so that in the case of collision, the damage may be confined to one compartment. Hull Insurance : The Hull insurance policy covers the hull, machinery and complete equipment of the ship. Knot : A measure of speed, being one nautical mile of 6080 ft. Traversed in one hour. Bonded goods : The goods deposited in a bonded warehouse until such time as the duty upon them has been paid. Lien : The right of holding goods until debt in respect of such goods is satisfied. Maritime Lien : Lien which travels with the ship even after change of its ownership.

Bill of sale : A statutory document showing transfer of ownership of vessel. Rummaging : The search off a ship by customs for smuggled or prohibited goods. Laid-up ship : A ship which is not in use, put in a safe anchorage with a view to activate it in future either for trading for scrapping.

Proformae of some important documents 11.1 Letter of Credit - A typical letter of credit opened by a ship breaker is in the following format. Non-negotiable Telex message no. message from State bank of Saurashtra Darbargadh branch Bhavnagar India for SBI Frankfurt :::: test non-negotiable for USD dated

opened our letter of credit no. dated for an amount not exceeding USD

favouring for account of for 180 days usance (hereinafter referred as beneficiary) non-negotiable (hereinafter referred as applicant) and available by beneficiarys signed draft for maximum period of 180 days usance from the date of physical delivery and opening bank for 100 percent invoice value for delivery of old ship M.V. ex

for demolition purpose at Alang district Bhavnagar India. Draft must state drawn under our letter of credit no dated of stop drafts to be accompanied by the following documents in English. 1. Additional draft for USD for maximum period of 180 days usance drawn on applicant being total purchase price of old ship M.V. 1a. Separate drafts drawn on applicant for maximum period of 180 days usance along with invoice for USD being 7.5 percent per annum interest amount for maximum 180 days usance from the date of physical delivery, or at the prime rate of USA prevailing on the date of negotiation, whichever is lower, as per MA dated ________. This amount is in addition to the L/C amount and to be claimed on due date.

1b. Signed commercial invoice in sextuplicate certifying the details of the vessel as described below and purchase price USD ___________ as per MA dated _________ and to mention L / C number. Description as under Name (mention exnames also) Type Built (year and country) Name of shipbuilder Converted (lengthened) Conversion year Flag and port of registry GRT / NRT Original LDT Present LDT excl Permanent ballast Length (registered) Breadth Light draft Working propeller Spare propeller Spare tail shaft Main engine : : : : : : : : : : : : : : : : : :

Auxiliaries/generations : Ballast tanks : Insulation : Construction : 2. Notarised / legal bill of sale in favour of the applicant certifying that the vessel is free from all encumbrances maritime liens and any other debts whatsoever duly signed under beneficiarys common stamps, dated and attested by notary public in Hamburg and/or legalised by the Indian consulate in Hamburg. The full name and designation of the signatories to the bill of sale should be clearly specified on the bill of sale. 3. Original trim and stability book or capacity plan or letter from builders/builders successors substantiating the light weight or light ship displacement of the vessel as _______ metric tonnes or __________ long tons excluding permanent ballast. 4. Certificate from the beneficiary certifying that the vessel at the time of delivery is free from all encumbrances maritime liens and any other debts and liabilities of any description whatsoever, and indemnifying the applicant against the consequences of any claim which have been incurred prior to the time of delivery of the vessel. 5. Original certificate from registration authorities of the vessels present port of registry with their seal and stamps and signed manually in original by concerned port authorities in the name of the former owners certifying that the vessel_____________ is free from all encumbrances,

mortgages, maritime liens and debts on the vessel at the time of delivery of the vessel to the applicants. this certificate must not be dated more than seven days prior tot the date of negotiation of documents. 6. Photocopy of bill of sale from the registered owners to ________________________ deleting the purchase price. 7. Certificate from the negotiating bank certifying that they have paid the full purchase price of the vessel ____________________ to the owner of the vessel as shown in the registration certificate. 8. Copy of the beneficiarys telegram/telex/fax sent by beneficiary registered as owner in the port of registry to the master of the vessel incorporating delivery instructions to deliver the vessel ___________________ physically to the applicant or their nominated representative on as is where is basis at Alang anchorage not before ___________ but not later than _________ unless extension of delivery date is mutually agreed on condition as she is safely afloat port worthy, virtually intact, free of fire damage, free of arms and ammunitions, free of hull leakage, free of cargo, charter fee, having all her anchors in working condition and under her own power during business hours of a working day, with repeat message to the applications. 9. Letter of undertaking from the beneficiaries guaranteeing that they will submit to the applicant a deletion certificate from the authorities of the vessels

port of registry as soon as possible but not later than months from the date of delivery. 10. A tested telex / cable from opening bank confirming that the applicant have received the notice of readiness from the beneficiaries agent in Alang and that the vessel has been physically delivered safely afloat at Alang anchorage. 11. Certificate from applicant that the vessel has been successfully beached at plot no. ________ at Alang. Special instructions 1. All bank charges outside India are for beneficiarys account including L/C advising charges of L/C advising bank, whether L/C is utilised or not. 2. Last date of delivery under this credit is ___________ and of negotiation is __________. Instructions to the negotiating bank 1. They should invariably confirm prime rate prevailing on the date of negotiations of documents. 2. They should forward to opening bank the drafts and the original documents by the quickest possible means i.e. international air courier service on the date of negotiations itself. 3. Please advise opening bank by urgent telex at no. ___________ or by cable addressed to branch,

____________, India receipt of documents in conformity with the letter or credit terms. 4. The negotiating bank should obtain reimbursement on due date as confirmed by opening bank from ___________________________ certifying therein that the terms and conditions of the credit have been complied with. 5. Negotiating bank to negotiate/discount documents for USD _______ only of the invoice/draft amount and balance of USD _______ to be released by negotiating bank only if tested telex message within seven days of negotiation is sent by opening bank to negotiating bank confirming successful beaching of the vessel _________________ at plot no. ______ at Alang and also confirming receipt of certificate of Lloyds approved agent duly counter signed by the applicant and Notarised by public notary in Bhavnagar certifying therein all the details of vessel ____________ as described in clause 1b of this letter of credit. The surveyors will also specifically confirm light displacement tonnage excluding permanent ballast and weight and material of propeller and tail shaft of the vessel. This is an operative instrument and no mail confirmation will follow. please advise the beneficiary accordingly. Please not that L/C advising charges, if any, to be paid by beneficiary whether the L/C is utilised or not. We hereby engage with drawers endorsers and bonfire holders of the drafts drawn under and in compliance with the terms of this credit that such drafts shall be duly honoured on presentation and delivery of documents as

specified above. except as otherwise expressly stated this credit is subject to the uniform customs and practice for documentary credits (1993 revision) International Chamber of Commerce publication no. 500. ______________________________________________ ___________________________________ 11.2 Stock statement - A typical proforma of fortnightly Stock statement given by a ship breaker to his bankers, is as under State Bank of Saurashtra, Darbargadh branch, Bhavnagar Fortnightly Stock statement as on ___________ M/s Part-I (a) Name : M.V. (b) C.C. a/c no. : (c) Import price : (d) Total import price : (e) Usance interest : (f) Total import price with : usance interest (g) Conversion rate :

(h) Total import price with : usance int. (i) Other landing expenses a. Custom : b. Excise : c. Port charges : d. Insurance premium : e. Beaching charges : f. Other (bank charges) : total :............... : (j) total landed cost. ( h + i ) : (Rs. per M.T.) (k) Average landed cost : (l) Average cutting cost per LDT/M.T. : (m) Average total cost of broken Stock : Part - II Unbroken stock M.T. (a) Stock as on last fortnight : (b) Stock broken during the fortnight : (c) Stock as on the date of statement. ( a - b ) :

(d) Value of Stock as on the date of statement : PART-II A SEMI-BROKEN STOCK (a) Stock as on last fortnight. : (b) Stock broken during the fortnight : (c) Total semifinished Stock : (d) Goods finished : (e) Stock of semi finished goods : PART- III BROKEN STOCK (a) Stock as on last fortnight : (b) Stock broken during fortnight (Part II (b) less 10% cutting loss) : (c) Total broken Stock ( a + b ) : (d) Stock sold during fortnight : (e) Stock as on the date of statement (c - d) : (f) Value of the broken Stock PART - IV TOTAL STOCK / RECEIVABLES (a) Total unbroken stock (Part -III) : (b) Total broken stock (Part III) : (b-1) Total semi finish stock (Part II-a) :

(c) Total stock (a + b) : (d) Receivables : (e) Total stock & receivables (c + d) : F.D.R. L.C. TOTAL PART - V PROGRESSIVE REPORT Sales (a) Sales upto last fortnight : (b) Sales during this fortnight : (c) Total Sales upto this fortnight : (d) Book-debts as on last fortnight : (e) Gross addition to book-debts during fortnight : (f) Total book-debts. (d + e) : (g) Book-debts realised during fortnight. : (h) Book-debts as on this fortnight : (i) Deposit in CC/ TDR / CD out of sales : Certified that the details mentioned as above reflect the true and correct position obtained from out books of

accounts. we also certify that the assets shown above are exclusively of our ownership and no any other persons/institute has any interest, line or charge thereon. Date: horised Signatory Aut

-----------------------------------------------------------------------------------------------------------------------------------(for banks use only) Received on on Remark if any (1) Credit received upto last fortnight Rs. (2) Credit received during the fortnight Rs. (3) Total credit received upto fortnight Rs. ___________________________________________ __________________________ ____________ 11.3 Physical delivery certificate - A typical physical delivery certificate issued by the Master of Ship, while handing over possession of the ship to the ship breaker is in the following formatverified entered on signature

I, ____________________________________ Master of the vessel M.V./ ____________ do hereby physically deliver the said vessel at ALANG Anchorage at __________ hours on ________________. The vessel is delivered safely afloat port worthy virtually intact charter free, free of cargo, free of hull/stern gland leakage seepage, free of fire damage, free of arms and ammunitions, having both her anchors in working condition and under her own Power/tow. The vessel is delivered with everything on board including __________ working propeller, __________ spare propeller ______ spare Tail Shaft/but excluding the personal effects of Master, Officers and crew and any Items on Hire. As per the terms of the relevant MA between Buyers and the Sellers for M.V. / M.T. _________________________________________ and under Instructions from the Sellers the vessel is hereby delivered to M/s. __________________________________ ______________________________________________ __ represented by Mr. ______________________________________________ ______ to whom I am also handing over all classification certificate and/or copies for hull, engines anchors etc.. including ships Registry Book. I, hereby confirm that the undersigned and Officers/Crew of the vessel do not have any outstanding dues on the vessel.

For _________ SHIPPING SERVICES PVT. LTD. (as sellers agents) MASTER Taken delivery of M.V. ___________________ at ________ hours on _________ at ALANG / ANCHORAGE at ALANG. (Sd/-) ______________________________________________ ___________________________________ 11.4 Monthly Sales-tax Return - Monthly return of Sales is to be made under the Gujarat Sales Tax Act, in the following proforma -

FORM - 28-GH (RULE-25) Registration Certificate No. ___________________ Gujarat Sales-tax Act, 1969 and Gujarat Sales-tax Rules, 1970 Declaration for Sales-tax payable as per Rule 25 I, M/s ______________________________________________ _ address ______________________________________________ ___________ Prop. / Partner/ Director /Manager ____________________________________- on oath declared that following details given by me/my firm during

business myself/firm are true and based on complete and regular books of account and all Sales or Sales shown total and taxable turnover shown are actual and that is correct and true to be the best of knowledge and belief. 1. From ________________________ to ________________ month of accounting period. 2. Sales / total turnover Rs. ________________ 3. Taxable turnover Rs. ________________ 4. Payable total Sales-tax Rs. ________________ (including additional tax) 5. Sales-tax payable as per corresponding period (Month) Rs. _______________ of the said quarter 6. 1/3 of column No. 5 Rs. ________________ 7. Total Sales-tax payable as per col. 4 or 5 Rs. ________________ 8. Total Sales tax paid Rs. ________________ No. of Challans as per Form No. 33 ____________ Signature _______________ Date and Place _______________ (Proprietor / Partner / Director)

Directorate of Income Tax ( Systems )

Investigation Manual Volume - 2 Chapter - XIII ROAD TRANSPORT

Inland transport operators Introduction 1.1 Private road transporters play a vital role in the economy by moving goods and people across the country. Transport sector is basically a service sector, and its activities are quite different from those of traders / manufacturers. In this sector, the form of organisation varies from small time proprietor-operators of single truck / bus, to large-scale public limited companies. Since the service requires network of facilities across large parts of the country, the small operators generally give their lorries on hire to the bigger operators. Therefore, most of the

goods transport is in effect conducted by medium to largescale operators. 2.1 Unlike a trader whose business transaction is in most cases concluded at his own premises with the sale of a good, the business of the road transport operator must go wherever its lorry carrying the goods goes. A road transport operator must monitor the process right from the point when the goods are received by it from the customer, to the point where the goods are delivered to the intended party. Therefore, even the small-scale operators have to depend on agents at other places far away from their own headquarters. Therefore, road transport operators, particularly the large-scale operators, develop elaborate procedures and accounting methods which, must be understood to find potential areas of concealment. Thus a typical large-scale operator may be having a hierarchy of offices from the head office to the branch or booking office at the bottom. In a case where there are a number of branches spread over a vast geographic area, the management has to depend on a hierarchy of staff at various levels for conducting the business. This has implications on how the management can siphon off funds from the business. Organisation business and accounting in road transport

3.1 Usually, a large-scale transport operator has his own fleet of lorries. He may also hire lorries from others for carrying goods, when the business so demands. He also has a definite number of routes on which he offers to carry

the goods. Branch offices or agents are located along these routes for attending to booking and delivery of consignments from different places. The hierarchy of offices may comprise the booking-cum-delivery offices, regional offices (variously known as zonal office, divisional office, and so on), and the head office. 3.2.1 Booking-cum-delivery office - The business of road transport begins at the Booking- cum- Delivery Office. These are usually small offices and may be located in small towns too. Often, where there is no branch of the operator himself, there may be an arrangement for booking and delivery through a local agent. The Booking-cum-Delivery Office accepts consignments from consignors for transport to different destinations. It also receives consignments from other stations for delivery to consignees. A booking office may be a local branch office or it could also be a regional or a higher-level office in the hierarchy. A booking office may transport goods booked by it or it may forward consignments booked by it to a higher office for transporting the goods along with other consignments to destinations on the same route. 3.2.2 Goods may be booked in one of three ways, i.e. paid, or to be paid, or to be billed. Goods may be brought to the booking office by the consignor or may be picked up from the consignor by the transport operator using local lorries. When these are picked up from the consignor, the firm may engage a local lorry for which local lorry hire charges are paid. The consignments so collected are sorted according to the destination and

route. When a lorry load of goods is ready for transport on a particular route, it is loaded on the firms own lorry or on a hired lorry. 3.2.3 Following documents are prepared at the Bookingcum-Delivery Office The Consignment note is prepared in multiple copies, one each for the consignor, the consignee, the controlling office of the booking office, the destination office, and one copy for the driver to carry en-route. All consignment notes are entered in the Booking Register with full information such as consignment number, name of consignor, name of consignee, whether paid or to be paid, whether to be door delivered or otherwise, etc. Delivery of goods is made to the consignee on production of this consignment note. The lorry hire contract is a contract between the transporter and the owner of the lorry being hired. It contains information like lorry number, starting station and destination station, number of packages loaded, weight of the consignments loaded, the rate of hire agreed upon, the total hire to be paid, advance hire paid to the driver, details of fuel filled, etc. Lorry hire payments are made to the lorry owners from whom they are hired on the basis of such contracts. This is the main evidence of lorry hire paid by the assessee firm for lorries engaged to carry goods long distance from one station to another. This document is also prepared in multiple copies meant for the driver, for office records, for the destination station, and for the regional controlling office. An advance payment is made to

the driver at the starting station. The balance hire charges are paid to the driver at the destination station on production of the lorry hire contract after delivery of the goods as per the contract. Lorry challan is another important document prepared at the booking office. It is prepared for each lorry engaged to carry goods, and contains details of consignments carried on that particular lorry. It contains the lorry number, starting station and destination station, consignment-wise details giving consignment number, name of consignor, name of consignee, weight of the consignment, whether to be door delivered or otherwise, etc. Vouchers for local lorry hire expenses, relate to hire charges incurred for engaging local lorries to pick up consignments from consignors doorstep or to make door delivery of consignments at the destination station. These vouchers contain information like lorry number, date, starting point and destination, weight of consignment being transported, hire charges paid, name of person receiving payment, etc. These may be self-prepared vouchers on the firms own stationery. Vouchers for other expenses are prepared to vouch for expenses that may be incurred by a booking office on office maintenance, stationery, telephones, petty cash expenses, etc. Usually major expenses like purchase of lorries, tyres and tubes, settlement of claims for damages, etc. is dealt with by the head office or other regional offices, and not by booking offices. Only regional offices

that have control over owned lorries might lay out even fuel expenses. The booking office may not do any elaborate accounting of its transactions. Instead it may send periodical statements or reports to its controlling regional office. Usually a statement of income and expenditure along with supporting vouchers is sent periodically. 3.3.1 Regional offices and Head office - The organisational hierarchy in transport business may vary from case to case. The nomenclature for the different hierarchies above the booking office may also vary from case to case as zonal office, divisional office, regional office, circle office and so on. In a large-scale operators case the booking offices are numerous and spread over the entire country. Other offices at a higher level of hierarchy perform supervision and control of these offices. The booking offices send periodical statements and reports of their operations to these supervisory offices. 3.3.2 It is important to be aware of how the accounting of transactions takes place. It may be usually found that accounting is done at the head office based only on the statements and reports received from other offices. This enables the management to have effective control and supervision of the offices below. In a typical case, the transactions may be accounted and ledgerised at the head office or at a few selected accounting centres. The booking offices are never involved in accounting and ledgerising transactions. However, it is at the booking office that the main expenditure, namely lorry hire, and the

main receipt, namely freight, are generated. Therefore, it is the booking office and the documents prepared there that are important for any serious investigation. 3.3.3 The owned fleet of lorries is usually controlled and maintained by regional offices. Lorries are purchased and allotted to different offices by the regional offices or by the head office. Usually a small branch office may not have any lorry under its control. In order to keep a check on running expenses of the lorries, a record is maintained for each individual lorry. A trip account sheet or some similar record is maintained for own lorries indicating the various trips made by that lorry so that the management can monitor the consumption of fuel, and other expenses on that lorry in relation to the distance run by that lorry. Examination of accounts 4.1 Like any other assessee, road transport operators can also resort to suppression of receipts and inflation of expenses. The specific method followed to conceal income will, of course, vary from case to case. As already mentioned, a transport operator operates through many branch offices. Expenses under all major heads are incurred at the booking offices. Similarly the freight receipts are collected at the booking office. Therefore, as the management is not directly connected with collection of receipts and giving out cash for expenditure, it has to necessarily depend on its lower level employees at branch level offices to siphon off cash by inflating expenses or by suppressing income. This means that for a big transport operator with branches spread over different parts of the

country, the siphoning off of cash can take place only at a few selected offices through a few trusted employees. 4.2 Some preliminary steps that are applicable to all types of assessees should be taken in these cases also. It is useful to start with a thorough study of the information already available in the office. The past assessment records of the assessee must be intensively studied and abnormal features in expenses and incomes must be noted. Data on various items of receipts and expenses must be tabulated year-wise for 4 to 5 assessment years or more. This may reveal some interesting patterns to the eye of a discerning investigator. Some useful ratios / percentages can be worked out for the different years. For example, the percentage of lorry hire charges to freight receipts; of fuel expenses to freight receipts; and so on, can be calculated. It is expected that in the normal course these percentages will vary only within a range. Any sudden jump or fall in, say the percentage of lorry hire charges to freight receipts must be looked into to ascertain the reasons. If the explanation is not satisfactory it may deserve further investigation. Similar branch-wise analysis can also be done for transport operators with wide network of branch offices, for identifying the branches where cash is siphoned out of the books. 4.3 Next, the major items of income and expenditure may be studied. The main income will be freight receipts. There could be other items of miscellaneous income from sale of old lorries, old tyres, etc. The major item of expenditure will be lorry hire charges paid for lorries hired from others. Other major items of expenses will be on purchase of

tyres and tubes, fuel expenses, repairs and maintenance of lorries and so on. The main hurdle in examining the accounts of a transport operator is that the major items of receipts and expense (that is, freight receipts and lorry hire charges) are usually in numerous small amounts of a few thousand rupees, and are very often in cash. Moreover they relate to a number of different trips made by different lorries hired from a number of parties. Therefore, detection of suppression of receipts or inflation of lorry hire charges is a painstaking, and time-consuming process requiring collation and verification of a number of vouchers or other documents. The AO would do well to start the investigation early on so that there is sufficient time to collect information and confront the assessee with incriminating evidence. This may not be a major problem if the assessee has computerised its records. If so, the assessee must be asked to produce the relevant data in accessible electronic form for quick perusal and analysis by the AO. Assessees often take pleas like the accounts are written in an old programme and will not be accessible on your computer and so on. It may be necessary to use powers under sections 131 / 133A. Even where assessees accounts are not computerised it may be possible to obtain the necessary records and get them computerised in the AOs office to the extent necessary for investigation. Computerising the assessees records is extremely helpful in detecting methods of concealment. 4.4 Assessees often use the simplest possible, and at the same time hard-to-establish methods of concealment. If suppression of receipts or inflation of a particular head of

expenditure is going to involve employees at different levels and requires fabrication of many different documents to hide the concealment, then it is unlikely that the assessee would be manipulating that particular head of income or expenditure. The difficulty or otherwise of manipulating a particular item of expenditure or income depends on how elaborate the accounting procedures are for those items. A small road transport operator with a handful of lorries may be able to manipulate every item of receipt and expenditure. The same is not the case with a large-scale operator with hundreds of lorries and an elaborate system of record keeping and accounting. 4.5.1 Suppression of freight - In some cases there may be strong reason to suspect suppression of freight receipts. This is more likely to happen in case of cash receipts. Unlike inflation of expenses, suppression of receipts does not require fabrication of evidence. Rather, it requires destruction or concealing of evidence. This requires the AO to take recourse to indirect means to establish the suppression. 4.5.2 Under the Motor Vehicles Act, every commercial motor owner is under a statutory obligation to maintain a Good Vehicle Record, wherein day-to-day details of the movement of the vehicle and cargo carried by it are entered. Besides, the assessee itself may maintain similar record (the trip account sheet for example) for monitoring expenses incurred in respect of each of its own vehicles. These records contain details of the movements of the vehicle and the freight carried by it. In addition there is also another statutory form, called Invoice, carried by the

lorry driver or the conductor, which records the goods carried by the lorry on a particular trip. These records can be used to verify whether all the trips and the connected freight receipts have been properly accounted in the assessees books. 4.5.3 The trip account sheet and other similar record maintained by the assessee will have full information on the lorrys trips and also its consumption of fuel. Even kilometre readings at the start and end of a trip are noted. From the distance covered by a lorry and the standard freight rate per ton kilometre, it will be possible to work out the freight earnings by a particular lorry during a given year. Claims of empty return trips can also be verified from the trip sheets. 4.5.4 In case the assessee maintains computerised accounts, it may be called upon to furnish party-wise and lorry-wise earnings. Party-wise earnings may be cross verified with the parties concerned and lorry-wise earnings can be checked to see if they are commensurate with the distance run by the lorry. 4.6.1 Inflation of expenses - Lorry hire charges - A major item of expenditure is the lorry hire charges paid to outsiders. As already noted, there may be two types of lorry hire charges paid. The assessee may be hiring lorries for carrying goods from one station to another station or for local pick-ups and door delivery. The records maintained are likely to be different for these two kinds of hire charges. Local lorry hire charges are small amounts, almost always in cash, and supported by assessees own

vouchers. Hire charges for long distance hiring are in bigger amounts and are based on the lorry hire contract, which is prepared in multiple copies. However, in a small operators case such elaborate documentation may not be there. Wherever possible, party-wise and lorry-wise details of the hire charges paid, must be obtained and cross verified with the lorry owners. If assessees records are not computerised, these details can be got computerised and then analysed party-wise and lorry-wise. The lorry numbers must be got verified with the Road Transport authorities. It may, sometimes, emerge that hire charges are claimed to have been paid for non-existent lorries, or for lorries that were never at the place where they are claimed to have carried the goods for the assessee. It may be also found that the same lorry is claimed to have plied to different destinations (say, from Nagpur to Chennai and also to New Delhi) on the same date. Such evidence will help establish that the assessee is booking bogus hire charges. 4.6.2 Tyres and tubes - This is another major item of expenditure, which can be inflated easily. Usually, the assessees have a system of monitoring use of tyres. Otherwise, drivers or other staff may sell off new tyres and replace them with old. In big cases with a large fleet of own lorries, records will be maintained for each tyre purchased. Usually a regional office will purchase the tyres, and the details like tyre number, the date of fitting it to a lorry, the lorry number, and the kilometre reading at the time of fitting will be noted in records maintained by the assessee. Under normal conditions, a lorry tyre runs

upto 30000 kilometres subject to variation due to circumstances like quality of roads, weather conditions, etc. Using such information in respect of tyres consumed and kilometres run by the tyres, it is possible to verify whether the purchases of tyres claimed by the assessee are normal or otherwise. Wherever bogus purchase claims are suspected, enquiries must be conducted to trace the payments claimed to have been made to the parties concerned. It may turn out that the parties are fictitious. 4.6.3 Fuel expenses - The assessee may be inflating expenditure on fuel consumed also. Most purchases are likely to be from one or a few petrol pumps on a regular basis. It should be possible to work out the average fuel consumption by the assessees lorries from their trip sheets. Normally a lorry consumes diesel at the rate of about 3 kilometres per litre. Although there may be variation in the actual consumption of diesel for a number of reasons, abnormally high consumption of fuel should always be looked into deeply. 4.6.4 Other expenses like repairs and maintenance, salaries, advertisement, etc. may also require to be investigated in particular cases. Copies of account must be called for and cross-verified with the parties concerned. Case study 5.1 The assessee, a public limited company, is a major private road transport operator with its own fleet of about 300 lorries and about 600 branches spread all over the country. The company has a hierarchy of Branch offices, Divisional offices, Regional offices, and a Head office.

There are also transhipment centres at some major cities. At these transhipment centres consignments arriving from other stations are loaded on to a different lorry for onward carriage to another station. For example, goods for Cochin may arrive at Hyderabad by a lorry hired at Chandigarh up to Hyderabad. These goods are again loaded on another lorry for transportation from Hyderabad to Cochin. The assessee has a well-laid out system of management and accounting procedures commensurate with its size of operations. In the case of this assessee the accounting of transactions are done at designated Accounting centres, which were at many cities in different states. The accounting is done on the basis of a cash and Bank statement and vouchers sent to the Accounting centre from other offices for which it was the accounting centre. The vouchers and other basic records supporting the transactions were kept at the assessees head office Accounting Centre-wise. 5.2 Based on information in the past records and some preliminary studies, local lorry hire charges paid suspected to be inflated. The assessee was asked to furnish Accounting centre-wise details of hire charges paid. It was felt that the inflation must have been done only at a few Accounting centres where the management could have direct control over a few trusted employees who could be used to fabricate vouchers. Accounting centres at stations where members of the Board of Directors lived, were considered as the likely points for verification. Out of these, two centres closest to the AOs station were chosen for a thorough study.

5.3 The assessee was asked to produce local lorry hire vouchers for the two centres selected. It produced these before the AO in gunny bags. For one centre there were 8765 vouchers, and for the other centre 11,342 vouchers. These vouchers were for small amounts of Rs. 300 to Rs. 600. Undaunted by the huge numbers, they were examined closely. It appeared that a major chunk of these had been fabricated. The vouchers contained information of date, payees name, truck number, consignment number, local starting point and destination point, amount, and initials of the employee preparing the voucher countersigned by a supervisor and manager of the accounting centre. It was found that once in about five days there were bunches of very fresh-looking vouchers, which had been prepared by one and the same employee who had also countersigned the vouchers. It was noticed that there were many suspicious features in these vouchers. For example, the names of same payees were repeated for a number of different trucks; there were abnormal patterns in the truck numbers (the same fourdigit number would appear in combination with a number of different three-alphabet codes); the amounts were always in round figures, and so on. These patterns were there because as only a few employees fabricated the vouchers, they used same names and truck numbers over and over again, due to force of habit. Since it was impossible to track down each single voucher and prove that it was fabricated, it was decided to computerise the vouchers. The entire information from all the vouchers of the two selected centres was entered in computer, and sorted on various parameters to isolate only those

vouchers that had the suspicious features. In one centre about 1500 such vouchers were identified and in the second centre there were about 5000 such vouchers. It was found that two particular employees had prepared all these vouchers, whereas different employees had prepared the other vouchers on different occasions. In one centre it was the cashier who was engaged to fabricate the vouchers. The truck numbers on all these vouchers were listed and sent to various parts of the country for verification from the Road Transport authorities. The results were astounding. In a majority of cases where reports were received, it was found that either the vehicles never existed or the Registration numbers were of light vehicles like mopeds, scooters, auto rickshaws and so on. In some cases the numbers were of buses belonging to State Road Transport Corporations! It was then decided to examine the concerned employees. By then, however, the assessee got wind of the investigations and removed them from its employment. 5.4 The results of the investigations were put to the assessee who was asked to show cause why the expenditure claimed in those vouchers should not be disallowed. The assessee merely dodged the issue by raising questions about the enquiries, asking for copies of the enquiry reports, and so on. The assessment was completed making substantial addition on this ground. The additions have been confirmed in first appeal. 5.5 In the same case it was found that the assessee had also inflated expenditure on tyres and tubes. The assessee was asked to furnish details of purchases of tyre

for the various offices, which had incurred the expenditure. It was found that at one place the expenditure claimed was abnormally high compared to the number of trucks at that office. Examination of the bills strengthened the suspicion. Enquiries were conducted and the alleged suppliers were found to be non-existent. Quantitative details on tyres purchased and number of trucks using those tyres were also used to show that there was excessive consumption of tyres in that office. Substantial addition was made under this head also. Road transport Industry Introduction 6.1 Transport of bulk or Container cargo from ports to destinations hinterland is a major part of the road transport operations. However, the nature of this activity is in many ways different from inland transporters discussed so far. These transporters are closely connected with Shipping and Clearing / Forwarding agents. Shipping agents 7.1 The functions of Shipping agents include canvassing for and managing the business of their Principals (i.e. the foreign ship owners / Charterers) in India. They have to strive for maximising the freight / cargo being carried on the ships of their Principals arriving at Indian ports. They provide services to the Principals ships while in Indian ports, and are responsible for loading and unloading of containers / cargo on these ships. In turn, they engage operators catering to shipping

various contractors for providing services, for example, transporters for handling the cargo inside the port, Stevedores for stuffing and destuffing the cargo, Chandlers for provisions supplied to the ships, etc. The agents collect the freight and make payments to these contractors. They receive agency commission, of about 4% for rendering these services. Shipping agents also undertake the work of handling the import / export cargo of Indian importer / exporter. 7.2 The accounting system followed by Shipping agents needs to be understood. The shipping agents receives the Gross freight, Terminal Handling charges (THC), and Inland Haulage charges (IHC) from the importers / exporters referred to as the Shipper. The THC is fixed by the port authorities and includes transportation and handling charges for the containers inside the port and stevedoring charges for stuffing and destuffing of containers. The IHC is for transportation of containers from the Inland Container Depots (ICD) to the port of shipment. 7.3 All these receipts are credited to an account in the books of the agent called the Vessel Voyage Collection Account. The payments to various contractors such as transporters, stevedores, and other payments towards inland haulage, freight rebate, and freight brokerage are debited to an account called the Vessel Voyage Disbursement Account. These accounts are maintained vessel-wise and voyage-wise. For example, a vessel called Lanka Ruwan belonging to a Principal called CSCL

arrives for the 10th time and the voyage is then referred to as Lanka Ruwan 10, the accounts shall be called Lanka Ruwan 10 Collection Account and Lanka Ruwan 10 Disbursement Account. After about a month of the sailing of the vessel or thereabouts, the Shipping agent applies to the RBI to allow him to remit the surplus of the collection over the disbursement to the Principal. The RBI rules stipulate that before remittance, all expenses in connection with the voyage should either have been provided for, or paid. The Shipping agent has to certify the same. Hence, before seeking permission for remittance, the agent debits all expenses to the Vessel Voyage Disbursement Account, or debits provisions for the same. The balance of this account is then transferred to the Principals general account in the books of the agent. Similarly, the amount of freight received as well as receivable as per the Cargo Manifest is debited to the Vessel Voyage Collection Account, and credited to the Principals general account. From the general account the amounts are repatriated after obtaining permission of the RBI. Generally, full freight is received after a considerable lapse of time and hence, the total freight receivable including freight received is credited to the Principals general account by debiting the Vessel Voyage Collection Account. Thus, to the extent the freight is still receivable, the Vessel Voyage Collection Account shows a debit balance, which is the sum, total of the amount outstanding against different shippers. The two voyage accounts referred to above are together commonly referred to as the Voyage Account.

7.4 There are certain expenses not directly related to the voyage such as repair of the Principals containers, which are directly debited to the Principals general account. The only expense pertaining to the voyage, which can be debited after the remittance of the freight, is the ground rent charged by the Port Trust. One of the expenses debited to the Vessel Voyage Disbursement Account is the agency commission receivable by the agent, which is then credited to the agents P & L a/c. Other receipts and payments from the Voyage accounts are not credited or debited to the P & L account of the agent. The balances of all accounts however appear in the balance sheet of the Agent. The Agents P & L account, on the other hand, reflects receipt of agency commission and expenditure incurred in maintenance of staff and office etc. 7.5 Another charge collected by the Agent from the Shipper (importer / exporter), on behalf of the Principal is called Container Detention Charge (CDC). This charge is collected at rates fixed by the Director General (Shipping), and Port Trusts. This is dependent on the number of days that the container remains within the port. At present the peak rate of CDC in the Mumbai port is 48 USD per 20 ft container. However, the entire amount of the CDC is not repatriable to the Principal. Only 12.5 USD per container is repatriable and the balance collection has to be held on behalf of the Principal by the Shipping agents till such time as the permission is given by the RBI to repatriate the same. In the Chennai port, the peak rate for a 20 ft container is 15 USD. Container handlers / transporters

8.1 The shipping agents engage transporters / container handlers for transportation within the Port area as well as for inland transport. Often, the transporters, in return for the contracts received, pay cash kickbacks / commission to the Shipping agents. Container handlers by the very nature of the services provided couldnt have unaccounted receipts except in one specific function discussed later. They have to account for their receipts because the Shipping agent who is making payment to them is doing it on behalf of its Principal, and each and every payment has to be accounted for. Moreover, it is a deductible expense for the shipper, and he in turn requires bills for the same. Hence, to generate the required cash for paying cash commissions to the Shipping agent, the transporter has to book bogus expenses. The rates fixed between Shipping agents (on behalf of the Principal), and the transporters are exorbitant, primarily because the commissions that the agent expects to receive are built into these. For example, at Mumbai port, the rate for moving one 20 ft container from the Container Freight Station (CFI) to the hook point (approx. 1 km) ranges from Rs. 2,200 to Rs. 2,400. Similarly, the rate for moving an empty container from CFI to storage yard is in the region of Rs. 700, and for stacking the same in the storage yard it ranges from Rs. 300 to Rs. 400/-. Searches in the case of prominent transporters brought out evidence showing that bogus expenses are claimed under different heads discussed below. 8.2 Spare parts and repairs - This is the easiest area where bogus expenditure can be introduced. False vouchers are readily available through brokers and in

return for cheques issued, cash is handed back on payment of a small commission (normally 3%). In one case, it was seen that bills had been obtained from brokers in the names of non-existent parties. These parties would appear as sundry creditors in the books of the assessee, for long periods and as and when cash was required cheques would be drawn in the names of these parties and handed over to the brokers and cash received. On detailed enquiries, it was seen that cheques drawn by the assessee were deposited in the bank accounts opened in the names of these non-existent parties, and on the same day, the entire amount was withdrawn in cash. Moreover, the parties in whose names the bills were given were not traceable at the stated address. In fact the addresses given were bogus. The introducer of all the accounts was the same person, who could also not be traced. In another case, accounts had been opened by the assessee itself and were operated by the staff members. Passbooks and chequebooks of the accounts in the names of the bogus parties were found during the search. The AOs conducting enquiries in such cases should trace the route of such cheques issued in the names of parties who appear bogus especially those, which appear as sundry creditors from year to year. 8.3 Tyres - Specialised tyres, such as 1000/20 tyres, are consumed by these transporters. The bills are normally received from registered dealers of major tyre manufacturers. The dealer cannot normally issue bogus bills since the discrepancy can be easily detected on verification of his Stock register and his purchase bills. In

one case, documentary evidence was found which showed that the dealer was giving bills to the assessee in respect of tyres sold to other parties who had made cash purchases and had not taken bills. However, without documentary evidence it shall be difficult to prove such a transaction. The AOs should however scrutinise the books for payments made to unregistered dealers for purchase of tyres. 8.4 Petrol and diesel - A major head of expenditure is purchase of petrol and diesel. In the case of an assessee, documentary evidence was found which showed that bills were issued to the assessee by registered dealers, in respect of sale of diesel made in cash to parties who did not take the bills or who did not require bills. Here again since the Stock register shall tally and also because the transaction is recorded at all ends, it is difficult to prove concealment in the absence of documentary evidence. 8.5 Spare parts - In the search case mentioned earlier, it was noticed that bulk of bogus billing was on spare parts, which is easily identifiable. 8.6 Cash cartage - Another area of concealment detected in the cases of such transporters, pertains to suppression of cash cartage receipts. As discussed above this is the only area where the transporters can receive cash and can manipulate receipts. 8.6.1 Cash cartage refers to receipts of cartage in cash at the Container Freight Stations (CFS) in the port area for loading and unloading of containers. The main business of these transporters is movement and handling of

containers inside the Port area. They receive stuffed export containers after custom examination, at predesignated points called CFS. The transporter is required to load the containers on to his trailer at the CFS, and then to carry it from point to point inside the Port like the stack point, storage yard, hook point, etc., for various purposes, and finally to load these on the ship. For this, they utilise their trailers, forklifts, cranes and top-lifters etc. 8.6.2 In respect of imports, these transporters have to unload the container from the ship and after moving it inside the port, to deliver it at the CFS for examination by the Customs. They are under contract with various Shipping agents for performing these services, and receive payments at prefixed rates in cheque from the Shipping agents. However, sometimes after the examination of an import container by the Customs authorities, the importer may wish to carry his cargo to his factory in the container itself, rather than unload the cargo and move it in loose form on some truck. Hence, the container has to be loaded on the importers hired truck by forklift / cranes of these transporters. 8.6.3 Similarly, in respect of exports the exporter may sometimes send his cargo in a container from his factory itself rather than send it in a truck in bulk form and stuff it on to a container at the CFS. For unloading the container from the exporters hired truck / trailer at the CFS for examination by customs and onward movement and loading of container on the ship after examination by the Customs, these transporters receive cartage over and

above what is received as per the contract with the Shipping agent. 8.6.4 This cartage is received at a rate of Rs. 400/- per 20 ft container, as fixed by transporters. The rationale behind such charges, according to the transporters, is that their contracts with the Shipping agents cover movement of containers inside the Port area upto unloading of import containers and loading of export containers at the CFS. This extra loading / unloading of some containers at the CFS is not covered by the contract. Moreover, although the CFS is in the Port area it is deemed to be outside it and the contract with the Shipping agent is only for movement inside the Port area. This cartage is received in cash by the transporters from the exporters and importers or their Clearing agents. 8.6.5 The Clearing agents who handle such movement in the CFS always make payments in cash because they submit a lump sum bill to their customers i.e. Importers / Exporters, covering all services rendered. No supporting bills are given and in turn the Clearing agents withdraw cash and make cash payments. Since a major part of their expenses are speed money paid in the Port area and Custom house, they prefer such a system. In a search case, documentary evidence in the form of diaries indicating actual receipts were found in the possession of the Supervisor in charge of their Port operations, showing that only 1/3 rd of such receipts were being accounted. Directorate of Income Tax ( Systems )

Investigation Manual Volume - 2 Chapter - XIII ROAD TRANSPORT

Inland transport operators Introduction 1.1 Private road transporters play a vital role in the economy by moving goods and people across the country. Transport sector is basically a service sector, and its activities are quite different from those of traders / manufacturers. In this sector, the form of organisation varies from small time proprietor-operators of single truck / bus, to large-scale public limited companies. Since the service requires network of facilities across large parts of the country, the small operators generally give their lorries on hire to the bigger operators. Therefore, most of the goods transport is in effect conducted by medium to largescale operators. 2.1 Unlike a trader whose business transaction is in most cases concluded at his own premises with the sale of a good, the business of the road transport operator must go

wherever its lorry carrying the goods goes. A road transport operator must monitor the process right from the point when the goods are received by it from the customer, to the point where the goods are delivered to the intended party. Therefore, even the small-scale operators have to depend on agents at other places far away from their own headquarters. Therefore, road transport operators, particularly the large-scale operators, develop elaborate procedures and accounting methods which, must be understood to find potential areas of concealment. Thus a typical large-scale operator may be having a hierarchy of offices from the head office to the branch or booking office at the bottom. In a case where there are a number of branches spread over a vast geographic area, the management has to depend on a hierarchy of staff at various levels for conducting the business. This has implications on how the management can siphon off funds from the business. Organisation business and accounting in road transport

3.1 Usually, a large-scale transport operator has his own fleet of lorries. He may also hire lorries from others for carrying goods, when the business so demands. He also has a definite number of routes on which he offers to carry the goods. Branch offices or agents are located along these routes for attending to booking and delivery of consignments from different places. The hierarchy of offices may comprise the booking-cum-delivery offices, regional offices (variously known as zonal office, divisional office, and so on), and the head office.

3.2.1 Booking-cum-delivery office - The business of road transport begins at the Booking- cum- Delivery Office. These are usually small offices and may be located in small towns too. Often, where there is no branch of the operator himself, there may be an arrangement for booking and delivery through a local agent. The Booking-cum-Delivery Office accepts consignments from consignors for transport to different destinations. It also receives consignments from other stations for delivery to consignees. A booking office may be a local branch office or it could also be a regional or a higher-level office in the hierarchy. A booking office may transport goods booked by it or it may forward consignments booked by it to a higher office for transporting the goods along with other consignments to destinations on the same route. 3.2.2 Goods may be booked in one of three ways, i.e. paid, or to be paid, or to be billed. Goods may be brought to the booking office by the consignor or may be picked up from the consignor by the transport operator using local lorries. When these are picked up from the consignor, the firm may engage a local lorry for which local lorry hire charges are paid. The consignments so collected are sorted according to the destination and route. When a lorry load of goods is ready for transport on a particular route, it is loaded on the firms own lorry or on a hired lorry. 3.2.3 Following documents are prepared at the Bookingcum-Delivery Office -

The Consignment note is prepared in multiple copies, one each for the consignor, the consignee, the controlling office of the booking office, the destination office, and one copy for the driver to carry en-route. All consignment notes are entered in the Booking Register with full information such as consignment number, name of consignor, name of consignee, whether paid or to be paid, whether to be door delivered or otherwise, etc. Delivery of goods is made to the consignee on production of this consignment note. The lorry hire contract is a contract between the transporter and the owner of the lorry being hired. It contains information like lorry number, starting station and destination station, number of packages loaded, weight of the consignments loaded, the rate of hire agreed upon, the total hire to be paid, advance hire paid to the driver, details of fuel filled, etc. Lorry hire payments are made to the lorry owners from whom they are hired on the basis of such contracts. This is the main evidence of lorry hire paid by the assessee firm for lorries engaged to carry goods long distance from one station to another. This document is also prepared in multiple copies meant for the driver, for office records, for the destination station, and for the regional controlling office. An advance payment is made to the driver at the starting station. The balance hire charges are paid to the driver at the destination station on production of the lorry hire contract after delivery of the goods as per the contract.

Lorry challan is another important document prepared at the booking office. It is prepared for each lorry engaged to carry goods, and contains details of consignments carried on that particular lorry. It contains the lorry number, starting station and destination station, consignment-wise details giving consignment number, name of consignor, name of consignee, weight of the consignment, whether to be door delivered or otherwise, etc. Vouchers for local lorry hire expenses, relate to hire charges incurred for engaging local lorries to pick up consignments from consignors doorstep or to make door delivery of consignments at the destination station. These vouchers contain information like lorry number, date, starting point and destination, weight of consignment being transported, hire charges paid, name of person receiving payment, etc. These may be self-prepared vouchers on the firms own stationery. Vouchers for other expenses are prepared to vouch for expenses that may be incurred by a booking office on office maintenance, stationery, telephones, petty cash expenses, etc. Usually major expenses like purchase of lorries, tyres and tubes, settlement of claims for damages, etc. is dealt with by the head office or other regional offices, and not by booking offices. Only regional offices that have control over owned lorries might lay out even fuel expenses. The booking office may not do any elaborate accounting of its transactions. Instead it may send periodical statements or reports to its controlling regional office. Usually a

statement of income and expenditure supporting vouchers is sent periodically.

along

with

3.3.1 Regional offices and Head office - The organisational hierarchy in transport business may vary from case to case. The nomenclature for the different hierarchies above the booking office may also vary from case to case as zonal office, divisional office, regional office, circle office and so on. In a large-scale operators case the booking offices are numerous and spread over the entire country. Other offices at a higher level of hierarchy perform supervision and control of these offices. The booking offices send periodical statements and reports of their operations to these supervisory offices. 3.3.2 It is important to be aware of how the accounting of transactions takes place. It may be usually found that accounting is done at the head office based only on the statements and reports received from other offices. This enables the management to have effective control and supervision of the offices below. In a typical case, the transactions may be accounted and ledgerised at the head office or at a few selected accounting centres. The booking offices are never involved in accounting and ledgerising transactions. However, it is at the booking office that the main expenditure, namely lorry hire, and the main receipt, namely freight, are generated. Therefore, it is the booking office and the documents prepared there that are important for any serious investigation. 3.3.3 The owned fleet of lorries is usually controlled and maintained by regional offices. Lorries are purchased and

allotted to different offices by the regional offices or by the head office. Usually a small branch office may not have any lorry under its control. In order to keep a check on running expenses of the lorries, a record is maintained for each individual lorry. A trip account sheet or some similar record is maintained for own lorries indicating the various trips made by that lorry so that the management can monitor the consumption of fuel, and other expenses on that lorry in relation to the distance run by that lorry. Examination of accounts 4.1 Like any other assessee, road transport operators can also resort to suppression of receipts and inflation of expenses. The specific method followed to conceal income will, of course, vary from case to case. As already mentioned, a transport operator operates through many branch offices. Expenses under all major heads are incurred at the booking offices. Similarly the freight receipts are collected at the booking office. Therefore, as the management is not directly connected with collection of receipts and giving out cash for expenditure, it has to necessarily depend on its lower level employees at branch level offices to siphon off cash by inflating expenses or by suppressing income. This means that for a big transport operator with branches spread over different parts of the country, the siphoning off of cash can take place only at a few selected offices through a few trusted employees. 4.2 Some preliminary steps that are applicable to all types of assessees should be taken in these cases also. It is useful to start with a thorough study of the information

already available in the office. The past assessment records of the assessee must be intensively studied and abnormal features in expenses and incomes must be noted. Data on various items of receipts and expenses must be tabulated year-wise for 4 to 5 assessment years or more. This may reveal some interesting patterns to the eye of a discerning investigator. Some useful ratios / percentages can be worked out for the different years. For example, the percentage of lorry hire charges to freight receipts; of fuel expenses to freight receipts; and so on, can be calculated. It is expected that in the normal course these percentages will vary only within a range. Any sudden jump or fall in, say the percentage of lorry hire charges to freight receipts must be looked into to ascertain the reasons. If the explanation is not satisfactory it may deserve further investigation. Similar branch-wise analysis can also be done for transport operators with wide network of branch offices, for identifying the branches where cash is siphoned out of the books. 4.3 Next, the major items of income and expenditure may be studied. The main income will be freight receipts. There could be other items of miscellaneous income from sale of old lorries, old tyres, etc. The major item of expenditure will be lorry hire charges paid for lorries hired from others. Other major items of expenses will be on purchase of tyres and tubes, fuel expenses, repairs and maintenance of lorries and so on. The main hurdle in examining the accounts of a transport operator is that the major items of receipts and expense (that is, freight receipts and lorry hire charges) are usually in numerous small amounts of a

few thousand rupees, and are very often in cash. Moreover they relate to a number of different trips made by different lorries hired from a number of parties. Therefore, detection of suppression of receipts or inflation of lorry hire charges is a painstaking, and time-consuming process requiring collation and verification of a number of vouchers or other documents. The AO would do well to start the investigation early on so that there is sufficient time to collect information and confront the assessee with incriminating evidence. This may not be a major problem if the assessee has computerised its records. If so, the assessee must be asked to produce the relevant data in accessible electronic form for quick perusal and analysis by the AO. Assessees often take pleas like the accounts are written in an old programme and will not be accessible on your computer and so on. It may be necessary to use powers under sections 131 / 133A. Even where assessees accounts are not computerised it may be possible to obtain the necessary records and get them computerised in the AOs office to the extent necessary for investigation. Computerising the assessees records is extremely helpful in detecting methods of concealment. 4.4 Assessees often use the simplest possible, and at the same time hard-to-establish methods of concealment. If suppression of receipts or inflation of a particular head of expenditure is going to involve employees at different levels and requires fabrication of many different documents to hide the concealment, then it is unlikely that the assessee would be manipulating that particular head of income or expenditure. The difficulty or otherwise of

manipulating a particular item of expenditure or income depends on how elaborate the accounting procedures are for those items. A small road transport operator with a handful of lorries may be able to manipulate every item of receipt and expenditure. The same is not the case with a large-scale operator with hundreds of lorries and an elaborate system of record keeping and accounting. 4.5.1 Suppression of freight - In some cases there may be strong reason to suspect suppression of freight receipts. This is more likely to happen in case of cash receipts. Unlike inflation of expenses, suppression of receipts does not require fabrication of evidence. Rather, it requires destruction or concealing of evidence. This requires the AO to take recourse to indirect means to establish the suppression. 4.5.2 Under the Motor Vehicles Act, every commercial motor owner is under a statutory obligation to maintain a Good Vehicle Record, wherein day-to-day details of the movement of the vehicle and cargo carried by it are entered. Besides, the assessee itself may maintain similar record (the trip account sheet for example) for monitoring expenses incurred in respect of each of its own vehicles. These records contain details of the movements of the vehicle and the freight carried by it. In addition there is also another statutory form, called Invoice, carried by the lorry driver or the conductor, which records the goods carried by the lorry on a particular trip. These records can be used to verify whether all the trips and the connected freight receipts have been properly accounted in the assessees books.

4.5.3 The trip account sheet and other similar record maintained by the assessee will have full information on the lorrys trips and also its consumption of fuel. Even kilometre readings at the start and end of a trip are noted. From the distance covered by a lorry and the standard freight rate per ton kilometre, it will be possible to work out the freight earnings by a particular lorry during a given year. Claims of empty return trips can also be verified from the trip sheets. 4.5.4 In case the assessee maintains computerised accounts, it may be called upon to furnish party-wise and lorry-wise earnings. Party-wise earnings may be cross verified with the parties concerned and lorry-wise earnings can be checked to see if they are commensurate with the distance run by the lorry. 4.6.1 Inflation of expenses - Lorry hire charges - A major item of expenditure is the lorry hire charges paid to outsiders. As already noted, there may be two types of lorry hire charges paid. The assessee may be hiring lorries for carrying goods from one station to another station or for local pick-ups and door delivery. The records maintained are likely to be different for these two kinds of hire charges. Local lorry hire charges are small amounts, almost always in cash, and supported by assessees own vouchers. Hire charges for long distance hiring are in bigger amounts and are based on the lorry hire contract, which is prepared in multiple copies. However, in a small operators case such elaborate documentation may not be there. Wherever possible, party-wise and lorry-wise details of the hire charges paid, must be obtained and cross

verified with the lorry owners. If assessees records are not computerised, these details can be got computerised and then analysed party-wise and lorry-wise. The lorry numbers must be got verified with the Road Transport authorities. It may, sometimes, emerge that hire charges are claimed to have been paid for non-existent lorries, or for lorries that were never at the place where they are claimed to have carried the goods for the assessee. It may be also found that the same lorry is claimed to have plied to different destinations (say, from Nagpur to Chennai and also to New Delhi) on the same date. Such evidence will help establish that the assessee is booking bogus hire charges. 4.6.2 Tyres and tubes - This is another major item of expenditure, which can be inflated easily. Usually, the assessees have a system of monitoring use of tyres. Otherwise, drivers or other staff may sell off new tyres and replace them with old. In big cases with a large fleet of own lorries, records will be maintained for each tyre purchased. Usually a regional office will purchase the tyres, and the details like tyre number, the date of fitting it to a lorry, the lorry number, and the kilometre reading at the time of fitting will be noted in records maintained by the assessee. Under normal conditions, a lorry tyre runs upto 30000 kilometres subject to variation due to circumstances like quality of roads, weather conditions, etc. Using such information in respect of tyres consumed and kilometres run by the tyres, it is possible to verify whether the purchases of tyres claimed by the assessee are normal or otherwise. Wherever bogus purchase claims

are suspected, enquiries must be conducted to trace the payments claimed to have been made to the parties concerned. It may turn out that the parties are fictitious. 4.6.3 Fuel expenses - The assessee may be inflating expenditure on fuel consumed also. Most purchases are likely to be from one or a few petrol pumps on a regular basis. It should be possible to work out the average fuel consumption by the assessees lorries from their trip sheets. Normally a lorry consumes diesel at the rate of about 3 kilometres per litre. Although there may be variation in the actual consumption of diesel for a number of reasons, abnormally high consumption of fuel should always be looked into deeply. 4.6.4 Other expenses like repairs and maintenance, salaries, advertisement, etc. may also require to be investigated in particular cases. Copies of account must be called for and cross-verified with the parties concerned. Case study 5.1 The assessee, a public limited company, is a major private road transport operator with its own fleet of about 300 lorries and about 600 branches spread all over the country. The company has a hierarchy of Branch offices, Divisional offices, Regional offices, and a Head office. There are also transhipment centres at some major cities. At these transhipment centres consignments arriving from other stations are loaded on to a different lorry for onward carriage to another station. For example, goods for Cochin may arrive at Hyderabad by a lorry hired at Chandigarh up to Hyderabad. These goods are again loaded on another

lorry for transportation from Hyderabad to Cochin. The assessee has a well-laid out system of management and accounting procedures commensurate with its size of operations. In the case of this assessee the accounting of transactions are done at designated Accounting centres, which were at many cities in different states. The accounting is done on the basis of a cash and Bank statement and vouchers sent to the Accounting centre from other offices for which it was the accounting centre. The vouchers and other basic records supporting the transactions were kept at the assessees head office Accounting Centre-wise. 5.2 Based on information in the past records and some preliminary studies, local lorry hire charges paid suspected to be inflated. The assessee was asked to furnish Accounting centre-wise details of hire charges paid. It was felt that the inflation must have been done only at a few Accounting centres where the management could have direct control over a few trusted employees who could be used to fabricate vouchers. Accounting centres at stations where members of the Board of Directors lived, were considered as the likely points for verification. Out of these, two centres closest to the AOs station were chosen for a thorough study. 5.3 The assessee was asked to produce local lorry hire vouchers for the two centres selected. It produced these before the AO in gunny bags. For one centre there were 8765 vouchers, and for the other centre 11,342 vouchers. These vouchers were for small amounts of Rs. 300 to Rs. 600. Undaunted by the huge numbers, they were

examined closely. It appeared that a major chunk of these had been fabricated. The vouchers contained information of date, payees name, truck number, consignment number, local starting point and destination point, amount, and initials of the employee preparing the voucher countersigned by a supervisor and manager of the accounting centre. It was found that once in about five days there were bunches of very fresh-looking vouchers, which had been prepared by one and the same employee who had also countersigned the vouchers. It was noticed that there were many suspicious features in these vouchers. For example, the names of same payees were repeated for a number of different trucks; there were abnormal patterns in the truck numbers (the same fourdigit number would appear in combination with a number of different three-alphabet codes); the amounts were always in round figures, and so on. These patterns were there because as only a few employees fabricated the vouchers, they used same names and truck numbers over and over again, due to force of habit. Since it was impossible to track down each single voucher and prove that it was fabricated, it was decided to computerise the vouchers. The entire information from all the vouchers of the two selected centres was entered in computer, and sorted on various parameters to isolate only those vouchers that had the suspicious features. In one centre about 1500 such vouchers were identified and in the second centre there were about 5000 such vouchers. It was found that two particular employees had prepared all these vouchers, whereas different employees had prepared the other vouchers on different occasions. In one

centre it was the cashier who was engaged to fabricate the vouchers. The truck numbers on all these vouchers were listed and sent to various parts of the country for verification from the Road Transport authorities. The results were astounding. In a majority of cases where reports were received, it was found that either the vehicles never existed or the Registration numbers were of light vehicles like mopeds, scooters, auto rickshaws and so on. In some cases the numbers were of buses belonging to State Road Transport Corporations! It was then decided to examine the concerned employees. By then, however, the assessee got wind of the investigations and removed them from its employment. 5.4 The results of the investigations were put to the assessee who was asked to show cause why the expenditure claimed in those vouchers should not be disallowed. The assessee merely dodged the issue by raising questions about the enquiries, asking for copies of the enquiry reports, and so on. The assessment was completed making substantial addition on this ground. The additions have been confirmed in first appeal. 5.5 In the same case it was found that the assessee had also inflated expenditure on tyres and tubes. The assessee was asked to furnish details of purchases of tyre for the various offices, which had incurred the expenditure. It was found that at one place the expenditure claimed was abnormally high compared to the number of trucks at that office. Examination of the bills strengthened the suspicion. Enquiries were conducted and the alleged suppliers were found to be non-existent. Quantitative

details on tyres purchased and number of trucks using those tyres were also used to show that there was excessive consumption of tyres in that office. Substantial addition was made under this head also. Road transport Industry Introduction 6.1 Transport of bulk or Container cargo from ports to destinations hinterland is a major part of the road transport operations. However, the nature of this activity is in many ways different from inland transporters discussed so far. These transporters are closely connected with Shipping and Clearing / Forwarding agents. Shipping agents 7.1 The functions of Shipping agents include canvassing for and managing the business of their Principals (i.e. the foreign ship owners / Charterers) in India. They have to strive for maximising the freight / cargo being carried on the ships of their Principals arriving at Indian ports. They provide services to the Principals ships while in Indian ports, and are responsible for loading and unloading of containers / cargo on these ships. In turn, they engage various contractors for providing services, for example, transporters for handling the cargo inside the port, Stevedores for stuffing and destuffing the cargo, Chandlers for provisions supplied to the ships, etc. The agents collect the freight and make payments to these contractors. They receive agency commission, of about operators catering to shipping

4% for rendering these services. Shipping agents also undertake the work of handling the import / export cargo of Indian importer / exporter. 7.2 The accounting system followed by Shipping agents needs to be understood. The shipping agents receives the Gross freight, Terminal Handling charges (THC), and Inland Haulage charges (IHC) from the importers / exporters referred to as the Shipper. The THC is fixed by the port authorities and includes transportation and handling charges for the containers inside the port and stevedoring charges for stuffing and destuffing of containers. The IHC is for transportation of containers from the Inland Container Depots (ICD) to the port of shipment. 7.3 All these receipts are credited to an account in the books of the agent called the Vessel Voyage Collection Account. The payments to various contractors such as transporters, stevedores, and other payments towards inland haulage, freight rebate, and freight brokerage are debited to an account called the Vessel Voyage Disbursement Account. These accounts are maintained vessel-wise and voyage-wise. For example, a vessel called Lanka Ruwan belonging to a Principal called CSCL arrives for the 10th time and the voyage is then referred to as Lanka Ruwan 10, the accounts shall be called Lanka Ruwan 10 Collection Account and Lanka Ruwan 10 Disbursement Account. After about a month of the sailing of the vessel or thereabouts, the Shipping agent applies to the RBI to allow him to remit the surplus of the collection

over the disbursement to the Principal. The RBI rules stipulate that before remittance, all expenses in connection with the voyage should either have been provided for, or paid. The Shipping agent has to certify the same. Hence, before seeking permission for remittance, the agent debits all expenses to the Vessel Voyage Disbursement Account, or debits provisions for the same. The balance of this account is then transferred to the Principals general account in the books of the agent. Similarly, the amount of freight received as well as receivable as per the Cargo Manifest is debited to the Vessel Voyage Collection Account, and credited to the Principals general account. From the general account the amounts are repatriated after obtaining permission of the RBI. Generally, full freight is received after a considerable lapse of time and hence, the total freight receivable including freight received is credited to the Principals general account by debiting the Vessel Voyage Collection Account. Thus, to the extent the freight is still receivable, the Vessel Voyage Collection Account shows a debit balance, which is the sum, total of the amount outstanding against different shippers. The two voyage accounts referred to above are together commonly referred to as the Voyage Account. 7.4 There are certain expenses not directly related to the voyage such as repair of the Principals containers, which are directly debited to the Principals general account. The only expense pertaining to the voyage, which can be debited after the remittance of the freight, is the ground rent charged by the Port Trust. One of the expenses

debited to the Vessel Voyage Disbursement Account is the agency commission receivable by the agent, which is then credited to the agents P & L a/c. Other receipts and payments from the Voyage accounts are not credited or debited to the P & L account of the agent. The balances of all accounts however appear in the balance sheet of the Agent. The Agents P & L account, on the other hand, reflects receipt of agency commission and expenditure incurred in maintenance of staff and office etc. 7.5 Another charge collected by the Agent from the Shipper (importer / exporter), on behalf of the Principal is called Container Detention Charge (CDC). This charge is collected at rates fixed by the Director General (Shipping), and Port Trusts. This is dependent on the number of days that the container remains within the port. At present the peak rate of CDC in the Mumbai port is 48 USD per 20 ft container. However, the entire amount of the CDC is not repatriable to the Principal. Only 12.5 USD per container is repatriable and the balance collection has to be held on behalf of the Principal by the Shipping agents till such time as the permission is given by the RBI to repatriate the same. In the Chennai port, the peak rate for a 20 ft container is 15 USD. Container handlers / transporters 8.1 The shipping agents engage transporters / container handlers for transportation within the Port area as well as for inland transport. Often, the transporters, in return for the contracts received, pay cash kickbacks / commission to the Shipping agents. Container handlers by the very

nature of the services provided couldnt have unaccounted receipts except in one specific function discussed later. They have to account for their receipts because the Shipping agent who is making payment to them is doing it on behalf of its Principal, and each and every payment has to be accounted for. Moreover, it is a deductible expense for the shipper, and he in turn requires bills for the same. Hence, to generate the required cash for paying cash commissions to the Shipping agent, the transporter has to book bogus expenses. The rates fixed between Shipping agents (on behalf of the Principal), and the transporters are exorbitant, primarily because the commissions that the agent expects to receive are built into these. For example, at Mumbai port, the rate for moving one 20 ft container from the Container Freight Station (CFI) to the hook point (approx. 1 km) ranges from Rs. 2,200 to Rs. 2,400. Similarly, the rate for moving an empty container from CFI to storage yard is in the region of Rs. 700, and for stacking the same in the storage yard it ranges from Rs. 300 to Rs. 400/-. Searches in the case of prominent transporters brought out evidence showing that bogus expenses are claimed under different heads discussed below. 8.2 Spare parts and repairs - This is the easiest area where bogus expenditure can be introduced. False vouchers are readily available through brokers and in return for cheques issued, cash is handed back on payment of a small commission (normally 3%). In one case, it was seen that bills had been obtained from brokers in the names of non-existent parties. These parties would appear as sundry creditors in the books of

the assessee, for long periods and as and when cash was required cheques would be drawn in the names of these parties and handed over to the brokers and cash received. On detailed enquiries, it was seen that cheques drawn by the assessee were deposited in the bank accounts opened in the names of these non-existent parties, and on the same day, the entire amount was withdrawn in cash. Moreover, the parties in whose names the bills were given were not traceable at the stated address. In fact the addresses given were bogus. The introducer of all the accounts was the same person, who could also not be traced. In another case, accounts had been opened by the assessee itself and were operated by the staff members. Passbooks and chequebooks of the accounts in the names of the bogus parties were found during the search. The AOs conducting enquiries in such cases should trace the route of such cheques issued in the names of parties who appear bogus especially those, which appear as sundry creditors from year to year. 8.3 Tyres - Specialised tyres, such as 1000/20 tyres, are consumed by these transporters. The bills are normally received from registered dealers of major tyre manufacturers. The dealer cannot normally issue bogus bills since the discrepancy can be easily detected on verification of his Stock register and his purchase bills. In one case, documentary evidence was found which showed that the dealer was giving bills to the assessee in respect of tyres sold to other parties who had made cash purchases and had not taken bills. However, without documentary evidence it shall be difficult to prove such a

transaction. The AOs should however scrutinise the books for payments made to unregistered dealers for purchase of tyres. 8.4 Petrol and diesel - A major head of expenditure is purchase of petrol and diesel. In the case of an assessee, documentary evidence was found which showed that bills were issued to the assessee by registered dealers, in respect of sale of diesel made in cash to parties who did not take the bills or who did not require bills. Here again since the Stock register shall tally and also because the transaction is recorded at all ends, it is difficult to prove concealment in the absence of documentary evidence. 8.5 Spare parts - In the search case mentioned earlier, it was noticed that bulk of bogus billing was on spare parts, which is easily identifiable. 8.6 Cash cartage - Another area of concealment detected in the cases of such transporters, pertains to suppression of cash cartage receipts. As discussed above this is the only area where the transporters can receive cash and can manipulate receipts. 8.6.1 Cash cartage refers to receipts of cartage in cash at the Container Freight Stations (CFS) in the port area for loading and unloading of containers. The main business of these transporters is movement and handling of containers inside the Port area. They receive stuffed export containers after custom examination, at predesignated points called CFS. The transporter is required to load the containers on to his trailer at the CFS, and then to carry it from point to point inside the Port like the stack

point, storage yard, hook point, etc., for various purposes, and finally to load these on the ship. For this, they utilise their trailers, forklifts, cranes and top-lifters etc. 8.6.2 In respect of imports, these transporters have to unload the container from the ship and after moving it inside the port, to deliver it at the CFS for examination by the Customs. They are under contract with various Shipping agents for performing these services, and receive payments at prefixed rates in cheque from the Shipping agents. However, sometimes after the examination of an import container by the Customs authorities, the importer may wish to carry his cargo to his factory in the container itself, rather than unload the cargo and move it in loose form on some truck. Hence, the container has to be loaded on the importers hired truck by forklift / cranes of these transporters. 8.6.3 Similarly, in respect of exports the exporter may sometimes send his cargo in a container from his factory itself rather than send it in a truck in bulk form and stuff it on to a container at the CFS. For unloading the container from the exporters hired truck / trailer at the CFS for examination by customs and onward movement and loading of container on the ship after examination by the Customs, these transporters receive cartage over and above what is received as per the contract with the Shipping agent. 8.6.4 This cartage is received at a rate of Rs. 400/- per 20 ft container, as fixed by transporters. The rationale behind such charges, according to the transporters, is that their

contracts with the Shipping agents cover movement of containers inside the Port area upto unloading of import containers and loading of export containers at the CFS. This extra loading / unloading of some containers at the CFS is not covered by the contract. Moreover, although the CFS is in the Port area it is deemed to be outside it and the contract with the Shipping agent is only for movement inside the Port area. This cartage is received in cash by the transporters from the exporters and importers or their Clearing agents. 8.6.5 The Clearing agents who handle such movement in the CFS always make payments in cash because they submit a lump sum bill to their customers i.e. Importers / Exporters, covering all services rendered. No supporting bills are given and in turn the Clearing agents withdraw cash and make cash payments. Since a major part of their expenses are speed money paid in the Port area and Custom house, they prefer such a system. In a search case, documentary evidence in the form of diaries indicating actual receipts were found in the possession of the Supervisor in charge of their Port operations, showing that only 1/3 rd of such receipts were being accounted. Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter XV

MEDICAL PROFESSION & NURSING HOMES

General 1.1 Several systems of medicine are prevalent in the world. However, allopathy is by far the most acceptable system due to its global character, scientific system of examination and diagnosis based on continuing research on a worldwide scale. Its practitioners enjoy good status in the society and are assured of a decent income. Experience indicates that there is a large-scale tax evasion by medical professionals. Some cases where action u/s 132 or 133A was taken show that even leading professionals are disclosing only a fraction of their actual receipts. 1.2 The scale of evasion is illustrated by the case of a surgeon in a metro city, in whose case, papers found during a search revealed that though he was charging fees varying from Rs. 10,000/- to Rs. 25,000/-, depending on the financial status and the urgency of the patient but was disclosing only about 5% of his actual receipts. His receipts from some foreign patients were huge, but hardly any of these, was entered in the books. He was found to be in

possession of unaccounted cash of Rs. 59 lakhs. Besides, evidence of large unaccounted investment in several immovable properties, and unaccounted expenditure on frequent foreign trips with his family members were also uncovered. He eventually admitted concealed income of more than Rs. 2 crores. His disclosed income in the year preceding the search was Rs. 89,000/-, whereas the actual income for that year quantified on the basis of seized records worked out to Rs. 70 lakh. In a case of an orthopaedic surgeon the search brought to light a novel method of suppression. Patient slips seized from his clinic revealed that as a matter of procedure, he used to enter receipts from only the first 5 patients in his books while the remaining 30 to 40 slips were destroyed every day. These examples are only a pointer to the massive generation of black money in medical profession Special features of medical profession 2.1 It is difficult to verify the reasonableness of the income disclosed by medical professionals in absence of proper records and accounts of their receipts / expenses and their investments. It, therefore, becomes necessary to make a proper enquiry for making a reasonable estimate of income. 2.2 A sizable part of their receipts is in cash, which makes it difficult for an AO to verify the correctness of the disclosed receipts. Cross-verification becomes difficult in absence of documentary evidence and the

tendency amongst rich patients to pay in cash and / or from their unaccounted sources. 2.3 Doctors generally keep their accounts on cash basis, and claim that only cash realisations and cash outgoings should be taken into account. This allows them opportunity to postpone the taxability of receipts due but not actually received. 2.4 There are no fixed norms or standards for the scale of fees charged by a Practitioner. Fees vary depending on the locality, city etc.. as also the professional competence, qualifications and experience of the doctor. Therefore, where a practitioner suppresses the figures of patients treated or the fees received from them, or both, quantification of income becomes difficult. 2.5 It is not possible for an AO to make a reasonable estimate of income without collecting data regarding the extent of practice of the doctor or his personal expenses & investments. Besides, it is quite possible that professional income may fluctuate from year to year, depending on several factors including competition, sudden outbreak of epidemics or unfavourable and favourable climates etc.. This argument becomes a convenient handle to manipulate the returned incomes. Professionals, as a class, return higher incomes only in the year(s) in which they are required to account for some investments, or large personal expenditure.

2.6 Sometimes doctors are also paid in kind by affluent patients. It was noticed in some cases that the doctors were given expensive gifts by the patients or their families after the treatment. Detection of such receipts in kind is not an easy task and their quantification all the more difficult. Sometimes it may be akin to a barter deal - medical professionals not charging anything from legal professionals for the legal services rendered by them and vice-versa. 2.7 A common occurrence in these cases is the diversion of the black money of the doctors to their family members and relatives through gifts including foreign gifts, agricultural income, stridhan etc.. Classification of medical services 3.1 Family physicians - General practitioners or GPs or family physicians is a popular group of medical men. They are the first contact point for a patient. GPs initially diagnose the ailment, refer the case to a Specialist and make house calls. They become familys friends, philosophers and guides during a medical emergency. They decide the stage when reference is to be made to Specialists, or a Surgeon or a Clinic for hospitalisation. Sometimes they also dispense medicines from their clinics. Their charges may vary from place to place and even locality to locality. Some families retain physicians on monthly or yearly basis. But most GPs charge fees on each consultation. Charges tend to be significantly higher during house visits, and visits during odd hours.

Some general practitioners also charge commission from Specialists, Laboratories and Nursing homes. 3.2 Specialists - Specialisations have come up in several medical fields viz. Ophthalmology, Orthopaedics, Gynaecology, ENT, Nephrology, Oncology, Urology, Paediatrics, Dentistry, Neurology, Radiology, Cardiology, Dermatology, and so on. The Specialists in these fields develop lucrative practice after a few years of experience. Cases are referred to these specialists either by general practitioners, or patients directly approach them. Surgeons have income, both from consultation and from performing operations though a large part comes from operation fee. These specialists may be in employment of Government or other hospitals some of which do not permit private practice. Cases of Specialists having substantial private practice require special probe. 3.3 Super specialists - A new category of Superspecialists is emerging because of the rapid advancement in medical sciences. Some recent super-specialties relate to Psychosomatic disorders; Immuno-deficiency disorders; Schizophrenia & delusional disorders; Delirium / dementia / sleep disorders; Muscular dystrophy & related disorders; Peripheral nerve disorders; Optic nerve and Retinal problems and disorders of conjunctiva; Eye-lid and tear gland disorders; Sports injuries; Electrical injuries, Childrens congenital defects; Blood disorders; and mental disorders etc.. There are also

specialists in microsurgery; laser surgery; and transplant of organs. The private super-specialists charge very high fees. However these specialists / super-specialists also spend substantially on periodic updates, journals and magazines, familiarisation / study trips abroad and acquiring latest equipments. Legal provisions under IT Act 1961 4.1 An activity carried on by an individual by his personal skill is a professional activity & encompasses the services rendered by him using that skill. Revenue receipts arising from exercise of a profession including the medical profession are chargeable u/s 28 of the Act even if they are of a casual & nonrecurring nature. Earlier the main difficulty in correctly computing the income of the professionals was non-maintenance of proper books of account by them. Therefore, Taxation Laws (Amendment) Act, 1975 introduced Section 44 AA with effect from 01-04-1976, obliging medical professionals to maintain such records as would enable the AO to compute his income in accordance with the Act. 4.2 Rule 6F of IT Rules 1962 prescribes the books of account & records required to be maintained by certain medical professionals, under section 44 AA of the Act. Section 44 AB requires that professional having receipts exceeding Rs. 10 lakh in any year will get their accounts audited and submit an audit report in the prescribed proforma.

Records normally maintained by medical professionals 5.1 It is often seen that most medical practitioners do not maintain reliable and proper books of account. Some doctors maintain elementary books but these are not strictly according to accounting norms. Some keep diaries or slips but do not truthfully present them before the AOs. Records generally maintained comprise of the patient register or patient cards, appointments diary, receipt books, and a rudimentary form of cashbook. 5.2 However, with the advent of computers, most of the professionally organized medical practitioners maintain records of their patients on computers. Special computerized software packages allow medical professionals ready access to the medical history of their patients. Most of these packages also enable maintenance of record of appointments, as also accounts. These may therefore have all the information needed by the AO for verifying / ascertaining the income. However, it is possible that for income tax purposes the doctor may deny existence of these computerised accounting records. Devices employed by medical professionals for tax evasion 6.1 Medical practitioners often not only suppress their receipts but also inflate the expenses and divert the

incomes as would be apparent from following examples. 6.2 A pediatrician having a large practice in a major city was also running a pathological laboratory in the name of his wife. Information was received that the lady hardly had any proficiency to run the laboratory. Spot enquiries and examination u/s 131 of the Act confirmed that she was not even a graduate and hardly visited the laboratory. The building where the laboratory was located was shown as belonging to the assessees mother-in-law who was being paid rent. On a sustained cross-examination the doctor admitted that the income of the pathology belonged to him, and that payment of rent was only to inflate the expenses. 6.3 In another case a husband-wife doctor team was running a nursing home. The husband was a surgeon and wife a gynaecologist. Both were examining their patients in the same nursing home and maintained a common Patients register. The register had no column for charges paid by the patients. Statements of four patients were recorded by the Inspector. They categorically stated that they had each paid Rs. 200/as consultation fee, and that the doctor was not issuing any receipt. During cross-examination, the doctor initially stated that there were no manipulations & and they were charging only nominal fees from the patients. However when confronted with the statements of the patients, he admitted these facts.

Ultimately both file-revised returns admitting much higher incomes. 6.4 The main allegation against a leading cardiovascular surgeon was that he was charging very high fees varying from Rs. 1 lakh to 2.50 lakh per patient in cash for performing heart operations. The fee was either not accounted or was only partly accounted in the books. It was also alleged that he was investing his unaccounted income in real estate & had purchased several immovable properties including agricultural land around the city. After discreet enquiry, a search was conducted, which resulted in seizure of unaccounted assets of more than Rs. 1 Crore. He was also found to have opened 17 benami bank accounts where unaccounted deposits of nearly Rs. 2.50 Crore were found. 6.5 A surgeon was attached with 2 nursing homes. However, in his return of income receipts from only one nursing home were being declared. During a survey u/s 133A papers found showed that he was working in two shifts in two nursing homes but was suppressing receipts from the second nursing home. His daily receipts were around Rs. 15,000/- to Rs. 20,000/- though disclosed receipts were not more than 40% of this. 6.6 A search was conducted in the case of a bone & joint expert of 12 years standing, running 3 nursing homes. It emerged that he had acquired a big farm house and 13 flats including two in posh areas of the

city in benami names of his family members who hardly had any ostensible source of income. Though he was an orthopaedic surgeon, his nursing home was mostly frequented by Arab patients for rest. These patients used to be admitted in the nursing home for minor joint problems and small surgeries, and used to be kept there for 10-12 days against room charges of Rs. 1,000/- to Rs. 1500/- per day besides other incidentals. Payments for Consultation, Operation, and other surgical charges were mostly in cash. Scrutiny of bank pass books and account books revealed that his income during preceding four years varied from Rs. 50 to 80 lakhs per annum, though the returned incomes never exceeded Rs. 1 lakh. Most of the properties were acquired in benami names during this period against substantial cash payments to the sellers. Large unaccounted amounts were spent on renovations / repairs outside the books of account. When confronted with this evidence he admitted that manipulation of books and admitted additional income as per the seized records. Checkpoints for scrutiny 7.1 General - While taking up these cases for scrutiny, the AO should first ascertain the locality where the doctors clinic is located; his professional qualifications, experience, & expertise; and his standing, reputation and the type of clientele he attracts.

7.2 Professional receipts - Since suppression of receipts is a very common feature in the cases of medical practitioners, it is necessary to ascertain the scale of fees charged by them from their patients for different types of services. The scale of fees will vary for different types of practices, e.g. General physician, Specialists, Surgeons, and Consultants etc.. It will also depend upon the type of facilities in the hospital / clinic, where the services are being rendered. Therefore the AO should first find out

The nature of services being provided by the doctor / clinic, and the structure of fees for each of these services existing at the relevant time. The amount of consultation fees charged from each patient. If the doctor is a surgeon, the normal range of fee charged for different types of major and minor operations. The fees charged in the cases of employees of Banks, PSUs, and such other bodies where medical expenses of employees are reimbursed by the Employers, can be a good evidence of the scale of actual fees being charged. The rates prescribed by CGHS for treatment of its beneficiaries in private / approved hospitals for various ailments, can be another good indicator. Similarly, fees charged in case of reimbursement of medical bills of different types by Insurance companies, e.g. in Mediclaim Policies can also be a basis. In the cases of dentists, the fees for extraction, filling and other dental treatments etc.. may be

found. Some dentists specialise in Root-canal treatment where charges may be very high. Likewise some orthodontists specialise in other protracted dental treatments. It may be necessary to find out the exact fee-structure for each type of treatment. In the cases of ophthalmologists, fee for consultations, for minor ailments, for cataract operations etc.. can be ascertained. The fees are still higher for retinal, and other major problems. The branch in which the doctor specialises and the types of operations he performs can be ascertained. Charges may also vary according to the technique employed, e.g. laser techniques. In all cases where surgical procedure is used under anaesthesia, the Surgeons obtain written consents of the patient or his relatives for carrying out the operation. These consent letters are usually preserved for long periods. These can give an idea of the number of operations carried out during the year. Details regarding the attachment of the doctor with various nursing homes and private hospitals, as also retainership with companies and public sector undertakings can be obtained, along with the terms of the contract It is also useful to know the socioeconomic composition of the doctors clientele, e.g. whether he is treating a large number of diplomats, foreigners, tourists, people from the upper

income groups, as in such cases fees may be very high. 7.3 Based on the above information relating to the nature of practice, the professional standing / reputation of the doctor, the composition of his clientele, the volume of his practice, the number of patients that he examines per day on an average, and the nature of services provided by him, it should be possible to make a reasonable, though rough estimate of the likely annual receipts of the doctor. 7.4 Professional expenses - As regards the reasonableness of the professional expenses claimed, it may be useful to obtain following particulars

Rent, Rates, Taxes and Insurance, Expenses on water, electricity, cleanliness and maintenance, and security Telephone expenses. Expenses on papers, magazines, technical journals, TV and Internet. Salary or other payments to clinical staff e.g. Consultants, Anesthetists, Radiologists, Blood bank, junior doctors etc.. Expenses on membership of Professional associations, medical conferences, foreign trips, etc..

7.5 Personal expenses and investments - Since definitive checks are not possible on the actual

professional earnings, particularly in cases where proper books of accounts are not maintained, in a case where the disclosed income appears to be grossly inadequate, it may be advisable to examine the outgoings in respect of personal expenses and investments, and verify their reasonableness. For this purpose, a breakup of personal expenses can be obtained in respect of

Rent, taxes, Society charges, Electricity, and Water bills for residence Expenses on Cars, drivers etc.. Expenses on childrens education including tutors fees Salary to servants, Chowkidars and malis Travel, and holiday expenses - both inland & foreign Expenses on entertainment, Club fees, hotel bills etc.. Expenses on PPF, LIP contributions, Medicare premia, Tax payments etc.. Gifts / donations exceeding Rs. 5000/Expenses on Credit Card payments. Expenses on purchase of expensive Consumer Durables. Expenses on major functions, ceremonies, marriages etc.. Expenditure, if any, on purchase / construction / repairs / interior decoration of house. Particulars of new investments in shares, fixed deposits, and other movable property.

7.6 Bank accounts - Though part of black money earned by doctors & other professionals may be spent on lavish lifestyle a part may indirectly find way to bank accounts of the doctor, his spouse, and children etc.. Therefore, scrutiny of bank accounts often leads to discovery of vital clues enabling an AO to collect sufficient evidence of unaccounted deposits transfers, interest etc.. Detailed guidelines for examination of bank accounts have been discussed in Chapter V and XVI of Volume I of this Manual, and may be referred to. 7.7 Statement of total wealth - Another useful tool of investigation in these cases is the power available u/s 142(1), to call the statements of total wealth as at the beginning and at the end of the accounting year. The AO can then examine the accretion in wealth, and the personal expenses with reference to the disclosed income. Detailed discussions regarding the calling of the statements of total wealth, and their examination have been made in Chapter IV of Volume I of this Manual, and may be referred to. Nursing Homes 8.1 During the last three decades private nursing homes, maternity homes and polyclinics have mushroomed in all big and small towns. In one metro city there are reported to be more than 1000 nursing homes. Huge investment is made in constructing and equipping these private nursing homes, which are constantly upgraded and expanded. Some of the

nursing homes are as big as mini-hospitals with excellent surgical and nursing facilities. They normally maintain Admission register; Births and deaths register; Receipt book; Bill book; Day book; Cash book; Ledger; and Salary register etc.. besides the records of the patients. On the basis of these records, a Receipt and Expenditure can be drawn. 8.2 Verification of receipts - Details relating to preliminary consultations, room charges, various Pathology tests / X- ray charges, charges for Anaesthesia, Charges for Consultations with other experts, Pre and Post- operative charges, Operation fees and charges for medicines, and charges for blood transfusion etc., must be closely examined. Maternity homes are, by law, required to give intimation of births, and deaths at their premises to the municipal authorities under the Registration of Births and Deaths Act. The statutory records maintained under this Act can give valuable information regarding the number of maternity cases handled in a year. Similarly under the Medical Termination of Pregnancies Act, the maternity homes are required to maintain records relating to the abortions carried out at their premises. Prominent nursing homes in important towns are approved by various Public Sector Undertakings, Private Limited Companies, for treating their Directors / Senior Executives. Details of payments by the PSUs/Companies can be obtained from these concerns and cross-verified with the statements

submitted by the nursing homes. The rate structure of charges in these statements can be used to verify the reasonableness of receipts shown from other patients. 8.3 Verification of expenses - Details of expenses on Rent, Rates & Taxes; Society charges; Expenses on laboratory; charges on Technicians; Salaries; Laundry charges; Expenses on running and maintenance of vehicles/ambulance; Payments to associates; Expenses on medical journals, magazines; Misc. charges like postage, stationery, computer / internet etc.. can be called and verified. The genuineness of payments to associates, other Specialists, junior doctors, nurses etc.. should be checked carefully with respect to their terms and of their engagements. 8.4 Investments - The investment in construction of the nursing home and Purchase / installation of costly equipments must be critically examined. There is a tendency to understate the investment in purchase of land and construction of building to overcome the difficulty of explaining the source of investment. On the other hand, - expenses incurred on airconditioning, special fitting / sound proofing and in purchase / installation of expensive equipment/ X-ray machines etc.. is overstated to avail higher loans from Banks, and higher depreciation. Therefore these should also be properly looked into. Often owners / trustees of nursing homes connive with the

suppliers/manufacturers of costly equipment/ X-ray machines and manage to procure fake / inflated bills 8.5 Very often the involvement of family members is so skillfully planned that in the first instance it appears genuine. The devices mentioned below need to be carefully looked into to ascertain the genuineness of such claims

Showing the spouse of the assessee as the owner or main tenant of the building from where the clinic is run, and paying inflated rent to such ostensible owner Showing the spouse or a relative as the owner of a Pathology or a laboratory, or a medicine shop, or an expensive machine, or an expensive service e.g. ambulances, needed by the Nursing home, and paying inflated charges to such concern.

8.6 Bank accounts - While investigating cases of private nursing homes Bank passbooks of the owners / doctors and their family members may also be examined. Detailed guidelines for examination of Bank accounts have been given in Chapters V and XVI of Volume I of this Manual, which may be referred to. In serious cases of tax evasion, Total Wealth statements of the main owners can be called, as discussed in Para 7.6 above. Diagnostics Centres

9.1 During last few years a number of Diagnostics, and fitness centres have been set up with state of the art medical facilities and expert team of consultants. The concept, which is borrowed from foreign countries, is of one-stop-shop for primary health care, diagnostics & fitness. They provide facilities like - Medical & surgical consultations; Health screening; Pathology; Radiology & Imaging; Physiotherapy; Dentistry; Hoemodialysis; Yoga & Stress management etc.. While examining such cases proper enquiry should be made regarding the reasonableness of the investment shown and the sources of investment. It is necessary to obtain a list of the services provided by various doctors / experts attached. The AO should also obtain the list of major equipments installed, and examine the source of investment in the same, as these ultramodern health centres are often set up to invest unaccounted funds.

Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2

Chapter - XVI OTHER PROFESSIONS (Other than medical profession)

General 1.1 The idea of valuation of human resource material i.e. skilled individuals and professionals in the financial statements is just gaining acceptance. So is the concept of sweat equity, which is being offered to professional entrepreneurs in lieu of their knowledge and skills. In the developed countries such human skills are already being rated, and valued. A profession is the commercial practice or exploitation of ones individual skill, which can be across a large number of activities needed by a particular section of society at a particular time. Therefore, a professions requirements keep getting continuously upgraded to meet the market demands. With the globalisation of economy, and the trend of professionalisation of various services, professionals are entering into new areas different from their traditional roles of medical professionals, advocates and legal advisors etc.. The increase in general prosperity, and a larger availability of spendable incomes, is creating demand of professional help in entirely new areas. Therefore, there is increasing demands of professional fashion designers and models, jewellery designers,

professional singers, industrial consultants and valuers, financial analysts, interior decorators, event managers, Public relation consultants, private detectives, script-writers, Vastushastris, software consultants, and so on. There is a boom in service sector of the economy, providing opportunities to these skilled individuals. It is also a fact that service sector contributes a very large proportion to the overall black economy. This is also an area, which provides the easiest avenues of consumption of black money. Investigations in the cases of professionals pose an altogether different kind of problems than those arising in the case of a trader or manufacturer, because, unlike the cases of traders or manufacturers, the backward and forward linkages of the professionals with the persons to whom he has provided services are not available. Scope of professional income 2.1 Under section 2(36) of the Act, the term profession has been given an inclusive definition, to include vocation. Generally, profession is an occupation requiring either purely intellectual skills, or some special manual skills of the operator (as for example in painting). Therefore, exercise of professional skills is to be distinguished from operations involving production or sale of commodities. It is often said that, all professions are business but all businesses are not professions.

There are some subtle distinctions between the terms business and profession namely

While business, involves production or trading of a commodity or goods, no such items are required for profession. A profession is basically commercial exploitation of ones skill and knowledge. In profession, the capital requirement is either low or nil; while in business capital is a major input.

Thus, professional activity can be understood as an activity carried on by the individual by his personal skill and intelligence, to offer specialised services to his clients. 2.2 In theory, a profession can be carried out by an individual alone or by a group of individuals. However, these days there are large firms of professionals e.g. firms of Chartered Accountants. Or financial consultants etc.. Every profession involves making up of successive engagements and successive contracts. All revenue receipts arising from the exercise of a profession are chargeable u/s 28 of the Act, even if they are casual and nonrecurring in nature. Payments voluntarily made by persons who are under no legal obligation to pay anything at all, would be income in the hands of the recipient, if they were received in the course of exercise of profession. Therefore, an amount received by a lawyer from a person who was not a client but who had benefited by the lawyers professional service would be taxable in

the formers hand. Similarly, shares gifted by clients to a lawyer who had assisted in, say floating a company, would also be taxable in the latters hand. Problems in determining professional income 3.1 The main problem in determination of professional income is the difficulty of verifying the correctness of the disclosed income because these persons generally declare their income on estimate and do not maintain adequate records of their income, expenses and investments. It, therefore, often becomes necessary to estimate their income, on the basis of information about their investments and expenses. 3.2 Another problem is the possibility of large fluctuation of annual incomes from year to year. The sudden rise or fall in the income can be easily ascribed by a professional to a greater or lesser number of clients in a particular year. This provides them considerable scope to manipulate disclosed incomes, and to disclose larger income in the year in which some investments are made while getting away by disclosing smaller incomes in other years. 3.3 Professionals, by and large, keep their accounts on cash basis, as per which only cash realisations and cash outgoings are taken into account. This allows them considerable flexibility in postponing receipts to a later year depending upon the cash flow situation.

3.4 A very large part of professional receipts are generally in cash. This is further compounded by the fact that their clients also generally make payments from out of their unaccounted income. Cash receipts are easily concealed by simple omission to enter some receipts, and detection is difficult. 3.5 The fees charged by the professionals vary widely, depending on the qualification, competence, and popularity of the professional, as also on the paying capacity, relationship and standing of the client. For instance, in the case of Architects the fees may range from 0.5% to 10% of the total cost, depending on the size of the project, the standing of the Architect, and his relations between with the builder. This circumstance offers a large scope for understating the fees received. 3.6 Many times professionals, like Advocates also act as retainers for which they get, a fixed amount of fee, as also perquisites in the form of rent-free/ furnished accommodation, and/or some other facilities. They also charge fees separately for appearing in the cases before various courts. The value of these perquisites and the full fee charged for such representation are at times not disclosed. 3.7 Professionals often spend large amounts on lavish lifestyles and conspicuous consumption to increase their clientele network, as also out of sheer compulsions of their professional activities. While the traditional professionals like lawyers, architects etc..

may fall in the former category; the new breed of the glitterati world like fashion gurus, pop singers, actors / actresses, and models etc.. flaunt lavish life styles due to their professional demands and to profess that they are successful. Therefore, it becomes necessary to ascertain their lifestyle, personal expenses and investments etc. 3.8 Another problem common to all professionals is of artificial diversion of income in the hands of near relatives, nominees & benamidars etc., and its subsequent capitalisation in their hand. This is done by taking recourse to various escape routes such as gifts including foreign gifts, agricultural income, streedhan, fictitious wills of deceased relatives etc.. Some novel methods include relinquishing of rights in shares in favour of close relative, and bartering assets at understated costs. Therefore, it becomes necessary to examine the creation of wealth in the hands of the relatives/benamidars etc.. 3.9 Every profession has its own distinct modus operandi, ambiance and ethos depending upon the section of society it is catering to. During an action u/s 132 against some fashion designers at Delhi, their professional records and accounts were found to be in a state of complete disarray. It emerged that they hardly had any time or inclination to pay attention to such mundane things as their financial records. Provisions of IT Act

4.1 The main hurdle in correctly computing the income of professionals is the absence of proper books of account. For this reason, Section 44 AA was inserted by the Taxation Laws (Amendment) Act, 1975 with effect from 1-4-1976, making it obligatory for persons engaged in specified professions to maintain such books of account as may enable the AO to compute their income under the Act. Further, Section 44 AB requires a professional having gross receipt of Rs. 10 lakhs and above, to get his accounts audited. The audit reports, wherever available, become an important tool of investigation. However, in most cases these statutory norms are not complied with. Therefore, by and large the cases of professionals have to be investigated not only with the help of accounts produced by them, but with reference to information of their professional activities, life style, expenses and investments gathered from different sources. Legal Profession 5.1 The legal professionals may broadly be categorized as Lawyers commonly called Counsels, Solicitors, or Advocates-on-record in the Supreme Court. The Advocates Act, 1961 regulates the legal profession. By Section 14 of that Act, a unified Bar has been created in India. Section 16 of the Act provides that there shall be two classes of advocates, namely, Senior Advocates and others. Section 20 provides that Advocates will be entitled to practice the

profession of law, and Section 30 provides that every advocate whose name is entered in the Common Roll of Advocates shall be entitled to practice throughout India in all courts including the Supreme Court. Section 52 of this Act expressly provides that nothing shall be deemed to affect the power of the Supreme Court to make rules under Article 145 of the Constitution laying down conditions subject to which a Senior advocate shall be entitled to practice before it. The Bar of the Supreme Court is divided into three categories, viz. Advocates-on-record; Advocates other than Senior advocates; and Senior advocates. 5.2 Senior advocates - Section 16(2) of the Advocates Act provides that an advocate may, with his consent, be designated as Senior advocate if Supreme Court or a High Court is of the opinion that by virtue of his ability, experience and standing at the Bar, he is deserving of such a distinction. 5.3 Junior advocates - The pleading advocates, other than senior advocates, whose names are entered on the Common Roll, come in this category. 5.4 Lawyers who have civil practice appear before Munsifs, Civil Judges, District Judges, High Courts, and the Supreme Court, while those practicing on Criminal side appears before Magistrates, District and Sessions Judges, High Courts and Supreme Court. Besides, there are those who specialise in Labour laws, Income tax or Sales tax etc.. They appear before Labour Tribunals, Income-tax/ Sales-tax

authorities and Tribunals and also before the High Courts and Supreme Court. 5.5 Solicitors - The primary function of a Solicitor is that of an agent for litigants whose cases have gone before the High Courts. Under the rules of procedures of the Calcutta and Bombay High Courts, no Barrister or Advocate can be engaged to plead a case before the High Court on the original side, unless he is instructed by a Solicitor. In other words, where a litigant wants to file a suit before these High Courts, a Solicitor has to be engaged. The Solicitors work includes drafting of petition, consultation, settling of petition, and such other miscellaneous matters. They also often work as Liquidators or Receivers, give legal advice or obtain it for their clients, and handle legal aspects of setting up new companies, issue of debentures, underwriting of shares etc. 5.6 Advocates-on-record - Till 1954 a dual system obtained in the Supreme Court, the Agent taking the place of the Solicitor. From that year, however, this system was abolished, and the institution of Advocate-on-record was introduced. To be qualified to be registered, as an Advocate-on-record, one has to satisfy the following conditions

His name is borne on the roll of any State Bar Council for a period of not less than three years; He has undergone training for one year with an advocate-on-record approved by the Court, and

has thereafter passed such tests as may be held by the Court; and He has an office in Delhi within a radius of 16 kilometers from the Court house and gives an undertaking to employ, within one month of his being registered, a registered clerk.

The Supreme Court rules prescribe that no person other than an Advocate-on-record can appear and act for a party and no advocate can appear for a party at the hearing unless he is an Advocate-on-record or is instructed by an Advocate-on-record. Rule 6(a) of the Supreme Court Rules 1966 specifies that an advocate-onrecord, subject to his filing a memorandum of appearance on behalf of a party accompanied by a Vakalatnama, is entitled to (i) To act as well as plead for the party in the matter and to conduct and prosecute before the court all proceedings that may be taken in respect of the said matter or any application connected with the same or any decree or order passed therein including proceedings in taxation and applications for review; and (ii) to deposit and receive money on behalf of the said party. Rule 6 (c) lays down that Every advocate-on-record shall keep such books of account as may be necessary to show and distinguish in connection with his practice as an advocate-on-record, (i) moneys received from or on account of and the money paid to or on account of each of his clients; and (ii) the moneys received and the moneys paid on his own account.

Sub-rule (d) of Rule 6 lays down an important condition, namely Every advocate-on-record shall, before taxation of the Bill of Costs, file with the Taxing Officer a Certificate showing the amount of fee paid to him or agreed to be paid to him by his client. Thus, the duties of an advocate-on-record are similar to those of the Solicitor. They charge fees for consultation, drafting petitions, settling petitions by the Senior Counsel, and filing papers in the Court, and collect lump sum amounts to defray expenses. The Solicitors and advocates-on-record generally maintain Cash Book; Clients ledger, Bills register; and Journals. An important issue needs mention here. While in the weekly or fortnightly cause-lists issued by the High Courts, the names of the both Solicitors and / or lawyers who represent the litigants are mentioned, the cause-list of the Supreme Court gives names of only the Advocates-onrecord, who alone can furnish the name of the Counsel appearing in a particular case. It is, therefore, necessary that a list of fees paid by an Advocate-on-record to different Counsels on behalf of his clients be obtained for verifying the receipts shown by an advocate. 5.7 Checkpoints for scrutiny

A complete list of cases in which the lawyer appeared before different the courts, as also other cases handled by him during the year, can

be obtained from him. Receipts from important / major clients can be verified. Solicitors can be asked to give complete list of lawyers engaged by them on behalf of their clients along with particulars of payments made to them. Weekly / fortnightly / monthly cause-lists of the High Courts can be obtained in cases of senior lawyers / solicitors where concealment is suspected. As these lists contain names of the solicitor / advocate connected with each case, these provide valuable information for crossverification. The terms and conditions of retainerships, including discontinued retainerships, if any, can be examined. Particulars of other part-time activities and remunerations there from, such as part-time lectures in law colleges and valuation of answer sheets; appointment as receivers / commissioners, arbitrators; giving opinions, arranging negotiations / out of court settlements etc., can be verified. In the cases of advocates handling high profile/sensitive cases, discreet enquiries can be carried out, particularly where there is information regarding huge pay-offs / package deals etc.. In such cases, information could be forthcoming from the rival. Many times high profile and sensitive cases continue for years and lawyers maintain separate accounts of such cases. These

accounts should be closely scrutinised to find out whether advances shown as liabilities are actually final receipts. The expenses (debits) may be also overstated or fictitious. Juniors / Subordinates working under senior lawyers may have vital information about the extent of receipts and high profile cases handled, during the year. Many a time remuneration to juniors is overstated to reduce the taxable income. Money deposited in the bank accounts of solicitors / Advocates-on-record and claimed to be deposited by clients is often advanced for services to clients (including fees for senior advocate, solicitor, clerkage and other incidentals). The veracity of such deposits needs to be closely examined, as these may be unaccounted money of the solicitors / advocates. Remunerations from services such as for floating new companies, negotiating sale of controlling interest in a company i.e. takeover deals of corporates, can be verified. Sometimes interest, which may not at all relate to the professional activities of the lawyer, is debited to the accounts. Similarly, depreciation may be claimed in respect of items not connected with the professional activities. While such amounts will have to be disallowed, a scrutiny of the accounts and the depreciation claimed may also give clues to the unaccounted investments.

Chartered accountants / Tax practitioners 6.1 Chartered accountants have basically two specialisations- auditing and taxation. The functions of the Tax practitioners and tax consultants are, of course, limited to taxation only. Besides auditing accounts, Chartered accountants also attend to taxation matters of their clients. The checks elaborated with regard to the legal profession are also applicable to this class of professionals. But there is one important distinguishing feature. The Chartered accountants and Tax practitioners almost always have a permanent clientele, in contrast to the members of the legal profession who have a shifting clientele. Therefore, it is relatively less difficult for an AO to get the details of clients of each Chartered accountant or Tax practitioner. 6.2 Some typical checks relevant in these cases are

Full list of cases can be obtained, showing the fees received by the Chartered Accountant for statutory audits, for other audits, and for representation of the client in income tax, sales tax and other quasi-judicial proceedings. In the case of a Tax Practitioner, list of payments received by him in connection with the preparation of returns of income and appearances on behalf of the clients in incometax/sales-tax matters can be obtained. Important particulars from these lists can be crosschecked with the corresponding details

obtained from the concerned clients. Often Chartered accountants and Tax Practitioners are also engaged as retainers by reputed concerns. The terms and conditions of such retainerships can also be obtained. Architects 7.1 In the case of Architects also, the clientele changes from time to time. For example, once a particular project designed by an Architect is complete, chances are that need for his services may not arise to that client at least in the near future. 7.2 Following points may be kept in mind in these cases

A substantial part of unaccounted money is consumed in real estate investments. Since the fee of an architect depends on the size and cost of the project, a portion of the Architects fee may also remain unaccounted. Many architects are also Registered Valuers. It must be seen whether the fees charged for valuation work have been properly accounted. Often extra fees are charged by these professional for understating the valuation of a property. Many architects are known to take money from contractors for certifying the quality of the work of a carpenter, a plumber, an electrician or a civil

contractor, which is usually a certain percentage of the project cost that he is certifying. Inflation of expenditure, which is common to all professionals, is equally rampant in the cases of architects. For example, an architect may claim that he had paid certain percentage of his fees to structural / electrical / plumbing designers, though in actual fact he may not have paid any sum at all, or paid a lesser percentage. Inflation of salary to staff (e.g. Draughtsman) is another mode of understating the income.

Authors, Artists and Musicians 8.1 Uncertainty of career - It is an admitted fact that popularity of these professionals is of a fleeting nature, depending on passing taste, whims and fancy of the public. As a result, their careers fluctuate with popular demand, and are generally short-lived. Not unnaturally, therefore, these people make efforts to earn as much as possible in the short time in which their popularity is high. Therefore, they are often tempted to declare only a part of their income. Even where they wish to declare their true income, the persons making payments to them prefer to make payments out of their unaccounted income. 8.2 The Departments experience in the cases of many established artists is that they do not maintain any books of account. They generally file statements of receipts and expenses only. Many times omissions of receipts have been detected in such statements.

For ascertaining the receipts of established film artists etc.. up-to-date information regarding their work will have to be gathered from as many sources as possible. Trade journals are of great help in this regard. 8.3 In the case of reputed singers, musicians and authors it is necessary to ensure that the royalties received by them from the recording companies/publishers on the sale of their discs/publications etc.. are properly disclosed. Famous musicians are also in demand for giving music concerts locally as well as in foreign countries. There is a tendency to suppress the income from such programs, including the travelling and hotel expenses received. Efforts should, therefore, be made to obtain the details of such payments from the organisers of the programs. 8.4 Most authors do not keep proper books of account. It is therefore necessary to verify the disclosed receipts with reference to the information collected from the publishers. In significant cases, the AO may obtain extracts from the catalogues of major publishers which give details of books including the name of the author, publisher etc.. The information collected could then be verified with reference to the receipts disclosed by the author. Race horse trainers and Jockeys

9.1 As per the rules of the Turf Clubs in general, and of Royal Calcutta Turf Club in particular, Turf clubs maintain detailed accounts of both, the trainers and Jockeys regarding payments made to them by racehorse owners, in respect of the horses maintained in their stables, and for the races conducted in the race course of the club. The clubs also maintain accounts of the amounts receivable from other clubs in case a horse from their stable is entered in a race conducted by an outside club. Therefore, the income declared by Jockeys / trainers can be verified from the turf clubs. 9.2.1 Trainers - Trainers normally receive

Basic training fees paid by the owners of the racehorses. This varies from season to season as per rates fixed by the parent Turf club; Commission from Racehorse owners is paid as per the rules of the Turf clubs, as a percentage of the prize money on the winning horses as well as for horses placed upto 3rd position in a race of 7 horses and upto 4th position in races of 8 or more horses. The exact percentage of prize money can be ascertained from the concerned Turf club; and Percentage of Cup Value as per rules of the concerned club is also given to trainers.

9.2.2 While dealing with cases of the Trainers, the AO should check the expenses claimed by them. Most of the Trainers claim large expenses on horses in the

races conducted by other Turf clubs. These include transport of horses, maintenance of horses at the outside club, stable rent, etc.. It is essential to verify the Club certificates to ascertain the exact position. Some of these clubs as well as the parent clubs generally, subsidise transportation cost and the stable and maintenance expenses in respect of horses participating in such races. Often the horse owners bear most of such expenses. Generally, the trainers are not expected to bear the expenses outside the parent club premises. 9.2.3 As regards the receipts of the trainers, it is essential to verify the Clubs circulars relating to the particular race and the Racing guide, for determining the quantum of owners commission as also the percentage receipt of the cup value. In the case of a trainer who is also the owner of race horses, it will be necessary to examine both the accounts carefully, especially the amounts receivable by him, under the Club rules, as Trainer of his own horses. Jockeys 9.3.1 Jockeys receive amounts from the owners as per the rate fixed by the parent Turf club, from the following sources

Riding fees is received from the owner directly, or through the club, irrespective of the fact whether the horse ridden by him wins or loses. The fees club usually certifies, the amounts

receivable by the jockey from the owners and from other turf clubs. Commission from owners also goes to the jockey of a winning horse. The jockey receives 10% and 7.5%, of the prize money, for riding a horse placed first or second. In respect of other horses placed, his share is 5% of the prize money. However, the jockey does not receive any amount in respect of the cup value.

9.3.2 A jockey cannot claim expenses against his professional receipts except as specified in the statute viz., for insurance, transport etc.. As in the case of Trainers, it is essential to cross-verify the declared income with reference to the accounts maintained by the club. 9.3.3 Apart from, the payments regulated by the rules of the Turf Clubs, detailed above, there are other receipts also. It is well known that Trainers and Jockeys receive extra payments from the owners, at times, of a substantial nature. These are gratuitous payments especially when races are fixed. It is also commonly known that the owners of horses share a part of their stake money with both the Trainers and Jockeys. It is learnt that in respect of fixed races heavy odds are offered and Trainers and Jockeys also share the earnings. Joint Ventures between Jockeys or between Trainers and Jockeys are also not uncommon. It may be noted that turf clubs do not

permit Trainers and Jockeys to bet or act as ordinary punters. 9.3.4 The usual method adopted for concealment by these professionals is not to show the receipts other than those permitted by the Clubs. In the case of Trainers, the expenditure account relating to horses entered in races conducted by outside clubs need scrutiny and verification. Interior decorators 10.1 Some architects also do interior decoration work. But there are professional interior decorators also, who specialise in lifestyles and ambiance. These professionals are concentrated in metropolitan cities where space constraints and the desire to lead aristocratic lifestyles go together. Many interior decorators operate through Architects. 10.2 The clientele of the interior decorators is generally developed through personal contacts and recommendations, which may not be on records. This renders the traditional methods of investigation through accounts, ineffective. Therefore, ascertaining particulars of clients to whom services were provided during the year is a difficult exercise. However, names of the architects are on the record of builders. The reputation of architects also contributes to the market price of the project.

10.3 The scope of the work of an architect is visible through exterior structures, while the work of the interior decorator remains behind doors. Unless one enters the house, it is difficult to ascertain the cost or the quality of the interior decoration. This enables the interior decorators to operate on cash basis. Both, the cost of interior decoration, and the charges of designer are generally paid from unaccounted money. Naturally, therefore, the interior decorators also do not report such receipts in their books. Therefore, the AO has to focus on personal expenses, investments and bank accounts, rather than receipts. 10.4 The fees charged by interior decorators are often exorbitant. In most of the cases it exceeds 10% of the cost of renovation. In mega cities, such as Mumbai, often the cost of renovation exceeds the cost of the flat itself. In an action u/s 132 at Mumbai, it was noticed that a particular businessman had spent more than Rs. 2 crores on renovations while the cost of the flat was much less. The cash component in renovations was found to be more than 60%. In nutshell, these professionals have large earnings away from public gaze. 10.5 Many well-known interior decorators are not even assessed to tax. In these cases, the Architects provide the crucial links. In majority of cases, the interior designer operates through the Architects. Therefore verification from the architects about the

particulars of the interior decorator engaged may yield valuable information. Fashion designers and Models 11.1 These are a new class of professionals operating in the glamorous section of the market. This is a field where money is intrinsically associated with the fame of a person. Therefore, there is large number of entrants, mostly upcoming and upwardly mobile youth, operating mainly in black segment of the economy. 11.2 The factors contributing to the rapid growth of these professions are the widespread industrialisation, urbanisation and growth of consumerism. The fashion and garment industry has grown exponentially, benefiting the designer houses, and the in-house designers. Today, leading chains of garment stores and brand movers in the garment industry are having in-house fashion designers and consultants. Nonetheless, the facts remain that this class absorbs the conspicuous consumption by the upper strata of society having pots of black money. People like film celebrities, sports star, industrial icons, models, film producers etc.. are ready to spend huge sums for acquiring a different look. 11.3 The relation between models and fashion designers is akin to that between an actor and the director of a film unit. Models are the mainstay of the fashion-designing world. Therefore, with the advent of

fashion designing, modeling has also become a full time profession. Modeling has a wider scope than fashion designing. Modeling is intricately related to growth of consumerism and brand advertisement culture. Several advertisement companies have exclusive models, for their assignments. 11.4 In the case of modeling, generally there is a contract for certain period of time during which the model has to work for the Agency, depending upon of the terms and conditions. The receipts of models, from the Agencies, are by and large, properly verifiable because the Agency has to claim the payments made to models, as expenditure in its own case. Therefore, inflation of expenses is a more common mode of suppression of taxable income in these cases. It is however, possible that a particular model may have worked for several assignments with several Agencies. In such cases, it may be necessary to ensure that all receipts are accounted for. 11.5 The profession of fashion designers is an exclusive field where, generally, considerations are kept confidential. For example, how can one ascertain the amount charged by the designer for the winning designer costume of say Miss Universe or any other pageant? Therefore, in the case of these professionals, their life style, consumption pattern and personal expenses need to be thoroughly scrutinised. For instance, these professionals often travel abroad to participate and/or attend foreign fashion shows and

exhibitions etc.. Therefore, expenses on foreign trips can be an area of scrutiny. 11.6 The professions of modeling and fashion designing etc.. are relatively new. Very often, these professionals are ignorant of their obligations under the tax laws, particularly relating to maintenance of record. Therefore, the AO must try to collect outside information, such as market and media reports in glamour periodicals and collect data regarding prominent fashion shows and exhibitions etc. Common methods of evasion, and investigation 12.1 The prevalent methods of tax evasion in these cases are also basically the same, i.e. either suppression of receipts, or inflation of expenses or both. Suppression of receipts is generally resorted to where the fees / payments received are either in cash or received out of unaccounted sources of the payer. This is an easier method of evasion in these cases. The need for inflating expenses arises only when the accounted receipts become very large in comparison to the income intended to be offered for taxation. 12.2 Some points should be noted at the outset, viz

Fees received from unaccounted sources of the payer are normally not meant to be disclosed by the professionals. Professionals like lawyers / advocates, often do not account for the out-of-pocket expenses, or

the remuneration for an out-of-court settlement etc.., received in high profile / sensitive cases. When the fees / remunerations is received in cash, the normal tendency is not to account it in the books. Where receipts are not subject to proper checks or verification, the only way out is to proceed for verification of personal expenses & investments.

12.3 Verification of bank accounts - This is the single most important avenue of investigation. The trend of todays financial world is that most of transactions, including fraudulent ones are routed through banks in some form or the other. All large transactions have to go through banking channel at same stage, if only to give these a colour of authenticity. The points arising in investigation of bank accounts have been discussed at length in Chapters V & XVI of Volume I. These may be kept in mind. 12.4 Statement of total wealth - Another important tool of investigation in these cases is calling of statements of total wealth at the beginning & end of the investigation period, using the power available u/s 142(1) of the Act. Details in this regard have been discussed in Chapter III of Volume I and may be referred to. 12.5 Inquiries from passport / travel agents Verification of particulars of passport can bring out the details of foreign travel. Thereafter, verification from

travel agents can be made to find out expenses on air tickets, foreign exchange, hotels bookings etc.. Similarly travel agencies patronised by these person can be a source of information for their domestic travel, holidays, hotel bookings, and expenses on hospitality etc.. Verification, from luxury hotels, caterers, event managers etc.. can bring out information on expenses incurred on major parties, functions & events etc.. 12.6 Surveys u/s 133A - Lastly, surveys, particularly in the case of architects, interior designers, fashion designers, industrial consultants and valuers etc.., can yield extremely useful information relating to for suppression of income. Surveys sometime become inevitable due to the fact that accounts of professional are generally not properly maintained. For instance, appointment diary of lawyer/advocates; list of projects undertaken by architects, interior designers; the estimates of cost of construction/renovation of a project; the noting of actual expenses etc.., if found can be of immense use during the course of investigation. 12.7 Inquiries from investment agents / advisers Most of these person entrust their investment work either to a trusted confidante or to a professional investment consultant/adviser. Particular of such person generally become known, as they are paid fees for their services. Enquiries or even a survey in the case of these persons can often bring out a

wealth of information regarding the actual investments of the professional concerned.

Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter - XVII HOSPITALITY INDUSTRY

General 1.1 The concept of hospitality in India is very broad, sacred and woven into our culture. In India, we believe in Atithi Devobhava. However, over time the concept of hospitality has acquired the contours of an industry. The philanthropic services of Dharamshalas & Sarais, have metamorphosed into hotels of three star, five star or seven star deluxe hotels of today.

1.2 Generally, hotels can be categorised into the following

Guest houses in big cities with or without the provisions for supply of food. Reasonably good budget hotels with no Star status catering to middle class. Three or four Star hotels located in big towns with facilities of Air conditioning, Conference rooms, Email, Fax machines, etc.., and catering to the upper class. Five Star Hotels or other Super Deluxe Star Hotels mostly located in big towns, Metropolitan cities or at places of tourist attraction mostly catering to the affluent sections of society and the corporate world.

1.3 Broadly, the functioning of a hotel is divided into Front Office and a Back Office. Then, there are various sections such as - Reception, Room service, House keeping, Laundry, Travel desk, Health club, Gym, Pubs, Coffee shop, Florist, Telephone, Kitchen, Business Centre, Conference halls, Banquet centre, Security. These different sections have definite duty assignments, and raise bills giving details of expenses incurred in their respective departments and maintain a separate folder for each guest of the hotel, in which all the vouchers are kept till the guest vacates or settles his accounts. Copies of these bills are sent to the Accounts department for billing purpose. At the time of vacating the room or settlement of the account, a copy of these vouchers is given to the guests. These vouchers are called supporting vouchers.

1.4 Apart from the front office and back office, the hotel can be divided into

Accommodation section Service Section Administration

Accommodation 2.1 The accommodation is provided normally by the reception counter of the hotel. There are various types of guests in a hotel, such as, company guests, regular guests, frequents travellers, walk-in guests, booked guests, privileged guests, etc.. 2.2 Usually, there is immediate allotment of room to the agreed rate guests. The reception can also offer discount upto 10% in most of the hotels to walk-in guests. Normally, the front manager is allowed to give discount from 20% to 30% for which he may negotiate with the guests. Rate thus agreed upon for a particular customer is entered on to the computer. 2.3 Guests registration forms - As a standard practice, all hotels require the guests to fill information in a registration form and the hotel guest register. The information required in this form is in the nature of name, profession, address, place of origin, arrival from, departure to, arrival date and time, and expected departure date and time, room number, mode of payment and signature. The laws and rules of the hotel are read over to the guests at the time of their checking in to the hotel. In respect of

foreign travellers, the information in the registration form also includes details regarding their nationality, passport number (date of issue, place of issue, validity, Visa Number, and its validity period etc.). The information regarding a foreign traveller / guest is sent to the Police Commissioners office on the next working day against acknowledgment. A copy of this acknowledgment is kept with hotel. 2.4 The registration forms of guests maintained by the hotel, is an excellent starting point for any worthwhile investigation. Registers maintained by room service, restaurants, house keeping and laundry are excellent cross checking points. If a particular expenditure is mentioned with regard to a particular room in the room service register, but if the occupancy register does not have any information about any person who has checked into that room at that point of time, and it is shown as vacant then an obvious inference can be raised. Similar is the case with regard to other sections. The information maintained in the registers of these sections can be utilised for cross checking. As soon as a guest arrives and checks into the room, a key card is normally given for identification of the guest in the hotel and, for utilisation of the services of the hotel. In some hotels the room key itself serves the purpose of identification of a guest. The information regarding the guests has to be invariably sent to the house keeping and the room service sections from the reception counter. The house keeping section keeps the records of duration of occupancy of the guest and the needs of the guest. The room service keeps the records of

various orders placed from the room as also the time. Similar records are kept by the laundry, restaurant, telephone, health club, gym and pub etc.. A floor-wise register is usually maintained by the house keeping section to indicate the number of rooms occupied and the number of rooms lying vacant. Every floor has a house keeper who has to maintain this register. O is mentioned for Occupied and V is mentioned for vacant room in floor register /chart. 2.5 Room charges - The charges of a room fixed by a hotel are normally based on size of the room; the amenities provided (fruit basket, welcome drink, soap, shower, caps, tooth brush, tooth paste, shampoo, toilet rolls etc..); the facilities provided in the room (TV, telephone, size of the bed, sitting area i.e. whether separate dining table is provided, writing table, number of lights in the room etc..); other conveniences provided by the hotel to its guests such as free use of business centre, swimming pool, health club etc..; tariffs of other hotels of same category; overheads; Star rating and exclusive nature of the facilities. 2.6 Night auditing - The reports of the night auditors submitted every day are very important for the purposes of investigation of the accounts of a hotel. These night auditors cross check the accounts with respect to the services rendered by each department to a guest or a visitor to a restaurant, a party or a function organised in the hotel. They have to ensure that all the services have been appropriately charged and in case of mistakes, they

direct the correction of the same. One set of the report of the night auditors remains with the Accounts section in the back office, and another set is sent to the front office. Service section 3.1 This section includes maintenance of upkeep of hotel building, machinery, equipments, garden, lighting, kitchen, catering, and delivery and room maintenance. 3.2 Stores - Stores in a hotel are handled by a store keeper or a material manager. The Materials manager has to ensure that all necessary items are available at all points of time. For maintenance of desired level of stock, the manager has to do various calculations with regard to each items based on the consumption of a particular item for a particular period of time. In smaller hotels, five days to a weeks consumption of the hotel is kept in stock. In bigger hotels, this time period may be one month. As soon as the stock of any item comes down, the material manager and the store keeper take steps to replenish the same. Different hotels may follow different practices for purchase of consumable stores. For this they may conduct market survey or call tenders from the suppliers on annual rate basis. Once the rates are finalised for the entire year, the supplier has to supply the item through out the year at the agreed rates irrespective of the market rates of the items at any particular point of time in the year. 3.3 ABC analysis - Most of the hotels carry out ABC analysis for their stocks. One way of looking at this analysis is - A category items are very fast moving items,

such as vegetables, chicken, mutton, milk products, oil, tea, coffee, beer etc..; B category items are the second fast moving items such as dals (pulses), masala and other provisions.; C category items are slow moving items which can be stored for a longer duration, such as canned foods, bottled juices, linen, toiletries etc.. Another way of looking at the ABC analysis is A category includes those items in the stock, whose cost is very high. The cost of these items can be 80% of the total value of stock at any particular point of time even though the number of items would be only 5% of the total inventory. B category would be of such items whose total value would be 15% whereas the number of items in the inventory would be 20%. In the C category, are items whose value may be only 5% of the total stock, but whose numbers is in the range of 75% of total number of items. In any hotel, the endeavour is to block the least amount in A category items. 3.4 For a better understanding of management of stocks in a hotel, the equations regarding stock levels etc., have to be known to an investigator. While managing the stock, a decision has to be taken as to at what point of time further stock of a particular type or item is to be ordered for purchase. This is known as reorder level. Reorder level = Maximum consumption x Maximum delivery period

Suppose the maximum consumption of an item is 600 unit per week, and its delivery period (lead time) is 4 to 6 weeks, then Reorder level = 600 x 6 = 3600 units. The point of time at which fresh purchase order is to be made depends on the minimum level prescribed by the hotel management. It is determined as underMinimum level = Reorder level (Average consumption x Average delivery period) Suppose the minimum consumption of the above item is 200 units per week, we have the following data -

Maximum consumption Minimum consumption Delivery period (lead time) Reorder level

= 600 units per week = 200 units per week = 4-6 weeks = 3600 units

Minimum level = 3600 (600 + 200) x (4 + 6) = 1600 units 2 2

Annual consumption = Maximum Consumption + Minimum consumption x 52 2 = 600 + 200 x 52 = 28,800 units 2 The reorder quantity or economic order quantity for a hotel is determined by the following formula Reorder quantity = Square root of ( 2 x (annual consumption x cost per order) ) Carrying cost per unit = Square root of ( 2 x 20800 x 250 ) = 1442 units 5 In the above example, the cost per order has been taken at 250, whereas the carrying cost per unit of that item has been taken as 5. Based on these figures, the reorder quantity of that particular item comes to 1442 unit. The maximum level of a particular item to be kept in stock, is arrived at as under Maximum level = The reorder level + reorder quantity - (minimum consumption x minimum delivery period)

= 3600 + 1442 (200 x 4) = 4242 units Thus, we see that for a particular item the minimum level was 1600 units, the maximum level is 4242 units and the reorder level was 3800 units. The reorder quantity was 1442 units. Considering the delivery period of 4 to 6 weeks, the hotel would ensure that the item is ordered well before it reaches minimum level. Reference may be made to the books on cost accountancy by Sri M.K.Prasad or by W W Bigg, or by Weldon. Using these equations, it is possible to find out the minimum & maximum consumption, minimum level and maximum level and it can also determine the annual average consumption of each item. 3.5 A hotel may categorise its stock into two categories, i.e. stock and non-stock. Items of frequent and normal consumption e.g. food items, napkins, bulbs, toilet rolls, provisions, crockery, cutlery, mineral water, soaps, shampoo, cigarettes, vegetables, etc.. are categorised, as stocks. The non-stock items are items such as fans, phones, TV etc., which are not required to be purchased on daily basis. The stock items, are indented on daily basis depending on the lead time (delivery period), and the requirements of the hotel. The non-stock items, are purchased once in a while on the basis of a particular indent of a particular consuming department of the hotel. Thus, while the stock

items are to be regularly replenished, the non-stock items are to be purchased as and when required. 3.6 Catering - In cases of catering / restaurants, it is use full to have and idea of consumption of the main inputs for food items required for a party of 100 persons to have buffet type of lunch/ dinner. The information gathered from a five star hotel and a three star hotel is as under hotel Chicken chicken Five star Three star hotel 16 to 18 kg or 20 numbers of 10-12 kg 8 6 kg 10-12 7-8 4 6 3 4 7 5 12 10

Mutton curry kg Fish curry Paneer Dal Rice Atta & Maida

There is considerable variation between the consumption shown in a five star hotel and a three star hotel. These figures also vary from region to region depending upon local tastes/preferences - e.g. in Punjab the consumption of chicken / paneer will be higher, in Southern India, consumption of rice may go up and wheat may be lower. 3.7 Menu costing - The prices mentioned in the menu of a restaurant for various eatables takes into account the following parameters

Actual cost of the item, which is the cost of raw materials as per standard recipe. Profitability margin + Overheads Price of the same item being charged by competitors.

Normally if the price of an item is Rs. 100 /-, then 30% to 35% is the cost of the food item, 50% to 60% represents overheads, i.e. salary and wages, fuel, marketing and advertisements, interest, depreciation, repairs and maintenance etc.. and the net profit stated by the hotels is 10% to 25%. In some food items, the cost of the food item may vary, e.g. for prawns, the cost is 60 to 65%, while for soups the cost is only 10% to 15%. However, taking into account the wide variation of 10% to 60% in the actual food cost, the average food cost for any item as mentioned above is 30 to 35%. For further information on menu costing, the book Food and Beverages Cost Control, by Ramesh Takulia, may be referred.

In smaller restaurants, the food items such as chicken, mutton, fish or paneer etc.. are cut into pieces manually. Because of this manual operation there can be variation in the size of the pieces. However, in expensive restaurants the chopping of food items is done by machines, and the size of items is same. Besides, there is less wastage. Different practices are followed by different hotels for purchase of food articles, e.g. some hotels may purchase whole fish, while others may purchase fish fillets i.e. only the real meat portion. From fish fillets the yield is 90% of the total weight purchased. At the same time, the price for purchasing fish fillets would be higher as compared to the prices for purchasing whole fish. For whole fish, the percentage of yield would be much less such as

Coconut fish 40% Sea fish 70% Beckti 36% Robol 35% Prawns 50% Chicken (boneless) 40% Chicken (curry) 60% Mutton (Lamb leg and chop) 70% Lamb (whole) 78%

One chicken of one kg would normally give a yield of 600 gms which will give four portions of curry. But, if the same

chicken is purchased after dressing and trimming, one kg of chicken may yield 90%. Thus there can also be variation in the costing based on the method of purchase adopted by a particular hotel. Records maintained 4.1 The books of accounts & records maintained by a hotel depends upon nature of its ownership, size of its activities, nature of services offered. Basic records maintained by all hotels areCash Book General ledger Guest Register with guest registration forms Occupancy register maintained by some of the hotels. Debtors ledger Stock register Suppliers ledger Fixed assets ledger Salary register Guest complaint register Attendance rolls of employees Excise register

These records may be in computerised or manual format. Some common methods of evasion 5.1 The stores are manipulated to suit the stock as per books vis--vis the sales on a day, or during a week or month or a year. The stores are generally so manipulated that no evidence is left with regard to actual purchase made and the actual consumption of the stores. However, if suppliers register is cross checked with the books of accounts of the supplier, the actual purchases of stores by a hotel can be traced. By working out the average consumption over different periods, the actual stock levels can also be determined, using the equations discussed above. 5.2 Room occupancy is often understated and shown at 30 to 40%, even if the actual occupancy is 70 to 80%. It may be mentioned that even if the room occupancy register is manipulated, it is possible to cross-check the actual occupancy levels, with the help of the registers maintained in the different sections of the hotel, such as room service register, house keeping register, restaurant register, telephone bill register, health club, gym register etc.. all or some of which may not have been doctored. If this cross checking is done methodically, it may be possible to prove that the room occupancy is not being properly reflected. In fact, the guest registration register cannot be easily manipulated.

5.3 As soon as a guest arrives in a hotel and is booked into the guest arrival register by the Receptionist, the Receptionist informs the checking in of the guest to the various departments of the hotel, namely, house keeping, room service, telephone operator, engineering department and the finance department. All these departments open a separate ledger account for the particular guest in which the transactions relating to the guest are entered. These departments send a note to the finance department for billing at the time of checking out. When a guest checks in, he may be asked deposit a particular amount depending upon the duration of his stay and probable expenditure in the hotel. In case the guest over stays or his expenditure is more than the deposit amount, even during the original stay period, the finance department/ reception takes a further deposit from the guest to cover further expenses. Thus, the finance department is kept abreast of the expenses incurred by a particular guest in a hotel. Even if the records in the finance department are subsequently altered the position of occupancy in the ledger accounts and the bill book of various departments, can give correct information. As per international norms, the receipts of a hotel are normally 80% from the room tariff and the balance 20% is on account of sale of food and other services utilised by the guests of the hotel. 5.4 Many hotels maintain liasion with the local water supply department to manipulate electricity/water bills. Normally, the water consumption shown in the meter is only for six to seven days. On the balance days, the meter is turned off. Often water consumption is inflated by

showing purchases from potable water supply tankers. Bogus bills from water supply concerns are taken for this purpose. Thus, this manipulation cuts both ways i.e. in cases of large hotels this expenditure is concealed whereas in smaller hotels, this expenditure is inflated. 5.5 Manipulation in the banquet halls - Understatement of catering receipts from parties etc. by understating the number of people or the charges per persons or both, is quite common. Normally, in large hotels the information of any party to be held and the number of people likely to attend such a party is immediately sent along with the approved menu to the kitchen, stores, engineering department, reception, bell desk as also to vigilance and security, general manager, executive manager and house keeping. The trail as to the actual number of people who attended the party may be left in several of these departments, and the registers maintained by them. If the store registers for the given day are properly checked with respect to the quantity issued, the number of person attending the party on that day can be inferred. The manager has to give a Kitchen Order Ticket (KOT) for the exact number of people so that the kitchen would prepare the food for that many people. Two copies of this KOT go to the kitchen, another copy goes to the cashier or the finance department, and fourth copy remains in the books. In some outlets, the KOT has three copies, two of which will go to the kitchen and third will remain in the book. This KOT has to be maintained till the night auditor checks the accounts. This position is not only applicable for big parties, but also to the hotel guests or restaurants etc..

Checking of the KOT in the kitchen and from the cashier can lead to clues with regard to the number of people who attended a particular party or with regard to the occupancy of the hotel at a particular point of time or also with regard to the actual receipts in a restaurant of the hotel. KOT is a good tool in the hands of a diligent investigator. 5.6 In corporate hotels, this manipulation has a different dimension. In such hotels, the bill of a party of say 1000 persons is broken into various separate segments. Either it will be shown in the form of break fast, lunch and dinner and thus a single party of 1000 persons would be broken into three segments in different names or it will be shown as if three parties were held in the same hall by three different persons. One of the names would be of the person who has actually held the party and the other two names would be dummy. Case study 6.1 In the case of one of the biggest chain of five star hotels assessed in Mumbai, the declared income for A.Y. 1997-98 was Rs. 69.85 crores. However, the income finally taxed was Rs. 95.36 crores. Some of the additions were as follows

An amount of Rs. 14,94,960/- was added out of the expenditure on tea, coffee etc.. to employees, outside the hotel. Reliance was placed on the decision of ITAT B Bench, Mumbai in Tata Mcgraw Hill for A.Y. 86-87. In that case, the Tribunal held that only the expenditure on food

and beverages to employees at the office, factory or other place of work, was not to be included in the definition of entertainment. However, if any such expenditure is incurred by the employees at places other than the place of their duty was to be treated as entertainment, covered by Explanation 2 to Section 37(2A). The claim of deduction of Rs. 2,95,53,291/- u/s 80HHC was denied to the assessee, holding that sales made at its flight kitchens to various international airlines, do not constitute export of a commodity. The assessee had claimed an expenditure of Rs. 4,95,41,757/- on purchase of linen (Rs. 2,60,03,216/-) and carpets (Rs. 2,35,38,541/-), submitting that, this was a recurring revenue expenditure as these items were regularly required to be replaced. The claim regarding expenditure on carpets was disallowed based on the decision of ITAT, Mumbai in M/s PIEM Hotels Ltd. (order dated 6.3.97 in appeal No.ITA/8106/Bombay/95 for A.Y. 92-93). In that order, the ITAT held that though the expenditure incurred on linen was revenue expenditure, the expenditure incurred on purchase of carpets, is not a revenue expenditure. Accordingly, after allowing depreciation at 15%, the net disallowance out of the purchase of carpets came to Rs. 2,00,07,760/-. The assessee has claimed deduction of Rs. 1,31,16,665/- u/s 80-O. The assessee had not

debited any expenditure for earning this foreign currency. Its contention was that this amount was received for services rendered outside India, on which no expenditure was incurred as the expenditure on deputation of personnel to render such services in foreign countries was reimbursed by the foreign parties, and no separate deduction u/s 80-O was being claimed on such reimbursement. However, placing reliance on the decision of ITAT in the TATA Unisys Ltd. Vs DCIT (58 ITD 334) and Petroleum India International Ltd. 71 ITD 31, wherein it has been held that the deduction u/s 80-O has to be allowed on a net basis (net foreign earnings), the AO estimated the deductible expenditure on the foreign earnings at 20% of such earnings and allowed deduction u/s 80-O at 50% of such figure. Thus only an amount of Rs. 52,46,666/was allowed and an addition of Rs. 78,69,999/was made. The assessee had claimed deduction of Rs. 76,72,89,635/- u/s 80 HHD. For claiming this deduction the assessee had taken the receipt in foreign exchange at Rs. 3,40,66,99,520/-. It was noticed that out of this, a sum of Rs. 41,09,64,421/- was the receipt from pure encashment in the business of authorised foreign exchange agents. This amount was excluded from the foreign exchange receipts for computation of deduction u/s 80HHD. Another amount of Rs. 29,98,16,680/- being 10% for

business visitors was also excluded from the foreign exchange receipts. On recalculating the deduction u/s 80HHD, a sum of Rs. 14,10,48,700/- was disallowed as under -

1 Receipts in foreign exchange as per Rs. assessee 3,40,66,99,520 2 Add: Form 10 CCAE received subsequently Rs. 6 24,31,77

Rs. 3,40,91,31,296 3 4 5 Less :pure encashment Balance Less: 10% for business visitors Rs. 1 41,09,64,42

Rs. 2,99,81,66,875 Rs. 8 29,98,16,68

6 Balance, i.e. receipts in foreign exchange eligiblefor deduction u/s Rs. 80HHD ( 2,69,83,50,187 A) 7 Total business receipts Rs.

6,66,51,86,260 8 Less: pure encashment Rs. 1 41,09,64,42

9 Total business receipts 1 Profits from 0 business

(B) (C)

Rs. 6,25,42,21,839 Rs. 1,45,14,97,939

Deduction u/s 80HHD = ( A x C ) = 2,69,83,50,187 x 1,45,14,97,939 = 62,62,40,935 B 6,25,42,21,839 Thus, a disallowance of Rs. 14,10,48,700/- was made. The assessee claimed a deduction of Rs. 3,61,76,925/u/s 80-I in respect of its Calcutta unit. While claiming this deduction, the assessee took the profit of that unit only. It however, did not take into account the head office expenditure. It was held by the AO that the head office expenses are required to be charged to the profit of the respective unit. In the absence of specific figures, the prorata head office expenditure was estimated at 5% of the total expenses of the head office. The deduction u/s 80 I was computed as under -

1 Income

Rs.45,51,49,695/-

2 Expenses a. In the unit Rs.27,84,88,639/-

b. In the head office (pro Rs. 2,27,57,485/rata) Rs.15,39,03,571/3 Less: depreciation Rs. 3,19,53,356/Rs.12,19,50,215/-

4 Profit

Deduction u/s 5 80 I (25% of Rs. 3,04,87,554/above) Thus, an addition of Rs. 56,87,371 was made. Flight kitchens 7.1 An interrelated aspect of the hospitality industry is Flight Kitchens run by various hotels which are catering to various airlines. This could be said to be hospitality at high altitude. Since this service is meant for the higher echelons of society, it is a costly affair. 7.2 In India mostly 4 flight kitchens in operation. These are - Taj Air Caterers, run by the Taj Group of Hotels, Ambassadors Sky Chef run by Ambassador Hotel, Oberoi

Flight Services run by the Oberoi Group of Hotels and Chef Air run by the Air India Group. Their headquarters of most of these are in Mumbai and they also have flight kitchens at Delhi, Chennai and Calcutta. At other places they have subsidiary tie-up services. Maximum i.e. 22 airlines are serviced by Taj Air Caterers, followed by 11 airlines being catered to by Ambassador Sky Chef, and 6 airlines by Oberoi Flight Services. Chef Air mostly caters to Air India, Indian Airlines and Alliance Airlines. 7.3 Most of these flight kitchens are state-of-the-art food factories producing food in a very orderly and regulated manner. The entire operation starting from washing the dishes and the trays, cooking of the food, filling the trays, packing them on trolleys and preserving the trolleys at (-) 10 degree to (-) 22 degree is carried out in a sanitised and centrally air-conditioned work place. 7.4 Used trays, utensils from which food has been consumed by the air travellers is stacked on to the service trolleys after taking it out from airplanes at the airport. These service trolleys are offloaded into a transportation truck supplied by the flight kitchens. The offloading is carried out in the presence of an Officer from the Customs. These trucks are then locked by the Customs at and driven to the flight kitchens of the respective companies. At the destination i.e. flight kitchens, these locks are opened and the trolleys are offloaded at the unloading dock in the presence of the Officers from the Customs Department.

7.5 There is a highly technical washing area where these trolleys, dishes and utensils are thoroughly washed and disinfected. From there the trolleys, dishes and utensils are moved to an area called equipment hold, by a conveyor belt. In the other areas meanwhile, food is being cooked in what is called hot kitchen, cold kitchen, bakery, patisserie etc.. For cooking of food, there are meat butcheries, stores, chocolate room, fruit processing area etc.. As per the orders relating to a particular meal [breakfast, lunch, evening tea with snacks, dinner etc..,] from a particular airline, the food as per the menu decided by the Airline is prepared well in advance, sometimes, even two to three days before the actual service requirement. From the equipment hold the utensils are moved to what is called Tray set up Area. In this area, the food is set into the trays according to order and quantity. These trays are then placed on the trolleys of the respective airlines. From there these are moved to refrigerated holding halls, where the temperature is controlled from (-) 4 degree to (-) 22 degree. Mostly the temperature range used is (-) 10 degree to (-) 22 degree. These trolleys are kept in these holding bays for as long as the required time for their journey to the destined airline at the destined time. 7.6 It is a difficult job to keep the utensils of a respective airline separately from similar utensils of other airlines. For this, most of these flight kitchens have got separate areas earmarked for the same operations for separate airlines. The washing areas are automatic. The movement from the washing area to the equipment hall and to the tray set up

area is by automatic conveyor belts. The efficiency and the cleanliness as observed in these Indian flight kitchens is of a very high order. The trays of a particular airline are to be set up in a particular fashion and these are carried out in these kitchens with remarkable efficiency and ease. 7.7 At the destined time these loaded trolleys are moved to the Loading Docks where these are loaded into the transporting trucks in the presence of a Customs representative and locked. These trucks are then moved to the waiting airlines at the airport where the locks are opened by the Customs and these trolleys are loaded on to the aircrafts. In the aircraft the dishes are warmed and served to the air travellers. 7.8 These flight kitchens are a part and parcel of the respective hotel chains. These are massive buildings located within a 5 km radius of the international airport. The accounts and the income generated from these flight kitchens is clubbed into the accounts of the respective hotel. However, these are run by a separate administration and a separate workforce. The staff are highly trained not only for cooking the best but also in the matters relating to cleanliness and hygiene. 7.9 The food prepared in the flight kitchens is subject to international standards. A company called SGS India Limited, SGS House, NF Road, Mumbai 400 001, carries out the verification of the quality of food and issues a certificate of hazard analysis and critical control point (HACCP) verification. This certificate has to be obtained by all the flight kitchens and is valid for 6 months. The

certificate includes all varieties of food prepared in the flight kitchen. The certificate says that the processor has conducted a hazard analysis and a HACCP plan has been implemented in accordance with the US (United States) Food & Drug Administrations mandatory food HACCP regulation. 7.10 The flight kitchens have custom bonded warehouses in their premises, where various ancillary food items required to be served with the food belonging to different airlines is stored. The airlines want to serve their own liquors, salt, pepper, sugar, tomato ketchup, jams, hams, toiletries, aircraft napkins etc. in their flight. These items are brought in by these airlines either in the airplane or through ships. Under the supervision of the Custom Superintendent these are offloaded and inventorised and brought to the flight kitchens for storage. The lock of these warehouses is operated by 2 keys. One key remains with the airline official and the other with the Officer of the Customs. In most of these flight kitchens a Superintendent of Customs along with some staff is posted round the clock. As and when the tray for a particular airlines is to be prepared, the bonded warehouse is opened in the presence of a Customs representative and the requisite amount of liquor, soda, sugar, salt, pepper, tomato ketchup, jams etc.. are taken out. The inventory earlier prepared is reduced by the items which have been taken out. These items are placed on the tray and the liquor, soda etc. are sent to the airport to be loaded on to the airplane. Thus each airline has its own bonded warehouse in the premises of the flight kitchen for their daily needs

and requirements. The operation of these bonded warehouses is under strict control and guidance of the Custom authorities. The flight kitchens charge fees and rent from the respective airlines depending on the area of the bonded warehouses for storage, upkeep and removal of these items kept in the warehouses. This is an additional source of revenue to the flight kitchens. 7.11 The sources of income of a flight kitchen, are as under (i) Catering food bill as per agreement with particular airlines prescribing rates and time period for which these rates are applicable. (ii) Transportation charges for transporting the material to and from the airport. (iii) Handling charges - these are with regard to washing, cleaning and storage of the utensils and trays. (iv) Charges for cabin services - some of the airlines are also providing crews to clean the cabins of the aircraft on these international airports. These cleaning people would go to the aircraft during the halt at the international airport in India and clean the interiors of the aircraft. For these services separate charges depending on the importance of work involved are collected by these flight kitchens. (v) Cleaning charges with regard to linen and other material as required by airlines.

(vi) Charges collected with respect to the services rendered in respect of the bonded warehouses. Sometimes if the contract does not provide, no charges may be collected for the bonded warehouses which may be treated as a service rendered by the flight kitchen to the airlines. However, in certain agreements, the flight kitchens separately charge the airlines for the use of the bonded warehouses. The supply of food items at specified rates is regulated between the airlines and the flight kitchens as per a written agreement entered into between them. The flight kitchens, in addition to normal books of account, also maintain suppliers ledger, Handling income account ledger, Excise ledger, Customs ledger and transport ledger. 7.12 The foreign airlines as also the Indian airlines including Jet & Sahara Airways pay the charges on food, transportation, cleaning, bonded warehouses, cabin services, laundry support etc.. only by cheques. Thus, the receipt side is generally verifiable as the receipts are coming not only by cheques but also generating foreign currency. Therefore, manipulation is possible only by inflating the purchases or expenses, which can be examined in detail. No doubt huge purchases of various food related items are made. One of the flight kitchens admitted that they are serving 12 million meals in an year. As in the case of any other hotel, it is possible to manipulate the cost of these purchases. Similarly, as various types of expenditure are involved including the transportation charges, there could be inflation with

respect to these expenses. One aspect which needs attention is the claim of deduction by these flight kitchens u/s 80HHC. In a leading group of hotels this claim of Rs. 2,95,53,291/- was denied on the plea that sales made to flight kitchens of various airlines does not constitute export of a commodity. The reason given was that the food is being prepared in India and is being supplied to the aircrafts on the international airports in Indian territory. Thus, even though the payments were being received in foreign currency, there was no actual export of the commodity. Banquet halls, Kalyana mantapams 8.1 In most parts of Southern India a number of marriage halls have come up which are used for weddings as also other social functions. These halls are known as Kalyana Mantapams. Many of these Kalyana Mantapams are constructed by charitable trusts claiming it as a charitable activity. The hire charges received are sometimes disguised as donations or even donations towards corpus. This tactic is employed to circumvent the provisions of Section 11 or to avoid the requirements regarding application or accumulation of funds. In fact, many of these Kalyana Mantapams are pure and simple business propositions constructed for profit. The hire charge is given for the user of the premises for the function. A donation is a voluntary payment given without any anticipation of return of any kind. Thus, such compulsory payments towards hire charges involving quid-pro-quo are not donations. The decision of the Honble Supreme Court

in 101 ITR on page 465 is a case on the issue defining donations. Therefore, the AO can examine and find evidence to prove that the alleged donations were actually rent or hire charges. The onus of establishing that there was a quid-pro-quo is on the AO. As far as the running of Kalyana Mantapams is concerned it is a systematic activity for the purpose of profit earning and therefore, the income earned is a business income which can be fortified with the decision of the Supreme Court in AIR 1992 SC 1456. Whether this income is incidental to the avowed charitable objects of the Trust may have to be examined and a discussion reported on pages 47 to 49 of 236 ITR (ITAT portion) may be of relevance. 8.2 Another variation of these alleged donations is that while the donation is given in one name the marriage function is organised in the name of another person. On the surface there would appear to be no nexus between the donation and the function. These tactics are applied to avoid scrutiny vis-a-vis the provisions of Section 11 of the Income tax Act. However, these marriage halls are booked sometimes 6 to 8 months in advance. At the time of booking an advance is given by the original person who is actually organising the function. In the entry for the advance it is clearly noted that certain amount has been received from Mr. X for the purposes of a marriage on such and such a date. However, subsequently, the donation is given in another name and the advance is refunded to the original person. By seeing the advance register and by proving that the marriage or other function was actually solemnised by the original person on that

particular date in the hall, the management can be questioned as to why no payment has been taken from the original person for the said function. If properly cornered, the falsity of the claim of donation by the other person can be found out and the amount can be brought to tax. 8.3 The above stipulation apart, some of these Kalyana Mantapams are constructed by individuals for business purposes. Some of these halls are very lavishly constructed and charge even up to Rs. 1,00,000/- for the use of the hall for a day. This activity involves the following services provided either directly or through contractors Running & maintenance of these halls on daily basis. Providing of decoration services Taking various permissions from Police, Municipality or other departments for organising of a particular function. Contract for music and sound appliances provided to the hirers. Provision of food to the guests. Providing chairs, sofas, tables and other seating arrangements. Providing the services of daily wage workers. Provision of marriage band or an orchestra.

 Charging of rent for the hall and for any or all of the above services from the hirer. Income earned disposal of various types of left overs. Providing telephone or fax services in the hall. Providing generators. Providing gas burners, utensils and crockery. Providing video coverage. Providing for flower arrangement. 8.4 In such an organised activity, an AO will have to examine as to whether proper accounts have been maintained. If it is a case simply of giving on hire the hall without attending to any of the services mentioned above, then it is a simple matter. However, in case the management of the hall is providing or organising any of the above attendant services, relating to the function, then, the matter is slightly complicated. It also may have to be seen as to whether tax deduction at source is being made from the payments made to various contractors. It may also have to be seen as to what is the profit element in providing the attendant services. 8.5 Most of these Kalyana Mantapams and the management of the community halls make it obligatory for the hirer to take the services for furniture, decoration, sound system, flowers for decoration, video coverage, food service etc.. Only from the management of the hall. In

such cases, the entire receipts may have to be reflected in the accounts maintained by the management of the hall. This point has to be enquired into by the AO. 8.6 Once the function is over all the paraphernalia is immediately removed within no time. The management may choose to show the hiring and occupancy as per its own sweet will and books of accounts can be suitably written. Therefore, the AO would have to see as to what is the type of management and what financial control is being exercised by the management on the hiring activities. Records relating to the permissions obtained from the authorities for holding functions in the hall, can provide information regarding the functions & the dates on which these were organised. An AO may have to find out after making market enquiries the nature of business schedule of a particular hall. It is common knowledge that occupancy schedule of hire of such halls is normally deflated. Electricity and water bills, particularly during the auspicious months in which marriage functions etc.. are commonly organised can be a guide to the actual user of the hall. In the telephone and fax facilities are provided in the hall the these bills those particular dates can also provide clues as to whether functions were organised on those dates. 8.7 Apart from suppressing the occupancy rate the management can also inflate the expenditure on running and maintenance of the hall. The number of workers actually employed on a regular basis can be found out. Sometimes, some of the management have many halls in

different parts of the cities where the same workers are transported for the running and maintenance. However, for each hall separate workers may be shown as having been employed for the purpose of running and maintenance. By a determined enquiry this inflation can be found out. 8.8 These halls have regular contractors, for providing various services. A cross-check with the books of accounts of these contractors can also give clues regarding the occupancy of the halls as also the income earned by the management of the halls.

Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter XVIII TRAVEL AND TOUR INDUSTRY

Introduction 1.1 Tourism has emerged today as one of the fastest growing industry in the world. In 1998, the number of travelers in the world was 625 million providing gross revenues of 440 billion US dollars. Indias share in terms of world tourist arrivals and receipts is however, negligible. It is ranked 34 with international tourist revenues of over three billion US dollars. While there has been a substantial increase both in terms of tourists arrivals and receipts the world over, Indias position has remained stagnant at around 0.5%. Even a minute half percent increase in international tourism traffic into India will mean additional foreign exchange of nearly 3 billion US dollars. 1.2 Tourism has great potential in India. International institutions like the World Tourism Organisation and World Travel and Tourism Council have all predicted that India is going to be an important destination in the 21st century. India has a blend of rich cultural and scenic locations in the right proportion, offering a tourist options from snow capped peaks to beautiful beaches, the choicest hill stations, pilgrimage sites, health resorts, back waters etc.. If our infrastructure facilities could keep pace with the growth in the tourism industry the tourism revenues can develop by leaps and bounds. The World Travel and Tourism Council estimates that the contribution of the hospitality industry to Indian GDP will go up to 6.6% and foreign exchange receipts from 10.8% to 12% of the

aggregate export earnings. The role of the travel agent therefore assumes significance. 1.3 Before any country, can attract tourists on a large scale, certain important facilities and services must exist to cater to the needs of tourists from the time of arrival to their departure. The businesses and organizations, which provide the facilities and services, make up the tourism industry. 1.4 Using the words origin and destination, are two main ways to describe the movement of tourists from one place to another. Inbound and outbound tourists are terms commonly used in the tourism industry. Inbound tourists are tourists entering a country from their country of origin and outbound tourists are those who leave their country of origin to travel to another country. The word in bound and out bound only apply on the outward journey at the beginning of the tourist place. On the return trip, the tourist is simply returning home. Domestic tourist is the term used to describe tourist trips which takes place by tourists in their own country. In other words, when the country of origin and the country of destination are same. The retail travel trade 2.1 The most visible part of the retail travel trade is the travel agency. This is the place the customers of the industry first visit to buy travel tickets or holidays. Almost every important area now a days has a travel agency. All year round, the displays in the travel agency windows tempt us with offers of holidays in far away places offering

heavy discounts. Newspapers and magazines are full of such advertisements. These packages are sold by travel agencies on which they earn commission. 2.2 Travel agents undertake a specific function in the tourism industry. They make travel arrangements on behalf of individuals or group. They act as intermediaries between the customers and organizations that provide travel products and services. Travel agencies are the retail arm of the travel and tourism industry. The fact that opening a travel agency does not involve a heavy initial capital outlay attracts many people to this trade. 2.3 Travel agencies act on behalf of two parties when they undertake their work. They are agents for the customers on whose behalf they are making the travel arrangements, and also for the company that is supplying the product i.e. the Principal, who could be one or more of the following

A tour operator An airline A coach company A hotel A car hire company Railways A cruise line

Travel agents earn commission from the Principals whose products they sell. The commission payment is usually

expressed as a percentage and varies according to the product being sold and the commission policy of the Principal. Commission levels fluctuate in response to the activities of competitors. Some Principals offer incentive commission where the amount paid increases as the sales rise. Overriding commission is paid when an office has sole agency status with a particular Principal. The overriding commission allows the sole agency to pay standard commission to the agents and retain a small override to cover its costs. 2.4 Most people associate travel agencies with the business of ticketing and sale of one particular product i.e. Overseas package holidays. An analysis of the work of a typical travel agency, however, shows that it actually offers a wide range of products and services including

Overseas package tours. Air tickets, both domestic and international Rail tickets. Car hire. Coach services. Cruise trips. Hotel and other accommodations Travel Insurance. Foreign currency and travelers cheques Visa & Passport applications.

All these items earn the travel agent commission which keeps the business running. In the case of airline, coach or rail tickets sold by a travel agency, the carrier pays the commission to the travel agent. But a high proportion of income of travel agents comes through selling the package holidays. The role of the travel agency is to advise customers on a wide range of matters relating to travel. 2.5 Some travel agencies make their living by selling travel related services only to business customers rather than to members of the general public. These are known as business house agencies. Staff of business house agencies often visit large companies to try to persuade the manager to make all their travel arrangements through their company. Most travel agencies, however sell both to companies and the general public. Ticketing business 3.1 There are a large number of travel agents who are engaged in ticketing of domestic and international airlines. These can be classified as

Agents accredited with I.A.T.A. Non I.A.T.A. agents General Sales Agents

3.2 Almost all the important air carriers are members of International Air Transport Association (IATA) which is an international agency under the U.N. charter. All the

approved carriers are bound by resolutions of IATA. The accreditation by IATA is granted after a thorough scrutiny of the agents financial status. He also has to provide a bank guarantee which can be invoked in case the agent commits a default in payments. The IATA accredited agents hold tickets of all the approved airlines and sell their tickets. They are eligible for the prescribed percentage of commission. The agent has to submit the statement of tickets sold on a fortnightly basis. 3.3 The commission earned on domestic air lines is 5% from Indian airlines and 6% from other private air taxi operators. As per the IATA resolution, the rate of commission on international air passenger to an IATA agent is generally 9% of the applicable fare or as otherwise authorized. The rate of overriding commission payable to the general sales agent is 3%. The resolution provides for special commission in respect of a tour conductor who is in charge of or escorts a minimum of 10 passengers. In case of a group size of 15 or more passengers, one free tour conductors ticket is issued for every 15 passengers. If the group comprises of 10 to 14 passengers, 50% of the applicable normal / special fair as paid by the group is applicable for the tour conductor. These free/reduced fare facilities are cumulative. The company makes the payment to the airline after deducting their commission and this practice is as per the procedure laid down by the IATA which provides for submitting the statement of tickets issued on a fortnightly basis. The IATA agents also receive other incentives which may extend up to 25% of the fare. Besides the commission and

incentives, they are eligible for productivity linked benefits linked with the targets given by various airlines depending on the volume of the business done for the airlines. 3.4 Billing & Settlement plan - Commonly known as BSP this is a simple form which provides for the selling, reporting and remitting procedures of IATA agents. The key feature of the BSP is a single standard traffic document which is used by IATA agents on behalf of all the participating airlines represented. Earlier they were required to prepare and keep separate stock and accounts for different airlines. BSP uses the services of the Data Processing Centers to compute billing and monetary amounts which agents remit to the appointed clearing banks. It also computes the division of these amounts by the bank for settlement among the airlines. The center conducts the editing and checking of data from all documents and generates one consolidated billing to each agent in respect of all moneys owed to the BSP airlines. The agent then makes a single remittance to the appointed clearing bank. 3.5 Accounting procedures - The airlines provide the agents with the net fare chargeable for all tickets issued. The tickets are then recorded in the purchase register and payments are made to the IATA BSP on a fortnightly basis. These amounts are debited to the cost of sales in INR through the purchase register. The net fare charged by the airlines is decided at the beginning and these amounts are applicable when the tickets are issued. There are two ways of getting the rates from the airlines. Either,

at the beginning of the year, the airline quotes the net fair on the specified route which is applicable for issuing of the tour tickets or a percentage basis which ranges from 9% + additional incentive. The additional incentive is generally provided on the net amount after deducting normal commission of 9%. For instance, if incentive is mentioned as 9 plus 25, it implies 9% plus 25% of 91%. These incentives are generally fixed in the beginning of the year. During lean seasons, the airlines announce concessional fares which are the net fare payable to the airlines. As the tickets show the full fare, the difference between the price for which the ticket is sold and the net fare paid to the airlines is the profit margin of the agent. The payments are settled on a fortnightly basis. For the tickets issued for the first fortnight, the payments are made on the 30th of the month and for the tickets issued in the second fortnight payments are made on the 15th of the following month based on the fortnightly sales report prepared by the agent for all the tickets issued in the fortnight. Non - IATA agents 4.1 These are the subagents who are not accredited by IATA. They do booking on behalf of various IATA agents, who pass on to them, a part of the commission received by them from the airlines. These sub agents also part with a small part of their commission to the walk-in customers who purchase tickets from them. The extent of commission passed on to the customers depends upon the competition and negotiating ability of the customers. Non-IATA agents do not have stock of the air tickets.

General sales agents 5.1 General Sales Agents are appointed by the scheduled airlines to sell the tickets of that particular airline in a particular territory. They cannot sell the tickets of any other airline. They normally do not operate at a place where that airline has its office. The General Sales Agent is entitled to an overriding commission of 3% on all the sales made in his region. Problems in investigations & suggestions 6.1 The walk-in customers generally purchase tickets in cash. The commission passed on to them is deducted in the sale bill itself. The customers therefore, are paying the net amount to the agent i.e., gross value of the air ticket minus commission passed on to them. Investigations in some cases indicate that, the agents do not have any evidence in the form of vouchers/receipts containing the signatures of the customers. The evidence of passing of commission to the customers available with the assessee are the sale bills given to the customers. These sales bills also do not contain the signature of the customer. In the absence of such evidence, the quantum of commission actually passed on to the customers, can not be properly ascertained. It is possible that the assessee after having given a sale bill to such a customer can increase the quantum of commission passed on to the customers in the copy of the sale bill which remains with the assessee and which forms a part of the books of accounts. The quantum of commission claimed to have been passed on to the

walk-in customers is often as high as 30 to 40% of the commission received from the airlines. 6.2 It is well known that the airlines provide several incentives to the agents in the form of free tickets and other freebies which may not be disclosed by the agent. It is also possible that additional incentives and productivity linked benefits are not fully disclosed by the agents. It would therefore, be worthwhile to collect information from the airlines directly about the commission and incentives paid to the travel agents. The airlines should be asked to provide circulars by which special fares or various commission/discount/incentives were announced. Similarly information may be collected from subagents about the actual commission received by them. Inquiries in some of the cases reveal that there is a difference between the amount of commission shown by subagents, which means that either agents are passing less commission to the subagents compared to that shown in their books of account or subagents are showing less commission than what they have received. Packaged holidays & Tour operators 7.1 Package holidays, also known as package tours, include transport to the destination; food and accommodation at the destination; services of a guide or a holiday representative to help with any problems and advice on excursions or sight seeing tours. Most holidays advertised in holiday brochures contain these elements in one package. The people who put together these elements are called tour operators.

7.2 Unlike travel agents who sell the holidays and other travel products, tour operators actually develop different holiday plans putting together different packages tailored to suit the needs of individual travelers. They play the part of the wholesaler who buy hotel space, airline seats and other services in bulk and then repackage them into the holidays that we see offered for sale through travel agents. 7.3 Component of package holidays - Most of overseas inclusive tours have three separate elements

Accommodation. Transportation. Other services.

The accommodation component of the package is either serviced or self-catering. Sometimes meals are not included in the accommodation or only bed & breakfast is included. The transport element of a package holiday can be travel by air, coach, rail or ship. Whichever mode of transport is used, the tour operator will be offered preferential discounted rates known as inclusive tour rates. Depending on the volume of business generated, a ferry company, for example, can offer a tour operator prices which may be discounted by as much as 50% of their standard tariff. It is therefore common for tour operators to offer their clients discounted travel. Apart from accommodation and transport, a package holiday may usually include other services such as

transfers, the services of a representative, car hire, excursions, equipment hire etc. Tour operators 8.1 If we consider that travel agents as the retail arm of the travel business then tour operators can be likened to wholesalers since they buy in bulk from the providers of travel services such as hoteliers and airlines, break the bulk into manageable packages and offer the finished product, which is the inclusive tour for sale via a travel agent or direct to the consumer. The tour operators can be divided into following four categories

Mass market operators. Specialist operators. Domestic operators. Incoming tour operators.

8.2 Mass market operators include some of the wellknown names in the industry such as Thomas Cook and Raj Travels. These companies cover a major share of the package holiday market. The specialist operators offer holidays and other travel arrangements to a particular geographical region or destination. Domestic operators specialise in marketing of domestic tours only. Inbound tour operators cater to the needs of overseas visitors who choose to visit India. Discounting

9.1 Tour operators obtain different elements of their inclusive tours at discounted rates from suppliers such as hoteliers and airlines who are happy to negotiate a discount in return for releasing an agreed amount of stock. Discounting is also prevalent at the other end of the distribution chain namely discounted holidays offered for sale by a travel agency. 9.2 The travel agent/tour operator has to be in touch with the following types of leisure facility operators and also get commission from them

Establishments offering accommodation- for example, hotels, guest houses etc.. Catering & hospitality facilities- cafes, restaurant, fast food outlets, bars and pubs etc.. Arts and entertainment venues- art galleries, theaters, casinos. Sport & recreation facilities- parks, golf courses, outdoor stadiums. Heritage & Cultural facilities- including museums, historic places, gardens etc..

9.3 Now a days some of the travel agents/tour operators are tying up with the budget hotels on an exclusive basis. It is learnt that travel agents and tour operators are assuring the hotels of a steady business for a commission ranging from 25 % to 35%. The tie up is on exclusive basis i.e. no business will be given to any other hotel except the

one with whom they had tied up or in some cases two agencies enter into alliance with each other assuring to give business on exchange of good commission. 9.4 The tour operators organise various services in the following manner

First, visas are arranged for allowing the customer to enter their respective destinations abroad. Apart from the visa fees paid to the embassies or consulates, fees are charged for the services rendered. The land arrangements for customers includes services such as hotel stay, meals, breakfast and transfers. These services are provided as per the brochures published. The POE (Protector of Emigration services) clearance is arranged for those persons for whom emigration check is required. A service charge of Rs. 100/- to Rs. 200/-is charged by the agents in normal cases. Mediclaim policy is obtained when the passenger travels to European countries and the United States. This insurance protects the customers and all his medical expenses are taken care of. The premium amount is paid to the insurance company, and Rs. 100/- to Rs. 200/- are charged from the customer.

Booking procedures - Outbound tours

10.1 The customers are booked at the branches by paying a certain amount of deposit depending upon the tour which they want to undertake. The bookings are also received through travel agents on behalf of the customers. The branch accountant maintains client-wise accounts to keep track of his deposits and the expenses incurred. The branch office advises the bookings made for the day to the tour operation unit in the head office. The tour operation unit takes the booking on record specifying the tour and date etc. and it advises the land operator abroad for providing necessary services in the respective countries. The head office maintains the books of accounts such as cash book, ledger, purchase and sale registers etc.. The payments are received at the branch office for which payment & receipt scrolls are prepared and forwarded to the head office. 10.2 The branch office receives payment in INR and USD. The INR is spent towards meeting expenses of visa, Mediclaim and ticketing and the USD is spent towards land arrangements. The sales register is normally maintained for all the payments received from the customers and details are reflected such as invoice number and date, customers name, tour and the amount. The sundry creditors register is maintained for all Purchases done from airlines and the land operators. Some of the tour operators do not show receipts of amounts collected in forex on the plea that the passenger makes his payment in rupees in India and US dollars abroad from his entitlement to the foreign tour operator for

meeting the land arrangements, meals, hotel accommodation etc.. 10.3 The foreign exchange is received from the customers from their BTQ (Basic Travel Quota) entitlement. It is collected as per the tour, the customer is joining. If it is accounted in the books, the agent/operator debits the amount payable by the customer and credit is given to the various turnover accounts. 10.4 In case of fly-now-pay-later schemes, the customers credibility is got assessed by some finance company. The finance company makes down payment after deducting their charges (10-15%) which is included in the package and makes the net payment to the assessee depending upon each tour. The customer makes the equated payment to the finance company. Inbound tours 11.1 Normally, under the agreement between a foreign travel agent and the Indian inbound tour operators, the Indian tour operator has to provide the following services

Arranging for and supplying tariff details to cover the handling of tourists, including hotel accommodation, boarding, air transportation between India and overseas, local transportation, sight seeing arrangements etc.. Making all arrangements in India for visits of tourists to different places of interest including air port transfers, hotel accommodation, boarding,

ground, air and water transportation providing qualified English or other language guides, entertainment and such other facilities to make the visit of the tourist comfortable.

Obtaining licenses or permits required to enable the tourists to complete their tour itineraries. Arranging in India for ticket bookings and reservations subject to the terms and conditions as may be prescribed by the parties for whom such ticket bookings and reservations are made.

11.2 The Indian company sends itemised invoices for each group giving the actual cost for all services and adding a mark up. It may also decide to charge a lump sum amount depending upon the settlement with the overseas agent. Accounting for inbound tour business 12.1 The procedure adopted by some of the inbound tour operators is as follows

For every tour, a separate ledger account is opened. The bill raised on the overseas tour operator is credited to this account. All costs incurred for that tour, like air tickets, hotel bills, transporters bills guide charges etc.. are debited to this account.

The difference between the bills raised and cost incurred is transferred to the inbound tours commission account. For all tours completed on or before 31st March, the tour commission is accounted for in that financial year itself. If for any tour completed before 31st March, some bills for cost are not received till 31st March, then provision for that amount is kept in that tour account and commission is accounted for accordingly. In the next year, expenses pertaining to that tour get adjusted towards the provisions.

12.2 Tour Commission - For every tour, a bill is raised on an overseas tour operator. Expenses on tours like hotel, transport, air tickets, escort and guide charges are paid by the Indian agent. The difference between amount billed to the overseas operator for a particular tour and the expenses incurred for that tour is booked as tour commission. 12.3 Books of account maintained - Normally following types of books are maintained

Domestic travel register International travel register Passport and visa register Hotel register

Tour register (inbound and outbound) Bill register Rail register etc.

The ledgers are general ledger, debit and credit, travel, tour, hotel, airlines ledgers etc. Investigation of accounts of travel agents / tour operators 13.1 The basic problems which arise in investigating the accounts of travel agents and tour operators relate to ascertaining the amount of commission/discount received by them and commission/discount passed on to the sub agents or customers. The travel agents get a good deal of commission in selling these packaged tours and the tour operators obtain heavy discount from hotels, airlines and other facility providers. Even for arranging shopping from select shops and emporiums, agent/coach operator is given a certain amount of commission. Though it is difficult to ascertain the exact amount of commission, discounts or incentive passed on in this trade, an attempt can be made by comparing these figures in the books of the commission giver and the recipient. A wide variation has been observed in cases where such enquiries have been conducted. 13.2 Commission payable to sub agents is debited in the books of accounts but not paid. While the travel agent deducts this amount from his income, sub agents do not

show such receipts on the ground that they are maintaining accounts on cash basis. 13.3 Some tickets are given free by the airlines which can be sold, some are given at discount and some at a discount for the employees. It may be verified whether these are reflected in the accounts. There are occasions when airlines have given luxury cars like Mercedes Benz to the agents for achieving certain targets. Such expenses are debited under the sales promotion account of the airlines. The AO may see as to what treatment has been given by the agent to such gifts. 13.4 If there are no connecting flights, as also in some other special circumstances, free stay in hotels is provided by the air carrier. These facilities are sometimes charged by the travel agent. 13.5 Some of the agents, in their books of accounts show income from ticketing only. Miscellaneous income earned by way of passport and visa services, cancellation etc.. are not shown. This may be looked into. 13.6 In case of unskilled workers who go abroad in groups, the amount towards the ticketing and POE charges is received in cash. Substantial discounts may be shown in such cases, though in reality, it may not have been passed on. The amount of discount given to the customers in such cases may be carefully examined. 13.7 A glance at the profit and loss account of major travel agents may reveal that they have credited only net

commission to the P / L account. If a part of the commission is given to a client out of the commission received from the airlines, the same is netted off from the commission account itself. The travel agent reduces his income with that amount instead of showing it as an expense. Similarly, for inbound tours, he essentially books hotels, arrange transfers etc.. on behalf of the overseas tour operators and earns commission in the process. Here also, only the net figure is credited to the P & L a/c after deducting expenses incurred on providing services for each tour. In view of this the AO may have to call for the books of accounts and examine the ledger account of each tour to see what type of expenses have been debited and what discounts have been received. 13.8 A large amount of commission/handling charges is sometimes paid to intermediaries which are sister concerns of the agent. Services rendered by these concerns, should be checked. 13.9 As mentioned earlier, the foreign exchange component collected from the customers in respect of outbound tours is not reflected by the tour operators on the ground that payment is made abroad for land arrangements. The receipts in forex charged by the tour operator and the amount spent should be examined. Deduction u/s 80HHD of the Income tax Act, 1961 14.1 Both the travel agent and approved tour operators are eligible for deduction under the provisions of this section. The term Travel Agent has been defined in

clause (a) of the Explanation at the end of the section to mean a travel agent or other person (not being an airline or a shipping company) who holds a valid license granted by the Reserve Bank of India u/s 32 of Foreign Exchange Regulation Act, 1973. Similarly the tour operator has to be approved by the Prescribed Authority, who is the Director General of Tourism. Unless these conditions are satisfied, no deduction is available to the travel agent or the tour operator. 14.2 Section 80 HHD provides for deduction in respect of earnings in convertible foreign exchange. Clause (c) of the Explanation clarifies that services provided to foreign tourist shall not include services by way of sale in any shop owned and managed by the tour operator/travel agent. However, services provided at health clubs, beauty parlors, barber shops etc.. owned or managed by such persons will be included in the term services provided to the foreign tourist and will be entitled to deduction under this Section. But if such health club, beauty parlors etc.. also sells some goods to foreign tourists, such sale can not be included in the term services provided to the foreign tourist. 14.3 The deduction is not restricted to the first recipient of the convertible foreign exchange. In some cases the foreign tourist visits India on a package tour and makes payment in foreign exchange in one lump sum to a tour operator in India and the Indian tour operator thereafter, makes payments to the hotels where the tourist groups are lodged. The Section has been amended to provide

that in cases where payments for services to the foreign tourist provided by hotel, tour operator or a travel agent are received in Indian currency from another tour operator or travel agent or airline, the person providing services to the foreign tourist will be eligible for the deduction u/s 80HHD in relation to profits derived there from, subject to the condition that the payment in Indian currency is made out of funds obtained by conversion of foreign exchange brought to India, through an authorised dealer in foreign exchange, by the tour operator, travel agent, or the airline on behalf of the foreign tourist. The person claiming the deduction is required to furnish along with the return of income a certificate obtained from the person making payment in Indian currency out of foreign exchange paid by the foreigner. Impact of Internet 15.1 There has been a complete change in the travel agency business due to impact of information technology and the internet. The travel agents are moving from being mere ticket-issuers to travel consultants taking complete responsibility for the customers needs. The incomes are changing from commission to fees. Pressure has also been compounded by the decision of large multinationals to centralise their travel decisions globally with consolidated purchase of airline tickets and hotels. Travel costs comprise the third largest expense for corporates, therefore, it is not surprising that net-savvy multinationals are intent on exploiting their buying power.

15.2 Today, a majority of the airline ticket distribution is by traditional distribution methods like travel agents and only 25% is through direct means. However, in the near future the distribution structure is likely to change with about 50% being distributed through electronic channels, airline portals and electronic travel agents like travelorcity and the remaining half through travel agents. 15.3 Information technology has become a priority area for all airlines with most trying to do direct business through their own web sites. The advent of portals like travelorcity and price line.dotcom have queered the pitch even more. Millions of airline passengers in the USA have registered themselves to receive weekly E-mail from airlines who give them information on fares and discounts. Discounted fare are announced on line each week for travel on the weekend. For the airlines, the icing on the cake is that passengers are being weaned away from the travel agents. Paperless tickets 16.1 Ticket-less travel may not be associated with the usual stigma in the days to come. Net-savvy airlines have already begun e-ticketing or paperless tickets on the web. The concept is still nascent but it involves booking on the net and being given a consumer number. Passengers then have to present the number on the day of the flight with relevant travel papers. Among the airlines pursuing eticketing is Alaska Airlines which has gone the whole way and is even offering an Internet check-in facility. The passenger can use the system on the day of the flight. The

system asks them the same questions about luggage that are normally asked. Using the net can free staff and space at the check-in counters at crowded airports. 16.2 Travelmartindia.com Indias first travel related ecommerce portal has also plans on introducing e-ticketing in India, whereby once the ticket has been paid for by credit card, the client is given an exclusive number which he is required to provide at the check-in counter to board the flight. The role of the travel agent is changing with the advent of the internet. Now, if one simply logs on to the site, there are various categories such as airlines, hotel, car, cruise, vacation and forex etc.. By typing the requisite data, users can choose from a variety of options. The competition among the agents has also increased due to a spurt in the number of travel agents. Their role however, is getting marginalised in the sense that the booking can now be made through the internet as all the information is available on web sites. The concept therefore, is changing from charging of commission to a management fee concept. This is being practiced by many countries and essentially means charging a fee for the service which in turn can find favour with the travellers only if there is enough value addition to the basic product services.

Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter XIX

CHARITABLE TRUSTS AND INSTITUTIONS

Introduction 1.1 Charity has emerged as the third sector apart from the public and the private sectors, and is playing a major role in improving the lot of the underprivileged. State is an important stakeholder in this sector. It has to ensure that the sector plays this role meaningfully. One of the mechanisms through which it enforces its interest is taxation. The AO should keep this underlying philosophy in mind. 1.2 Charitable purpose is defined in the Income tax Act in a wide manner. Charity for tax purposes is not confined to relief of poverty. It is concerned with improving the quality of life all-round and embraces all income classes. It may seek to promote health, welfare, happiness and culture. In this sense it is more philanthropy than charity.

Basics 2.1 The expression used in Section 11 is trust or institution. The word trust connotes a legal relation based on confidence by which a property is held by one person on behalf of and for the benefit of another. According to Section 3 of the Indian Trusts Act 1882, a trust is an obligation annexed to the ownership of property and arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him, for the benefit of another, or of another and the owner. The trust property is owned by the trustee who is under a legal obligation to use his ownership for the benefit of the beneficiaries. 2.2 The dedication of property to a charitable or religious trust is permanent. Even the fact that the trustees have failed to carry out the objects of the trust will not invalidate it, and neither the founder nor his heirs can resume it. The founder cannot alter the terms of the trust deed either. Only a court can u/s 92 CPC settle a scheme, appoint new trustees, authorise the whole or any part of the trust property to be let, sold, mortgaged or exchanged. If the purpose of the trust becomes superfluous or illegal due to a change in law or social habits and needs, the trustees are obliged to apply to the court for a cy- pres scheme providing for alternative charity. 2.3 The term institution will take in - a society registered under the Societies Registration Act 1860 and a company incorporated without profit motive and registered under Section 25 of the Companies Act 1956. It is necessary that

it should have legal existence. A body having no separate legal existence cannot come within the scope of Section 11. However, the word institution appearing in Section 10(23C) has no such connotation. Thus, an educational institution or a medical institution having a separate identity, though not legal existence, may also come within its scope. However, the status of the owner - trust, society or company - may be relevant for determining whether the institution is one existing solely for educational purposes. The Good ones and the Bad ones 3.1 Identifying and segregating the bad trusts or institutions from the good ones is difficult. It can be done through certain tests respect of their activities, governance and finances. 3.2 As for activities, a bad organisation is not likely to have any vision. If it has one, the vision is unclear or it keeps changing and it is driven by money / resources. Similarly, the organisation may not have any mission. If it has a mission, it is unclear and /or keeps changing. The organisation is not likely to have any long term goals or objectives. There are no programmes / activities but money is spent in large amounts in the name of application. Even if there are activities they are not resulting in any clear benefit to the beneficiaries. Often, there is no definite target population and there is no particular geographical area where its activities are implemented. And there is no planning process. If there is any planning at all, it is top-down. As the trustees wish, they decide and implement.

3.3 In the sphere of governance, a bad organisation has generally a closed, non-rotating and / or dysfunctional board. No meetings of the board are held. If held, they are irregular and their quality poor. The benefit to the trustees is high, some times exceeding what is provided in the corporate sector. 3.4 The area of finances, resources and their management is the most critical area which shows whether an organisation is using its resources effectively or misusing them. Malpractices in the area of collection of funds are several. Funds received for a particular purpose are not used for that purpose. Funds are collected from more than one source for a single purpose. Funds are collected coercively - as in the case of admissions to schools and colleges. Funds are collected but are not accounted for as income of the organisation and pocketed by the trustees. 3.5 In the area of utilisation of funds one or more of the following irregularities can be noticed in the case of a bad organisation - funds received for a particular purpose are diverted for another. Money spent on acquiring assets and not on carrying out programmes benefiting the people. Disproportionately high expenditure is incurred on administration and very little is spent on genuine charity. Assets are purchased in the names of the trustees, not in the name of the organisation. 3.6 The following irregularities in the spheres of compliance with laws characterise a bad organisation Other applicable laws are not complied with - as in the

case of a society which has been declared defunct under the Societies Registration Act due to noncompliance but which still keeps filing tax returns and getting assessed. Different figures of receipts and expenditure are shown to different government authorities. The AOs should be vigilant and check on the above aspects so that the fake ones do not get the benefits intended for genuine organisations. Institutions claiming exemption u/s 10 4.1 Exemption u/s 10 and that u/s 11 are not mutually exclusive. An assessee may choose to claim exemption under either of the Sections. Exemption u/s 10 is governed by the provisions of only that Section. The conditions relevant for exemption u/s 11 are not to be imported mechanically while claims of deciding exemption u/s 10(23C), etc. 4.2 The exemption u/s 10(22) (now 10(23C) is available to an educational institution existing solely for educational purpose and not for purposes of profit. It is the income of the institution not only the income from the institution, which is exempt. The former is a wider concept. This has been illustrated by the facts in Brahmin Educational Society v. CIT (1997) 227 ITR 317 (Ker.). The Society had organised chits, the business income from which was used for educational purposes. The Court held that, if an institution existed solely for educational purposes, the income derived by it from any of source would be covered by the exemption in Section 10(22). The AO should bear this in mind and desist from useless additions. He can

however look into the fact whether such income is used only for the purpose of education. If it is otherwise, he may draw and inference that the institution is not existing solely for the purpose of education. 4.3 The educational institution referred to in Section 10(22) {now 10(23C)} need not have a separate legal existence. It can be a constituent of a trust, society or a company. It can be run even by an individual. Still if it answers the requirements of that section, it will qualify for exemption. See the decision of Madras High Court in Calavala Cunnan Chetty Charities (1982) 135 ITR 485 and also Boards Instruction no. 1112 dated 9.7.1977. The Court has held that in the case of a multipurpose (not merely educational) charitable trust running educational institutions and charities, the educational institutions will qualify for exemption u/s 10(22), if they have distinct identities and accounts. Investigations in such cases should be directed towards finding out whether the institution has distinct identity and separate books and whether the educational funds are retained and used only for education. 4.4 Conversely, a society formed for the sole purpose of establishing, running, managing or assisting schools and colleges is itself an educational institution entitled to exemption u/s 10(22). Aditanar Educational Institution v. Addl CIT (supra). What is to be looked into in such cases is whether the sole purpose of the trust is education - not merely the stated purpose but the real purpose.

4.5 The requirement existing solely for educational purposes should not be decided on the facts of just one year only. The fortuitous circumstance of having a large surplus in one year or the solitary fact of diverting income to objects charitable, but not educational, by itself will not make the purpose any the less educational. Birla Vidya Vihar Trust v. CIT (1982)136 ITR 445 (Cal). 4.6 The expression not for purposes of profit does not stipulate that the institution should provide education at cost or below cost and should not make any surplus. The very scheme of the law contemplates surplus, as otherwise there will be no need for a provision like Section 10(23C) giving exemption to it. What is prohibited is only private gain from out of such surplus. As long as the surplus is ploughed back into the institution and utilised for its purposes, the exemption will be available. In its Instruction No. 1112 the Board has clarified that only if the profit of the educational institution can be diverted for the personal use of the proprietor thereof, the income will be subject to tax. The claims regarding ploughing back of income should be checked for factual veracity. Private gain should be assiduously ruled out. The seemingly contrary decision of the Supreme Court in the case of Safdar Jung Enclave Education Society v. Municipal Corporation of Delhi AIR 1992 SC 1456 was rendered in the context of definition of charitable purpose. However, in blatantly profit-oriented cases the decision may be relied upon to deny the exemption not deserved.

4.7 In case of medical institutions, the condition is that they should exist solely for philanthropic purposes and not for purposes of profit. The term philanthropic purposes is broader in scope than the term medical purposes and it has been interpreted by the courts to include activities promoting goodwill to mankind or activities beneficial to humanity at large. In CIT v. Pulikkal Medical Foundation (1994) 210 ITR 299 (Ker) the Court held that, where a hospital exists solely for philanthropic purposes, even if, incidentally profit is also earned, the hospital is entitled to benefit of exemption. Neither the fortuitous factor of large surplus in any particular year, nor the fact of diverting some to objects which are not philanthropic in themselves, is decisive of the matter, it held. Such a wide interpretation should be kept in view. 4.8 It has been held by the Supreme Court in Aditanar Educational Trust V. Addl. CIT (1997) 224 ITR 310 (SC) that eligibility for the exemption is subject to departmental scrutiny year after year. This decision being the law of the land makes it obligatory for all educational institutions to submit their returns. Hence the AO will be within his rights in asking the assessee to file its returns and subject itself to tax scrutiny. This obligation is yet to be written into the statute book, though. Charitable Purpose - Section 2(15) 5.1 The concept of charity under tax law is much wider than the common understanding of charity. The expression Charitable purpose in Section 2(15) includes relief of poor, education, medical relief and

advancement of any other object of general public utility. The AO should not be unduly influenced by the common notions of charity according to which only the relief of poor is charity. 5.2 To qualify as charitable, a purpose must have a public character. It must aim to benefit the community or a section of it, and not particular private individuals or identifiable groups. This test should be rigorously applied to exclude private trusts from benefiting from the exemption. However, it should be borne in mind that every object of general utility to the community is not necessarily charitable. 5.3 A trust established for the benefit of the employees of a company, even as big public sector company as the ITI, does not satisfy the conditions of Section 2(15). If the relevant rules indicate that the benefit of the scheme or the alleged charitable purpose can be utilised only by specified persons who are required to be the subscribers or their dependents, there is no charitable purpose. See CIT v. BEL Employees Death Relief Fund (1997) 225 ITR 270 and CIT v. ITI Employees Death etc.. Fund (1998) 234 ITR 308 (both Kar). 5.4 For purposes of tax law, religious or political purposes are not charitable purposes. The AO should be careful about political activities being masked as charitable activities. 5.5 Relief of poor is a charitable purpose. Very often relatives, friends or employees are conferred benefits in

the guise of general poor. Hence, any claim of relief of poor should be subjected to scrutiny as to the intended and actual beneficiaries. 5.6 Education is one of the purposes listed in Section 2(15) as charitable. It must mix with public benefit. In Safdar Jung Enclave Education Society v. Municipal Corporation of Delhi (supra) the Supreme Court held that education per se is not charitable unless an element of public benefit or philanthropy is present and that, if education is run on commercial lines, the institution should not get the exemption merely because it is a school. 5.7 The term education is not to be understood in a wide sense, but in the narrow sense of giving systematic instruction in a formal environment. See Loka Shikshana Trust (1975) 101 ITR 234 (SC). Whenever an claim is made on grounds of education, details of the mode of imparting education should be obtained and examined. In Bihar Institute of Mining and Mines Surveying v. CIT 1994 208 ITR 608 (Patna), the court held that coaching of students for a particular examination on fixed fees schedule on a time bound basis was business and not imparting of education. 5.8 Medical relief is not confined to medical relief of the poor. Providing medical aid to needy patients, whether poor or rich, is a charitable purpose. Medical relief does not mean free treatment or treatment at a concessional price to all patients. The AO should keep in mind this settled position in law while making investigations.

However, he may note the following view held by a section of the departmental officers The term used is medical relief, not medical aid, nor medical purpose. The use of the word relief signifies that there must be some relief. It cannot be relief in the sense of relief from the pain. When used in a taxing statute, it must mean a relief in monetary terms. As such, any institution which generates surplus year after year which is accumulated (even if for expansion) cannot be held as engaged in charitable activities. Such an institution may qualify for exemption under Section 10(23C) (via) but not under Section 11. The above view is, however, open to debate. 5.9 Advancement of any other object of general public utility is a charitable purpose. The expression is wide in its sweep. Yet, it includes only those objects which promote welfare of the general public. The restriction not involving the carrying on of any activity for profit is no longer there. An object beneficial to only a section of the public is also an object of general public utility. It is not necessary that the purpose should provide something for nothing or for less than it costs or for less than the ordinary price. When an object seeks to protect the interests of a particular trade or industry that object may be an object of general public utility, but not so, if it seeks

to promote the interests of those who conduct the said trade or industry. 5.10 Any purpose aimed at promotion of social intercourse among the members is not a charitable purpose. Any institution having it as its dominant object is a social club. The AO should be alert to this issue as there is no charity here even in the extended sense. 5.11 The tendency often is to mistake the accidental surplus from charitable activity as the result of a commercial activity and seek to deny the exemption on that score. Surplus is a normal incident of any well-run institution, whether charitable or otherwise. The Act itself envisages surplus. Otherwise, there is no need for exemption of income. Mere presence of surplus, without more, will not convert a charitable activity into a noncharitable commercial activity. Institutions claiming exemption u/s 11 6.1 General issues 6.1.1 Objects and activities - Broadly, the conditions for exemption are that - The property from which income is derived should be held under trust or other legal obligation, for charitable or religious purpose(s). The exemption is available for the income applied to or accumulated for such purposes in India. It is for the assessee to show that his case qualifies for the exemption.

6.1.2 Existence of the trust or legal obligation is of prime importance. A body which has no legal existence or has ceased to have such existence cannot be allowed tax exemption. The AO should be vigilant about instances of this kind. 6.1.3 The trust in respect of the property must be complete. No exemption is to be allowed where only the income and not the property itself is held under trust. Such income will be liable to be taxed in the hands of the Settlor u/s 60. In case of a trust in relation to an immovable property, the instrument of trust should be duly registered. For exemption u/s 11 there should be a legal obligation to distribute profits for charitable purposes. Actual distribution of profits for such purposes is not sufficient. 6.1.4 A charitable trust should have specific objects. Where the objects are too wide, the trust may not qualify for exemption. See Gangabai Charities v. CIT (1992)197 ITR 416 (SC). Similarly, where there are several objects of a trust, some of which are charitable and some noncharitable and the trustees are permitted to apply its income to any of the objects in their discretion, exemption u/s 11 will not be available. The recent decision of the Delhi High Court in Daulat Ram Public Trust v. CIT (2000) 112 Taxman 128 reinforces this view. 6.1.5 Not only its objects but also its activities should be studied before a trust or institution is accepted as charitable. In S.B.Adityan v. First ITO 52 ITR 453 (Mad) the Court held that the AO is not bound by the terms of the

trust deed, and it is open to him to take other factors such as the real purpose into consideration. 6.1.6 It is not possible to rectify the objects of the trust. The Madras High Court has held that a rectification deed cannot be valid unless there is power to alter the objects in the trust deed itself. Sakthi Charities v. CIT (1984) 149 ITR 624. (The issue is now before the Supreme Court in an SLP) However, removal of infirmities or ambiguities is possible by an amendment deed. See CIT v. Ganpatrai Sagarmal (1990) 182 ITR 89 (Cal). 6.1.7 As far as exemption provisions are concerned, even where the objects are amended with retrospective effect, the amendment would operate only prospectively from the date of amendment. See CIT v. Kamla Town Trust (1996) 217 ITR 699 (SC). Exemption can be considered only from the date on which the amendment made the trust fully charitable. 6.1.8 The objects of the trust and the powers given to the trustees are two different things. Powers are given to facilitate the objects. They should not be mistaken for the objects. Thiagarajar Charities v. Addl CIT (1997)225 ITR 1010 (SC). This should be so even where the powers are put under the objects clause in the trust deed. 6.1.9 Often trusts / institutions get tax exemptions submitting vague and imprecise things as objects and proposed activities. This can be checked quite effectively at the registration stage. The new Section 12 AA has made an enquiry into the activities of the trust possible

before granting registration to it. The trust may be required to furnish the following

Its immediate plan of action, area (locality) where the activity is planned to be carried out, the target population, the time frame, how the resources are proposed to be raised, and the result aimed (impact).

A commitment in this respect will oblige the trust to abide by its words. The AO may later check up whether the plan has in fact been carried out. Income from property held under trust 6.2.1 Section 11 exempts income from property held under trust. Where the exemption is denied, what is to be taxed is the income, not the gross receipts. 6.2.2 The meaning of the term Income in Section 11 is different from that of total income in Section 2(45). Income contemplated in Section 11 is real income and not total income. If the accounts of the assessee are properly maintained according to accepted principles of accountancy, the income as per these accounts is the income for the purpose of Section 11. So long as the trust has applied its actual income for Charitable purposes, it

will not be liable to tax irrespective of the position of its total income. Hence, head-wise computation of income is not necessary. 6.2.3 If the trust has not utilised part of its actual income, the balance after accumulation of 25 % as per Section 11(1)(a), and any additional amount accumulated u/s 11(2) will be liable to tax. Where, however, the trust has not applied any income for charitable purposes at all, nor applied for accumulation of income, or has totally forfeited exemption u/s 11, the income liable to tax will be its total income as computed under the Act. Such income includes voluntary contributions, both for corpus and non-corpus, as income from other sources. Section 11(4) however stipulates that, where a business undertaking is held under trust, the income there from should be computed in accordance with the provisions of the Act and the difference between that income as per the Act and the book profit, should be taken as applied to purposes other than charitable purposes. The AO should keep these provisions in view. He should see to it that the book profits are not artificially depressed to report a lower income. 6.2.4 What qualifies for exemption u/s 11 is the income derived from property held under trust. It is not sufficient that the property is indirectly responsible for the income. The income must directly and substantially arise from property held under trust. The onus is on the assessee to prove that a particular income flowed from genuine sources and comes within the ambit of Section 11. See decisions reported in 10 ITR 26 (BOM) and 14 ITR 362(

Cal). Thus, income from undisclosed sources can be denied exemption even where it is shown to have been applied to charitable purposes. 6.2.5 Exemption u/s 5(1)(i) of the Wealth tax Act is available only for the property held under trust for a public purpose of charitable or religious nature in India. The purpose should be in India. The situs of the property is irrelevant. This has been clarified recently by the Supreme Court in Nizams Pilgrimage Money Trust v. CIT. 6.2.6 The Act deems certain items as incomes of the institution during the previous year, as per Sections 11 (IB), 11(3), and 11(4). Often, the institutions do not report such incomes and the AO has to piece together the bits of information. These deemed incomes are to be taxed no matter the application during the year is large enough to cover them also. A contrary view will be against the scheme of the Act and its express provisions. The AO should collect the relevant details and bring these incomes to tax. Voluntary Contributions 6.3.1 Section 2 (24) (iia) defines income as including voluntary contribution received by a trust created wholly or partly for charitable or religious purposes. Section 12 on the other hand deems only non-corpus donations as income from property held under trust. Thus, corpus donation is not income from property held under trust, though income in the broader sense. While a distinction is made in Section 12 between corpus donations and non-

corpus donations, no such distinction is made in Section 2(24). Therefore, where exemption u/s 11 is denied in toto, provisions of Sections 11 and 12 governing that exemption recede from operation. Then, even corpus donations become assessable as income by virtue of Section 2(24) (ii a). True, Section 11 (1)(d) specifically provides for exemption of corpus donations, but that provision operates only if Section is applicable to a particular case. 6.3.2 The direction regarding corpus donation should come voluntarily from the donor. The AO should be alert to any evidence to the contrary. In many cases the printed receipts issued by the trusts carry the words The donation is towards the corpus of the trust. Strictly speaking, this is not a direction suo-motu from the donor. The inference is that the trust itself has decided to treat the donation as towards the corpus leaving no option to the donor. Similarly, donations received by way of box collections and other anonymous donations can not form part of the corpus of the trust. In Prabodhan Prakashan v. ADIT (1994) 50 ID 135 (BOM), the ITAT has decided that the inscription donations towards corpus on the box merely amounted to direction by the donee, not by the donor, and that it was not sufficient to hold the donations as corpus donations. 6.3.3 Corpus donation is a major area where black money operates. Claims of large corpus donations should be viewed with caution. The burden of showing the contribution as corpus donation is on the taxpayer. The AO will be well within his rights in putting it to strict proof.

Failure on the assessees part may be dealt with in either of the following ways

The contribution may be treated as non-corpus donation and hence deemed income from property held under trust. This will bring it under the discipline of Section. The contribution may, if the circumstances so warrant, be treated as income from undisclosed sources and denied the exemption.

6.3.4 Disguising capitation fee receipts as donations from unidentified donors is common with professional educational institutions. In such cases the assessee may be asked to prove the genuineness of the donations, on pain of such donations being treated as its income from undisclosed sources and denied exemption. The nexus between the admission and the donation, when established, may help bust the claim of corpus donation but may not help in denying the exemption, as it will then be income from property held under trust. 6.3.5 In some cases the ITAT has repelled the assessees contentions that voluntary contributions received from offeratory boxes (hundials) were corpus donations. In such cases, the Tribunal has held that the burden of proving the contributions as corpus donations was on the assessee. The assessee failing in this, such contributions would be exempt only if they were applied to or accumulated for charitable purposes in India. The claim of receipts from the boxes should itself be factually verified through enquiries and spot inspections, if necessary. Conversion of black

money into white by disguising it as box collections is often attempted. A trust in Chennai claimed all of a sudden box collections of Rs. 1.5 crores in one year, never before and never after, to explain away investment of an identical amount in immovable property in that year. 6.3.6 Under Section 12, voluntary contributions are deemed to be income from property held under trust. If the contribution is not voluntary, but a compulsory exaction, it may still be income from property, not just deemed income from property. Such income may qualify for exemption u/s 11, if it is applied or accumulated for charitable purposes. In this connection please see the decision in Rangaraya Medical College v. ITO (1979) 117 ITR 284 (AP). 6.3.7 The claim of donations, especially corpus donations, by one trust to another should be examined carefully. Usually this is a device adopted between trusts of the same group to claim exemption without doing any charity. It is also employed to escape the rigours of the provisions relating to accumulation. The effort should be to ascertain the reality behind the veil. If the AO finds that the move is a devious tax device, he can invoke the decision in McDowell & Co Ltd. v. CTO (1985) 154 ITR 148 (SC) and deny the exemption to the donor-trust. 6.3.8 There was a view, now discarded, that donation by one charitable trust to another could be reckoned as application only if the donee trust applied the funds to charity during the year itself. It is now settled that such donation for utilisation by the donee trust towards its

charitable objects is application of income for charitable purposes in the hands of the donor-trust. The CBDT Instruction No. 1132 dated 5. 1.1981 directed that the donor-trust would not lose exemption merely because the donee-trust did not apply the donations to charitable purposes during the year of receipt itself. The Boards Instruction No. 1582 dated 19.10.1984 has clarified that no unqualified benefit should be given to the donor-trust and the AO should be satisfied that the funds which have been donated to the donee-trust will be utilised only for charitable purposes. In this context it may be advisable for the AO to go behind the facade and see the reality. 6.3.9 A number of professional educational institutions have been started in States like Tamilnadu by persons who were once politically active. At least in some of these cases, these are reasons making it difficult to believe that their intentions are educational. Substantial funds have been introduced in these institutions as voluntary contributions from numerous donors. It is possible that the amounts are the unaccounted funds of the founder and his associates. Extensive investigations and sustained questioning of the alleged donors, especially with reference to the minor and intricate details of the so-called contributions, may help in establishing the truth. Business 6.4.1 There is no prohibition on a charitable trust carrying on a business. Where a business is carried on, what is to be looked into is whether the dominant object of the

activity is profit-making or carrying out a charitable purpose. If it is the former, the trust is a commercial venture which will not get tax exemption. If it is the latter, the trust qualifies for exemption. The only requirement, then, is that the carrying on of the business should be incidental to the attainment of the objects of the trust. It should feed the charity and not be fed by it. (If this is not the case, only the business income from that business will suffer tax despite the fact that it has been applied to charitable purposes. The other incomes will still enjoy exemption if the other conditions are satisfied.) Even this condition will not apply to a case where the business undertaking itself is a property held under trust. Hence, seeking to deny the exemption wholesale will be unwarranted and useless. 6.4.2 A trust circumscribed by the restriction that the business should be incidental to the attainment of the objects of the trust, usually tries to set up the plea that the business is not one carried on by it, but one held under trust. Such claims, when made, should be put to strict evidence by examining how the business came into the assessees possession in the first place and whether it can be considered as forming part of the corpus. It should however be kept in mind that there need not be a preexisting business to justify the claim that the business is subject matter of trust 147 ITR 521 (Bom.) 6.4.3 Section 11(4) deals with cases where a business undertaking is held in trust, and empowers the AO to compute the business income there from in accordance

with the provisions of the Act. The excess of such income over the income as per the accounts shall be treated as applied to non-charitable purposes. 6.4.4 Trusts running businesses like Kalyana Mantapam (wedding halls) have a tendency to disguise a part of the business receipts as donations. The true nature of such receipts should be exposed by showing the nexus. A reference in this regard may be made to discussions in Chapter X of this Volume. 6.4.5 A business carried on by a trust is as much business as one carried on by any other person. Depreciation is allowable on assets used in that business, in computing the income. If depreciation is allowed, the income to be applied for charitable purposes gets reduced, but the cash balance increases to the extent of the depreciation allowed. Such cash may be spent on non-charitable purposes without there being any reference to it in the income and expenditure account. The AO can detect such items either by scrutinising the cash book or by asking the assessee to furnish a receipt and payments account incorporating the opening and closing balances. 6.4.6 Whether depreciation is allowable on assets acquired through application of funds ? Income from property is to be computed in accordance with commercial principles. Any asset which is being used in incomeearning activity will qualify for depreciation. But the issue whether an asset whose entire cost has been allowed deduction by way of exemption u/s 11 should be considered for this benefit - is still open. Though no direct

provision, instruction or judicial decision is available on this point, the decision of the Supreme Court in Escorts Ltd. v. Union of India (1993)199 ITR 43 is relevant. In the Courts opinion, double deduction or weighted deduction for an item should not be easily inferred. Wherever the Legislature wanted to give such deduction it has specifically said so. The Court observed that a double deduction cannot be a matter of inference, it must be provided for in clear and express language, regard being had to its unusual nature and its serious impact on the revenues of the state. Hence, it is reasonable to presume that in the absence of express provision, depreciation cannot be allowed on assets whose cost has already been allowed as application. The AO should keep track of such assets and be alert to depreciation claims on them. 6.4.7 There is another depreciation-related issue. Under the scheme of the Act depreciation is allowable on an asset employed in income-earning activities like business. Whether depreciation is allowable on assets employed in charitable activities, i.e., activities pertaining to application of income ? Considering that depreciation is not a tangible outgo, there is no money going out of the hands of the trust. Hence, the money equivalent of the depreciation allowance cannot be taken as applied. This being so, the assessee is under obligation to show that money as accumulation and observe the conditions for accumulation. Application and accumulation

6.5.1 Application of income is the main area for investigation. The AO should concentrate on factual verification of the claim. Field enquiries should be made as often as necessary, as mere verification of records may not bring out the true position. 6.5.2 Application of income to a charitable purpose, not included in the objects, may be breach of trust. There is a view that exemption u/s 11 can be denied in that event. This view is open to debate. The language of Section is neutral on this issue. 6.5.3 The corpus is the capital fund of the trust. It is supposed to keep it intact and do charity using only the yield there from. Hence application out of the corpus is to be discouraged. The trust should be told to recoup the corpus as early as possible. 6.5.4 There is no requirement in law that application should precede the receipt of income. A date-wise reconciliation of receipt and application is not contemplated. Even the excess application in the earlier year can be set off against the income of the succeeding year(s). Similarly, repayment of a loan taken in an earlier year for charitable purposes, if repaid by the income of the subsequent year, will be taken as application of income of the latter year. Where a trust incurs a debt to fulfill one or more of its objects, the repayment of the debt would amount to application of income for charitable purposes. (CBDT Circular No. 100 dated 24.1.1973). Genuineness of the claim of debt can be examined.

6.5.5 Whether loans advanced by an educational trust to students for higher studies would be treated as application of income for charitable purposes? If the object of the trust is advancement of education and granting of scholarship loans is only one of the activities, granting of loans, even if interest-bearing, will amount to application of income. Their recovery when made is income of that year. See CIT v. Cutchi Memon Union (1985) 189 ITR 5 (BOM). However, if the only object of the trust is to give interestbearing loans for higher studies, it will amount to carrying on of money lending business. Whether the trust is accounting for all such recoveries is also a point to enquire into. 6.5.6 Mere making of entries in the assessees books does not amount to application of income. These entries can be reversed if and when the assessee chooses to do that. The AO should be vigilant to this possibility. However, if there was communication sent to the doneeeducational institution that any such sum had been set apart in its favour and there had been reciprocal entries made in the donees books, the case will be different. See CIT v. Thanthi Trust (1999) 239 ITR 502 (SC). 6.5.7 There are charitable trusts which go on adding to the assets over the years without doing any charity whatever. They comply with law only in letter. In such cases of nominal compliance the use to which the assets are put should be enquired into. This will help in baring the noncharitable intent.

6.5.8 Application of income may be by adding to the corpus of the fund. In a case where the surplus income was utilised for making additions to a building, the building was let out and the rent from it was applied for charitable purposes, the amount spent on making the additions itself was held as applied for charitable purposes. CIT v. St. George Forana Church (1988) 170 ITR 62 (Ker). Repayment of the loan taken for construction of a building (the rent from which would feed the charitable purpose of the trust) was also held as proper application. 6.5.9 Application by way of investment in immovable properties is common on the ground that they will be used for charitable purposes. Often, such properties are not used for such purposes or, even if used so initially, are put to non-charitable uses later. A look into this area, probably a spot inspection, will help prove that the application of income in the first instance itself was not for charitable purposes. 6.5.10 Application especially in the form of acquisition of properties should be looked into not merely from the legal but from factual angle also. Acquisition in whose name, whether it is properly vouched, whether the stated cost is reasonable - these are valid questions. 6.5.11 It is possible that in some cases the application of income by way of investment in properties is overstated and the excess money siphoned off. Such cases are well worth referring to the Valuation cell for quantifying the short application.

6.5.12 Establishment expenditure is a pre-accrual charge to arrive at the income. Hence, it is to be treated as expenditure ordinarily, but not as application. There are a number of genuine organisations doing laudable work among the masses. They have to incur considerable expenditure on their personnel who do the field work. Without such expenditure the work is not possible. Such work and its results are not quantifiable in money terms. The establishment expenditure in such cases is bound to be high. Though high administrative expenditure should normally raise eyebrows, this aspect should be kept in view and any possible harassment to genuine organisations should be avoided. 6.5.13 Capital gains arising on transfer of a capital asset held under trust are part of income. They will be exempt if applied for the purposes of the trust, just like any other income. Besides, there is a deemed application - to the extent to which the sold proceeds are utilised for acquiring a new capital asset to be held under trust. The object is to enable corpus to remain intact though in a different form. Wherever the benefit of deeming is claimed, it is necessary to ascertain the character of both the transferred asset and the acquired asset - whether they are part of the property held under trust. 6.5.14 Law permits accumulation. But, the purposes of accumulation should be precise, not vague. DIT (E) Vs. Trustees of Singhania Charitable Trust 199 ITR 819 (Cal). Such vagueness is resorted to for tax-dodging. A trust

cannot list all its objects as purposes for accumulation. This is an area for scrutiny. 6.5.15 There is a statutory time limit for utilising the accumulated moneys. Non-utilisation within this period entails assessment of the accumulated funds as income. It is essential that proper records are kept and compliance watched. This is an important area requiring attention, but is usually overlooked. Whether the funds remain invested in the approved modes should also be checked. 6.5.16 Where the accumulated amount cannot be applied for the purpose for which it was accumulated due to circumstances beyond the control of the trust, the AO may, on an application being made to him, allow the trust to apply it for any other charitable or religious purpose in India which is in conformity with the trusts objects. An application from the trust and the AOs order thereon are necessary for such diversion. See Section 11 (3A). The AO should be watchful about this aspect. Prohibitions 6.6.1 The apparent is not always the real. A trust may claim to be public but in reality it may be a private trust. A look into the activities of the trust will unravel the reality. Registration u/s 12A / 12 AA becomes inconsequential where it is manifest that the trust is a private trust, because Section 13(1)(a) comes into operation. 6.6.2 Section 13(1)(b) governs the taxability of the income of trusts / institutions, created or established for the benefit

of any particular religious community or caste. Difficulty arises when this fact is not expressly mentioned in the deed but the trust carries on activities benefiting a particular community. There is a view that there is not even a theoretical possibility of denying the exemption to such a trust. This difficulty can be got over by gathering details regarding the activities of the trust and then proving that, though professedly created for the benefit of the mankind, the trust has actually been created for the benefit of that particular community. This proof will bring the case within the scope of Section 13(1)(b). 6.6.3 Under Section 13(1)(c) there is a disqualification if any part of the trusts income is used or applied, or enures directly or indirectly for the benefit of the specified persons. One such person is a substantial contributor whose total contributions to the trust upto the end of the year exceed Rs. 50,000. A trust which had received a donation of over Rs. 50,000 from another trust may violate Section 13(1)(ii) if it then makes any donation or extends any benefit to the latter. See Champa Charitable Trust v. CIT (1995) 214 ITR 764 (BOM). Inter-trust donations should be watched for this purpose. It is advisable to keep the list of substantial donors in the permanent record for of easy retrieval. 6.6.4 Section 13(1)(d) provides that investment in any of the prohibited modes will rob a trust of its tax exemption. Instances of prohibited modes being dressed up as approved modes are not rare. The assessee keeping money in the bank account of another person is

sometimes shown as deposit in the assessees own bank account. 6.6.5 In cases of violations of Section 13(1)(c) and (d), tax is charged at the maximum marginal rate, u/s 164 (2) and its proviso. 6.6.6 Section 21A of the Wealth tax Act 1957 deals with assessment in cases of diversion of property, or of income from property, held under trust. If any property or any income enures directly or indirectly for the benefit of any person referred to in Section 13(3) of the Income tax Act, wealth tax also becomes leviable. Action to be taken 6.7.1 It should be first checked whether the trust has been registered u/s 12 AA. The objects should be studied before the accounts are scrutinised. The activities should tally with the objects. The composition of the Board of trustees should be looked into. If the Board comprises only the family members of the settlor there may be something amiss. The scrutiny in that event should be deeper. 6.7.2 Where the total donations received by a trust exceeds Rs 10 lakhs, details should be obtained and looked into. The donation receipts should be got tallied with the bank account credits. Where individual corpus donations exceed Rs 1 lakh, the information should be communicated to the AOs of the donors. 6.7.3 The audit report furnished u/s 12A (b) should be perused for any qualifications and other relevant

information that may lead to serious enquiries. If administrative expenses exceed 50 percent of gross receipts, matter may require scrutiny. Details of phone expenses, travel expenses including foreign travel and provision of rent-free accommodation should be called for. A cost - benefit analysis may be worthwhile. 6.7.4 Details of investments made by the trust should always be obtained. In fact there is a requirement in the return form itself - Part A to ANNEXURE D of Form No 3A. It should be checked whether purchase of new assets is properly vouched. Whether the assets of the trust, particularly vehicles, have been purchased in the name of the trust or in the names of trustees, is a matter needing attention. It should be checked whether properties of the trust have been sold only after following necessary procedures. Investment of sale proceeds of immovable properties should be verified. 6.7.5 The reasonableness of salary and perquisites allowed to trustees and interested persons should be examined. Details of contracts given to persons mentioned in Section 13(3) should be obtained. In cases of donations to educational institutions the relationship of the donors to the students of the institutions should be ascertained. Any violations of Section 13(1)(c) should be examined. 6.7.6 Influential people build empires. There are educational empires also. It is a common sight - a person who has had his field day in some other field like politics, starting a host of educational institutions. Such institutions offer a safe haven for the black money earned elsewhere

along with the scope for earning more money. They pass off as educational or charitable institutions. In such cases, a certain amount of enquiry and investigation is necessary in respect of donations claimed as received, expenses incurred and amounts applied. The decision in Safdar Jung Enclave Education Trust (supra) helps such enterprise of the Department. 6.7.7 In the case of an orphanage which gives children in adoption, scrutiny should be intense. Such orphanages usually receive donations (mostly from abroad) towards rearing expenses of the children. While giving away the child in adoption they again collect the entire expenses from the adoptive parents. It should be checked whether the collections are duly accounted for. 6.7.8 Surveys u/s 133A may not be possible in most cases of trust, as trusts generally do not carry on any business or profession. However, enquiries u/s 142(2) are possible for the purpose of obtaining full information in respect of the income or loss of any person. The Section does not contain any restrictions regarding the time at which, the place where, the persons with whom and the manner in which the enquiry can be conducted. Institutions claiming exemption u/s 80G 7.1 Religious purpose is not charitable purpose. Hence deduction u/s 80G is available for donations to charity only. Approval should be recommended only in cases of such trusts whose objects are all charitable. Trusts having even one religious purpose among many charitable

purposes may not qualify for approval. This is notwithstanding the introduction of Section 80G (5B) effective 1.4.2000. That provision merely condones religious expenditure by charitable trusts to a certain extent. However, donations to religious institutions notified by the Board under Section 80G (2)(b) are eligible for the deduction. 7.2 Purchase of seats in a medical or engineering college by paying hefty amounts as donation is in vogue. Such donation is not donation but mere purchase price for the seat. It does not qualify for deduction u/s 80G in the donors hands, even though the institution may have been approved for purposes of Section 80G. As regards action to be taken in the case of the donee-institutions, a view exists that the donation, if it exceeds Rs. 50,000 is a substantial contribution. The substantial donor has got a benefit for his ward in the shape of a seat in the college. Hence the provisions of Section 13 (1)(c) may be attracted. However, this view has yet to be tested in appeals. 7.3 Instances are not rare where black money of persons associated with trusts are introduced into the trusts as donations received from others. In one instance the employees of a bank - even those working in far-off branches - with which the person had accounts were issued receipts for supposed donations for amounts varying from Rs. 5,000 to 10,000. While the person got his black income whitened, the employees got deduction u/s 80 G for donations not given! In such cases the person is

not likely to be charitably dispositioned. In all probability what he creates is a business edifice disguised as charity. Such cases can be attacked from both the donation angle and the application angle. Probing the immediate source of the donor for the donation and a reference to his bank account will be rewarding. In all likelihood, the sourcemoney would have come into the account just that day or a few days before. The supposed donors history also will reveal some interesting aspects. How the donor came to know of the trust will be another relevant question. 7.4 There are some trusts that are in the habit of issuing receipts for supposed donations which had not in fact been received. What they get from the unscrupulous donor is, not donation of the full amount, but a fraction as commission. This helps the donor to claim deduction for the donation. Enquiries on the lines similar to the above will help. Coordination with other agencies 8.1 The trust or institution should have legal existence to qualify for exemption u/s 11. Only income from property held under trust or other legal obligation is eligible for exemption. For a society or company to retain the legal status it is necessary that it should have registered with the concerned Registrar and should stay so. Once its name is struck off the registers of the Registrar it loses its legal personality. Enquiries with the Registrar will be necessary in doubtful cases.

8.2 Charitable organisations are exempt from Customs duty in respect of imports made by them for charitable purposes. Some unscrupulous elements use this route for evading Customs duty on goods imported for noncharitable, usually commercial, purposes. Enquiry in coordination with the Customs Department into the import and the use to which it is put may bring to light such deviations. 8.3 Foreign Contribution (Regulation ) Act 1976 is administered by the Internal security wing of the Ministry of Home Affairs. Foreign contribution means donation, delivery or transfer made by a foreign source. It includes money received from foreign sources in India in Indian currency. All charitable organisations in India come under the Act. They must report in Form FC-3 to the Government, the foreign contribution received within 30 days of the receipt of the amount. Separate set of accounts and records and bank account are required to be maintained in respect of foreign contributions. Coordination with the Home Ministry will be helpful in cases involving foreign contributions. 8.4 Trusts engaged in social work have considerable interaction with State government agencies. Enquiries with these agencies helps in ascertaining the real state of affairs. Laws governing local self government (municipal authorities) provide for concessional treatment to charitable institutions. The treatment accorded by the local authority to the institution concerned is relevant for tax investigations.

8.5 The Charity Commissioner functioning under the Bombay Public Trusts Act 1950 in Mahrashtra and Gujarat exercises general superintendence over the affairs of charitable organisations. He is empowered to sanction sale, mortgage, exchange, gift or lease of immovable property, hold enquiries, order special audit of the accounts, frame or modify a scheme and give notice for cy pres application. Liaising with his office may be useful in trust investigations. 8.6 In states like Tamilnadu, the agricultural income of charitable institutions is exempt for state agricultural income tax purposes only if the conditions for registration, application/ accumulation of income, bar against benefit to interested persons, etc., under the Income Tax Act in 1961 are met. Even an institution with only agricultural income is required to register u/s 12A with the CIT/ DIT and fulfill all the conditions prescribed in Sections 11 to 13. Cases of agricultural income not fulfilling these conditions should be reported to the Agricultural Income Tax authorities. 8.7 A number of trusts which were created by philanthropists at the turn of the 20th century have become headless due to the passing away of the trustees in course of time. These trusts had been formed with noblest of intentions with valuable properties. Now, these are administered by the Administrator General/ official trustee appointed by the jurisdictional High Court. The rents realised from these properties, though low, add up to large amounts. The official trustees who have to get the High Courts nod for applying these incomes seldom

approach the court. They just go on accumulating the incomes year after year. Sometimes, the properties under trust are sold ostensibly for maintenance of construction on other properties. Not rarely, properties of high value get sold for small consideration, after making false representation to the court. Thus, the noble objects for which the trusts had been created are twisted. In such cases, it is necessary for the AO to closely scrutininse the earning and applying of incomes and strictly apply the provisions of Section 11. Where businesses are run by these trusts, the AO should examine the accounts to see whether any income is unreported. If he comes across any major defect, he should bring it to the notice of the court for remedying it. Conclusion 9.1 The idea behind the exemption provisions in tax law is to regulate the affairs of the organisations which claim to be charitable. Here, we are dealing with a special category of assessees who have come into being with the stated purpose of doing or promoting charity. The focus, then, should be on encouraging real charity - on detecting violations and meting out appropriate tax treatment and on identifying fake organisations and denying them the exemption. Making big tax demands and collections cannot by itself be the aim of any investigation. Obsession with law often blunts investigations. The AO should not get carried too far by legal issues. The focus should be essentially on facts. Any claim made should be checked

for factual veracity. If the AO fails to bring out relevant facts, Departments case is lost for ever. 9.2 Investigation in trust cases should be purposeful, specific and pointed, as any investigation should be. The AO should have a clear idea of what he is seeking to achieve. He should steer clear of foggy thought processes. While investigating, the AO should be familiar with the case law on the point. 9.3 There are several trusts created with anything but a charitable intention. Their objects are noble, but activities are not. Many of them are just money-spinning mechanisms. That the Legislature is aware of this evil is evident from the attempts it makes year after year to contain it. The AO should keep in mind the larger social considerations while making investigations. He should be firm and unsparing with such trusts. But he should be discriminating enough to spare the really good organisations from any destructive scrutiny.

Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter - XX EDUCATIONAL & COACHING INSTITUTES

Salient features 1.1 Educational institutions functioning in India are owned and managed either by public trusts or by societies registered under the Societies Registration Act of 1860. In some of the States, for example, Maharashtra and Gujarat, where local Public Trusts Acts have been passed, all the societies registered under the Societies Registration Act, are required to be simultaneously registered under the local Public Trusts Act. 1.2 The public trusts are generally managed by Board of Trustees, one of whom may be designated as Chairman or Managing Trustee. Societies are autonomous bodies with office bearers consisting of president, vide president, secretary, treasurer and executive committee members. The general body consists of all the members of the society. Societies/trusts which run number of colleges, schools, etc., have a governing body for managing the affairs of each individual school or college, wherein head of the school/college such as the principal of the college or the head master of the school may be inducted as a member of the governing body. The responsibility of governing body is to manage the affairs and ensure smooth functioning of individual school or college.

1.3 The colleges which are affiliated to the State / Central level Universities under the relevant University Act are required to have a governing body or managing committee to manage the affairs of the college concerned. The governing bodies/managing committees of educational institutions may be supported by various committees, e.g. finance committee, library committee, science committee, sports committee, etc. for streamlining of the decisionmaking process. Members of such committees may be the members of governing body, teaching faculty and administrative staff depending upon the nature of the functions of the committee. 1.4 Educational institutions which fulfill the eligibility requirements laid down by the Government are eligible to get assistance in the form of Grant-in-aid from the Government. The grants are released on the basis of audited statements of accounts of the educational institutions. Apart from grant, part of the expenses of the educational institutions are met from the funds raised by the educational institutions themselves, either by way of fees, or from donations collected from public. Exemption of institutions incomes of certain educational

2.1 Section 10(23C) of the Income-tax Act, 1961 exempts certain incomes of educational institutions from being included in the total income. The relevant Rules are Rule 2 BC and 2CA of IT. Rules.

Records to be institutions

maintained

by

educational

3.1 Educational institutions are required to maintain proper books of account so as to comply with the terms and conditions laid-down for the purpose of grant and also to comply with the provisions of the Societies Registration Act, 1860 or the provisions of the Public Trusts Act as may be applicable and as may be in force in the State in which the Institution is situated. In addition, the provisions regarding maintenance of accounts contained in the trust deed /rules and regulations of the institution will also have to be complied with. Normally, an educational institution is expected to keep such books as are necessary to give a true and fair view of the state of affairs and income and expenditure of the institution. It must also ensure that there is effective internal control system in operation. 3.2 Educational institutions generally maintain Cash Book, Bank Book, Journal, General Ledger, and subsidiary Ledgers. Besides, they also maintain following records

Fees registers (to record admission fee, tuition fee, library fee, examination fee ) Register for Grants-in-aid. Register for scholarship and special stipends. Registers for funds such as building, library, laboratory, games, furniture and equipment, endowment, provident fund, poor students fund, deposits etc.

Register of immovable properties and other fixed assets. Register of investments. Minute books.

Sources & application of funds of educational institutions 4.1 The main sources of funds of educational institutions are as under

Educational institutions are permitted to collect tuition fees, admission fees, development fees, sports fees, examination fees, library fees etc.., from the students as per the rules and limits prescribed by the Government. No fees other than those permitted can be collected. The subscriptions, donations or endowments from the public may be received either in cash or in kind to meet recurring or nonrecurring expenditure of the institutions like construction of buildings, repairs, scholarships etc.. The donations in kind can be in the form of land, buildings, shares, securities, utensils, furniture, fixtures and the like. Grants from State Government, Central Government and the University Grants Commission. From the accounting point of view, the grants are classified as recurring & nonrecurring grants.

(a) Recurring grants, in the form of maintenance grants, are received in installments throughout the year. The formula for payment of maintenance grants differs from State to State. In some cases the percentage of permissible expenditure is reimbursed to the institutions, while in other cases entire admissible expenses of the institution are borne by the Government and in addition a fixed percentage of admissible expenditure is given for contingent expenses. (b) Nonrecurring grants from the government are in respect of building, furniture, library, laboratory and other equipment. Building grants are sanctioned to the educational institutions for the purposes of erecting, purchasing, expanding or reconstructing school buildings. The building grants usually constitute a percentage of the total expenditure.

Educational institutions also earn interest/dividends from investments in government securities, debentures and shares, and deposits with banks and post offices etc.. Educational institutions may, in some cases, derive income by way of rent by letting out its premises. Educational institutions also receive grants from local authorities or other charitable institutions for payment of scholarships, stipends and other

concessions to the students. The institution will have to conform to the stipulations of such authorities/institutions, as per which the grant is sanctioned. 4.2 Educational institutions generally incur recurring expenditure under the heads of salaries and allowances to teaching and non-teaching staff; training expenses; rent, rates, taxes and insurance; Repairs and maintenance; stationery, printing, postage; telephone; electricity; laboratory; drawing material; library; prizes and medals; etc.. 4.3 Educational institutions also incur nonrecurring expenditures on such items, as Construction of building; purchase of furniture / office equipment / library books / laboratory equipment / sports equipment / teaching aids / and other assets. Issues for verification 5.1 On the receipts side

It is always advisable to have the knowledge of the local Trust Act of the State in which the institution is located, and to familiarise with the regulations of the State Government regarding incorporation, functioning, supervision and control of educational institutions. Thereafter, the basic documents evidencing the constitution of the educational institution i.e., the Memorandum, Rules, Trust Deed etc. must be studied.

Minute book of the meetings of the managing committee / governing body contains valuable information which enable to comprehend salient developments /events having bearing on the accounts. In case the institution has its own accounting manual or instructions, these may be examined. The latest audit report along with particulars of preceding 2 to 3 years may be studied to examine the observations/qualifications made by the Auditors therein. In serious investigation cases, the Fee collection register and other similar record can be examined to verify the amounts receivable from students on account of - admission fee; tuition fee; library fee; examination fee; laboratory / science fee; sports fee; fines; miscellaneous charges ;contribution (for funds etc..); Hostel room /service charges ;mess & other charges. It may be worthwhile to check whether the amounts shown as recoverable in the register of fees and charges are based on rates applicable/stipulated for each category of students; and whether the names of all students on the rolls of the institution have been duly entered. It may also be examined whether bills have been raised, at prescribed intervals in respect of all the students on the rolls of the institution. Most of the donations are received towards corpus. Therefore, it is often necessary to verify whether donations received are properly

recorded in separate accounts depending on the nature of and the purpose for which the donations/endowments were given, i.e. towards corpus; or for a specific purposes, e.g., for purchase of capital equipment, grant of scholarships, awards etc..; or for general purpose, as evidenced by the communication from the donors indicating their intention / purpose. Certain institutions receive donations in cash which are not accounted in the books of accounts at all. It may be verified whether interest earned on fixed deposits, loans and securities have been accounted or not. It may also be ascertained whether interest accrued but not received on loans have been accounted or not where the institution is following mercantile system of accounting. In this context, bank accounts can be examined on test check basis to ascertain that interest received is being accounted properly. Amounts due on account of lease money / rent as per to the terms of the lease deed / rent deed entered into in respect of any portion of the premises let out by the institution, may be checked. Records pertaining to temporary hire / rental of the premises of the institution, e.g., for functions, examinations etc.., may be examined to ascertain whether recoveries have been made and recorded at the stipulated rates. It may also be worthwhile to verify the nature of the various grants applied for and sanctioned in

favour of the institution and whether grants-in-aid are being recorded in the books of account based on their nature and the purposes for which such grants are sanctioned - particular care being taken to segregate recurring and nonrecurring grants and those on capital account or otherwise. Reference may also be made to the related discussions in Paragraphs 4.8, 5.6, 5.7, 6.3.4, 6.3.9, 6.7.6, and 7.2 of the preceding Chapter XII relating to Charitable trusts and institutions .

5.2 On the expenditure side

The remuneration payable to various functionaries may be checked with respect to the terms and conditions of appointment to each category of staff employed by the institution. Many institutions obtain receipts for higher amounts from their employees towards salary but the actual salary paid to them is much less. The difference amount is secreted away as concealed income. If necessary, statements of some of the employees can be recorded to ascertain the true facts. It may be checked whether scholarship amounts have been disbursed to eligible students in accordance with the criteria laid down by the institution or the terms laid down by the donors in case scholarships are out of endowments / grants etc..

In case of residential schools, expenses on purchases, food grains, provisions, electricity, water, rent, repairs, maintenance etc.., may need verifications. Often, these expenses are inflated to generate unaccounted cash. The correspondence regarding sanction/disbursement of various grants can be examined to ensure that expenditure incurred in respect of grants for specific purposes, is strictly in accordance with the terms and conditions stipulated. The utilisation of grants and expenditure incurred can be checked with reference to the original evidence/supporting vouchers; entries in the cash book and bank statements; minutes of the managing committee/governing body as regards sanction of expenditure; and utilisation certificates, if any, furnished to the authorities concerned as per the terms of the grants. It may be necessary to verify the terms and conditions of loans; whether loans have been taken on proper authority or not ; and whether these have been utilised for the specific purposes of the educational institution or not. Often, loans obtained are diverted to sister concerns without charging interest. It is also necessary to check whether security deposits received from the students during the previous year have been accounted. Similarly, refund of security and other deposits to students, may be checked with reference to the

acknowledgments from them on final settlement of dues. Often, security deposit is not refunded to some or many students at the time of leaving of the school, however, an acknowledgment in that regard is obtained from the student/parent. In cases of such an allegation, the mode of payment i.e., cheque or cash may be verified and in case it is felt necessary the cross verification from the student/guardian may be made. Often fixed assets are purchased at inflated prices from connected parties etc.. The excess money charged flows back to the management / controlling body. In appropriate cases fixed assets may be physically examined and their type, make, model, quality etc., may be noted down and the market price of similar items may also be ascertained by local enquiry to ascertain whether the assets have been purchased at inflated rates. Often, surplus funds of the institution are diverted to sister / group concerns of the main persons managing the institution. This aspect must be borne in mind, with reference to provisions of Section 13. Where any loans have been granted, the authority and terms and conditions of such loans may be verified. It may also be seen whether recovery of the principal and interest amount is in accordance with the stipulated terms and conditions or not, and whether there is any nexus

between persons controlling the institution and the person to whom the loan has been given. It is also necessary to verify whether any expenditure (capital or revenue) has been incurred or any property or funds applied for objects and purposes other than those contained in the Trust Deed, Memorandum / Rules of Society etc..

Provisions relating to trusts running educational institutions 6.1 Many schools, colleges and educational institutions are controlled and run by charitable trusts. The relevant provisions contained in Sections 11 to 13 have been discussed in the preceding chapter relating to Charitable trusts. Some common methods of evasion adopted by educational institutions 7.1 Some methods of tax evasion noticed in the cases of educational institutions are listed below

Cash donations are demanded and accepted from parents at the time of admission of the child / ward without issuance of any receipt for the same. Some educational institutions insist that donation be made to a particular charitable trust and receipt for a specified sum be obtained from that trust before admission is granted to the child.

The relatives of the trustee / author of the trust are appointed to responsible positions in the institution and given handsome salary and perquisites not commensurate either with their qualifications or the work done by them. Property / building etc., belonging to the relatives of the trust are leased out to the educational institutions. The lease rental, however, charged is quite high and not reasonable as per the market rentals for the same property. Expenses relating to purchase of furniture, fixtures, books, stationery, computers etc.., are inflated Salary bill is inflated by paying amounts less than the amount for which receipts are obtained from the teachers. Large sums are collected from students by way of donations are lent out to sister concerns without adequate interest. The school runs ancillary services e.g. book shops, Shops for school uniform, school buses, etc. on commercial basis through its nominees. Often a separate firms are created to manipulate the income that is generated from such operations. Since it is a statutory requirement for charitable trusts to apply 75% of their income to charitable

activities, many institutions debit bogus expenses to obtain exemption u/s 11. Case study of a Coaching institute 8.1 In this case, a group of 7 firms were running coaching classes providing specialised coaching to students of 9th to 12th standard, besides vocational courses. It was not running a proper school but providing extra tuition classes to the students studying in a regular schools. It was observed that though the number of students in this coaching institute was very high, the income returned by the institution was meagre. A survey u/s 133A was conducted in December 1998. The books of accounts of various firms up to FY 1997-98 were found available in the form of computer print outs / bound red books, which showed nominal incomes. However, the transactions for the current year i.e. part of FY 1998-99 were found recorded in rough exercise books in the nature of cash book and ledger for each firm, but these were not regular books of accounts. A number of items in these rough cash book were not ledgerised. Although, the total of cash balances of all the concerns as per these rough cash books came to more than Rs. 1.19 Crores, the cash available at the business premises, was a nominal amount. There was absolutely no explanation as to why such huge cash would be kept as cash on hand, despite the fact that all the firms were operating their bank accounts regularly. It was stated by one of the partners that cash was lying partly at residence and partly in bank lockers. Further, as per these rough books of accounts,

the total profits of all the firms till the date of action worked out to more than Rs. 1.16 Crores, whereas the profits disclosed by all the firms during all the preceding years put together, was not even one tenth of this. The advance tax payments for the current year were very nominal, and as per these the total income of all the firms put together the group would not be more than Rs. 2 to 3 lac. The only conclusion therefore was that the rough exercise books showed the real incomes of these firms, but these were not meant to be disclosed to the department. It emerged that the assessee group had been concealing its income during past assessment years by rewriting the books of accounts and fee registers after the close of the relevant financial years. It also became clear that during the currency of the FY these firms maintained regular accounts but these were not meant to be disclosed to the department. Therefore, the survey was converted into a search. It finally emerged that, the assessees were suppressing receipts by replacing the rough books of accounts maintained during the course of the year, with rewritten proper books of accounts, prepared after the close of the year. A comparison of the incomes of the different firms was as under Name F.Y. Name of firm M/s. A Typing Gross receipts & Gross profit rate 1997-98 1998-99 Rs. in G.P. Rs. in G.P. % lakhs % lakhs 3.38 19.9 4.07 80.85

Classes M/s. B Computer Classes M/s. C Arts Classes M/s. D Coaching Classes M/s. E Coaching Classes M/s. F Commerce Classes M/s. G Science Classes

3.44

21.10 5.39

73.10

9.16 7.98

30.70 21.85 11.90 17.34

81.75 74.76

11.37

31.23 24.26

70.20

10.98

34.50 35.29

82.58

11.9

35.30 44.57

78.72

The above table shows that disclosed Gross Profit rates for FY 1997-98 varied from 11.9% to 35.3%. At the time of search, the returns for FY 1997-98 had been filed. However, returns for FY 1998-99 had not become due. It was observed that the gross profit rates for FY 1998-99 as per books found varied from 70% to 82.58%. There was no reason for this abrupt increase in the Gross Profit rates for FY 1998-99 as compared to the Gross Profit rates of FY 1997-98. In fact for the still earlier years the Gross Profit rates and the total incomes disclosed were much lower. It was later found on enquiry that after the

completion of the year, the assessees were replacing the fee receipt registers prepared during the course of the year, by totally different fee receipt registers where the gross fee receipts were suppressed considerably. It was found that these fee receipt registers meant for being produced before the department, were prepared at a stretch. Examination showed that the receipt numbers issued to the students of the same concern were not always sequential. This gave the clue that though the students might have been issued genuine fee receipts at the time of actual receipt of fees, the picture presented before the department would be a make-believes picture created with the help of fabricated fee receipts registers, prepared at will after the close of the accounting period. Names and addresses of some students were obtained and their statements recorded, and the fee receipts produced by them were compared with the figure of fees payment shown in the register. It turned out that there was suppression of fees ranging between Rs. 800 to Rs. 6000/- per student. During the course of search cash totaling Rs. 1.19 crores stashed away in bank lockers, and cupboards at the residence, was found.The other modus for concealing income adopted by the assessee was that the teachers were paid a salary lower than the figure debited in the books of accounts. Statements of some of the teachers were recorded to establish this part of concealment. In fact, it came to light that one of the teachers was providing honorary service and was charging no remuneration at all from the assessee. However, the assessee had debited a salary of around Rs.

4,500/- per month in the name of this teacher also.

Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 2 Chapter XXI

COMPUTER TRAINING INSTITUTIONS

Introduction 1.1 During the late eighties and nineties, the concepts of downsizing and flat organizational structure have become popular management policies in developed countries, especially the United States. Machines replaced men. Now, computers are being widely used with a view to increase the efficiency of the organization. As a result the dependence of the organization on computers and the personnel to man the computers has increased manifold.

But the educational systems of the developed countries are not in a position to cope with the new demand for computer-literate personnel. They started looking towards developing countries for this purpose. India with its huge English speaking technical graduates suits the bill. Therefore, there is a sudden and huge demand for software professionals from India. Categories 2.1 The computer educational institutions fall into two categories : (i) Independent institutions, and (ii) Franchisee institutions. The first type are those which stand on their own. They are not affiliated to any central institution. The second type have arrangements with and share revenues with their Principal institutions i.e. the Franchisers. Some of the well known players in the industry like NIIT, APTECH and SSI have hundreds of franchisees all over the country. 2.2 Whether stand alone or franchisee the basic infrastructure required for setting up a computer educational institution is floor space, computer hardware and software, teaching aids, classroom furniture and air conditioning. Normally the faculty plays an important role in the popularity of an institution and a good faculty is the most valuable asset of the institution. Independent institutions 3.1 Normally, stand alone institutions are started by persons who have acquired goods knowledge and name as faculty in a particular branch of software. So long as

there is a demand for that branch, the institution thrives. Once the demand diminishes, these institutions wind up as they find it difficult to migrate to new technologies. Franchise arrangement 4.1 In a typical franchise arrangement the franchisee is responsible for arranging the capital required for the venture. He is expected to provide the space and the interiors and procure the faculty. He is the one who runs the show. On his part, the franchiser provides the hardware and the software. In some cases hardware too is arranged by the franchisee. The franchisor gives standardized course contents, courseware, teaching material, training inputs for the faculty and certificates to the students passing out. Some of the franchisors are affiliated to foreign universities. 4.2 The franchisor usually insists on certain conditions to be met in managing the institution in line with his brand image. He collects a deposit from the franchisee which is refundable only when the arrangement is terminated. For the purpose of the franchise agreement, the amount collected towards software could be termed as technical know-how fee or royalty. The fee to be charged for each course is decided by the franchisor. He collects a percentage of the fee at the time of issuing certificates to the students. Normally it is insisted that a joint account or an escrow account be opened for depositing the fee collected from the students from which the franchisor can directly draw his share of the revenue. In some cases, the bills raised on the students are in the name of the

franchisor who then pays the franchisees share to him. In some agreements, an Auditor is appointed by mutual consent to examine the accounts of the franchisee, and certify that the share of franchisor is as per the agreement. 4.3 The demand for a particular branch of software is driven by market forces of the developed countries. For example, during the Y2K scare period, there was lot of demand for personnel well versed with mainframe technologies and Cobol language. Then, there was demand for oracle and visual basic software. Currently the requirement is for java and other internet based technologies. Due to rapid changes in the market requirements, similar charges are required to be made in the curriculum of the computer education institutions. The franchisor is expected to follow the current trends and design courses to meet the emerging demand. This is the basic advantage franchisee institutions have over stand alone institutions. Beside, franchisors have a large brand image, through publicity and media company. Tax investigation 5.1 The taxation issues pertaining to computer educational institutions are quite a few. The foremost among them is examination of the source for the capital invested. Most of the computer educational institutions are started by firsttime entrepreneurs. Setting up a computer educational institution costs between Rs. 5 lacs to Rs. 20 lacs depending on the level of interiors and number of computer installed. It is seen that in most cases, the investment made in a computer educational institution is

understated. It will be worthwhile to verify the adequacy of investment shown with reference to the number of computers installed, facilities created, etc.. In case of franchisee institutions, the amounts paid to the franchisor may be cross-verified. 5.2 The second issue relates to the software installed. One of the major costs for a computer educational institution is the cost of software. The entire software that is used is produced overseas, mostly in the United States. The US-based software manufacturers sell their software in India through their authorized dealers. The conditions under which the software is sold are stringent. The price paid is user-specific. It is only a licence fee to use the software and not for ownership rights. For example, the price for a five user version of popular Windows software is in the region of Rs. 20,000/- and for every extra user, an amount of Rs. 1,500/- is to be paid by way of licence fee. Recently, a suit has been filed before the MRTP Commission that this kind of licensing arrangement is discriminatory. The Commissions decision is awaited. But, as on date the conditions imposed at the time of purchasing the software licence hold good and they are protected by the Copyright Act. 5.3 In these case the details regarding the type of software installed at the institution should be obtained and examined. It should be insisted that the bills for the purchases of software licenses be produced. Where such bills are not produced, there are goods grounds for holding the value of the software as unaccounted investment. Magazines like Chip, C World regularly give the prices of

various softwares and the data available in such magazines can be used to arrive at the value of the unaccounted investment. 5.4 In many institutions, especially stand alone institutions, often pirated software is used. The cost of pirated software is a fraction of the cost of original software. For example, official version of UNIX software costs nearly Rs. 1 lac, whereas the pirated copy is available for Rs. 200/-. In case it is admitted that pirated software is used, it may not be possible to make any significant additions but such cases should be reported to the police authorities. 5.5 In the case of a franchisee institution, the software is supplied by the franchisor In some cases, it was noted that the franchisor was leasing the software to the franchisee institution and claiming depreciation on the same. In such cases, the ownership of the software leased out has to be thoroughly examined. As mentioned above, the software is sold with stringent conditions with regard to number of users etc.. and normally no ownership rights are transferred. In case it is found that the franchisor is not the owner and he is not entitled to lease out the software licence within the terms of the purchase of the software licence, the depreciation claimed by the franchisor on such leased out software will have to be disallowed. In the case of the franchisee, the lease rentals claimed may not be of revenue nature depending upon the pattern of use of the software licence. The agreements between the franchisor and the franchisee for supply of software should be called for examining this issue. The AO of the franchisor may be requested to examine the allowability of depreciation on

the leased software. Proprietary software self-developed by the franchisor can be leased out, but in such cases, capitalization of such software is expected to be routed through the profit and loss account by way of credit to that account. 5.6 The fees collected in cash by these institutions are often underreported. In some cases, especially in stand alone institutions, it has been noticed that full receipt is not given for the fee collected from the student. In one case at Hyderabad, discreet enquiries were conducted by the investigation wing and it was found that the institution was charging Rs. 18,000 for a course but giving bill for Rs. 8,000 only. A search was conducted of the institution and considerable unaccounted cash was found. Statement recorded from the parents of the students confirmed the fact that the fee paid was actually Rs. 18,000/-. The AO should be alert to the fact that the institution may not be offering all the fees collected from the students. Wherever suspicions arise, enquiries may be conducted with the students and their parents. 5.7 Payments made to star faculty are another area for tax investigations. As mentioned elsewhere, the most important asset of a computer educational institution is its faculty. Students prefer an institution with good faculty to one with good brand image. Many institutions enter into profit-sharing arrangements with good faculty members or agree to pay them substantial cash rewards. Such arrangements may not be disclosed in the return. The excess amounts paid to such faculty members are compensated by inflating the other heads of expenditure.

It will benefit tax investigations if market intelligence in gathered to identify the institutions with star faculty. In such cases, deep scrutiny is needed in regard to expenditure claimed under other heads. 5.8 Issues relating to TDS also may crop up in these cases. In a typical franchise arrangement, it is seen that the franchisor provides technical and management consultancy to the franchisee. There is a view that the payments made by the franchisee to the franchisor are covered by Section 194J of the Act and he is required to deduct tax from such payments. A careful reading of the franchise agreement is necessary before action for TDS is initiated. 5.9 Some of the franchisors issue foreign certificates to the students passing out of their affiliates. The franchisor enters into an agreement with a foreign company like IBM or Oracle and designs a course on the latters specifications. The foreign company certifies that the franchisor has conducted the course according to its specifications and that the particular student has completed the course. In these cases the franchisor pays royalty to the foreign company on per-certificate basis. Here also, the liability to deduct tax arises. The AO should look into this aspect.

Directorate of Income Tax ( Systems )

Investigation Manual

Expert Group constituted by CBDT vide order dated 5.8.99 for rewriting the earlier publication Investigation of Accounts S / Shri S.N. L. Chief CIT Agarwala (since retired) K.D. Gupta Chief CIT Ahmedabad Chairman Lucknow Cochairman, later Chairman Member Member Member Member Member

H.C. Parikh S.D. Kapila A. Selvaraj

DGIT (Inv.) DGIT (Vig.)

Chennai Delhi Delhi Chennai Calcutta

S.S. Khan CIT DIT (E)

A.K. DIT (Inv.) Dasgupta B.N. Addl. CIT

Ahmedabad Member /

Dutta

Secretary

Directorate of Income Tax ( Systems )

Investigation Manual

Acknowledgments ( Officers contributing to Volume - II) S / Shri H.C. Parikh

DGIT (Inv.) S.S. Khan CIT A. Selvaraj DIT (E) K. K. Kapila CIT M.C. Joshi CIT (Appeals) Y.K. Ghaiah CIT Abhay Kumar CIT B. N. Dutta Addl. CIT Y.K. Batra Addl. CIT G.S. Kurup Addl. CIT

Chennai New Delhi Chennai Ludhiana New Delhi New Delhi Mysore Ahmedabad Chandigarh Chennai

Rajiv Nabar T.P. Krishnakumar K. Satyanarayana V.K. Pandey

Addl. CIT Ahmedabad Addl. CIT Chennai Addl. CIT Chennai

Addl. CIT Mumbai (now at Delhi) Dinesh Varma Addl. CIT Mumbai S. K. Mishra Addl. CIT Ahmedabad V. S. Kumar Addl. CIT Chennai K. P. Addl. CIT Coimbatore Karunakaran R. K. Gupta Addl. CIT Ahmedabad Omkareshwar Joint CIT Chennai Chidra K.V. Joint CIT Chennai Radhakrishna B.K.S. Pandya Joint CIT Jamnagar (now at Hubli) J. Albert Joint CIT Hyderabad (now at Chennai) Vimal Shah Joint CIT Ahmedabad V. Mahalingam Joint CIT Mysore K. Krishnarao Joint CIT Coimbatore Pushpinder Joint CIT NWR

Punia S.Ram S. K. Singh Rahul Kaul Prabhat Jha

DCIT Rajkot DCIT Rajkot DCIT Mumbai DDIT(Inv.) Bhavnagar (now at Surat) Vijay Shankar DDIT(Inv.) Rajkot S. ITO Coimbatore Sankaralingam S. K. Pathak ITO Bhadohi

Directorate of Income Tax ( Systems )