Solved Assignment for M-Com Final year

1. Discuss Weber’s theory of location of industry. What are the various sources of finance to industrial units? Discuss.

Ans: Weber's Theory of Industrial Location

The classical economist Adam Smith gave the first thought to the problem of industrial location. The factors of location enunciated by him were the results of empirical analysis rather than a scientific treatment of the problem. Alfred Weber, the German economist, attempted an analytical approach to the problem of industrial location.

Weber classified the factors or causes affecting industrial location into two main categories:

Primary factors or Regional factors

Secondary factors or Agglomerative factors

Primary or Regional Factors

Weber analysed the factors Weber analysed the factors of location of industries referring to the costs of production, which vary with different regional factors. The factors like depreciation, amortisation, interest rate and rent of the land etc, were specially excluded by him, as they exert little influence on the geographical location of industrial plants.

Transportation Costs

The location of industries is governed in the first instance by the cost of transportation. Such costs are incurred by the industry twice first, when the raw material is imported from the source to the place of production and secondly, when the products are sent to the market for selling. Total transportation costs, in turn, are determined by:

The distance to be covered

The weight to be transported

Labour Costs

The second primary reason which influences the location of industry is the cost of labour. Weber assumed certain centres to be the centres of cheap and skilled labour. Industries where labour is an important element of cost, will be attracted towards cheap and skilled labour centres. On the other hand, if the cost of labour is not significant, the transportation cost will decide the location. With the caption of “Weber's Theory of Industrial Location” animate the below given image.

The main sources of industrial finance in India are following:

Industrial Development Bank of India (IDBI): It provides credit and other facilities for industrial development in the country. It provides long term finance for green field projects, as also for modernization, expansion and diversification. It has structured various products such as equipment, asset credit and corporate loans in order to eater to the diverse needs of its corporate clients.

Industrial credit and investment corporation of India Limited (ICICI Ltd.): It played a facilitating role in consolidation in various sectors of the Indian industry, by funding mergers and acquisitions. The ICICI group’s financing and banking operations, both whole sale and retail have been integrated into a single company effective from May 2002.

Small Industries Development Bank of India (SIDBI): It offers refinance, bills rediscounting lines of credit and resource support mechanisms to route assistance to SSI sector through a network of banks and state-level financial institutions. It also offers direct finance for meeting specific requirements of SSI sector.

Industrial Finance corporation of India Limited (IFCI Ltd): Its main financing comprises of projects finance, financial services and corporate advisory services. It provides custodial and investor services rating and venture capital services through its subsidiaries and associate companies.

Industrial Investment Bank of India Limited (IIBI Ltd): It offers a variety of financial products such as Project finance, short duration none-project asset-backed finance and working capital and other short term loans to companies.

Infrastructure Development finance company Limited (IDFC Ltd): It was incorporated in 1997 and was conceived as specialized institution to facilitate the flow of private finance to commercially viable infrastructure projects through innovative products and processes.

Industrial Reconstruction Bank of India (IRBI): It has main aim to revive sick industries and make them able to exist and compete in market by assistance.

State financial corporation’s (SFCs): It provides loans to need industries. They also promote shares and debentures, if required they would provide guarantee for loans of third parties. Apart from these through foreign investments, IPOs, these industries also get financial assistance.

2. Write short notes on (any two):

(a) Optimum size of units.

(b) Micro, small and medium enterprises

(c) NEDFi

Ans: (b) Micro, Small and Medium Enterprises

The Government of India has enacted the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 in terms of which the definition of micro, small and medium enterprises is as under:

(a) Enterprises engaged in the manufacture or production, processing or preservation of goods as specified below:

(i) A micro enterprise is an enterprise where investment in plant and machinery does not exceed Rs. 25 lakh;

(ii) A small enterprise is an enterprise where the investment in plant and machinery is more than Rs. 25 lakh but does not exceed Rs. 5 crore; and

(iii) A medium enterprise is an enterprise where the investment in plant and machinery is more than Rs.5 crore but does not exceed Rs.10 crore.

In case of the above enterprises, investment in plant and machinery is the original cost excluding land and building and the items specified by the Ministry of Small Scale Industries vide its notification No.S.O.1722 (E) dated October 5, 2006

(b) Enterprises engaged in providing or rendering of services and whose investment in equipment (original cost excluding land and building and furniture, fittings and other items not directly related to the service rendered or as may be notified under the MSMED Act, 2006 are specified below.

i. A micro enterprise is an enterprise where the investment in equipment does not exceed Rs. 10 lakh;

ii. A small enterprise is an enterprise where the investment in equipment is more than Rs.10 lakh but does not exceed Rs. 2 crore; and

iii. A medium enterprise is an enterprise where the investment in equipment is more than Rs. 2 crore but does not exceed Rs. 5 crore.

(c) NEDFi

The North Eastern Development Finance Corporation Ltd (NEDFi) is a Public Limited Company registered under the Companies Act 1956 on 9th August, 1995. It is notified as a Public Financial Institution under Section 4A of the said Act and was registered as an NBFC in 2002 with RBI. The shareholders of the Corporation are IDBI, SBI, LICI, SIDBI, ICICI, IFCI, SUUTI, GIC and its subsidiaries. The management of NEDFi has been entrusted upon the Board of Directors comprising representatives from shareholder institutions, Diner, State Governments and eminent persons from the NE Region and outside having wide experience in industry, economics, finance and management.

NEDFi provides financial assistance to micro, small, medium and large enterprises for setting up industrial, infrastructure and agri-allied projects in the North Eastern Region of India and also Microfinance through MFI/NGOs. Besides financing, the Corporation offers Consultancy & Advisory services to the state Governments, private sectors and other agencies. We conduct sector or state specific studies under its Techno-Economic Development Fund (TEDF) and are the designated nodal agency for disbursal of Govt. of India incentives to the industries in the North-East India under North–East Industrial and Investment Promotion Policy 2007 (NEIIPP 2007). Our promotional activities include NEDFi Haat, NEDFi Convention Center, and NEDFi Pavillion etc.

NEDFi is an ISO 9001:2008 certified company since 2001 and our mission is for the economic development of the North Eastern Region of India by identifying, financing and nurturing commercially and financially viable projects in the region.

1. Discuss the distinctive features of modern approach to financial management.

Ans: MODERN APPROACH TO FINANCIAL MANAGEMENT

Henry Ford has once remarked “Money is an arm or a leg; you either use it or lose it”. Though the above statement looks simple but it is quite meaningful. In the today’s money oriented economy finance is one of the basic foundations of all kinds of economic activities. Actually finance is the backbone of every business.

MEANING OF BUSINESS FINANCE

Business Finance is the business activity that is concerned with the acquisition and conservation of capital funds in meeting financial needs and overall objectives of a business enterprise. There are three A’s in Financial Management

Anticipating Financial needs Acquiring Financial Resources Allocating funds in business

MANAGEMENT OF MONEY IN BUSINESS

Handling a business is similar to handling a home, with all the different expenses to consider preventing the business from going under with deficits and bankruptcy. A business has “children” in terms of all the employed workers working hand-in-hand and with utmost efficiency to make sure that

the finances float above break even. There is one main focus for a business to thrive and exist in security and balance, and that is the knowledge of knowing how to manage money in business with the overhead and operation expenses.

THE RIGHT APPROACH

According to the modern approach the term financial management provides a conceptual and analytical framework for financial decision making. That means, the finance function covers both acquisition of funds as well as their allocation. This new approach views the term financial management in a broader sense. It is viewed as an integral part of overall management.

The modern approach of financial Management can be divided into four major decisions as function of finance:

The investment decision The financial decision The dividend policy decision The funds requirement decision

INVESTMENT DECISIONS:

This is concerned with the allocation of capital. It has to show the funds can be invested in assets which would yield benefit in future. This is a decision based on risk and uncertainty. Finance Manager has to evaluate the investment in relation to their expected results and risk to determine whether the investment is feasible or not.

FINANCIAL DECISIONS

This decision is concerned with the mobilization of finance for investment. The Finance Manager has to take the decisions regarding the acquisition of finance. Whether entire capital required should be raised in the form of equity capital or the amount should be borrowed totally or a balance should be struck between equity and borrowed capital has to be decided. Even the timing of acquisition of capital should also be perfectly made.

DIVIDEND DECISION

The dividend decision involves the determination of the percentage of profit earned by the enterprise which is paid to the shareholders. The dividend payout ratio must be evaluated in the light of the objective of maximizing shareholder’s wealth. Thus, the dividend decision has become a vital aspect of financial decision.

CURRENT ASSETS MANAGEMENT

The Finance Manager should also manage the current assets to have liquidity in the business. Investment of funds in current assets reduces the profitability of the firm. However the finance manager should also equally look after the current financial needs of the firm to maintain optimum production.

While investing in current assets, he should see that proper trade off is maintained between the profitability and liquidity.

2. Explain and evaluate the various bases for determining the proportions (weights) to be employed in calculating the weighted average cost of capital.

Ans: Weighted average cost of capital

A firm uses various sources of finance to finance its projects. Each source of finance will be having a specific cost. So in order to determine the overall cost of capital of the firm, the weighted average cost of individual sources of finance should be determined with the weights being the proportion of each type of capital used.

The Weighted Average Cost of Capital (WACC) is defined as the weighted average of the cost of various sources of finance, weights being the book value or market values of each source of finance. If ko represents the weighted average cost of capital or overall cost of capital then,

ko = wdkd + wpkp + wtkt + weke + wrkr

where,

ko = weighted average cost of capital

kd = cost of debt

kp = cost of preferred stock

kt = cost of term loan

ke = cost of equity

kr = cost of retained earnings.

wd = Proportion of total capital supplied by debt

wp = Proportion of total capital supplied by preferred stock

wt = Proportion of total capital supplied by term loan

we = Proportion of total capital supplied by external equity

wd = Proportion of total capital supplied by retained earnings

If debt and equity are the only sources of finance used by the firm, the Weighted Average Cost of Capital can be calculated as follows:

WACC = Cost of equity x Proportion of equity in the financing mix + Cost of debt x Proportion of debt in the financing mix i.e.

ko = wdkd + weke

or ko = ke [E/(D+E)] + kd [D/(D+E)]

Where,

D = proportion of debt in the financing mix

E = proportion of equity in the financing mix

The weights used in determining the weighted average cost of capital of a firm are historical weights. Historical weights are based on a firm’s existing capital structure. The use of these weights is based on the assumption that the firm’s existing capital and therefore should be maintained in the future. Two types of historical weights can be used – book value weights and market value weights.

1. Book Value Weights: The use of book value weights in calculating the firm’s weighted cost of capital assumes that new financing’s will be raised using the same method the firm used for its present capital structure. The weights are determined by dividing the book value of each capital component by the sum of the book values of all the long-term capital sources.

2. Market Value Weights: Market value weights are determined by dividing the market value of each source by the sum of the market values of all sources. The use of market value weights for computing a firm’s weighted average cost of capital is more scientific than the use of book value weights because the market values of the securities closely approximate the amount to be received from their sale.

Importance of Weighted Average Cost of Capital

The weighted average cost of capital (overall cost of capital) is of utmost importance in capital structure planning and in capital budgeting decisions.

In capital structure planning a company strives to achieve the optimal capital structure in order to maximize the value of the firm. The optimal capital structure occurs at a point where the overall cost of capital is minimum.

Since overall cost of capital is the minimum rate of return required by the investors, this rate is used as the discount rate or the cut-off rate for evaluating the capital budgeting

1. Discuss the application of management accounting techniques for managerial decisions.

Ans: Applications of Management accounting in Managerial decisions:

Management accounting can be viewed as Management-oriented Accounting. Basically it is the study of managerial aspect of financial accounting, "accounting in relation to management function". It shows how the accounting function can be re-oriented so as to fit it within the framework of management activity. The primary task of management accounting is, therefore, to redesign the entire accounting system so that it may serve the operational needs of the firm. If furnishes definite accounting information, past, present or future, which may be used as a basis for management action. The financial

data are so devised and systematically development that they become a unique tool for management decision.

The Report of the Anglo-American Council of Productivity (1950) has also given a definition of management accounting, which has been widely accepted. According to it, "Management accounting is the presentation of accounting information in such a way as to assist the management in creation of policy and the day to day operation of an undertaking". The reasoning added to this statement was, "the technique of accounting is of extreme importance because it works in the most nearly universal medium available for the expression of facts, so that facts of great diversity can be represented in the same picture. It is not the production of these pictures that is a function of management but the use of them." An analysis of the above definition shows that management needs information for better decision-making and effectiveness. The collection and presentation of such information come within the area of management accounting. Thus, accounting information should be recorded and presented in the form of reports at such frequent intervals, as the management may want. These reports present a systematic review of past events as well as an analytical survey of current economic trends. Some of best tools and techniques of management accounting and their respective applications are outlined below:

1st Tool : Analysis of Financial Statements

Analysis of financial statements is the main tool of management accounting. In this tool, we collect four financial statements, one is profit and loss account, second is balance sheet, third is cash flow statement and fourth and last is fund flow statement. After this, we calculate more than 30 ratios and also analyze the financial statement by financial analysis, fund flow analysis and cash flow analysis. Main aims of analysis of financial statements are following :

1. Profitability - its ability to earn income and sustain growth in both short-term and long-term. A company's degree of profitability is usually based on the income statement, which reports on the company's results of operations;

2. Solvency - its ability to pay its obligation to creditors and other third parties in the long-term;

3. Liquidity - its ability to maintain positive cash flow, while satisfying immediate obligations;

4. Stability- the firm's ability to remain in business in the long run, without having to sustain significant losses in the conduct of its business. Assessing a company's stability requires the use of the income statement and the balance sheet, as well as other financial and non-financial indicators.

2nd Tool : Budgetary Control

This is that tool of management accounting in which we make budgets for planning and control of fund. All budgets are made with past historical accounting data and future expectations. After this budgeted data is compared with actual recorded accounting data and performance is calculated on the basis of deviation between actual and expected performance.

3rd Tool : Decision Accounting

There are lots of decision which businessman has to take on the basis of tools of management accounting. One of management accounting tool is decision accounting. It is helpful to take main decision which we can explain following ways :

a) To Buy or to construct any fixed asset

b) Do's or Don’ts to do any business activity

c) To choose best alternative

d) Calculation the price of product

4th Tool : Throughput accounting

Throughput Accounting (TA) is a dynamic, integrated, principle-based, and comprehensive management accounting's tool that provides managers with decision support information for enterprise optimization. Actually this is the extension of decision accounting. Throughput accounting is relatively new in management accounting. It is an approach that identifies factors that limit an organization from reaching its goal, and then focuses on simple measures that drive behavior in key areas towards reaching organizational goals.

5th Tool : Management Information system (MIS)

Use of MIS tool provides information needed to manage organizations effectively . If we have to understand MIS, we need to understand ERP, SCM, CRM, DSS and other computer techniques for providing information with effective ways.

6th Tool : Financial Policy

Financial policy is that tool of management accounting which is needed to make good structure of capital mix We decide the proportion of share capital and loans in capital structure. Financial and operating leverages are also its sub-tools.

7th Tool : Working Capital Management

With this tool of management accounting, we manage short term assets and short term liabilities. All cash management, debtor management and inventory management will include in working capital management. We make also working capital cycle for knowing the firm's ability to convert its resources into cash. If there is low time for conversion of raw material into sales and then cash from debtor, it is good indication.

2. State the need for cost control. Indicate the use of control techniques in better cost management.

Ans: Cost Control and Its need:

Cost control, also known as cost management or cost containment, is a broad set of cost accounting methods and management techniques with the common goal of improving business cost-efficiency by reducing costs, or at least restricting their rate of growth. Businesses use cost control methods to monitor, evaluate, and ultimately enhance the efficiency of specific areas, such as departments, divisions, or product lines, within their operations.

During the 1990s cost control initiatives received paramount attention from corporate America. Often taking the form of corporate restructuring, divestment of peripheral activities, mass layoffs, or outsourcing, cost control strategies were seen as necessary to preserver corporate profits and to maintain gain competitive advantage. The objective was often to be the low-cost producer in a given industry, which would typically allow the company to take a greater profit per unit of sales than its competitors at a given price level.

Some cost control proponents believe that such strategic cost-cutting must be planned carefully, as not all cost reduction techniques yield the same benefits. In a notable late 1990s example, chief executive Albert J. Dunlap, nicknamed "Chainsaw Al" because of his penchant for deep cost cutting at the companies he headed, failed to restore the ailing small appliance maker Sunbeam Corporation to profitability despite his drastic cost reduction tactics. Dunlap lay off thousands of workers and sold off business units, but made little contribution to Sunbeam's competitive position or share price in his two years as CEO. Consequently, in 1998 Sunbeam's board fired Dunlap, having lost confidence in his "one-trick" approach to management.

Use of Cost Control Techniques

A complex business requires frequent information about operations in order to plan for the future, to control present activities, and to evaluate the past performance of managers, employees, and related business segments. To be successful, management guides the activities of its people in the operations of the business according to pre-established goals and objectives. Management's guidance takes two forms of control:

(1) the management and supervision of behavior, and

(2) the evaluation of performance.

Behavioral management deals with the attitudes and actions of employees. While employee behavior ultimately impacts on success, behavioral management involves certain issues and assumptions not applicable to accounting's control function. On the other hand, performance evaluation measures outcomes of employee's actions by comparing the actual results of business outcomes to predetermined standards of success. In this way management identifies the strengths it needs to maximize, and the weaknesses it seeks to rectify. This process of evaluation and remedy is called cost control.

Cost control is a continuous process that begins with the proposed annual budget. The budget helps:

(1) to organize and coordinate production, and the selling, distribution, service, and administrative functions; and

(2) to take maximum advantage of available opportunities. As the fiscal year progresses, management compares actual results with those projected in the budget and incorporates into the new plan the lessons learned from its evaluation of current operations.

Control refers to management's effort to influence the actions of individuals who are responsible for performing tasks, incurring costs, and generating revenues. Management is a two-phased process: planning refers to the way that management plans and wants people to perform, while control refers to the procedures employed to determine whether actual performance complies with these plans. Through the budget process and accounting control, management establishes overall company objectives, defines the centers of responsibility, and determines specific objectives for each responsibility center, and designs procedures and standards for reporting and evaluation.

A budget segments the business into its components or centers where the responsible party initiates and controls action. Responsibility centers represent applicable organizational units, functions, departments, and divisions. Generally a single individual heads the responsibility center exercising substantial, if not complete, control over the activities of people or processes within the center and controlling the results of their activity. Cost centers are accountable only for expenses, that is, they do not generate revenue. Examples include accounting departments, human resources departments, and similar areas of the business that provide internal services. Profit centers accept responsibility for both revenue and expenses. For example, a product line or an autonomous business unit might be considered profit centers. If the profit center has its own assets, it may also be considered an investment center, for which returns on investment can be determined. The use of responsibility centers allows management to design control reports to pinpoint accountability, thus aiding in profit planning.

A budget also sets standards to indicate the level of activity expected from each responsible person or decision unit, and the amount of resources that a responsible party should use in achieving that level of activity. A budget establishes the responsibility center, delegates the concomitant responsibilities, and determines the decision points within an organization.

The planning process provides for two types of control mechanisms:

1. Feed forward: providing a basis for control at the point of action (the decision point); and

2. Feedback: providing a basis for measuring the effectiveness of control after implementation.

Management's role is to feed forward a futuristic vision of where the company is going and how it is to get there, and to make clear decisions coordinating and directing employee activities. Management also oversees the development of procedures to collect, record, and evaluate feedback. Therefore, effective management controls results from leading people by force of personality and through persuasion; providing and maintaining proper training, planning, and resources; and improving quality and results through evaluation and feedback.

1. State the evolution and present status of direct taxes as provided in the Indian constitution.

Ans: Evolution of taxation

The history of taxation dates back to time immemorial and it is not a recent development by any account. A thorough research on the history of taxation system shows that taxes were levied on either on the sale and purchase of merchandise or livestock.

Further, the history of taxation suggests that the process of levying and the manner of tax collection were unorganized. But it suggests that all historical leaders and head countrymen collected taxes to run its authority. In other words taxes on income, sale, purchase and properties were collected to run the ruling Government machineries. Further, these taxes were collected to meet their military and civil expenditure and also to meet the common needs of the subjects like maintenance of roads, drainage system, government buildings, administration of justice and other functions of the region. day India tax machinery is very much based on that laid down foundation.

Although, there were no homogeneous tax rate structures but it depended on the production capacity and commodity of that particular country and/or region. Moreover, the tax rates and quantum varied according to the annual production. These taxes were collected in cash or in kind and it entirely depended on the type of commodity or service on which it was levied upon. For example, there was a very common practice of selling food crops and cash crops to government machineries against no money. The history of taxation suggests these were done to store government buffer stocks to meet emergencies. Taxes were levied on all classes of citizens, like actors, dancers, singers and even dancing girls. Taxes were paid in the form of gold-coins, cattle, grains, raw-materials and even by rendering personal service.

In India, the tradition of taxation has been in force from ancient times. It finds its references in many ancient books like 'Manu Smriti' and 'Arthasastra'. There was a perfect admixture of direct taxes with indirect taxes and they were varied in nature. India's history of taxation suggests existence of a large and composite taxable population. With the advent of the moguls in India the country witnessed a sea of change in the taxation system of India. Although, they also practiced the same norm of taxation but it was more homogeneous in structure and collection. The period of British rule in India witnessed some remarkable change in the whole taxation system of India. Although, it was highly in favor of the British government and its exchequer but it incorporated modern and scientific method of taxation tools and systems. In 1922, the country witnessed a paradigm shift in the overall Indian taxation system. Setting up of administrative system and taxation system was first done in the history of taxation system in India. The period thereafter witnessed rapid growth and modernization of the Indian taxation system and the present.

Tax status as per constitution of India

Constitution is the foundation and source of powers to legislate all laws in India. Parliament, as well as State Legislatures gets the power to legislate various laws from the Constitution only and therefore every law has to be within the vires of the Constitution.

Talking about the taxation laws and the interpretation of taxation laws, every lawyer or a tax professional practicing taxation laws must understand the basic provisions of Constitution relating to taxation including the powers of Parliament and State Legislatures to legislate regarding levy and collection of tax, the restrictions imposed by our Constitution on such powers, entries concerning taxation in Central List i.e. List-1 and State List i.e. List-2 of Seventh Schedule to Constitution of India.

All laws and executive actions are subordinate to the Constitution. To form clear understanding of the basic concepts relating to taxation laws one must understand the relevant provisions of the Constitution, as the power to levy and collect tax by State Governments or Union Government comes from the Constitution only.

One thing must be kept in mind that there is always an object behind every law and that object ultimately exists to achieve the objects enumerated in the Preamble of our Constitution, which runs as under: “While interpreting every law one has to keep in mind the object behind the law, if any provision of the law or any administrative action or any interpretation of the law defeats the object of such law for which it is being legislated and consequently is not in accordance with the Constitution then it is illegal, void and ultra vires of the Constitution.”

Therefore it is important to understand the powers and scheme of taxation under Constitution before understanding the taxation laws. Whenever I try to understand any complicated provision of law, I refer to the object of the law for which it has been legislated and also the power of the Parliament or State legislature under the Constitution to legislate such law for better understanding of the subject.

For example State VAT Acts have been legislated by State Legislatures under Entry 54 of List-II of the Seventh Schedule to the Constitution, which runs as under: “Tax on sale or purchase of goods other than newspapers except tax on interstate sale or purchase.”

Hence every law legislated under Entry 54 of State List must levy tax only on the sale or purchase of goods other than newspapers within the State Jurisdiction. If a State law legislated under entry 54 levies tax on the inter-state sale or purchase of goods, it has to be struck down as ultra vires of the Constitution. The roots of every law in India lies in the Constitution, therefore understanding the provisions of Constitution is foremost to have clear understanding of any law.

Now, Let us go through some of the relevant provisions of our Constitution relating to taxation:

Article 246(1) of Constitution of India states that Parliament has exclusive powers to make laws with respect to any of matters enumerated in List I in Seventh Schedule to Constitution(i.e. Union list). Article 246(3) provides that State Government has exclusive powers to make laws for State with respect to any matter enumerated in List II of Seventh Schedule to Constitution(i.e. State List).

Parliament has exclusive powers to make laws in respect of matters given in Union List and State Government has the exclusive jurisdiction to legislate on the matters containing in State List.

There is yet another list i.e. List III (called concurrent list) in the Seventh Schedule to the Constitution. In respect of the matters contained in List III both the Central Government and State Governments can exercise powers to legislate. In case of Union Territories Union Government can make laws in respect of all the entries in all the three lists.

List III of Seventh Schedule(i.e. Concurrent list) includes entries like Criminal law and Procedure, Trust and Trustees, Civil Procedures, economic and social planning, trade unions, charitable institutions, price control factories, etc.

In case there is a conflict between the laws legislated by State Government and Central Government in respect of entries contained in Concurrent list, law made by Union Government prevails.

However there is one exception to this rule, if law made by State contains any provision repugnant to earlier law made by Parliament, law made by State Government prevails, if it has received assent of President. Even in such cases, Parliament can make fresh law and amend, repeal or vary law made by State.

2. State the provisions of the Income Tax Act with regard to tax deducted at source.

Ans: Tax Deducted at Source (TDS) Provisions:

TDS (Tax Deducted at Source on payment of interest (or any other service fees) to non Banking financial Companies and Public Financial Institutions.

Non Banking Financial Institution: A Non Banking financial Company is a company registered under Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/ stocks/bonds/debentures/securities issued by Government or Local authority or other marketable securities of a like nature, leasing, hire – purchase, insurance business, chit business, but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any service and sale / purchase/ construction of immovable property.

Public Financial Institution: Section 4A of Companies Act, 1956 – Public financial Institutions

1. Each of the financial institutions specified in this sub-section shall be regarded, for the purposes of this Act, as a public financial institution namely-

i. the industrial Credit and Investment Corporation of India Limited, a company formed and registered under the India Companies Act, 1913;

ii. the Industrial Finance Corporation of India, established under section 3 of the Industrial Finance Corporation Act, 1948;

iii. the Industrial Development Bank of India, established under section 3 of Life Insurance Corporation Act, 1956;

iv. the Unit Trust of India, established under section 3 of The Unit Trust of India Act, 1963;

v. the Infrastructure Development Finance Company Limited, a company formed and registered under this Act.

vi. the securitization company or reconstruction company who has obtained a certificate of registration under sub-section (4) of section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.

2. Subject to the provisions of sub-section (1) the Central Government may, by notification in the Official Gazette, specify such other institution as it may think fit to be a public financial institution:

Provided that no institution shall be so specified unless-

i. It has been established or constituted by or under any Central Act, or

ii. Not less than fifty – one percent, of the paid – up share capital of such institution is held or controlled by the Central Government.

From the above, we can conclude that Non Banking financial Companies and Public financial Institution both are not same.

Tax Deducted at source on Interest: In accordance with the Section 2 (28A) of Income Tax Act, 1961

Interest means interest payable in any manner in respect of any money borrowed or debt incurred (including a deposit, claims or other similar rights or obligation) and includes any service fee or other charge in respect of the money borrowed or debt incurred or in respect of any credit facility which has not been utilized.

Interpretation of the above definition

From the above definition it is being clarified that Interest and loan processing fee are same in the eyes of law (Income Tax Act, 1961). Hence, TDS compliances on both must be same.

If TDS is required to be deducted by any entity on interest then it must be deducted on loan processing fee or any other service fee.

Section 194A of Income Tax Act, 1961 - TDS on Interest (other than interest on securities)

Section 194A explains that Any person, not being an individual or a Hindu Undivided Family who is responsible for paying to a resident any income by way of interest, other than interest on securities, is required to deduct income tax thereon at the rate of 10% at the time of credit of such income to the account of payee, or interest payable account or suspense account or at the time of payment thereof, in cash or by issue of a cheque or draft or by any other mode, whichever is earlier,

However this section also state some cases where provisions of this section are not applicable which includes:

TDS is not required to be deducted where interest is credited or paid to any banking company, co-operative societies engaged in banking business, public financial institutions, the Life Insurance Corporation, the unit Trust of India, a company or a co – operative society carrying on the business of insurance, or notified institution. But this section does not provide any exemption from TDS to Non Banking financial companies.

Conclusion: TDS is not required to be deducted on payment of interest (or any other service fee) if the payment is made to some Public financial Institutions, however need to comply with the TDS provisions under section 194A if payment is made to any Non – Banking financial Companies.

Points to be remembered while Auditing

a. No difference is made between interest and any loan processing fee or any other related service fee under Income Tax act,1961, hence TDS Compliance on their payments must be checked under Section 194A – TDS on Interest ( other than interest on securities). Refer Section 2(38) as explained above.

b. Auditors must check the status of the company or institution form whom the loan is taken before applying the provisions regarding TDS under section 194A of Income Tax Act,1961 as exemption is provided to only Public financial Institutions and not to Non Banking financial Companies.