The stage of inception for any business is one of the most crucial phases in the life cycle. In this critical inception stage, the companies incur several expenses.
Amortization Of Preliminary Expenses:
The amortization of the preliminary expenses that are incurred before the commencement of the business, making extension of an already existing business, to set up a new section and so on get the eligibility to get amortized following the section 35D of the Income Tax Act of 1961.
The eligibility of the Assessee
- Any company from India, or simply an individual person, apart from a company, who is a citizen of India is eligible for the purpose of that section according to the section 35D of the Income Tax Act.
The purpose of the preliminary expenses:
As mentioned before, incur of the preliminary expenses are to be conducted for the following purposes:
- In order to commence a new business
- In order to extend an existing business
- In order to set up a new undertaking
Categories of the preliminary expenses which are entitled to get amortized should have expenditure which is incurred via connection with these:
- The preparation of the feasibility reports, engineering service reports, market survey reports and project reports
- The legal charges for making the drafts of the required agreements in order to purposefully carry out the company
- The legal charges for making a draft about the “Memorandum of Association and Articles of Association”
- The charges related to the print making of the aforementioned documents
- The charges which are incurred for the registration of the enterprise with the ROC
- Underwriting the brokerage, commission and the charges which are paid keeping connection with the topic of shares and the debentures of the issues of the prospectus.
- The other expenses which may get prescribed and not deductible following any of the other sections.
Allowed Extension of the Deduction
Only deduction of the expenses lower than the actual expense to be incurred or –
- 5% of the project cost, where the cost of the project equates to the cost of the assets which are fixed up to the last day of the year before
- 5% of the capital engaged, which is applicable to any company. In this case the capital engaged or employed equates to the paid up long term borrowings plus debentures plus the capital up to the last day of the year before
- The amounts which are calculated following the above methods are allowed to be a deduction for a time frame of 5 years
The Key Differences between the Accounting Treatment and the Income Tax Act According To the AS22
Income Tax Act makes it mandatory for the preliminary expenses to get amortized on equal terms within the time frame of around 5 years. Meanwhile, the accounting treatment has a preference to have the amortization fully in the same year. This, however, creates an issue regarding the time since the tax payer has to offer more than required income tax and simultaneously has to pay less tax in the future; because one-fifth of the deduction allowed over a period of five years.
Hence, the tax payer has to keep in mind that there will an occurrence of a Direct Tax Asset (DTA) for the preliminary expenses.
In case of a merger or a demerger, the unamortized expenses are to taken care of in the following ways:
In the case of a merger or a demerger, the company which is merged is a resultant business which will be allowed to get the rest of the preliminary expenses amortized throughout the rest of the years.
Preliminary expenses are a very important side to be considered in the beginning of any business. It is crucial to know about it and have the knowledge about it in details in order to avoid monetary accidents.
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