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Section 35D

Let us start with a small practical scenario.

Vita biscuit Limited (VBL) was incorporated on 1st November, 2019. However, it started commercial production on 14th February, 2021. VBL incurred various preliminary expenses of Rs.9,00,000 before commencement.

Following is the extract of Balance Sheet of VBL

On March 31, 2020(Rs)On March 31, 2021 (Rs)
Cost of the Project17,00,0001,36,00,000
Issued Share Capital1,00,0001,50,00,000
Paid Up Share Capital1,00,0001,30,00,000
Debentures10,00,00010,00,000
Long Term Borrowing in Foreign Country9,00,00015,00,000

Determine the amount of deduction under section 35D.

Before we jump into the technical aspects of section 35D, let me give you a quick overview of section 35D.

Q1. Who can claim deduction under section 35D of the Act?
Ans. Indian company or a non-corporate resident assesse

Q2. What will be time and purpose of incurring preliminary expenses?
Ans.

Time of incurring expensesPurpose of incurring expenses
Before commencement of businessFor setting up of any undertaking or business
After commencement of businessExtension of the undertaking or setting up a new unit

Q3. What will be the upper limit on such expenses?
Ans. It depends on the type of assessee, whether corporate or non-corporate

Upper limit in the case of a corporate assesseeUpper limit in the case of a non-corporate assessee
a. 5 per cent of cost of project; or
b. 5 per cent of capital employed, whichever is more
5 per cent of cost of project

Q4. What will be quantum of deduction and for how many years same can be claimed?
Ans. The maximum qualifying expenditure as computed above will be allowed as a deduction in 5 equal installments starting from the previous year in which the assessee commences business.

Two technical issues involved

On close reading of the above referred problem of VBL, following two technical aspects emerge:

(1) What shall be the meaning of term “capital employed” for the purpose of computing upper limit?

(2) What shall be the value date for computing capital employed / cost of project? Shall we take it 31-03-20 being the last day of the previous year in which VBL got incorporated or shall we take it 31-03-2021 being the last day of the previous year in which VBL commenced the business operations?

Analysis and Conclusion

Both the above issues get resolved with the help of term “Capital Employed” for the purpose of section 35D. The term “Capital Employed” means the aggregate of the issued share capital, debentures and long-term borrowings, as on the last day of the previous year in which the business of the company commences.

Therefore, answer to the first issue is that total of the following three items shall be termed as capital employed:

a. Issued share capital
b. Debentures
c. Long-term borrowings.

Interestingly, the amount of “Paid up share capital” has no role to play while determining “Capital Employed”.

And answer to the second issue is that value date for computing capital employed / cost of project would be 31-03-2021 being the last day of the previous year in which VBL commenced the business operations and not the last day of previous year in which assessee got incorporated.

Computation of deduction under section 35D in the hands of VBL

Finally, what shall be the amount of deduction under section 35D in the hands of VBL? Do post your answer in comment box.

You can listen to me on Section 35D by clicking here

All The Best, Happy Learning 🙂

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