SUGGESTED ANSWERS BY ICAI FOR CA FINAL MAY...

SUGGESTED ANSWERS BY

ICAI FOR CA FINAL

MAY 2011 EXAMS

(GROUP-II)

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PAPER – 5 : ADVANCED MANAGEMENT ACCOUNTING Question No.1. is compulsory.

Answer any five questions from the remaining six questions

Question 1 (a) A company actually sold 8000 units of A and 10,000 units of B at ` 12 and ` 16 per unit

respectively against a budgeted sale of 6000 units of A at ` 14 per unit and 9000 units of B at ` 13 per unit. The standard costs of A and B are ` 8 and ` 10 per unit respectively and the corresponding actual costs are ` 5.5 and `14.5 per unit.

Compute the product wise sales margin mix and sales margin price variances, indicating clearly, whether the variances are favorable or adverse. (5 Marks)

(b) A company makes a single product which sells at ` 800 per unit and whose variable cost of production is ` 500 per unit. Production and sales are 1000 units per months. Production is running to full capacity and there is market enough to absorb an additional 20% of output each month. (5 Marks)

The company has two options: Option-I Inspect finished goods at ` 10,000 per month. 4% of production is detected as defectives

and scrapped at no value. There will be no warranty replacement, since every defect is detected. A small spare part which wears out due to defective material is required to be replaced at ` 2,000 per spare for every 20 units of scrap generated. This repair cost is not included in the manufacturing cost mentioned above.

Option-II Shift the finished goods inspection at no extra cost, to raw material inspection, (since

defective raw materials are entitled to free replacement by the supplier), take up machine set-up tuning and machine inspection at an additional cost of ` 8,000 per month, sop that scrap of finished goods is completely eliminated. However, delivery of uninspected finished products may result in 1 % of the quantity sold to be replaced under free warranty due to minor variation in dimensions, which does not result in the wearing out of the spare as stated in Option-I (i) Using monthly figures relevant for decision making, advise which option is more

beneficial to the company from a financial perspective. (ii) Identify the quality costs that can be classified as

(a) appraisal costs and (b) external failure costs.

© The Institute of Chartered Accountants of India

FINAL EXAMINATION : MAY, 2011

2

(c) Pick out from each of the following items, costs that can be classified under ‘committed fixed costs’ or ‘discretionary fixed costs”. (i) Annual increase of salary and wages of administrative staff by 5% as per agreement (ii) New advertisement for existing products is recommended by the Marketing

Department for achieving sales quantities that were budgeted for at the beginning of the year.

(iii) Rents paid for the factory premises for the past 6 months and the rents payable for the next six months. Production is going on in the factory.

(iv) Research costs on a product that has reached ‘maturity’ phase in its life cycle and the research costs which may be needed on introducing a cheaper substitute into the market for facing competition.

(v) Legal consultancy fees payable for patent rights on anew product Patenting rights have been applied for. (5 Marks)

(d) The following matrix is a minimization problem for transportation cost. The unit transportation costs are given at the right hand corners of the cells and the ijD values are encircled.

D1 D2 D3 Supply

F1

500

F2

300

300

F3

200 200

Deamnd 300 400 300 1000 Find the optimum solution (s) and the minimum cost.

Answer (a)

BQ RBQ AQ AP BP BC BM AM A 6000 7200 8000 12 14 8 6 4 B 9000 10800 10000 16 13 10 3 6 15000 18000

3 4 4

9 6 7

4 6 5 8

0 2

2


PAPER – 5 : ADVANCED MANAGEMENT ACCOUNTING

3

Sales Margin Mix Variance: (Actual Qty in Budgeted Mix – Actual Qty in Actual Mix) х Budgeted Margin A : (7,200 – 8,000) х 6 = - 4,800 (Fav) B : (10,800 – 10,000) х 3 = 2,400 (Adv) Total Mix Variance = - 2,400 (Fav) Sales Margin Price Variance = Actual Qty (Budgeted Margin – Actual Margin) A 8,000 (6 – 4) = 16,000 (A) B 10,000 (3 – 6) = 30,000 (F)

Total Price Variance 14,000 (F) (b)

Option I Option II Production 1000

Units 1000 Units

Finished Goods Inspection 10,000 Appraisal - Raw Material Inspection scrap 4% = 40 units х variable cost per unit 500

20,000

Appraisal

10,000

Contribution lost 300 х 40 12,000 Appraisal Machine repair 4,000 Appraisal - Machine set up 8,000 Warranty replacement - 1% х 1000 = 10 unit Contribution lost 10 х 300 3,000 External failure Variable Cost lost 10 х 500 5,000 External failure Quality Cost 46,000 26,000 Better Option II

(c) Committed Fixed Cost Discretionary Fixed Cost

(i) Salary and wage increase (ii) New Advertisement Cost (iii) Rents payable for the next 6 months (iv) Research cost for substitutes (v) Legal fees for filing for patent rights.



4

(d) Δij values are given for unallocated cells. Hece, no. of allocated cells = 5, which = 3 + 3 – 1 = no. of columns + no of rows – 1.

Allocating in other than Δij cells. Factory S1 D2 D3 Supply

300 100

100

500

300

300

200

200

300 400 300 1000 This solution is optional since Δij are non-ve. For the other optional solution, which exists since Δij= 0 at R3 C1, this cell should be brought in with a loop : R3, C1 – R1 C1 – R1C3 – R3C3. Working Notes: Step I : R1C1 (Minimum of 300, 500) Step II : R2C2 (Minimum of 300, 400) Step III : R1C2 balance of C2 total : 100, R1 Total = 100 Step IV : R1C3 100 (balance of C3 total = 200) Step V : R3C3 200 Solution I

-100 +100 300 100 100 300

+100 200 -100 Solution II

200 100 200 300 100 100

3 4 4

9 6 7

4 6 5 8

0 2

2

0



5

Solution I Solution II Cost: 3 х 300 = 900 3 х 200 = 600 4 х 100 = 400 4 х 100 = 400 4 х 100 = 400 4 х 200 = 800 6 х 300 = 1800 6 х 300 = 1800 5 х 200 = 1000 5 х 100 = 500 4 х 100 = 400 Minimum Cost 4500 4500

Question 2 (a) During the last 20 years, KL Ltd’s manufacturing operation has become increasingly

automated with computer-controlled robots replacing operators. KL currently manufacturers over 100 products of varying levels of design complexity. A single plant wise overhead absorption rate, based on direct labor hours is absorb overhead costs.

In the quarter ended March, KL’s manufacturing overhead costs were: (` 000) Equipment operation expenses 125 Equipment maintenance expenses 25 Wages paid to technicians 85 Wages paid to component stores staff 35 Wages paid to dispatch staff 40 Total 310

During the quarter, the company reviewed the Cost Accounting System and concluded that absorbing overhead costs to individual products on a labour hour absorption basis was meaningless and that overhead costs should be attributed to products using an Activity Based Costing (ABC) system, The following are identified as the most significant activities. (i) Receiving component consignments from suppliers. (ii) Setting up equipment for production runs (iii) Quality inspections (iv) Dispatching goods as per customer’s orders.

Equipment operation and maintenance expense are apportioned as : · Component stores 15% production runs 70% and dispatch 15%



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Technician’s wages are apportioned as: · Equipment maintenance 30% set up equipment for production runs 40% and quality

inspections 30% During the quarter:

(i) 980 component consignments were received from suppliers. (ii) 1020 production runs were set up (iii) 640 quality inspections were carried out. (iv) 420 orders were dispatched to customers.

KL’s production during the quarter included component R. The following information is available: Component

R Component Consignments received 45 Production runs 16 Quality Inspections 10 Orders (goods ) dispatched 22 Quantity produced 560

Calculate the unit manufacturing overhead cost of component R using ABC system. (8 Marks) (b) State any three differences between PERT and CPM (3 Marks) (c) What are the disadvantages of Cost Plus Pricing ? (5 Marks) Answer (a)

Receiving Supplies (Rs.000)

Set ups (Rs. 000)

Quality Inspection

(Rs.000)

Despatch (Rs.000)

Total (Rs.’000)

Equipment Operation Expenses

18.75 87.50 18.75 125.00

Maintenance technicians wages initially allocated to maintenance (30% of Rs. 85,000 = Rs. 25,500

3.75 17.50 3.75 25.00

and then reallocated on 3.83 17.85 3.82 25.50



7

the same basis on maintenance Balance of technician wages, allocated to set ups and quality inspections

34.00 25.50 59.50

Stores wages – Receiving 35.00 35.00 Despatch wages – Despatch

40.00 40.00

61.33 156.85 25.50 66.32 310.00 Note: Equipment operations expenses and Maintenance allocated on the basis 15%,

70%, and 15% as specified in the question. The next stage is to identify cost drivers for each activity and established cost driver

rates by dividing the activity costs by a measure of cost drive usage for the period. The Calculations are as follows:

Receiving supplies (Rs. 61,330/980) = Rs. 62.58 per component Performing set ups (Rs. 1,56,850/1020) = Rs. 153.77 per set up Despatching goods (Rs. 66,320/420) = Rs. 157.93 per goods order despatched Quality Inspection (Rs. 25,500/640) = Rs. 39.84 Finally the costs are assigned to components based on their cost driver usage. The

assignments are as follows: (Rs.) Direct Labour 300.00 Direct Materials 1200.00 Receiving supplies

2816.10

Performing Set Up 2460.32 Quality Inspection 398.40 Despatching goods 3474.46 Total Overhead Costs 10461.54 (Rs.) No. of units produced 560 Cost per unit 16.34

For components the overhead costs have been assigned as follows (for components R) Receiving supplies (45 receipts at Rs. 62.58)



8

Performing setups (16 production runs at Rs. 153.77) Quality Inspections (10 at Rs. 39.84) Despatching goods (22 at Rs. 157.93) (b)

PERT CPM (i) Non repetitive jobs Repetitive Jobs (ii) Probabilistic Model Deterministic Model (iii) Event oriented Activity oriented (iv) Incorporates statistical analysis Does not incorporate statistical analysis (v) Useful as control device Difficulty to use as control device

(c) Disadvantages of cost plus pricing: (i) If ignores demand, facts to take into account buyers’ needs and willingness to pay. (ii) Fails to reflect competition adequately. (iii) Assumes correct cost estimation, whereas in multiproduct firm, costs may be

arbitrarily allocated. (iv) In many decision, incremental costs are more relevant than full cost. This is

ignored. (v) Fixed Overheads depends on volume if volume is more cost is less, and vice-versa.

Increase decrease in sales volume depends on price. Thus it is a vicious circle – cost plus markup is a price based on sales volume & sales volume is based on price.

Question 3 (a) A manager was asker to assign tasks to operators (one task per operator only) so as to

minimize the time taken. He was given the matrix showing the hours taken by the operators for the tasks.

First, he preformed the row minimum operation. Secondly, he did the column minimum operation. Then, he realized that there were 4 tasks and 5 operators. At the third step he introduced the dummy row and continued with his fourth step of drawing lines to cover zeros. He drew 2 vertical lines (under operator III and operator IV) and two horizontal lines (aside task T4 and dummy task T5 ) At step 5, he performed the necessary operation with the uncovered element, since the number of lines was less than the order of the matrix . After this, his matrix appeared as follows:



9

Operators Tasks I II III IV V T1 4 2 5 0 0 T2 6 3 3 0 3 T3 4 0 0 0 1 T4 0 0 5 3 0 T5 (dummy) 0 0 3 3 0 (i) What was the matrix after step II ? Based on such matrix, ascertain (ii) and (iii)

given below. (ii) What was the most difficult task for operators I, II and V ? (iii) Who was the most efficient operators? (iv) If you are not told anything about the manager’s errors, which operator would be

denied any task? Why? (v) Can the manager go ahead with his assignment to correctly arrive at the optional

assignment, or should he start afresh after introducing the dummy task at the beginning? (10 Marks)

(b) Classify the following measures under appropriate categories in a balanced score card for a banking company which excels in it s home loan products: (i) A new product related to life insurance is being considered for a tie up with the

successful housing loan disbursements. e.g. every housing loan applicant to be advised to take a life policy or compelled to

take a fire insurance policy. (ii) How different sectors of housing loans with different interest rates have been

sanctioned, their volumes of growth in the past 4 quarters. (iii) How many days are taken to service a loan, how many loans have taken longer,

what additional loans are to be released soon, e.t.c (Students are not required to copy these statements into their answer books) (3 Marks) (c) A company can make any one of the 3 products X,Y or Z in a year. It can exercise its

option only at the beginning of each year. Relevant information about the products for the next year is given below.

X Y Z Selling Price (`/u) 10 12 12 Variable Costs(`/u) 6 9 7



10

Market Demand (units) 3000 2000 1000 Production capacity (units) 2000 3000 900 Fixed Costs (`) 30,000

You are required to compute the opportunity costs for each of the products.

Answer (a)

01 02 03 04 05 (given)

T1 4 2 5 0 0 T2 6 3 3 0 3 T3 4 0 0 0 1 T4 0 0 5 3 0 T5 0 0 3 3 0

(Dummy) Junction values at dummy = 3. 3 was the minimum uncovered element. Previous step was

7 5 5 0 3 9 6 3 0 6 7 3 0 0 4 0 0 2 0 0 0 0 0 0 0

(i) At step II the matrix was:

7 5 5 0 3 9 6 3 0 6 7 3 0 0 4 0 0 2 0 0

(ii) For Operator I, Most difficult task will be indicated by hours = T2 Operator II T2 Operator V T2 (iii) Most efficient operator = Operator 4



11

(iv) If the Manager’s mistake was not known,

4 2 5 0 6 3 3 3 4 0 0 1 0 0 5 3 0 0 0 3 3 0

We continue the assignment; T1 – 05, T2 – 04, T3 – 03 are fixed. Between T4 and T5, 01 or 02 Can be allotted. So, other 01 or 02 Can be denied the job. (v) Yes, the Manager can go ahead with the optimal assignment Row minimum is not affected by when the dummy was introduced.

Column minimum was affected. But in the process, more zeros were generated to provide better solution.

(b) (i) New product tie up - Innovation/learning perspective (ii) Growth of Volume - Financial perspective (iii) Time for loan/Fresh products - Customer perspective (c)

X Y Z Contribution per unit 4 3 5 Units (lower of production/ market demand)

2000 2000 900

Possible Contribution (Rs.) 8000 6000 4500 Opportunity Cost 6000 8000 8000

(Note: Opportunity cost is maximum benefit for gone. Question 4 Answer any four out of the following five subdivisions: (a) 6000 pen drives of 2 GB to be sold in a perfectly competitive market to earn `1,06,000

profit, whereas in a monopoly market only 1200 units are required to be sold to earn the same profit. The fixed costs for the period are ` 74,000 . the contribution per unit in the monopoly market is as high as three fourths its variable cost. Determine the targets selling price per unit under each market condition.

(b) In a company, factory, overheads are applied on the basis of direct labour hours.

0 0

0



12

The following information is given: Department

A B Fixed factory overheads(`) 3,36,000 1,26,000 Variable labour hours (` per hour) required as per direct labour hour budget

0.50 1.50

For product X 1,40,000 70,000 For product Y 28,000 56,000

(c) Classify the following items under the three measures used in the theory of constraints: (i) Research and Development Cost (ii) Rent/Utilities (iii) Raw materials used for production (iv) Depreciation (v) Labour Cost (vi) Stock of raw materials (vii) Sales (viii) Cost of equipments and buildings.

(d) Will the initial solution for a minimization problem obtained by Vogel’s Approximation Method and the Least Cost Method be the same ? Why?

(c) Name any four stage in the process of bench marking. (4 х 4 = 16 Marks)

Answer (a)

Perfect Competition Monopoly Units 6,000 1,200 Contribution (1,06,000 + 74,000) 1,80,000 1,80,000 Contribution per unit 30 150

Variable Cost per unit 15043

¸ 200

Variable Cost per unit 200 Selling Price per unit 230 350



13

(b)

Products X Y Variable Overheads 175000 98000 Fixed Overheads 350000 112000 Total 525000 210000

Working Note:

Department A Department B Variable Overheads Product X 70,000 1,05,000 Product Y 14,000 84,000 Fixed Overheads Product X 2,80,000 70,000 Product Y 56,000 56,000

(c) The 3 key measures are : Contribution (iii) Raw Material for production (vii) Sales Operating Costs (ii) Rent/utilities (iv) Depreciation (v) Labour Investments: (i) R& D (vi) Raw Material Stock (viii) Building and Equipment Cost (d) The initial solution need not be the same under both methods. Vogel’s Approximation Method uses the differences between the minimum and the next

minimum costs for each row and column. This is the penalty or opportunity cost of not utilising the next best alterative. The highest penalty is given the 1st preference. This need not be the lowest cost.

For example if a row has minimum cost as 3, and the next minimum as 2, penalty is 1; whereas if another row has minimum 4 and next minimum 6, penalty is 2, and this row is given preference. But least cost given preference to the lowest cost cell, irrespective of the next cost.

Vogel’s Approximation Method will to result in a more optimal solution than least cost. They will be the same only when the maximum penalty and the minimum cost coincide.



14

(e) Various stages in the process of benchmarking. I Planning - Determination of benchmarking goal statement - Identification of best performance - Establishment of the benchmarking or process improvement team - Defining the relevant benchmarking measures II Collection of data and information III Analysis of finding based on data collected IV Formulation and implementation of recommendation V Constant Monitoring and reviewing. Question 5 (a) A Company has two manufacturing divisions X and Y, X has a capacity of 96000 hours

per annum. It manufactures two products. ‘Gear ’and ‘Engines’ as [per the following details.

Gears Engines Direct Materials 240 64 Variable costs at `64/hour 256 64 Selling price in the outside market 640 128

Division ‘Y’ produces product ‘Wheels’ as per the following details:

` /unit Imported components 640 Direct Materials 96 Variable cost at ` 40 per hour 320 Selling price in the outside market 1,160

The fixed overheads for X and Y are ` 24 lakhs and ` lakhs respectively. With a view to minimizing dependence on the imported component, the company has explored a possibility of Division Y using product ‘Gears’ instead of the imported component. This is possible provided Division Y spends 2 machine hours entailing an additional expenditure of ` 64 per component on modification of product ‘Gears’ to fit into ‘wheels’. Production and sales of ‘Wheels’ in Division Y is limited to 5000 units per annum. (i) What will be maximum transfer price per unit that Y will offer ? (ii) In each of the following independent situations, state with supporting calculations,

the minimum transfer price per unit that X will demand from Y, if 5000 units are required by Y.



15

(iii) In which of the above situations in (ii) will the Management step in and compel X to sell to Y in the interest of overall company’s profits ? (11 Marks)

(b) A company manufactures two products X and Y involving three departments, Machining, Fabrication and Assembly which have limitations on the hours as 720 hours, 1800 hours and 900 hours respectively. X and Y require 1 and 2 hour of machining time per unit and 3 hours and 1 hours of assembly time per unit respectively. X and Y fetch ` 80 and ` 100 as respective unit contributions. (i) Write the linear program to maximize contribution (ii) Introducing appropriate variables, restate the problem as linear equations fit to be

incorporated in the simplex tableau.

Answer (a) Y will pay only a maximum of Rs. (640-64) = Rs. 576 so that its outside purchase cost is

matched. i.e Maximum Transfer price by Y = 576 Rs. per unit.

Gears Engines (no. of units) Market demand is limited to 20,0000 20,000 Market demand is limited to 15,000 10,000 Market demand is limited to 18,000 24,000

Gears Engines Total Hours per unit 4 1 Hours available 96,000 Units possible 24,000 or 96,000 (ii) (a) Outside Demand 20,000 20,000 Hours required 80,000 20,000 Units required by Y 5,000 Hours required 20,000 Contribution per hour 36 30 Maximise Sales so that hours= 80,000 16,000 Hours used for Y 4,000 16,000 Contribution per units of Y required 1,000 4,000 On units transferred to Y 30 x 16,000 + 36 x 4000 = 480,000 + 1,44,000



16

= 6,24,000 Contribution per units = 6,24,000/5,000 = 124.80

Minimum Transfer price per unit = Contribution + variable cost

= 124.8 + 240 + 256 = Rs. 620.80 (b) Gears Eng. Market Demand 15,000 10,000 Hours required per unit 4 1 Hours required 60,000 10,000 Spare capacity available = 26,000 Units of Gears possible = 26,000 per unit = 6,500 Required For transfer = 5,000 Since spare capacity is used, minimum transfer Price = variable cost of manufacturing = 240 + 256 = 496 X will agree to anything above Rs. 496 per unit

(c) Market Demand Units 18,000 24,000 Hours per units 4 1 Hours required 72,000 24,000 Hours required for Y’s demand 20,000

This will be need by sacrificing production of ‘Engines’. Hence contribution per hours for transferred Units must be atleast.

Contribution Required on 5000 units = 20,000 x 30 = 6,00,000

Contribution Required per unit = 000,5

000,00,6 = 120 Rs.

Minimum Transfer Price = Contribution per unit + Variable Cost = 120 + 240 + 256 = Rs. 616 per unit Gears and Engines earn a contribution.



17

Variable Cost of in house manufacturing of imported Components = 240 + 256 + 64 = 560 Production Outside = Rs. 640 Rs. 80/- per unit is being paid for outside purchase

Contribution Lost per unit of facility X = 20480

= hrs.

Since X is earning higher contribution per hours 36 & 30 for each product, the management will not have to interfere in situation (a) & (c) where full production capacity is used for outside sales.

In (i) (b) Management need not interfere since it is a win-win situation. Departments can negotiate in the relevant range between 496 and 576.

(b) Maximize Z = 80Xx + 100 Y subject to x+2Y £ 720 5x+4y £ 1800 3x+y £ 900 x ³ 0; y ³ 0 Where x is the number of units of A and y is the number of units of B By the addition of slack variables, S1 S2 S3 the inequality can be converted to the

equations. The problem thus becomes Z = 80X+100Y subject to x+2y+S1 = 720 5x+4y+S2 = 1800 3x+y+S3 = 900 x ³ 0; y ³ 0 S1 ³ 0; S2 ³ 0; S3 ³ 0. Question 6 (a) Explain the pre-requisites for successful operation of material requirement planning. (5 Marks) (b) Point out the errors in the network given below, going by the usual conventions while

drawing a network to use CPM (6 Marks) (c) Maruthi Agencies has received an order from a valuable client for supplying 3,00,000

pieces of a component at ` 550 per unit at a uniform rate of 25000 units a month. Variable manufacturing costs amount to `404,70 per unit, of which direct materials is `

355 per unit. Fixed production overheads amount to ` 30 lacs per annun, ecluding depreciation. There is a penalty/reward clause of ` 30 per unit for supplying less/more than 25000 units per month. to adhere to the schedule of supply, the company procured



18

a machine worth ` 14.20 lacs which will wear out by the end of the year and will fetch ` 3,55 lakh sat the year end. After this supply of machine, the supplier offers another advanced machine which will cost ` 10.65 lakhs , will wear out by the year end and not have any resale value. If the advanced machine is purchased immediately, the purchaser will exchange the earlier machine supplied at the price of the new machine. Fixed costs of maintaining the advanced machine will increase by ` 14,200/- per month for the whole year. While the old machine had the capacity to complete the production in 1 year, the new machine can complete the entire job in 10 months. The new machine will have material wastage of 0.5% . assume uniform production throughout the year for both the machines.

Using incremental cost/revenue approach, decide whether the company should opt for the advanced version.

Answer (a) Pre-requisites for successful operation of MRP system are:

(i) The latest production and purchasing schedules prepared should be strictly adhered to Day to Day change from predetermined schedules will cause chaos.

(ii) Raw Materials, sub-assemblies and components required for production should be pre-determined in quantifiable terms. Standard should be set for the consumption quantity, quality, mix and yield of raw materials for every unit of finished product.

(iii) Work-force must be appraised of the system and the need for absolute adherence to the schedules prepared.

(iv) Necessary internal control system should be developed to ensure total adherence to the schedule.

(v) Accuracy of the data supplied is vital to the MRP system. (b) Flows

2 – 3 : There are 2 activities which are duplicate. In case they are two different activities, one may pass through a dummy

2 – 5 is a dangling activity; No complete path exists. Can be joined to (9) with a dummy 4 – 6 & 6 – 4 : looping exists; This is not proper sequencing

(c)

Old (Rs.)

New (Rs.)

Incremental

Depreciation Rs.14.2 lakhs – Rs. 3.55 lakhs

10,65,000

10,65,000

-



19

Fixed Cost increase 1,70,400 (-) 1,70,400 Resale value +3,55,000 - (-) 3,55,000 Material Rs./u 355 x .5% 1.775 x 3,00,000 5,32,500 (-) 5,32,500 Increase in Costs in new Machine purchased (-) 10,57,900 Penalty @ Rs. 30 per unit - - Reward @ Rs. 30 per unit 5000 per months x 10 months = 50,000 x 30 = + 15,00,000 Gain 4,42,100

Decision: Buy the advanced version. Working Note:

1st machine 25,000 per month, no penalty, no reward

new machine: 10

000,00,3 = 30,000 per months

advance supply per month = 5,000 = 5,000 x 10 months = 50,000 units reward. Question 7 (a) A car rental agency has collected the following data on the demand for five-seater

vehicles over the past 50 days. Daily Demand 4 5 6 7 8 No. of Days 4 10 16 14 6

The agency has only 6 cars currently. (i) Use the following 5 random numbers to generate 5 days of demand fo the rental

agency Random Nos 15,48,71,56,90

(ii) What is the average number of cars rented per day for the 5 days ? (iii) How many rentals will be lost over the 5 days? (5 Marks)

(b) Entertain U Ltd. hires an air-conditioned theatre to stage plays on weekend evenings. One play is staged pea evening. The following are the seating arrangements:

VIP rows-the first 3 rows of 30 seas per row, priced at ` 320 per seat. Middle level-the next 18 rows of 20 seats per row priced at ` 250 per sea.



20

Last level -6 rows of 30 seats per room priced at ` 120 per seat. For each evening a drama troup has to be hired at ` 71,000, rent has to be paid for the

theatre at ` 14,000 per evening and air conditioning and other state arrangements charges work out to ` 7,400 per evening. Every time a play is staged, the drama troup’s friends and guests occupy the first row of the VIP class, free or charged. by virtue of passes granted to these guest. the troupe ensures that 50% of the remaining seats of the VIP class and 50% of the seats of the other two classes are sold to outsiders in advance and the money is passed on to Entertain U. The troupe also finds for every evening, a sponsor who pouts up his advertisements banner near the stage and pays Entertain U a sum of ` 9,000 per evening. Entertain U supplies snacks during though interval free of charge to all the guests in the hall, including the VIP free guests. The snacks cost Entertain U ` 20 per person. Entertain U sells the remaining tickets and observes that for every one seat demanded from the last level, there are 3 seats demanded from the middle level and 1 seat demanded from the VIP level. You may assume that in case any level is filled, the visitor busy the next higher or lower level, subject to availability. (i) You are required to calculate the number of seats that Entertain U has to sell in

order to break-even and give the categorywise total seat occupancy at BEP. (ii) Instead of the given pattern of demand, if Entertain U finds that the demand for VIP,

Middle and Last level is in the ratio 2:2:5, how many seats each category will Entertain U have to sell in order to break-even.?

Answer (a)

Daily demand

Days Probability Cumulative probability

Random No.

Day Demand

Rented Rental lost

4 4 0.08 0.08 00.07 1 5 5 5 10 0.20 0.28 08-27 2 6 6 6 16 0.32 0.60 28-59 3 7 6 1 7 14 0.28 0.88 60-87 4 6 6 8 6 0.12 1.00 88-99 5 8 6 2 50 1.00 29 3

Average no. of cars rented = 529 = 5.8

Rental lost = 3 (b) Fixed Costs

Rs. Rs.



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Troupe hire 71,000 Rent 14,000 A/C 7,400 VIP Snacks 600 93,000 Fixed Revenues: Seats Sold by the troupe 54,000 Sponsor’s advertisement 9,000 63,000 Net fixed costs recovered by Entertain U to Break even 30,000 Seats Sold by the troupe 54,000 Sponsor’s advertisement 9,000 63,000 VIP Med Lost Total seats available 90 360 180 Less: Free 30 Less: Sold by troupe 30 180 90 Can be sold by Entertain U 30 180 90 Row Price 320 220 120 Variable cost 20 20 20 (Snacks) Contribution per seat 300 200 100 Demand 1 : 3 : 1

=131

1 100 3 200 1300++

´+´+´

=5

100600300 ++ = 5

1000 = 200 (1 Mark)

\ Break Even Point for EntertianU = Rs. 200

000,30 = 150 No. of seats

VIP Rows Middle Level Last Level BF Seats Total 150 30 90 30 Contribution per unit 300 200 100



22

Contribution (Rs.) 9,000 18,000 3,000 30,000 Rs.

Category wise occupancy at Break Even Point VIP 30+30+30 = 90 Middle = 90+180 = 270 Last = 120

(ii) If demand is in the ratio 2 : 2 : 5

Weighted contribution per seats = 9

100520023002 ´+´+´

= 9

500400600 ++ = 9

1500

= 500,1000,30 9´ = 180 seats

Ratio 40 40 100 Quantity available 30 180 90 Break Even quantity 30 10 90 10 10 30 60 90

Contribution per unit 300 200 100 No. of seats 30 60 90 Contribution Rs. 9,000 12,000 9,000 Total = 30,000

(b) Alternative approach of solution: Rs Net fixed cost to be recovered by EU ( As worked earlier pages)

30,000

(i) When demand in ration 1:3:1



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VIP Seats Mid Level Last Level Total Seats Available to EU (Max) (no)

30 180 90 300

Net contribution per seat (Rs)

300 200 100

Contribution based on demand pattern (Rs)

300 600 100 1000

BEP Seats in std. demand ratio (no)

30 90 30 150

Contb. on BEP seats (verification ) (Rs.)

9000 18000 3000 30,000

Weighted avg. contribution per seat as per std.

demand pattern 200.Rs5

1000=

No of seats for BEP = 150200.Rs

30000.RsonContributi.AvstNetFixedCo

== seats

(ii) When demand in ratio 2:2:5 VIP Mid Level Last Level Total Seats Available to Eu (Max) (no)

30 180 90 300

Net Contribution per seat (Rs)

300 200 100

Contribution based on demand pattern (Rs.)

600 400 500 1500

BEP Seats in std. demand ratio (nos)

40 40 100 180

Seats adjusted to level (nos)

(--)10 20 (---)10



24

BEP seats adjusted) (nos)

30 60 90 180

Contb. amount (Rs)

9000 12000 9000 30,000

Weighted average contribution per seat as per

demand pattern 9

1500 = Rs. 166.66

No. of Seats for BEP = 67.166.Rs

000,30.Rs = 150 seats


PAPER – 6 : INFORMATION SYSTEMS CONTROL AND AUDIT Question No. 1 is compulsory.

Attempt any five questions from the remaining six questions.

Question 1 XYZ Industries Ltd., a company engaged in a business of manufacturing and supply of electronic equipments to various companies in India. It intends to implement E-Governance system at all of its departments. A system analyst is engaged to conduct requirement analysis and investigation of the present system. The company’s new business models and new methods presume that the information required by the business managers is available all the time; it is accurate and reliable. The company is relying on Information Technology for information and transaction processing. It is also presumed that the company is up and running all the time on 24 x 7 basis. Hence, the company has decided to implement a real time ERP package, which equips the enterprise with necessary capabilities to integrate and synchronise the isolated functions into streamlined business processes in order to gain a competitive edge in the volatile business environment. Also, the company intends to keep all the records in digitized form. (a) What do you mean by system requirement analysis? What are the activities to be

performed during system requirement analysis phase? (5 Marks) (b) What are the business risks that an organization faces when migrating to real time

integrated ERP system? (5 Marks) (c) What are the points that need to be taken into account for the proper implementation of

physical and environmental security in respect of Information System Security? (5 Marks) (d) What is the provision given in Information Technology (Amended) Act 2008 for the

retention of electronic records? (5 Marks)

Answer (a) System requirements analysis is a phase, which includes a thorough and detailed

understanding of the current system, identification of the areas that need modification/s to solve the problem, the determination of user/managerial requirements and to have fair ideas about various system development tools. The following activities are performed in this phase: · To identify and consult the stake owners to determine their expectations and resolve

their conflicts; · To analyze requirements to detect and correct conflicts and determine priorities; · To verify requirements in terms of various parameters like completeness,

consistency, unambiguous, verifiable, modifiable, testable and traceable; · To gather data or find facts using tools like- interviewing, research/document

collection, questionnaires, observation;



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· To develop models to document Data Flow Diagrams, E-R diagrams; and · To document activities such as interviews, questionnaires, reports etc. and

development of a system dictionary to document the modeling activities. The document/deliverable of this phase is a detailed system requirements report, which is generally termed as SRS.

(b) Organizations face several business risks when migrating to real-time, integrated ERP systems. These risks are given as follows: · Single point of failure: Since all the organization's data and transaction processing

is within one application system, single point failure may be a major risk. · Structural changes: Significant personnel and organizational structure changes

associated with reengineering or redesigning business processes may pose a big challenge.

· Job role changes: Transition of traditional user's roles to empowered-based roles with much greater access to enterprise information in real time and the point of control shifting from the back-end financial processes to the front-end point of creation are also great risks.

· Online, real-time: An online real-time environment requires a continuous business environment capable of utilizing the new capabilities of the ERP application and responding quickly to any problem requiring re-entry of information.

· Change management: The level of user acceptance of the system has a significant influence on its success. Users must understand that their actions or inaction have a direct impact upon other users and, therefore, must learn to be more diligent and. efficient in the performance of their day-to-day duties.

· Distributed computing experience: Inexperience with implementing and managing distributed computing technology may pose significant challenges.

· Broad system access: Increased remote access by users and outsiders and high integration among application functions allow increased access to application and data.

· Dependency on external assistance: Organization accustomed to in-house legacy systems may find that they have to rely on external help. Unless such external assistance is properly managed, it could introduce an element of security and resource management risk that may expose the organizations to greater risk. .

· Program interfaces and data conversions: Extensive interfaces and data conversions from legacy systems and other commercial software are often necessary. The exposure of data integrity, security and capacity requirements for ERP are therefore often much higher.

· Audit expertise: Specialist expertise is required to effectively audit and control an ERP environment. The relative complexity of ERP systems has created


PAPER – 6 : INFORMATION SYSTEMS CONTROL AND AUDIT

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specialization such that each specialist may know a small fraction of the entire ERP's functionality in a particular core module.

(c) For the proper implementation of Physical and Environmental Security, the following points need to be taken into account: · Physical security should be maintained and checks must be performed to identify all

vulnerable areas within each site. · The IT infrastructure must be physically protected. · Access to secure areas must remain limited to authorized staff only. · Confidential and sensitive information and valuable assets must be securely locked

away, when they are not in use. · Computers must never be left unattended whilst displaying confidential or sensitive

information or whilst logged on to the systems. · Supplies and equipments must be delivered and loaded in an isolated area to

prevent any unauthorized access to key facilities. · Equipment, information or software must not be taken off-site without proper

authorization. · Wherever practical, premises housing computer equipment and data should be

located away from, and protected against threats of deliberate or accidental damage such as fire and natural disaster.

· The location of the equipment rooms must be away from, and protected against threats of unauthorized access and deliberate or accidental damage, such as system infiltration and environmental failures.

(d) Retention of Electronic Records: [Section 7] of ITAA 2008 The provision for the retention of electronic records is discussed in Section 7 of ITAA 2008, which is given as follows: (1) Where any law provides that documents, records or information shall be retained for

any specific period, then, that requirement shall be deemed to have been satisfied if such documents, records or information are retained in the electronic form, – (a) the information contained therein remains accessible so as to be usable for a

subsequent reference; (b) the electronic record is retained in the format in which it was originally

generated, sent or received or in a format, which can be demonstrated to represent accurately the information originally generated, sent or received;



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(c) The details, which will facilitate the identification of the origin, destination, date and time of dispatch or receipt of such electronic record are available in the electronic record.

However, this clause does not apply to any information, which is automatically generated

solely for the purpose of enabling an electronic record to be dispatched or received. (2) Nothing in this section shall apply to any law that expressly provides for the

retention of documents records or information in the form of electronic records, publication of rules, regulation etc. in Electronic Gazette.

Question 2 (a) Discuss the policies and controls that any financial institution needs to consider when

utilizing public key infrastructure. (8 Marks) (b) Describe the benefits of performing a technology risk assessment. (4 Marks) (c) Why do you think a separate standard (SAS 70) is useful for auditing a service

organization especially with respect to examination of general controls over Information Technology and related processes? (4 Marks)

Answer (a) When utilizing PKI, financial institutions need to consider the following policies and controls:

· Defining within the certificate issuance policy, the methods of initial verification that are appropriate for different types of certificate applicants and the controls for issuing digital certificates and key pairs;

· Selecting an appropriate certificate validity period to minimize transactional and reputation risk exposure- expiration provides an opportunity to evaluate the continuing adequacy of key lengths and encryption algorithms, which can be changed as needed before issuing a new certificate;

· Ensuring that the digital certificate is valid by such means as checking a certificate revocation list before accepting transactions accompanied by a certificate;

· Defining the circumstances for authorizing a certificate's revocation, such as the compromise of a user's private key or the closing of user accounts;

· Updating the database of revoked certificates frequently, ideally in real-time mode; · Employing stringent measures to protect the root key including limited physical access

to Certifying Authority (CA) facilities, tamper-resistant security modules, dual control over private keys and the process of signing certificates, as well as the storage of original and backup keys on computer that do not connect with outside networks;



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· Requiring regular independent audits to ensure controls are in place, public and private key lengths remain appropriate, cryptographic modules conform to industry standards, and procedures are followed to safeguard the CA system;

· Recording in a secure audit log all significant events performed by the CA system, including the use of the root key, where each entry is time/date stamped and signed;

· Regularly reviewing exception reports and system activity by the CA' s employees to detect malfunctions and unauthorized activities; and

· Ensuring the institution's certificates and authentication systems comply with widely accepted PKI standards to retain the flexibility to participate in ventures that require the acceptance of the financial institution's certificates by other CAs.

(b) Benefits of performing a technology risk assessment are given as follows: · To have a business driven process to identify, quantify, and manage risks while

detailing future suggestions for improvement in technical delivery; · To have a framework that governs technical choice and delivery processes with

cyclic checkpoints during the project lifecycle; · Interpretation and communication of potential risk impact and where appropriate,

risk reduction to a perceived acceptable level; and · Implementation of strict disciplines for active risk management during the project

lifecycle. The technology risk assessment needs to a mandatory requirement for all projects to ensure that proactive management of risks occurs and that no single point of failure are in advertently built into the overall architecture.

(c) Yes, to our opinion, a separate statement on Auditing Standard (SAS) No. 70 is useful for auditing a service organization especially with respect to examination of general controls. A SAS 70 audit or service auditor’s examination is widely recognized, because it represents that a service organization has been through an in-depth audit of their control activities, which generally include controls over Information Technology and related processes.

SAS 70 is the authoritative guidance that allows service organizations to disclose their control activities and processes to their customers and their customers’ auditors in a uniform reporting format. A SAS 70 examination signifies that a service organization has had its control objectives and control activities examined by an independent accounting and auditing firm. A formal report including the auditor’s opinion (Service Auditor’s Report) is issued to the service organization at the conclusion of SAS 70 examination.

SAS 70 provides guidance to enable an independent auditor (Service Auditor) to issue an opinion on a service organization’s description of controls through a Service Auditor’s Report. SAS 70 is not a predetermined set of control objectives or control activities that service organization must achieve.



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SAS 70 is generally applicable when an auditor (user auditor) is auditing the financial statements of an entity (user organization) that obtains services from another organization (service organization). Service organizations that provide such services could be application service providers, bank trust departments, claims processing centres, Internet data centres or other data processing service bureaus.

Question 3 (a) As an IS Auditor, discuss the various contents in brief to be included in a standard audit

report. (8 Marks) (b) What are the characteristics of Executive Information System? (4 Marks) (c) Discuss the various backup options considered by a security administrator when

arranging alternate processing facility. (4 Marks)

Answer (a) An Audit report includes the following sections: title page, table of contents, summary

(including recommendations), introduction, findings and appendices. These are discussed below: · Cover and Title Page: Audit reports should use a standard cover page, with a window

showing the title "Information System Audit" or “Data Audit”, the department's name and the report's date of issue. These items are repeated at the bottom of each page. The title page may also indicate the names of the audit team members.

· Table of contents: The table lists the sections and subsections with page numbers including summary and recommendations, introduction, findings and appendices.

· Summary/Executive Summary: The summary gives a quick overview of the salient features at the time of the audit in light of the main issues covered by the report. It should not exceed three pages, including recommendations.

· Introduction: It should include the following elements: v Context: This subsection briefly describes conditions in the audit entity during the

period under review, for instance, the entity's role, size and organization with regard to information system management, significant pressures on information system management during the period under review, events that need to be noted, organizational changes, IT disruptions, changes in roles and programs, results of internal audits or follow-up to our previous audits, if applicable.

v Purpose: This subsection is a short description of what functions and special programs were audited and the client's authorities.

v Scope: The scope lists the period under review, the issues covered in each function and program, the locations visited and the on-site dates.

v Methodology: This section briefly describes sampling, data collection techniques and the basis for auditor's options. It also identifies any



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weakness/es in the methodology to allow the client and auditee to make informed decisions as a result of the report.

· Findings: Findings constitute the main part of an audit report. They result from the examination of each audit issue in the context of established objectives and client's expectations. If the auditor is using any standard grading, the arrived value should also be stated.

· Opinion: If the audit assignment requires the auditor to express an audit opinion, the auditor shall do so in consonance to the requirement.

· Appendices: Appendices can be used when they are essential for understanding the report. They usually include comprehensive statistics, quotes from publications, documents, and references.

(b) Major characteristics of an Executive Information System (EIS) are given as follows: · EIS is a computer-based-information system that serves the information need of top

executives. · EIS enables users to extract summary data and model complex problems without

the need to learn query languages, statistical formulae or high computing skills. · EIS provides rapid access for timely information and direct access to the

management reports. · EIS is capable of accessing internal and external data both. · EIS provides extensive online analysis tools like trend analysis, market conditions etc. · EIS can easily be given a DSS support for decision making.

(c) Security administrators should consider the following backup options while arranging alternate processing facility: · Cold site: If an organization can tolerate some down time, cold site backup might

be appropriate. A cold site has all the facilities needed to install a mainframe system, raised floors, air conditioning, power, communication lines, and so on. An organization can establish its own cold site facility or enter into an agreement with another organization to provide a cold site facility.

· Hot site: If fast recovery is critical, an organization might need hot site backup. All hardware and operations facilities will be available at the host site. In some cases, software, data and supplies might also be stored there. A hot site is expensive to maintain. They are usually shared with other organizations that have hot site needs.

· Warm site: It provides an intermediate level of backup. It has all cold site facilities in addition with hardware that might be difficult to obtain or install. For example, a warm site might contain selected peripheral equipment plus a small mainframe with sufficient power to handle critical applications in the short run.



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· Reciprocal agreement: Two or more organizations might agree to provide backup facilities to each other in the event of one suffering a disaster. This backup option is relatively cheap, but each participant must maintain sufficient capacity to operate another's critical system.

Question 4 (a) Explain the common threats to the computerized environment of an organization. (8 Marks) (b) Describe the role of an IS auditor in the evaluation of physical access control. (4 Marks) (c) What are the tasks for which the company should be ready for post implementation

period of an ERP System? (4 Marks) Answer (a) The common threats to the computerized environment of an organization are given as

follows: (i) Power failure: Power failure can cause disruption of entire computing equipments

since computing equipments depend on power supply. (ii) Communication failure: Failure of communication lines result in inability to transfer

data which primarily travel over communication lines. Where the organization depends on public communication lines, e.g. for e-banking, communication failure present a significant threat that will have a direct impact on operations.

(iii) Disgruntled Employees: A disgruntled employee presents a threat since, with access to sensitive information of the organization, he may cause intentional harm to the information processing facilities or sabotage operations.

(iv) Errors: Errors which may result from technical reasons, negligence or otherwise can cause significant integrity issues. A wrong parameter setting at the firewall to ‘allow’ attachments instead of ‘deny’ may result in the entire organization network being compromised with virus attacks.

(v) Malicious code: Malicious codes such as viruses and worms which freely access the unprotected networks may affect organizational and business networks that use these unprotected networks.

(vi) Abuse of access privileges by employees: The security policy of the company authorizes employees based on their job responsibilities to access and execute select functions in critical applications.

(vii) Natural disasters: Natural disasters such as earthquakes, lighting, floods, tornado, tsunami, etc. can adversely affect the functioning of the Information System operations due to damage to Information System facilities.

(viii) Theft or destruction of computing resources: Since the computing equipments form the back-bone of information processing, any theft or destruction of the resource can result in compromising the competitive advantage of the organization.



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(ix) Downtime due to technology failure: Information System facilities may become unavailable due to technical glitches or equipment failure and hence the computing infrastructure may not be available for short or extended periods of time. However, the period for which the facilities are not available may vary in criticality depending on the nature of business and the critical business process that the technology supports.

(x) Fire, etc: Fire due to electric short circuit or due to riots, war or such other reasons can cause irreversible damage to the IS infrastructure.

(b) Role of an IS auditor in evaluation of Physical Access Controls is described below: (i) Risk assessment: The auditor must satisfy him/herself that the risk assessment

procedure adequately covers periodic and timely assessment of all assets, physical access threats, vulnerabilities of safeguards and exposure there from.

(ii) Controls assessment: The auditor based on the risk profile evaluates whether the physical access controls are in place and adequate to protect the IS assets against the risks.

(iii) Planning for review of physical access controls: It requires examination of relevant documentation such as the security policy and procedures, premises plans, building plans, inventory list and cabling diagrams.

(iv) Testing of controls: The auditor should review physical access controls to satisfy for their effectiveness. This involves: · Tour of organizational facilities including outsourced and offsite facilities; · Physical inventory of computing equipment and supporting infrastructure; · Interviewing personnel can also provide information on the awareness and

knowledge of procedures; · Examination of physical access logs and reports. Review of physical access

procedures including user registration and authorization etc.; and

· Observation of safeguards and physical access procedures. (c) Having evolved the processes while the configuration, construction and implementation

are in progress, the organization needs to ready itself for the post-implementation period. Some of the tasks that are to be performed are to: · develop the new job descriptions and organization structure to suit the post ERP

Scenario; · determine the skill gap between existing jobs and envisioned jobs; · assess training requirements, and create and implement a training plan; · develop and amend HR, financial and operational policies to suit the future ERP

environment; and



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· develop a plan for workforce logistics adjustment. Question 5 (a) An organization is audited for effective implementation of ISO 27001 – Information

Security Management Standard. What are the factors verified under (i) establishing management framework? (ii) Implementation? (iii) documentation? (8 Marks)

(b) Enumerate the characteristics of a Computer Based Information System. (4 Marks) (c) Describe the duties of certifying authorities under Section 30 of Information Technology

(Amended) Act 2008. (4 Marks)

Answer (a) ISO 27001-Information Security Management Standard: The requirements of

information security system as described by the standard are stated below. An organization must take a clear view on these issues before trying to implement an Information Security Management Systems (ISMS). General: Organization shall establish and maintain documented ISMS addressing assets to be protected, organizations approach to risk management, control objectives and controls, and degree of assurance required. Establishing Management Framework: This would include the following: · Defining information security policy; · Defining scope of ISMS including functional, asset, technical, and locational

boundaries; · Making appropriate risk assessment; · Identifying areas of risk to be managed and degree of assurance required; · Selecting appropriate controls; · Preparing Statement of Applicability, Implementation: Effectiveness of procedures to implement controls to be verified while reviewing security policy and technical compliance. Documentation: The documentation shall consist of evidence of actions undertaken under establishment of the following :

· Management control; · Management framework summary, security policy, control objective, and

implemented controls given in the Statement of Applicability; · Procedure adopted to implement control under Implementation clause;



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· ISMS management procedure; · Document Control: The issues focused under this clause would be: § Ready availability, § Periodic review, § Maintain version control, § Withdrawal when obsolete, and § Preservation for legal purpose.

· Records: The issues involved in record maintenance are as follows: § Maintain evidence compliance to the standard, § Procedure for identifying, maintaining, retaining, and disposing of such

evidence, § Records to be legible, identifiable and traceable to activety involved, and § Storage to augment retrieval, and protection against damage.

(b) Major characteristics of a Computer Based Information System are as follows: 1. All systems work for predetermined objectives and the system is designed and

developed, accordingly. 2. In general, a system has a number of interrelated and interdependent subsystems

or components. No subsystem can function in isolation; it depends on other subsystems for its inputs.

3. If one subsystem or component of a system fails, in most of the cases, the whole system does not work. However, it depends on ‘how the subsystems are interrelated’.

4. The way a subsystem works with another subsystem is called interaction. Different subsystems interact with each other to achieve the goal of the system.

5 The work done by individual subsystem is integrated to achieve the central goal of the system. The goal of the individual subsystem is of lower priority than the goal of the entire system.

(c) Duties of Certifying Authorities-Section 30 of ITAA 2008 This section provides that every Certifying Authority shall follow certain procedures with respect of Digital Signatures as given below. Every Certifying authority shall- a. make use of hardware, software and procedures that are secure from intrusion and

misuse; b. provide a reasonable level of reliability in its services which are reasonably suited to

the performance of intended functions;



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c. adhere to security procedures to ensure that the secrecy and privacy of the Electronic Signature are assured (Amended vide ITAA 2008) . (ca) be the repository of all Electronic Signature Certificates issued under this Act

(Inserted vide ITAA 2008) (cb) publish information regarding its practices, Electronic Signature Certificates

and current status of such certificates; and (Inserted vide ITAA 2008) d. Observe such other standards as may be specified by regulations.

Question 6 (a) Discus in brief the various functional areas to be studied by a system analyst for a

detailed investigation of the present system. (8 Marks) (b) As an IS Auditor, explain the types of information collected for auditing by using System

Control Audit Review File (SCARF) technique. (4 Marks) (c) What are the audit tools and techniques used by an IS Auditor to ensure that disaster

recovery plan is in order? Briefly explain them. (4 Marks)

Answer (a) Detailed investigation of the present system involves collecting, organizing and

evaluating facts about the system and the environment in which it operates. Survey of existing methods, procedures, data flow, outputs, files, input and internal controls should be done intensively to fully understand the present system and its related problems. The following areas should be studied in depth by a System Analyst for a detailed investigation of the present system: (i) Review historical aspects: A brief history of the organization is a logical starting point

for an analysis of the present system. The historical facts should identify the major turning points and milestones that have influenced its growth. A review of annual reports and organization chart can identify the growth of management levels as well as the development of various functional areas and departments. The system analyst should investigate what system changes have occurred in the past including operations that have been successful or unsuccessful with computer equipments and techniques.

(ii) Analyze inputs: A detailed analysis of present inputs is important since they are basic to the manipulation of data. Source documents are used to capture the originating data for any type of system. The system analyst should be aware of the various sources from where the data are initially captured, keeping in view the fact that outputs for one area may serve as an input for another area. The system analyst must understand the nature of each form, what is contained in it, who prepared it, from where the form is initiated, where it is completed, the distribution of the form and other similar considerations. If the analyst investigates these questions thoroughly, he will be able to determine how these inputs fit into the framework of the present system.



37

(iii) Review data files maintained: The analyst should investigate the data files maintained by each department, noting their number and size, where they are located, who uses them and the number of times per given time interval these are used. Information on common data files and their size will be an important factor, which will influence the new information system. This information may be contained in the systems and procedures manuals. The system analyst should also review all on-line and off-line files which are maintained in the organization as it will reveal information about data that are not contained in any outputs. The related cost of retrieving and processing the data is another important factor that should be considered by the systems analyst.

(iv) Review methods, procedures and data communications: Methods and procedures transform input data into useful output. A method is defined as a way of doing something; a procedure is a series of logical steps by which a job is accomplished. A procedure review is an intensive survey of the methods by which each job is accomplished, the equipment utilized and the actual location of the operations. Its basic objective is to eliminate unnecessary tasks or to perceive improvement opportunities in the present information system. The system analyst must review the types of data communication equipments including data interface, data links, modems, dial up and leased lines and multiplexers, The system analyst must also understand how the data-communications network is used in the present system so as to identify the need to revamp the network when the new system is installed.

(v) Analyze outputs: The outputs or reports should be scrutinized carefully by the system analysts in order to determine how well they will meet the organization's needs. The analysts must understand what information is needed and why, who needs it and when and where it is needed. Additional questions concerning the sequence of the data, how often the form reporting is used, how long it is kept on file, etc. must be investigated.

(vi) Review internal controls: A detailed investigation of the present information system is not complete until internal control is reviewed. Locating the control points helps the analyst to visualize the essential parts and framework of a system. An examination of the present system of internal controls may indicate weaknesses that should be removed in the new system. The adoption of advanced methods, procedures and equipments might allow much greater control over the data.

(vii) Model the existing physical system and logical system: As the logic of inputs, methods, procedures, data files, data communications, reports, internal controls and other important items are reviewed and analyzed in a top down manner; the process must be properly documented. The flow charting and diagramming of present information not only organizes the facts, but also helps disclose gaps and duplication in the data gathered. It allows a thorough comprehension of the numerous details and related problems in the present operation.



38

(viii) Undertake overall analysis of the present system: The final phase of the detailed investigation includes the analysis of the present work volume; the current personnel requirements; the present benefits and costs and each of these must be investigated thoroughly.

(b) An IS Auditor might use SCARF to collect the following types of information: · Application system errors: SCARF audit routines provide an independent check on

the quality of system processing, whether there are any design and programming errors as well as errors that could creep into the system when it is modified and maintained.

· Policy and procedural variances: Organizations have to adhere to the policies, procedures and standards of the organization and the industry to which they belong. SCARF audit routines can be used to check when variations from these policies, procedures and standards have occurred.

· System exception: SCARF can be used to monitor different types of application system exceptions.

· Statistical sample: Some embedded audit routines might be statistical sampling routines, SCARF provides a convenient way of collecting all the sample information together on one file and use analytical review tools thereon.

· Snapshots and extended records: Snapshots and extended records can be written into the SCARF file and printed when required.

· Profiling data: Auditor can use embedded audit routines to collect data to build profiles of system users. Deviations from these profiles indicate that there may be some errors or irregularities.

· Performance measurement: Auditors can use embedded routines to collect data that is useful for measuring or improving the performance of an application system.

(c) The audit tools and techniques used by an IS Auditor to ensure that disaster recovery plan is in order, are given as follows: (i) Automated Tools: Automated tools make it possible to review large computer

systems for a variety of flaws in a short time period. They can be used to find threats and vulnerabilities such as weak access controls, weak passwords, lack of integrity of the system software, etc.

(ii) Internal Control Auditing: This includes inquiry, observation and testing. The process can detect illegal acts, errors, irregularities or lack of compliance of laws and regulations.

(iii) Disaster and Security Checklists: A checklist can be used against which the system can be audited. The checklist should be based upon disaster recovery policies and practices, which form the baseline. Checklists can also be used to verify changes to the system from contingency point of view.

(iv) Penetration Testing: Penetration testing can be used to locate vulnerabilities.



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Question 7 Write Short notes on any four of the following: (a) Business applications of Expert systems for Management Support systems. (b) Firewalls. (c) Delphi technique for risk evaluation. (d) Capability Maturity Model. (e) Authentication of electronic records in Information Technology (Amended) Act 2008. (4 х 4=16 Marks) Answer (a) Business applications of Expert Systems for Management Support Systems are given as

follows: (i) Accounting and Finance: It provides tax advice and assistance, helping with credit

authorization decisions, selecting forecasting models, providing investment advice. (ii) Marketing: It provides establishing sales quotas, responding to customer inquiries,

referring problems to telemarketing centers, assisting with marketing timing decisions, determining discount policies. .

(iii) Manufacturing: It helps in determining whether a process is running correctly, analyzing quality and providing corrective measures, maintaining facilities, scheduling job-shop tasks, selecting transportation routes, assisting with product design and faculty layouts.

(iv) Personnel: It is useful in assessing applicant qualifications, giving employees assisting at filling out forms.

(v) General Business: It helps in assisting with project proposals, recommending acquisition strategies, educating trainees, evaluating performance.

(b) Firewalls A firewall is a collection of components (Computers, routers and software) that mediate access between different security domains. All traffic between the security domains must pass through the firewall, regardless of the direction of the flow. Since the firewall serves as an access control point for traffic between security domains, they are ideally situated to inspect and block traffic and co-ordinate activities with network Intrusion Detection Systems (IDSs).

There are four primary firewall types from which to choose: packet filtering, stateful inspection, proxy servers, and application-level firewalls. Any product may have characterization of one or more firewall types. The selection of firewall type is dependent on many types of characteristics of the security zone, such as the amount of traffic, the sensitivity of the systems and data, and applications. Additionally, consideration should be given to the ease of firewall administration, degree of firewall monitoring support through



40

automated logging and log analysis, and the capability to provide alerts for abnormal activity. Typically, firewalls block or allow traffic based on rules configured by the administrator. Rule sets can be static or dynamic. A static rule set is an unchanging statement to be applied to packet header, such as blocking all incoming traffic with certain source addresses. A dynamic rule set often is the result of coordinating a firewall and an IDS. For example, an IDS that alerts on malicious activity may send a message to the firewall to block the incoming IP address. The firewall, after ensuring the IP is not on a ‘white list’, creates a rule to block the IP. After a specified period of time, the rule expires and traffic is once again allowed from that IP.

Firewalls are subject to failure. When firewalls fail, they typically should fail closed, blocking all traffic, rather than failing open and allowing all traffic to pass.

(c) Delphi Technique for Risk Evaluation The Delphi Technique was first used by the Rand Corporation for obtaining a consensus opinion. Here, a panel of experts is appointed. Each expert gives his/her opinion in a written and independent manner. They enlist the estimate of the cost, benefits and the reasons why a particular system should be chosen, the risks and the exposures of the system. These estimates are then compiled together. The estimates within a pre-decided acceptable range are taken. The process may be repeated four times for revising the estimates falling beyond the range. Then a curve is drawn taking all the estimates as points on the graph. The median is drawn and this is the consensus opinion.

(d) Capability Maturity Model (CMM) The CMM presents sets of recommended practices in a number of key process areas

that have been shown to enhance software process capability. The CMM is based on knowledge acquired from software process assessments and extensive feedback from both industry and government.

The capability maturity model for software provides software organizations with guidance on how to gain control of their processes for developing and maintaining software and how to evolve toward a culture of software engineering and management excellence. The CMM was designed to guide software organizations in selecting process improvement strategies by determining current process maturity and identifying the few issues most critical to software quality and process improvement. By focusing on a limited set of activities and working aggressively to achieve them, an organization can steadily improve its organization-wide software process to enable continuous and lasting gains in software process capability.

(e) Authentication of Electronic Records: [Section 3] of ITAA 2008 Section 3 of ITAA 2008 provides the conditions subject to which an electronic record may be authenticated by means of affixing digital signature, which is given below: (1) Subject to the provisions of this section any subscriber may authenticate an

electronic record by affixing his Digital Signature.



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(2) The authentication of the electronic record shall be effected by the use of asymmetric crypto system and hash function which envelop and transform the initial electronic record into another electronic record.

Explanation - For the purposes of this subsection, "Hash function" means an algorithm mapping or

translation of one sequence of bits into another, generally smaller set known as "Hash Result" such that an electronic record yields the same hash result every time the algorithm is executed with the same electronic record as its input making it computationally infeasible (a) to derive or reconstruct the original electronic record from the hash result

produced by the algorithm; (b) that two electronic records can produce the same hash result using the

algorithm. (3) Any person by the use of a public key of the subscriber can verify the electronic record. (4) The private key and the public key are unique to the subscriber and constitute a

functioning key pair.


PAPER – 7 : DIRECT TAX LAWS Working notes should form part of the answer.

Question No.1 is compulsory. Attempt any five questions from the remaining six questions.

Question 1 (A) PQR Limited has two units - one engaged in manufacture of computer hardware and the

other involved in developing software. As a restructuring drive, the company has decided to sell its software unit as a going concern by way of slump sale for Rs.385 lakh to a new company called S Limited, in which it holds 74% equity shares. The balance sheet of PQR limited as on 31st March 2011, being the date on which software unit has been transferred, is given hereunder –

Balance Sheet as on 31.3.2011

Liabilities Rs. in lakh Assets Rs. in lakh Paid up Share Capital 300 Fixed Assets General Reserve 150 Hardware unit 170 Share Premium 50 Software unit 200 Revaluation Reserve 120 Debtors Current Liabilities Hardware unit 140 Hardware unit 40 Software unit 110 Software unit 90 Inventories Hardware unit 95 Software unit 35 750 750

Following additional information are furnished by the management: (i) The Software unit is in existence since May, 2007. (ii) Fixed assets of software unit includes land which was purchased at Rs.40

lakh in the year 2004 and revalued at Rs.60 lakh as on March 31, 2011. (iii) Fixed assets of software unit mirrored at Rs.140 lakh (Rs.200 lakh minus land value

Rs.60 lakh) is written down value of depreciable assets as per books of account. However, the written down value of these assets under section 43(6) of the Income-tax Act is Rs.90 lakh.

The Suggested Answers for Paper 7: - Direct Tax Laws are based on the provisions applicable for A.Y. 2011-12, which is the assessment year relevant for May, 2011 examination.


PAPER – 7 : DIRECT TAX LAWS

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(a) Ascertain the tax liability, which would arise from slump sale to PQR Limited. (b) What would be your advice as a tax-consultant to make the restructuring plan of the

company more tax-savvy, without changing the amount of sale consideration? (10 Marks)

(B) How shall the assets retained pursuant to an order passed as per section 37A(5A) of the Wealth-tax Act, 1957 be dealt with? (3 Marks)

(C) Can summons enforcing attendance and to take evidence on oath be issued by a Valuation Officer to the seller of the building for which a reference under section 16A has been made by the Wealth-tax Officer? (3 Marks)

(D) Mr. ‘W’ gifted a gold chain worth Rs.1,00,000 to the adopted minor child of his son. On 31st March, 2011, the net wealth of Mr. ‘W’ is worth Rs.50 lakh whereas the net wealth of W’s wife is Rs.60 lakh. Besides, the net wealth of W’s son is worth Rs.30 lakh while the net wealth of his daughter-in-law is worth Rs.40 lakh. State with reason, in whose net wealth the value of gifted chain will be included. Will it make any change in your answer if the marriage of the parents of adopted minor child does not subsist and the child is maintained by his father? (4 Marks)

Answer (A) (a) As per section 50B, any profits and gains arising from the slump sale effected in the

previous year shall be chargeable to income-tax as capital gains arising from the transfer of capital assets and shall be deemed to be the income of the previous year in which the transfer took place. If the assessee owned and held the undertaking transferred under slump sale for more than 36 months before slump sale, the capital gain shall be deemed to be long-term capital gain. Indexation benefit is not available in case of slump sale as per section 50B(2). Ascertainment of tax liability of PQR Limited from slump sale of software unit

Particulars (Rs. in

lakh) Sale consideration for slump sale of Software Unit 385 Less:Cost of acquisition being the net worth of Software Unit 185 Long term capital gains arising on slump sale 200 (The capital gains is long-term as the Software Unit is held for more than 36 months)

Tax liability on LTCG Under section 112 @ 20% on Rs. 200 lakhs 40.00



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Add: Surcharge 7½% 3.00 43.00 Add: Education cess @ 2% and SHEC @ 1% i.e., totalling 3% 1.29 44.29 Working Note (Rs.

in lakh)

Computation of net worth of Software Unit

(1) Book value of non-depreciable assets (i) Land (Revaluation not to be considered) 40 (ii) Debtors 110 (iii) Inventories 35 (2) Written down value of depreciable assets under section 43(6) (Note 1) 90 Aggregate value of total assets 275 Less:Current liabilities of software unit _90 Net worth of software unit 185

Note 1: For computing net worth, the aggregate value of total assets in the case of depreciable assets shall be the written down value of the block of assets as per section 43(6).

(b) Tax-advice (i) Transfer of any capital asset by a holding company to its 100% Indian

subsidiary company is exempt from capital gains under section 47(iv). Hence, PQR Limited should try to acquire the remaining 26% equity shares in S Limited then make the slump sale in the above said manner, in which case the slump sale shall be exempt from tax. For this exemption, PQR Limited will have to keep such 100% holding in S Limited for a period of 8 years from the date of slump sale, otherwise the amount exempt would be deemed to be income chargeable under the head “Capital Gains” of the previous year in which such transfer took place.

(ii) Alternatively, if acquisition of 26% share is not feasible, PQR Limited may think about demerger plan of Software Unit to get benefit of section 47(vib) of the Income-tax Act, 1961.

(B) The assets retained pursuant to an order passed under section 37A(5A) of Wealth-tax Act, 1957 may be dealt with in the manner as specified under section 37C as under: - (i) the amount of the existing liability and the amount of liability determined on

completion of the regular assessment or reassessment including the amount of any



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penalty or interest in respect of which the assessee is in default or is deemed to be in default may be recovered out of such assets.

(ii) where the assets consist solely of money or partly of money and partly of other assets, the money may be applied in discharge of such liabilities and the assessee shall be treated as discharged to the same extent.

(iii) assets other than money may also be applied for discharge of such liabilities as remains undischarged. The Assessing Officer may recover the amount of such liabilities by sale of such assets effected in the manner laid down in Third Schedule to the Income-tax Act, 1961 as made applicable to the Wealth-tax Act, 1957 by section 32.

(C) Section 38A(1) empowers the Valuation Officer to enter any land, building or other place belonging to or occupied by any person in connection with whose assessment a reference has been made under section 16A or inspect any asset in respect of which a reference under that section has been made and require any person in charge of or in occupation or possession of such land, building to afford him necessary facility to survey or inspect the building or estimate its value or inspect any books of account etc. which may be relevant for valuation of such building or gather other particulars relating to such building. If any person who is required to afford any facility to the Valuation Officer, either refuses or evades to afford such facility, the Valuation Officer, by virtue of section 38A(2), is empowered to invoke powers under section 37(1) and issue summons enforcing the attendance of any person and examining him on oath.

(D) As per section 4(1)(a)(ii), the assets held by a minor child (including step child/adopted child, not being a married daughter) will be included in the net wealth of that parent whose net wealth [excluding the assets of minor child so includible under section 4(1)] is greater. In the given problem, the value of gold chain of adopted minor grandson of W, which was transferred to him by W, shall be included in the net wealth of the mother of the adopted minor child, because the net wealth of the mother of the minor child exceeds that of the father of the minor child. Where, however, the marriage of parents does not subsist, the assets of the minor child shall be included in the net wealth of that parent who maintains the minor child during the previous year ending on the valuation date. If the marriage of the parents of the adopted minor child does not subsist and the child is maintained by his father, then it will be included in the net wealth of his father.

Question 2 (A) The procedure relating to the recovery of tax due or the arrears of taxes from a non-

resident is different than the resident assessee. Comment and state how such recovery is to be made along with its limitation. (6 Marks)



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(B) Explain in the context of provisions of the Act: (i) The underlying idea behind DTAA. (ii) Rate of tax in other country. (4 Marks)

(C) “Any transfer of a capital asset or intangible asset by a private company or unlisted public company to a LLP or any transfer of share or shares held in a company by a shareholder on conversion of a company into a LLP in accordance with section 56 and section 57 of the Limited Liability Partnership Act, 2008, shall not be regarded as a transfer for the purposes of levy of capital gains tax under section 45 subject to fulfillment of certain conditions”. Explain in the context of the provisions contained in the Act. (6 Marks)

Answer (A) The provisions for recovery of tax in respect of non-residents are contained in section

173. According to this section, the tax chargeable on the income, which is deemed to accrue or arise in India under section 9(1)(i), in the name of the non-resident or his agent who is liable as a representative assessee, maybe recovered by deduction of tax at source under any of the provisions of Chapter XVII-B. Any arrears of tax may be recovered also in accordance with the provisions of the Income-tax Act, 1961. However, the limitation contained in section 173 is that such recovery can be made only from any assets of the non-resident which are within India or which may at any time come within India. Note The provisions for recovery of tax in respect of non-residents and the limitation thereto required for in the question can be answered on the basis of the provisions of section 173. However, students may note that in a case where the Central Government has entered into an agreement for recovery of tax with the Government of the country where the non-resident resides, the provisions of section 228A provide for an exception to the limitation contained in section 173. Under section 90A(1), the Central Government may enter into an agreement with the Government of any country outside India or specified territory outside India for, inter alia, recovery of income-tax under the Income-tax Act, 1961 and under the corresponding law in force in that country or specified territory. Section 228A provides for the procedure of recovery of tax in pursuance of an agreement entered into by the Central Government with the Government of any country outside India. Sub-section (2) thereof provides that where an assessee is in default or is deemed to be in default in making a payment of tax, the Tax Recovery Officer may, if the assessee has property in a country outside India, forward to the Board a certificate drawn up by him under section 222 and the Board may take such action thereon as it may deem appropriate having regard to the terms of the agreement with such country.



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(B) (i) The underlying idea behind Double Taxation Avoidance Agreement entered between two countries is to promote mutual economic relations by relieving the tax payers from the burden of paying tax twice on the same income in two different countries.

(ii) Rate of tax in the other country means income tax and super tax actually paid in that country in accordance with the corresponding laws in force in that country after deduction of all relief due, but before deduction of any relief due in the said country on account of double taxation, divided by the whole amount of income assessed in that country.

(C) Any transfer of a capital asset or intangible asset by a private company or unlisted public company to a LLP or any transfer of a share or shares held in a company by a shareholder on conversion of a company into a LLP shall not be regarded as a transfer for a purpose of levy of capital gains tax under section 45 on fulfillment of the following conditions:- (1) the total sales, turnover or gross receipts in business of the company should not

exceed Rs.60 lakh in any of the three preceding previous years; (2) all the shareholders of the company become partners of the LLP and their capital

contribution and profit sharing ratio in the LLP are also in the same proportion as their shareholding in the company on the date of conversion;

(3) no consideration other than share in profit and capital contribution in the LLP arises to the shareholders of the company;

(4) the erstwhile shareholders of the company continue to be entitled to receive at least 50% of the profits of the LLP for a period of 5 years from the date of conversion;

(5) all assets and liabilities of the company immediately before the conversion become the assets and liabilities of the LLP; and

(6) no amount is paid, either directly or indirectly, to any partner out of the accumulated profit of the company for a period of 3 years from the date of conversion.

Question 3 (Answer any four out of five) (A) Mr. Ramanand, after putting 25 years of service, opted for voluntary retirement and under

approved scheme received an amount of Rs.20 lakhs as VRS compensation on 01.01.2011. He was advised by his tax consultant to claim exemption to the extent as specified in section 10(10C) and also the relief under section 89. He, in order to have an expert opinion, consults you and asks whether such a treatment of VRS compensation is permissible under the Act.

(B) “Save Wild Life” an institution having its main object as ‘preservation of wildlife’, used the entire income derived from an activity in the nature of trade for its main object during the previous year ended on 31.03.2011. The institution seeks your opinion to know whether such utilization of its income be treated for “charitable purpose”? Would your



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answer be different, if the main object of the institution is “advancement of object of general public utility”?

(C) Which are the conditions to be satisfied by an electoral trust for claiming the benefit of exemption of its income? Is this benefit available in respect of all the income earned by an electoral trust?

(D) Mr. Divyam avails the benefit of LTC and went by air (economy class) on a holiday in India on 25.01.2011 along with his wife and three children consisting of son aged 4 years and twin daughters of 1 year age. Total cost of tickets reimbursed by his employer was Rs.90,000 (Rs.60,000 for 2 adults and Rs.30,000 for the three children). State with reasons the amount which can be claimed by Mr. Divyam out of the reimbursement as not subject to tax. Will your answer be different where among his three children the twins were of 4 years of age and the age of the son was of 1 year ?

(E) Mr. M is working with MNO Limited for the last 10 years. He was granted an option on 1.7.2008 by the company to purchase 800 equity shares at a price of Rs.250 per share. The period during which the option can be exercised to purchase 800 shares at a pre-determined price of Rs.250 per share commencing on 1.7.2008 and ending on 31.3.2011. Mr. M exercised the option on 15.3.2010 to purchase 500 shares. Fair market value on the said date was Rs.6490 on the Bombay Stock Exchange and Rs.6500 on the National Stock Exchange. The NSE has recorded the higher volume of trading in that share. The company has allotted him 500 shares on 24th April, 2010. The fair market value on the date of allotment was Rs.7100 per share on NSE and Rs.7110 on the BSE, that has recorded the higher volume of trading in that share. The option was granted for making available rights in the nature of intellectual property rights. Determine the taxability of perquisite. Does it make any difference if the option was granted for providing technical know-how? (4 × 4 = 16 Marks)

Answer (A) Where any relief was allowed under section 89 for any assessment year in respect of any

amount received or receivable on voluntary retirement, no exemption under section 10(10C) shall be allowed in respect of the said sum in that assessment year or any other assessment year. Similarly, relief under section 89 cannot be claimed if benefit of exemption has been claimed under section 10(10C). Mr. Ramanand can, therefore, opt to claim exemption of Rs.5 lakh under section 10(10C) or relief under section 89(1) in respect of compensation received on voluntary retirement, but not both. Accordingly, the advice given by his tax consultant is not correct.

(B) Section 2(15) defines “charitable purpose” to include relief of the poor, education, medical relief, preservation of environment (including watersheds, forests and wildlife) and preservation of monuments or places or objects of artistic or historic interest and the



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advancement of any other object of general public utility. However, the “advancement of any other object of general public utility” shall not be a charitable purpose, if the institution is carrying on any activity in the nature of trade, commerce or business, or any activity of rendering any service in relation to any trade, commerce or business, for a cess or fee or any other consideration, irrespective of the nature of use or application, or retention, of the income derived from such activity. Therefore, preservation of wildlife is included in the definition of “charitable purpose” under section 2(15). Further, an institution having the preservation of wildlife as its main object would not be subject to the restrictions which are applicable to the “advancement of any other object of general public utility”. Such institution would continue to retain its “charitable” status, even if it derives income from an activity in the nature of trade. However, if an institution having its main object as “advancement of any other object of general public utility”, derives income from an activity in the nature of trade during a financial year, it would lose its “charitable” status for that year, even if it applies such income for its main objects. It may be noted that if the receipts from such activity does not exceed Rs.10 lakh in that year, then, the institution would not lose its “charitable” status.

(C) An approved electoral trust is eligible for exemption under section 13B in respect of voluntary contributions received by it. The voluntary contributions received by such electoral trust shall be treated as its income under section 2(24), but shall be exempt under section 13B, if the trust distributes to a registered political party during the year, 95% of the aggregate donations received by it during the year along with the surplus, if any, brought forward from any earlier previous year. Another condition for availing the benefit under this section is that the electoral trust should function in accordance with the rules made by the Central Government. The benefit under section 13B is available only in respect of voluntary contribution received by an electoral trust and not in respect of its other income

(D) Mr. Divyam can avail exemption as per section 10(5) on the entire amount of Rs. 90,000 reimbursed by the employer for the LTC as the same was availed for himself, his wife and the three children in India and the journey was also undertaken by economy class airfare. The restriction imposed for two children is not applicable to the multiple births which take place after the first child. However, if the age of the twin daughters is more than the age of the son, the restriction imposed for two children under the section would be applicable and therefore, Mr. Divyam cannot avail exemption in this case for all the three children. The exemption of LTC can be availed in respect of only two children. Therefore, the fare of Rs.10,000 (i.e., Rs. 30,000 × 1/3) reimbursed for one child will form part of taxable salary and balance amount of LTC of Rs. 80,000 (90,000 - 10,000) will be exempt under section 10(5).



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(E) The perquisite of sweat equity shares shall be taxable in the previous year 2010-11 (assessment year 2011-12), being the previous year of allotment of such shares. The value of sweat equity shares shall be the fair market value of such shares on the date on which the option is exercised by the assessee, as reduced by any amount actually paid by, or recovered from, the assessee in respect of such shares. As per Rule 3(8) of the Income-tax Rules, 1962, the fair market value of a share on the date of exercising the option shall be the price of the share on the recognized stock exchange which records the highest volume of trading in such shares. Hence, the value of taxable perquisite for sweat equity shares

= FMV on the date of exercising the option on the NSE (since it recorded higher volume that BSE)

(-) Amount recovered from the employee

= 500 × Rs.6500 (-) 500 × Rs.250 = Rs. 32,50,000 (-) Rs. 1,25,000 = Rs.31,25,000

As per section 17(2)(vi), “sweat equity shares” means equity shares issued by a company to its employees or directors at a discount or for consideration other than cash for providing technical knowhow or making available rights in the nature of intellectual property rights or value additions, by whatever name called. Therefore, this provision is equally applicable whether the sweat equity shares option was granted for making available rights in the nature of intellectual property rights or for providing technical know-how.

Question 4 (A) Examine the following statements in the context of the provisions contained in the

various Chapters of the Act: (i) “The provisions of section 115JB are not applicable in case of foreign

companies”. (ii) “The provisions of dividend distribution tax are also applicable to an undertaking or

enterprise engaged in developing, operating and maintaining a Special Economic Zone (SEZ)”.

(iii) “A penalty for concealment can be imposed even in the case where the claim of the assessee is debatable or arguable”. (3 × 3 = 9 Marks)

(B) Can the brought forward losses and unabsorbed depreciation be set off against the profit determined under section 44B? (4 Marks)

(C) Mr. Balram is a non-resident. The appeal pertaining to the assessment year 2010-11 is pending before the Income-tax Appellate Tribunal, the issue involved being computation of export profit and tax thereon. The same issue persists for the assessment year 2011-



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12 as well. Mr. Balram’s brother Mr. Krishna has obtained an advance ruling under Chapter XIX - B of Income-tax Act, 1961 from the Authority for Advance Ruling on an identical issue. Mr. Balram proposes to use the said ruling for his assessment pertaining to the assessment year 2011-12. Can he do so? (3 Marks)

Answer (A) (i) “The provisions of section 115JB are not applicable in case of foreign companies” -

The statement is not correct since there is no provision in section 115JB restricting its applicability to only domestic companies and therefore, section 115JB is applicable to both domestic and foreign companies. The provisions of section 115JB are applicable in the case of an assessee, being a company, where 18% of its book profit exceeds the tax payable on the total income computed under the provisions of the Act. Therefore, the provisions of section 115JB would be attracted in the case of a domestic and foreign company, if the tax payable on its total income is less than 18% of its book profit. However, section 115JB will not be applicable to a foreign company which has no presence or permanent establishment in India - Timken Company., In re. (2010) 326 ITR 193 / 193 Taxman 20 (AAR- New Delhi).

(ii) The statement is not correct. As per section 115-O(6), no tax on distributed profits shall be chargeable in respect of the total income of an undertaking or enterprise engaged in developing or developing and operating or developing, operating and maintaining a Special Economic Zone for any assessment year on any amount declared, distributed or paid by such Developer or enterprise, by way of dividends (whether interim or otherwise) on or after 1.4.2005 out of its current income either in the hands of the Developer or enterprise or the person receiving such dividend. Note - The Finance Act, 2011 has introduced a sunset clause to remove the above exemption in respect of dividend distribution tax for dividends declared, distributed or paid on or after 1st June, 2011. However, the amendments made by the Finance Act, 2011 are not applicable for May 2011 examination. Therefore, the question has been answered on the basis of the position prior to amendment by the Finance Act, 2011.

(iii) The Rajasthan High Court in the case of CIT vs. Harshvardhan Chemicals & Minerals Ltd. (2003) 259 ITR 212 has held that if the claim of a deduction or an expenditure is either debatable or controversial or even arguable, in such cases, it cannot be said that the assessee has concealed any income or has furnished inaccurate particulars of its income with the intention of evasion of tax and hence, penalty cannot be levied under section 271(1)(c). Note – This question may also be answered on the basis of the Apex Court ruling in CIT v. Reliance Petro Products Pvt. Ltd. (2010) 322 ITR 158, where it was held that



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a mere making of a claim, which is not sustainable in law, would not, by itself, tantamount to furnishing inaccurate particulars and hence, penalty provisions under section 271(1)(c) would not be attracted. Therefore, since an incorrect claim itself will not attract penal provisions under section 271(1)(c), there is no question of imposition of penalty in respect of a claim which is debatable or arguable.

(B) The provisions of section 44B, introduced w.e.f. 1.4.1976, requiring computation of income of a non-resident from shipping business on a presumptive basis are mandatory and not optional. Therefore, there is no possibility of having a business loss where income is computed on presumptive basis under section 44B. In case the brought forward losses mentioned in the question are taken to be business losses, there is an inbuilt presumption that such losses and depreciation relate to another business of the non-resident and not the shipping business. In such a case, both business loss and unabsorbed depreciation of another business can be set-off against the profits determined under section 44B in respect of shipping business. Even though the provisions of section 44B are applicable “notwithstanding anything to the contrary contained in sections 28 to 43A”, it is possible to take a view since the non obstante clause is relevant only for computation of income from shipping business under section 44B, it does not bar set-off of unabsorbed depreciation relating to some other business.

(C) As per section 245S(1), the advance ruling pronounced under section 245R by the Authority for Advance Ruling shall be binding only on the applicant who had sought it and in respect of the specific transaction in relation to which advance ruling was sought. In view of the above provision, Mr. Balram cannot use the advance ruling, obtained on an identical issue by his brother, for his assessment.

Question 5 (A) Examine the taxability or allowability or otherwise in the following cases while computing

income under the head “Profits and gains from business or profession” to be declared in the return of income for the financial year ended on 31.3.2011: (i) Amount received towards power subsidy with a stipulation that the same is to be

adjusted in the electricity bills. (ii) Donations received by a person in the course of carrying on vocation from his

followers. (iii) Profit derived by an assessee engaged in carrying the business as dealers in

shares on exchange of the shares held as stock in trade of one Company with the shares of other Company.

(iv) Interest received by a contractor on the amount of compensation awarded by an arbitrator resolving the dispute relating to the work done.



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(v) The amount of margin money forfeited by a bank on the failure of its constituents of not taking the delivery of the shares purchased by such bank on their behalf.

(vi) Depreciation on the “decoders” given on loan to the cable operators but owned by the assessee who is engaged in the business of distributing satellite channels.

(2 × 6 = 12 Marks) (B) X Co. Ltd. was amalgamated with Y Co. Ltd. on 30.04.2010. X Co. Ltd. was engaged in

real estate and whereas Y Co. Ltd. was engaged in manufacture of textile articles. Y Co. Ltd. after amalgamation altered its objects clause of Memorandum of Association, to carry on real estate business.

The stock in trade of X Co. Ltd. (being vacant lands) was taken over at Rs.110 lakhs by Y Co. Ltd. as against their original cost of Rs.125 lakhs to X Co. Ltd. for the purpose of amalgamation. Y Co. Ltd incurred Rs.25 lakhs towards development of those lands obtained on amalgamation. It sold the entire land for Rs.160 lakhs during the year ended 31.03.2011.

Determine the tax implication of the transaction in the hands of Y Co. Ltd. for the assessment year 2011-12. (4 Marks)

Answer (A) (i) Power subsidy received by the assessee is revenue in nature as it goes towards

reduction of the electricity bills. Therefore, the subsidy is taxable as business income. It was so held by the Supreme Court in CIT vs. Rajaram Maize Products (2001) 251 ITR 427.

(ii) Donations received by a person from his followers in the course of carrying on vocation for the furtherance of the objects of his vocation were receipts arising from the carrying on of his vocation and not casual or non-recurring receipts. The Supreme Court, in Dr. K. George vs. CIT (1985) 156 ITR 412, held that such donations are taxable as a business income as there is a direct nexus between the vocation carried on by the assessee and the receipt of such donation.

(iii) The difference between the cost/book value of shares of the first company and the market value of shares of the new company on the date of such exchange has to be treated as profit derived by the dealer in shares (on exchange of shares held as stock-in-trade of first company with the shares of the new company) in the normal course of his business, and hence such profit is taxable as business income. It was so held by the Supreme Court in Orient Trading Co. Ltd. vs. CIT (1997) 224 ITR 371.

(iv) Interest received by a contractor on the amount of compensation awarded by an arbitrator resolving the dispute relating to the work done is in the nature of receipt relating to the business of the contractor and shall be, thus, assessable as business income. This view was upheld by the Supreme Court, in CIT vs. B. N. Agarwal and Co. (2003) 259 ITR 754.



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(v) Since the bank is purchasing shares on behalf of the constituents, the forfeiture of margin money by the bank from the constituents for not paying the balance amount of purchase price and taking delivery of shares purchased by the bank on their behalf is in the normal course of its banking business and hence, the forfeited amount is assessable as business income of the bank. The forfeited amount being revenue in nature cannot be adjusted against the purchase price of the shares. The Supreme Court, in the case of CIT vs. Lakshmi Vilas Bank Ltd. (1996) 220 ITR 305, has confirmed this view.

(vi) Loan of decoders to cable operators is in the normal course of the assessee’s business of distribution of satellite channels, and hence the same can be treated as use of asset for business purposes. Since the assessee is the owner of decoders used for business purposes, therefore, he is entitled to depreciation under section 32. The Delhi High Court, in CIT vs. Turner International (P) Ltd. (2008) 297 ITR 373, has also confirmed this view.

(B) The provisions of section 43C would be attracted in this case. Where an asset which becomes the property of an amalgamated company under a scheme of amalgamation is sold by the amalgamated company as its stock in trade, then, the cost of acquisition of the said asset to the amalgamated company in computing the profits and gains derived from sale of such asset would be the cost of acquisition of such asset to the amalgamating company plus the cost of any improvement incurred thereto and the expenditure incurred wholly and exclusively in connection with such transfer by the amalgamating company. In this case, since the stock-in-trade of X Co. Ltd. is taken over by Y Co. Ltd. on amalgamation, the provisions of section 43C are attracted and the cost of acquisition of vacant lands to Y Co. Ltd. (the amalgamated company) will be Rs.125 lakhs, being the original cost of such lands to X Co. Ltd., the amalgamating company. Since the stock in trade of X Co. Ltd (being vacant land) is taken over by Y Co Ltd., which has altered its object clause immediately after amalgamation to include real estate business, a view can be taken that the provisions of section 45(2) are not attracted in this case. The business income of Y Co. Ltd. on sale of such lands would be calculated as under -

Particulars (Rs in lakhs) Sale price (in the hands of Y Co Ltd) 160 Less: Cost of acquisition under section 43C, being the original cost to the amalgamating company, X Co. Ltd

125

Cost of improvement (incurred by Y Co. Ltd) 25 150 Taxable business income chargeable in the hands of Y Co. Ltd 10



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Question 6 (A) Nandita, an individual resident retired employee of the Prasar Bharati aged 60 years, is a

well-known dramatist deriving income of Rs.1,10,000 from theatrical works played abroad. Tax of Rs.11,000 was deducted in the county where the plays were performed. India does not have any Double Tax Avoidance Agreement under section 90 of the Income-tax Act, 1961, with that country. Her income in India amounted to Rs.5,10,000. In view of tax planning, she has deposited Rs.70,000 in Public Provident Fund and paid contribution to approved Pension Fund of LIC Rs.32,000 along with subscription to notified long-term infrastructure bonds Rs.25,000. She also contributed Rs.18,000 to Central Government Health Scheme during the previous year and gave payment of medical insurance premium of Rs.21,000 to insure the health of her father, a non-resident aged 76 years, who is not dependent on her. Compute the tax liability of Nandita for the Assessment year 2011-12. (8 Marks)

(B) Is it valid in law to rectify an assessment order under section 154 due to subsequent change of law on retrospective basis? Also state, whether a Supreme Court judgement would warrant a rectification under section 154 in respect of an order passed earlier by the Assessing Officer. (4 Marks)

(C) Maya Bank credited Rs.73,50,000 towards interest due on the deposits in a separate account for macro-monitoring only by using Core-branch Banking Solutions (CBS) software. No tax was deducted at source in respect of interest on deposits so credited even where the interest payable in respect of some deposits exceeded the limit of Rs.10,000. The Assessing Officer disallowed the entire interest expenditure where the interest due on time deposits credited exceeded the limit of Rs.10,000 and also levied penalty under section 271C. Decide the correctness of action of the Assessing Officer. (4 Marks)

Answer

(A) Computation of tax liability of Nandita for the A.Y. 2011-12 Particulars (Amount in Rs.)

Indian Income 5,10,000 Foreign Income 1,10,000 Gross Total Income 6,20,000 Less: Deduction under section 80C Deposit in PPF 70,000 Under section 80CCC Contribution to approved Pension Fund of LIC 32,000 1,02,000



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Under section 80CCE The aggregate deduction under section 80C, 80CCC

and 80CCD has to be restricted to Rs. 1,00,000

1,00,000

Under section 80CCF Subscription to notified long-term infrastructure bonds,

Rs.25,000, restricted to Rs.20,000, being the maximum deduction allowable under section 80CCF

20,000

Under section 80D Contribution to Central Government Health Scheme

Rs.18,000. As per the Finance Act, 2010, this contribution is also allowable as deduction under section 80D, but restricted to Rs.15,000

15,000

Medical insurance premium of Rs. 21,000 paid for

father aged 76 years. Since the father is a non-resident in India, he will not be entitled for the higher deduction of Rs. 20,000 eligible for a senior citizen, who is resident in India. Hence, the deduction will be restricted to maximum of Rs.15,000.

15,000

1,50,000

Total Income 4,70,000 Tax on Total Income Income-tax 28,000 Add : Education cess @ 2% 560 Add: SHEC @ 1% 280 28,840 Average rate of tax in India (i.e. 28,840/4,70,000 × 100)

6.14%

Average rate of tax in foreign country (i.e. 11,000/1,10,000 ×100)

10%

Rebate under section 91 on Rs.1,10,000 @ 6.14% (lower of average Indian-tax rate or average foreign tax rate)

6,754

Tax payable in India (Rs.28,840 - Rs.6,754) 22,086 (B) The Calcutta High Court, in CIT v. E.Sefton & Co. (P.) Ltd. (1989) 179 ITR 435, observed

that if the assessment order is plainly and obviously inconsistent with the specific and clear provision as amended retrospectively, undisputably there is a mistake apparent



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from record. In the light of the retrospective amendment, the assessment order had to be revised. In view of this, it can be said that the Assessing Officer can, under section 154 of the Income-tax Act, 1961, rectify the order of assessment in the light of the later amendment of the law with retrospective effect. The Gujarat High Court, in CIT v. Subodhchandra S Patel (2004) 265 ITR 445, held that non-consideration of a judgment of the jurisdictional High Court or the Apex Court would always constitute a mistake apparent from the record, regardless of the judgment being rendered prior to or subsequent to the order proposed to be rectified. Note – The Calcutta High Court, however, expressed a different view in Geo Miller & Co. v. DCIT [2003] 262 ITR 0237 holding that a subsequent exposition of law by Supreme Court does not render assessment order as made on mistake.

(C) The Explanation below section 194A(1) provides that where any income by way of interest other than interest on securities is credited to any account, whether called ‘interest payable account’ or ‘suspense account’ or by any other name, in the books of account of the person liable to pay such income, such crediting shall be deemed to be credit of such income to the account of the payee and provisions of section 194A shall apply accordingly. The CBDT Circular No.3/2010 dated 02.03.2010 has clarified that Explanation to section 194A will not apply in cases of banks where credit is made to provisioning account on daily/monthly basis for the purpose of macro monitoring only by the use of CBS software. Since no constructive credit to the depositor's / payee's account takes place while calculating interest on daily / monthly basis in the CBS software used by banks, tax need not be deducted at source on such provisioning of interest by banks for the purposes of macro monitoring only. In such cases, tax shall be deducted at source on accrual of interest at the end of the financial year or at periodic intervals as per practice of the bank or as per the depositor's or payee’s requirement or on maturity or on encashment of time deposit, whichever event takes place earlier, whenever the aggregate amounts of interest income credited or paid or likely to be credited or paid during the financial year by the banks exceeds the limits specified in section 194A. In view of the above, the action of the Assessing Officer in disallowing the interest expenditure credited in a separate account for macro monitoring purpose is not valid and consequent penalty proceedings are also not tenable in law. Note: In the question, it has been stated that no tax was deducted at source in respect of interest on deposits credited to a separate account for macro monitoring only using CBS software, even where the interest payable in respect of some deposits exceeded the limit



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of Rs.10,000. Further, it has been given that the Assessing Officer disallowed the entire interest expenditure where the interest due on time deposits credited exceeded the limit of Rs.10,000. The use of the words “payable” and “due” in the question may lead to an inference that TDS provisions under section 194A are attracted in such a case, since it is the interest due which has exceeded Rs.10,000 and not just the interest credited to the provisioning account for macro monitoring. The CBDT Circular exempting deduction of tax at source would apply where interest has been credited to provisioning account for macro monitoring only by the use of CBS software. However, if such interest has already fallen due and the amount exceeds the threshold limit of Rs.10,000 in any case or cases, the provisions of section 194A would be attracted, since such interest would have been credited to the account of the payee when it fell due. On the basis of the above reasoning, it is possible to answer that the provisions of section 194A would be attracted in this case, since the interest due has exceeded the limit of Rs.10,000. Therefore, the action of the Assessing Officer in disallowing the interest under section 40(a)(ia) and levying penalty under section 271C is correct. It is presumed that the Assessing Officer is a Joint Commissioner.

Question 7 (A) Seizures were made from Mr. Sunder pursuant to a search conducted in his premises.

He filed an application for settlement by claiming to have received the amount by way of loans from several persons. The Settlement Commission accepted his statement and made an order. The CBI, however, conducted enquiry at the instance of the Revenue regarding the claimed amount of loans and opined that the alleged lenders had no means or financial capacity to advance such huge loans to Mr. Sunder and were mere name lenders only. The Commissioner filed an application under section 245D(6) praying for the order to be declared void and for withdrawal of benefit granted. Mr. Sunder, however, contended that the order of the Settlement Commission was final and any fresh analysis would amount to sitting in judgement over an earlier decision, for which the Settlement Commission was not empowered. Discuss the correctness of Mr. Sunder's contention. (6 Marks)

(B) Mayur gifted amount of Rs.5,00,000 to the wife of his brother which was used by her for the purchase of a house and simultaneously, on the same day, Mayur’s brother gifted shares owned by him in a foreign company worth Rs.5,00,000 to the minor son of Mayur. What will be the impact of such transfers in the hands of both the transferors and the transferees? (5 Marks)

(C) State whether the following assessees have to file return of income and if so, the due date for the assessment year 2011-12:



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(i) A public charitable trust registered under the Act is running an educational institution with aggregate annual receipt of Rs.65,00,000 and total income of Rs.3,20,000. Is the accounts of the trust liable for audit under section 44AB of the Act?

(ii) A registered trade union having income from let out property of Rs.1,00,000. (iii) A public trust hospital having an aggregate annual receipt of Rs.200 lakhs and

availing exemption under section 10(23C)(via) with total income of Rs.1,10,000. (5 Marks)

Answer (A) The Apex Court, in CIT vs. Om Prakash Mittal (2005) 273 ITR 326, observed that a plain

reading of section 245D(6) shows that every order passed under sub-section (4) has to provide for:- (i) the terms of settlement; and (ii) that the settlement would become void, if it is subsequently found by the Settlement

Commission that it has been obtained by fraud or misrepresentation of facts. The decision that the order has been obtained by fraud or misrepresentation is that of the Settlement Commission. However, there is no requirement that the action be initiated by the Settlement Commission suo moto. The Revenue can move the Settlement Commission for decision on an issue if it has material to show that the order was obtained by fraud or misrepresentation of facts. The Supreme Court observed that the foundation for settlement is an application which an assessee can file at any stage of a case relating to him in such form and manner as may be prescribed. The fundamental requirement of the application under section 245C is that there must be full and true disclosure of the income along with the manner in which it has been derived. If an order is obtained by fraud or misrepresentation of facts, it cannot be said that there is a full and true disclosure and therefore, the Legislature has prescribed the condition relating to declaration of the order void when it is obtained by fraud or misrepresentation of facts. The Supreme Court held that merely because section 245-I provides that the order of settlement is conclusive, it does not take away the power of the Settlement Commission to decide whether the settlement order has been obtained by fraud or misrepresentation of facts. If the Commissioner is able to establish that the earlier decision was void because of misrepresentation of facts, then it is open for the Settlement Commission to decide the issue. It cannot be called by any stretch of imagination to be a review of the earlier judgment or the subsequent Bench sitting in appeal over the earlier Bench’s decision. Mr. Sunder's contention is, therefore, not correct.



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(B) In the given case, Mayur is making a gift of Rs.5,00,000 to the wife of his brother for the purchase of a house by her and simultaneously, his brother is making a gift to the minor son of Mayur, shares owned by him in a foreign company worth Rs.5,00,000. These transfers are in the nature of cross transfers. Accordingly, the income from the assets transferred would be assessed in the hands of the deemed transferor because the transfers are so intimately connected to form part of a single transaction and each transfer constitutes consideration for the other by being mutual or otherwise. The Supreme Court has, in CIT vs. Keshavji Morarji (1967) 66 ITR 142, held that if two transactions are inter-connected and are part of the same transaction in such a way that it can be said that the circuitous method was adopted as a device to evade tax, the implication of clubbing provisions would be attracted. Accordingly, the income arising to the wife of Mayur's brother from the house property would be included in the total income of his brother and the dividend from shares transferred to Mayur's minor son would be taxable in the hands of Mayur. This is because both Mayur and his brother are the indirect transferors of the income yielding assets to their minor child and spouse, respectively, with an intention to reduce their burden of taxation.

(C) (i) Since the total income of Rs.3,20,000 exceeds the basic exemption limit of Rs.1,60,000, the mandatory requirement of filing return under section 139(4C) will apply. The accounts of the charitable trust running an educational institution with an aggregate annual receipt of less than 100 lakhs is eligible for exemption under section 10(23C)(iiiad) and therefore, the accounts of such trust need not be audited under section 44AB. Therefore, the due date of filing of return of income of the public charitable trust running an educational institution eligible for exemption under section 10(23C)(iiiad) is 31st July 2011.

(ii) A registered trade union is having income from property, which is exempt under section 10(24). Section 139(4C) mandates filing of return only when the total income exceeds the maximum amount which is not chargeable to tax without giving effect to the provisions of section 10. Even without giving effect to section 10(24), the total income is below basic exemption limit and therefore, there is no mandatory requirement to file the return of income.

(iii) Since the total income of the public trust hospital, without giving effect to the exemption under section 10(23C)(via), is less than the basic exemption limit of Rs.1,60,000, the trust need not file its return of income.


PAPER – 8: INDIRECT TAX LAWS

Question No. 1 is compulsory

Answer any five from the remaining six questions.

Question 1

(a) ABC Co. Ltd. procured the following inputs during the month of Jan 2011. Determine the amount of CENVAT credit available with necessary explanations for treatment of various items.

Items Excise duty paid (Rs.) Raw materials 52,000 Manufacturing machine 1,00,000 Light diesel oil 40,000 Greases 10,000 Office equipment 20,000 Paints 5,000

(Note: M/s. ABC Co. Ltd. is not eligible to avail exemption under a notification based on value of clearances in a financial year) (5 Marks)

(b) SSI & Co. is eligible for exemption in terms of Notification No. 8/2003-CE dated 1-3-2003 for the year 2010-11. It provides the following particulars with regard to the clearances of goods effected during the said year. Determine the duty payable in respect of the year 2010-11:

Aggregate Rs. (in lakhs) Value of domestic clearance of goods with own brand name 120 Value of clearance of goods with the brand name of others (including Rs. 30 lakhs in respect of goods manufactured in a rural area)

100

Value of clearances for exports 50 Value of clearances for captive consumption 40 Value of clearances of exempted goods 20 (Assume rate of excise duty at 12%)

Show your workings with explanations where required. (5 Marks)

The suggested answers for Indirect Tax Laws (Paper 8) are based on the provisions as amended by the Finance Act, 2010 and notifications/circulars issued up to 31.10.2010 which are relevant for May 2011 examinations.



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(c) M/s. Commercial Goods Services, a goods transport agency, furnishes the following information in respect of services provided for the year ending March 31, 2011. Determine the value of taxable services and tax thereon under ‘transport of goods by road’ falling under section 65(105)(zzp) of the Finance Act, 1994.

Rs. (i) Service provided to M/s. XYZ Co. Ltd. 30,00,000 (ii) Freight for transport of food grains and pulses 1,50,000 (iii) Service to an unregistered firm 6,00,000 (iv) Service provided as a ‘clearing and forwarding agent’ 2,00,000 (v) Composite service provided which includes packing/unpacking,

loading, unloading in the course of transportation by road

2,00,000 (vi) Service tax paid on input services used for providing goods

transport agency services 72,000

(Provide suitable explanations where required) (5 Marks)

(d) From the following particulars compute net VAT payable by M/s. TAB & Co. for the period ending March 31, 2011.

Inputs procured : Rs. (i) Raw material at Nil VAT 10,00,000 (ii) Raw material at 4% VAT 40,00,000 (iii) Raw material at 12% VAT 20,00,000 Output (i) Intra state sale of finished goods at 4% VAT (these goods were

produced entirely from raw material at NIL VAT rate procured as inputs)

15,00,000

(ii) Exempted sales (these goods were procured from raw material procured at 4% VAT to the extent of 50%)

20,00,000

(iii) Sale of finished goods intrastate at 12% VAT 20,00,000 (iv) Intrastate sale of raw material purchased at 4% 10,00,000 (v) 50% of the raw material produced at 12% VAT has been

utilised to produce capital goods for the manufacturing process in TAB & Co’s factory (Market Value):

15,00,000

Provide explanations where necessary. (5 Marks)

(e) Compute the assessable value of the machine imported by M/s. Exports India Pvt. Ltd., under the Customs Act, 1962.


PAPER – 8 : INDIRECT TAX LAWS

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US$ FOB price of the machine 10,000 Air freight paid 2,500 Insurance for transit of machine Not Ascertainable Cost of development work in India Rs. 40,000 Local agent’s commission Rs.10,000 Cost of local transport Rs.5,000

Exchange rate applicable US $ 1 = Rs. 45 Provide explanation for your answer. (5 Marks)

Answer (a) Computation of CENVAT credit available to ABC Co. Ltd. for purchases made

during the month of January, 2011:

Particulars CENVAT credit available (Rs.)

Raw materials 52,000 Manufacturing machine (1,00,000 × 50%) (Note – 1) 50,000 Greases 10,000 Paint 5,000 CENVAT credit available 1,17,000

Notes: 1. As per third proviso to rule 4(2)(a) of the CENVAT Credit Rules, 2004, assessee

eligible for SSI exemption can avail CENVAT credit of the whole amount of the duty paid on the capital goods in the same financial year in which such goods are received. However, since ABC Co. Ltd. is not eligible for SSI exemption, CENVAT credit of only 50% is available in respect of the manufacturing machine in the year of purchase.

2. Light Diesel Oil is not an input as per the definition of inputs under rule 2(k) of the CENVAT Credit Rules, 2004. Hence, it is not eligible for the CENVAT credit.

3. Office equipment is not a capital good as per the definition of capital goods under rule 2(a) of the CENVAT Credit Rules, 2004.

4. It is assumed that the excise duty paid on various items includes education cess and secondary and higher education cess.



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(b) Computation of excise duty payable by M/s. SSI & Co. during the year 2010-11:-

Particulars Rs. in lakh Turnover to be excluded: Value of clearances for export [Note – 1] 50 Value of clearances for captive consumption [Note – 1] 40 Value of clearances of exempted goods [Note – 1] 20 Value of domestic clearance of goods with brand name of others (excluding goods manufactured in rural area) [Note – 2]

70

Turnover to be included: Value of domestic clearances with own brand name 120 Value of clearances of goods with brand name of others manufactured in rural area

30

Total 150

Tax liability

On 1st clearance of Rs. 150 lakh duty is Nil On clearances with brand name of others worth Rs. 70 lakh (excluding rural area clearances) duty @ 12% [Note 3]

8,40,000

Add: Education cess and secondary and higher education cess @ 3% 25,200 Total duty liability 8,65,200

Notes: 1. As per Notification No. 8/2003 CE dated 01.03.2003, export clearance, captive

consumption and exempted clearances are not included in determining the limit of first Rs.150 lakh for SSI exemption.

2. As per Notification No. 8/2003 CE dated 01.03.2003, the clearances with the brand name of others which are ineligible for SSI exemption has to be excluded while determining the limit of Rs.150 lakh. However, clearances with the brand name of others manufactured in rural area are eligible for SSI exemption and hence, such clearances are included while determining the limit of Rs.150 lakh.

3. Export clearance, captive consumption and exempted clearances are exempted from excise duty. Thus, duty will be payable only in respect of the goods manufactured with brand name of others.



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(c) Computation of value of taxable services and service tax payable thereon by Commercial Goods Services under transport of goods by road service for the year ending 31.3.2011:-

Particulars Rs. (i) Service provided to M/s XYZ Co. Ltd. Not taxable (ii) Freight for transporting food grains/pulses Exempt (iii) Service provided to an unregistered firm 6,00,000 (iv) Service provided as clearing & forwarding agent Not covered (v) Composite services provided which include packing/ unpacking,

loading/unloading

2,00,000 Gross Taxable Value 8,00,000 Less: Abatement @ 75% 6,00,000 Net taxable value 2,00,000 Service tax payable @10.30% 20,600 Notes:

Item (i) Service has been provided to company. Hence, service tax is to be paid by the person paying freight and not by M/s Commercial Goods Services [Rule 2(d)(v) of the Service Tax Rules, 1994]

Item (ii) Freight for transporting food grains/pulses/fruit etc. is exempt [Notification No. 33/2004 ST dated 03.12.2004]

Item (iii) Since, Service has been provided to unregistered firm, service tax liability is on the service provider [Rule 2(d)(v) of the Service Tax Rules, 1994]

Item (iv) Service provided as ‘clearing & forwarding agent’ does not come under the purview of “transport of goods by road” service

Item (v) Composite services are included in the invoice issued by GTA and would form part of GTA vide Circular No.104/07/2008-ST dated 06.08.2008 and are eligible for abatement.

As per rule 2(p) of the CENVAT Credit Rules, 2004, definition of output service specifically excludes goods transport agency service. Hence, CENVAT credit of the service tax of Rs. 72,000 paid on the input services used in providing GTA services cannot be availed.



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(d) Computation of Net VAT payable by M/s. TAB & Co.:- Output VAT payable

S.No. Particulars Rs. 1. Intra-state sale of goods at 4% VAT (Rs.15,00,000 × 4%)

(manufactured out of exempted material) 60,000

2. Sale of finished goods at 12% VAT (Rs.20,00,000 × 12%) 2,40,000 3. Sale of raw materials purchased at 4% VAT (Rs.10,00,000 × 4%) 40,000 Total (A) 3,40,000

Input tax credit available

S.No. Particulars Rs. 1. Purchase of raw material @ 4% VAT

(50% of Rs.40,00,000 x 4%) (Note – 1) 80,000

2. Purchase of 12% VAT including purchases used for capital goods produced (12% of Rs.20,00,000) (Note – 2)

2,40,000

Total (B) 3,20,000 Net VAT payable = (A) - (B) = Rs.3,40,000 – Rs.3,20,000 = Rs.20,000. Notes:

1. Input tax credit for goods used to produce exempted goods will not be allowed. Hence, 50% of the input tax credit has been disallowed on purchases of goods at 4% VAT and utilized to produce exempted goods.

2. Input tax credit on raw materials is allowed even if the same has been consumed to produce capital goods. Hence, full input tax credit on goods purchased at 12% VAT has been allowed.

(e) Computation of assessable value of machine for customs duty:-

FOB price of the machine US$ 10,000.00 Add: Air freight (Maximum 20% of FOB) (Note-1) US$ 2,000.00 Insurance charges (1.125% of FOB) (Note-2) US$ 112.50 Value (excluding local agent commission) 12,112.50 CIF value in Indian rupees = (Rs.12,112.5 × 45) Rs.5,45,062.5 Add: Local agent commission (Note-4) 10,000 CIF Value 5,55,062.5 Add: Landing charges (1% of CIF) (Note-6) 5,550.62 Assessable value 5,60,613.12 Assessable value (rounded off) Rs.5,60,613



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Notes:

1. Air freight cannot exceed 20% of FOB value of the goods [Second proviso to rule 10(2) of the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007]

2. Cost of insurance is taken at 1.125% of FOB value of the goods [First proviso to rule 10(2)].

3. Cost of local transport is not includible in assessable value as it is a post importation activity.

4. Local agent commission is not a buying commission and hence, includible in assessable value [Rule 10(1)(a)].

5. Cost of development work in India is not includible in the assessable value [Rule 10(1)(b)].

6. Landing charges should be 1% of CIF value [First proviso to rule 10(2)]. Question 2

(a) Briefly explain whether the following statements are correct with reference to the Central Excise Act, 1944 and the changes effected by the Finance Act, 2010.

(i) Penalty can be imposed under Section 11A(2B) in case where the assessee pays duty and interest voluntarily before issue of show cause notice.

(ii) Time limit for passing of the settlement order in terms of Section 32F(6) is nine months from the last day of the month in which the application was made and no extension of this period is permissible.

(iii) An assessee cannot apply for settlement more than once under Section 32-O. (3 x 2 = 6 Marks)

(b) Explain briefly the correctness of the following statements with reference to the Finance Act, 1994 relating to service tax and the changes effected by the Finance Act, 2010.

(i) With regard to residential complex service (Section 65(105)(zzzh) unless the entire payment for the property is paid by the buyer after completion of construction, the activity of construction would be deemed to be a taxable service.

(ii) The application of the rules in respect of classification of services under Section 65A have been excluded in the case of specific taxable services. (2 x 3 = 6 Marks)

(c) Explain briefly with reference to the changes effected by the Finance Act, 2010 to the Customs Tariff Act, 1975 how additional customs duty has to be determined in respect of goods imported requiring MRP based assessment under the Medicinal and Toilet Preparations (Excise Duties) Act, 1955. (3 Marks)



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Answer (a) (i) False. The Finance Act, 2010 has inserted explanation 3 to section 11A(2B) which

clarifies that no penalty under any of the provisions of this Act (Central Excise Act, 1944) or the rules made thereunder can be imposed in case of voluntary payment of duty and interest before issuance of show cause notice. Note: The above statement can also be answered as false on the reasoning that it is the duty and interest which is paid voluntarily by the assessee under section 11A(2B) before issue of show cause notice and no penalty can be imposed under this section.

(ii) False. Finance Act, 2010 has amended section 32F(6) by adding a proviso to the aforesaid section which provides that Settlement Commission can extend time-limit for passing of the settlement order for a further period not exceeding three months for reasons to be recorded in writing by the Settlement Commission.

(iii) False. Finance Act, 2010 has amended section 32-O thereby providing that the assessee is now entitled to apply for settlement more than once.

Note: The above statement can also be answered as false on the reasoning that since an application for settlement is made under section 32E, settlement cannot be applied for under section 32-O.

(b) (i) The statement is correct. The Finance Act, 2010 has added an explanation to section 65(105)(zzzh) to the effect that the construction of a complex which is intended for sale wholly or in part by a builder or any person authorized by the builder, before during or after construction except in cases where no sum is received from or on behalf of the buyer before issue of completion certification by the competent authority is to be deemed to be a service provided by the builder to the buyer.

(ii) The statement is correct. With effect from 1.7.2010, the Finance Act, 2010 has provided that the provisions of section 65A shall not apply to any service when the same is rendered entirely within (i) the port or (ii) other port; or (iii) the Airport of Civil enclave.

Now port service means any service rendered within a port or other port in any manner. Similar changes have been effected in respect of airport services as well.

(c) The Finance Act, 2010 has amended the first proviso to section 3(2)(ii) of the Customs Tariff Act, 1975 to provide that the value of the imported goods for the purpose of charging countervailing duty (CVD) in respect of goods chargeable to excise duty on the basis of Maximum Retail Sales Price under Medical and Toilet Preparation (Excise Duties) Act, 1955 would be deemed to be the retail sale price declared on such imported goods less the amount of abatement, if any, from such retail price as the Central Government may, by notification in the Official Gazette, allow in respect of such like article.



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Moreover, where on any imported goods more than one retail price is declared, the maximum of such retail sale price shall deemed to be the retail sale price for the purpose of this section.

Question 3

(a) PQR & Co. is engaged in the business of fabrication and erection of structures of various types on contract basis. They entered into a contract with M/s. XYZ Co. for fabrication, assembly and erection on turn key basis of a waste water treatment plant. This activity involved procurement, supply, fabrication, transportation of various duty paid components and finally putting up a civil construction and erection of the waste water treatment plant and commissioning the same. The entire fabrication is done at site. The pressure testing was carried out as such until it was wholly built. The excise department has issued a show cause notice that the fabrication at site amounted to manufacture of excisable goods since the plant came into existence in an unassembled form, as per drawings and designs approved by the client, M/s. XYZ Co. before the fabrication activity was undertaken. Therefore, according to the department, excise duty was payable on the value of the plant excluding the value of the civil work. Briefly discus with reference to case law whether the show cause notice is sustainable in law. (5 Marks)

(b) Sweet Sugar Mills is engaged in the manufacture of sugar. Government of India had issued directions under the Sugar Control Order for sugar companies to maintain buffer stock of sugar of certain quantity for a specified period. In order to compensate the sugar mill the Government had extended buffer stock subsidy towards storage, interest and insurance charges in respect of the buffer stock of sugar actually held by the sugar mill. The department has issued a show cause notice to the assessee raising a demand of service tax on the ground that the amount received by the sugar mill as buffer subsidy is covered under the taxable service of ‘storage and warehousing’. Discuss briefly with reference to decided case law whether the action of the department is sustainable in law. (5 Marks)

(c) The customs authorities had confiscated the gold carried by Mr. Lovegold from Bahrain. Mr. Lovegold informed the customs authorities that he was filing an appeal against the order of confiscation. The customs authorities informed Mr. Lovegold that the confiscated goods had been handed over to the warehouse of the custom house for disposal and consequently auctioned the confiscated goods. Discuss briefly the validity of the action taken by the customs authorities with the help of decided case law. Also discuss the validity of the claim of Mr. Lovegold in seeking market value of the confiscated goods and whether he is liable to pay the duty, fine and penalty imposed by the original authority. (5 Marks)

Answer (a) No, the show cause notice is not sustainable in law. The facts of the case are similar to

the case of Larsen & Toubro Ltd. v. UOI 2009 (243) E.L.T. 662 (Bom.). The High Court opined that mere bringing of the duty paid parts in an unassembled form at one place,



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i.e. at the site, does not amount to manufacture of a plant. Simply collecting together at site the various parts would not amount to manufacture unless an excisable movable product (say a plant) comes into existence by assembly of such parts.

In the present case, as the petitioner had stated that the waste water treatment plant did not come into existence unless all the parts were put together and embedded in the civil work. Waste water treatment plant did not become a plant until the process which included the civil work, was completed. Thus, the Court held that no commercial movable property came into existence until the assembling was completed by embedding different parts in the civil works. Accordingly, since waste water treatment plant was not a separate movable marketable good and came into existence only on assembly of parts in the civil work, there was no question of levying excise duty on it.

(b) No, the action of the Department is not sustainable in law. The facts of the case are similar to the case of CCE v. Nahar Industrial Enterprises Ltd. 2010 (19) STR 166 (P & H). While dismissing the contention of Revenue, the High Court, after perusing the relevant sections viz. section 65(105)(zza) and 65(102) of Finance Act, 1994, said that it is apparent that service tax can be levied only if service of ‘storage and warehousing’ is provided. Nobody can provide service to himself.

In the present case, it is undisputed that the assessee stored the goods owned by himself. After the expiry of the storage period, the assessee was free to sell to the buyers of its own choice. The assessee had stored goods in compliance to directions of Government of India issued under Sugar Development Fund Act, 1982. The assessee had received subsidy not on account of services rendered to Government of India but had received compensation on account of loss of interest, cost of insurance etc., incurred on account of maintenance of stock. The act of assessee cannot be called as rendering of services.

The High Court concurred with the Tribunal’s decision that just because the storage period of free sale sugar had to be extended at the behest of Government of India, neither the assessee becomes ‘storage and warehouse keeper’ nor the Government of India becomes their ‘client’ in this regard. Therefore, the storage of specific quantity of free sale sugar could not be treated as providing ‘storage and warehousing’ services to Government of India.

(c) No, the action taken by the custom authorities is not valid in law. The facts are similar to the case decided by the Bombay High Court in the matter of Shabir Ahmed Abdul Rehman v. UOI 2009 (235) E.L.T. 402 (Bom.). The High Court noticed that the assessee had informed the Customs authorities that he is filing an appeal against the original order of confiscation. Handing over the confiscated gold immediately after serving the order of confiscation was held to be improper. The Customs authorities ought to have stopped the auction sale of the confiscated gold after receipt of letter from the assessee. The High Court observed that the claim of the assessee in seeking market value of the gold could not be accepted. It held that the assessee cannot escape payment of fine and



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penalty. Duty would be required to be paid only if the gold was actually allowed to be redeemed. Since what is being given is the sale proceeds, the question of paying duty will not arise. It further ruled that the Customs authorities were liable to return the entire sale proceeds without deducting therefrom the duty but subject to deduction of fine and penalty with interest.

Note: A stay has been granted by the Supreme Court in the aforementioned case vide Union of India v. Shabir Ahmed Abdul Rehman 2010 (253) E.L.T. A142 (S.C.).

Question 4

(a) C & C Co. Ltd. manufactured non-alcoholic beverage bases known as concentrates. These were sold to bottling companies who in turn sold the aerated beverages manufactured from the concentrates to distributors. These were then sold to retailers and thereafter to the ultimate consumers. The advertisement and market research activities were undertaken by M/s. C & C Co. Ltd. Input credit of service tax paid on the advertising service used for marketing of soft drinks removed by bottlers was claimed by M/s. C & C Co. Ltd. This credit was denied on the ground that advertisements did not relate to the concentrates manufactured by M/s. C & C Co Ltd. Discuss briefly with reference to decided case law whether M/s. C & C Co. Ltd. is eligible to avail CENVAT credit paid on advertising services which was utilised towards payment of excise duty on concentrates. (5 Marks)

(b) ‘Smartphone’ is in the business of providing mobile telephone service. The assessee sells ‘SIMCARDS’ to its mobile telephone subscribers for a price. ‘Smartphone’ pays service tax on the activation and other charges. On the ‘SIMCARDS’ sold to the customers, VAT under the applicable State law is paid. The Department’s view is that the ‘SIMCARDS’ is used for provision of mobile services and is a part of the service and therefore the value of the ‘SIMCARDS” has to be included in the category of ‘telecommunication services’ for purpose of service tax. Explain with a brief note and reference to decided case law whether the view taken by the department is correct in law. (5 Marks)

(c) ABC Company Ltd. has imported brine shrimp eggs. This was classified as “prawn feed’ for customs duty purposes under chapter heading No. 2309 of the Customs Tariff schedule which includes use as animal feed. The department’s view was that this should be classified under chapter heading No. 051199 as non-edible animal products unfit for human consumption. M/s. ABC Co. provided literature to support their contention that the imported material contained little organisms/embryos which later became larva that were fed to the prawns. Therefore, according to the importers, the nature and character of the product was not changed or altered by nurturing or incubation. Hence, the classification should be as prawn feed under chapter heading No. 2309.



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Decide with the help of case law, if any, whether the contention of the assessee, M/s. ABC Co. is correct in law. (5 Marks)

Answer (a) The fact of the case are similar to the case of Coca Cola India Pvt. Ltd. v. CCE (2009) 15

STR 657 (Bom). The Bombay High Court held that though the contents of advertisements made by the appellants (the manufacturer of ‘concentrates’) essentially featured the ‘bottle of aerated waters’ (the bottles being the final products manufactured by bottlers and not by the appellants), the credit on advertising services received by the appellant could not be denied on the ground that the advertisement was not of the final product of the appellants (viz. ‘concentrates’), but of the final product of the bottlers (viz. ‘aerated waters’) (Rule 2(l) of CENVAT Credit Rules, 2004).

The High Court observed that any input service that forms a part of value of final product should be eligible for the benefit of CENVAT credit. In the said case, since the advertising cost formed part of the assessable value, the assessee was eligible to take credit of tax paid on advertising services. So long as the manufacturer can demonstrate that the advertisement services availed have an effect or impact on the manufacture of the final product and establish the relationship between the input service and the manufacture of final product, credit must be allowed. In the present case, the Court held that the advertisement of soft-drink enhanced the marketability of the concentrate.

In view of the above-mentioned judgment, C & C Co Ltd. is eligible to avail CENVAT credit paid on advertising services.

(b) Yes, the view taken by the Department is correct in law. The facts of the above case are similar to the case of CCE v. Idea Mobile Communications Ltd. 2010 (19) STR 18 (Ker.).

The High Court, while examining the functioning of a SIM Card, admitted that SIM card is a computer chip having its own SIM number on which telephone number can be activated. SIM card is a device through which customer gets connection from the mobile tower. Unless the SIM card is activated, service provider cannot give service connection to the customer because signals are transmitted and conveyed through towers and through SIM card communication signals reach the customer’s mobile instrument. Hence, it can be inferred that it is an integral part required to provide mobile service to the customer.

Further, SIM card has no intrinsic value or purpose other than use in mobile phone for receiving mobile telephone service from the service provider. Thus, the Court accepted the view that SIM cards, were not goods sold or intended to be sold to the customer, but supplied as part of service. Consequently, it held that the value of SIM card supplied by the assessee would form part of the value of taxable service on which service tax was payable by the assessee.

(c) Yes, the contention of the assessee is justified in law. The facts of the given case are similar to the case of Atherton Engineering Co. Pvt. Ltd. v. UOI 2010 (256) ELT 358



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(Cal.). In the instant case, the Court noted that it was the use of the product that had to be considered in the instant case. If a product undergoes some change after importation till the time it is actually used, it is immaterial, provided it remains the same product and it is used for the purpose specified in the classification. Therefore, in the instant case, it examined whether the nature and character of the product remained the same.

The Court opined that if the embryo within the egg was incubated in controlled temperature and under hydration, a larva was born. The larva did not assume the character of any different product. Its nature and characteristics were same as the product or organism which was within the egg.

Hence, the Court held that the said product should be classified as feeding materials for prawns under the heading 2309. These embryos might not be proper prawn feed at the time of importation but could become so, after incubation.

Question 5 (a) (i) Write a short note with reference to the Central Excise Act, 1944 and CENVAT

Credit Rules 2004 on “goods” and “exempted goods”. (ii) Explain briefly the significance of “trade parlance test” with respect to classification

of excisable goods under the Central Excise Act, 1944. (2 x 3 = 6 Marks) (b) (i) Explain with a brief note with reference to the Finance Act, 1994 whether the

business auxiliary service provided by a sub-broker to a stock-broker in relation to sale or purchase of securities listed on a registered stock exchange is liable to service tax.

(ii) Briefly explain the policy contained in the ‘white paper’ on introduction of VAT with regard to availment of input credit on capital goods. (2 x 3 = 6 Marks)

(c) Explain briefly with reference to the Customs Act, 1962 the significance of “Indian Customs Waters”. (3 Marks)

Answer (a) (i) Section 2(d) of the Central Excise Act, 1944 carries an explanation which states that

the expression “goods”, for purpose of the said clause, includes any article, material or substance which is capable of being bought and sold for a consideration and such goods shall be deemed to be marketable.

Rule 2(d) of the CENVAT Credit Rules, 2004 defines exempted goods as excisable goods which are exempt from the whole of the duty of excise leviable thereon and includes goods which are chargeable to nil rate of duty.

(ii) Under normal circumstances, it is the responsibility of the Department to establish the correct tariff heading under which the product falls. Once this is discharged, the burden shifts to the assessee to prove a particular classification.

According to the trade parlance test, if a product is not defined in the Schedule and



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Section Notes and Chapter Notes of the Central Excise Tariff Act, 1985, then it should be classified according to its popular meaning or meaning attached to it by those dealing with it, i.e., its commercial sense. However, where the tariff heading itself uses highly scientific or technical terms, goods should be classified in scientific or technical sense.

(b) (i) Notification No.31/2009-ST dated 1.9.2009 has exempted the business auxiliary service provided by a sub-broker to a stock broker in relation to sale or purchase of securities listed on a registered stock exchange from the whole of the service tax leviable thereon. Thus, the business auxiliary service is not liable to service tax if it is provided by a sub-broker to a stock broker listed on a registered stock exchange.

Finance (No.2) Act 2009 amended the definition of stock broker under section 65(101) to exclude sub-broker from the ambit of stock broker service. Consequently, the services provided by a sub-broker under stock broker service are outside the purview of service tax. The above notification exempts the service provided by the sub-broker under business auxiliary service also.

(ii) The policy contained in the ‘White Paper’ lays down that in relation to capital goods, set-off will be available to traders and manufacturers.

The most important factor is that the White Paper recognizes the fact that set-off is to be given to both traders and manufacturers. It is well known that under traditional sales-tax system, in some States, partial credit was allowed on capital goods to the manufacturers but no credit was allowed to traders. In the White Paper, taking into account the very basis of VAT system, laid down a policy statement that set-off will be allowed to both manufacturers and traders.

However, as per the White Paper, the State Governments can provide to give set-off on a staggering basis, at the most in 36 instalments. This is subject to the policy of individual States.

(c) Significance of Indian Customs Waters (i) If an officer of customs has reason to believe that any person in India or within the

Indian customs waters has committed an offence punishable under section 132 or section 133 or section 135 or section 135A or section 136, he may arrest such person informing him of the grounds for such arrest. [Section 104 of Customs Act]

(ii) Where the proper officer has reasons to believe that any vessel in India or within Indian customs waters has been used in the smuggling of any goods or in the carriage of any smuggled goods, he may stop any such vehicles, animal or vessel or in case of an aircraft, compel it to land. [Section 106 of Customs Act].

(iii) Any vessel which is or has been within the Indian customs waters is constructed, adapted, altered or fitted in any manner for the purpose of concealing goods shall be liable to confiscation. [Section 115(1)(a) of Customs Act].



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(iv) Customs Officer has the power to search any person who has landed from/about to board/is on board any vessel within Indian customs waters and who has secreted about his person, any goods liable to confiscation or any documents relating thereto. [Section 100(2)(a) of Customs Act].

(v) Any goods which are brought within the Indian Customs Waters for the purpose of being imported from a place outside India, contrary to any prohibition imposed by or under this Act or any other law for the time being in force, shall be liable to confiscation. [Section 111(d) of Customs Act].

Note: Any three points may be mentioned. Question 6

(a) Write a brief note on the warehousing procedure for goods removed from the factory under the Central Excise Act, 1944 and Rules made thereunder. (6 Marks)

or

(i) Explain briefly “Annual Financial Information Statement” under the Central Excise Rules, 2002. (3 Marks)

(ii) State briefly the procedure for adducing additional evidence in appeal proceedings before the Commissioner (Appeals) under Section 35 of the Central Excise Act, 1944.

(3 Marks) (b) (i) Explain briefly the three variants of VAT. (2 Marks) (ii) Briefly write a short note on the due dates for monthly and quarterly payment of

service tax in respect of various classes of assessees. (4 Marks) (c) State briefly the provisions under the Customs Act, 1962 relating to duty drawback on re-

export of goods. (3 Marks)

Answer (a) The procedure for warehousing of goods removed from a factory is detailed below:

(i) The consignor shall prepare an application for removal of goods from a factory to a warehouse in quadruplicate and also prepare an invoice for goods to be warehoused.

(ii) He has to send original, duplicate and triplicate application and duplicate invoice along with goods to the warehouse of destination. The quadruplicate copy of application has to be sent to the Superintendent of Central Excise in-charge of his factory within 24 hours.

(iii) Within 24 hours of receipt of the goods the consignee shall verify the goods with all the copies of application.



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(iv) The consignee has to send: (a) Original copy to Superintendent-in-charge of his warehouse.

(b) Duplicate copy of consignor and retain the triplicate for record. (v) The Superintendent-in-charge of the warehouse shall countersign the application

received by him and send the same to Superintendent-in-charge of the consignor. (vi) The consignor shall retain the duplicate application duly endorsed by the consignee for

his record. (a) (i) Annual Financial Information Statement is a return to be submitted in Form-ER-4. It

is to be submitted by every assessee to the Superintendent of Central Excise for the preceding financial year by 30th November of the succeeding year [Rule 12(2)(a) of the Central Excise Rules, 2002].

The following assessees have been exempted from such submission of ER-4 : (i) An assessee who pays less than Rs.1 crore of excise duty during the financial

year to which ER-4 relates. (ii) Indian Ordinance Factories, Department of Defence Production and Ministry of

Defence. (ii) The Commissioner (Appeals) shall not admit any additional evidence unless the

adjudicating authority or his authorized person in this behalf has been allowed a reasonable opportunity:- (a) to examine the evidence or documents or to cross-examine any witness

produced by the appellant, or (b) to produce any evidence or any witness in rebuttal of the additional evidence

produced by the appellant. However, the Commissioner (Appeal) must record in writing the reason for admission of additional evidence.

(b) (i) The three variants of VAT are (a) Gross Product Variant, (b) Income Variant and (c) Consumption Variant. 1. Gross Product Variant: Tax is levied on all sales and deduction for tax paid

on inputs excluding capital inputs is allowed. 2. Income Variant: Tax is levied on all sales with set-off for tax paid on inputs

and only depreciation on capital goods. 3. Consumption Variant: Tax is levied on all sales with deduction for tax paid on

all business inputs (including capital goods).



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(ii) According to rule 6(1) of the Service Tax Rules, 1994, service tax wouldbe paid to the credit of Central Government: (i) by the 6th day of the month, if the duty is deposited electronically through

internet banking; and (ii) by the 5th of the month, in any other case, immediately following the calendar

month in which the payments are received towards the value of taxable services.

However, first proviso to rule 6(1) provides that where the assessee is an individual or proprietary firm or partnership firm, service tax would be paid to the credit of Central Government by the 6th day of the month if the duty is deposited electronically through internet banking or in any other case, the 5th day of month as the case may be, immediately following the quarter in which payments are received towards the value of taxable services.

Further, according to third proviso to rule 6(1), service tax on the value of taxable service received during the month of March or quarter ending in March, would be paid by 31st day of March of the calendar year.

(c) When imported goods on which duty has been paid on importation are exported, 98% of the customs duty will be paid back as drawback on satisfaction of the following conditions: (i) Goods must be easily identified. (ii) Proper Officer makes an order permitting clearance for loading of the goods for

exportation. (iii) If goods are exported as baggage, the owner of the baggage makes a declaration of

its contents to the proper officer which will be considered as entry for export and such officer permits clearance of the goods for exportation.

(iv) If exported through post, the Proper Officer makes an order for clearance for export. Question 7 (a) (i) State briefly the circumstances under which a refund claim could be admitted under

the proviso to section 11B(2) of the Central Excise Act, 1944. (3 Marks) (ii) Explain briefly the significance of Rule 10A of the Central Excise Valuation

(Determination of Price of Excisable Goods) Rules, 2000 relating to goods produced or manufactured by a job worker. (3 Marks)

(b) (i) Briefly explain the provisions relating to export of services under the Export of Service Rules, 2005. (3 Marks)

(ii) Explain briefly the mandatory provisions under VAT with respect to the records to be maintained by the assessee. (3 Marks)



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(c) Briefly explain “Prohibited goods” under the Customs Act, 1962. (3 Marks)

Answer (a) (i) Under proviso to section 11B(2), a refund claim of excise duty made by a

buyer/assessee can be admitted only in the following cases: (i) Rebate of excise duty on excisable goods exported out of India or on excisable

materials used in the manufacture of goods which are exported out of India; (ii) Unspent advance deposits lying in applicant’s account current; (iii) Refund of credit of duty paid on inputs, provided it is payable according to any

rule or notification; (iv) Refund of duty to manufacturer, if he has not passed on the incidence of duty

to another person; (v) Refund of duty to buyers, provided he has borne the duty and if he has not

passed on the incidence of the duty to any other person; (vi) To any other class of applicant, if borne by any such class of applicants, as

may be specified by the Government of India, if the incidence of duty has not been passed on to any other person.

(ii) Rule 10A of Central Excise Valuation (Determination of Price of Excisable Goods) Rules, 2000 provides that where goods are manufactured by a job-worker on behalf of a person (commonly known as principal manufacturer), the value for payment of excise duty would be based on the sale value at which the principal manufacturer sells the goods, as against the past practice where the value was taken as cost of raw material plus the job charges. Where the goods are sold by the principal manufacturer from the factory of the job worker’s factory, the price charged by the principal to his customer would have to be taken as the value on which duty would have to be paid at the applicable rate. If the buyer is related to the principal manufacturer, the valuation would have to be done as in case of clearances to related parties. Where the goods are not removed for sale from the job worker’s factory but cleared to some other premises of the principal from where the goods are sold, the valuation at the time of removal from the job worker’s premises would be similar to what is followed under rule 7.

(b) (i) Rule 3 of the Export of Service Rules, 2005 classifies the taxable services in three categories:- (a) When the immovable property in respect of which the service is rendered is

situated abroad. (b) When the service is performed outside India. (c) When the service is provided to a recipient located outside India.



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In the first category, exemption is available in respect of the specified services only when the immovable property is outside India. In the second category, a group of services have been listed. If any such service is partly performed outside India, it shall be considered to have been performed outside India. The services listed in third category when provided in relation to business or commerce shall be eligible for exemption as ‘export of services’ when the recipient of such services are located outside India. Any service which is taxable may be exported without payment of service tax provided the export receipts are in convertible foreign exchange. Central Government has granted some rebate notifications for input services or inputs used for export of taxable services.

(ii) The following records should be maintained under VAT system: (i) Purchase records (ii) Sales records (iii) VAT account containing the details of output tax and input tax together with

credit and debit notes issued during the period (iv) Separate record for exempt sale The following records should also be kept and produced to an officer:- Copies of invoices, debit and credit notes issued, all purchase invoices, details of tax charged on purchases and sales, total output tax, input tax and net tax for each period, details of goods manufactured and delivered from the factory, details of each supply of goods from the business premises. Failure to keep these records may attract penal provisions under the State VAT law.

(c) The term prohibited goods has been defined under section 2(33) of the Customs Act, 1962 as the goods the import or export of which is subject to any prohibition under the Act or any other law for the time being in force but does not include any such goods in respect of which the conditions subject to which the goods are permitted to be imported or exported have been complied with.


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