Investment Limits for MSMEs Sector

The issue of revision of investment limit for Micro, Small and Medium Enterprises (MSMEs) is under consideration of the Government.

On the basis of the data on Gross Domestic Product (GDP) published by Central Statistics Office (CSO), the Ministry of Statistics & Programme Implementation and final results of the latest Census (Fourth Census), the estimated contribution of MSME Sector to GDP during 2010-11, 2011-12 and 2012-13 are 36.69%, 37.97% and 37.54% respectively.

As per Directorate General of Commercial Intelligence and Statistics (DGCI&S) estimated data, the share/contribution of MSMEs in export during 2011-12, 2012-13 and 2013-14 is 43%, 43% and 42.40 % respectively.

The Ministry of MSME has been allocated outlays of Rs.2,700.00 crore, Rs.2,835.00 crore, Rs.2,977 crore and Rs.3,327.00 crore for 2011-12, 2012-13, 2013-14 and 2014-15 respectively for providing incentives and subsidies etc. for promotion of MSMEs through various schemes and programmes.

This information was given by the Union Minister for Micro, Small and Medium Enterprises, Shri Kalraj Mishra in a written reply to a question in Lok Sabha.

Source:
Press Information Bureau
Government of India
Ministry of Micro,Small & Medium Enterprises

Sum received on transfer of carbon credits isn’t taxable, as no profit element is involved on their transfer

CIT V. MY HOME POWER LTD [2014] 46 taxmann.com 314 (Andhra Pradesh High Court)

Where assessee, engaged in business of power generation, received carbon credits, such carbon credits not being linked with power generation, amount received on their transfer did not have element of profit or gain, and it could not be charged to tax.

Facts:

• The assessee-company was engaged in business of power generation through biomass power generation unit. It received carbon credits, namely, carbon Emission Reduction Certificates for its project activity of conversion of fossil fuel from naptha and diesel to biomass;
• It transferred said carbon credits and offered receipt from said transfer as capital receipt. However, the revenue treated said receipt as business income and brought it to tax. c)Further, the Tribunal held in favour of assessee and it opined that carbon credit had no element of profit or gain.

On appeal, the High Court held in favour of assessee as under:

• The Tribunal had factually found that "Carbon Credit was not an offshoot of business but an offshoot of environmental concerns. No asset was generated in the course of business but it was generated due to environmental concerns."
• We agree with this factual analysis as the assessee was carrying on the business of power generation. The Carbon Credit was not even directly linked with power generation.
• On the sale of excess Carbon Credits the income was received and, hence, as correctly held by the Tribunal it was capital receipt and it could not be deemed as business receipts or income. Thus, the appeal was to be dismissed.

Transfer of division in exchange of shares only couldn’t be held as slump sale

CIT VS. BHARAT BIJLEE LTD. [2014] 46 taxmann.com 257 (Bombay High Court)

Facts

• The assessee had transferred its lift division to T Ltd and the said transfer took place under the Scheme of Arrangement under section 391, read with section 394 of the Companies Act, 1956. 
• The disbursement on transfer of division was made by way of allotment or issue of bonds/preference shares. The Assessing Officer (‘AO’) opined that the transfer of division was a slump sale under section 2(24C) and was taxable in terms of section 50B. c)The order of AO was affirmed by CIT(A). However, it was rejected by the Tribunal. The aggrieved revenue filed the instant appeal.

The High Court held in favour of assessee as under:

• Section 2(42C) of the Income-tax Act defines slump sale as under: ‘Slump sale' means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales. 
• Thus, from the bare reading of the definition of slump sale, it is clear that sale must be affected for a lump sum consideration to hold it as slump sale. 
• The Tribunal had rightly held that it was not a case where the consideration was determined and decided by parties in terms of money, rather its disbursement was made by way of allotment of bonds/preference shares. Thus, it was a case of exchange and not a sale. Accordingly, the impugned transaction was not a slump sale and the additions made by the Assessing Officer was not sustainable.
  

DuPont Analysis – Return on Equity (ROE) Analysis

Financial statement analysis is employed for a variety of reasons. Outside investors are seeking information as to the long run viability of a business and its prospects for providing an adequate return in consideration of the risks being taken. Creditors desire to know whether a potential borrower or customer can service loans being made. Internal analysts and management utilize financial statement analysis as a means to monitor the outcome of policy decisions, predict future performance targets, develop investment strategies, and assess capital needs. As the role of the credit manager is expanded cross-functionally, he or she may be required to answer the call to conduct financial statement analysis under any of these circumstances. The DuPont analysis is a useful tool in providing both an overview and a focus for such analysis.

History of DuPont Analysis

The DuPont model of financial analysis was made by F. Donaldson Brown, an electrical engineer who joined the giant chemical company’s Treasury department in 1914. A few years later, DuPont bought 23 percent of the stock of General Motors Corp. and gave Brown the task of cleaning up the car maker’s tangled finances. This was perhaps the first large-scale re-engineering effort in the USA. Brown devised formulae to analyse the source of shareholder returns generated by these companies. These formulae or methods came to be known as DuPont system of analysis. Ensuing success launched the DuPont model towards prominence in all major U.S. corporations. It remained the dominant form of financial analysis until the 1970’s. The DuPont analysis is known by many other names, including DuPont Equation, DuPont Framework, DuPont Identity, DuPont Model, DuPont Method, or Strategic Profit Model.

Framework of DuPont Analysis

The DuPont Analysis is a wonderful synthesis of the different ratios to end up with the Return on Equity (ROE).  ROE effectively measures how much profit a company can generate on the equity capital investors have deployed in the business, and can be used over time to evaluate changes in a company’s financial situation. Simply, ROE indicates the amount of earnings generated by each dollar of equity. It can be a valuable insight into a company’s operations. In general, the higher the ROE the better, as high ROE companies, all other things being equal, will produce more earnings and free cash flow that can be used to support a higher level of growth, keep the company financially strong, and provide cash returns to shareholders.

The DuPont analysis breaks down a company’s return on equity (ROE) into three components.

1. Profit Margin as measured by net income as a percentage of sales (net profit/sales)
2. Asset Turnover which is net sales divided by the total assets of a firm (sales/assets)
3. Degree of Financial Leverage as measured by the equity multiplier which is the ratio of total assets financed by stockholders’ equity (assets/equity)

Under DuPont analysis, Return on Equity (ROE) is equal to the Profit Margin multiplied by Asset Turnover multiplied by Financial Leverage.

Return on Equity (ROE) = Profit Margin x Asset Turnover x Financial Leverage = (Net Profit/Sales) x (Sales/Assets) x (Assets/Equity)

• Profit margin is an indicator of a company’s pricing strategies and how well the company controls costs. Profit margin is calculated by finding the net profit as a percentage of the total revenue. If the profit margin of a company increases, every sale will bring more money to a company’s bottom line, resulting in a higher overall return on equity. Even though the common consensus is that the higher the net profit margin the more preferable it is, executives may often intentionally decrease this ratio this in an attempt to attract an increase in sales.
• Asset turnover, on the other hand, measures the efficiency of the company in generating sales for every dollar of asset. Asset turnover tends to have an inverse relationship with profit margin, meaning that if a firm has a high profit margin it generally has a low asset turnover. Similar to profit margin, if asset turnover increases, a company will generate more sales per asset owned, once again resulting in a higher overall return on equity.
• Lastly, the equity multiplier of Financial Leverage shows how leveraged a company is by computing how much financing stockholders provided for every dollar of asset. As was the case with asset turnover and profit margin, increased financial leverage will also lead to an increase in return on equity. This is because the increased use of debt as financing will cause a company to have higher interest payments, which are tax deductible. Because dividend payments are not tax deductible, maintaining a high proportion of debt in a company’s capital structure leads to a higher return on equity.

Breaking ROE into these three parts allows evaluation of how well one can manage the company’s assets, expenses, and debt. Financial managers have basically three ways of improving operating performance in terms ROE. These are:

1. Increase operating profit margins
2. Increase capital asset turnover
3. Change financial leverage

The above DuPont equation is the 3 step DuPont analysis. There is also the 5 step DuPont analysis. The additional parts are derived from the profit margin part. Instead of a single profit margin, we break up the profit margin component into three parts.

Return on Equity (ROE) = (Net Income/EBT) x (EBT/EBIT) x (EBIT/Sales) x (Sales/Assets) x (Assets/Equity)

The first three parts are the profit margin component. Notice how the terms can be cancelled out and Net Income/Sales stands out after cancellation. The ratio (Net Income/EBT) called as tax burden, this is also given by (1- Effective Tax Rate). The higher the tax expense, the lower will be this fraction. Remember this part will be less than 1. When using in the main equation denote this in decimal, not percentage. The second ratio (EBT/EBIT) called as interest burden. The higher the interest expense, the lower will be result of this fraction. Remember this part will also be less than 1 unless interest expense is nil. Lower this number, worse off the ROE will be. Denote this is also in decimal, not percentage. The third ratio (EBIT/Sales) called as Operating Profit margin.

There is an inter-relationship between the above three ratios in 5 step DuPont analysis. For example if debt is low in a company, interest burden might be low resulting in higher EBT/EBIT ratio; but the offset will take place in the financial leverage part of the equation (Assets/Equity). Lower debt means higher equity, thus lower financial leverage.

The DuPont analysis is an excellent method to determine the strengths and weaknesses of a company. A low or declining ROE is a signal that there may be a weakness. However, using the analysis you can better determine the source of weakness. Expressing the individual components rather than interpreting ROE itself may identify these weaknesses more readily.

There are some disadvantages in using ROE alone in financial statement analysis. ROE may be volatile due to the business’s normal sales cycles, or ROE may be lower or higher depending on the general profitability of the industry in which the company operates. A company may have an inflated ROE because of a very small value of book equity on its balance sheet, perhaps due to rapid growth or because the company has made large share repurchases. Likewise, the company may have taken on a large debt burden, increasing its leverage and potentially increasing ROE without increasing profitability or efficiency.

Companies (Amendment) Bill, 2014

The Union Cabinet, chaired by the Prime Minister Shri Narendra Modi, approved the introduction of the Companies (Amendment) Bill, 2014 in Parliament to make certain amendments in the Companies Act, 2013. 

The Companies Act, 2013 (Act) was notified on 29.8.2013. Out of 470 sections in the Act, 283 sections and 22 sets of Rules corresponding to such sections have so far been brought into force. In order to address some issues raised by stakeholders such as Chartered Accountants and professionals, following amendments in the Act have been proposed: 

1. Omitting requirement for minimum paid up share capital, and consequential changes. (For ease of doing business) 

2. Making common seal optional, and consequential changes for authorization for execution of documents. (For ease of doing business) 

3. Prescribing specific punishment for deposits accepted under the new Act. This was left out in the Act inadvertently. (To remove an omission) 

4. Prohibiting public inspection of Board resolutions filed in the Registry. (To meet corporate demand) 

5. Including provision for writing off past losses/depreciation before declaring dividend for the year. This was missed in the Act but included in the Rules. 

6. Rectifying the requirement of transferring equity shares for which unclaimed/unpaid dividend has been transferred to the IEPF even though subsequent dividend(s) has been claimed. (To meet corporate demand) 

7. Enabling provisions to prescribe thresholds beyond which fraud shall be reported to the Central Government (below the threshold, it will be reported to the Audit Committee). Disclosures for the latter category also to be made in the Board’s Report. (Demand of auditors) 

8. Exemption u/s 185 (Loans to Directors) provided for loans to wholly owned subsidiaries and guarantees/securities on loans taken from banks by subsidiaries. (This was provided under the Rules but being included in the Act as a matter of abundant caution). 

9. Empowering Audit Committee to give omnibus approvals for related party transactions on annual basis. (Align with SEBI policy and increase ease of doing business) 

10. Replacing ‘special resolution’ with ‘ordinary resolution’ for approval of related party transactions by non-related shareholders. (Meet problems faced by large stakeholders who are related parties) 

11. Exempt related party transactions between holding companies and wholly owned subsidiaries from the requirement of approval of non-related shareholders. (corporate demand) 

12. Bail restrictions to apply only for offence relating to fraud u/s 447. (Though earlier provision is mitigated, concession is made to Law Ministry & ED) 

13. Winding Up cases to be heard by 2-member Bench instead of a 3-member Bench. (Removal of an inadvertent error) 

14. Special Courts to try only offences carrying imprisonment of two years or more. (To let magistrate try minor violations). 

Erecting road, bus shelters and so forth as part of advertisement business couldn’t be termed as infrastructure development

CIT V. SKYLINE ADVERTISING (P.) LTD [2014] 45 taxmann.com 532 (Karnataka High Court)

Where assessee-company had developed road medians, erected bus-shelters and light poles for its advertisement business, activities indulged by it were part of its normal activities of advertising and publicity rather than one of infrastructure development and, therefore, were not eligible for deduction under section 80-IA(4).

Facts

• Assessee, an advertisement company, had entered into an agreement with the local authority for construction of bus shelters, putting up of footbridge, beautifying the road medians and erecting streetlights.
• The assessee was allowed to utilize these bus-shelters, lampposts, road medians and footbridges for its advertisement business to recoup the expenditure incurred on them. The assessee claimed deduction under section 80-IA(4) after considering such activities as infrastructural activity.
• The Assessing Officer (‘AO’) denied the benefit under section 80-IA(4). On appeal, the CIT(A) confirmed the order of AO. However, the ITAT set aside the order of CIT(A). The aggrieved-revenue filed the instant appeal.

The High Court held in favour of revenue as under:

• Assessee was not an engineering or construction company that puts up public-infrastructure. It was only an advertising company which was interested only to find out the best space at the best locations for advertisements.
• CBDT vide its Circular No. 777, dated 14/08/1995 made it clear that to avail deduction, income should arise from the use of infrastructural facility. But, in the instant case, the assessee derived income only from the advertisement hoardings erected on the bus-shelters, road medians and the street light poles. Hence, the said income could not be treated as income derived from the 'infrastructure facility'.
• The benefit under section 80-IA could be extended only to those assessees who had developed infrastructural facility as defined under sub-section (4) of section 80-IA, i.e., road or a toll road, bridge, highway or a rail system. But, in the instant case, the assessee had developed the existing road median, erected bus shelters and light poles for its advertisement business, which, in any case could not be treated as infrastructure development.
• Thus, the assessee was not eligible for Section 80-IA benefit and the order passed by Tribunal could not be sustained.

No disallowance of lawful expenditure merely due to non-compliance with provisions of Companies Act

JAI SURGICALS LTD. V. ACIT [2014] 46 taxmann.com 246 (Delhi - Tribunal)

If the expenditure was otherwise lawful and neither amounted to offence nor any law prohibited it, but the procedural provisions attached to it were not complied with, no doubt irregularity would creep in, but such irregularity would not make the expenditure itself as unlawful under section 37(1).

Facts:

• The Assessing Officer (‘AO’) noticed that the assessee had made payment of job work charges to a related party without obtaining prior approval of the Central Government in accordance with the provisions of section 297 of the Companies Act, 1956.
• He, accordingly, made additions on the ground that Explanation to Section 37(1) was triggered as on the day of payment of such expenditure there was no prior approval of Central government.
• On appeal, the CIT(A) sustained the disallowance. The aggrieved-assessee filed the instant appeal.

The Tribunal held in favour of assessee as under:

• The offence or prohibition referred to in the Explanation to section 37(1) had to be judged with reference to the 'purpose' of the expenditure on a standalone basis divorced from the fulfillment of procedural formalities attached with it and necessary for the incurring of such expenditure.
• The Explanation to section 37(1) provided for disallowance of any expenditure incurred for 'any purpose’, which was either an offence or prohibited by law. If, however, the purpose of the expenditure was neither to commit an offence nor any law prohibited it, then there could be no question of disallowance.
• If the expenditure was otherwise lawful and neither amounted to offence nor any law prohibited it, but the procedural provisions attached to it were not complied with, no doubt irregularity would creep in, but such irregularity would not make the expenditure itself as unlawful so as to be brought within the scope of the Explanation to sec. 37(1).