Saturday, August 31, 2013

[aaykarbhavan] Business standard news updates 1-9-2013



Evading wealth tax is a criminal offence


AMARPAL S CHADHA

The deadline for filing the income tax return just got over and most taxpayers would have filed their income tax returns. However, only a few taxpayers are aware that they also have to file wealth tax returns. Every individual and Hindu Undivided Family (HUF) who has wealth exceeding 30 lakh is required to file a return of wealth tax with the revenue authorities and pay wealth tax. Currently, the wealth tax rate is 1 per cent.

Wealth includes certain prescribed assets such as building or land ( with certain exceptions), motor cars, jewellery, bullion, yachts, boats and aircraft ( other than ones used for commercial purposes), urban land, cash in hand exceeding 50,000, etc. Any debt owed in respect of such assets can be reduced from the value of the assets. For the purpose of calculating wealth tax, the value of the assets would be as on the last day of the respective previous year ( that is, March 31). There are prescribed guidelines that need to be followed to value assets to arrive at your wealth tax liability.

Let us take an example. Rahul Singhal has a residential house property worth 1 crore ( on which there is an outstanding loan of 70 lakh), motor car worth 13 lakh, gold jewellery 40 lakh and cash in hand of 2 lakh. For the purpose of wealth tax, we will first need to calculate Singal's total wealth.

Singal's net wealth works out to 25 lakh ( aggregate of 55 lakh for gold jewellery, motor car and cash in hand minus 30 lakh).

A self- occupied residential house or a plot of land that does not exceed 500 square meters is exempt from wealth tax.

Also, a residential house or a commercial building which forms part of stock- in- trade or any house which the taxpayer may occupy for the purpose of any business or profession carried out by him or a property in the nature of commercial establishment or complexes are all excluded from the purview of wealth tax.

For taxpayers who have more than one house property ( in addition to one residential property), the additional house properties are excluded from wealth tax if they are let out for a minimum of 300 days during the previous year.

All productive assets such as mutual funds, fixed deposits, exchange traded gold funds and savings bank accounts are not included in wealth tax. Wealth tax, typically, is levied on non- productive assets.

It should be noted that dispersing assets among family members is not a solution that will exempt one from wealth tax status. Clubbing provisions, similar to the Indian Income Tax Act, exist in the individual to his under a revocable his spouse or son's wife, without adequate consideration form a part of his/ her wealth and not that of the transferee.

All resident individuals are liable to pay wealth tax on their global wealth, whereas not ordinarily residents/ non- resident individuals and foreign citizens are liable to pay wealth tax only on the assets situated in India.

So what happens if you do not pay wealth tax and do not file your wealth tax return? You certainly cannot get away with it. There are strict penalties imposed for evading wealth tax.

If the declaration of wealth made is incorrect, revenue authorities can impose a penalty of up to 500 per cent of the amount of tax evaded.

In cases of wilful default, imprisonment of up to seven years could also be imposed. In order to defend apenalty proceeding, a bona fide and reasonable cause for not furnishing the assets or furnishing inaccurate particulars of assets would need to be established.

Revenue authorities are also increasingly focussing on whether all tax payers have complied with their wealth tax returns.

Tax authorities are asking assesses to furnish a copy of the wealth tax return while auditing their income tax returns . The revenue authorities for wealth and income tax are the same. And hence, an income tax officer can easily call for a list of assets owned by the taxpaper Under the proposed Direct Tax Code ( DTC), the threshold limit to levy wealth tax could be raised from 30 lakh to 1 crore. In addition, there are some more assets that have been included under the purview of wealth tax.

If you have not yet filed your wealth tax return, it is time for you to look at your assets and determine if you have a wealth tax liability.

The author is tax partner, Ernst & Young (Rama Karmakar, senior tax professional, EY contributed to the article) ( Views expressed are personal)

You could be charged penalty of up to 500 per cent of tax amount or face imprisonment HOW TO CALCULATE WEALTH TAX

Singhal s assets: Gold 40 lakh (55- 30)

 

 


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[aaykarbhavan] Re: Lawyers Club India , Information and Judgments






Brief introduction
1. There are various issues involved in availability of the Cenvat credit in case of restaurant and outdoor catering services. These have been discussed in this article.
Background of service tax on restaurant and outdoor catering services
2. Section 66E(i) of the Finance Act, 1994 defines following as 'declared service' - Service portion in an activity wherein goods, being food or any other article of human consumption or any drink (whether or not intoxicating) is supplied in any manner as a part of the activity.
As per Article 366(29A)(f), a tax on the supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service, is for cash, deferred payment or other valuable consideration, is 'deemed sale of goods'.
Such 'deemed sale of goods' has been excluded from the definition of 'service' itself , vide section 66B(44)(a)(ii) of the Finance Act, 1994.
Thus, mere supply of food is not 'service' at all. Further, only service portion which is not 'deemed sale of goods' can be subject to service tax.
This service was earlier (upto 1-7-2012) partly covered as 'outdoor catering' service under section65(105)(zzt) of the Finance Act, 1994 and partly under 'restaurant service' under section 65(105)(zzzzv) of the Finance Act.
Now, both outdoor catering and restaurant services have been clubbed together under one head w.e.f. 1-7-2012.
Exemption to services provided in restaurants without air conditioning or central heating
3. Services provided in relation to serving of food or beverages by a restaurant, eating joint or a mess, other than those having the facility of air-conditioning or central air-heating in any part of the establishment, at any time during the year,are exempt from service tax – Vide Sr. No. 19 of Notification No. 25/2012-ST, dated 20-6-2012 w.e.f. 1-7-2012 as amended w.e.f. 1-4-2013.
Till 1-4-2013, services provided in relation to serving of food or beverages by a restaurant, eating joint or a mess, other than those having: (i) the facility of air-conditioning or central air-heating in any part of the establishment, at any time during the year, and (ii) a licence to serve alcoholic beverages are exempt from service tax - Vide Sr. No.19 of Notification No. 25/2012-ST, dated 20-6-2012 w.e.f. 1-7-2012 as existing upto 1-4-2013.
Thus, after 1-4-2013, all restaurants having AC or central heating system in any part of establishment will be subject to service tax, even if the restaurant does not have a bar. From 1-7-2012 to 31-3-2013, only restaurants with AC/central heating and bar were subject to service tax.
Thus, service tax provisions apply to air conditioned restaurants and those restaurants having central air-heating in any part of establishment [Assessees in Gujarat are unhappy as till 1-4-2013 they were exempt from service tax, as they could not officially serve liquor].
Restaurants with AC/central heating to pay service tax on 40% of amount charged
4. The restaurants with AC/central heating and bar are required to pay service tax on 40% of the amount charged. They can avail of Cenvat credit of input services, capital goods and input goods other than food items
Rule 2C of the Service Tax (Determination of Value) Rules, 2006 [effective from 1-7-2012] makes provision for valuation of supply of food articles and drinks in a restaurant or as an outdoor catering service.
Subject to section 67 of the Finance Act, 1994, the value of taxable service involved in the supply of food or drinks for consumption either in a restaurant or as an outdoor catering, shall be the percentage of total amount charged for such supply, as follows –
Service portion in an activity wherein goods, being food or any other article of human consumption or any drink (whether or not intoxicating) is supplied in any manner as a part of the activity, at a restaurant 40% of total amount charged
Service portion in outdoor catering wherein goods, being food or any other article of human consumption or any drink (whether or not intoxicating) is supplied in any manner as a part of such outdoor catering 60% of total amount charged
Food as part of other services like convention, pandal, shamiana, etc. (Abatement Scheme) 70% of total amount charged
Restrictions on Cenvat credit
5. Cenvat credit of input services and capital goods will be available.
Any goods classifiable under Chapters 1 to 22 of the Central Excise Tariff Act, 1985 meant for human consumption shall not be considered as "inputs" for the service portion in an activity wherein goods, being food or any other article of human consumption or drink is supplied in any manner as part of the activity.
Thus, Cenvat credit of food items (falling under Chapters 1 to 22 of the Central Excise Tariff) is not available. Cenvat credit of other input goods is available [There will be hardly such an input].
Cenvat credit of service tax and excise duty
6. The service provider can avail of Cenvat credit of service tax paid on input services and excise duty paid on capital goods, but not of excise duty paid on food items.
The service tax is payable on 40%/60%/70% of 'total amount'.
Issue is whether 100% Cenvat credit of input services is available or only proportionate Cenvat credit of input services and input goods (other than those covered under Chapter headings 1 to 22) is available, as per rule 6 of the Cenvat Credit Rules.
Composite contract of material plus service
7. The contract is composite contract of material plus services. Hence, rule 6 of the Cenvat Credit Rules should be applicable.
Food served in restaurant is 'exempted goods'
8. There is no doubt that food prepared in hotel and restaurant is 'manufactured' as new and an identifiable product emerges.
As per Sr. Nos. 12 and 13 of Notification No. 12/2012-CE, dated 17-3-2012, food preparations, including food preparations containing meat, fruits and vegetables, which are prepared or served in a hotel, restaurant or retail outlet whether or not such food is consumed in such hotel, restaurant or retail outlet, falling under Chapter heading 16, 19 or 20 (except 1905) are fully exempt from excise duty.
Thus, all food preparations falling under Chapter heading 16 (preparation of meat, fish), heading 19 (preparations of cereals, flour, starch or milk) or heading 20 (preparations of vegetables, fruit, nuts) except heading 1905 (bread, pastry, cakes, biscuits and other baker's wares) are exempt from excise duty. Hence, these are 'exempted goods'.
Departmental clarification
9. Para 8.4.3 of the CBE&C's Education Guide released on 20-6-2013 states that sale of food in restaurant would amount to clearance of exempt goods and, thus, provisions of rule 6 of the Cenvat Credit Rules will be applicable.
Sale of food is deemed sale of goods, as per Constitution
10. Article 366(29A) of the Constitution, as amended by the Constitution (46th Amendment) Act, 1982, w.e.f. 2-2-1983 states as follows :- 'Tax on the sale or purchase of goodsincludes - - (f) a tax on supply, by way of or as part of any service or in any manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service is for cash, deferred payment or other valuable consideration - - and such transfer, delivery or supply of any goods shall be deemed to be a sale of those goods by the person making the transfer, delivery or supply and a purchase of those goods by the person to whom such transfer, delivery or supply is made.
Thus, this is 'deemed sale of goods'.
Value in case of trading
11. As per the Explanation I(c) to rule 6(3D) of the Cenvat Credit Rules, in case of trading, 'Value' for purpose of rule 6(3) and 6(3A) of the Cenvat Credit Rules shall be the difference between the sale price and the cost of goods sold (determined as per the generally accepted accounting principles without including the expenses incurred towards their purchase) or 10% of cost of goods sold, whichever is more.
Cenvat credit in respect of common input services
12. It is a fact that common input services are used both for deemed sale of goods and provision of output (taxable) service. There are following three possible views on how to apply rule 6 in case of common input services service.
(a)  60% (in case of restaurant service)/40% (in case of outdoor catering service)/30% (in case of food service with mandap/shamiana/convention service) of value (on which service tax is not paid) shall be deemed to be value of 'exempted goods'. In effect, assessee can avail of only 40% (in case of restaurant service)/60% (in case of outdoor catering service)/70% (in case of food service with mandap/shamiana/convention service) of the Cenvat credit of input services and balance Cenvat credit is required to be reversed.
(b)   The sale of food is to be treated as sale of goods as per Constitutional provisions. Thus, difference between sale price of goods and purchase price of inputs should be taken as the value of 'exempted services' as per the Explanation I(c) to rule 6(3D) of the Cenvat Credit Rules. For example, in case of restaurant services, service tax is payable on 40% of value. Thus, 60% is to be taken as the value of sale of food. If total value is 100 and value of purchase of goods is (say) 40, the value of 'exempted service' will be 20 (60 - 40). Thus, total value of service = taxable service + exempt service = 40 + 20 = 60. Thus, the assessee can avail of Cenvat credit of common input services in the ratio of 40/60, i.e., 66.67% of common input services and balance 33.33% should be reversed.
(c)   Explanation 2 to rule 2C of Service Tax (Determination of Value) Rules, 2006 (as inserted w.e.f. 1-7-2012) states as follows:- For the removal of doubts, it is clarified that the provider of taxable service shall not take Cenvat credit of duties or cess paid on any goods classifiable under Chapters 1 to 22 of the Central Excise Tariff Act, 1985. This implies that other Cenvat credit is fully available, overriding provisions of rule 6 of the Cenvat Credit Rules. This is on the principle that a specific provision (Explanation 2 in rule C) prevails over a general provision (rule 6 of the Cenvat Credit Rules) [Generalia specialibus non derogant - General things do not derogate from special, i.e., - Special provision prevails over general provision].
Which alternative assessee should follow?
13. The first alternative is of course conservative and hopefully free from litigation.
The second alternative can be justified on the basis that deeming Constitutional provision should prevail over a statutory provision in the Central Excise Tariff Act. Hence, such sale of food should be treated as 'sale of goods' and difference between sale price and purchase price shall be taken as value of 'exempted service' and then rule 6 of the Cenvat Credit Rules should be applied in respect of common input services (like audit, security, banking, etc.).
The issue is not free from doubt and ultimate result is uncertain, though as per basic principle of VAT, such proportionate reversal of the Cenvat credit can be justified.
If assessee intends to follow this option, it is advisable to make full disclosure to department to avoid charge of suppression of facts.
The third alternative appears to be very aggressive. I doubt if this view will be accepted, as the fact remains that the common input services are used in respect of provision of food and provision of service. As per rule 2(l) of the Cenvat Credit Rules, input services are only those which are used for providing an output service. Though the inclusive part of definition of input service expands the scope of 'input service', yet it cannot cover input services which are not related to output services. Thus, entire input service cannot be said to be 'used for providing an output service'.
Entire Cenvat credit of duty paid on capital goods available
14. Cenvat credit of 100% of excise duty paid on capital goods is available (and not restricted to 60%/40%/30%), in view of rule 6(4) of the Cenvat Credit Rules.
Entire Cenvat credit of input services directly relating to provision of taxable service
15. It may be noted that rule 6(3) of the Cenvat Credit Rule applies only to common input services.
Para 2 of the CBEC Circular No. 754/70/2003-CX, dated 9-10-2003 states as follows : 'The option to maintain the separate accounts or payment of 8% of the price of the exempted goods can be exercised only in respect of common inputs used for the manufacture of dutiable and exempted goods'.
This view has been upheld in Chennai Petroleum Corporation Ltd., In re (2012) 286 ELT 467 (Commr Appl). In this case it was held that rule 6 is only for common inputs and input services. Rule 6(3) is only procedural in nature. It cannot take away right to avail of credit fully on inputs and input services used in dutiable goods or taxable services. Credit of service tax paid on input services exclusively used in dutiable goods is not covered under rule 6 but under rule 3 of the Cenvat Credit Rules.
Thus, entire Cenvat credit should be available where there is one-to-one relation between input service and output service (like back-to-back services).
16. Conclusion
 100% Cenvat credit is available in case of capital goods and input services used exclusively for providing output (taxable) services.
 In case of common input services, on the basis of Constitutional deeming provision, it can be argued that only difference between sale price and purchase price should be taken as the value of exempted services and then rule 6 should be applied. Issue is litigation prone and, hence, this, option should be taken after full disclosure to the department and where stakes are high and assessee is willing to contest the issue
 If assessee is conservative or where stakes are not high, it is advisable to treat sale of food as 'exempted goods' and then apply rule 6 (i.e., take only 40% of the Cenvat credit in case of restaurant service, 60% in case of outdoor catering service and 70% in case of other composite services).

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Regards,

Pawan Singla
BA (Hon's), LLB
Audit Officer


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Re: [aaykarbhavan] Query on Builder / Developer



Link.

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Accounting-for-Construction-Contracts-Construction-Tax-Tips

Accounting for Construction Contracts - Construction Tax Tips

What is Taxable Income?

When you are paid for work, the income you earn is taxable. This is true whether you are an employee or a subcontractor. The income you earn from all side jobs is also taxable. It does not matter whether you:
  • Are paid by cash or check,
  • Get a credit on a bill,
  • Receive other goods or services in exchange,
  • Collect the payment later, or
  • Receive a Form 1099 or W-2 (or not) showing the amount of income you earned.
Example: Joe, as an employee of ABC, Inc., installs cabinets. He also does remodeling side jobs.
In addition to his wages from ABC, Inc., Joe's income includes everything he earns from his side jobs, whether or not he receives a Form 1099.
When you work as an employee, your employer gives you a W-2 form that shows the income you have earned. When you work for yourself, you may or may not receive a Form 1099 from the people you work for; however, you are responsible for keeping track of and reporting all of your income. Now that you know what is included in income, you need to choose an accounting method.

What is an Accounting Method?

Every taxpayer reports income and expenses on their tax return according to a method of accounting. An accounting method is a set of rules used to determine when and how to report income and expenses. Basically, accounting methods are divided into two categories - the cash and accrual methods. There are several different accrual methods.
You must use an accounting method that clearly shows your income. An accounting method clearly shows your income when it treats all income and expenses the same from year to year and is appropriate for your line of work. Choosing the right method is important to your business because it will affect when you report income and deduct expenses.

How Do I Choose a Method?

There are special tax rules that control the accounting method you must use for your construction business. Generally, you choose your tax accounting method when you file your first tax return for the business.
Your choice of accounting method depends on:
  1. The type of contracts you have,
  2. Your contracts' completion status at the end of your tax year, and
  3. Your average annual gross receipts.
Most construction businesses use two different tax accounting methods; one for their long-term contracts and one overall method for everything else. A long-term contract is any contract that is not completed in the same year it's started.
Most construction businesses use the Accrual Method for their overall method of accounting. See the Accrual section for information on the Accrual Method.

Cash Method of Accounting

One method that some construction contractors can use for both their overall method and for their long-term contracts is the cash method. However, there are significant limitations on who can and cannot use this method.

How Does the Cash Method of Accounting Work?

A contractor using the cash method of accounting reports cash receipts as income when received and deducts expenses when paid. If you pay an expense that benefits you for more than one tax year, you must spread the cost over the period you receive the benefit.
Example: You pay $1,000 in Year 1 for a business insurance policy that is effective for one year, beginning July 1st. You can deduct $500 in Year 1 and $500 in Year 2.
In the cash method, income may be actually or constructively received. If you received a check from a customer in Year 1 but did not deposit or cash it until Year 2, it is still included in income in Year 1 because that's the year you actually received it.
Constructive receipt occurs when you have unrestricted access to income you have earned.
  • If a customer called you in December and told you that a payment for a job was ready, but you didn't pick it up until January, you would have constructive receipt of the income in December.
  • If someone else receives the money for you, you have constructively received the money.
The key to constructive receipt is IF you could have received the money in one year but chose not to receive it until a later year, it must be included in your income in the first year as if it had been actually received in that year. You cannot postpone including it in your income until the next year.

What are the Limitations on the Use of the Cash Method?

There are two situations in which your use of the cash method of accounting can be limited. First, you are not allowed to use the cash method if your business is a corporation or a partnership with a C corporation as a partner, whose average annual gross receipts exceed $5 million. There is no exception to this limitation.
Second, depending on what type of business you have, you may not be allowed to use the cash method if your total purchases of "merchandise" for the year are "substantial" compared to your gross income for the year.
So, what do the terms "merchandise" and "substantial" mean?
Merchandise includes any item physically incorporated in a product you transfer to your customers. In the construction industry, merchandise is commonly called materials. For example, the lumber used to frame a building is merchandise for tax purposes.
Merchandise is generally considered to be substantial when it is at least 10% - 15% of your gross income for the year. This percentage is not a hard and fast rule, but a guideline used in some court cases.

Exception to the Merchandise Limitation

An exception to the requirements to use an accrual method and to account for inventories is found in Revenue Procedure 2001-10 (PDF), which permits most small businesses with average annual gross receipts of $1 million or less to use the cash method of accounting.  Rev. Proc. 2002-28 expanded the use of the cash method to average annual gross receipts of $10 million or less.
The rest of this tax tip assumes you have to use one of the accrual methods and you use a calendar tax year, from the 1st of January to the 31st of December. The rules that follow show you how to choose a method of accounting for your long-term contracts.

Accrual Methods of Accounting

If you can't use the cash method, you must choose an accrual method of accounting. In the construction industry, there are several specialized accrual methods available, each of which has its own set of rules and limitations. In general, all accrual methods attempt to match the expenses that relate to a specific contract to the income from that contract.
The rest of this tax tip concentrates on helping you choose the correct accrual method for your construction business and assumes that you use a calendar tax year, from the 1st of January to the 31st of December.

Choosing an Accrual Method

Choosing a permissible method of accounting for tax purposes involves the four steps discussed below. As your business grows and changes, you might have to use a different method of accounting. You should review the following four steps every year to ensure that you are using a permissible method of accounting for your construction contracts.
Step One - Classify all Construction Contracts as either Short-Term or Long-Term.
A long-term contract is any contract that spans a year-end. If you have a contract that you start on December 26th but do not complete until January 23rd, you have a long-term contract. Therefore, a short-term contract is any contract you start and finish within one taxable year.
Use your overall method (i.e. accrual or cash, if allowed) for your short-term contracts. You must then choose an accounting method for all your long-term contracts. The rest of these steps will lead you through the process of choosing your long-term contract accounting method.
Step Two - Classify all Long-Term Contracts as either Home Construction or General Construction Contracts.
Home Construction Contracts are contracts for work on buildings that have four or fewer dwelling units. Eighty percent or more of the estimated total contract costs must be for the construction, improvement, or rehabilitation of these units. If a contract is not a home construction contract, it is a general construction contract.
Example: Contracts to build single-family homes, duplexes, triplexes, or quadplexes would be home construction contracts. Contracts to build apartment buildings would not be home construction contracts.
To select an accounting method for home construction contracts, see the Home Construction Contracts section. For long-term general construction contracts, there is one more step to take to choose the correct accounting method.
Step Three - Classify Yourself as Either a Small or Large Contractor
This is a two-part step. The first part is to measure your average annual gross receipts for the last three tax years of your construction business. If the amount is $10 million or less, you are a small contractor. If it is more than $10 million, you are a large contractor and do not have to consider the second part of this step. Large contractors are required to account for long-term contracts using the percentage-of-completion method (PCM) for their general construction contracts. Under PCM, contract income is reported annually according to the percentage of the contract completed in that year.   For example, if a contract is 50% complete at the end of the taxable year, 50% of the contract income would be included in taxable income.   
If you are a small contractor, the second part of this step requires that you separate your long-term general construction contracts into two categories. The first category is those contracts that are reasonably likely to be completed within two years from the date work begins.
The second category is long-term general construction contracts that you estimate will take two years or more to complete. For these longer-duration contracts, you must use a large contractor method, even though you are a small contractor.
Example: Carl's Construction had average annual gross receipts for the last three tax years of less than $10 million. In 2000, Carl had 20 contracts.
At the time he entered 19 of the contracts, he estimated they could be completed in less than two years from when they are started. He estimated one of the contracts would take three years to complete. Carl will use the large contractor rules for that one contract and the small contractor rules for the other 19 contracts.
Example: Use the same facts as the last example, except assume Carl's Construction had average annual gross receipts of $12 million for the last three tax years. Since his average annual gross receipts for the last three years were over $10 million, Carl is required to use the large contractor rules for all of his contracts. The estimated completion time of the contracts does not matter.

Are You a Small or Large Contractor?

Determine if you are either a small or large contractor by answering the following questions:
Q: Are your annual gross receipts for the last 3 years $10 million or less?
Y: Answer the next question.
N: As a Large Contractor, you must use the Percentage of Completion Method (PCM) for your general construction contracts.
Q: Do you have any general construction contracts that you estimate will take more than 2 years to complete?
Y: Use Percentage of Completion Method (PCM) for your longer-duration general construction contracts.
N: As a Small Contractor, you should use either: Accrual, Exempt Percentage of Completion Method (EPCM), Completed Contract Method (CCM), or Percentage of Completion Method (PCM) for all your general construction contracts.
This table shows the methods that are available to use on your general construction contracts. Most contractors will use the Accrual Method for their overall method of accounting.
 
LONG-TERM CONTRACT METHODS
TYPE OF CONTRACTOR* ACCRUAL EPCM PCM CCM
Small Contractor YES YES YES YES
Large Contractor NO NO YES NO
* The overall method should be accrual.

Types of Costs

Before you can understand how the different accrual methods work, it's important to know about the different types of costs your construction business will have.
The two basic categories of costs your construction business will have are job costs and general and administrative (or G&A) costs.
Job Costs are the expenses related, either directly or indirectly, to the construction job, like construction wages, materials, and allocated indirect costs. G&A Expenses are the day-to-day expenses of running the business, like office expenses and utilities. However, certain administrative costs are sometimes treated like indirect job costs to figure the income earned on a contract.

General and Administrative Expenses

General and administrative (G&A) expenses are indirect costs of operating a construction business that cannot be traced to specific jobs. However, certain administrative costs may be treated like indirect job costs.
For example, the wages paid to the person in the office who keeps track of the costs for each job is a G&A type expense that would be treated as an indirect job cost. On the other hand, selling and advertising costs are G&A expenses that would not be treated like indirect job costs.
Generally, your G&A expenses will be deductible under the accrual rules, as explained later.
 

Job Costs

Job costs are divided into two groups. Direct job costs such as labor, materials, and subcontractor expenses can be traced directly to the construction project. The wage paid to a site manger is an example of a direct labor cost. Similarly, direct materials would include lumber for framing a house or concrete for the foundation of a shopping center.
Direct costs also include amounts paid to subcontractors. Subcontractors work for and are paid by the general contractor on a project. Subcontractors may also provide the raw materials for the job. Labor and materials provided by a subcontractor are generally treated as direct costs.
Indirect job costs are all the costs necessary for the performance of the contract other than direct materials, direct labor, and subcontractors. The expenses included in indirect job costs differ depending on whether you are a small or large contractor.

Allocating Indirect Costs

You have learned that indirect job costs benefit the project but are not tied as clearly to it as direct costs are. Indirect job costs often involve expenses that benefit more than one job and must be allocated among all the jobs that received benefit.
Example: Norm started three different jobs in 2000. None of the jobs were completed by the end of 2000. He spent 6 months on the first job, 4 months on the second job, and 2 months on the third job.
He had $12,000 of indirect costs to be allocated to the three jobs. Norm would allocate the indirect costs as:
First Job
6 mo. X $12,000 = $6,000 Allocated Indirect Costs
12 mo.
Second Job
4 mo. X $12,000 = $4,000 Allocated Indirect Costs
12 mo.
Third Job
2 mo. X $12,000 = $2,000 Allocated Indirect Costs
12 mo.
 
Indirect Job Costs for Small Contractors
  • Repair & maintenance expenses for equipment & facilities
  • Utilities
  • Rent of equipment & facilities
  • Quality control
  • Taxes relating to labor, materials, supplies, equipment or facilities
  • Administrative costs
  • Indirect materials and supplies
  • Tools & Equipment
  • Depreciation
  • Insurance on equipment & machinery
  • Indirect labor and contract supervisory wages
  • Production period interest expense

Small Contractor Methods

Accrual Method of Accounting

Income: You include an item in income in the tax year when all events have occurred that fix your right to receive the income and you can determine the amount with reasonable accuracy. Generally, this means you:
Report income:
  • When it's earned, or
  • When it's due from the customer, or
  • When it's received from the customer
  • Whichever is earlier
Income is generally earned when you have finished the work to your customer's satisfaction and due when you bill your customer. This means that sometimes you will include an item in income before you have actually received payment.
You may use this method for your long-term contracts only if your annual gross receipts do not exceed $10 million AND the estimated completion time does not exceed 2 years.
Advance Payments
Generally, advance payments for services are included in income when you receive the payment. You may delay including an advance payment in income until the next tax year for services you will perform in a subsequent year per the provisions of Revenue Procedure 2004-34.
Expenses: G&A expenses and job costs are deducted in the tax year you incur them. An expense is incurred:
the later of:
  • When the merchandise or services are received, or
  • When the amount of the expense can be accurately determined
This means that sometimes you will deduct expenses before you actually pay them. However, if you pay an expense that benefits you for more than one tax year, you must spread the cost over the period you receive the benefit. You also cannot take an immediate deduction for any capital expenditures.  Examples of capital expenditures are buildings, machinery, equipment, furniture and fixtures, and similar property having a useful life substantially beyond the taxable year.   Generally, capital expenditures must be deducted by means of depreciation or amortization.  For more information on depreciation, please see How to Depreciate Property.
Accrual Example: Cooper's Construction agreed to remodel Steve's office. Cooper uses the accrual method and estimates the job will take about 6 weeks.
He finished the job on December 8 of Year 1 and sent Steve a bill on December 15 for $8,000. Steve paid it in full on January 22 of Year 2.
On December 1 of Year 1, Cooper received a $4,500 invoice from the lumberyard for the materials used on the job. He paid it on January 5 of Year 2. Cooper also had $2,000 of G&A costs for Year 1.
On the accrual method of accounting, Cooper will report the $8,000 income from this contract in Year 1 because the income had been earned when the job was completed. He will deduct the $4,500 of job costs and the $2,000 of G&A costs in Year 1 because the expenses had been incurred in that year.
The one variation on the accrual method is an election to exclude retainages from income until you have an unconditional right to receive them. If you make this election, you also have to wait to deduct retainages payable until they are paid.
You cannot elect to exclude retainages if you use the PCM or CCM methods.
For the cash or accrual method of accounting, it isn't necessary to trace job costs to a particular job. However, many businesses keep track of which costs relate to which job to have more accurate data on the profitability of their jobs and to improve their bidding process. If you use the Percentage of Completion or Completed Contract Method, it is very important to keep each job's costs separate.
There are some advantages to using the Accrual Method:
  • It provides better matching of income and expenses  
  • It gives a more accurate picture of your financial position than the cash method
If you have jobs that extend over the year-end, you may want to choose the Percentage of Completion or Completed Contract Method. They may be more advantageous to you than the accrual method.

Exempt Percentage of Completion Method - General Rule

The Exempt Percentage of Completion Method (EPCM) is a method that only affects how your income is computed and reported on your tax return. When you use this method, all G&A and job costs are deducted using the accrual method.
With this method, you report income from long-term contracts as work progresses. A long-term contract is any contract that spans a year-end. If you have a contract that you start on December 26th but do not complete until January 23rd, you have a long-term contract. You will report some income in each year of a long-term contract.
There are several advantages to using  EPCM:
  • It is the most accurate way to measure income
  • It evens out the reporting of income over the life of the contract
  • Losses may be recognized based on the percentage of the contract completed
  • It is the method preferred by most banks and bonding companies
The main disadvantage is its complexity and the fact that it accelerates income compared to other methods.
To determine your current year's gross receipts from a long-term contract, you multiply its "completion factor" (i.e., percentage of completion) by its "total contract price" and then subtract the amount of gross receipts you previously reported for this contract. You compute your gross receipts in this way even if you bill the customer for a different amount.
There are two ways to compute your income under EPCM, either the cost comparison method or the work comparison method. Both of these methods are explained in detail below.

EPCM Cost Comparison Method

You compute your income under this method by dividing the deductible job costs for the year by the estimated total job costs. This percentage is multiplied by the contract price to figure out how much income to report in each year. The contract price has to include all retainages receivable, any change orders agreed upon at the time of the computation, and any reimbursements for costs incurred by the contractor.
The income to be reported on the tax return is computed this way even if the customer is billed a different amount.
Notice that even though G&A and Job Costs are deducted under the accrual method, Job Costs are used in the computation of income under the EPCM Cost Comparison Method.
EPCM Cost Comparison Method Example: Calvin's Construction contracted with Tom and Allison to build a warehouse for their business. Calvin estimated the construction would take about 9 months, starting on October 1, 2000. This was Calvin's only contract for the year and he uses Old PCM and a cost comparison method.
The total contract price was $300,000 and estimated total costs for the contract were $250,000. By December 31, 2000, Calvin had billed Tom and Allison $100,000 and spent $75,000 in deductible job costs. Calvin's G&A expenses for the year were $10,000. He computes income like this:
The job costs deductible in 2000 divided by the total estimated costs for the contract equals the percentage of the contract that is completed in 2000. Multiply that percentage by the contract price to get the amount of income to report in 2000.
Costs deductible in 2000 $75,000 = 30% Completed
Total estimated costs $250,000
$300,000
Contract Price
X 30%
Percentage of Completion for 2000
$ 90,000
Income to be reported in 2000
Calvin's net income for the year is:
$ 90,000
Contract Income
(75,000)
Job Costs
(10,000)
G&A Costs
$ 5,000
Net Income
 

EPCM Work Comparison Method

You compute a contract's completion factor by comparing the work performed to date to estimated work to be performed. For each year of the contract, the completion factor must be certified by an architect or engineer or otherwise supported by appropriate documentation.
EPCM Work Comparison Method Example:
Charlie contracted with Murphy to build a building. Charlie estimated the construction would take about 18 months, starting on July 1 of Year 1. Charlie uses Old PCM and the work comparison method.
The contract price was $1,500,000. By December 31 of Year 1, Charlie had finished one-third of the work on the building (certified by the architect) and he had billed Murphy $550,000 and incurred $410,000 in job costs on the first restaurant. His G&A costs for Year 1 were $20,000. He computes his Year 2 net income like this:
Work Performed to Date = 33.33% Completed
Estimated Work to be Performed
Contract Price  
$1,500,000
Completed  
X 33.33%
Income to be Reported in Year 1  
$ 500,000
Job Costs  
( 410,000)
G&A Costs  
( 20,000)
Year 1 Net Income  
$ 70,000
By December 31 of Year 2, Charlie had finished the other two restaurants. In Year 2, he billed Murphy $950,000 and incurred $840,000 in job costs. His G&A costs were $30,000. He computes his Year 2 net income like this:
Work Performed to Date = 100% Completed
Estimated Work to be Performed
Contract Price
$1,500,000
Completed
X 100 %
Total Income
$1,500,000
Income Reported in Year 1
( 500,000)
Income to be Reported in Year 2
$1,000,000
Job Costs
( 840,000)
G&A Costs
( 30,000)
Year 2 Net Income
$ 130,000
The computation for the entire contract is:
 
Year 1
Year 2
Total
Income
$500,000
$1,000,000
$1,500,000
Job Costs
(410,000)
(840,000)
(1,250,000)
Contract Profit
$90,000
$160,000
$250,000
G&A Costs
(20,000)
(30,000)
(50,000)
Net Income
$70,000
$130,000
$200,000
Notice that the income to be reported on the tax return is different than the amount billed to the customer in each year of the contract.

Completed Contract Method

With this method, you report all the income from the contract and deduct all the related job costs in the year the project is considered complete.
The number of indirect costs that you must characterize as job costs will vary depending on your size. In general, a large homebuilder has to capitalize a greater number of indirect costs than a small homebuilder or small general contractor. You should consult your tax advisor regarding types of indirect costs that you must capitalize.
G&A expenses, net of any amounts included in job costs, should be deducted as explained in the Accrual Method.
Completed Contract Method Example:
Craig uses CCM. In June of Year 1, he contracted with Murphy to build a restaurant for $500,000. The estimated total costs for the contract were $400,000. On March 31 of Year 2, the contract was completed and Murphy accepted the building.
As of December 31 of Year 1, Craig had $370,000 of job costs tied to the contract. From January 1 to March 31 of Year 2, he incurred another $30,000 of job costs on the restaurant.
Craig's income and job costs from other contracts in Year 1 and Year 2 were:
 
Year 1
Year 2
Income
$750,000
$300,000
Job Costs
(525,000)
(225,000)
G&A Costs
(75,000)
(85,000)
Net Income (Loss)
$150,000
($10,000)
Under CCM, Craig must capitalize all the job costs related to the restaurant contract and wait to deduct them until the job is completed and the income is reported in Year 2. In Year 1 and Year 2 Craig will report:
 
Year 1
Year 2
Gross Income
$750,000
$800,000
Job Costs
(525,000)
(625,000)
G&A Expenses
(75,000)
(85,000)
Net Income
$150,000
$90,000
The advantage of the completed contract method is that it normally achieves the maximum deferral of taxes.
The disadvantages of the completed contract method are:
  • The books and records do not show clear information on operations
  • Income can be bunched into a year when a lot of jobs are completed, and
  • Losses on contracts are not deductible until the contracts are completed
It is important to note that the Completed Contract Method may only be used by small contractors and any home construction contracts.
 
Many taxpayers will choose to use PCM as their long-term contract method for their books (so they can give their banks and bonding companies the type of financial statements they prefer) and CCM for their tax returns (so they can have the maximum deferral of taxes).
How Do You Account for Home Construction Contracts?  Read the section.


From: Diya Jain <diyarakeshjain@yahoo.com>
To: aaykarbhavan@yahoogroups.com
Sent: Saturday, 31 August 2013 7:31 AM
Subject: [aaykarbhavan] Query on Builder / Developer

 

I would like to know :-
(Case of Builder / Developer)

How to determine Sales / Closing Stock / WIP / Purchases / Advances recd but Agreement for sale not entered) / Profit

And What would be the best method of accounting on Receipt or % completion method.


Kindly suggest as soon as possible since the method would determine i'm under tax audit or not

Thanks in Advance




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