What is the treatment of tax audit fee profit prior to incorporation?
Answers
Sometimes, a company is formed for purchasing certain running or going concern. A company comes into existence only after its registration i.e., its incorporation. A company can earn profits only after its incorporation, but not before its incorporation. In many cases, th6 date of acquisition of business may not coincide with the date of the incorporation.
For instance, a company incorporated on 1st May 2004 may purchase a business from 1st January 2004, the date on which the financial year starts. Generally the business of going concern is purchased on the basis of last Balance Sheet.
It will be more convenient to both—the vendor and the vendee. In case if the business is purchased on a date other than the date of Balance Sheet, accounts of stocks, assets, liabilities etc. have to be taken and verified. The processes are tedious jobs. To avoid such a tedious job, the business may be acquired from the date the firm prepared its last final accounts.
A private company can commence business soon after its incorporation, while a public company can commence business only after obtaining the certificate of commencement of business. That is, any profit made, in case of private company, before incorporation and in case of public company any profit made before the commencement of business, should be taken as a capital profit. However, it should be noted carefully that it is the date of incorporation and not the date of commencement of business which is taken into consideration for calculating profit or loss prior to incorporation.
For instance, a company incorporated on 1.4.2004 agrees to take over a running business from 1.1.2004. It closes its accounts on 31st December. The company is entitled to not only the profit or loss from 1.1.2004 to 31.3.2004 but also the profit or loss from 1.4.2004 to 31.12.2004. The profit earned prior to incorporation i.e., 1.1.2004 to 31.3.2004 is known as PRE-INCORPORATION PROFIT, which cannot be taken as revenue profit, but is CAPITAL PROFIT.
Such profit is to be transferred to CAPITAL RESERVE or may be used in writing down capital loss. When, there arises a loss in the pre-incorporation period, the loss should be debited to GOODWILL ACCOUNT. The profit earned during post period i.e., in the above example, from 1.4.2004 to 31.12.2004, is revenue profit and is available for dividend.